(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated
Financial Statements
1. Summary of Significant Accounting Policies
a.
Principles of Consolidation
The consolidated financial statements include State Auto Financial Corporation (State
Auto Financial) and its wholly-owned subsidiaries:
|
|
|
State Auto Property and Casualty Insurance Company (State Auto P&C), an Iowa corporation
|
|
|
|
Milbank Insurance Company (Milbank), a South Dakota corporation
|
|
|
|
Farmers Casualty Insurance Company (Farmers), an Iowa corporation
|
|
|
|
State Auto Insurance Company of Ohio (SA Ohio), an Ohio corporation
|
|
|
|
State Auto National Insurance Company (SA National), an Ohio corporation
|
|
|
|
Stateco Financial Services, Inc. (Stateco), an Ohio corporation
|
|
|
|
Strategic Insurance Software, Inc. (S.I.S.), an Ohio corporation
|
The financial statements include the operations and financial position of 518 Property Management and Leasing, LLC (518 PML),
whose members are State Auto P&C and Stateco.
State Auto Financial, an Ohio corporation, is a majority-owned
subsidiary of State Automobile Mutual Insurance Company (State Auto Mutual), an Ohio corporation. State Auto Financial and subsidiaries are referred to herein as the Companies or the Company. All significant
intercompany balances and transactions have been eliminated in consolidation.
b. Description of Business
The Company, through State Auto P&C, Milbank, Farmers and SA Ohio, provides standard personal and business insurance to its
policyholders. The Companys principal lines of insurance include personal and commercial automobile, homeowners, commercial multi-peril, workers compensation, general liability and fire insurance. SA National provides nonstandard
automobile insurance. State Auto P&C, Milbank, Farmers, SA Ohio and SA National operate primarily in the central and eastern United States, excluding New York, New Jersey and the New England states, through an independent insurance agency
system. State Auto P&C, Milbank, Farmers, SA Ohio and SA National are chartered and licensed property and casualty insurers. As such, they are subject to the regulations of the applicable Departments of Insurance of their respective states of
domicile (the Departments) and the regulations of each state in which they operate. These property and casualty insurance companies undergo periodic financial examination by the Departments and insurance regulatory agencies of the states
that choose to participate. A large portion of the Companys revenues are derived from a reinsurance pooling agreement with State Auto Mutual and its affiliates. The nature of the underlying policies and geographical distribution of State Auto
Mutuals and its affiliates underwriting activity is similar to the Company.
Through State Auto P&C, the
Company provides management and operation services under management agreements for all insurance and non-insurance affiliates.
Through Stateco, the Company provides investment management services to affiliated companies.
The Company,
through S.I.S., develops and sells software for the processing of insurance transactions, database management for insurance agents and electronic interfacing of information between insurance
83
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
companies and agencies. S.I.S. sells services and products to insurance agencies and nonaffiliated insurers and their agencies. S.I.S. also delivers services
and sells products to affiliated entities.
518 PML, an Ohio limited liability company, was formed to engage in the
business of owning and leasing property to the Companys affiliates.
c. Basis of Presentation
The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States,
which vary in certain respects from statutory accounting principles followed by State Auto P&C, Milbank, Farmers, SA Ohio and SA National that are prescribed or permitted by the Departments.
In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported
amounts of assets and liabilities as of the date of the balance sheet, revenues and expenses for the periods then ended, and the accompanying notes to the financial statements. Such estimates and assumptions could change in the future as more
information becomes known which could impact the amounts reported and disclosed herein.
Material estimates that are
particularly susceptible to significant change in the near term relate to the determination of losses and loss expenses payable. In connection with the determination of this estimate, management uses historical data, current business conditions and
assumptions about future conditions to formulate estimates of the ultimate cost to settle claims. These estimates by their nature are subject to uncertainties for various reasons. The Companys results of operations and financial condition
could be materially impacted in future periods should the ultimate payments required to settle claims vary from the amount of the liability currently provided.
Certain reclassifications have been made to the 2006 and 2005 financial statements to conform to the 2007 presentation. This includes reclassifications in the consolidated balance sheet that
consist of separately presenting certain other invested assets that are included in the Companys available-for-sale portfolio from all other invested assets as well as aggregating the Companys benefit plans where permitted, namely
postretirement and pension liability or asset presentation. Consistent with balance sheet reclassifications, 2006 and 2005 line items in the consolidated statement of cash flows have been combined to conform with balance sheet presentation,
specifically postretirement and pension benefits (assets).
d. Investments
Investments in fixed maturities, equity securities and certain other invested assets are classified as available-for-sale and, therefore,
are carried at fair value. The unrealized holding gains or losses, net of applicable deferred taxes, are shown as a separate component of stockholders equity as a part of accumulated other comprehensive (loss) income 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 regularly monitors its investments that have fair values less than cost or amortized cost for signs of other-than-temporary impairment. Among the factors that management considers are
market conditions, the amount, timing and length of decline in fair value, events impacting the issuer and the Companys positive intent and ability to hold the security until anticipated recovery or maturity. For declines in value that are not
84
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
solely attributable to interest rate movements, the Company considers positive evidence indicating that the cost of the investment is recoverable within a
reasonable period of time and evidence to the contrary in considering the severity and duration of the impairment in relation to the anticipated market price recovery. When a decline in fair value is deemed to be other-than-temporary, the investment
cost is written down to fair value on the date the determination is made and a realized loss is recorded. The cost is not adjusted for any subsequent recovery in fair value.
e. Cash Equivalents
The Company considers all highly liquid debt instruments with a maturity of three months or less to be cash equivalents.
f.
Deferred Policy Acquisition Costs
Acquisition costs, consisting of commissions, premium taxes and certain underwriting
expenses that relate to and vary with the production of new and renewal property and casualty business, are deferred and amortized ratably over the contract period. The method followed in computing deferred policy acquisition costs limits the amount
of such deferred costs to their estimated realizable value. In determining estimated realizable value, the computation gives effect to the premium to be earned, losses and loss expenses to be incurred, and certain other costs expected to be incurred
as premium is earned. These amounts are based on estimates and accordingly, the actual realizable value may vary from the estimated realizable value. Net deferred policy acquisition costs for the years ended December 31 are:
|
|
|
|
|
|
|
|
|
|
|
($ millions)
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Balance, beginning of year
|
|
$
|
104.0
|
|
|
106.0
|
|
|
97.5
|
|
Effect of January 1, 2005 pooling change (Note 6)
|
|
|
|
|
|
|
|
|
5.3
|
|
Acquisition costs deferred
|
|
|
244.5
|
|
|
246.1
|
|
|
255.0
|
|
Amortized to expense
|
|
|
(242.7
|
)
|
|
(248.1
|
)
|
|
(251.8
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Balance, end of year
|
|
$
|
105.8
|
|
|
104.0
|
|
|
106.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
g. Federal Income Taxes
The Company files a consolidated federal income tax return, and pursuant to a written tax sharing agreement, each entity within the
consolidated group pays its share of federal income taxes based on separate return calculations.
Income taxes are
accounted for using the liability method. Using this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates and
laws that will be in effect when the differences are expected to reverse.
Interest and penalties related to unrecognized
tax obligations are recorded in the balance sheet as other liabilities, and recognized in the income statement as other expenses.
85
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
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 $29.3 million and $29.0 million at December 31, 2007 and 2006,
respectively, has been established to cover the estimated ultimate cost to settle insured losses. The amounts are necessarily based on estimates of future rates of inflation and other factors, and accordingly, there can be no assurance that the
ultimate liability will not vary 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 managements best estimate of the ultimate liability related to reported and unreported claims.
i. Premiums
Premiums
are recognized as earned in proportion to the insurance protection provided using the monthly pro rata method over the contract period. Unearned premiums represent the portion of premiums written relative to the unexpired terms of coverage.
j. Comprehensive Income (Loss)
Comprehensive income (loss) is defined as all changes in an enterprises equity during a period other than those resulting from investments by owners and distributions to owners. Comprehensive income (loss)
includes net income and other comprehensive income (loss). Other comprehensive income (loss) includes all other non-owner related changes to equity and includes net unrealized gains and losses on available-for-sale investments, derivative
instruments and unrecognized benefit plan obligations, adjusted for deferred federal income taxes.
k. Share-Based Compensation
See Note 12Share-Based Compensation regarding the Companys adoption of SFAS 123(R) Share-Based
Payment (SFAS 123(R)) on January 1, 2006. The Companys share-based compensation plans authorize the granting of various equity-based incentives including stock options, restricted stock and restricted share units to employees and
non-employee directors and agents. The expense for these equity-based incentives is based on their fair value at date of grant and amortized over their vesting period. The fair value of each stock option is estimated on the date of grant using the
Black-Scholes closed-form pricing model. The pricing model requires assumptions such as the expected life of the option and expected volatility of the Companys 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.
86
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
Prior to January 1, 2006, the Company accounted for share-based compensation
plans for employees and non-employee directors under the measurement and recognition provisions of Accounting Principles Board Opinion 25, Accounting for Stock Issued to Employees (APB 25) and related Interpretations, as
permitted by Statement of Financial Accounting Standards 123, Accounting for Stock-Based Compensation (SFAS 123). Had compensation cost of the employee and non-employee directors plans for 2005 been determined based on
the fair values at the grant dates consistent with the method of SFAS 123, the Companys pro-forma net earnings and net earnings per share information would have been as follows:
Pro-forma Fair Value Method:
|
|
|
|
|
($ millions, except per share amounts)
|
|
2005
|
|
Net income as reported
|
|
$
|
125.9
|
|
Less pro-forma stock compensation expense, net of tax
|
|
|
(3.5
|
)
|
|
|
|
|
|
Pro-forma net income
|
|
$
|
122.4
|
|
|
|
|
|
|
Pro-forma net earnings per common share
|
|
|
|
|
Basic
|
|
$
|
3.04
|
|
|
|
|
|
|
Diluted
|
|
$
|
2.92
|
|
|
|
|
|
|
|
|
|
|
|
The fair value of stock option awards granted to employees and directors in 2005
were estimated at the date of grant using the Black-Scholes option-pricing model. The weighted average fair values and related assumptions for options granted were as follows:
|
|
|
|
|
|
|
2005
|
|
Fair value
|
|
$
|
10.38
|
|
Expected dividend yield
|
|
|
0.77
|
%
|
Risk free interest rate
|
|
|
3.8
|
%
|
Expected volatility factor
|
|
|
35.8
|
%
|
Expected life in years
|
|
|
6.7
|
|
|
|
|
|
|
l. New Accounting Standards
Adoption of Recent Accounting Pronouncements
In September 2006, the Financial
Accounting Standards Board (FASB) issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R) (SFAS
158) that requires employers with defined benefit pension and postretirement benefit plans other than pensions (collectively benefit plans) to recognize the funded status of their benefit plans in their balance sheet, measure the
fair value of plan assets and benefit obligations as of the date of the fiscal year-end balance sheet date thereby eliminating the use of an earlier measurement date and provide additional disclosures. The new measurement date requirement is not
effective until fiscal years ending after December 15, 2008. On December 31, 2006, the Company adopted the recognition and disclosure provisions of SFAS 158, which had no effect on the Companys consolidated statement of income for
year ended December 31, 2006, or for any prior period presented in the 2006 Form 10-K, and it will not affect the Companys operating results in future periods. Adopting SFAS 158 required the Company to recognize the
87
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
funded status (i.e. the difference between the fair value of plan assets and the benefit obligations) of its benefit plans in the December 31, 2006
balance sheet, with a corresponding adjustment to other comprehensive loss, net of tax of $63.9 million. The adoption did not have an impact on the Companys debt covenants. At December 31, 2007 and 2006, the Company continued to use the
earlier measurement date of September 30, and is currently reviewing the transition alternatives available and the related impact.
In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxesan interpretation of FASB Statement No. 109 (FIN 48), which was effective for
fiscal years beginning after December 15, 2006. FIN 48 clarified the accounting for income taxes by prescribing the minimum recognition threshold a tax position is required to meet before being recognized in the financial statements. FIN 48
also provides guidance on derecognition, measurement, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company adopted the provisions of FIN 48, on January 1, 2007. As a result of the
implementation of FIN 48, the Company recognized no increase in the liability for unrecognized tax benefits. See Note 8 for additional required disclosures.
