=============================================================================
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 quarter ended June 30, 2001.
-------------
[ ] 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 0-5544
OHIO CASUALTY CORPORATION
(Exact name of registrant as specified in its charter)
OHIO
(State or other jurisdiction of incorporation or organization)
31-0783294
(I.R.S. Employer Identification No.)
9450 Seward Road, Fairfield, Ohio
(Address of principal executive offices)
45014
(Zip Code)
(513) 603-2400
(Registrant's telephone number)
Securities registered pursuant to Section 12(g) of the Act:
Common Shares, Par Value $.125 Each
(Title of Class)
Common Share Purchase Rights
(Title of Class)
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
The aggregate market value as of August 1, 2001 of the voting stock held
by non-affiliates of the registrant was $746,296,214.
On August 1, 2001 there were 60,075,112 shares outstanding.
Page 1 of 18
==============================================================================
PART I
ITEM 1. FINANCIAL STATEMENTS
Ohio Casualty Corporation & Subsidiaries
CONSOLIDATED BALANCE SHEET
June 30, December 31,
(In thousands, except per share data) (Unaudited) 2001 2000
- ----------------------------------------------------------------------------
Assets
Investments:
Fixed maturities:
Available for sale, at fair value
(cost: $2,525,019 and $2,470,375) $2,556,829 $2,513,654
Equity securities, at fair value
(cost: $128,953 and $168,779) 660,432 754,919
Short-term investments, at fair value
(cost: $92,991 and $59,679) 92,991 59,679
- ----------------------------------------------------------------------------
Total investments 3,310,252 3,328,252
Cash 22,553 30,365
Premiums and other receivables, net of allowance
for bad debts of $9,000 and $10,700,
respectively 365,378 357,108
Deferred policy acquisition costs 172,415 175,071
Property and equipment, net of accumulated
depreciation of $126,095 and $122,040,
respectively 93,631 91,259
Reinsurance recoverable 194,823 148,633
Agent relationships, net of accumulated
amortization of $30,740 and $25,013,
respectively 250,283 263,379
Other assets 96,954 95,298
- ----------------------------------------------------------------------------
Total assets $4,506,289 $4,489,365
============================================================================
Liabilities
Insurance reserves:
Unearned premiums $ 702,263 $ 696,513
Losses 1,700,550 1,627,568
Loss adjustment expenses 380,062 375,951
Notes payable 210,487 220,798
California Proposition 103 reserve 8,783 17,500
Deferred income taxes 43,495 65,613
Other liabilities 374,498 368,831
- ----------------------------------------------------------------------------
Total liabilities 3,420,138 3,372,774
Shareholders' Equity
Common stock, $.125 par value
Authorized: 150,000 shares; issued
shares: 94,418 11,802 11,802
Preferred stock, No par value
Authorized: 2,000 shares; issued
shares: 0 0 0
Additional paid-in capital 4,173 4,180
Common stock purchase warrants 21,138 21,138
Accumulated other comprehensive income:
Unrealized gain on investments, net of
applicable income taxes 366,912 409,904
Retained earnings 1,135,423 1,122,867
Treasury stock, at cost:
(Shares: 34,346; 34,346) (453,297) (453,300)
- ----------------------------------------------------------------------------
Total shareholders' equity 1,086,151 1,116,591
- ----------------------------------------------------------------------------
Total liabilities and shareholders'
equity $4,506,289 $4,489,365
============================================================================
Accompanying notes are an integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on
pages 29-40 of the Corporation's 2000 Annual Report to Shareholders.
