XNAS:STFC State Auto Financial Corporation Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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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 June 30, 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 file  ¨                                     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 July 27, 2012, the Registrant had 40,448,334 Common Shares outstanding.

 

 

 


Table of Contents

Index to Form 10-Q Quarterly Report for the three and six month periods ended June 30, 2012

 

Part I. Financial Information   

Item 1.

   Financial Statements (Unaudited)   
   Condensed consolidated balance sheets – June 30, 2012 and December 31, 2011      1   
   Condensed consolidated statements of income – Three months ended June 30, 2012 and 2011      2   
   Condensed consolidated statements of income – Six months ended June 30, 2012 and 2011      3   
   Condensed consolidated statements of comprehensive income – Three months ended June 30, 2012 and 2011      4   
   Condensed consolidated statements of comprehensive income – Six months ended June 30, 2012 and 2011      5   
   Condensed consolidated statements of cash flows – Six months ended June 30, 2012 and 2011      6   
   Notes to condensed consolidated financial statements – June 30, 2012      7   

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      25   

Item  3.

   Quantitative and Qualitative Disclosures About Market Risk      64   

Item 4.

   Controls and Procedures      64   
Part II. Other Information   

Item 1.

   Legal Proceedings      66   

Item 1A.

   Risk Factors      67   

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds      67   

Item 3.

   Defaults upon Senior Securities      67   

Item 4.

   Reserved      67   

Item 5.

   Other Information      67   

Item 6.

   Exhibits      67   
   Signatures      68   


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)    June 30
2012
(unaudited)
    December 31
2011
As adjusted
 
      
           (see note 1)  
Assets     

Fixed maturities, available-for-sale, at fair value
(amortized cost $1,790.4 and $1,817.3, respectively)

   $ 1,911.5        1,934.9   

Equity securities, available-for-sale, at fair value
(cost $174.3 and $141.7, respectively)

     204.8        167.3   

Other invested assets, available-for-sale, at fair value
(cost $48.8 and $48.6, respectively)

     57.8        57.2   

Other invested assets

     0.5        0.5   

Notes receivable from affiliate

     70.0        70.0   
  

 

 

   

 

 

 

Total investments

     2,244.6        2,229.9   

Cash and cash equivalents

     55.4        356.0   

Accrued investment income and other assets

     40.5        30.2   

Deferred policy acquisition costs

     93.6        91.7   

Reinsurance recoverable on losses and loss expenses payable

     21.5        25.5   

Prepaid reinsurance premiums

     8.8        7.9   

Current federal income taxes

     11.2        12.3   

Net deferred federal income taxes

     0.8        0.5   

Property and equipment, at cost

     10.5        10.4   
  

 

 

   

 

 

 

Total assets

   $ 2,486.9        2,764.4   
  

 

 

   

 

 

 
Liabilities and Stockholders’ Equity     

Losses and loss expenses payable (affiliates $377.6 and $376.8, respectively)

   $ 933.8        907.1   

Unearned premiums (affiliates $101.7 and $98.4, respectively)

     491.5        470.2   

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

     116.1        116.4   

Postretirement and pension benefits

     109.1        112.8   

Due to affiliate

     4.4        349.4   

Other liabilities

     112.3        84.7   
  

 

 

   

 

 

 

Total liabilities

     1,767.2        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; 47.2 and 47.1 shares issued, respectively, at stated value of $2.50 per share

     118.0        117.8   

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

     (115.8     (115.8

Additional paid-in capital

     129.5        127.3   

Accumulated other comprehensive income

     74.1        63.8   

Retained earnings

     513.9        530.7   
  

 

 

   

 

 

 

Total stockholders’ equity

     719.7        723.8   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 2,486.9        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
June 30
 
(unaudited)    2012     2011
As adjusted
 
    
           (see note 1)  

Earned premiums (ceded to affiliates $199.8 and $202.4, respectively)

   $ 258.4        352.4   

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

     20.5        25.2   

Net realized gain on investments:

    

Total other-than-temporary impairment losses

     (1.3     (0.8

Portion of loss recognized in other comprehensive income

     —          —     

Other net realized investment gains

     8.0        7.3   
  

 

 

   

 

 

 

Total net realized gain on investments

     6.7        6.5   

Other income from affiliates

     1.1        0.3   
  

 

 

   

 

 

 

Total revenues

     286.7        384.4   

Losses and loss expenses (ceded to affiliates $167.7 and $265.5, respectively)

     201.7        401.6   

Acquisition and operating expenses

     83.6        117.8   

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

     1.7        1.7   

Other expenses

     2.4        2.6   
  

 

 

   

 

 

 

Total expenses

     289.4        523.7   
  

 

 

   

 

 

 
Loss before federal income taxes      (2.7     (139.3

Federal income tax expense

     —          74.8   
  

 

 

   

 

 

 
Net loss    $ (2.7     (214.1
  

 

 

   

 

 

 

Loss per common share:

    

Basic

   $ (0.07     (5.33
  

 

 

   

 

 

 

Diluted

   $ (0.07     (5.33
  

 

 

   

 

 

 

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)

 

 

 

Condensed Consolidated Statements of Income

 

($ millions, except per share amounts)    Six months ended
June 30
 
(unaudited)    2012     2011
As adjusted
 
    
           (see note 1)  

Earned premiums (ceded to affiliates $396.7 and $407.9, respectively)

   $ 513.3        702.6   

Net investment income (affiliate $2.4 and $2.4, respectively)