In February 2006, the FASB issued SFAS 155, Accounting for Certain Hybrid Financial Instrumentsan amendment of FASB Statements No. 133 and 140 (SFAS 155), which
was effective for all financial instruments acquired or issued after the beginning of an entitys fiscal year after September 15, 2006. SFAS 155 permits fair value re-measurement for any hybrid financial instruments that contain an
embedded derivative that would otherwise require bifurcation, clarifies which interest-only strips and principal-only strips are not subject to the requirements of Statement 133, establishes a requirement to evaluate interests in securitized
financial assets in order to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of
subordination are not embedded derivatives, and amends Statement 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another
derivative financial instrument. The Company adopted this guidance effective January 1, 2007 and there was no impact on the Companys financial statements.
In September 2005, the Accounting Standards Executive Committee issued Statement of Position 05-1, Accounting by Insurance Enterprises for Deferred Acquisition Costs in Connection With
Modifications or Exchanges of Insurance Contracts (SOP 05-1), which was effective for fiscal years beginning after December 15, 2006. SOP 05-1 provides guidance on accounting for deferred acquisition costs associated with
modifications to or the internal replacement of insurance contracts. SOP 05-1 focuses on modifications to contracts with integrated product features and internal replacement of contracts in which the new contract offers product features not included
in the old contract when both were priced together. The Companys insurance contracts include only nonintegrated contract features as defined in SOP 05-1, which are contract features that provide coverage that is underwritten and priced only
for that incremental insurance coverage and that do not result in re-underwriting or re-pricing of other components of the contract. Nonintegrated contract features do not change the existing base contract and do not require further evaluation under
SOP 05-1. The Company adopted this guidance effective January 1, 2007 and there was no impact on the Companys financial statements.
Pending
Adoption of Accounting Pronouncements
In September 2006, the FASB issued SFAS 157, Fair Value Measurements
(SFAS 157), which is effective for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. SFAS 157 establishes a single authoritative definition of fair value, sets out a framework for
measuring fair value, and requires additional disclosures about fair-value measurements. The statement imposes no new requirements for additional fair-value measures in financial statements. The Company adopted this guidance effective
January 1, 2008.
88
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for
Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 expands the standards under SFAS 157 to provide entities with a one-time election to measure existing financial instruments and certain other items at fair value at
the date of adoption. SFAS 159 also amends SFAS No. 115 Accounting for Certain Investments in Debt and Equity Securities to require a specific presentation of investments categorized as available-for-sale. This statement is
effective for the first fiscal year that begins after November 15, 2007. The Company adopted this guidance on January 1, 2008 and did not elect the fair value option for any of its eligible assets or liabilities as of this date.
In June 2007, the FASB issued EITF 06-11, Accounting for Income Tax Benefits of Dividends on Share-Based Payment
Awards (EITF 06-11). EITF 06-11 addresses how a company should recognize the income tax benefit received on dividends that are (a) paid to employees holding equity-classified non-vested shares, equity-classified non-vested
share units, or equity-classified outstanding share options, and (b) charged to retained earnings under FAS 123(R). The tax benefit received on dividends paid to employees associated with their share-based awards should be recorded in
additional paid-in capital until the award is settled through exercise (if the award is an option) or vesting (if the award is non-vested stock). This will be effective for tax benefits of dividends declared in fiscal years beginning after
December 15, 2007. The Company adopted this guidance effective January 1, 2008 and it had no material impact on the Companys financial statements.
2. Investments
The following tables summarize the cost or amortized cost of
available-for-sale securities at December 2007 and 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ millions)
|
|
Cost or
amortized
cost
|
|
Gross
unrealized
holding
gains
|
|
Gross
unrealized
holding
losses
|
|
|
Fair
value
|
Available-for-sale at December 31, 2007:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. treasury securities and obligations of U.S. government agencies
|
|
$
|
90.9
|
|
$
|
2.2
|
|
$
|
(0.1
|
)
|
|
$
|
93.0
|
Obligations of states and political subdivisions
|
|
|
1,432.7
|
|
|
23.6
|
|
|
(4.3
|
)
|
|
|
1,452.0
|
Corporate securities
|
|
|
10.7
|
|
|
0.3
|
|
|
|
|
|
|
11.0
|
U.S. government agencies mortgage-backed securities
|
|
|
188.6
|
|
|
2.6
|
|
|
(1.8
|
)
|
|
|
189.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities
|
|
|
1,722.9
|
|
|
28.7
|
|
|
(6.2
|
)
|
|
|
1,745.4
|
Equity securities
|
|
|
210.2
|
|
|
47.4
|
|
|
(3.4
|
)
|
|
|
254.2
|
Other invested assets
|
|
|
20.1
|
|
|
0.3
|
|
|
(0.1
|
)
|
|
|
20.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,953.2
|
|
$
|
76.4
|
|
$
|
(9.7
|
)
|
|
$
|
2,019.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
89
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ millions)
|
|
Cost or
amortized
cost
|
|
Gross
unrealized
holding
gains
|
|
Gross
unrealized
holding
losses
|
|
|
Fair
value
|
Available-for-sale at December 31, 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. treasury securities and obligations of U.S. government agencies
|
|
$
|
180.1
|
|
$
|
0.6
|
|
$
|
(2.8
|
)
|
|
$
|
177.9
|
Obligations of states and political subdivisions
|
|
|
1,229.8
|
|
|
23.7
|
|
|
(2.5
|
)
|
|
|
1,251.0
|
Corporate securities
|
|
|
15.8
|
|
|
0.4
|
|
|
(0.1
|
)
|
|
|
16.1
|
U.S. government agencies mortgage-backed securities
|
|
|
204.9
|
|
|
1.7
|
|
|
(4.2
|
)
|
|
|
202.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities
|
|
|
1,630.6
|
|
|
26.4
|
|
|
(9.6
|
)
|
|
|
1,647.4
|
Equity securities
|
|
|
230.8
|
|
|
54.6
|
|
|
(1.2
|
)
|
|
|
284.2
|
Other invested assets
|
|
|
4.0
|
|
|
0.5
|
|
|
|
|
|
|
4.5
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,865.4
|
|
$
|
81.5
|
|
$
|
(10.8
|
)
|
|
$
|
1,936.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Deferred federal income taxes on the net unrealized holding gains for
available-for-sale investments were $23.3 million and $24.7 million at December 31, 2007 and 2006, respectively.
At
December 31, 2007 and 2006, there were no individual investments reflected in the tables below with an unrealized holding loss that had a fair value significantly below cost continually for more than one year. There are no individual material
securities with an unrealized holding loss at December 31, 2007 and 2006. The following tables reflect the Companys gross unrealized losses and fair value on its investments, aggregated by investment category and length of time for
individual securities that have been in a continuous unrealized loss position, at December 31, 2007 and 2006:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2007
|
|
Less than 12 months
|
|
12 months or more
|
|
Total
|
Description of
Securities
|
|
Fair
Value
|
|
Unrealized
Losses
|
|
|
Number
of
Positions
|
|
Fair
Value
|
|
Unrealized
Losses
|
|
|
Number
of
Positions
|
|
Fair
Value
|
|
Unrealized
Losses
|
|
|
Number
of
Positions
|
($ millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. treasury securities and obligations of U.S. government agencies
|
|
$
|
5.4
|
|
$
|
|
|
|
2
|
|
$
|
6.5
|
|
$
|
(0.1
|
)
|
|
4
|
|
$
|
11.9
|
|
$
|
(0.1
|
)
|
|
6
|
Obligations of states and political subdivisions
|
|
|
204.1
|
|
|
(1.8
|
)
|
|
75
|
|
|
283.2
|
|
|
(2.5
|
)
|
|
106
|
|
|
487.3
|
|
|
(4.3
|
)
|
|
181
|
Corporate securities
|
|
|
|
|
|
|
|
|
|
|
|
1.0
|
|
|
|
|
|
1
|
|
|
1.0
|
|
|
|
|
|
1
|
U.S. government agencies mortgage backed securities
|
|
|
2.8
|
|
|
(0.1
|
)
|
|
2
|
|
|
101.2
|
|
|
(1.7
|
)
|
|
46
|
|
|
104.0
|
|
|
(1.8
|
)
|
|
48
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities
|
|
|
212.3
|
|
|
(1.9
|
)
|
|
79
|
|
|
391.9
|
|
|
(4.3
|
)
|
|
157
|
|
|
604.2
|
|
|
(6.2
|
)
|
|
236
|
Equity securities
|
|
|
36.6
|
|
|
(3.4
|
)
|
|
16
|
|
|
|
|
|
|
|
|
|
|
|
36.6
|
|
|
(3.4
|
)
|
|
16
|
Other invested assets
|
|
|
15.9
|
|
|
(0.1
|
)
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
15.9
|
|
|
(0.1
|
)
|
|
2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total temporarily impaired securities
|
|
$
|
264.8
|
|
$
|
(5.4
|
)
|
|
97
|
|
$
|
391.9
|
|
$
|
(4.3
|
)
|
|
157
|
|
$
|
656.7
|
|
$
|
(9.7
|
)
|
|
254
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
90
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
At December 31, 2006
|
|
Less than 12 months
|
|
12 months or more
|
|
Total
|
Description of
Securities
|
|
Fair
Value
|
|
Unrealized
Losses
|
|
|
Number
of
Positions
|
|
Fair
Value
|
|
Unrealized
Losses
|
|
|
Number
of
Positions
|
|
Fair
Value
|
|
Unrealized
Losses
|
|
|
Number
of
Positions
|
($ millions)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
U.S. treasury securities and obligations of U.S. government agencies
|
|
$
|
11.9
|
|
$
|
(0.1
|
)
|
|
7
|
|
$
|
111.3
|
|
$
|
(2.7
|
)
|
|
51
|
|
$
|
123.2
|
|
$
|
(2.8
|
)
|
|
58
|
Obligations of states and political subdivisions
|
|
|
90.0
|
|
|
(0.6
|
)
|
|
35
|
|
|
232.8
|
|
|
(1.9
|
)
|
|
89
|
|
|
322.8
|
|
|
(2.5
|
)
|
|
124
|
Corporate securities
|
|
|
|
|
|
|
|
|
|
|
|
3.0
|
|
|
(0.1
|
)
|
|
2
|
|
|
3.0
|
|
|
(0.1
|
)
|
|
2
|
U.S. government agencies mortgage backed securities
|
|
|
17.2
|
|
|
(0.4
|
)
|
|
8
|
|
|
135.2
|
|
|
(3.8
|
)
|
|
51
|
|
|
152.4
|
|
|
(4.2
|
)
|
|
59
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total fixed maturities
|
|
|
119.1
|
|
|
(1.1
|
)
|
|
50
|
|
|
482.3
|
|
|
(8.5
|
)
|
|
193
|
|
|
601.4
|
|
|
(9.6
|
)
|
|
243
|
Equity securities
|
|
|
21.6
|
|
|
(1.2
|
)
|
|
9
|
|
|
|
|
|
|
|
|
|
|
|
21.6
|
|
|
(1.2
|
)
|
|
9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total temporarily impaired securities
|
|
$
|
140.7
|
|
$
|
(2.3
|
)
|
|
59
|
|
$
|
482.3
|
|
$
|
(8.5
|
)
|
|
193
|
|
$
|
623.0
|
|
$
|
(10.8
|
)
|
|
252
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The amortized cost and fair value of available-for-sale fixed maturities at
December 31, 2007, by contractual maturity, are summarized as follows:
|
|
|
|
|
|
|
($ millions)
|
|
Amortized
cost
|
|
Fair
value
|
Due in 1 year or less
|
|
$
|
16.9
|
|
$
|
16.9
|
Due after 1 year through 5 years
|
|
|
60.5
|
|
|
62.5
|
Due after 5 years through 10 years
|
|
|
437.5
|
|
|
451.1
|
Due after 10 years
|
|
|
1,019.4
|
|
|
1,025.5
|
U.S. Government agencies mortgage-backed securities
|
|
|
188.6
|
|
|
189.4
|
|
|
|
|
|
|
|
Total
|
|
$
|
1,722.9
|
|
$
|
1,745.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expected maturities may differ from contractual maturities because the issuers may
have the right to call or prepay the obligations with or without call or prepayment penalties.
Fixed maturities with fair
values of approximately $55.1 million and $52.5 million were on deposit with regulators as required by law or specific escrow agreement at December 31, 2007 and 2006, respectively.