2
Ohio Casualty Corporation & Subsidiaries
STATEMENT OF CONSOLIDATED INCOME AND COMPREHENSIVE INCOME
Three Months
Ended June 30,
(in thousands, except per share data) (Unaudited) 2001 2000
- -----------------------------------------------------------------------------
Premiums and finance charges earned $ 376,575 $ 369,874
Investment income less expenses 52,120 49,275
Investment gains (losses) realized, net 42,419 (2,387)
- ----------------------------------------------------------------------------
Total revenues 471,114 416,762
Losses and benefits for policyholders 263,853 276,618
Loss adjustment expenses 43,704 40,579
General operating expenses 29,913 38,242
Amortization of agent relationships 2,855 2,818
Write-off of agent relationships 2,870 0
Early retirement charge 9,600 0
Amortization of deferred policy acquisition costs 94,349 98,590
California Proposition 103 reserve, including
interest 0 611
- ----------------------------------------------------------------------------
Total expenses 447,144 457,458
- ----------------------------------------------------------------------------
Income (loss) from continuing operations
before income taxes 23,970 (40,696)
Income tax (benefit) expense:
Current 4,703 (12,098)
Deferred 2,616 (20,400)
- ----------------------------------------------------------------------------
Total income tax (benefit) expense 7,319 (32,498)
- ----------------------------------------------------------------------------
Net income (loss) 16,651 (8,198)
============================================================================
Other comprehensive income (loss), net of taxes:
Net decrease in unrealized gains, net decrease
in tax expense of $(13,248) and $(5,458),
respectively (24,605) (10,138)
- ----------------------------------------------------------------------------
Comprehensive loss $ (7,954) $ (18,336)
============================================================================
Average shares outstanding - basic* 60,072 60,075
============================================================================
Earnings per share - basic:*
Net income (loss), per share $ 0.28 $ (0.14)
Average shares outstanding - diluted* 60,089 60,075
============================================================================
Earnings per share - diluted:*
Net income (loss), per share $ 0.28 $ (0.14)
Cash dividends, per share $ 0.00 $ 0.12
============================================================================
Accompanying notes are an integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on pages
29-40 of the Corporation's 2000 Annual Report to Shareholders.
3
Ohio Casualty Corporation & Subsidiaries
STATEMENT OF CONSOLIDATED INCOME AND COMPREHENSIVE INCOME
Six Months
Ended June 30,
(in thousands, except per share data) (Unaudited) 2001 2000
- -------------------------------------------------------------------------
Premiums and finance charges earned $ 760,070 $ 757,062
Investment income less expenses 103,400 101,068
Investment gains (losses) realized, net 55,032 (8,695)
- -------------------------------------------------------------------------
Total revenues 918,502 849,435
Losses and benefits for policyholders 531,526 571,255
Loss adjustment expenses 90,450 87,729
General operating expenses 65,074 80,449
Amortization of agent relationships 5,728 5,886
Write-off of agent relationships 7,274 42,169
Early retirement charge 9,600 0
Amortization of deferred policy acquisition
costs 190,560 197,449
Restructuring charge 0 22
California Proposition 103 reserve, including
interest 0 1,222
- -------------------------------------------------------------------------
Total expenses 900,212 986,181
- -------------------------------------------------------------------------
Income (loss) from continuing operations
before income taxes 18,290 (136,746)
Income tax (benefit) expense:
Current 4,703 (25,084)
Deferred 1,031 (28,451)
- -------------------------------------------------------------------------
Total income tax (benefit) expense 5,734 (53,535)
- -------------------------------------------------------------------------
Net income (loss) 12,556 (83,211)
=========================================================================
Other comprehensive income (loss), net of taxes:
Net decrease in unrealized gains, net decrease
in tax expense of $(23,149) and $(15,732),
respectively (42,992) (29,218)
- -------------------------------------------------------------------------
Comprehensive loss $ (30,436) $ (112,429)
=========================================================================
Average shares outstanding - basic* 60,072 60,077
=========================================================================
Earnings per share - basic:*
Net income (loss), per share $ 0.21 $ (1.39)
Average shares outstanding - diluted* 60,080 60,077
=========================================================================
Earnings per share - diluted:*
Net income (loss), per share $ 0.21 $ (1.39)
Cash dividends, per share $ 0.00 $ 0.35
=========================================================================
Accompanying notes are an integral part of these financial statements.