     38.0        46.2   

Net realized gain on investments:

    

Total other-than-temporary impairment losses

     (1.7     (0.9

Portion of loss recognized in other comprehensive income

     —          —     

Other net realized investment gains

     15.5        15.6   
  

 

 

   

 

 

 

Total net realized gain on investments

     13.8        14.7   

Other income from affiliates

     1.9        1.1   
  

 

 

   

 

 

 

Total revenues

     567.0        764.6   

Losses and loss expenses (ceded to affiliates $323.8 and $408.9, respectively)

     393.0        644.2   

Acquisition and operating expenses

     171.2        235.7   

Interest expense (affiliates $0.4 and $0.4, respectively)

     3.5        3.5   

Other expenses

     4.0        4.9   
  

 

 

   

 

 

 

Total expenses

     571.7        888.3   
  

 

 

   

 

 

 
Loss before federal income taxes      (4.7     (123.7

Federal income tax expense

     —          77.6   
  

 

 

   

 

 

 
Net loss    $ (4.7     (201.3
  

 

 

   

 

 

 

Loss per common share:

    

Basic

   $ (0.12     (5.01
  

 

 

   

 

 

 

Diluted

   $ (0.12     (5.01
  

 

 

   

 

 

 

Dividends paid per common share

   $ 0.30        0.30   
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

3


Table of Contents

STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

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

 

 

 

Condensed Consolidated Statements of Comprehensive Income

 

($ millions, except per share amounts)    Three months ended
June 30
 
(unaudited)    2012     2011
As adjusted
 
           (see note 1)  

Net loss

   $ (2.7     (214.1

Other comprehensive (loss) income, net of tax:

    

Net unrealized holding (loss) gains on investments:

    

Unrealized holding gain arising during year

     0.5        28.5   

Reclassification adjustments for gains realized in net loss

     (6.7     (6.5

Income tax benefit (expense)

     0.3        (7.8
  

 

 

   

 

 

 

Total net unrealized holding (loss) gains on investments

     (5.9     14.2   

Amortization of gain on derivative used in cash flow hedge

     (0.1     (0.1

Net unrecognized benefit plan obligations:

    

Reclassification adjustments for amortization to statements of income:

    

Transition asset

     —          (0.1

Negative prior service cost

     (1.3     (0.3

Net actuarial loss

     1.9        1.7   

Income tax benefit

     —          (0.2
  

 

 

   

 

 

 

Total net unrecognized benefit plan obligations

     0.6        1.1   
  

 

 

   

 

 

 

Other comprehensive (loss) income

     (5.4     15.2   
  

 

 

   

 

 

 

Comprehensive loss

   $ (8.1     (198.9
  

 

 

   

 

 

 

 

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)

 

 

 

Condensed Consolidated Statements of Comprehensive Income

 

($ millions, except per share amounts)    Six months ended
June 30
 
(unaudited)    2012     2011
As adjusted
 
           (see note 1)  

Net loss

   $ (4.7     (201.3

Other comprehensive income, net of tax:

    

Net unrealized holding gains on investments:

    

Unrealized holding gain arising during year

     22.6        43.5   

Reclassification adjustments for gains realized in net (loss) income

     (13.8     (14.7

Income tax benefit (expense)

     0.3        (10.1
  

 

 

   

 

 

 

Total net unrealized holding gains on investments

     9.1        18.7   

Amortization of gain on derivative used in cash flow hedge

     (0.1     (0.1

Net unrecognized benefit plan obligations:

    

Reclassification adjustments for amortization to statements of income:

    

Transition asset

     0.1        (0.2

Negative prior service cost

     (2.6     (0.6

Net actuarial loss

     3.8        3.4   

Income tax benefit

     —          (0.7
  

 

 

   

 

 

 

Total net unrecognized benefit plan obligations

     1.3        1.9   
  

 

 

   

 

 

 

Other comprehensive income

     10.3        20.5   
  

 

 

   

 

 

 

Comprehensive income (loss)

   $ 5.6        (180.8
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements.

 

5


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)    Six months ended
June 30
 
(unaudited)    2012     2011
As adjusted
 
           (see note 1)  

Cash flows from operating activities:

    

Net loss

   $ (4.7     (201.3

Adjustments to reconcile net loss to net cash (used in) provided by operating activities:

    

Depreciation and amortization, net

     2.2        0.8   

Share-based compensation

     1.9        1.9   

Net realized gain on investments

     (13.8     (14.7

Changes in operating assets and liabilities:

    

Deferred policy acquisition costs

     (1.9     (7.8

Accrued investment income and other assets

     2.5        (0.6

Postretirement and pension benefits

     (2.3     6.8   

Other liabilities and due to/from affiliates, net

     (23.3     (11.5

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

     3.2        (4.0

Losses and loss expenses payable

     26.6        95.9   

Unearned premiums

     21.2        28.1   

Federal income taxes

     1.1        79.1   

Cash used in December 31, 2011 unearned premium transfer related to the homeowners’ quota-share reinsurance agreement

     (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

     (324.2     41.8   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Purchases of fixed maturities – available-for-sale

     (259.2     (261.9

Purchases of equity securities – available-for-sale

     (64.7     (75.8

Purchases of other invested assets

     (0.7     (0.7

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

     147.4        147.4   

Sales of fixed maturities – available-for-sale

     170.8        70.2   

Sales of equity securities – available-for-sale

     41.1        80.8   

Sales of other invested assets

     0.4        0.5   

Sale of subsidiary, net of expenses

     —          13.2   

Net additions of property and equipment

     (0.2     —     
  

 