91
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
Components of net investment income for the year ended December 31 are
summarized as follows:
|
|
|
|
|
|
|
|
($ millions)
|
|
2007
|
|
2006
|
|
2005
|
Fixed maturities
|
|
$
|
75.3
|
|
73.6
|
|
72.8
|
Equity securities
|
|
|
5.7
|
|
5.1
|
|
4.0
|
Cash and cash equivalents, and other
|
|
|
5.5
|
|
6.1
|
|
3.6
|
|
|
|
|
|
|
|
|
Investment income
|
|
|
86.5
|
|
84.8
|
|
80.4
|
|
|
|
|
Investment expenses
|
|
|
1.8
|
|
1.7
|
|
1.7
|
|
|
|
|
|
|
|
|
Net investment income
|
|
$
|
84.7
|
|
83.1
|
|
78.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Companys current investment strategy does not rely on the use of
derivative financial instruments. See Note 3 for additional fair value disclosures.
The Company recognized realized losses
on other-than-temporary impairments of $0, $3.8 million and $0.6 million on its fixed maturity portfolio in 2007, 2006 and 2005, respectively. The Company recognized realized losses on other-than-temporary impairments of $1.9 million, $1.6 million
and $1.0 million in 2007, 2006 and 2005, respectively on its equity security portfolio. During 2007 the Company outsourced a segment of its investment portfolio to external money managers. When assessing other-than-temporary impairment on this
segment of the investment portfolio, management considers its inability to make the assertion regarding its intent to hold a particular security that is currently valued below cost until recovery in the near term. The Company reviewed its
investments at December 31, 2007, and determined no additional other-than-temporary impairment exists in the gross unrealized holding losses due to the evidence that would indicate only temporary impairment.
Proceeds on sales of available-for-sale securities in 2007, 2006, and 2005 were $262.2 million, $275.2 million and $340.1 million,
respectively.
92
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
Realized and unrealized gains and losses for the years ended December 31 are
summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
($ millions)
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Realized gains:
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities
|
|
$
|
0.8
|
|
|
1.8
|
|
|
5.9
|
|
Equity securities
|
|
|
19.7
|
|
|
15.6
|
|
|
6.7
|
|
|
|
|
|
|
|
|
|
|
|
|
Total realized gains
|
|
|
20.5
|
|
|
17.4
|
|
|
12.6
|
|
Realized losses:
|
|
|
|
|
|
|
|
|
|
|
Fixed maturities
|
|
|
1.3
|
|
|
4.8
|
|
|
1.7
|
|
Equity securities
|
|
|
7.1
|
|
|
7.0
|
|
|
5.3
|
|
|
|
|
|
|
|
|
|
|
|
|
Total realized losses
|
|
|
8.4
|
|
|
11.8
|
|
|
7.0
|
|
|
|
|
|
|
|
|
|
|
|
|
Net realized gains on investments
|
|
$
|
12.1
|
|
|
5.6
|
|
|
5.6
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in unrealized gains (losses):
|
|
|
|
|
|
|
|
|
|
|
Increase (decrease) in unrealized holding gains fixed maturity securities
|
|
$
|
5.7
|
|
|
(3.2
|
)
|
|
(30.2
|
)
|
(Decrease) increase in unrealized holding gains equity securities
|
|
|
(9.4
|
)
|
|
22.6
|
|
|
0.6
|
|
(Decrease) increase in unrealized holding gains other invested assets
|
|
|
(0.3
|
)
|
|
(0.3
|
)
|
|
0.6
|
|
Deferred federal income taxes (benefits) thereon
|
|
|
1.4
|
|
|
(6.7
|
)
|
|
10.3
|
|
|
|
|
|
|
|
|
|
|
|
|
(Decrease) increase in net unrealized holding gains
|
|
$
|
(2.6
|
)
|
|
12.4
|
|
|
(18.7
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
3. Fair Value of Financial Instruments
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
Investment securities:
Fair values for investments in fixed maturities are based on quoted market prices, where
available. For fixed maturities not actively traded, fair values are estimated using values obtained from independent pricing services. The fair values for equity securities are based on quoted market prices.
Cash and cash equivalents:
The carrying amounts reported for these instruments approximate their fair value.
93
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
Notes payable:
The carrying amount of the Trust Preferred note (defined in
Note 6b) in the consolidated balance sheets approximates its fair value as the interest rate adjusts quarterly. The $100.0 million, 6.25% Senior Notes (defined in Note 7) have a fair value of $103.6 million and $99.1 million at December 31,
2007 and 2006, respectively. The fair value of the Senior Notes is based on the quoted market price at December 31, 2007 and 2006, respectively.
|
|
|
|
|
|
|
|
|
|
|
|
|
($ millions)
|
|
December 31, 2007
|
|
December 31, 2006
|
|
|
Carrying
Value
|
|
Fair
Value
|
|
Carrying
Value
|
|
Fair
Value
|
Fixed maturities
|
|
$
|
1,745.4
|
|
$
|
1,745.4
|
|
$
|
1,647.4
|
|
$
|
1,647.4
|
Equity securities
|
|
|
254.2
|
|
|
254.2
|
|
|
284.2
|
|
|
284.2
|
Other invested assets
|
|
|
21.6
|
|
|
21.6
|
|
|
6.3
|
|
|
6.3
|
Cash and cash equivalents
|
|
|
70.9
|
|
|
70.9
|
|
|
73.4
|
|
|
73.4
|
Notes payable
|
|
|
118.0
|
|
|
119.1
|
|
|
118.4
|
|
|
114.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
4. Losses and Loss Expenses Payable
Activity in the liability for losses and loss expenses for the year ended December 31 is summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
($ millions)
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Losses and loss expenses payable, at beginning of year
|
|
$
|
674.5
|
|
|
728.7
|
|
|
681.8
|
|
Less: reinsurance recoverable on losses and loss expenses payable
|
|
|
13.5
|
|
|
17.4
|
|
|
25.9
|
|
|
|
|
|
|
|
|
|
|
|
|
Net balance at beginning of year
|
|
|
661.0
|
|
|
711.3
|
|
|
655.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Incurred related to:
|
|
|
|
|
|
|
|
|
|
|
Current year
|
|
|
645.5
|
|
|
659.3
|
|
|
657.7
|
|
Prior years
|
|
|
(54.7
|
)
|
|
(71.7
|
)
|
|
(44.3
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total incurred
|
|
|
590.8
|
|
|
587.6
|
|
|
613.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Paid related to:
|
|
|
|
|
|
|
|
|
|
|
Current year
|
|
|
368.7
|
|
|
389.4
|
|
|
350.5
|
|
Prior years
|
|
|
236.0
|
|
|
248.5
|
|
|
242.8
|
|
|
|
|
|
|
|
|
|
|
|
|
Total paid
|
|
|
604.7
|
|
|
637.9
|
|
|
593.3
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Impact of pooling change, January 1, 2005 (Note 6a)
|
|
|
|
|
|
|
|
|
35.3
|
|
|
|
|
|
|
|
|
|
|
|
|
Net balance at end of year
|
|
|
647.1
|
|
|
661.0
|
|
|
711.3
|
|
Plus: reinsurance recoverable on losses and loss expenses payable
|
|
|
11.2
|
|
|
13.5
|
|
|
17.4
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses and loss expenses payable, at end of year (affiliate $257.2, $281.7 and $302.6, respectively)
|
|
$
|
658.3
|
|
|
674.5
|
|
|
728.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company recorded favorable loss and loss expense reserve development in 2007,
2006, and 2005 of $54.7 million, $71.7 million and $44.3 million, respectively. The favorable development in 2007 was primarily due to auto liability and other liability losses being approximately $23.5 million less than anticipated as current loss
projections using more mature claim data resulted in lower claim severity than in past projections, loss adjustment expenses being approximately $11.8 million lower than anticipated in proportion to losses and ceded
94
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
losses being above previously anticipated levels by approximately $10.0 million. The favorable development in 2006 was largely due to ceded reserves being
above previously anticipated levels by $23.7 million, auto liability losses being $24.7 million less than anticipated as current loss projections using more mature claim data resulted in lower average claim severities than in past projections, and
loss adjustment expenses declining by $13.5 million in proportion to losses. The favorable development in 2005 was largely due to ceded reserves being above previously anticipated levels by $14.8 million, catastrophe losses associated with the 2004
hurricanes developing $5.8 million better than previous estimates, and loss adjustment expenses developing favorably by $13.7 million in proportion to losses.
5. Reinsurance
In the ordinary course of business, the Company assumes and cedes reinsurance with other
insurers and reinsurers and is a member in various pools and associations. See Note 6a for discussion of reinsurance with affiliates. The voluntary arrangements provide greater diversification of business and limit the maximum net loss potential
arising from large risks and catastrophes. Most of the ceded reinsurance is effected under reinsurance contracts known as treaties; the remainder is by negotiation on individual risks. Although the ceding of reinsurance does not discharge the
original insurer from its primary liability to its policyholder, the insurance company that assumes the coverage assumes the related liability.
Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured business. The recoverability of these assets depends on the reinsurers ability to
perform under the reinsurance agreements. The Company evaluates and monitors the financial condition and concentrations of credit risk associated with its reinsurers under voluntary reinsurance arrangements to minimize its exposure to significant
losses from reinsurer insolvencies. The Company has reported ceded losses and loss expenses payable and prepaid reinsurance premiums with other insurers and reinsurers as assets. All reinsurance contracts provide for indemnification against loss or
liability relating to insurance risk and have been accounted for as reinsurance.
Prior to the reinsurance transaction with
State Auto Mutual under the Pooling Arrangement, as discussed in Note 6a, the effect of the Companys external reinsurance on its balance sheets and income statements is summarized as follows:
|
|
|
|
|
|
|
|
($ millions)
|
|
December 31
|
|
|
|
2007
|
|
|
2006
|
|
Losses and loss expenses payable:
|
|
|
|
|
|
|
|
Direct
|
|
$
|
396.0
|
|
|
387.2
|
|
Assumed
|
|
|
5.1
|
|
|
5.6
|
|
Ceded
|
|
|
(10.1
|
)
|
|
(10.8
|
)
|
|
|
|
|
|
|
|
|
Net losses and loss expenses payable
|
|
$
|
391.0
|
|
|
382.0
|
|
|
|
|
|
|
|
|
|
Unearned premiums:
|
|
|
|
|
|
|
|
Direct
|
|
$
|
315.3
|
|
|
309.2
|
|
Assumed
|
|
|
1.2
|
|
|
1.2
|
|
Ceded
|
|
|
(6.0
|
)
|
|
(6.0
|
)
|
|
|
|
|
|
|
|
|
Net unearned premiums
|
|
$
|
310.5
|
|
|
304.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
95
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
|
|
|
|
|
|
|
|
|
|
|
($ millions)
|
|
Year ended December 31
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Written premiums:
|
|
|
|
|
|
|
|
|
|
|
Direct
|
|
$
|
757.4
|
|
|
748.8
|
|
|
749.5
|
|
Assumed
|
|
|
6.5
|
|
|
7.1
|
|
|
6.0
|
|
Ceded
|
|
|
(18.8
|
)
|
|
(17.7
|
)
|
|
(16.9
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net written premiums
|
|
$
|
745.1
|
|
|
738.2
|
|
|
738.6
|
|
|
|
|
|
|
|
|
|
|
|
|
Earned premiums:
|
|
|
|
|
|
|
|
|
|
|
Direct
|
|
$
|
751.0
|
|
|
743.1
|
|
|
746.9
|
|
Assumed
|
|
|
6.5
|
|
|
7.1
|
|
|
6.1
|
|
Ceded
|
|
|
(18.8
|
)
|
|
(17.6
|
)
|
|
(16.4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net earned premiums
|
|
$
|
738.7
|
|
|
732.6
|
|
|
736.6
|
|
|
|
|
|
|
|
|
|
|
|
|
Losses and loss expenses incurred:
|
|
|
|
|
|
|
|
|
|
|
Direct
|
|
$
|
438.5
|
|
|
415.0
|
|
|
455.7
|
|
Assumed
|
|
|
2.0
|
|
|
10.8
|
|
|
14.6
|
|
Ceded
|
|
|
(2.9
|
)
|
|
(3.5
|
)
|
|
(8.2
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net losses and loss expenses incurred
|
|
$
|
437.6
|
|
|
422.3
|
|
|
462.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
6. Transactions with Affiliates
a. Reinsurance
Prior
to 2005, State Auto P&C, Milbank, Farmers, SA Ohio (the STFC Pooled Companies), State Auto Insurance Company of Wisconsin (SA Wisconsin) and State Auto Florida Insurance Company (SA Florida) participated in a
quota share reinsurance pooling arrangement (the Pooling Arrangement) with State Auto Mutual. Effective January 1, 2005, the Pooling Arrangement was amended to add as participants Meridian Security Insurance Company (Meridian
Security) and Meridian Citizens Mutual Insurance Company (Meridian Citizens), Indiana domiciled property and casualty insurers. Meridian Security is a wholly-owned subsidiary of Meridian Insurance Group, Inc. (MIGI),
which is wholly-owned by State Auto Mutual. MIGI is party to an affiliation agreement with Meridian Citizens. Meridian Security and Meridian Citizens Mutual are hereafter referred to collectively as the MIGI Insurers and together with
MIGI as the MIGI Companies. SA Wisconsin and SA Florida are wholly owned subsidiaries of State Auto Mutual.