For complete disclosures see Notes to Consolidated Financial Statements
on pages 29-40 of the Corporation's 2000 Annual Report to Shareholders.
4
Ohio Casualty Corporation and Subsidiaries
STATEMENT OF CONSOLIDATED
SHAREHOLDERS' EQUITY
Accumulated
Additional Common other Total
(in thousands, except per Common paid-in stock purchase comprehensive Retained Treasury shareholders'
share data) (Unaudited) Stock capital warrants income earnings stock equity
- ----------------------------------------------------------------------------------------------------------------------------
Balance
January 1, 2000 $11,802 $ 4,286 $ 21,138 $ 329,354 $ 1,237,562 $ (453,155) $ 1,150,987
Net change in unrealized gain (44,950) (44,950)
Deferred income tax on net
change in unrealized gain 15,732 15,732
Net forfeiture of stock
under stock award
plan (8 shares) (82) (105) (187)
Net loss (83,211) (83,211)
Cash dividends paid
($.35 per share) (21,028) (21,028)
- ----------------------------------------------------------------------------------------------------------------------------
Balance,
June 30, 2000 $11,802 $ 4,204 $ 21,138 $ 300,136 $ 1,133,323 $ (453,260) $ 1,017,343
==============================================================================================================================
Balance
January 1, 2001 $11,802 $ 4,180 $ 21,138 $ 409,904 $ 1,122,867 $ (453,300) $ 1,116,591
Net change in unrealized gain (66,141) (66,141)
Deferred income tax on net
change in unrealized gain 23,149 23,149
Net issuance of stock
under stock award
plan (0 shares) (7) 3 (4)
Net income 12,556 12,556
- ----------------------------------------------------------------------------------------------------------------------------
Balance,
June 30, 2001 $11,802 $ 4,173 $ 21,138 $ 366,912 $ 1,135,423 $ (453,297) $ 1,086,151
==============================================================================================================================
Accompanying notes are an integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on pages
29-40 of the Corporation's 2000 Annual Report to Shareholders.
5
Ohio Casualty Corporation and Subsidiaries
STATEMENT OF CONSOLIDATED CASH FLOWS
Six Months
Ended June 30,
(in thousands) (Unaudited) 2001 2000
- ----------------------------------------------------------------------------------
Cash flows from:
Operations
Net income (loss) $ 12,556 $ (83,211)
Adjustments to reconcile net income to cash
from operations:
Changes in:
Insurance reserves 82,843 71,722
Income taxes 30,790 (39,524)
Premiums and other receivables (8,270) (40,711)
Deferred policy acquisition costs 2,656 (3,238)
Reinsurance recoverable (46,190) (20,141)
Other assets 2,762 74,345
Other liabilities (15,644) 19,396
California Proposition 103 reserves (8,717) 1,222
Amortization and write-down of agent
relationships 13,002 48,055
Depreciation and amortization 3,855 7,840
Investment (gains) losses (55,032) 8,695
- ----------------------------------------------------------------------------------
Net cash generated by operating activities 14,611 44,450
- ----------------------------------------------------------------------------------
Investments
Purchase of investments:
Fixed income securities - available for sale (802,190) (527,636)
Equity securities (2,660) (30,119)
Proceeds from sales:
Fixed income securities - available for sale 693,615 451,693
Equity securities 88,222 17,186
Proceeds from maturities and calls:
Fixed income securities - available for sale 50,640 43,604
Equity securities 0 10,200
Property and equipment
Purchases (7,015) (5,381)
Sales 588 1,712
- ----------------------------------------------------------------------------------
Net cash generated (used) from investing
activities 21,200 (38,741)
- ----------------------------------------------------------------------------------
Financing
Notes payable:
Repayments (10,312) (20,325)
Proceeds from exercise of stock options 1 67
Dividends paid to shareholders 0 (21,028)
- ----------------------------------------------------------------------------------
Net cash used in financing activities (10,311) (41,286)
- ----------------------------------------------------------------------------------
Net change in cash and cash equivalents 25,500 (35,577)
Cash and cash equivalents, beginning of period 90,044 149,957
- ----------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 115,544 $ 114,380
==================================================================================
Accompanying notes are an integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on
pages 29-40 of the Corporation's 2000 Annual Report to Shareholders.