 

   

 

 

 

Net cash provided by (used in) investing activities

     34.9        (26.3
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Proceeds from issuance of common stock

     0.8        1.7   

Payment of dividends

     (12.1     (12.1
  

 

 

   

 

 

 

Net cash used in financing activities

     (11.3     (10.4
  

 

 

   

 

 

 

Net (decrease) increase in cash and cash equivalents

     (300.6     5.1   

Cash and cash equivalents at beginning of period

     356.0        88.3   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 55.4        93.4   
  

 

 

   

 

 

 

Supplemental disclosures:

    

Interest paid (affiliates $0.4 and $0.4, respectively)

   $ 3.5        3.5   
  

 

 

   

 

 

 

Federal income taxes received

   $ (1.1     (1.5
  

 

 

   

 

 

 

See accompanying notes to condensed 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 (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 and six month periods ended June 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. 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 is 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 this 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   

 

7


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 and six months ended June 30, 2011 was as follows:

 

($ in millions, except per share amounts)    Three Months Ended
June 30, 2011
 
     As
Previously
Reported
    Effect of
Change
    As
Adjusted
 

Acquisition and operating expenses

   $ 116.1      $ 1.7      $ 117.8   

Income tax expense

     63.8        11.0        74.8   

Net loss

     (201.4     (12.7     (214.1

Loss Per Share:

      

Basic

   $ (5.01   $ (0.32   $ (5.33

Diluted

   $ (5.01   $ (0.32   $ (5.33
($ in millions, except per share amounts)    Six Months Ended
June 30, 2011
 
     As
Previously
Reported
    Effect of
Change
    As
Adjusted
 

Acquisition and operating expenses

   $ 234.2      $ 1.5      $ 235.7   

Income tax expense

     66.5        11.1        77.6   

Net loss

     (188.7     (12.6     (201.3

Loss Per Share:

      

Basic

   $ (4.70   $ (0.31   $ (5.01

Diluted

   $ (4.70   $ (0.31   $ (5.01

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 is effective on a prospective basis for fiscal years and interim periods beginning after December 15, 2011. The Company adopted this guidance at January 1, 2012 and it did not have a material impact on the 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

 

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)

 

 

 

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 is effective for fiscal years and interim periods beginning after December 15, 2011, with early adoption permitted. The Company adopted this guidance at January 1, 2012 and it did not have any impact on the consolidated financial statements.

2. Investments

The following tables set forth the cost or amortized cost and fair value of available-for-sale securities by lot at June 30, 2012 and December 31, 2011:

 

($ millions)    Cost or
amortized
cost
     Gross
unrealized
holding

gains
     Gross
unrealized
holding
losses
    Fair
value
 
At June 30, 2012:           

Fixed maturities:

          

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

   $ 404.3         36.2         (0.2     440.3   

Obligations of states and political subdivisions

     719.0         48.2         (0.9     766.3   

Corporate securities

     242.6         15.7         (0.1     258.2   

U.S. government agencies residential mortgage-backed securities

     424.5         23.2         (1.0     446.7   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total fixed maturities

     1,790.4         123.3         (2.2     1,911.5   

Equity securities:

          

Large-cap securities

     134.1         22.9         (2.6     154.4   

Small-cap securities

     40.2         10.2         —          50.4   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total equity securities

     174.3         33.1         (2.6     204.8   

Other invested assets

     48.8         9.0         —          57.8   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total available-for-sale securities

   $ 2,013.5         165.4         (4.8     2,174.1   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

($ 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   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

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 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 June 30, 2012 and December 31, 2011:

 

     Less than 12 months      12 months or more      Total  
($ millions, except # of positions)    Fair
value
     Unrealized
losses
    Number
of
positions
     Fair
value
     Unrealized
losses
    Number
of
positions
     Fair
value
     Unrealized
losses
    Number
of
positions
 
At June 30, 2012:                        

Fixed maturities:

                       

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

   $ 25.6       $ (0.2     8       $ —         $ —          —         $ 25.6       $ (0.2     8   

Obligations of states and political subdivisions

     94.3         (0.9     34         —           —          —           94.3         (0.9     34   

Corporate securities

     13.5         (0.1     6         —           —          —           13.5         (0.1     6   

U.S. government agencies residential mortgage-backed securities

     16.9         —          6         33.8         (1.0     12         50.7         (1.0     18   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total fixed maturities

     150.3         (1.2     54         33.8         (1.0     12         184.1         (2.2     66   

Large-cap equity securities

     18.0         (2.2     9         2.0         (0.4     2         20.0         (2.6     11   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total temporarily impaired securities

   $ 168.3       $ (3.4     63       $ 35.8       $ (1.4     14       $ 204.1       $ (4.8     77   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

     Less than 12 months      12 months or more      Total  
($ millions, except # of positions)    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   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

 

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)

 

 

 

The Company reviewed its investments at June 30, 2012, and determined no additional other-than-temporary impairment existed in the gross unrealized holding losses other than those listed in the table below. The following table sets forth the realized losses related to other-than-temporary impairments on the Company’s investment portfolio recognized for the three and six months ended June 30, 2012 and 2011:

 

($ millions)    Three months ended
June  30
    Six months ended
June  30
 
     2012     2011     2012     2011  

Equity securities:

