XNAS:STFC State Auto Financial Corp Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

x Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended March 31, 2012

or

 

¨ Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from _________ to _________

Commission File Number 000-19289

STATE AUTO FINANCIAL CORPORATION

(Exact name of Registrant as specified in its charter)

 

Ohio   31-1324304

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

518 East Broad Street, Columbus, Ohio   43215-3976
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (614) 464-5000

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes  x    No   ¨

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

Yes  x    No   ¨

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ¨                                     Accelerated filer  x                                     Non-accelerated filer  ¨

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  ¨     No  x

On April 27, 2012, the Registrant had 40,376,941 Common Shares outstanding.

 

 

 


Table of Contents

Index to Form 10-Q Quarterly Report for the three month period ended March 31, 2012

 

   Part I. Financial Information   

Item 1.

   Financial Statements (Unaudited)   
   Condensed consolidated balance sheets – March 31, 2012 and December 31, 2011      1   
   Condensed consolidated statements of income – Three months ended March 31, 2012 and 2011      2   
   Condensed consolidated statements of cash flows – Three months ended March 31, 2012 and 2011      4   
   Notes to condensed consolidated financial statements – March 31, 2012      5   

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      24   

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk      53   

Item 4.

   Controls and Procedures      53   
   Part II. Other Information   
     

Item 1.

   Legal Proceedings      54   

Item 1A.

   Risk Factors      55   

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds      55   

Item 3.

   Defaults upon Senior Securities      55   

Item 4.

   Reserved      55   

Item 5.

   Other Information      55   

Item 6.

   Exhibits      55   
   Signatures      56   


Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

 

 

 

PART I – FINANCIAL STATEMENTS

Item 1. Condensed Consolidated Balance Sheets

 

($ millions, except per share amount)    March 31
2012
(unaudited)
    December 31
2011
As adjusted
 
       (see note 1)   

Assets

    

Fixed maturities, available-for-sale, at fair value
(amortized cost $1,787.1 and $1,817.3, respectively)

   $ 1,904.1        1,934.9   

Equity securities, available-for-sale, at fair value
(cost $142.7 and $141.7, respectively)

     179.9        167.3   

Other invested assets, available-for-sale, at fair value
(cost $48.9 and $48.6, respectively)

     61.5        57.2   

Other invested assets

     0.5        0.5   

Notes receivable from affiliate

     70.0        70.0   
  

 

 

   

 

 

 

Total investments

     2,216.0        2,229.9   

Cash and cash equivalents

     63.0        356.0   

Accrued investment income and other assets

     30.9        30.2   

Deferred policy acquisition costs

     94.2        91.7   

Reinsurance recoverable on losses and loss expenses payable
(affiliates none)

     27.0        25.5   

Prepaid reinsurance premiums (affiliates none)

     8.5        7.9   

Current federal income taxes

     12.3        12.3   

Net deferred federal income taxes

     0.6        0.5   

Property and equipment, at cost

     10.3        10.4   
  

 

 

   

 

 

 

Total assets

   $ 2,462.8        2,764.4   
  

 

 

   

 

 

 

Liabilities and Stockholders’ Equity

    

Losses and loss expenses payable (affiliates $368.6 and $376.8, respectively)

   $ 920.2        907.1   

Unearned premiums (affiliates $108.3 and $98.4, respectively)

     479.3        470.2   

Notes payable (affiliates $15.5 and $15.5, respectively)

     116.3        116.4   

Postretirement and pension benefits

     111.1        112.8   

Due to affiliate

     2.0        349.4   

Other liabilities

     101.6        84.7   
  

 

 

   

 

 

 

Total liabilities

     1,730.5        2,040.6   

Stockholders’ equity:

    

Class A Preferred stock (nonvoting), without par value. Authorized 2.5 shares; none issued

     —          —     

Class B Preferred stock, without par value. Authorized 2.5 shares; none issued

     —          —     

Common stock, without par value. Authorized 100.0 shares; 47.1 and 47.1 shares issued, respectively, at stated value of $2.50 per share

     117.8        117.8   

Treasury stock, 6.8 and 6.8 shares, respectively, at cost

     (115.8     (115.8

Additional paid-in capital

     128.1        127.3   

Accumulated other comprehensive income

     79.5        63.8   

Retained earnings

     522.7        530.7   
  

 

 

   

 

 

 

Total stockholders’ equity

     732.3        723.8   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 2,462.8        2,764.4   
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

1


Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

 

 

 

Condensed Consolidated Statements of Income

 

($ millions, except per share amounts)    Three months ended
March 31
 
(unaudited)        2012         2011
As adjusted
 
       (see note 1)   

Earned premiums (ceded to affiliates $196.9 and $205.5, respectively)

   $     254.9        350.2   

Net investment income (affiliate $1.2 and $1.2, respectively)

     17.5        21.0   

Net realized gain on investments:

    

Total other-than-temporary impairment losses

     (0.4     (0.1

Portion of loss recognized in other comprehensive income

     —          —     

Other net realized investment gains

     7.5        8.3   
  

 

 

   

 

 

 

Total net realized gain on investments

     7.1        8.2   

Other income from affiliates

     0.8        0.8   
  

 

 

   

 

 

 

Total revenues

     280.3        380.2   

Losses and loss expenses (ceded to affiliates $156.1 and $143.4, respectively)

     191.3        242.6   

Acquisition and operating expenses

     87.6        117.9   

Interest expense (affiliates $0.2 and $0.2, respectively)

     1.8        1.8   

Other expenses

     1.6        2.3   
  

 

 

   

 

 

 

Total expenses

     282.3        364.6   
  

 

 

   

 

 

 

(Loss) income before federal income taxes

     (2.0     15.6   

Federal income tax expense

     —          2.8   
  

 

 

   

 

 

 

Net (loss) income

   $ (2.0     12.8   
  

 

 

   

 

 

 

(Loss) earnings per common share:

    

Basic

   $ (0.05     0.32   
  

 

 

   

 

 

 

Diluted

   $ (0.05     0.32   
  

 

 

   

 

 

 

Dividends paid per common share

   $ 0.15        0.15   
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

2


Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

 

 

 

Consolidated Statements of Comprehensive Income

 

($ millions, except per share amounts)    Three months ended
March 31
 
(unaudited)    2012     2011
As adjusted
 
       (see note 1)   

Net (loss) income

   $ (2.0     12.8   

Other comprehensive income, net of tax:

    

Net unrealized holding gains on investments:

    

Unrealized holding gain arising during year

     22.1        15.0   

Reclassification adjustments for gains realized in net (loss) income

     (7.1     (8.2

Income tax expense

     —          (2.3
  

 

 

   

 

 

 

Total net unrealized holding gains on investments

     15.0        4.5   

Net unrecognized benefit plan obligations:

    

Reclassification adjustments for amortization to statements of income:

    

Transition asset

     0.1        (0.1

Negative prior service cost

     (1.3     (0.3

Net actuarial loss

     1.9        1.7   

Income tax benefit

     —          (0.5
  

 

 

   

 

 

 

Total net unrecognized benefit plan obligations

     0.7        0.8   
  

 

 

   

 

 

 

Other comprehensive income

     15.7        5.3   
  

 

 

   

 

 

 

Comprehensive income

   $         13.7        18.1   
  

 

 

   

 

 

 

 

3


Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

 

 

 

Condensed Consolidated Statements of Cash Flows

 

($ millions)    Three months ended
March 31
 
(unaudited)    2012     2011
As adjusted
 
       (see Note 1)   

Cash flows from operating activities:

    

Net (loss) income

   $ (2.0     12.8   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization, net

     2.7        2.1   

Share-based compensation

     0.8        0.8   

Net realized gain on investments

     (7.1     (8.2

Changes in operating assets and liabilities:

    

Deferred policy acquisition costs

     (2.5     1.1   

Accrued investment income and other assets

     (0.8     (2.4

Postretirement and pension benefits

     (1.1     5.7   

Other liabilities and due to/from affiliates, net

     (16.6     (16.8

Reinsurance recoverable on losses and loss expenses payable and prepaid reinsurance premiums

     (2.1     0.6   

Losses and loss expenses payable

     13.1        13.7   

Unearned premiums

     9.0        (6.9

Federal income taxes

     —          2.8   

Cash used in Homeowners’ Quota Share initial net unearned premium transfer

     (75.5     —     

Cash (used in) provided from pooling changes, December 31, 2011 and January 1, 2011 (see Note 4)

     (261.4     69.1   
  

 

 

   

 

 

 

Net cash (used in) provided by operating activities

     (343.5     74.4   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Purchases of fixed maturities – available-for-sale

     (76.8     (188.2

Purchases of equity securities – available-for-sale

     (24.0     (56.2

Purchases of other invested assets

     (0.5     (0.5

Maturities, calls and pay downs of fixed maturities – available-for-sale

     84.7        89.7   

Sales of fixed maturities – available-for-sale

     45.9        21.4   

Sales of equity securities – available-for-sale

     27.0        45.6   

Sales of other invested assets

     0.2        0.3   

Sale of subsidiary, net of expenses

     —          13.2   
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     56.5        (74.7
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Proceeds from issuance of common stock

     —          0.4   

Payment of dividends

     (6.0     (6.0
  

 

 

   

 

 

 

Net cash used in financing activities

     (6.0     (5.6
  

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (293.0     (5.9

Cash and cash equivalents at beginning of period

     356.0        88.3   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 63.0        82.4   
  

 

 

   

 

 

 

Supplemental disclosures:

    

Interest paid (affiliates $0.2 and $0.2, respectively)

   $ 0.2        0.2   
  

 

 

   

 

 

 

Federal income taxes paid

   $         —          —     
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

4


Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Notes to Condensed Consolidated Financial Statements, Continued (Unaudited)

 

 

 

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of State Auto Financial Corporation and Subsidiaries (“State Auto Financial” or the “Company”) have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements. In the opinion of the Company, all adjustments (consisting of normal, recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three month period ended March 31, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2011. The balance sheet at December 31, 2011 has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete financial statements.

For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2011 (the “2011 Form 10-K”). Capitalized terms used herein and not otherwise defined shall have the meaning ascribed to them in the 2011 Form 10-K.

Adoption of Accounting Pronouncements

Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts

In October 2010, the FASB issued updated guidance to address diversity in practice for the accounting of costs associated with acquiring or renewing insurance contracts. This guidance modifies the definition of acquisition costs to specify that a cost be directly related to the successful acquisition of a new or renewal insurance contract in order to be deferred. This guidance was effective for fiscal years beginning after December 15, 2011. The Company adopted this guidance, with retrospective application, at January 1, 2012. The cumulative effect of the retrospective adoption of this guidance reduced stockholders’ equity by $20.5 million, after-tax, at January 1, 2010. Previously reported financial information has been revised to reflect the effect of the Company’s adoption of this accounting standard.