6
Ohio Casualty Corporation & Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Ohio Casualty Corporation (the Corporation) is the holding company of The Ohio
Casualty Insurance Company (the Company), which is one of six property-
casualty companies that make up the Ohio Casualty Group (the Group).
NOTE I - INTERIM ADJUSTMENTS
It is believed that all material adjustments necessary to present a fair
statement of the results of the interim period covered are reflected in this
report. The operating results for the interim periods are not necessarily
indicative of the results to be expected for the full year. These statements
should be read in conjunction with the financial statements and notes thereto
in the Corporation's 2000 Annual Report to Shareholders.
NOTE II - RECENTLY ISSUED ACCOUNTING STANDARDS
In June 1998, the Financial Accounting Standards Board (FASB) issued Statement
of Financial Accounting Standard (SFAS) 133 "Accounting for Derivative
Instruments and Hedging Activities." This statement standardizes the
accounting for derivative instruments by requiring those items to be
recognized as assets or liabilities with changes in fair value reported in
earnings or other comprehensive income in the current period. In June 1999,
the FASB issued SFAS 137 which deferred the effective date of adoption of SFAS
133 for fiscal quarters of fiscal years beginning after June 15, 2000 (January
1, 2001 for the Corporation). The adoption of FAS 133 has had an immaterial
impact on the financial results of the Corporation.
In June 2001, the FASB issued SFAS 141, Business Combinations, and SFAS 142,
Goodwill and Other Intangible Assets, effective for fiscal years beginning
after December 15, 2001. Under the new rules, goodwill will no longer be
amortized but will be subject to annual impairment tests in accordance with
the Statements. Other intangible assets will continue to be amortized over
their useful lives. The Corporation will apply the new rules on accounting
for goodwill and other intangible assets beginning in the first quarter of
2002. During 2002, the Corporation will perform the first of the required
impairment tests of goodwill as of January 1, 2002 and, therefore, has not
yet determined what the effect of these tests will be on the earnings and
financial position of the Corporation.
NOTE III - EARNINGS PER SHARE
Basic and diluted earnings per share are summarized as follows (in thousands,
except per share data):
Three months ended Six months ended
June 30 June 30
2001 2000 2001 2000
---- ---- ---- ----
Income (loss) from continuing
operations $16,651 $ (8,198) $12,556 $(83,211)
Weighted average common shares
outstanding - basic 60,072 60,075 60,072 60,077
Basic income (loss) from continuing
operations - per average share $ 0.28 $ (0.14) $ 0.21 $ (1.39)
===================================================================================
Weighted average common shares
outstanding 60,072 60,075 60,072 60,077
Effect of dilutive securities 17 0 8 0
- -----------------------------------------------------------------------------------
Weighted average common shares
outstanding - diluted 60,089 60,075 60,080 60,077
Diluted income (loss) from continuing
operations - per average share $ 0.28 $ (0.14) $ 0.21 $ (1.39)
===================================================================================
7
NOTE IV -- SEGMENT INFORMATION
The Corporation has determined its reportable segments based upon its method
of internal reporting in the quarter, which was organized by product line.
The Corporation adopted a new Corporate Strategic Plan in the second quarter
of 2001 that realigned its method of internal reporting during the quarter to
three reportable segments. In accordance with SFAS 131, the Corporation has
elected to restate prior period segment information in order to present
comparable segment information. The new property and casualty segments are
standard commercial lines, specialty commercial lines, and personal lines.
Standard commercial lines includes workers' compensation, general liability,
CMP, fire, inland marine, and commercial auto. Specialty commercial lines
includes umbrella, fidelity and surety. Personal lines includes private
passenger auto, homeowners, fire, inland marine, and umbrella. These segments
generate revenues by selling a wide variety of personal, commercial and surety
insurance products. The Corporation also has an all other segment which
derives its revenues from investment income and premium financing.