        

Small-cap securities

   $ (1.1     (0.8   $ (1.5     (0.9

Fixed maturities:

     (0.2     —          (0.2     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other-than-temporary impairments

   $ (1.3     (0.8   $ (1.7     (0.9
  

 

 

   

 

 

   

 

 

   

 

 

 

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 June 30, 2012:

 

($ millions)    Amortized
cost
     Fair
value
 

Due in 1 year or less

   $ 49.2         49.8   

Due after 1 year through 5 years

     302.0         318.0   

Due after 5 years through 10 years

     463.0         502.8   

Due after 10 years

     551.7         594.2   

U.S. government agencies residential mortgage-backed securities

     424.5         446.7   
  

 

 

    

 

 

 

Total

   $ 1,790.4         1,911.5   
  

 

 

    

 

 

 

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 $10.0 million and $9.9 million were on deposit with insurance regulators as required by law at June 30, 2012 and December 31, 2011, respectively.

 

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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 components of net investment income for the three and six months ended June 30, 2012 and 2011:

 

($ millions)    Three months ended
June  30
     Six months ended
June  30
 
     2012      2011      2012      2011  

Fixed maturities

   $ 18.7         22.9       $ 34.4         41.8   

Equity securities

     1.0         1.5         2.0         2.8   

Cash and cash equivalents, and other

     1.3         1.4         2.7         2.8   
  

 

 

    

 

 

    

 

 

    

 

 

 

Investment income

     21.0         25.8         39.1         47.4   

Investment expenses

     0.5         0.6         1.1         1.2   
  

 

 

    

 

 

    

 

 

    

 

 

 

Net investment income

   $ 20.5         25.2       $ 38.0         46.2   
  

 

 

    

 

 

    

 

 

    

 

 

 

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 and six months ended June 30, 2012 and 2011:

 

($ millions)    Three months ended
June 30
    Six months ended
June  30
 
     2012     2011     2012     2011  
Realized gains:         

Fixed maturities

   $ 7.5        0.9      $ 10.7        1.8   

Equity securities

     2.3        8.9        6.7        17.7   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total realized gains

     9.8        9.8        17.4        19.5   
Realized losses:         

Equity securities:

        

Sales

     (1.8     (1.6     (1.9     (3.0

OTTI

     (1.1     (0.8     (1.5     (0.9

Fixed maturities:

        

OTTI

     (0.2     —          (0.2     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total realized losses

     (3.1     (2.4     (3.6     (3.9
  

 

 

   

 

 

   

 

 

   

 

 

 

Net realized gain on investments

   $ 6.7        7.4      $ 13.8        15.6   
  

 

 

   

 

 

   

 

 

   

 

 

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

Fixed maturities

   $ 4.1        27.1      $ 3.5        24.0   

Equity securities

     (6.7     (8.0     4.9        (0.8

Other invested assets

     (3.6     2.9        0.4        5.6   

Deferred federal income tax liability

     2.3        (7.8     (3.1     (10.1

Valuation allowance

     (2.0     —          3.4        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

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

   $ (5.9     14.2      $ 9.1        18.7   
  

 

 

   

 

 

   

 

 

   

 

 

 

There was a deferred federal income tax liability on the net unrealized holding gains at June 30, 2012 and December 31, 2011, of $52.8 million, net of a valuation allowance of $3.4 million, and $53.1 million, respectively.

 

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)

 

 

 

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 June 30, 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 June 30, 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.

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.

 

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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)

 

 

 

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 $52.6 million at June 30, 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.

 

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)

 

 

 

The following tables set forth the Company’s available-for-sale investments within the fair value hierarchy at June 30, 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 June 30, 2012:

           

Fixed maturities:

           

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

   $ 440.3         —           440.3         —     

Obligations of states and political subdivisions

     766.3         —           766.3         —     

Corporate securities

     258.2         —           255.4         2.8   

U.S. government agencies residential mortgage-backed securities

     446.7         —           446.7         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total fixed maturities

     1,911.5         —           1,908.7         2.8   

Equity securities:

           

Large-cap securities

     154.4         154.4         —           —     

Small-cap securities

     50.4         50.4         —           —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total equity securities

     204.8         204.8         —           —     

Other invested assets

     57.8         5.2         52.6         —     
  

 

 

    

 

 

    

 

 

    

 

 

 

Total available-for-sale investments

   $ 2,174.1         210.0         1,961.3         2.8   
  

 

 

    

 

 

    

 

 

    

 

 

 
($ 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   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

15


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 and six months ended June 30, 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   

Total realized gains (losses) – included in earnings

     (0.2

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

     —     

Purchases

     0.1   

Sales

     —     

Transfers into Level 3

     —     

Transfers out of Level 3

     —     
  

 

 

 

Balance at June 30, 2012

   $ 2.8   
  

 

 

 
($ 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   
  

 

 

 

 

16


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 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:

Financial Instruments Disclosed, But Not Carried, At Fair Value

Notes Receivable from Affiliates

In May 2009, the Company entered into two separate credit agreements with State Auto Mutual pursuant to which it loaned State Auto Mutual a total of $70.0 million. Under these agreements, State Auto Financial earned interest of $1.2 million and $2.4 million for the three and six months ended June 30, 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)    June 30, 2012     December 31, 2011  
     Carrying
value
     Fair
value
     Interest
rate
    Carrying
value
     Fair
value
     Interest
rate
 