The effect of adoption of this new guidance on the Company’s consolidated balance sheet as of December 31, 2011 and 2010 and on stockholder’s equity as of December 31, 2009 was as follows:

 

($ in millions)    As
Previously
Reported
    Effect of
Change
    As
Adjusted
 

December 31, 2011:

      

Deferred policy acquisition costs

   $ 118.1      $ (26.4   $ 91.7   

Other liabilities

     76.6        8.1        84.7   

Deferred federal income taxes

     0.5               0.5   

Retained earnings

     565.2        (34.5     530.7   

Stockholders’ equity

     758.3        (34.5     723.8   

December 31, 2010:

      

Deferred policy acquisition costs

   $ 150.2      $ (31.7   $ 118.5   

Deferred income tax liability

     (86.3     (11.1     (97.4

Retained earnings

     736.1        (20.6     715.5   

Stockholders’ equity

     851.8        (20.6     831.2   

December 31, 2009:

      

Retained earnings

   $ 735.6      $ (20.5   $ 715.1   

Stockholders’ equity

     849.4        (20.5     828.9   

 

5


Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Notes to Condensed Consolidated Financial Statements, Continued (Unaudited)

 

 

 

The effect of adoption of this new guidance on the consolidated income statement for the three months ended March 31, 2011 was as follows:

 

($ in millions, except per share amounts)    Three Months Ended March 31, 2011  
                     
    

As

Previously

     Effect of     As  
     Reported      Change     Adjusted  

Acquisition and operating expenses

   $ 118.1       $ (0.2   $ 117.9   

Income tax expense

     2.7         0.1        2.8   

Net income

     12.7         0.1        12.8   

Earnings Per Share:

       

Basic

   $ 0.32       $ —        $ 0.32   

Diluted

   $ 0.32       $ —        $ 0.32   

Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS

The amendments in this guidance result in common fair value measurement and disclosure requirements in GAAP and International Financial Reporting Standards (“IFRS”). Consequently, the amendments in the guidance change the wording used to describe many of the requirements in GAAP for measuring fair value and for disclosing information about fair value measurements. For many of the requirements, the FASB does not intend for the amendments in the guidance to result in a change in the application of the requirements in the Fair Value Measurements Topic. The guidance also clarifies the FASB’s intent about the application of existing fair value measurement requirements as well as changes to a particular principle or requirement for measuring fair value or for disclosing information about fair value measurements. This guidance was effective on a prospective basis for fiscal years and interim periods beginning after December 15, 2011. The Company’s adoption of this guidance at January 1, 2012 and did not have a material impact on its consolidated financial statements.

Testing Goodwill for Impairment

In September 2011, the FASB issued updated guidance in relation to testing goodwill for impairment. The amendments in the update permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment. The more-likely-than-not threshold is defined as having a likelihood of a more than 50 percent. Previous guidance under Topic 350 (Intangibles, Goodwill and Other), required an entity to test goodwill for impairment on an annual basis. Under this updated guidance, the test for impairment should be performed on an annual basis unless an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. If the fair value of a reporting unit is less than its carrying amount, the second step of the test must be performed to measure the amount of the impairment loss, if any. However, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. This guidance was effective for fiscal years and interim periods beginning after December 15, 2011, with early adoption permitted. The Company’s adoption of this guidance at January 1, 2012 and did not have any impact on its consolidated financial statements.

 

6


Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Notes to Condensed Consolidated Financial Statements, Continued (Unaudited)

 

 

 

2. Investments

The following tables set forth the cost or amortized cost and fair value of available-for-sale securities by lot at March 31, 2012 and December 31, 2011:

 

($ millions)    Cost or
amortized
cost
     Gross
unrealized
holding

gains
     Gross
unrealized
holding
losses
    Fair
value
 

At March 31, 2012:

          

Fixed maturities:

          

U.S. treasury securities and obligations of U.S. government agencies

   $ 417.6         34.2         (0.4     451.4   

Obligations of states and political subdivisions

     731.9         51.1         (0.1     782.9   

Corporate securities

     230.1         14.4         (0.1     244.4   

U.S. government agencies residential mortgage-backed securities

     407.5         19.1         (1.2     425.4   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total fixed maturities

     1,787.1         118.8         (1.8     1,904.1   

Equity securities:

          

Large-cap securities

     105.8         26.0         (1.7     130.1   

Small-cap securities

     36.9         12.9         —          49.8   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total equity securities

     142.7         38.9         (1.7     179.9   

Other invested assets

     48.9         12.6         —          61.5   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total available-for-sale securities

   $ 1,978.7         170.3         (3.5     2,145.5   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

($ millions)    Cost or
amortized
cost
     Gross
unrealized
holding

gains
     Gross
unrealized
holding
losses
    Fair
value
 

At December 31, 2011:

          

Fixed maturities:

          

U.S. treasury securities and obligations of U.S. government agencies

   $ 433.8         35.0         (0.1     468.7   

Obligations of states and political subdivisions

     761.3         50.0         (0.1     811.2   

Corporate securities

     231.4         13.7         (0.3     244.8   

U.S. government agencies residential mortgage-backed securities

     390.8         20.3         (0.9     410.2   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total fixed maturities

     1,817.3         119.0         (1.4     1,934.9   

Equity securities:

          

Large-cap securities

     106.4         18.9         (3.2     122.1   

Small-cap securities

     35.3         9.9         —          45.2   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total equity securities

     141.7         28.8         (3.2     167.3   

Other invested assets

     48.6         8.6         —          57.2   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total available-for-sale securities

   $ 2,007.6         156.4         (4.6     2,159.4   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Notes to Condensed Consolidated Financial Statements, Continued (Unaudited)

 

 

 

The following tables set forth the Company’s gross unrealized losses and fair value on its investments by lot, aggregated by investment category and length of time for individual securities that have been in a continuous unrealized loss position at March 31, 2012 and December 31, 2011:

 

($ millions, except # of positions)    Less than 12 months      12 months or more      Total  
      Fair
value
     Unrealized
losses
    Number
of
positions
     Fair
value
     Unrealized
losses
    Number
of
positions
     Fair
value
     Unrealized
losses
    Number
of
positions
 

At March 31, 2012:

                       

Fixed maturities:

                       

U.S. treasury securities and obligations of U.S. government agencies

   $ 40.9       $ (0.4     11       $ 3.4       $ —          2       $ 44.3       $ (0.4     13   

Obligations of states and political subdivisions

     2.6         (0.1     1         —           —          —           2.6         (0.1     1   

Corporate securities

     16.2         (0.1     5         —           —          —           16.2         (0.1     5   

U.S. government agencies residential mortgage-backed securities

     25.6         (0.3     8         33.9         (0.9     12         59.5         (1.2     20   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total fixed maturities

     85.3         (0.9     25         37.3         (0.9     14         122.6         (1.8     39   

Large-cap equity securities

     14.6         (1.7     8         —           —          —           14.6         (1.7     8   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total temporarily impaired securities

   $ 99.9       $ (2.6     33       $ 37.3       $ (0.9     14       $ 137.2       $ (3.5     47   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

($ millions, except # of positions)    Less than 12 months      12 months or more      Total  
      Fair
value
     Unrealized
losses
    Number
of
positions
     Fair
value
     Unrealized
losses
    Number
of
positions
     Fair
value
     Unrealized
losses
    Number
of
positions
 

At December 31, 2011:

                       

Fixed maturities:

                       

U.S. treasury securities and obligations of U.S. government agencies

   $ 5.0       $ —          1       $ 9.0       $ (0.1     3       $ 14.0       $ (0.1     4   

Obligations of states and political subdivisions

     8.9         (0.1     4         2.1         —          1         11.0         (0.1     5   

Corporate securities

     23.0         (0.3     9         —           —          —           23.0         (0.3     9   

U.S. government agencies residential mortgage-backed securities

     18.3         (0.1     4         35.3         (0.8     13         53.6         (0.9     17   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total fixed maturities

     55.2         (0.5     18         46.4         (0.9     17         101.6         (1.4     35   

Large-cap equity securities

     19.3         (3.0     9         2.7         (0.2     1         22.0         (3.2     10   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total temporarily impaired securities

   $ 74.5       $ (3.5     27       $ 49.1       $ (1.1     18       $ 123.6       $ (4.6     45   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

8


Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Notes to Condensed Consolidated Financial Statements, Continued (Unaudited)

 

 

 

The following table sets forth the realized losses related to other-than-temporary impairments on the Company’s investment portfolio recognized for the three months ended March 31, 2012 and 2011:

 

($ millions)    Three months ended
March  31
 
     2012      2011  

Equity securities:

     

Small-cap securities

   $ 0.4         0.1   
  

 

 

    

 

 

 

Total other-than-temporary impairments

   $ 0.4         0.1   
  

 

 

    

 

 

 

The Company did not recognize other-than-temporary impairments on its fixed maturity securities for the three months ended March 31, 2012 and 2011. The Company reviewed its investments at March 31, 2012, and determined no additional other-than-temporary impairment existed in the gross unrealized holding losses.

The Company regularly monitors its investments that have fair values less than cost or amortized cost for signs of other-than-temporary impairment, an assessment that requires significant management judgment regarding the evidence known. Such judgments could change in the future as more information becomes known, which could negatively impact the amounts reported. Among the factors that management considers for fixed maturity securities are the financial condition of the issuer including receipt of scheduled principal and interest cash flows, and intent to sell including if it is more likely than not that the Company will be required to sell the investments before recovery. When a fixed maturity has been determined to have an other-than-temporary impairment, the impairment charge is separated into an amount representing the credit loss, which is recognized in earnings as a realized loss, and the amount related to non-credit factors, which is recognized in accumulated other comprehensive income. Future increases or decreases in fair value, if not other-than-temporary, are included in accumulated other comprehensive income.

Among the factors that management considers for equity securities and other invested assets are the length of time and/or the significance of decline below cost, the Company’s ability and intent to hold these securities through their recovery periods, the current financial condition of the issuer and its future business prospects, and the ability of the market value to recover to cost in the near term. When an equity security or other invested asset has been determined to have a decline in fair value that is other-than-temporary, the cost basis of the security is adjusted to fair value. This results in a charge to earnings as a realized loss, which is not reversed for subsequent recoveries in fair value. Future increases or decreases in fair value, if not other-than-temporary, are included in accumulated other comprehensive income.