Each segment of the Corporation was managed separately during the quarter.
The property and casualty segments are managed by assessing the performance
and profitability of the segments through analysis of industry financial
measurements including statutory loss and loss adjustment expense ratios,
statutory combined ratio, premiums written, premiums earned and statutory
underwriting gain/loss. The following tables present this information by
segment as it is reported internally to management. Asset information by
reportable segment is not reported, since the Corporation does not produce
such information internally.
8
New Reportable Segments
(Effective Second Quarter of 2001)
Six Months Ended June 30
(in thousands)
Standard Commercial Lines 2001 2000
- --------------------------------------------------------------------
Net premiums written $364,142 $383,787
% Increase (decrease) (5.1)% 8.2%
Net premiums earned 359,438 361,221
% Increase (decrease) (0.5)% 6.3%
Underwriting gain (loss)
(before tax) (75,918) (107,453)
Loss ratio 70.2% 76.6%
Loss expense ratio 14.6% 12.9%
Underwriting expense ratio 35.9% 37.9%
Combined ratio 120.7% 127.4%
Specialty Commercial Lines 2001 2000
- --------------------------------------------------------------------
Net premiums written $66,968 $52,871
% Increase (decrease) 26.7% 20.3%
Net premiums earned 64,195 49,089
% Increase (decrease) 30.8% 13.7%
Underwriting gain (loss)
(before tax) 15,245 4,712
Loss ratio 34.3% 37.0%
Loss expense ratio 5.1% 4.4%
Underwriting expense ratio 35.3% 45.5%
Combined ratio 74.7% 86.9%
Personal Lines 2001 2000
- --------------------------------------------------------------------
Net premiums written $329,622 $340,196
% Increase (decrease) (3.1)% (15.4)%
Net premiums earned 335,985 346,152
% Increase (decrease) (2.9)% (7.8)%
Underwriting gain (loss)
(before tax) (46,687) (72,895)
Loss ratio 76.6% 79.9%
Loss expense ratio 10.3% 11.3%
Underwriting expense ratio 27.5% 30.4%
Combined ratio 114.4% 121.6%
Total Property & Casualty 2001 2000
- --------------------------------------------------------------------
Net premiums written $760,732 $776,854
% Increase (decrease) (2.1)% (3.0)%
Net premiums earned 759,618 756,462
% Increase (decrease) 0.4% (0.3)%
Underwriting gain (loss)
(before tax) (107,360) (175,636)
Loss ratio 70.0% 75.5%
Loss expense ratio 11.9% 11.6%
Underwriting expense ratio 32.2% 35.2%
Combined ratio 114.1% 122.3%
Impact of catastrophe losses
on combined ratio 2.7% 3.8%
All other 2001 2000
- --------------------------------------------------------------------
Revenues $ 3,411 $ 2,423
Expenses 7,011 8,155
- -------------------------------------------------------------------
Net income (loss) $ (3,600) $(5,732)
Reconciliation of Revenues 2001 2000
- --------------------------------------------------------------------
Net premiums earned for
reportable segments $759,618 $756,462
Investment income 102,571 99,112
Realized gains (losses) 50,668 (469)
Miscellaneous income 352 341
- --------------------------------------------------------------------
Total property and casualty
revenues (Statutory basis) 913,209 855,446
Property and casualty statutory
to GAAP adjustment 1,882 (8,434)
- --------------------------------------------------------------------
Total revenues property and
casualty (GAAP basis) 915,091 847,012
Other segment revenues 3,411 2,423
- --------------------------------------------------------------------
Total revenues $918,502 $849,435
====================================================================
Reconciliation of Underwriting
gain (loss) (before tax) 2001 2000
- --------------------------------------------------------------------
Property and casualty under-
writing gain (loss) (before
tax)
(Statutory basis) $(107,360) $(175,636)
Statutory to GAAP adjustment (23,852) (42,438)
- --------------------------------------------------------------------
Property and casualty under-
writing gain (loss) (before
tax)
(GAAP basis) (131,212) (218,074)
Net investment income 103,400 101,068
Realized gains (losses) 55,032 (8,695)
Other income (losses) (8,930) (11,045)
- --------------------------------------------------------------------