Notes receivable from affiliate

   $ 70.0       $ 78.5         7.00   $ 70.0       $ 77.5         7.00
  

 

 

    

 

 

      

 

 

    

 

 

    

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)    June 30, 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

   $ 100.6       $ 99.2         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         4.67        15.5         15.5         4.73   
  

 

 

    

 

 

      

 

 

    

 

 

    

Total notes payable

   $ 116.1       $ 114.7         $ 116.4       $ 115.8      
  

 

 

    

 

 

      

 

 

    

 

 

    

The following table sets forth the Company’s assets and liabilities within the fair value hierarchy at June 30, 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 June 30, 2012:            

Assets:

           

Notes receivable from affiliate

   $ 78.5         —           78.5         —     

Liabilities:

           

Senior Notes

     99.2         —           99.2         —     

Affiliate Subordinated Debentures

     15.5         —           —           15.5   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total liabilities

   $ 114.7         —           99.2         15.5   

 

17


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)

 

 

 

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.”

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
  

 

 

 

 

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)

 

 

 

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 and six months ended June 30, 2012 and 2011:

 

($ millions)    Three months ended
June 30
    Six months ended
June 30
 
     2012     2011     2012     2011  

Premiums earned:

        

Assumed from external insurers and reinsurers

   $ 1.0        5.6      $ 2.0        14.1   

Assumed under Pooling Arrangement

     258.4        352.4        513.3        702.6   

Ceded to external insurers and reinsurers

     (8.1     (6.2     (15.5     (12.3

Ceded under Pooling Arrangement

     (199.8     (202.4     (396.7     (407.9
  

 

 

   

 

 

   

 

 

   

 

 

 

Net assumed premiums earned

   $ 51.5        149.4      $ 103.1        296.5   
  

 

 

   

 

 

   

 

 

   

 

 

 

Losses and loss expenses incurred:

        

Assumed from external insurers and reinsurers

   $ 1.0        3.5      $ 1.9        9.2   

Assumed under Pooling Arrangement

     202.1        400.8        393.6        642.4   

Ceded to external insurers and reinsurers

     1.2        (7.7     (4.6     (13.0

Ceded under Pooling Arrangement

     (167.7     (265.5     (323.8     (408.9
  

 

 

   

 

 

   

 

 

   

 

 

 

Net assumed losses and loss expenses incurred

   $ 36.6        131.1      $ 67.1        229.7   
  

 

 

   

 

 

   

 

 

   

 

 

 

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 and six months ended June 30, 2012 and 2011:

 

($ millions)    Three months ended
June 30
    Six months ended
June 30
 
     2012     2011     2012     2011  
           %           %           %           %  

Amount at statutory rate

   $ (0.9     35      $ (48.7     35      $ (1.6     35      $ (43.2     35   

Tax-exempt interest and dividends received deduction

     (2.2     79        (2.6     2        (4.4     94        (5.7     5   

Other, net

     0.3        (11     (0.4     —          0.3        (9     —          —     

Valuation allowance

     2.8        (103     126.5        (91     5.7        (120     126.5        (102
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Federal income tax expense (benefit) and effective rate

   $ —          —        $ 74.8        (54   $ —          —        $ 77.6        (62
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

19


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 June 30, 2012 and December 31, 2011:

 

($ millions)    June 30,
2012
     December 31,
2011
 

Deferred tax assets:

     

Unearned premiums not currently deductible

   $ 33.8         32.4   

Losses and loss expenses payable discounting

     25.8         25.0   

Postretirement and pension benefits

     38.1         39.4   

Realized loss on other-than-temporary impairment

     9.7         11.4   

Other liabilities

     13.6         14.9   

Net operating loss carryforward

     63.8         56.0   

Tax credit carryforward

     0.7         0.7   

Other

     9.3         9.2   
  

 

 

    

 

 

 

Total deferred tax assets

     194.8         189.0   

Deferred tax liabilities:

     

Deferral of policy acquisition costs

     32.8         32.1   

Net unrealized holding gains on investments

     56.2         53.1   
  

 

 

    

 

 

 

Total deferred tax liabilities

     89.0         85.2   
  

 

 

    

 

 

 

Total net deferred tax assets before valuation allowance

     105.8         103.8   
  

 

 

    

 

 

 

Less valuation allowance

     105.0         103.3   
  

 

 

    

 

 

 

Net deferred federal income taxes

   $ 0.8         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 June 30, 2012 and December 31, 2011 the Company recorded a valuation allowance of $105.0 million and $103.3 million, respectively. The $0.8 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. 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 and six months ended June 30, 2012 is as follows:

 

($ millions)    Three months ended
June  30,
2012
     Six months ended
June  30,
2012
 

Continuing operations

   $ 2.8       $ 5.7   

Other comprehensive income

     1.7         (4.0
  

 

 

    

 

 

 

Change in valuation allowance

   $ 4.5       $ 1.7   
  

 

 

    

 

 

 

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.