The following table sets forth the amortized cost and fair value of available-for-sale fixed maturities by contractual maturity at March 31, 2012:

 

($ millions)    Amortized
cost
     Fair
value
 

Due in 1 year or less

   $ 37.2         37.6   

Due after 1 year through 5 years

     354.6         374.0   

Due after 5 years through 10 years

     502.5         542.1   

Due after 10 years

     485.3         525.0   

U.S. government agencies residential mortgage-backed securities

     407.5         425.4   
  

 

 

    

 

 

 

Total

   $ 1,787.1         1,904.1   
  

 

 

    

 

 

 

Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay the obligations with or without call or prepayment penalties.

Fixed maturities with fair values of $9.9 million were on deposit with insurance regulators as required by law at March 31, 2012 and December 31, 2011.

 

9


Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Notes to Condensed Consolidated Financial Statements, Continued (Unaudited)

 

 

 

The following table sets forth the components of net investment income for the three months ended March 31, 2012 and 2011:

 

($ millions)    Three months ended
March  31
 
     2012      2011  

Fixed maturities

   $ 15.7         18.9   

Equity securities

     1.0         1.3   

Cash and cash equivalents, and other

     1.4         1.4   
  

 

 

    

 

 

 

Investment income

     18.1         21.6   

Investment expenses

     0.6         0.6   
  

 

 

    

 

 

 

Net investment income

   $ 17.5         21.0   
  

 

 

    

 

 

 

The Company’s current investment strategy does not rely on the use of derivative financial instruments.

The following table sets forth the realized and unrealized holding gains (losses) on the Company’s investment portfolio for the three months ended March 31, 2012 and 2011:

 

($ millions)    Three months ended
March 31
 
     2012     2011  

Realized gains:

    

Fixed maturities

   $ 3.1      $ 0.9   

Equity securities

     4.4        8.8   
  

 

 

   

 

 

 

Total realized gains

     7.5        9.7   

Realized losses:

    

Equity securities:

    

Sales

     —          (1.4

OTTI

     (0.4     (0.1
  

 

 

   

 

 

 

Total realized losses

     (0.4     (1.5
  

 

 

   

 

 

 

Net realized gain on investments

   $ 7.1      $ 8.2   
  

 

 

   

 

 

 

Change in unrealized holding gains (losses), net of tax:

    

Fixed maturities

   $ (0.6   $ (3.1

Equity securities

     11.6        7.2   

Other invested assets

     4.0        2.7   

Deferred federal income tax liability thereon

     (5.4     (2.3

Valuation allowance

     5.4        —     
  

 

 

   

 

 

 

Change in net unrealized holding gains (losses), net of tax

   $ 15.0      $ 4.5   
  

 

 

   

 

 

 

There was a deferred federal income tax liability on the net unrealized holding gains at March 31, 2012 and December 31, 2011, of $53.1 million, net of a valuation allowance of $5.4 million, and $53.1 million, respectively.

 

10


Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Notes to Condensed Consolidated Financial Statements, Continued (Unaudited)

 

 

 

3. Fair Value of Financial Instruments

Below is the fair value hierarchy that categorizes into three levels the inputs to valuation techniques that are used to measure fair value:

 

   

Level 1 includes observable inputs which reflect quoted prices for identical assets or liabilities in active markets at the measurement date.

   

Level 2 includes observable inputs for assets or liabilities other than quoted prices included in Level 1, and it includes valuation techniques which use prices for similar assets and liabilities.

   

Level 3 includes unobservable inputs which reflect the reporting entity’s estimates of the assumptions that market participants would use in pricing the asset or liability (including assumptions about risk).

The Company utilizes one nationally recognized pricing service to estimate the majority of its available-for-sale investment portfolio’s fair value. The Company obtains one price per security and the processes and control procedures employed by the Company are designed to ensure the value is accurately recorded on an unadjusted basis. Through discussions with the pricing service, the Company gains an understanding of the methodologies used to price the different types of securities, that the data and the valuation methods utilized are appropriate and consistently applied, and that the assumptions are reasonable and representative of fair value. To validate the reasonableness of the valuations obtained from the pricing service, the Company compares to other fair value pricing information gathered from other independent pricing sources. At March 31, 2012 and December 31, 2011, the Company did not adjust any of the prices received from the pricing service.

Transfers between level categorizations may occur due to changes in the availability of market observable inputs. Transfers in and out of level categorizations are reported as having occurred at the beginning of the quarter in which the transfer occurred. There were no transfers between level categorizations during the three months ended March 31, 2012 and 2011.

The following sections describe the valuation methods used by the Company for each type of financial instrument it holds that are carried at fair value:

Fixed Maturities

The Company utilizes a third party pricing service to estimate fair value measurements for the majority of its fixed maturities. The fair value estimate of the Company’s fixed maturity investments are determined by evaluations that are based on observable market information rather than market quotes. Inputs to the evaluations include, but are not limited to, market prices from recently completed transactions and transactions of comparable securities, interest rate yield curves, credit spreads, and other market-observable information. The fixed maturity portfolio pricing obtained from the pricing service is reviewed for reasonableness. Regularly, a sample of security prices are referred back to the pricing service for more detailed explanation as to how the pricing service arrived at that particular price. The explanations are reviewed for reasonableness by the portfolio manager and investment officer. Additionally, the prices and assumptions are verified against an alternative pricing source for reasonableness and accuracy. Any discrepancies with the pricing are returned to the pricing service for further explanation and if necessary, adjustments are made. To date, the Company has not identified any significant discrepancies in the pricing provided by its third party pricing service. Investments valued using these inputs include U.S. treasury securities and obligations of U.S. government agencies, obligations of states and political subdivisions, corporate securities (except for one security discussed below), and U.S. government agencies residential mortgage-backed securities. All unadjusted estimates of fair value for fixed maturities priced by the pricing service are included in the amounts disclosed in Level 2 of the hierarchy. If market inputs are unavailable, then no fair value is provided by the pricing service. For these securities, fair value is determined either by requesting brokers who are knowledgeable about these securities to provide a quote; or the Company internally determines the fair values by employing widely accepted pricing valuation models, and depending on the level of observable market inputs, renders the fair value estimate as Level 2 or Level 3. The Company holds one fixed maturity corporate security for which the Company estimates the fair value of this security using the present value of the future cash flows. Due to the limited amount of observable market information, the Company includes the fair value estimates for this security in Level 3.

 

11


Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Notes to Condensed Consolidated Financial Statements, Continued (Unaudited)

 

 

 

Equities

The fair value of each equity security is based on an observable market price for an identical asset in an active market and is priced by the same pricing service discussed above. All equity securities are recorded using unadjusted market prices and have been disclosed in Level 1.

Other Invested Assets

Included in other invested assets are two international private equity funds (“the funds”) that invest in equity securities of foreign issuers and are managed by third party investment managers. The funds had a fair value of $56.2 million and $52.6 million at March 31, 2012 and December 31, 2011, respectively, which was determined using each fund’s net asset value. The Company employs procedures to assess the reasonableness of the fair value of the funds including obtaining and reviewing each fund’s audited financial statements. There are no unfunded commitments related to the funds. The Company may not sell its investment in the funds; however, the Company may redeem all or a portion of its investment in the funds at net asset value per share with the appropriate prior written notice. Due to the Company’s ability to redeem its investment in the funds at net asset value per share at the measurement date, the funds have been disclosed in Level 2.

The remainder of the Company’s other invested assets consist primarily of holdings in publicly-traded mutual funds. The Company believes that its prices for these publicly-traded mutual funds based on an observable market price for an identical asset in an active market reflect their fair values and consequently these securities have been disclosed in Level 1.

 

12


Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Notes to Condensed Consolidated Financial Statements, Continued (Unaudited)

 

 

 

The following tables set forth the Company’s available-for-sale investments within the fair value hierarchy at March 31, 2012 and December 31, 2011:

 

($ millions)    Total      Quoted prices
in active
markets for
identical

assets
(Level 1)
     Significant
other
observable
inputs
(Level 2)
     Significant
unobservable
inputs
(Level 3)
 

At March 31, 2012:

           

Fixed maturities:

           

U.S. treasury securities and obligations of U.S. government agencies

   $ 451.4         —           451.4         —     

Obligations of states and political subdivisions

     782.9         —           782.9         —     

Corporate securities

     244.4         —           241.5         2.9   

U.S. government agencies residential mortgage-backed securities

     425.4         —           425.4         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities

     1,904.1         —           1,901.2         2.9   

Equity securities:

           

Large-cap securities

     130.1         130.1         —           —     

Small-cap securities

     49.8         49.8         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total equity securities

     179.9         179.9         —           —     

Other invested assets

     61.5         5.3         56.2         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale investments

   $ 2,145.5         185.2         1,957.4         2.9   
  

 

 

    

 

 

    

 

 

    

 

 

 
($ millions)    Total      Quoted prices
in active
markets for
identical

assets
(Level 1)
     Significant
other
observable
inputs
(Level 2)
     Significant
unobservable
inputs
(Level 3)
 

At December 31, 2011:

           

Fixed maturities:

           

U.S. treasury securities and obligations of U.S. government agencies

   $ 468.7         —           468.7         —     

Obligations of states and political subdivisions

     811.2         —           811.2         —     

Corporate securities

     244.8         —           241.9         2.9   

U.S. government agencies residential mortgage-backed securities

     410.2         —           410.2         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities

     1,934.9         —           1,932.0         2.9   

Equity securities:

           

Large-cap securities

     122.1         122.1         —           —     

Small-cap securities

     45.2         45.2         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total equity securities

     167.3         167.3         —           —     

Other invested assets

     57.2         4.6         52.6         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale investments

   $ 2,159.4         171.9         1,984.6         2.9   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

13


Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Notes to Condensed Consolidated Financial Statements, Continued (Unaudited)

 

 

 

For assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3), the following tables set forth a reconciliation of the beginning and ending balances for the three months ended March 31, 2012 and the year ended December 31, 2011, separately for each major category of assets:

 

($ millions)    Fixed
    maturities    
 

Balance at January 1, 2012

   $ 2.9   

Total realized gains (losses) – included in earnings

     —     

Total unrealized gains (losses) – included in other comprehensive income

     —     

Purchases

     —     

Sales

     —     

Transfers into Level 3

     —     

Transfers out of Level 3

     —     
  

 

 

 

Balance at March 31, 2012

   $ 2.9   
  

 

 

 
($ millions)    Fixed
maturities
 

Balance at January 1, 2011

   $ 2.7   

Total realized gains (losses) – included in earnings

     —     

Total unrealized gains (losses) – included in other comprehensive income

     —     

Purchases

     0.6   

Sales

     (0.4

Transfers into Level 3

     —     

Transfers out of Level 3

     —     
  

 

 

 

Balance at December 31, 2011

   $         2.9   
  

 

 

 

The following sections describe the valuation methods used by the Company for each type of financial instrument it holds that is not measured at fair value but for which fair value is disclosed:

Notes Receivable from Affiliates

In May 2009, the Company entered into two separate credit agreements with State Auto Mutual pursuant to which it loaned State Auto Mutual a total of $70.0 million. Under these agreements, State Auto Financial earned interest of $1.2 million for the three months ended March 31, 2012 and 2011. Interest income is included in net investment income on the condensed consolidated statements of income.