Income (loss) from continuing
operations before income taxes $ 18,290 $(136,746)
====================================================================
9
New Reportable Segments
(Effective Second Quarter of 2001)
Three months ended June 30
(in thousands)
Standard Commercial Lines 2001 2000
- --------------------------------------------------------------------
Net premiums written $185,719 $186,061
% Increase (decrease) (0.2)% 5.0%
Net premiums earned 177,019 178,023
% Increase (decrease) (0.6)% 11.7%
Underwriting gain (loss)
(before tax) (34,870) (55,839)
Loss ratio 67.0% 78.6%
Loss expense ratio 14.3% 12.5%
Underwriting expense ratio 36.6% 38.5%
Combined ratio 117.9% 129.6%
Specialty Commercial Lines 2001 2000
- --------------------------------------------------------------------
Net premiums written $ 36,949 $ 27,603
% Increase (decrease) 33.9% 18.5%
Net premiums earned 33,122 25,455
% Increase (decrease) 30.1% (2.3)%
Underwriting gain (loss)
(before tax) 6,125 3,219
Loss ratio 42.7% 31.0%
Loss expense ratio 5.6% 5.4%
Underwriting expense ratio 29.8% 47.0%
Combined ratio 78.1% 83.4%
Personal Lines 2001 2000
- --------------------------------------------------------------------
Net premiums written $166,715 $168,547
% Increase (decrease) (1.1)% (17.0)%
Net premiums earned 166,097 166,268
% Increase (decrease) (0.1)% (11.9)%
Underwriting gain (loss)
(before tax) (24,366) (31,689)
Loss ratio 79.0% 77.4%
Loss expense ratio 9.9% 10.2%
Underwriting expense ratio 25.7% 31.0%
Combined ratio 114.6% 118.6%
Total Property & Casualty 2001 2000
- --------------------------------------------------------------------
Net premiums written $389,383 $382,211
% Increase (decrease) 1.9% (5.3)%
Net premiums earned 376,238 369,746
% Increase (decrease) 1.8% (1.2)%
Underwriting gain (loss)
(before tax) (53,111) (84,309)
Loss ratio 70.1% 74.8%
Loss expense ratio 11.6% 11.0%
Underwriting expense ratio 31.3% 35.8%
Combined ratio 113.0% 121.6%
Impact of catastrophe losses on
combined ratio 5.0% 5.6%
All other 2001 2000
- --------------------------------------------------------------------
Revenues $ 2,385 $ 1,264
Expenses 3,431 3,532
- -------------------------------------------------------------------
Net income (loss) $(1,046) $(2,268)
Reconciliation of Revenues 2001 2000
- --------------------------------------------------------------------
Net premiums earned for
reportable segments $376,238 $369,746
Investment income 51,848 48,339
Realized gains (losses) 40,318 (701)
Miscellaneous income 306 (3)
- -------------------------------------------------------------------
Total property and casualty
revenues (Statutory basis) 468,710 417,381
Property and casualty statutory to
GAAP adjustment 19 (1,883)
- -------------------------------------------------------------------
Total revenues property and
casualty (GAAP basis) 468,729 415,498
Other segment revenues 2,385 1,264
- -------------------------------------------------------------------
Total revenues $471,114 $416,762
===================================================================
Reconciliation of Underwriting
gain (loss) (before tax) 2001 2000
- --------------------------------------------------------------------
Property and casualty under-
writing gain (loss) (before tax)
(Statutory basis) $(53,111) $(84,309)
Statutory to GAAP adjustment (13,462) 1,381
- -------------------------------------------------------------------
Property and casualty under-
writing gain (loss) (before tax)
(GAAP basis) (66,573) (82,928)
Net investment income 52,120 49,275
Realized gains (losses) 42,419 (2,387)
Other income (3,996) (4,656)
- -------------------------------------------------------------------
Income (loss) from continuing
operations before income taxes $ 23,970 $(40,696)
===================================================================
NOTE V - AGENT RELATIONSHIPS
The agent relationship asset is the identifiable intangible asset acquired in
connection with the Great American Insurance Company commercial lines
acquisition. Agent relationships are evaluated periodically as events or
circumstances indicate a possible inability to recover their carrying amount.