 

20


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 and six months ended June 30, 2012 and 2011:

 

     Pension     Postretirement     Pension     Postretirement  
($ millions)    Three months ended June 30     Six months ended June 30  
     2012     2011     2012     2011     2012     2011     2012     2011  

Service cost

   $ 1.9        2.6      $ —          1.5      $ 3.8        5.2      $ —          3.1   

Interest cost

     2.5        3.8        0.4        1.6        5.0        7.6        0.6        3.2   

Expected return on plan assets

     (2.9     (4.6     (0.1     —          (5.8     (9.1     (0.2     (0.1 )

Amortization of:

                

Prior service (benefits) costs

     0.1        0.1        (1.4     (0.4 )     0.1        0.2        (2.7     (0.8 )

Transition assets

     —          (0.1     —          —          —          (0.2     0.1        —     

Net loss

     1.7        1.7        0.2        —          3.4        3.4        0.4        —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net periodic cost

   $ 3.3        3.5      $ (0.9     2.7      $ 6.5        7.1      $ (1.8     5.4   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The Company contributed $6.5 million for the six months ended June 30, 2012 and expects to contribute an additional $3.3 million to the pension plan during 2012.

7. Loss per Common Share

The following table sets forth the compilation of basic and diluted net loss per common share for the three and six months ended June 30, 2012 and 2011:

 

($ millions, except per share amounts)    Three months ended
June 30
    Six months ended
June 30
 
     2012     2011     2012     2011  

Numerator:

        

Net loss for basic loss per common share

   $ (2.7     (214.1   $ (4.7     (201.3
  

 

 

   

 

 

   

 

 

   

 

 

 

Denominator:

        

Weighted average shares for basic net loss per common share

     40.3        40.2        40.3        40.2   

Effect of dilutive share-based awards

     —          —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted weighted average shares for diluted net loss per common share

     40.3        40.2        40.3        40.2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Basic net loss per common share

   $ (0.07     (5.33   $ (0.12     (5.01

Diluted net loss per common share

   $ (0.07     (5.33   $ (0.12     (5.01

 

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 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 and six months ended June 30, 2012 and 2011:

 

(number of options in millions)    Three months ended
June  30
     Six months ended
June  30
 
     2012      2011      2012      2011  

Number of options

     3.8         3.1         3.7         3.1   
  

 

 

    

 

 

    

 

 

    

 

 

 

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.

 

22


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 and six months ended June 30, 2012 and 2011:

 

($ millions)    Three months ended
June  30
    Six months ended
June  30
 
     2012     2011     2012     2011  

Revenues from external sources:

        

Insurance segments

        

Personal insurance

   $ 117.2        201.9      $ 234.7        405.5   

Business insurance

     79.4        94.7        156.7        189.5   

Specialty insurance

     61.8        55.8        121.9        107.6   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total insurance segments

     258.4        352.4        513.3        702.6   

Investment operations segment

        

Net investment income

     20.5        25.2        38.0        46.2   

Net realized capital gains

     6.7        7.4        13.8        15.6   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment operations segment

     27.2        32.6        51.8        61.8   

All other

     1.1        (0.6 )     1.9        0.2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues from external sources

     286.7        384.4        567.0        764.6   

Intersegment revenues:

     2.3        2.6        4.8        5.2   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     289.0        387.0        571.8        769.8   

Reconciling items:

        

Eliminate intersegment revenues

     (2.3     (2.6     (4.8     (5.2
  

 

 

   

 

 

   

 

 

   

 

 

 

Total consolidated revenues

   $ 286.7        384.4      $ 567.0        764.6   
  

 

 

   

 

 

   

 

 

   

 

 

 

Segment loss before federal income tax:

        

Insurance segments

        

Personal insurance SAP underwriting loss

   $ (10.7     (111.8   $ (11.6     (99.3

Business insurance SAP underwriting loss

     (16.7     (45.1     (33.4     (57.1

Specialty insurance SAP underwriting loss

     (0.1     (16.8     (12.4     (32.1
  

 

 

   

 

 

   

 

 

   

 

 

 

Total insurance segments

     (27.5     (173.7     (57.4     (188.5

Investment operations segment

        

Net investment income

     20.5        25.2        38.0        46.2   

Net realized capital gains

     6.7        7.4        13.8        15.6   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total investment operations segment

     27.2        32.6        51.8        61.8   

All other

     0.6        (0.8     1.1        (0.6
  

 

 

   

 

 

   

 

 

   

 

 

 

Total segment loss before tax expense (benefit)

     0.3        (141.9     (4.5     (127.3

Reconciling items:

        

GAAP expense adjustments

     0.1        5.3        5.4        8.7   

Interest expense on corporate debt

     (1.7     (1.7     (3.5     (3.5

Corporate expenses

     (1.4     (1.0     (2.1     (1.6
  

 

 

   

 

 

   

 

 

   

 

 

 

Total reconciling items

     (3.0     2.6        (0.2     3.6   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total consolidated loss before federal income tax expense (benefit)

   $ (2.7     (139.3   $ (4.7     (123.7
  

 

 

   

 

 

   

 

 

   

 

 

 

 

23


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)

 

 

 

Investable assets attributable to the Company’s investment operations segment totaled $2,300.0 million and $2,585.9 million at June 30, 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.

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.

 

24


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 “second quarter” as used below refers to the three months ended June 30 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 June 30, 2012 and December 31, 2011, and for the consolidated statements of income for the three and six-month periods ended June 30, 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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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.