The Company estimates the fair value of the notes receivable from affiliate using market quotations for U.S. treasury securities with similar maturity dates and applies an appropriate credit spread. Consequently this has been placed in Level 2 of the fair value hierarchy.

 

($ millions, except interest rates)    March 31, 2012     December 31, 2011  
     Carrying
value
     Fair
value
     Interest
rate
    Carrying
value
     Fair
value
     Interest
rate
 

Notes receivable from affiliate

   $         70.0       $ 77.6         7.00   $         70.0       $ 77.5         7.00
  

 

 

    

 

 

      

 

 

    

 

 

    

 

14


Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Notes to Condensed Consolidated Financial Statements, Continued (Unaudited)

 

 

 

Notes Payable

Included in notes payable are Senior Notes and Subordinated Debentures. The fair value of the Senior Notes is based on the observable market price and has been disclosed in Level 2. The carrying amount of the Subordinated Debentures approximates its fair value as the interest rate adjusts quarterly and has been disclosed in Level 3.

 

($ millions, except interest rates)    March 31, 2012     December 31, 2011  
     Carrying
value
     Fair
value
     Interest
rate
    Carrying
value
     Fair
value
     Interest
rate
 

Senior Notes due 2013: issued $100.0, November 2003 with fixed interest

   $ 100.8       $ 98.9         6.25   $ 100.9       $ 100.3         6.25

Affiliate Subordinated Debentures due 2033: issued $15.5, May 2003 with variable interest

     15.5         15.5         4.69        15.5         15.5         4.73   
  

 

 

    

 

 

      

 

 

    

 

 

    

Total notes payable

   $ 116.3       $ 114.4         $ 116.4       $ 115.8      
  

 

 

    

 

 

      

 

 

    

 

 

    

The following table sets forth the Company’s assets and liabilities within the fair value hierarchy at March 31, 2012:

 

($ millions)    Total      Quoted prices
in active
markets for
identical

assets
(Level 1)
     Significant
other
observable
inputs
(Level 2)
     Significant
unobservable
inputs
(Level 3)
 
At March 31, 2012:            

Assets:

           

Notes receivable from affiliate

   $ 77.6         —           77.6         —     

Liabilities:

           

Senior Notes

     98.9         —           98.9         —     

Affiliate Subordinated Debentures

     15.5         —           —           15.5   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities

   $ 114.4         —           98.9         15.5   

4. Reinsurance

The insurance subsidiaries of State Auto Financial, including State Auto Property & Casualty Insurance Company (“State Auto P&C”), Milbank Insurance Company, Farmers Casualty Insurance Company and State Auto Insurance Company of Ohio (collectively referred to as the “STFC Pooled Companies”) participate in a quota share reinsurance pooling arrangement (“the Pooling Arrangement”) with State Automobile Mutual Insurance Company (“State Auto Mutual”) and its subsidiaries and affiliates, State Auto Insurance Company of Wisconsin, State Auto Florida Insurance Company, Meridian Citizens Mutual Insurance Company, Meridian Security Insurance Company, Beacon National Insurance Company, Patrons Mutual Insurance Company of Connecticut, Litchfield Mutual Fire Insurance Company, Rockhill Insurance Company (“RIC”), Plaza Insurance Company (“Plaza”), American Compensation Insurance Company (“American Compensation”) and Bloomington Compensation Insurance Company (“Bloomington Compensation”), (collectively referred to as the “Mutual Pooled Companies”). RIC, Plaza, American Compensation and Bloomington Compensation are referred to as the “Rockhill Insurers.”

 

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Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Notes to Condensed Consolidated Financial Statements, Continued (Unaudited)

 

 

 

In conjunction with the January 1, 2011 Pooling Arrangement amendment, which added the Rockhill Insurers to the pool, the STFC Pooled Companies received $149.8 million ($69.1 million in cash and $80.7 million in investment securities) from the Rockhill Insurers for net insurance liabilities transferred on January 1, 2011. The following table sets forth the impact on the Company’s balance sheet at January 1, 2011, relating to this Pooling Arrangement amendment:

 

($ millions)       

Losses and loss expenses payable

   $ 124.1   

Unearned premiums

     34.1   

Other liabilities

     (0.1

Less:

  

Deferred acquisition costs

     8.3   
  

 

 

 

Net cash and investment securities received

   $ 149.8   
  

 

 

 

On December 31, 2011, the Pooling Arrangement was amended to reduce the overall participation percentage of the STFC Pooled Companies from 80% to 65% and to include the pooling of applicable balance sheet accounts such as applicable accumulated other comprehensive income related to employee benefit plans. In conjunction with this amendment, the STFC Pooled Companies paid $261.4 million in cash to the Mutual Pooled Companies in the first quarter 2012 for the net liabilities transferred on December 31, 2011. The following table sets forth the impact on the Company’s balance sheet at December 31, 2011, relating to this amendment:

 

($ millions)    (Decrease)/Increase  

Losses and loss expenses payable

   $ (203.4

Unearned premiums

     (106.8

Pension and postretirement liabilities

     (52.3

Other liabilities

     27.6   

Accumulated other comprehensive income

     59.1   

Less:

  

Deferred acquisition costs

     (21.8

Other assets

      7.4   
  

 

 

 

Net cash paid

   $ (261.4
  

 

 

 

 

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Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Notes to Condensed Consolidated Financial Statements, Continued (Unaudited)

 

 

 

The following table sets forth a summary of the Company’s external reinsurance transactions, as well as reinsurance transactions with State Auto Mutual under the Pooling Arrangement, for the three months ended March 31, 2012 and 2011:

 

($ millions)    Three months ended
March 31
 
     2012     2011  

Premiums earned:

    

Assumed from external insurers and reinsurers

   $ 1.0        8.5   

Assumed under Pooling Arrangement

     254.9        350.2   

Ceded to external insurers and reinsurers

     (7.4     (6.1

Ceded under Pooling Arrangement

     (196.9     (205.5
  

 

 

   

 

 

 

Net assumed premiums earned

   $ 51.6        147.1   
  

 

 

   

 

 

 

Losses and loss expenses incurred:

    

Assumed from external insurers and reinsurers

   $ 0.9        5.7   

Assumed under Pooling Arrangement

     191.5        241.6   

Ceded to external insurers and reinsurers

     (5.8     (5.3

Ceded under Pooling Arrangement

     (156.1     (143.4
  

 

 

   

 

 

 

Net assumed losses and loss expenses incurred

   $         30.5        98.6   
  

 

 

   

 

 

 

5. Income Taxes

The following table sets forth the reconciliation between actual federal income tax benefit and the amount computed at the indicated statutory rate for the three months ended March 31, 2012 and 2011:

 

     Three months ended
March 31
 
($ millions)    2012     2011  
    

 

        %        

 

        %      

Amount at statutory rate

   $ (0.7     35      $ 5.5        35   

Tax-exempt interest and dividends received deduction

     (2.2     115        (3.1     (20

Other, net

     0.1        (5     0.4        2   

Valuation allowance

     2.8        (145     —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Federal income tax expense and effective rate

   $     —          —        $     2.8        17   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Notes to Condensed Consolidated Financial Statements, Continued (Unaudited)

 

 

 

The following table sets forth the tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities at March 31, 2012 and December 31, 2011:

 

($ millions)    March 31,
2012
     December 31,
2011
 

Deferred tax assets:

     

Unearned premiums not currently deductible

   $ 33.1         32.4   

Losses and loss expenses payable discounting

     25.3         25.0   

Postretirement and pension benefits

     38.8         39.4   

Realized loss on other-than-temporary impairment

     9.4         11.4   

Other liabilities

     13.7         14.9   

Net operating loss carryforward

     62.0         56.0   

Tax credit carryforward

     0.7         0.7   

Other

     9.5         9.2   
  

 

 

    

 

 

 

Total deferred tax assets

     192.5         189.0   

Deferred tax liabilities:

     

Deferral of policy acquisition costs

     33.0         32.1   

Net unrealized holding gains on investments

     58.4         53.1   
  

 

 

    

 

 

 

Total deferred tax liabilities

     91.4         85.2   
  

 

 

    

 

 

 

Total net deferred tax assets before valuation allowance

     101.1         103.8   
  

 

 

    

 

 

 

Less valuation allowance

     100.5         103.3   
  

 

 

    

 

 

 

Net deferred federal income taxes

   $ 0.6         0.5   
  

 

 

    

 

 

 

Deferred income tax assets and liabilities represent the tax effect of the differences between the financial statement carrying value of existing assets and liabilities and their respective tax bases. The Company periodically evaluates its deferred tax assets, which requires significant judgment, to determine if they are realizable based upon weighing all available evidence, both positive and negative, including loss carryback potential, past operating results, existence of cumulative losses in the most recent years, projected performance of the business, future taxable income, including the ability to generate capital gains, and prudent and feasible tax planning strategies. In making such judgments, significant weight is given to evidence that can be objectively verified. At March 31, 2012 and December 31, 2011 the Company recorded a valuation allowance of $100.5 million and $103.3 million, respectively. The $0.6 million and $0.5 million of deferred income tax asset remaining after recognition of the valuation allowance represents a deferred tax asset on the gross unrealized fixed maturity losses where management determined this portion of the asset to be realizable due to management’s assertion that it has both the ability and intent to hold these securities through recovery or maturity at March 31, 2012 and December 31, 2011, respectively. Based on FASB ASC 740 Intraperiod tax allocation, the change in the valuation allowance attributable to continuing operations and other comprehensive income for the three months ended March 31, 2012 is as follows:

 

($ millions)       

Continuing operations

   $ 2.8   

Other comprehensive income

     (5.6
  

 

 

 

Change in valuation allowance

   $ (2.8
  

 

 

 

In future periods the Company will re-assess its judgments and assumptions regarding the realization of its net deferred tax assets, but until such time the positive evidence exceeds the negative evidence the Company will maintain a valuation allowance against its net deferred tax assets.