In
conjunction with the Pooling Arrangement amendment, the STFC Pooled Companies received $54.0 million in cash from the MIGI Insurers which related to the additional net insurance liabilities assumed on January 1, 2005.
In general, under the Pooling Arrangement, the STFC Pooled Companies, SA Wisconsin, SA Florida and the MIGI Insurers cede to State Auto
Mutual all of their insurance business and assume from State Auto Mutual an amount equal to their respective participation percentages in the Pooling Arrangement. The STFC Pooled Companies pooling participation percentage remained at 80% under
the amended pooling arrangement effective January 1, 2005. All premiums, losses and loss expenses and underwriting expenses are allocated among the participants on the basis of each Companys 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.
96
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
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. The STFC Pooled Companies pooling percentage has remained at an
80% participation level since 2001. All parties that participate in the Pooling Arrangement have an A.M. Best rating of A+ (Superior).
The following provides a summary of the reinsurance transactions on the Companys balance sheets and income statements for the Pooling Arrangement between the STFC Pooled Companies and State Auto Mutual:
|
|
|
|
|
|
|
|
($ millions)
|
|
December 31
|
|
|
|
2007
|
|
|
2006
|
|
Losses and loss expenses payable:
|
|
|
|
|
|
|
|
Ceded
|
|
$
|
(371.6
|
)
|
|
(358.2
|
)
|
Assumed
|
|
|
628.8
|
|
|
639.9
|
|
|
|
|
|
|
|
|
|
Net assumed
|
|
$
|
257.2
|
|
|
281.7
|
|
|
|
|
|
|
|
|
|
Unearned premiums:
|
|
|
|
|
|
|
|
Ceded
|
|
$
|
(298.6
|
)
|
|
(292.3
|
)
|
Assumed
|
|
|
418.1
|
|
|
410.7
|
|
|
|
|
|
|
|
|
|
Net assumed
|
|
$
|
119.5
|
|
|
118.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ millions)
|
|
Year ended December 31
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Written premiums:
|
|
|
|
|
|
|
|
|
|
|
Ceded
|
|
$
|
(702.3
|
)
|
|
(695.7
|
)
|
|
(685.8
|
)
|
Assumed
|
|
|
973.9
|
|
|
974.1
|
|
|
993.9
|
|
Earned premiums:
|
|
|
|
|
|
|
|
|
|
|
Ceded
|
|
$
|
(695.7
|
)
|
|
(687.6
|
)
|
|
(676.8
|
)
|
Assumed
|
|
|
965.5
|
|
|
976.0
|
|
|
994.4
|
|
Losses and loss expenses incurred:
|
|
|
|
|
|
|
|
|
|
|
Ceded
|
|
$
|
(405.6
|
)
|
|
(388.4
|
)
|
|
(423.4
|
)
|
Assumed
|
|
|
558.2
|
|
|
554.4
|
|
|
579.5
|
|
|
|
|
|
|
|
|
|
|
|
|
The STFC Pooled Companies, SA National, State Auto Mutual, SA Wisconsin, SA
Florida and the MIGI Insurers are collectively referred to as the State Auto Group.
State Auto P&C assumes
catastrophe reinsurance from the State Auto Group and Beacon National Insurance Company (Beacon National), a subsidiary of State Auto Mutual, in the amount of $100.0 million excess of $135.0 million in exchange for a premium paid by each
reinsured company. Under this agreement, the Company has assumed from State Auto Mutual and its affiliates premiums written and earned of $3.1 million, $3.0 million and $2.7 million for 2007, 2006 and 2005, respectively. There have been no losses
assumed under this agreement. The catastrophe reinsurance program with State Auto P&C has been excluded from the Pooling Arrangement.
97
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
As of July 1, 2005, SA National and State Auto Mutual terminated a reinsurance
agreement between the parties that included excess of loss and quota share coverages. SA National and State Auto Mutual mutually agreed to terminate the reinsurance agreement because of SA Nationals stronger surplus position, relative to the
commencement date of the agreement, which makes it more efficient for SA National to retain such exposures rather than to reinsure them. Under the terms of the termination, State Auto Mutual will continue to be liable, with respect to policies in
force at the termination date, for occurrences until the expiration, cancellation or next anniversary, not to exceed one year.
The following provides a summary of the ceded reinsurance transactions on the Companys balance sheet and income statement for the reinsurance agreement between SA National and State Auto Mutual:
|
|
|
|
|
|
($ millions)
|
|
2007
|
|
2006
|
Balance sheet:
|
|
|
|
|
|
Losses and loss expenses payable
|
|
$
|
1.1
|
|
2.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ millions)
|
|
2007
|
|
|
2006
|
|
2005
|
Income statement:
|
|
|
|
|
|
|
|
|
Written premiums
|
|
$
|
|
|
|
|
|
3.8
|
Earned premiums
|
|
$
|
|
|
|
0.2
|
|
6.6
|
Losses and loss expenses incurred
|
|
$
|
(0.6
|
)
|
|
0.7
|
|
4.8
|
|
|
|
|
|
|
|
|
|
Intercompany Balances
Pursuant to the Pooling Arrangement, State Auto Mutual receives all premiums and pays all losses and expenses associated with the insurance business produced by the pool participants and then
settles the intercompany balances generated by these transactions with the participating companies on a quarterly basis within 45 days following each quarter end. No interest is paid on this balance. When settling the intercompany balances, State
Auto Mutual provides the pool participants with full credit for the premiums written and net losses paid during the quarter and retains all receivable amounts from insureds and agents and reinsurance recoverable on paid losses from unaffiliated
reinsurers. Any receivable amounts that are ultimately deemed to be uncollectible are charged-off by State Auto Mutual and allocated to the pool member on the basis of pool participation. As a result, the Company has an off-balance sheet
creditrisk 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 Companys share of the premium balances due to State Auto Mutual
from agents and insureds at December 31, 2007 and 2006 is approximately $266.9 million and $250.3 million, respectively.
b. Notes
Payable
In May 2003, State Auto Financial formed a Delaware business trust (the Capital Trust) that issued $15.0
million mandatorily redeemable preferred capital securities to a third party and $0.5 million of its common securities representing all outstanding common securities to State Auto Financial (collectively, the capital and common securities are
referred to as the Trust Securities). The Capital Trust loaned $15.5 million in proceeds from the issuance of its Trust Securities to State Auto Financial in the form of a Floating Rate Junior Subordinated Debt Securities due in 2033
(the Subordinated Debentures). The Subordinated Debentures are the Capital Trusts only assets along with any interest accrued thereon. Interest on the Trust Securities are payable
98
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
quarterly at a rate equal to the three-month LIBOR rate plus 4.20% adjusted quarterly (total 9.32% at December 31, 2007). Prior to May 2008, the
interest rate may not exceed 12.5% per annum. The interest rate and interest payment dates on the Subordinated Debentures are the same as the interest rate and interest payment dates on the Trust Securities, thereby payments from the
Subordinated Debentures finance the distributions paid on the Trust Securities. State Auto Financial has the right to redeem the Subordinated Debentures, in whole or in part, on or after May 23, 2008. In accordance with FASB Interpretation
No. 46(R), (and related amendments and interpretations) Consolidation of Variable Interest Entities, State Auto Financial determined that the business trust is a variable interest entity for which it is not the primary beneficiary
and therefore, does not consolidate the Capital Trust with the Company. State Auto Financial has unconditionally and irrevocably guaranteed payment of any required distributions on the capital securities, the redemption price when the capital
securities are redeemed, and any amounts due if the Capital Trust is liquidated or terminated. State Auto Financials equity interest in the Capital Trust is included in other invested assets.
In December 2005, State Auto Financial repaid a $45.5 million line of credit it had with State Auto Mutual. This repayment was funded
through dividends from State Auto Financials insurance subsidiaries. The interest rate under this line of credit was 3.50% for 2005.
c. Management Services
Stateco provides State Auto Mutual and its affiliates investment management
services. Investment management income is recognized quarterly based on a percentage of the average fair value of investable assets and the equity portfolio performance of each company managed. Revenue related to these services amounted to $2.8
million, $2.5 million and $2.3 million in 2007, 2006 and 2005, respectively, and is included in other income (affiliates).
7. Notes Payable and Credit
Facility
In 2003, State Auto Financial issued $100.0 million of unsecured Senior Notes due November 2013. The Senior
Notes bear interest at a fixed rate of 6.25% per annum, which is payable each May 15 and November 15. The Senior Notes are general unsecured obligations ranking senior to all existing and future subordinated indebtedness and equal
with all existing and future senior indebtedness. The Senior Notes are not guaranteed by any of State Auto Financials subsidiaries and thereby are effectively subordinated to all subsidiaries existing and future indebtedness. As of
December 31, 2007, State Auto Financial was in compliance with all covenants related to the Senior Notes. State Auto Financial incurred $1.5 million in issuance costs related to the Senior Notes, which is recorded in other assets and is being
amortized into interest expense ($0.1 million each for 2007, 2006 and 2005) as the underlying interest expense is recognized on the Senior Notes.
On July 12, 2007, State Auto Financial terminated its previous credit agreement which provided for a $100.0 million five-year unsecured revolving credit facility and entered into a new credit agreement
(Credit Agreement) with a syndicate of lenders which provides for a $200.0 million five-year unsecured revolving credit facility (Credit Facility). State Auto did not borrow any funds under the previous credit agreement.
During the term of the Credit Facility, the Company has the right to increase the total facility to a maximum total facility amount of $250.0 million, provided that no event of default has occurred and is continuing. While the Credit Facility will
be available for general corporate purposes, including working capital, acquisitions and liquidity purposes, the Company presently intends to keep $100.0 million of the Credit Facility available in the event there is a need to fund losses under the
catastrophe reinsurance program with State Auto P&C. The Credit Facility provides for interest-only payments during its term, with principal due in full at maturity. Interest is
99
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
based on either a London interbank market rate or a base rate plus a calculated margin amount. The Credit Agreement contains certain covenants, including
financial covenants that require the Company to maintain a minimum net worth and not exceed a certain debt to capitalization ratio. As of December 31, 2007, State Auto Financial had not made any borrowings and was in compliance with all of the
covenants under the Credit Agreement. State Auto Financial incurred $0.5 million in issuance costs related to the Credit Agreement, which is recorded in other assets and is being amortized into expense ($0.1 million for 2007) over the life of the
Credit Agreement.
See discussion of affiliate notes payable at Note 6c. Notes payable at December 31 consisted of the
following:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ millions, except interest rates)
|
|
2007
|
|
|
2006
|
|
|
|
Carrying
Value
|
|
Fair
Value
|
|
Interest
Rate
|
|
|
Carrying
Value
|
|
Fair
Value
|
|
Interest
Rate
|
|
Senior Notes due 2013: issued $100.0, November 2003 with fixed interest
|
|
$
|
102.5
|
|
$
|
103.6
|
|
6.25
|
%
|
|
$
|
102.9
|
|
$
|
99.1
|
|
6.25
|
%
|
Affiliate subordinated debentures due 2033: issued $15.5, May 2003 with variable interest (see Note 6c)
|
|
|
15.5
|
|
|
15.5
|
|
9.32
|
|
|
|
15.5
|
|
|
15.5
|
|
9.57
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total Notes Payable
|
|
$
|
118.0
|
|
$
|
119.1
|
|
|
|
|
$
|
118.4
|
|
$
|
114.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
8. Federal Income Taxes
At December 31, 2007, the Company carried no balance for uncertain tax positions.
The Company had no accrual for the payment of interest and penalties at December 31, 2007 or 2006.
The Company is currently not under audit by either the Internal Revenue Service or any state jurisdiction for income tax purposes and all prior audits have been settled. Tax years 2004 through 2006 remain open for
audit for federal income tax purposes.