The current quarter included a $2.9 million before-tax write-off to the agent
relationships asset. The first quarter of 2001 included a $4.4 million before-
tax write-off to the agent relationships asset. Included in the write-offs
were agents cancelled and certain agents determined to be impaired based on
updated estimated future undiscounted cash flows that were insufficient to
recover the carrying amount of the asset for the agent. During the first
quarter of 2000, the Group made the strategic decision to discontinue its
relationship with Managing General Agents. The result was a write-off to the
agent relationships asset of $42.2 million. The Group believes the
termination of Managing General Agents will give it better control of its
underwriting and pricing practices. The remaining portion of the agent
relationships asset will be amortized on a straight line basis over the
remaining amortization period.
10
The purchase agreement with the Great American Insurance Company called for
an additional payment of up to $40.0 million if annualized revenue production
of the transferred agents for the 18 month period ending June 1, 2000 equaled
or exceeded production for the twelve months prior to the acquisition. The
Company paid an additional $27.4 million for the final payment. Of the $27.4
million payment, $27.1 million was paid in 2000, while the remaining $.3
million was paid in 2001. This amount was added to the agent relationships
asset for the acquisition and will be amortized over the remaining life.
Additional information related to agent relationships is included in Note 1G,
Agent Relationships on page 29 of the Corporation's 2000 Annual Report to
Shareholders.
NOTE VI - RESTRUCTURING CHARGE
During December 1998, the Group adopted a plan to restructure its branch
operations. To continue in the Corporation's efforts to reduce expenses,
personal lines business centers were reduced from five to three locations.
Underwriting branch locations were reduced from seventeen to eight locations
and claims branches were reduced from thirty-eight to six locations in 1999.
As part of this plan, the Corporation established a $10.0 million liability
for future expenses related to its branch office consolidation plan, resulting
in a one-time charge of $10.0 million being reflected in the 1998 income
statement. These expenses consisted solely of future contractual lease
payments related to abandoned facilities. The activities under the plan were
completed in 1999, but due to leases still in effect, the balance in the
restructuring reserve will continue to remain as leases expire. The
Corporation reduced $2.2 million of liability in 2000 due to payments under
leases. In the first six months of 2001, the Corporation further reduced $.6
million of the liability due to payments under leases. The balance in the
restructuring reserve was $1.9 million at June 30, 2001.
NOTE VII - EARLY RETIREMENT CHARGE
During the second quarter of 2001, the Corporation adopted an early retirement
plan. The early retirement plan is available to approximately 330 employees.
Of the employees eligible to retire under the program, approximately 50% are
currently estimated to accept. The retirements will affect the employee count
over the course of the next 14 months. The early retirement plan resulted in
a one-time before-tax charge of $9.6 million, or $.16 per share, to second
quarter 2001 earnings. The after-tax impact of this one-time charge to
earnings was $6.2 million, or $.10 per share.
11
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
-------------------------------------------------
Ohio Casualty Corporation (the Corporation) is the holding company of The
Ohio Casualty Insurance Company (the Company), which is one of six property-
casualty companies that make up the Ohio Casualty Group (the Group).