 

18


Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Notes to Condensed Consolidated Financial Statements, Continued (Unaudited)

 

 

 

6. Pension and Postretirement Benefit Plans

The following table sets forth the components of net periodic cost for the State Auto Group’s pension and postretirement benefit plans for the three months ended March 31, 2012 and 2011:

 

     Pension     Postretirement  
($ millions)    Three months ended March 31  
     2012     2011     2012     2011  

Service cost

   $ 1.9        2.6      $     —          1.6   

Interest cost

     2.5        3.8        0.2        1.6   

Expected return on plan assets

     (2.9     (4.5     (0.1     (0.1

Amortization of:

        

Prior service costs (benefits)

     —          0.1        (1.3     (0.4

Transition assets

     —          (0.1     0.1        —     

Net loss

     1.7        1.7        0.2        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic cost (benefit)

   $     3.2            3.6      $ (0.9         2.7   
  

 

 

   

 

 

   

 

 

   

 

 

 

The Company contributed $3.3 million for the three months ended March 31, 2012 and expects to contribute an additional $9.8 million to the pension plan during 2012.

7. (Loss) Earnings per Common Share

The following table sets forth the compilation of basic and diluted net (loss) earnings per common share for the three months ended March 31, 2012 and 2011:

 

($ millions, except per share amounts)    Three months ended
March 31
 
         2012             2011      

Numerator:

    

Net income for basic (loss) earnings per common share

   $ (2.0     12.8   
  

 

 

   

 

 

 

Denominator:

    

Weighted average shares for basic net (loss) earnings per common share

     40.3        40.1   

Effect of dilutive share-based awards

     —          0.1   
  

 

 

   

 

 

 

Adjusted weighted average shares for diluted net (loss) earnings per common share

     40.3        40.2   
  

 

 

   

 

 

 

Basic net (loss) earnings per common share

   $ (0.05     0.32   

Diluted net (loss) earnings per common share

   $ (0.05     0.32   

 

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Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Notes to Condensed Consolidated Financial Statements, Continued (Unaudited)

 

 

 

The following table sets forth the options to purchase shares of common stock that were not included in the computation of diluted earnings per common share because the exercise price of the options was greater than the average market price or their inclusion would have been antidilutive for the three months ended March 31, 2012 and 2011:

 

(number of options in millions)    Three months ended
March 31
 
         2012              2011      

Number of options

     3.7         2.9   
  

 

 

    

 

 

 

8. Segment Information

The Company has four reportable segments: personal insurance, business insurance, specialty 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 market a broad line of property and casualty insurance products throughout the United States through independent insurance agencies, which include retail agents and wholesale brokers. The personal insurance segment provides primarily personal automobile and homeowners to the personal insurance market. The business insurance segment provides primarily commercial automobile, commercial multi-peril, fire & allied and general liability insurance covering small-to-medium sized commercial exposures in the business insurance market. The specialty insurance segment provides commercial coverages, including workers’ compensation for both legacy State Auto Group and RTW, Inc.’s insurance subsidiaries, that require specialized product underwriting, claims handling or risk management services through a distribution channel of retail agents and wholesale brokers, which may include program administrators and other specialty sources. The investment operations segment, managed by Stateco, provides investment services.

The Company evaluates the performance of its insurance segments using industry financial measurements based on Statutory Accounting Practices (“SAP”), which include loss and loss adjustment expense ratios, underwriting expense ratios, combined ratios, statutory underwriting gain (loss), net premiums earned and net written premiums. One of the most significant differences between SAP and GAAP is that SAP requires all underwriting expenses to be expensed immediately and not deferred and amortized over the same period the premium is earned. The investment operations segment is evaluated based on investment returns of assets managed by Stateco.

Asset information by segment is not reported for the insurance segments because the Company does not produce such information internally.

 

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Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Notes to Condensed Consolidated Financial Statements, Continued (Unaudited)

 

 

 

The following table sets forth financial information regarding the Company’s reportable segments for the three months ended March 31, 2012 and 2011:

 

($ millions)    Three months ended
March 31
 
         2012             2011      

Revenues from external sources:

    

Insurance segments

    

Personal insurance

   $ 117.5        203.6   

Business insurance

     77.3        94.8   

Specialty insurance

     60.1        51.8   
  

 

 

   

 

 

 

Total insurance segments

     254.9        350.2   

Investment operations segment

    

Net investment income

     17.5        21.0   

Net realized capital gains

     7.1        8.2   
  

 

 

   

 

 

 

Total investment operations segment

     24.6        29.2   

All other

     0.8        0.8   
  

 

 

   

 

 

 

Total revenues from external sources

     280.3        380.2   

Intersegment revenues

     (2.5     (2.6 )
  

 

 

   

 

 

 

Total revenues

     277.8        377.6   

Reconciling items:

    

Eliminate intersegment revenues

     2.5        2.6   
  

 

 

   

 

 

 

Total consolidated revenues

   $ 280.3        380.2   
  

 

 

   

 

 

 

Segment (loss) income before federal income tax:

    

Insurance segments

    

Personal insurance SAP underwriting (loss) gain

   $ (0.9     12.5   

Business insurance SAP underwriting loss

     (16.7     (11.9

Specialty insurance SAP underwriting loss

     (12.2     (15.3
  

 

 

   

 

 

 

Total insurance segments

     (29.8     (14.7

Investment operations segment

    

Net investment income

     17.5        21.0   

Net realized capital gains

     7.1        8.2   
  

 

 

   

 

 

 

Total investment operations segment

     24.6        29.2   

All other

     0.4        0.1   
  

 

 

   

 

 

 

Total segment (loss) income before tax expense

     (4.8     14.6   

Reconciling items:

    

GAAP expense adjustments

     5.3        3.3   

Interest expense on corporate debt

     (1.8     (1.8

Corporate expenses

     (0.7     (0.5
  

 

 

   

 

 

 

Total reconciling items

     2.8        1.0   
  

 

 

   

 

 

 

Total consolidated (loss) income before federal income tax expense

   $ (2.0     15.6   
  

 

 

   

 

 

 

 

21


Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Notes to Condensed Consolidated Financial Statements, Continued (Unaudited)

 

 

 

The following table sets forth revenues from external sources for reportable segments for the three months ended March 31, 2012 and 2011:

 

($ millions)    Three months ended
March 31
 
         2012              2011      

Earned premiums:

     

Personal insurance:

     

Personal auto

   $ 96.0         127.1   

Homeowners

     14.6         67.9   

Other personal

     6.9         8.6   
  

 

 

    

 

 

 

Total personal insurance earned premiums

     117.5         203.6   

Business insurance:

     

Commercial auto

     19.1         23.4   

Commercial multi-peril

     22.2         25.1   

Fire & allied lines

     18.6         24.2   

Other & product liability

     13.1         16.6   

Other business

     4.3         5.5   
  

 

 

    

 

 

 

Total business insurance earned premiums

     77.3         94.8   

Specialty insurance

     60.1         51.8   
  

 

 

    

 

 

 

Total earned premiums

     254.9         350.2   

Investment operations:

     

Net investment income

     17.5         21.0   

Net realized capital gain

     7.1         8.2   
  

 

 

    

 

 

 

Total investment operations

     24.6         29.2   
  

 

 

    

 

 

 

Total revenues from reportable segments

   $ 279.5         379.4   
  

 

 

    

 

 

 

Investable assets attributable to the Company’s investment operations segment totaled $2,279.0 million and $2,585.9 million at March 31, 2012 and December 31, 2011, respectively.

9. Contingencies and Litigation

The Company is involved in numerous lawsuits arising in the ordinary course of the Company’s business operations arising out of or otherwise related to its insurance policies. Certain of these lawsuits allege extra-contractual damages. These lawsuits are in various stages of development. The Company will generally contest these matters vigorously but may pursue settlement if appropriate. The Company considers all such litigation in establishing its loss and loss adjustment expense reserves. Based on currently available information, the Company does not believe it is reasonably possible that any such lawsuit or related lawsuits will be material to its results of operations or have a material adverse effect on its consolidated financial or cash flow position.

Additionally, from time to time the Company may be involved in lawsuits arising in the ordinary course of business but not arising out of or otherwise related to its insurance policies. Based on currently available information, the Company does not believe it is reasonably possible that any such lawsuit or related lawsuits will be material to its results of operations or have a material adverse effect on its consolidated financial or cash flow position.

In accordance with the Contingencies Topic of the FASB ASC, the Company accrues for a litigation-related liability when it is probable that such a liability has been incurred and the amount can be reasonably estimated. Based on currently available information known to the Company, the Company believes that its reserves for litigation-related liabilities are reasonable. Given the inherent uncertainty surrounding the ultimate resolution of these legal proceedings, an adverse outcome could have a material impact to the Company’s results of operations in a future period, though in the opinion of the Company’s management, none would likely have a material adverse effect on its consolidated financial or cash flow position.

 

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Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

Notes to Condensed Consolidated Financial Statements, Continued (Unaudited)

 

 

 

Additionally, the Company may be impacted by adverse regulatory actions and adverse court decisions where insurance coverages are expanded beyond the scope originally contemplated in its insurance policies. The Company believes that the effects, if any, of such regulatory actions and published court decisions are not likely to have a material adverse effect on its financial or its cash flow position.

 

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Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

 

 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operation

The term “State Auto Financial” as used below refers only to State Auto Financial Corporation and the terms “our Company,” “we,” “us,” and “our” as used below refer to State Auto Financial Corporation and its consolidated subsidiaries. The term “first quarter” as used below refers to the three months ended March 31 for the time period then ended. For a glossary of terms for State Auto Financial Corporation and its subsidiaries and affiliates and a glossary of selected insurance and accounting terms, see the section entitled “Important Defined Terms Used in this Form 10-K” included in our Annual Report on Form 10-K for the year ended December 31, 2011 (the “2011 Form 10-K”).

The discussion and analysis presented below relates to the material changes in financial condition and results of operations for our consolidated balance sheets as of March 31, 2012 and December 31, 2011, and for the consolidated statements of income for the three-month periods ended March 31, 2012 and 2011. This discussion and analysis should be read together with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in the 2011 Form 10-K, and in particular the discussions in those sections thereof entitled “Overview,” “Executive Summary” and “Critical Accounting Policies.” Readers are encouraged to review the entire 2011 Form 10-K, as it includes information regarding our Company not discussed in this Form 10-Q. This information will assist in your understanding of the discussion of our current period financial results.