The reconciliation between actual federal income tax expense (benefit) and the
amount computed at the indicated statutory rate for the year ended December 31 is summarized as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ millions)
|
|
2007
|
|
|
%
|
|
|
2006
|
|
|
%
|
|
|
2005
|
|
|
%
|
|
Amount at statutory rate
|
|
$
|
54.4
|
|
|
35
|
|
|
$
|
56.6
|
|
|
35
|
|
|
$
|
60.2
|
|
|
35
|
|
Tax-free interest and dividends received deduction
|
|
|
(18.5
|
)
|
|
(12
|
)
|
|
|
(15.7
|
)
|
|
(10
|
)
|
|
|
(14.0
|
)
|
|
(8
|
)
|
Other, net
|
|
|
0.3
|
|
|
|
|
|
|
0.4
|
|
|
|
|
|
|
(0.1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Federal income tax expense and rate
|
|
$
|
36.2
|
|
|
23
|
|
|
$
|
41.3
|
|
|
25
|
|
|
$
|
46.1
|
|
|
27
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
100
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
The tax effects of temporary differences that give rise to significant portions of
deferred tax assets and deferred tax liabilities as of December 31 are presented below:
|
|
|
|
|
|
($ millions)
|
|
2007
|
|
2006
|
Deferred tax assets:
|
|
|
|
|
|
Unearned premiums not currently deductible
|
|
$
|
29.6
|
|
28.8
|
Losses and loss expenses payable discounting
|
|
|
20.1
|
|
20.7
|
Postretirement and pension benefits
|
|
|
42.4
|
|
47.9
|
Other
|
|
|
14.3
|
|
10.0
|
|
|
|
|
|
|
Total deferred tax assets
|
|
|
106.4
|
|
107.4
|
Deferred tax liabilities:
|
|
|
|
|
|
Deferral of policy acquisition costs
|
|
|
37.0
|
|
36.4
|
Unrealized holding gains on investments
|
|
|
23.3
|
|
24.7
|
|
|
|
|
|
|
Total deferred tax liabilities
|
|
|
60.3
|
|
61.1
|
|
|
|
|
|
|
Net deferred federal income taxes
|
|
$
|
46.1
|
|
46.3
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company is required to establish a valuation allowance for any portion of the
deferred tax asset that management believes will not be realized. In the opinion of management, it is more likely than not that the Company will realize the benefit of the deferred tax assets and, therefore, no such valuation allowance has been
established at December 31, 2007 or 2006.
9. Pension and Postretirement Benefit Plans
All Company personnel are employees of State Auto P&C. The Company, through 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 Companys benefit plans are allocated to affiliated companies based on allocations pursuant to intercompany management
agreements.
The Company provides a defined benefit pension plan for its eligible employees. Substantially all Company
employees become eligible to participate the year after becoming 20 years of age and vest with 5 years of credited service or attained age 65. The Companys 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 participants defined average annual compensation.
In addition to the defined benefit pension plan, the Company provides a postretirement benefit plan including certain health care and life insurance benefits for its eligible retired employees.
Substantially all of the Companys employees may become eligible for these postretirement benefits if they retire between age 55 and 65 with 15 years or more of service or if they retire at age 65 or later with 5 years or more of service. The
defined benefit pension and postretirement benefit plans are referred to herein as the benefit plans.
On
December 31, 2006, the Company adopted the recognition and disclosure provisions of SFAS 158. SFAS 158 required the Company to recognize the funded status of its benefit plans in the December 31, 2006 balance sheet, with a corresponding
adjustment to accumulated other comprehensive income, net of tax. The adjustment to accumulated other comprehensive income at adoption represents the net unrecognized actuarial losses, unrecognized prior service costs, and unrecognized transition
assets remaining from the initial adoption of
101
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
SFAS 87 and SFAS 106, all of which were previously netted against the plans funded status in the Companys balance sheet pursuant to the
provisions of SFAS 87 and SFAS 106. These amounts will be subsequently recognized as net periodic cost pursuant to the Companys historical accounting policy for amortizing such amounts. Further, actuarial gains and losses that arise in
subsequent periods and are not recognized as net periodic cost in the same periods will be recognized as a component of other comprehensive income. Those amounts will be subsequently recognized as a component of net periodic cost on the same basis
as the amounts recognized in accumulated other comprehensive income at adoption of SFAS 158.
The following table provides
the incremental effects of adopting the provisions of SFAS 158 on the Companys balance sheet at December 31, 2006. The adoption of SFAS 158 had no effect on the Companys consolidated statement of income for the year ended
December 31, 2006, or for any prior period presented.
|
|
|
|
|
|
|
|
|
|
|
|
($ millions)
|
|
Prior to
Adopting
SFAS 158
|
|
Effect of
Adopting
SFAS 158
|
|
|
As
Reported
|
|
Assets:
|
|
|
|
|
|
|
|
|
|
|
|
Net prepaid pension expense
|
|
$
|
61.8
|
|
$
|
(61.8
|
)
|
|
$
|
|
|
Deferred federal income taxes
|
|
|
5.6
|
|
|
40.7
|
|
|
|
46.3
|
|
|
|
|
|
Liabilities:
|
|
|
|
|
|
|
|
|
|
|
|
Postretirement benefits
|
|
|
98.1
|
|
|
26.7
|
|
|
|
124.8
|
|
Pension benefits
|
|
|
|
|
|
16.1
|
|
|
|
16.1
|
|
|
|
|
|
Stockholders Equity:
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated other comprehensive income (loss)
|
|
|
46.6
|
|
|
(63.9
|
)
|
|
|
(17.3
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
The Company uses September 30 as its measurement date to determine its
pension and postretirement benefit obligations.
102
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
Information regarding the Companys pension and postretirement benefit
plans change in benefit obligation, plan assets and funded status as of December 31 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ millions)
|
|
Pension
|
|
|
Postretirement
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
Change in benefit obligation:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Benefit obligation at beginning of year
|
|
$
|
213.4
|
|
|
206.8
|
|
|
122.7
|
|
|
109.2
|
|
Service cost
|
|
|
9.0
|
|
|
10.0
|
|
|
5.6
|
|
|
4.9
|
|
Interest cost
|
|
|
12.5
|
|
|
11.7
|
|
|
7.3
|
|
|
6.2
|
|
Actuarial (gain) loss
|
|
|
(5.6
|
)
|
|
(4.3
|
)
|
|
(9.7
|
)
|
|
5.5
|
|
Contributions
|
|
|
|
|
|
|
|
|
(2.9
|
)
|
|
(3.1
|
)
|
Benefits paid
|
|
|
(12.0
|
)
|
|
(10.8
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Benefit obligation at end of year
|
|
$
|
217.3
|
|
|
213.4
|
|
|
123.0
|
|
|
122.7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Change in plan assets:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value of plan assets at beginning of year
|
|
$
|
197.3
|
|
|
183.4
|
|
|
2.2
|
|
|
2.1
|
|
Employer contribution
|
|
|
11.5
|
|
|
10.0
|
|
|
|
|
|
|
|
Actual return on plan assets
|
|
|
23.2
|
|
|
14.7
|
|
|
0.1
|
|
|
0.1
|
|
Benefits paid
|
|
|
(12.0
|
)
|
|
(10.8
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair value of plan assets at end of year
|
|
$
|
220.0
|
|
|
197.3
|
|
|
2.3
|
|
|
2.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Contribution received during fourth quarter
|
|
|
|
|
|
|
|
|
(0.2
|
)
|
|
|
|
SERP (defined below)
|
|
|
|
|
|
|
|
|
(4.3
|
)
|
|
(4.3
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Funded status at end of year
|
|
$
|
2.7
|
|
|
(16.1
|
)
|
|
(125.2
|
)
|
|
(124.8
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Accumulated benefit obligation end of year
|
|
$
|
194.3
|
|
|
190.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
No assets are expected to be returned during the fiscal year-ended
December 31, 2008. The Company had no additional minimum liability included in other comprehensive income for the pension plan for 2006 (prior to adoption of SFAS 158) and 2005.
Included in accumulated other comprehensive loss are the following amounts that have not been recognized in net periodic cost:
|
|
|
|
|
|
|
|
($ millions)
|
|
December 31
|
|
|
|
2007
|
|
|
2006
|
|
Net actuarial loss
|
|
$
|
75.7
|
|
|
101.0
|
|
Prior service cost
|
|
|
5.7
|
|
|
6.6
|
|
Transition asset
|
|
|
(2.4
|
)
|
|
(3.0
|
)
|
|
|
|
|
|
|
|
|
Total
|
|
$
|
79.0
|
|
|
104.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
103
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
The amount of amortization expected to be recognized during the fiscal year ending
December 31, 2008 for the State Auto Group is as follows:
|
|
|
|
|
($ millions)
|
|
2008
|
|
Net actuarial loss
|
|
$
|
3.2
|
|
Prior service cost
|
|
|
0.9
|
|
Transition asset
|
|
|
(0.6
|
)
|
|
|
|
|
|
Total
|
|
$
|
3.5
|
|
|
|
|
|
|
|
|
|
|
|
Information regarding the State Auto Groups pension and postretirement
benefit plans components of net periodic cost for the year ended December 31 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ millions)
|
|
Pension
|
|
|
Postretirement
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Components of net periodic cost:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Service cost
|
|
$
|
9.0
|
|
|
10.0
|
|
|
8.0
|
|
|
5.6
|
|
|
4.9
|
|
|
4.4
|
|
Interest cost
|
|
|
12.5
|
|
|
11.7
|
|
|
11.2
|
|
|
7.3
|
|
|
6.2
|
|
|
6.5
|
|
Expected return on plan assets
|
|
|
(17.8
|
)
|
|
(17.0
|
)
|
|
(16.9
|
)
|
|
(0.2
|
)
|
|
(0.2
|
)
|
|
(0.2
|
)
|
Amortization of prior service cost
|
|
|
0.4
|
|
|
0.4
|
|
|
0.4
|
|
|
0.5
|
|
|
0.5
|
|
|
0.5
|
|
Amortization of transition asset
|
|
|
(0.6
|
)
|
|
(0.6
|
)
|
|
(0.6
|
)
|
|
|
|
|
|
|
|
|
|
Amortization of net gain
|
|
|
3.9
|
|
|
2.9
|
|
|
1.1
|
|
|
0.8
|
|
|
0.6
|
|
|
0.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net periodic cost
|
|
$
|
7.4
|
|
|
7.4
|
|
|
3.2
|
|
|
14.0
|
|
|
12.0
|
|
|
11.8
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The following benefit payments, which reflect expected future service, are
expected to be paid:
|
|
|
|
|
|
|
($ millions)
|
|
Pension
|
|
Postretirement
|
2008
|
|
$
|
9.0
|
|
$
|
4.0
|
2009
|
|
|
9.3
|
|
|
4.3
|
2010
|
|
|
9.7
|
|
|
4.7
|
2011
|
|
|
10.2
|
|
|
5.2
|
2012
|
|
|
11.2
|
|
|
5.6
|
2013 - 2017
|
|
|
72.9
|
|
|
35.7
|
|
|
|
|
|
|
|
The Companys share of the 2007, 2006, and 2005 net periodic costs for the
defined benefit plan were $7.4 million, $7.4 million, and $3.2 million, respectively. For postretirement benefits other than pensions, the Companys share of the 2007, 2006 and 2005 net periodic costs were $11.6 million, $10.3 million and $10.2
million, respectively.
104
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
Summarized in the following table are the weighted average assumptions used to
determine the Companys benefit obligations for the year ended December 31:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension
|
|
|
Postretirement
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
Benefit obligations weighted-average assumptions:
|
|
|
|
|
|
|
|
|
|
|
|
|
Discount rate
|
|
6.25
|
%
|
|
6.00
|
%
|
|
6.25
|
%
|
|
6.00
|
%
|
Rates of increase in compensation levels
|
|
4.00
|
|
|
4.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Summarized in the following table are the weighted average assumptions used to
determine the Companys net periodic cost:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension
|
|
|
Postretirement
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Weighted-average assumptions:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Discount rate
|
|
6.00
|
%
|
|
5.75
|
%
|
|
6.50
|
%
|
|
6.00
|
%
|
|
5.75
|
%
|
|
6.50
|
%
|
Expected long-term rate of return on assets
|
|
9.00
|
|
|
9.00
|
|
|
9.00
|
|
|
9.00
|
|
|
9.00
|
|
|
9.00
|
|
Rates of increase in compensation levels
|
|
4.00
|
|
|
5.00
|
|
|
5.00
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The Companys benefit plan obligations are long-term in nature and
consequently the investment strategies have a long-term time horizon. In establishing the long-term rate of return assumption on plan assets, management, along with its pension consulting actuary, reviews the historical performance of the plan
assets and the stability in the mix of the investment portfolio. The expected inflation rate and expected real rates of return of applicable asset classes are then determined to assist in setting appropriate assumptions.