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   
  

 

 

 

 

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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

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

 

 

 

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
  

 

 

 

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 –
June 30, 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   
  

 

 

   

 

 

 

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   

 

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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

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

 

 

 

RESULTS OF OPERATIONS

Our net loss for the three and six months ended June 30, 2012 was $2.7 million and $4.7 million, respectively, compared to net losses of $214.1 million and $201.3 million, respectively, for the same 2011 periods. Our pretax loss for the three and six months ended June 30, 2012 was $2.7 million and $4.7 million, respectively, compared to pretax losses of $139.3 million and $123.7 million, respectively, for the same 2011 periods. During the second quarter of 2012, our insurance segment results were negatively impacted by two events - wind and hail activity affecting the Louisville, Kentucky, and St. Louis, Missouri areas in late April and, to a lesser extent, wind activity from a storm event in the Midwest and Mid-Atlantic states at the end of June. Our 2012 results to date, when compared to our 2011 results, for the same period, have reflected a significant decrease in weather-related catastrophe losses. In addition, the second quarter of 2011 included a non-cash charge of $115.0 million to establish a valuation allowance against our net deferred tax asset at June 30, 2011. Our 2012 results have also been impacted by the reduction in our participation in the Pooling Arrangement to 65% from 80% in 2011, as well as the quota share reinsurance arrangement covering our homeowners book of business, discussed below.

 

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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 and six months ended June 30, 2012 and 2011:

 

($ millions, except per share amounts)    Three months ended
June 30
    Six months ended
June 30
 
GAAP Basis:    2012     2011     2012     2011  

Total revenues

   $ 286.7        384.4      $ 567.0        764.6   

Net loss

   $ (2.7     (214.1   $ (4.7     (201.3

Basic (loss) earnings per share

   $ (0.07     (5.33   $ (0.12     (5.01

Diluted (loss) earnings per share

   $ (0.07     (5.33   $ (0.12     (5.01

Stockholders’ equity

   $ 719.7        641.6       

Return on average equity (LTM)

     5.3     (22.8 )%     

Book value per share

   $ 17.82        15.94       

Debt to capital ratio

     13.9        15.4       

Cat loss and ALAE ratio

     13.2        44.3        10.5        24.5   

Non-cat loss and LAE ratio

     64.9        69.7        66.1        67.2   

Loss and LAE ratio

     78.1        114.0        76.6        91.7   

Expense ratio

     32.3        33.4        33.3        33.6   

Combined ratio

     110.4        147.4        109.9        125.3   

Premium written growth

     (30.4 )%      9.9        (30.3 )%      16.7 (1) 

Investment yield

     3.9     4.1        3.5     3.9   
     Three months ended
June 30
    Six months ended
June 30
 
SAP Basis:    2012     2011     2012     2011  

Cat loss and ALAE points

     13.2        44.3        10.5        24.5   

Non-cat loss and ALAE

     57.4        62.5        58.8        60.6   

ULAE

     7.5        6.9        7.4        6.5   

Loss and LAE ratio

     78.1        113.7        76.7        91.6   

Expense ratio

     31.3        32.4        33.3        32.4   

Combined ratio

     109.4        146.1        110.0        124.0   
           Twelve months ended
June 30
 
                 2012     2011  

Net premiums written to surplus

         1.9        2.4   

 

  (1) 

Includes an increase of 5.4 points for the six months ended June 30, 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, 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. 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 and six months ended June 30, 2012, the HO QS Arrangement reduced our GAAP net underwriting loss by $24.4 million and $31.6 million, respectively, and improved our GAAP combined ratio by 6.8 points and 3.9 points, respectively.

The following tables set 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 and six months ended June 30, 2012.

Reconciliation Table 1

        Three months ended June 30, 2012

 

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

Earned premiums

   $ 258.4      $ 41.8      $ 300.2   

Losses and LAE incurred:

      

Cat loss and ALAE

     34.0        30.1        64.1   

Non-cat loss and LAE

     167.7        24.0        191.7   
  

 

 

   

 

 

   

 

 

 

Total Loss and LAE incurred

     201.7        54.1        255.8   

Acquisition and operating expenses

     83.6        12.1        95.7   
  

 

 

   

 

 

   

 

 

 

Net underwriting loss

   $ (26.9   $ (24.4   $ (51.3
  

 

 

   

 

 

   

 

 

 

Cat loss and ALAE ratio

     13.2     72.0     21.4

Non-cat loss and LAE ratio

     64.9     57.4     63.9
  

 

 

   

 

 

   

 

 

 

Total Loss and LAE ratio

     78.1     129.4     85.3

Expense ratio

     32.3     29.0     31.9
  

 

 

   

 

 

   

 

 

 

Combined ratio

     110.4     158.4     117.2
  

 

 

   

 

 

   

 

 

 

 

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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

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

 

 

 

Reconciliation Table 2

        Six months ended June 30, 2012

 

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

Earned premiums

   $ 513.3      $ 83.5      $ 596.8   

Losses and LAE incurred:

      

Cat loss and ALAE

     54.0        47.5        101.5   

Non-cat loss and LAE

     339.0        43.4        382.4   
  

 

 

   

 

 

   

 

 

 

Total Loss and LAE incurred

     393.0        90.9        483.9   

Acquisition and operating expenses

     171.2        24.2        195.4   
  

 

 

   

 

 

   

 

 

 

Net underwriting loss

   $ (50.9   $ (31.6   $ (82.5
  

 

 

   

 

 

   

 

 

 

Cat loss and ALAE ratio

     10.5     56.9     17.0

Non-cat loss and LAE ratio

     66.1     52.0     64.1
  

 

 

   

 

 

   

 

 

 

Total Loss and LAE ratio

     76.6     108.9     81.1

Expense ratio

     33.3     29.0     32.7
  

 

 

   

 

 

   

 

 

 

Combined ratio

     109.9     137.9     113.8
  

 

 

   

 

 

   

 

 

 

 

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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

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

 

 

 

For the three and six months and ended June 30, 2012, the HO QS Arrangement reduced our SAP net underwriting loss by $26.1 million and $31.7 million, respectively, and improved our SAP combined ratio by 6.8 points and 3.9 points, respectively.