The discussion and analysis presented below includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements generally can be identified by the use of forward-looking terminology such as “may,” “will,” “expect,” “intend,” “estimate,” “anticipate,” “project,” “believe” or “continue” or the negative thereof or variations thereon or similar terminology. Forward-looking statements speak only as of the date the statements were made. Although we believe that the expectations reflected in forward-looking statements have a reasonable basis, we can give no assurance that these expectations will prove to be correct. Forward-looking statements are subject to risks and uncertainties that could cause actual events or results to differ materially from those expressed in or implied by the statements. For a discussion of the most significant risks and uncertainties that could cause our actual results to differ materially from those projected, see “Risk Factors” in Item 1A of the 2011 Form 10-K, updated by Part II, Item 1A of this Form 10-Q. Except to the limited extent required by applicable law, we undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

The Company has four reportable segments: personal insurance, business insurance, specialty 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 market a broad line of property and casualty insurance products throughout the United States through independent insurance agencies, which include retail agents and wholesale brokers. The personal insurance segment provides primarily personal automobile and homeowners to the personal insurance market. The business insurance segment provides primarily commercial automobile, commercial multi-peril, fire & allied and general liability insurance covering small-to-medium sized commercial exposures in the business insurance market. The specialty insurance segment provides commercial coverages, including workers’ compensation for both the legacy State Auto Group and the RTW, Inc. insurance subsidiaries, that require specialized product underwriting, claims handling or risk management services through a distribution channel of retail agents and wholesale brokers, which may include program administrators and other specialty sources. The investment operations segment, managed by Stateco, provides investment services. See “Personal and Business Insurance” and “Specialty Insurance” in Item 1 of the 2011 Form 10-K for more information about our insurance segments. Financial information about our reportable segments for 2012 is set forth in Note 8 of our condensed consolidated financial statements included in Item 1 of this Form 10-Q.

 

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Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

 

 

 

CRITICAL ACCOUNTING POLICIES

Deferred Acquisition Costs

As of January 1, 2012, we adopted retrospectively the FASB guidance Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts. See “New Accounting Standards –Adoption of Accounting Pronouncements-Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts” included in this Item 2 and Note 1 of our condensed consolidated financial statements included in Item 1 of this Form 10-Q for the impact of this adoption at January 1, 2010. Acquisition costs, consisting of commissions, premium taxes and certain underwriting expenses related to the successful acquisition of acquiring or renewing the production of property and casualty business, are deferred and amortized over the same period in which the related premiums are earned. The method followed for computing the acquisition costs limits the amount of such deferred costs to their estimated realizable value. In determining estimated realizable value, the computation gives effect to the premiums to be earned, losses and loss expenses expected to be incurred, and certain other costs expected to be incurred as premium is earned. Future changes in estimates, the most significant of which is expected losses and loss adjustment expenses, that indicate a reduction in expected future profitability may result in unrecoverable deferred acquisition costs. The impact of the adoption at December 31, 2011, was a reduction to shareholders’ equity of $34.5 million, or $0.86 book value per share, resulting in an adjusted book value per share of $17.95. The previously reported book value per share as of December 31, 2011 was $18.81 per share. All applicable prior period amounts have been adjusted to conform to current period presentation.

 

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Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

 

 

 

POOLING ARRANGEMENT

The STFC Pooled Companies and the Mutual Pooled Companies participate in a quota share reinsurance pooling arrangement referred to as the “Pooling Arrangement.” Under the Pooling Arrangement, State Auto Mutual assumes premiums, losses and expenses from each of the Pooled Companies and in turn cedes to each of the Pooled Companies a specified portion of premiums, losses and expenses based on each of the Pooled Companies’ respective pooling percentages. State Auto Mutual then retains the balance of the pooled business.

In 2011, we made two changes to the Pooling Arrangement. First, as of January 1, 2011, we added the Rockhill Insurers to the pool each with a participation percentage of 0.0% (the “1.1.11 pool change”). In conjunction with the 1.1.11 pool change, the STFC Pooled Companies received $149.8 million ($69.1 million in cash and $80.7 million in investment securities) from the Rockhill Insurers for net insurance liabilities transferred on January 1, 2011. The following table sets forth the impact on our balance sheet at January 1, 2011:

 

($ millions)    (Decrease)/Increase  

Losses and loss expenses payable

   $ 124.5   

Unearned premiums

     34.1   

Other liabilities

     (0.5

Less:

  

Deferred policy acquisition costs

     8.3   
  

 

 

 

Net cash and investment securities received

   $ 149.8   
  

 

 

 

Second, at the close of business on December 31, 2011, the Pooling Arrangement was amended to reduce the overall participation percentage of the STFC Pooled Companies from 80% to 65% and to include the pooling of applicable balance sheet accounts such as accumulated other comprehensive income related to employee benefit plans (the “12.31.11 pool change”). In conjunction with the 12.31.11 pool change, the STFC Pooled Companies paid $261.4 million in cash to the Mutual Pooled Companies subsequent to year end for net liabilities transferred on December 31, 2011. The following table sets forth the impact on our balance sheet at December 31, 2011:

 

($ millions)    (Decrease)/Increase  

Losses and loss expenses payable

   $ (203.4

Unearned premiums

     (106.8

Pension and postretirement liabilities

     (52.3

Other liabilities

     27.6   

Accumulated other comprehensive income

     59.1   

Less:

  

Deferred policy acquisition costs

     (21.8

Other assets

     7.4   
  

 

 

 

Net cash paid

   $ (261.4
  

 

 

 

 

 

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Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

 

 

 

The following table sets forth the participants and their participation percentages in the Pooling Arrangement for the period indicated:

 

     Close of  business
December 31, 2011 –
March 31, 2012
    January 1, 2011 –
December 31, 2011
 

STFC Pooled Companies:

    

State Auto P&C

     51.0     59.0

Milbank

     14.0        17.0   

Farmers

     0.0        3.0   

SA Ohio

     0.0        1.0   

SA National

     N/A        0.0   
  

 

 

   

 

 

 

Total STFC Pooled Companies

     65.0        80.0   

State Auto Mutual Pooled Companies:

    

State Auto Mutual

     34.0        19.0   

SA Wisconsin

     0.0        0.0   

SA Florida

     0.0        0.0   

Meridian Security

     0.0        0.0   

Meridian Citizens Mutual

     0.5        0.5   

Beacon National

     0.0        0.0   

Patrons Mutual

     0.4        0.4   

Litchfield

     0.1        0.1   

RIC

     0.0        0.0   

Plaza

     0.0        0.0   

American Compensation

     0.0        0.0   

Bloomington Compensation

     0.0        0.0   
  

 

 

   

 

 

 

Total State Auto Mutual Pooled Companies

     35.0        20.0   

RESULTS OF OPERATIONS

Our net loss was $2.0 million for the first quarter of 2012 compared to net income of $12.8 million for the first quarter of 2011. Our pretax loss was $2.0 million for the first quarter of 2012 compared to pretax income of $15.6 million for the first quarter of 2011. Our 2012 results, when compared to our 2011 results, have been and will continue to be impacted by the reduction in our participation in the Pooling Arrangement to 65% from 80% in 2011, as well as the recently implemented quota share reinsurance arrangement covering our homeowners book of business, discussed below. Our first quarter 2012 results were also impacted by an increase in the level of weather-related catastrophe losses in comparison to our first quarter 2011.

 

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Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

 

 

 

The following table sets forth certain key performance indicators we use to monitor our operations for the three months ended March 31, 2012 and 2011:

 

($ millions, except per share amounts)    Three months ended
March  31
 
GAAP Basis:    2012     2011  

Total revenues

   $ 280.3        380.2   

Net (loss) income

   $ (2.0     12.8   

Basic (loss) earnings per share

     (0.05     0.32   

Diluted (loss) earnings per share

     (0.05     0.32   

Stockholders’ equity

   $ 732.3        844.4   

Return on average equity

     (22.3 )%      2.8   

Book value per share

   $ 18.16        21.03   

Debt to capital ratio

     13.7        12.1   

Cat loss and ALAE ratio

     7.8     4.6   

Non-cat loss and LAE ratio

     67.2     64.7   

Loss and LAE ratio

     75.0     69.3   

Expense ratio

     34.4     33.7   

Combined ratio

     109.4     103.0   

Premium written growth (1)

     (30.2 )%      24.7   

Investment yield

     3.1     3.5   
     Three months ended
March 31
 
SAP Basis:    2012     2011  

Cat loss and ALAE points

     7.8     4.6   

Non-cat loss and ALAE

     60.0     58.7   

ULAE

     7.4     6.0   

Loss and LAE ratio

     75.2     69.3   

Expense ratio

     35.3     32.4   

Combined ratio

     110.5     101.7   
     Twelve months ended
March 31
 
     2012     2011  

Net premiums written to surplus

     2.1        1.7   

 

  (1)

Includes an increase of 11.8 points for 2011 related to the one-time $34.1 million transfer of unearned premium by the Rockhill Insurers on January 1, 2011, in conjunction with the 1.1.11 pool change.

 

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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

 

 

 

Homeowners Quota Share Arrangement

To reduce risk and volatility in our homeowners book of business, while providing us with additional catastrophe reinsurance protection, the State Auto Group entered into a quota share reinsurance agreement on December 31, 2011 with a syndicate of unaffiliated reinsurers covering its homeowners book of business (the “HO QS Arrangement”). Under the HO QS Arrangement, the State Auto Group ceded to the reinsurers 75% of its homeowners business under policies in force at December 31, 2011 and new and renewal policies thereafter issued during the term of the agreement. The HO QS Arrangement is in effect until December 31, 2014. See “Liquidity and Capital Resources – Reinsurance Arrangements” for a discussion of the HO QS Arrangement. The HO QS Arrangement worked as expected in the first quarter of 2012, and we believe the long term benefits of our homeowner actions will be a more predictable and profitable book of homeowners business and reduced risk to our capital base.

For the three months ended March 31, 2012, the HO QS Arrangement reduced our GAAP net underwriting loss by $7.1 million and improved our GAAP combined ratio by 1.1 points. The following table sets forth, on a pro forma GAAP basis, certain of our key performance indicators excluding the impact of the HO QS Arrangement cession for the three months ended March 31, 2012.

Reconciliation Table 1

 

($ millions)    GAAP HO QS Arrangement Cession - Overall Results  
     As Reported     HO QS Cession     Pro-Forma
without HO QS
Cession
 

Earned premiums

   $ 254.9      $ 41.7      $ 296.6   

Losses and LAE incurred:

      

Cat loss and ALAE

     20.0        17.4        37.4   

Non-cat loss and LAE

     171.3        19.3        190.6   
  

 

 

   

 

 

   

 

 

 

Total Loss and LAE incurred

     191.3        36.7        228.0   

Acquisition and operating expenses

     87.6        12.1        99.7   
  

 

 

   

 

 

   

 

 

 

Net underwriting loss

     (24.0     (7.1     (31.1
  

 

 

   

 

 

   

 

 

 

Cat loss and ALAE ratio

     7.8     41.7     12.6

Non-cat loss and LAE ratio

     67.2     46.3     64.3
  

 

 

   

 

 

   

 

 

 

Total Loss and LAE ratio

     75.0     88.0     76.9

Expense ratio

     34.4     29.0     33.6
  

 

 

   

 

 

   

 

 

 

Combined ratio

     109.4     117.0     110.5
  

 

 

   

 

 

   

 

 

 

 

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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

 

For the three months ended March 31, 2012, the HO QS Arrangement reduced our SAP net underwriting loss by $5.5 million and improved our SAP combined ratio by 1.0 point. The following table sets forth, on a pro forma SAP basis, certain of our key performance indicators excluding the impact of the HO QS Arrangement cession for the three months ended March 31, 2012.