The assumed health care cost trend rates used for the year ended December 31 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
Postretirement
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Assumed health care cost trend rates:
|
|
|
|
|
|
|
|
|
|
Health care cost trend rate assumed for the next year
|
|
10.00
|
%
|
|
10.00
|
%
|
|
10.00
|
%
|
Rate to which the cost trend rate is assumed to decline (the ultimate trend rate)
|
|
5.00
|
%
|
|
5.00
|
%
|
|
5.00
|
%
|
Year that the rate reaches the ultimate trend rate
|
|
2012
|
|
|
2011
|
|
|
2010
|
|
|
|
|
|
|
|
|
|
|
|
The assumed health care cost trend rates have a significant effect on the amounts
reported for the postretirement plan. A one percentage point change in assumed health care cost trend rates would have the following effects for the year ended December 31, 2007:
|
|
|
|
|
|
|
|
($ millions)
|
|
Postretirement
|
|
|
|
Increase
|
|
(Decrease)
|
|
One percentage point change:
|
|
|
|
|
|
|
|
Effect on total service and interest cost
|
|
$
|
3.1
|
|
$
|
(2.4
|
)
|
Effect on accumulated postretirement benefit obligation
|
|
|
23.3
|
|
|
(18.6
|
)
|
|
|
|
|
|
|
|
|
105
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
The Company also has a supplemental executive retirement plan (SERP) for
certain executives for which the accrued obligation at December 31, 2007 and 2006 was $4.3 million that is included as a component in postretirement and pension benefits liability in the accompanying consolidated balance sheets.
The Companys benefit plans weighted average asset allocations by asset category at the plans measurement date of
September 30 are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Pension
|
|
|
Postretirement
|
|
|
|
2007
|
|
|
2006
|
|
|
2007
|
|
|
2006
|
|
Asset Category:
|
|
|
|
|
|
|
|
|
|
|
|
|
Fixed maturity
|
|
37.9
|
%
|
|
35.4
|
%
|
|
100.0
|
%
|
|
100.0
|
%
|
U.S. large cap equity
|
|
40.3
|
|
|
64.6
|
|
|
|
|
|
|
|
U.S. small cap equities
|
|
12.4
|
|
|
|
|
|
|
|
|
|
|
International
|
|
9.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
|
|
100.0
|
|
|
100.0
|
|
|
100.0
|
|
|
100.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
The benefit plans investment policy objective is to preserve the investment
principal while generating income and appreciation in fair value to meet the benefit plans obligations. The benefit plans investment strategy and risk tolerance is balanced between meeting cash obligation requirements and a long term
relatively high risk tolerance. Since the nature and timing of the benefit plans liabilities and cash requirements are predictable, the liquidity requirements are somewhat moderate. During 2007, the following asset allocation targets, as a
percentage of total fair value, were approved. Management is in the process of moving towards these allocation targets as funds become available.
|
|
|
|
|
Asset
Allocation
Target
(0 to 100%)
|
Asset Category:
|
|
|
Fixed maturity
|
|
23
|
U.S. large cap equity
|
|
43
|
U.S. small/mid cap equity
|
|
14
|
Treasury inflation protected securities
|
|
10
|
International
|
|
10
|
|
|
|
The actuarially prepared funding amount to the pension plan ranges from the
minimum amount the Company would be required to contribute to the maximum amount that would be deductible for tax purposes. Contributed amounts in excess of the minimum amounts are deemed voluntary. Amounts in excess of the maximum amount would be
subject to an excise tax and may not be deductible for tax purposes. This range is generally not determined until the second quarter with respect to the contribution year. The Company expects to contribute approximately $12.0 million during 2008 to
its pension plan, depending on the actuarially calculated funding requirements of such plan. Postretirement and SERP plan payments are deductible for tax purposes when paid.
The Company maintains a defined contribution plan that covers substantially all employees of the Company. The Company matches the first 2% of contributions of participants salary at the
rate of 75 cents for each dollar
106
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
contributed. Participant contributions of 3% to 6% are matched at a rate of 50 cents for each dollar contributed. The Companys share of the expense
under the plan totaled $2.6 million, $2.5 million and $2.4 million for the years 2007, 2006 and 2005, respectively.
10. Stockholders Equity
a. Treasury Shares
On August 17, 2007, State Auto Financials board of directors authorized a plan to repurchase, from time to time, up to 4.0 million of its common shares, or approximately 10% of State Auto
Financials outstanding shares, over a period extending to and through December 31, 2009 (the Repurchase Plan). Under the Repurchase Plan, State Auto Financial may repurchase shares from State Auto Mutual in amounts that are
proportional to the respective current ownership percentages of State Auto Mutual, which is approximately 64%, and other shareholders. State Auto Financials total share repurchase activity in 2007 was approximately 0.8 million common
shares at an average repurchase price of $27.21 per share for a total of $22.1 million.
b. Dividend Restrictions and Statutory
Financial Information
State Auto P&C, Milbank, Farmers, SA Ohio and SA National are subject to regulations and
restrictions under which payment of dividends from statutory earned surplus can be made to State Auto Financial during the year without prior approval of regulatory authorities. Pursuant to these rules, at December 31, 2007, adjusted for
dividend payments made in the previous twelve-month period, approximately $79.6 million is available for payment to State Auto Financial from its insurance subsidiaries in 2008 without prior approval. In 2007 State Auto Financial received dividends
of $50.0 million from its insurance subsidiaries, $0 in 2006, and $40.5 million in 2005.
Reconciliations of statutory
capital and surplus and net income, as determined using statutory accounting principles, to the amounts included in the accompanying consolidated financial statements as of December 31 are as follows:
|
|
|
|
|
|
|
|
($ millions)
|
|
2007
|
|
|
2006
|
|
Statutory capital and surplus of insurance subsidiaries
|
|
$
|
916.4
|
|
|
856.2
|
|
Net liabilities of non-insurance parent and affiliates
|
|
|
(59.5
|
)
|
|
(71.4
|
)
|
|
|
|
|
|
|
|
|
|
|
|
856.9
|
|
|
784.8
|
|
Increases (decreases):
|
|
|
|
|
|
|
|
Deferred policy acquisition costs
|
|
|
105.8
|
|
|
104.0
|
|
Postretirement and pension obligations
|
|
|
(22.1
|
)
|
|
(38.2
|
)
|
Deferred federal income taxes
|
|
|
(33.6
|
)
|
|
(38.8
|
)
|
Fixed maturities at fair value
|
|
|
22.5
|
|
|
16.8
|
|
Other, net
|
|
|
6.0
|
|
|
5.6
|
|
|
|
|
|
|
|
|
|
Stockholders equity per accompanying consolidated financial statements
|
|
$
|
935.5
|
|
|
834.2
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
107
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
|
|
|
|
|
|
|
|
|
|
|
($ millions)
|
|
Year ended December 31
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Statutory net income of insurance subsidiaries
|
|
$
|
129.5
|
|
|
140.1
|
|
|
123.7
|
|
Net income (loss) of non-insurance parent and affiliates
|
|
|
0.5
|
|
|
(0.1
|
)
|
|
(2.1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
130.0
|
|
|
140.0
|
|
|
121.6
|
|
Increases (decreases):
|
|
|
|
|
|
|
|
|
|
|
Deferred policy acquisition costs
|
|
|
1.7
|
|
|
(2.0
|
)
|
|
8.5
|
|
Postretirement and pension benefit
|
|
|
(12.0
|
)
|
|
(11.8
|
)
|
|
(7.1
|
)
|
Deferred federal income taxes
|
|
|
5.4
|
|
|
0.3
|
|
|
2.7
|
|
Share-based compensation expense
|
|
|
(5.5
|
)
|
|
(6.5
|
)
|
|
|
|
Other, net
|
|
|
(0.5
|
)
|
|
0.4
|
|
|
0.2
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income per accompanying consolidated financial statements
|
|
$
|
119.1
|
|
|
120.4
|
|
|
125.9
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
11. Preferred Stock
State Auto Financial has authorized two classes of preferred stock. For both classes, upon issuance, the Board of Directors has authority to fix and determine the significant features of the
shares issued, including, among other things, the dividend rate, redemption price, redemption rights, conversion features and liquidation price payable in the event of any liquidation, dissolution, or winding up of the affairs of State Auto
Financial.
The Class A preferred stock is not entitled to voting rights until, for any period, dividends are in
arrears in the amount of six or more quarterly dividends.
12. Share-Based Compensation
Prior to January 1, 2006, the Company accounted for share-based compensation plans for employees and non-employee directors under the
measurement and recognition provisions of Accounting Principles Board Opinion 25, Accounting for Stock Issued to Employees, and related Interpretations, as permitted by Statement of Financial Accounting Standards 123, Accounting
for Stock-Based Compensation (SFAS 123). Accordingly, share-based compensation was included as a pro forma disclosure in the financial statement footnotes (See Note 1k Share-Based Compensation). For share-based awards
granted to the Companys independent insurance agencies, the Company recognized share-based compensation within its financial statements in accordance with SFAS 123 and related Interpretations.
The Company maintains share-based compensation plans for its key employees and outside, or non-employee, directors. The share-based
compensation plan for key employees is the Amended and Restated Equity Incentive Compensation Plan (the Equity Plan). In May 2005, the Companys shareholders approved amendments to, and a restatement of, the Equity Plan, which was
formerly called the 2000 Stock Option Plan. The stock-based compensation plan for outside directors is the Outside Directors Restricted Share Unit Plan (the Outside Directors RSU Plan), which was approved by the Companys
shareholders in May 2005. The Outside Directors RSU Plan replaced the 2000 Directors Stock Option Plan for outside directors (the Outside Directors Stock Option Plan).
Equity Plan
The 2000 Stock Option Plan provided only for the award of qualified and
nonqualified stock options. The Equity Plan now provides for the award of qualified and nonqualified stock options, restricted shares,
108
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
performance shares, performance units and other stock-based awards. The Company has reserved 3.5 million common shares under the Equity Plan. As of
December 31, 2007, a total of 1.1 million common shares were 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 individual is 250,000 shares. The Equity Plan automatically terminates on July 1, 2010.
The
Equity Plan provides that qualified stock options may be granted at an option price not less than the fair market value of the common shares at the date of grant and that nonqualified stock options may be granted at any price determined by the
Compensation Committee of the Board of Directors. Options granted generally vest over a three-year period, with one-third of the options vesting on each anniversary of the grant date, and must be exercised no later than ten years from the date of
grant. Stock options granted under the Equity Plan for 2007, 2006 and 2005 were 0.4 million, 0.3 million and 0.4 million, respectively.
The Equity Plan provides for the granting of restricted shares subject to a vesting schedule based on the employees 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. Restricted shares granted for 2007 and 2006 were
32,000 and 10,500, respectively, with a weighted average grant date fair value of $29.98 and $31.94, respectively. There were no restricted shares granted prior to January 1, 2006.
A summary of the status of the Companys non-vested restricted shares and changes for the year ended December 31 is as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
2006
|
|
|
Shares
|
|
Weighted
Average
Grant
Date Fair
Value
|
|
Shares
|
|
Weighted
Average
Grant
Date Fair
Value
|
Outstanding, beginning of year
|
|
10,500
|
|
$
|
31.94
|
|
|
|
|
|
Granted
|
|
32,000
|
|
|
29.98
|
|
10,500
|
|
$
|
31.94
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, end of year
|
|
42,500
|
|
|
30.46
|
|
10,500
|
|
|
31.94
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of December 31, 2007, there was $1.0 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 2.75 years. No shares vested during the years ended December 31, 2007 and 2006.
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 Companys
common shares. The purchase price of the common shares is 85%
109
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
of the lower of its beginning-of-interval or end-of-interval market price. The Company has reserved 3.4 million common shares under this plan. As of
December 31, 2007, a total of 2.4 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 Outside Directors RSU Plan is an unfunded deferred compensation plan which provides each outside director with an award of 1,400 restricted share units (the RSU award) following each annual meeting of shareholders, however,
the amount of the award may change from year to year, based on the provision described below. The RSU awards are fully vested upon grant. RSU awards are not common shares of the Company and, as such, no participant has any rights as a holder of
common shares under the Outside Directors 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 Companys common shares, on
all RSU awards granted to them. At the end of the restricted period, outside directors receive distributions of their RSU awards either (i) in a single lump sum payment, or (ii) in annual installment payments over a five- or ten-year
period, as previously elected by the outside director. The administrative committee for the Outside Directors RSU Plan (currently the Companys Compensation Committee) retains the right to increase the annual number of RSU awards granted to
each outside director to as many as 5,000 or to decrease such annual number to not less than 500, without seeking shareholder approval, if such increase or decrease is deemed appropriate by the administrative committee to maintain director
compensation at appropriate levels. The Outside Directors RSU Plan automatically terminates on May 31, 2015. The Company accounts for the Outside Directors RSU Plan as a liability plan. There were 11,200 and 9,800 RSUs granted in 2007 and
2006, respectively. There were no RSUs granted by the Company prior to January 1, 2006.