The following tables set 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 and six months ended June 30, 2012.

Reconciliation Table 3

        Three months ended June 30, 2012

 

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

Net written premiums

   $ 269.4      $ 47.7      $ 317.1   

Earned premiums

     258.4        41.8        300.2   

Losses and LAE incurred:

      

Cat loss and ALAE

     34.0        30.1        64.1   

Non-cat loss and ALAE

     148.5        24.0        172.5   
  

 

 

   

 

 

   

 

 

 

Total Loss and ALAE

     182.5        54.1        236.6   

ULAE

     19.2        —          19.2   
  

 

 

   

 

 

   

 

 

 

Total Loss and ALAE incurred

     201.7        54.1        255.8   

Underwriting expenses

     84.2        13.8        98.0   
  

 

 

   

 

 

   

 

 

 

Net underwriting loss

   $ (27.5   $ (26.1   $ (53.6
  

 

 

   

 

 

   

 

 

 

Cat loss and ALAE ratio

     13.2     72.0     21.4

Non-cat loss and ALAE ratio

     57.4     57.4     57.5
  

 

 

   

 

 

   

 

 

 

Total loss and ALAE ratio

     70.6     129.4     78.9

ULAE ratio

     7.5     —          6.4
  

 

 

   

 

 

   

 

 

 

Total loss and LAE ratio

     78.1     129.4     85.3

Expense ratio

     31.3     29.0     30.9
  

 

 

   

 

 

   

 

 

 

Combined ratio

     109.4     158.4     116.2
  

 

 

   

 

 

   

 

 

 

 

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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES

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

 

 

 

Reconciliation Table 4

        Six months ended June 30, 2012

 

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

Net written premiums

   $ 532.7      $ 83.9      $ 616.6   

Earned premiums

     513.3        83.5        596.8   

Losses and LAE incurred:

      

Cat loss and ALAE

     54.0        47.5        101.5   

Non-cat loss and ALAE

     301.3        43.4        344.7   
  

 

 

   

 

 

   

 

 

 

Total Loss and ALAE

     355.3        90.9        446.2   

ULAE

     38.2        —          38.2   
  

 

 

   

 

 

   

 

 

 

Total Loss and ALAE incurred

     393.5        90.9        484.4   

Underwriting expenses

     177.2        24.3        201.5   
  

 

 

   

 

 

   

 

 

 

Net underwriting loss

   $ (57.4   $ (31.7   $ (89.1
  

 

 

   

 

 

   

 

 

 

Cat loss and ALAE ratio

     10.5     56.9     17.0

Non-cat loss and ALAE ratio

     58.8     52.0     57.8
  

 

 

   

 

 

   

 

 

 

Total loss and ALAE ratio

     69.3     108.9     74.8

ULAE ratio

     7.4     —          6.4
  

 

 

   

 

 

   

 

 

 

Total loss and LAE ratio

     76.7     108.9     81.2

Expense ratio

     33.3     29.0     32.7
  

 

 

   

 

 

   

 

 

 

Combined ratio

     110.0     137.9     113.9
  

 

 

   

 

 

   

 

 

 

See additional pro forma reconciliation tables for the HO QS Arrangement cession on our personal insurance segment’s SAP underwriting results at Reconciliation Tables 7 and 8 and our homeowners’ line of business at Reconciliation Tables 9 and 10.

 

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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 and six months ended June 30, 2012, (ii) excludes the one-time impact of the 1.1.11 pool change for the six months ended June 30, 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 and six months ended June 30, 2012, and (b) perform a meaningful comparison of our results of operations for the three and six months ended June 30, 2012 and 2011. See Reconciliation Tables 1- 4 above and Reconciliation Tables 5-10 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 loss and SAP combined ratio for the three and six months ended June 30, 2012 and 2011:

 

($ millions)    Three months ended
June 30, 2012
 
     Personal(1)     %
Ratio
     Business     %
Ratio
     Specialty     %
Ratio
     Total(2)     %
Ratio
 

Written premiums

   $ 121.2           90.6           57.6           269.4     

Earned premiums

     117.2           79.4           61.8           258.4     

Cat loss and ALAE

     17.1        14.6         16.6        20.9         0.3        0.5         34.0        13.2   

Non-cat loss and ALAE

     68.2        58.2         39.3        49.5         41.0        66.5         148.5        57.4   

ULAE

     12.0        10.3         5.1        6.5         2.1        3.4         19.2        7.5   

Underwriting expenses

     30.6        25.3         35.1        38.7         18.5        32.1         84.2        31.3   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

SAP underwriting loss and SAP combined ratio

   $ (10.7     108.4         (16.7     115.6         (0.1     102.5         (27.5     109.4   
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 
($ millions)    Three months ended
June 30, 2011
 
     Personal     %
Ratio
     Business     %
Ratio
     Specialty     %
Ratio
     Total     %
Ratio
 

Written premiums

   $ 211.7           102.7           72.7           387.1     

Earned premiums

     201.9           94.7           55.8           352.4     

Cat loss and ALAE

     118.8        58.9         37.2