Reconciliation Table 2

 

($ millions)    SAP HO QS Arrangement Cession - Overall Results  
     As Reported     HO QS Cession     Pro-Forma
without HO  QS
Cession
 

Net written premiums

   $ 263.3      $ 36.2      $ 299.5   

Earned premiums

     254.9        41.7        296.6   

Losses and LAE incurred:

      

Cat loss and ALAE

     20.0        17.4        37.4   

Non-cat loss and ALAE

     152.8        19.3        172.1   
  

 

 

   

 

 

   

 

 

 

Total Loss and ALAE

     172.8        36.7        209.5   

ULAE

     18.9        —          18.9   
  

 

 

   

 

 

   

 

 

 

Total Loss and ALAE incurred

     191.7        36.7        228.4   

Underwriting expenses

     93.0        10.5        103.5   
  

 

 

   

 

 

   

 

 

 

Net underwriting loss

   $ (29.8   $ (5.5   $ (35.3
  

 

 

   

 

 

   

 

 

 

Cat loss and ALAE ratio

     7.8     41.7     12.6

Non-cat loss and ALAE ratio

     60.0     46.3     58.0
  

 

 

   

 

 

   

 

 

 

Total loss and ALAE ratio

     67.8     88.0     70.6

ULAE ratio

     7.4     —          6.4
  

 

 

   

 

 

   

 

 

 

Total loss and LAE ratio

     75.2     88.0     77.0

Expense ratio

     35.3     29.0     34.5
  

 

 

   

 

 

   

 

 

 

Combined ratio

     110.5     117.0     111.5
  

 

 

   

 

 

   

 

 

 

See additional pro forma reconciliation tables for the HO QS Arrangement cession on our personal insurance segment’s SAP underwriting results and our homeowners’ line of business at Reconciliation Tables 3 and 5, respectively.

 

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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

 

 

 

Use of Non-GAAP Financial Measures

Certain information and results in our personal, business and specialty insurance segments are presented in a manner which, on a pro forma basis, (i) excludes the impact of the HO QS Arrangement cession for the three months ended March 31, 2012, (ii) excludes the one-time impact of the 1.1.11 pool change for the three months ended March 31, 2011, and (iii) assumes the 12.31.11 pool change from an 80% to 65% participation percentage had been in effect as of January 1, 2011. These presentations are non-GAAP financial measures. We believe these non-GAAP financial measures will enable investors to (a) better understand the significance the reinsurance arrangement cession is contributing to our reported results for the three months ended March 31, 2012, and (b) perform a meaningful comparison of our results of operations for the three months ended March 31, 2012 and 2011. See Reconciliation Tables 1 and 2 above and Reconciliation Tables 3, 4 and 5 below.

Insurance Segments

The insurance segments market a broad line of property and casualty insurance products throughout the United States through independent insurance agencies, which include retail agents and wholesale brokers. The personal insurance segment provides primarily personal automobile and homeowners to the personal insurance market. The business insurance segment provides primarily commercial automobile, commercial multi-peril, fire & allied and general liability insurance covering small-to-medium sized commercial exposures in the business insurance market. The specialty insurance segment provides commercial coverages requiring specialized product underwriting, claims handling or risk management services through a distribution channel of retail agents and wholesale brokers, which may include program administrators and other specialty sources.

Insurance industry regulators require our insurance subsidiaries to report their financial condition and results of operations using SAP. We use SAP financial results, along with industry standard financial measures determined on a SAP basis and certain measures determined on a GAAP basis, to internally monitor the performance of our insurance segments and reward our employees.

One of the more significant differences between GAAP and SAP is that SAP requires all underwriting expenses to be expensed immediately and not deferred over the same period that the premium is earned. In converting SAP underwriting results to GAAP underwriting results, acquisition costs are deferred and amortized over the periods the related written premiums are earned. For a discussion of deferred acquisition costs, see “Critical Accounting Policies – Deferred Acquisition Costs” section included in Item 7 of our 2011 Form 10-K.

The accounting for retroactive reinsurance contributes to the difference between our GAAP loss and expense ratios and our SAP loss and expense ratios. Retroactive reinsurance balances result from reinsurance placed to cover losses on insured events occurring prior to the inception of a reinsurance contract. For GAAP reporting, retroactive reinsurance balances are included in losses and loss expenses in the condensed consolidated statements of income and the GAAP loss ratio. Statutory accounting practices require retroactive reinsurance balances to be recorded in other expenses rather than in losses and loss expenses, and included in the SAP expense ratio.

All references to financial measures or components thereof in this discussion are calculated on a GAAP basis, unless otherwise noted.

 

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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

 

 

 

The following tables set forth a summary of our insurance segments’ SAP underwriting gain (loss) and SAP combined ratio for the three months ended March 31, 2012 and 2011:

 

($ millions)    Three months ended
March 31, 2012
 
     Personal(1)     %
Ratio
     Business     %
Ratio
     Specialty     %
Ratio
     Total(2)     %
Ratio
 

Written premiums

   $ 113.0           80.0           70.3           263.3     

Earned premiums

     117.5           77.3           60.1           254.9     

Cat loss and ALAE

     5.8        4.9         14.2        18.3         —          —           20.0        7.8   

Non-cat loss and ALAE

     69.4        59.1         37.9        49.1         45.5        75.6         152.8        60.0   

ULAE

     11.3        9.6         5.8        7.4         1.8        3.1         18.9        7.4   

Underwriting expenses

     31.9        28.2         36.1        45.2         25.0        35.5         93.0        35.3   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

SAP underwriting loss and SAP combined ratio

   $ (0.9     101.8         (16.7     120.0         (12.2     114.2         (29.8     110.5   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 
($ millions)    Three months ended
March 31, 2011
 
     Personal     %
Ratio
     Business     %
Ratio
     Specialty     %(3)
Ratio
     Total     %(3)
Ratio
 

Written premiums (3)

   $ 189.5           94.5           93.1           377.1     

Earned premiums

     203.6           94.8           51.8           350.2     

Cat loss and ALAE

     13.5        6.6         2.5        2.6         —          —           16.0        4.6   

Non-cat loss and ALAE

     115.5        56.7         58.0        61.2         32.2        62.2         205.7        58.7   

ULAE

     12.6        6.2         6.4        6.8         1.9        3.5         20.9        6.0   

Underwriting expenses

     49.5        26.1         39.8        42.1         33.0        35.5         122.3        32.4   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

SAP underwriting gain (loss) and SAP combined ratio

   $ 12.5        95.6         (11.9     112.7         (15.3     101.2         (14.7     101.7   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

 

  (1) 

See Reconciliation Table 4 below for the impact of the HO QS Arrangement cession on the SAP personal insurance segment’s SAP underwriting results.

 

  (2) 

See Reconciliation Table 2 above for the impact of the HO QS Arrangement cession on our SAP underwriting results.

 

  (3) 

Written premium includes a one-time transfer of $34.1 million of unearned premiums by the Rockhill Insurers to our specialty insurance segment in conjunction with the 1.1.11 pool change. In connection with this unearned premium transfer, we paid a one-time ceding commission of $8.3 million to the Rockhill Insurers. Combined, these one-time transactions benefitted our specialty insurance segment’s statutory expense ratio by 6.3 points and our overall expense ratio by 0.8 points.

 

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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

 

 

 

Revenue

We measure top-line growth for our insurance segments based on net written premiums, which represent the premiums on the policies we have issued for a period, net of reinsurance. Net written premiums provide us with an indication of how well we are doing in terms of revenue growth before it is actually earned. Our policies provide a fixed amount of coverage for a stated period of time, often referred to as “the policy term.” As such, our written premiums are recognized as earned ratably over the policy term. The unearned portion of written premiums, called unearned premiums, is reflected on our balance sheet as a liability and represents our obligation to provide coverage for the unexpired term of the policies.

The following table sets forth the reconciliation of the one-time impact on net written premiums for the three months ended March 31, 2011, of the unearned premiums transferred by the Rockhill Insurers to us on January 1, 2011, in conjunction with the 1.1.11 pool change and for the three months ended March 31, 2011, on a pro forma basis which assumes that the 12.31.11 pool change from an 80% to 65% participation percentage had been in effect as of January 1, 2011:

 

Reconciliation Table 3   Net Written Premiums Reconciliation Table From 80% to Pro Forma 65%  
                Pro-Forma              
($ millions)   As Reported
2012 Net
Written
Premiums
    As Reported
2011 Net
Written
Premiums
    01.01.11
Pool
Change
Impact
    2011
Net Written
Premiums
Excluding
01.01.11 Pool
Change
    12.31.11
Pool Change
Impact
    Pro
Forma
3/31/11
    %
Change(1)
    %
Pro
Forma
Change(2)
 

Personal insurance segment:

               

Personal auto

  $ 94.0      $ 122.6      $ —        $ 122.6      $ 23.0      $ 99.6        (23.3     (5.6

Homeowners

    11.8       58.2        —          58.2        10.9        47.3        (79.7     (75.1

Other personal

    7.2       8.7        —          8.7        1.6        7.1        (17.2     1.4   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total personal

    113.0       189.5        —          189.5        35.5        154.0        (40.4     (26.6

Business insurance segment:

               

Commercial auto

    21.0       23.3        —          23.3        4.4        18.9        (9.9     11.1   

Commercial multi-peril

    23.7       26.4        —          26.4        5.0        21.4        (10.2     10.7   

Fire & allied lines

    17.9       23.4        —          23.4        4.4        19.0        (23.5     (5.8

Other & product liability

    13.4       16.2        —          16.2        3.0        13.2        (17.3     1.5   

Other commercial

    4.0       5.2        —          5.2        1.0        4.2        (23.1     (4.8
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total business

    80.0       94.5        —          94.5        17.8        76.7        (15.3     4.3   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Specialty insurance segment:

               

RED

    31.5       23.6        —          23.6        4.5        19.1        33.5        64.9   

Rockhill

    20.5       39.3        24.3        15.0        2.7        12.3        (47.8     66.7   

Workers’ compensation

    18.3       30.2        9.8        20.4        3.8        16.6        (39.4     10.2   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total specialty

    70.3       93.1        34.1        59.0        11.0        48.0        (24.5     46.5   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total net written premiums

  $ 263.3      $ 377.1      $ 34.1      $ 343.0      $ 64.3      $ 278.7        (30.2     (5.5
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

  (1)

Calculated based on as reported March 31, 2012 net written premiums change from as reported March 31, 2011 net written premiums.