During 2007 and 2006, common
shares valued at approximately $9,000 and $60,000, respectively, were distributed by the Company under the Outside Directors RSU Plan. No distributions were made in 2005.
Under the Outside Directors Stock Option Plan, following each annual meeting of shareholders, outside directors received nonqualified options to purchase 4,200 common shares at an option price
equal to the fair market value of the common shares at the close of business on the last trading day immediately prior to the date of the annual meeting. These nonqualified options vested upon grant and are exercisable for 10 years from the date of
grant. On May 11, 2005 (the date of the Companys 2005 annual meeting of shareholders), the Outside Directors Stock Option Plan was amended to prohibit the grant of further options under the plan.
Agent Stock Option Plan
The Company has a stock option incentive plan for certain designated independent insurance agencies (Agent Stock Option Plan) that represent the Company and its affiliates. The Company has reserved 0.4 million shares of
common stock under this plan. As of December 31, 2007, a total of 0.2 million shares were available for issuance under the Agent Stock Option Plan. The plan provides that the options become exercisable on the first day of the calendar year
following the agencys achievement of specific production and profitability requirements over a period not greater than two calendar years from the date of grant or a portion thereof in the
110
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
first calendar year in which an agency commences participation under the plan. Options granted under this plan have a ten-year term. Stock options granted
for the years 2007, 2006 and 2005 were 15,862, 16,452 and 29,505, respectively. The Agent Stock Option Plan terminates May 27, 2008.
Stock Options
The fair value of each stock option granted is estimated on the date of grant using the Black-Scholes closed-form
pricing model. The following tables present the weighted-average assumptions used in the option pricing model for options granted to employees and non-employees (independent insurance agencies) during 2007, 2006, and 2005. 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 Companys stock for a period approximating the expected life and the expected dividend yield is based on the Companys most recent periods 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 equal to the expected life.
The fair value of the independent agent options granted was estimated at the reporting date or vesting date using the Black-Scholes option-pricing model. The weighted average fair value and related assumptions are as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Fair value per share
|
|
$
|
7.10
|
|
|
16.61
|
|
|
18.24
|
|
Dividend yield
|
|
|
2.28
|
%
|
|
1.15
|
%
|
|
0.99
|
%
|
Risk free interest rate
|
|
|
3.9
|
%
|
|
4.7
|
%
|
|
4.3
|
%
|
Expected volatility factor
|
|
|
33.8
|
%
|
|
34.7
|
%
|
|
33.6
|
%
|
Expected life in years
|
|
|
8.5
|
|
|
8.4
|
|
|
6.4
|
|
|
|
|
|
|
|
|
|
|
|
|
The fair value of share-based awards granted to employees in 2007 and 2006 was
estimated at the date of grant using the Black-Scholes option-pricing model. The weighted average fair values and related assumptions for options granted were as follows:
|
|
|
|
|
|
|
|
|
|
2007
|
|
|
2006
|
|
Fair value per share
|
|
$
|
10.82
|
|
|
12.41
|
|
Expected dividend yield
|
|
|
1.46
|
%
|
|
1.12
|
%
|
Risk free interest rate
|
|
|
4.5
|
%
|
|
5.1
|
%
|
Expected volatility factor
|
|
|
33.4
|
%
|
|
32.4
|
%
|
Expected life in years
|
|
|
6.4
|
|
|
6.4
|
|
|
|
|
|
|
|
|
|
As of December 31, 2007, there was $5.4 million of total unrecognized
compensation cost related to option-based compensation arrangements granted under the plans. The remaining cost is expected to be recognized over a period of three years.
111
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
A summary of the Companys total stock option activity and related information
for these plans for the years ended December 31, follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ millions, except per share amounts)
|
|
2007
|
|
2006
|
|
2005
|
|
|
Options
|
|
|
Weighted-
Average
Exercise
Price
|
|
Options
|
|
|
Weighted-
Average
Exercise
Price
|
|
Options
|
|
|
Weighted-
Average
Exercise
Price
|
Outstanding, beginning of year
|
|
2.4
|
|
|
$
|
22.09
|
|
2.6
|
|
|
$
|
18.76
|
|
2.6
|
|
|
$
|
16.46
|
Granted
|
|
0.4
|
|
|
|
29.55
|
|
0.3
|
|
|
|
33.49
|
|
0.4
|
|
|
|
26.48
|
Exercised
|
|
(0.1
|
)
|
|
|
15.48
|
|
(0.5
|
)
|
|
|
12.35
|
|
(0.4
|
)
|
|
|
9.88
|
Canceled
|
|
|
|
|
|
31.91
|
|
|
|
|
|
27.14
|
|
|
|
|
|
23.34
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding, end of year
|
|
2.7
|
|
|
$
|
23.78
|
|
2.4
|
|
|
$
|
22.09
|
|
2.6
|
|
|
$
|
18.76
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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, 2007, 2006 and 2005, the total intrinsic value of stock options exercised was $2.6 million, $11.9 million and $6.0 million, respectively. The tax benefit for tax deductions from
share-based awards totaled $0.7 million, $3.2 million and $1.8 million for the years ended December 31, 2007, 2006 and 2005, respectively.
A summary of information pertaining to the total options outstanding and exercisable as of December 31, 2007 follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
($ millions, except per share amounts)
|
|
Options Outstanding
|
|
Options Exercisable
|
|
|
Number
|
|
Weighted-
Average
Remaining
Contractual
Life
|
|
Weighted-
Average
Exercise
Price
|
|
Number
|
|
Weighted-
Average
Exercise
Price
|
Range of Exercise Prices:
|
|
|
|
|
|
|
|
|
|
|
|
|
Less than $10.00
|
|
|
|
2.0
|
|
$
|
9.30
|
|
|
|
$
|
9.30
|
$10.01 $20.00
|
|
1.1
|
|
3.5
|
|
|
15.40
|
|
1.1
|
|
|
15.40
|
$20.01 $30.00
|
|
0.9
|
|
8.4
|
|
|
27.94
|
|
0.3
|
|
|
26.43
|
Greater than $30.01
|
|
0.7
|
|
7.4
|
|
|
32.11
|
|
0.5
|
|
|
31.60
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2.7
|
|
6.0
|
|
$
|
23.78
|
|
1.9
|
|
$
|
21.39
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Aggregate intrinsic value for total options outstanding at December 31, 2007
is $12.3 million. Aggregate intrinsic value for total options exercisable at December 31, 2007 is $12.3 million.
Compensation expense recognized during 2007, 2006 and 2005 was $6.0 million, $7.0 million and $0.3, respectively. See Note 1(k) for a discussion of share based compensation expense prior to the adoption of FAS 123(R) on January 1,
2006. 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, 2007, there was $6.1 million of
total unrecognized compensation cost related to option-based compensation arrangements granted under the plans. The remaining cost is expected to be recognized over a period of three years.
112
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
13. Net Earnings Per Common Share
The following table sets forth the compilation of basic and diluted net earnings per common share for the year ended December 31:
|
|
|
|
|
|
|
|
($ millions, except per share amounts)
|
|
2007
|
|
2006
|
|
2005
|
Numerator:
|
|
|
|
|
|
|
|
Net earnings for basic net earnings per common share
|
|
$
|
119.1
|
|
120.4
|
|
125.9
|
Effect of dilutive share-based awards
|
|
|
0.1
|
|
|
|
|
|
|
|
|
|
|
|
|
Adjusted net earnings for dilutive net earnings per common share
|
|
$
|
119.2
|
|
120.4
|
|
125.9
|
|
|
|
|
|
|
|
|
Denominator:
|
|
|
|
|
|
|
|
Weighted average shares for basic net earnings per common share
|
|
|
41.0
|
|
40.9
|
|
40.3
|
Effect of dilutive share-based awards
|
|
|
0.6
|
|
0.7
|
|
0.8
|
Adjusted weighted average shares for diluted net earnings per common share
|
|
|
41.6
|
|
41.6
|
|
41.1
|
|
|
|
|
|
|
|
|
Basic net earnings per common share
|
|
$
|
2.90
|
|
2.95
|
|
3.12
|
Diluted net earnings per common share
|
|
$
|
2.86
|
|
2.90
|
|
3.06
|
|
|
|
|
|
|
|
|
The following options to purchase shares of common stock were not included in the
computation of diluted earnings per share because the exercise price of the options was greater than the average market price for the year ended December 31:
|
|
|
|
|
|
|
(in millions)
|
|
2007
|
|
2006
|
|
2005
|
Number of options
|
|
0.7
|
|
0.3
|
|
0.4
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
113
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
14. Comprehensive Income
A reconciliation of each component of comprehensive income (loss) and the related federal income tax effect for the year ended December 31, is as follows:
|
|
|
|
|
|
|
|
|
|
|
($ millions)
|
|
Before-Tax
Amount
|
|
|
Tax
(Expense)
or Benefit
|
|
|
Net-of-Tax
Amount
|
|
2007:
|
|
|
|
|
Net income
|
|
$
|
155.3
|
|
|
(36.2
|
)
|
|
119.1
|
|
Other comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
Net unrealized holding loss on investments:
|
|
|
|
|
|
|
|
|
|
|
Unrealized holding loss arising during the year
|
|
|
8.1
|
|
|
(2.8
|
)
|
|
5.3
|
|
Reclassification adjustments for gains realized in net income
|
|
|
(12.1
|
)
|
|
4.2
|
|
|
(7.9
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(4.0
|
)
|
|
1.4
|
|
|
(2.6
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Amortization of gain on derivative used in cash flow hedge
|
|
|
(0.1
|
)
|
|
|
|
|
(0.1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Net unrecognized benefit plan obligations:
|
|
|
|
|
|
|
|
|
|
|
Net actuarial gain arising during period
|
|
|
20.6
|
|
|
(6.9
|
)
|
|
13.7
|
|
Reclassification adjustments for amortization to net income:
|
|
|
|
|
|
|
|
|
|
|
Transition asset
|
|
|
(0.6
|
)
|
|
0.2
|
|
|
(0.4
|
)
|
Net actuarial loss
|
|
|
4.7
|
|
|
(1.9
|
)
|
|
2.8
|
|
Prior service cost
|
|
|
0.9
|
|
|
(0.3
|
)
|
|
0.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
25.6
|
|
|
(8.9
|
)
|
|
16.7
|
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income
|
|
|
21.5
|
|
|
(7.5
|
)
|
|
14.0
|
|
Comprehensive income
|
|
$
|
176.8
|
|
|
(43.7
|
)
|
|
133.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
114
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
|
|
|
|
|
|
|
|
|
|
|
($ millions)
|
|
Before-Tax
Amount
|
|
|
Tax
(Expense)
or Benefit
|
|
|
Net-of-Tax
Amount
|
|
2006:
|
|
|
|
|
Net income
|
|
$
|
161.7
|
|
|
(41.3
|
)
|
|
120.4
|
|
Other comprehensive income:
|
|
|
|
|
|
|
|
|
|
|
Net unrealized holding gain on investments:
|
|
|
|
|
|
|
|
|
|
|
Unrealized holding loss arising during the year
|
|
|
24.7
|
|
|
(8.7
|
)
|
|
16.0
|
|
Reclassification adjustments for gains realized in net income
|
|
|
(5.6
|
)
|
|
2.0
|
|
|
(3.6
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
19.1
|
|
|
(6.7
|
)
|
|
12.4
|
|
Amortization of gain on derivative used in cash flow hedge
|
|
|
(0.1
|
)
|
|
|
|
|
(0.1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive income
|
|
|
19.0
|
|
|
(6.7
|
)
|
|
12.3
|
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
$
|
180.7
|
|
|
(48.0
|
)
|
|
132.7
|
|
|
|
|
|
|
|
|
|
|
|
|
2005:
|
|
|
|
|
Net income
|
|
$
|
172.0
|
|
|
(46.1
|
)
|
|
125.9
|
|
Other comprehensive loss:
|
|
|
|
|
|
|
|
|
|
|
Net unrealized holding loss on investments:
|
|
|
|
|
|
|
|
|
|
|
Unrealized holding gains arising during the year
|
|
|
(23.4
|
)
|
|
8.3
|
|
|
(15.1
|
)
|
Reclassification adjustments for gains realized in net income
|
|
|
(5.6
|
)
|
|
2.0
|
|
|
(3.6
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(29.0
|
)
|
|
10.3
|
|
|
(18.7
|
)
|
Amortization of gain on derivative used in cash flow hedge
|
|
|
(0.1
|
)
|
|
|
|
|
(0.1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Other comprehensive loss
|
|
|
(29.1
|
)
|
|
10.3
|
|
|
(18.8
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Comprehensive income
|
|
$
|
142.9
|
|
|
(35.8
|
)
|
|
107.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
15. Reportable Segments
Due to internal reorganization efforts which occurred throughout most of 2006, that included realigning people, processes, systems and compensation programs, the Company changed its significant
reportable segments from standard insurance and nonstandard insurance to the new segments described below, effective January 1, 2007. Prior reporting periods have been restated to conform to the new segment presentation
The Company has three significant reportable segments: personal insurance, business insurance, and investment operations. The reportable
insurance segments are business units managed separately because of the differences in the type of customers they serve or products they provide or services they offer. The insurance segments operate primarily in the central and eastern United
States, excluding New York, New Jersey, and New England states, distributing products through the independent insurance agency system. The personal insurance segment provides primarily personal auto (standard and nonstandard) and homeowners to the
personal insurance market. The business insurance segment provides primarily commercial auto, commercial multi-peril, fire and allied lines, other and product liability and workers compensation insurance to small to medium sized businesses
within the commercial insurance market. The investment operations segment, managed by Stateco, provides investment services for the Companys invested assets.
115
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
The Company evaluates the performance of its insurance segments using industry
financial measurements determined based on Statutory Accounting Principles (SAP), which include loss and loss adjustment expense ratios, underwriting expense ratios, combined ratios, statutory underwriting gain (loss), net premiums
earned and net written premiums. One of the most significant differences between SAP and GAAP is that SAP requires all underwriting expenses to be expensed immediately and not deferred and amortized over the same period the premium is earned as
under GAAP.
Asset information by segment is not reported for the insurance segments because the Company does not produce
such information internally. The investment operations segment is evaluated based on investment returns of assets managed by Stateco.
116
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
The following provides financial information regarding the Companys reportable
segments for the year ended December 31:
|
|
|
|
|
|
|
|
|
|
|
($ millions)
|
|
2007
|
|
|
2006
|
|
|
2005
|
|
Revenues from external customers:
|
|
|
|
|
|
|
|
|
|
|
Insurance segments
|
|
|
|
|
|
|
|
|
|
|
Personal insurance
|
|
$
|
609.6
|
|
|
614.8
|
|
|
641.0
|
|
Business insurance
|
|
|
402.0
|
|
|
409.0
|
|
|
409.3
|
|
|
|
|
|
|
|
|
|
|
|
|
Total insurance segments
|
|
|
1,011.6
|
|
|
1,023.8
|
|
|
1,050.3
|
|
Investment operations segment
|
|
|
|
|
|
|
|
|
|
|
Net investment income
|
|
|
84.7
|
|
|
83.1
|
|
|
78.7
|
|
Net realized gains on investments
|
|
|
12.1
|
|
|
5.6
|
|
|
5.6
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investment operations segment
|
|
|
96.8
|
|
|
88.7
|
|
|
84.3
|
|
|
|
|
|
All other
|
|
|
5.0
|
|
|
4.9
|
|
|
4.9
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues from external sources
|
|
|
1,113.4
|
|
|
1,117.4
|
|
|
1,139.5
|
|
|
|
|
|
Intersegment revenues:
|
|
|
9.4
|
|
|
9.0
|
|
|
9.0
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues
|
|
|
1,122.8
|
|
|
1,126.4
|
|
|
1,148.5
|
|
Reconciling items:
|
|
|
|
|
|
|
|
|
|
|
Eliminate intersegment revenues
|
|
|
(9.4
|
)
|
|
(9.0
|
)
|
|
(9.0
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total consolidated revenue
|
|
$
|
1,113.4
|
|
|
1,117.4
|
|
|
1,139.5
|
|
|
|
|
|
|
|
|
|
|
|
|
Segment income (loss) before federal income tax:
|
|
|
|
|
|
|
|
|
|
|
Insurance segments:
|
|
|
|
|
|
|
|
|
|
|
Personal insurance SAP underwriting gain
|
|
$
|
47.3
|
|
|
44.9
|
|
|
72.4
|
|
Business insurance SAP underwriting gain
|
|
|
40.6
|
|
|
61.5
|
|
|
26.5
|
|
|
|
|
|
|
|
|
|
|
|
|
Total insurance segments
|
|
|
87.9
|
|
|
106.4
|
|
|
98.9
|
|
Investment operations segment:
|
|
|
|
|
|
|
|
|
|
|
Net investment income
|
|
|
84.7
|
|
|
83.1
|
|
|
78.7
|
|
Net realized gains on investments
|
|
|
12.1
|
|
|
5.6
|
|
|
5.6
|
|
|
|
|
|
|
|
|
|
|
|
|
Total investment operations segment
|
|
|
96.8
|
|
|
88.7
|
|
|
84.3
|
|
|
|
|
|
All other segments (loss)
|
|
|
(2.6
|
)
|
|
(2.3
|
)
|
|
(1.1
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Reconciling items:
|
|
|
|
|
|
|
|
|
|
|
GAAP adjustments
|
|
|
(17.3
|
)
|
|
(21.7
|
)
|
|
0.6
|
|
Interest expense on corporate debt
|
|
|
(7.6
|
)
|
|
(7.4
|
)
|
|
(8.8
|
)
|
Corporate expenses
|
|
|
(1.9
|
)
|
|
(2.0
|
)
|
|
(1.9
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total consolidated income before federal income taxes
|
|
$
|
155.3
|
|
|
161.7
|
|
|
172.0
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
117
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
|
|
|
|
|
|
|
($ millions)
|
|
December 31
|
|
|
2007
|
|
2006
|
Segment assets:
|
|
|
|
|
|
|
Investment operations segment
|
|
$
|
2,092.1
|
|
$
|
2,011.3
|
|
|
|
|
|
|
|
Total segment assets
|
|
|
2,092.1
|
|
|
2,011.3
|
Reconciling items:
|
|
|
|
|
|
|
Corporate assets
|
|
|
245.8
|
|
|
243.8
|
|
|
|
|
|
|
|
Total consolidated assets
|
|
$
|
2,337.9
|
|
$
|
2,255.1
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Assets attributed to the Investment Operations segment include the Total
investments and Cash and cash equivalent categories from the balance sheet. All other assets are corporate assets and are not assigned to a segment.
Revenues from external sources for reportable segments include the following products and services for the year ended December 31:
|
|
|
|
|
|
|
|
($ millions)
|
|
2007
|
|
2006
|
|
2005
|
Earned premiums:
|
|
|
|
|
|
|
|
Personal insurance:
|
|
|
|
|
|
|
|
Standard auto
|
|
$
|
357.3
|
|
362.1
|
|
385.7
|
Nonstandard auto
|
|
|
42.9
|
|
44.8
|
|
53.0
|
Homeowners
|
|
|
186.5
|
|
185.2
|
|
178.7
|
Other personal
|
|
|
22.9
|
|
22.7
|
|
23.6
|
|
|
|
|
|
|
|
|
Total personal insurance earned premiums
|
|
|
609.6
|
|
614.8
|
|
641.0
|
Business insurance:
|
|
|
|
|
|
|
|
Commercial auto
|
|
|
96.9
|
|
100.3
|
|
103.2
|
Commercial multi-peril
|
|
|
86.8
|
|
87.5
|
|
84.6
|
Fire & allied lines
|
|
|
83.4
|
|
84.2
|
|
84.8
|
Other & product liability
|
|
|
75.5
|
|
77.5
|
|
76.7
|
Workers compensation
|
|
|
33.4
|
|
33.8
|
|
34.4
|
Other business
|
|
|
26.0
|
|
25.7
|
|
25.6
|
|
|
|
|
|
|
|
|
Total business insurance earned premiums
|
|
|
402.0
|
|
409.0
|
|
409.3
|
|
|
|
|
|
|
|
|
Total earned premiums
|
|
|
1,011.6
|
|
1,023.8
|
|
1,050.3
|
Investment operations:
|
|
|
|
|
|
|
|
Net investment income
|
|
|
84.7
|
|
83.1
|
|
78.7
|
Realized gains
|
|
|
12.1
|
|
5.6
|
|
5.6
|
|
|
|
|
|
|
|
|
Total investment operations
|
|
|
96.8
|
|
88.7
|
|
84.3
|
|
|
|
|
|
|
|
|
Total revenues from significant reportable segments
|
|
$
|
1,108.4
|
|
1,112.5
|
|
1,134.6
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
118
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
16.
Quarterly Financial Data (unaudited)
|
|
|
|
|
|
|
|
|
|
($ millions, except per share amounts)
|
|
2007
|
|
|
For three months ended
|
|
|
March 31
|
|
June 30
|
|
September 30
|
|
December 31
|
Total revenues
|
|
$
|
275.5
|
|
278.7
|
|
280.9
|
|
278.3
|
Income before federal income taxes
|
|
|
40.9
|
|
28.8
|
|
28.6
|
|
57.0
|
Net income
|
|
|
30.9
|
|
23.3
|
|
23.2
|
|
41.7
|
Net earnings per common share:
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.75
|
|
0.57
|
|
0.56
|
|
1.02
|
Diluted
|
|
$
|
0.74
|
|
0.56
|
|
0.55
|
|
1.01
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
($ millions, except per share amounts)
|
|
2006
|
|
|
For three months ended
|
|
|
March 31
|
|
June 30
|
|
|
September 30
|
|
December 31
|
Total revenues
|
|
$
|
276.8
|
|
280.0
|
|
|
279.6
|
|
281.0
|
Income (loss) before federal income taxes
|
|
|
56.7
|
|
(0.2
|
)
|
|
42.4
|
|
62.8
|
Net income
|
|
|
40.2
|
|
4.1
|
|
|
31.2
|
|
44.9
|
Net earnings per common share:
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
0.99
|
|
0.10
|
|
|
0.76
|
|
1.10
|
Diluted
|
|
$
|
0.97
|
|
0.10
|
|
|
0.75
|
|
1.08
|
|
|
|
|
|
|
|
|
|
|
|
17. Contingencies
The Companys insurance subsidiaries are involved in litigation and may become involved in potential litigation arising in the ordinary course of business. Additionally, the insurance
subsidiaries may be impacted by adverse regulatory actions and adverse court decisions where insurance coverages are expanded beyond the scope originally contemplated in the policies at December 31, 2007. In the opinion of management, the
effects, if any, of such litigation and published court decisions are not expected to be material to the consolidated financial statements.
18.
Subsequent Event (unaudited)
Effective January 1, 2008, the Pooling Arrangement, described in Note 6a, was further
amended to add Patrons Mutual Insurance Company of Connecticut (Patrons Mutual), Litchfield Mutual Fire Insurance Company (Litchfield) and Beacon National as participants and the middle market business of State Auto Mutual
and Meridian Security to the pool. Patrons Mutual and Litchfield are affiliate companies of State Auto Mutual. Concurrently with the addition of the three companies, certain individual participant percentages of State Auto Mutual and its
subsidiaries and affiliates were adjusted but continue to maintain an overall 20% participation percentage; STFCs insurance subsidiaries will maintain its 80% participation percentage.
119
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
(a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Notes to Consolidated Financial Statements, Continued
In conjunction with the Pooling Arrangement amendment, the STFC Pooled Companies will
receive approximately $92.0 million in cash, for additional net insurance liabilities assumed on January 1, 2008. All parties that participate in the Pooling Arrangement, effective January 1, 2008, have an A.M. Best rating of A+
(Superior). The following table presents an estimate of the impact on the Companys balance sheet at January 1, 2008, for additional net insurance liabilities.
|
|
|
|
|
($ millions)
|
|
|
|
Losses and loss expense payable
|
|
$
|
51.3
|
|
Unearned premiums
|
|
|
53.6
|
|
Deferred policy acquisition costs
|
|
|
(12.9
|
)
|
|
|
|
|
|
Net cash received
|
|
$
|
92.0
|
|
|
|
|
|
|
|
|
|
|
|
120