 

  (2) 

Calculated based on as reported March 31, 2012 net written premiums change from pro forma March 31, 2011 net written premiums.

 

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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

 

 

 

Personal Insurance Segment

The following table sets forth a summary of net written premiums, by major product line of business for our personal insurance segment for the three months ended March 31, 2012 and 2011, on a pro forma basis which assumes that the 12.31.11 pool change from an 80% to 65% participation percentage was in effect as of January 1, 2011 (See Reconciliation Table 3 above).

 

     Net written premiums  
($ millions)    2012      Pro-
Forma
2011
     %
Change
 

Personal insurance segment:

        

Personal auto

   $ 94.0         99.6         (5.6

Homeowners

     11.8         47.3         (75.1

Other personal

     7.2         7.1         1.4   
  

 

 

    

 

 

    

 

 

 

Total personal

   $ 113.0         154.0         (26.6
  

 

 

    

 

 

    

 

 

 

The following table sets forth a summary of SAP loss and ALAE ratios by major product line of business for our personal insurance segment with the catastrophe and non-catastrophe impact shown separately for the three months ended March 31:

 

    ($ millions)     %  
Statutory Loss and LAE Ratios   Earned
Premium
    Cat Loss
& ALAE
    Non-Cat
Loss &
ALAE
   

Statutory

Loss &
LAE

   

Cat loss

Ratio

   

Non-Cat

loss

Ratio

   

Total Loss
and LAE

Ratio

 

2012

               

Personal insurance segment:

               

Personal auto

  $ 96.0      $ 2.8      $ 59.5      $ 62.3        3.0        61.9        64.9   

Homeowners

    14.6        0.1        7.7        7.8        0.5        52.6        53.1   

Other personal

    6.9        2.9        2.2        5.1        41.9        31.6        73.5   

Total personal

    117.5        5.8        69.4        75.2        4.9        59.1        64.0   

ULAE

    —          —          —          11.3        —          —          9.6   

Total Loss and LAE

  $ 117.5      $  5.8      $  69.4      $  86.5        4.9        59.1        73.6   
 

2011

               

Personal insurance segment:

               

Personal auto

  $ 127.1      $  0.2      $ 78.1      $ 78.3        0.2        61.4        61.6   

Homeowners

    67.9        13.3        34.8        48.1        19.5        51.3        70.8   

Other personal

    8.6        —          2.6        2.6        (0.1     30.0        29.9   

Total personal

    203.6        13.5        115.5        129.0        6.6        56.7        63.3   

ULAE

    —          —          —          12.6        —          —          6.2   

Total Loss and LAE

  $ 203.6      $ 13.5      $ 115.5      $ 141.6        6.6        56.7        69.5   

 

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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

 

 

 

For the three months ended March 31, 2012, the HO QS Arrangement reduced our SAP net underwriting loss in our personal insurance segment by $5.5 million and improved our SAP combined ratio in our personal insurance segment by 4.0 points. The following table sets forth our personal insurance segment which excludes, on a pro forma SAP basis, the impact of the HO QS Arrangement cession for the three months ended March 31, 2012.

Reconciliation Table 4

 

     SAP HO QS Arrangement Cession - Personal Insurance  
($ millions)    As Reported     HO QS
Cession
    Pro-Forma
without HO QS
Cession
 

Net written premiums

   $ 113.0      $ 36.2      $ 149.2   

Earned premiums

     117.5        41.7        159.2   

Losses and LAE Incurred:

      

Cat loss and ALAE

     5.8        17.4        23.2   

Non-cat loss and ALAE

     69.4        19.3        88.7   
  

 

 

   

 

 

   

 

 

 

Total Loss and ALAE

     75.2        36.7        111.9   

ULAE

     11.3        —          11.3   
  

 

 

   

 

 

   

 

 

 

Total Loss and LAE incurred

     86.5        36.7        123.2   

Underwriting expenses

     31.9        10.5        42.4   
  

 

 

   

 

 

   

 

 

 

Net underwriting loss

   $ (0.9   $ (5.5   $ (6.4
  

 

 

   

 

 

   

 

 

 

Cat loss and ALAE ratio

     4.9     41.7     14.6

Non-cat loss and ALAE ratio

     59.1     46.3     55.7
  

 

 

   

 

 

   

 

 

 

Total Loss and ALAE ratio

     64.0     88.0     70.3

ULAE ratio

     9.6     —          7.1
  

 

 

   

 

 

   

 

 

 

Total Loss and LAE ratio

     73.6     88.0     77.4

Expense ratio

     28.2     29.0     28.4
  

 

 

   

 

 

   

 

 

 

Combined ratio

     101.8     117.0     105.8
  

 

 

   

 

 

   

 

 

 

Catastrophe losses on our personal insurance segment were $5.8 million, or 4.9 catastrophe loss ratio points, for the three months ended March 31, 2012 and included $3.9 million, or 3.3 catastrophe loss ratio points, of prior period favorable development. For the three months ended March 31, 2012, cessions under the HO QS Arrangement reduced our personal insurance segment catastrophe losses by $17.4 million, or 9.7 catastrophe loss ratio points. Catastrophe losses on our personal insurance segment were $13.5 million, or 6.6 loss ratio points, for the three months ended March 31, 2011, and included $0.1 million, or 0.1 catastrophe loss ratio points, of prior period favorable development.

Personal auto net written premiums for the three months ended March 31, 2012 decreased 23.3% compared to the same 2011 period. Personal auto net written premiums for the three months ended March 31, 2012 decreased 5.6% compared to the three months ended March 31, 2011 pro forma net written premiums. While we are experiencing a decline in premiums in our personal auto business, we continue to grow premiums in several states consistent with our strategy to expand our geographic footprint outside the Midwest. Much of this premium growth is from the states of Texas, Colorado, Connecticut and Georgia. In addition, we have had

 

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Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

 

 

 

continued personal auto premium growth in underserved Midwest states, such as Illinois and Michigan. While the overall premiums are down, we are experiencing a slight increase in personal auto new business premiums and improved issue to quote ratios. We are also experiencing a higher percentage of companion auto and home policies. We also believe our aggressive actions in addressing profit levels in our homeowners book of business has impacted the entire account and caused the loss of some auto policies, which has also contributed to the overall premium decline in personal auto.

The personal auto SAP non-catastrophe loss ratio for the three months ended March 31, 2012 increased 0.5 points compared to the same 2011 period primarily due to an increase in number of personal auto bodily injury losses.

Homeowners net written premiums for the three months ended March 31, 2012 decreased $46.4 million compared to the same 2011 period. Homeowners net written premiums for the three months ended March 31, 2012, decreased $35.5 million compared to three months ended March 31, 2011 pro forma net written premiums. The $35.6 million of net written premiums ceded under the HO QS Arrangement accounted for this decline when compared to the same 2011 period. The following table sets forth, on a pro forma SAP basis, the homeowners’ line of business excluding the impact of the HO QS Arrangement cession for the three months ended March 31, 2012.

Reconciliation Table 5

 

     SAP HO QS Arrangement Cession - Homeowners  
($ millions)    As Reported     HO QS
Cession
    Pro-Forma
without HO  QS
Cession
 

Net written premiums

   $ 11.8      $ 35.6      $ 47.4   

Earned premiums

     14.6        41.0        55.6   

Losses and LAE incurred:

      

Cat loss and ALAE

     0.1        17.4        17.5   

Non-cat loss and ALAE

     7.7        19.3        27.0   
  

 

 

   

 

 

   

 

 

 

Total Loss and ALAE incurred

   $ 7.8      $ 36.7      $ 44.5   

Cat loss and ALAE ratio

     0.5     42.4     31.4

Non-cat loss and ALAE ratio

     52.6     47.2     48.6
  

 

 

   

 

 

   

 

 

 

Total Loss and ALAE ratio

     53.1     89.6     80.0

The homeowners SAP non-catastrophe loss ratio for the three months ended March 31, 2012 increased slightly when compared to the same 2011 period. The reported homeowners SAP non-catastrophe loss ratio for the three months ended March 31, 2012 was 4.0 points higher than the homeowners SAP non-catastrophe loss ratio pro forma without the HO QS Arrangement due to unfavorable development from prior accident years which were not subject to the HO QS Arrangement. We continue to aggressively address our rate needs in the homeowners book of business and intend to file double digit rate increases in 17 out of 28 active states and in all of our wind and weather prone states.

We continue to implement strategies to improve our homeowner results. As of March 31, 2012, our CustomFitSM homeowners product, which uses by-peril rating, had been deployed in 16 out of 28 active states. We have placed a priority of introducing our CustomFit homeowners product in states which have historically experienced significant catastrophe losses. States in which CustomFit homeowners is currently offered represent approximately 75% of our homeowners premium and account for 82% of our five year wind/hail losses. We are in the process of developing our second generation of CustomFit homeowners in 2012.

 

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Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

(a majority-owned subsidiary of State Automobile Mutual Insurance Company)

 

 

 

In addition to rate increases and the continued deployment of our CustomFit homeowners product, we are aggressively evaluating and monitoring unprofitable agencies, which includes the review of an agency’s existing policies, implementation of tighter new business and renewal guidelines for that agency, and/or the application of other loss mitigation tools for use by that agency, all with the purpose of improving operating results at the agency level. We are continuing with a proactive insurance to value program, which is designed to have our insureds maintain an amount of coverage sufficient to replace their home and contents in the case of a total loss consistent with our loss settlement provisions. In addition, we have implemented mandatory wind and hail deductibles in all targeted states. We will continue to monitor to determine if this loss mitigation tool is necessary in additional states.

We continue to execute various initiatives implemented in prior periods within our property claims operations, which we believe will improve our loss ratio results. For example, our dependence on outside appraisers has declined by deploying in-house property adjusters working from their homes. In addition, all but a few large property claims and a significant percentage of catastrophe claims are now being handled in-house by State Auto adjusters. These changes are intended to improve service and reduce expenses, which we believe improve loss ratio results.

Business Insurance Segment

The following table sets forth a summary of net written premiums by major product line of business for our business insurance segment for the three months ended March 31, 2012 and 2011, on a pro forma basis which assumes that the 12.31.11 pool change from an 80% to 65% participation percentage was in effect as of January 1, 2011 (See Reconciliation Table 3 above).

 

     Net written premiums  
($ millions)    2012