Results of Operations
Property and casualty before-tax underwriting losses, excluding a one-time
early retirement charge, California Proposition 103 and restructuring
charges, for the six months ended June 30, 2001 were $121.6 million, $2.02
per share, compared with $216.8 million, $3.61 per share for the same period
in 2000. The $9.6 million one-time charge was related to an early retirement
plan announced in the second quarter of 2001. The 2000 loss included a $42.2
million write-off of the agent relationships intangible asset and $17.0
million in additional ceded premiums on experience rated reinsurance
contracts. The results for both periods were impacted by poor results in the
workers' compensation line of business. For the second quarter, property and
casualty before-tax underwriting losses, excluding the one-time early
retirement charge and California Proposition 103 were $57.0 million, or $.95
per share, compared with $82.3 million, or $1.37 per share, for the second
quarter of 2000.
The table below summarizes the increase (decrease) in property and casualty
premium results compared with same period prior year results:
2001 increase (decrease) from 2000 ($ in millions)
Gross Premiums Written Net Premiums Written
Second Year Second Year
Quarter To Date Quarter To Date
------- ------- ------- -------
Business Units
Personal Lines $ (8.4) $(18.3) $(1.8) $(10.6)
Standard Commercial Lines (17.6) (39.0) (.3) (19.6)
Specialty Commercial Lines 12.1 19.4 9.3 14.1
All Lines (13.9) (37.9) 7.2 (16.1)
Agency cancellations and tighter underwriting guidelines combined with strong
competition in the personal lines market contributed to the decrease in
personal lines premiums for the current year. The 2000 personal lines net
premiums written results included $5.8 million in additional ceded premiums
on experience rated reinsurance contracts. Despite the positive impact of
renewal price increases in the standard commercial lines, management's
decision in 2000 to cancel and eliminate consistently unprofitable business
led to a decrease in premiums. The 2000 standard commercial lines net
premiums written results included $11.2 million in additional ceded premiums
on experience rated reinsurance contracts. Renewal price increases in the
umbrella line of business in the specialty commercial lines contributed to
the increase in premiums for the current year.
When used in this report, renewal price increase means the average increase
in premium for policies renewed by the Group. The average increase in
premiums for each renewed policy is calculated by comparing the total
expiring premium for the policy with the total renewal premium for the same
policy. Renewal price increases include, among other things, the effects of
rate increases and changes in the underlying insured exposures of the policy.
Only policies issued by the Group in the previous policy term with the same
policy identification codes are included. Therefore, renewal price increases
do not include changes in premiums for newly issued policies and business
assumed through reinsurance agreements, including Great American business not
yet issued in the Group's systems. Renewal price increases also do not
reflect the cost of any reinsurance purchased on the policies issued.
During second quarter 2001, 17.4% of the Group's total net premiums written
were for policyholders in New Jersey, which historically has been a
profitable state for the Group. In recent years, however, New Jersey's
legislative environment has become less favorable. Legislative rules and
regulations have adversely impacted the Group's results.
12
Year-to-date consolidated before-tax investment income was $103.4 million, or
$1.72 per share, increasing from $101.1 million, or $1.68 per share, for the
same period last year. The effective tax rate year-to-date 2001 was 33.2%,
compared with 31.0% for year-to-date 2000. Second quarter consolidated
before-tax investment income was $52.1 million, or $.86 per share, increasing
from $49.3 million, or $.82 per share, for the same period last year. The
effective tax rate for the second quarter of 2001 was 33.6% compared with
31.0% for the comparable period in 2000. The increase in effective tax rate
reflects a reallocation of investments from tax exempt municipal bonds to
taxable bonds.
Year-to-date consolidated before-tax realized gain was $55.0 million, or $.92
per share, compared with a before-tax realized loss of $8.7 million, or $.14
per share, for year-to-date 2000. For the second quarter, consolidated
before-tax realized gain was $42.4 million, or $.71 per share, compared with
a before-tax realized loss of $2.4 million, or $.04 per share, for the same
period of 2000. As part of the Corporate Strategic Plan announced in the
second quarter of 2001, the Corporation began to reallocate a portion of its
appreciated equity portfolio holdings to fixed income holdings. The
reallocation contributed to the realized investment gains in the second
quarter of 2001.
Statutory Results
The statutory combined ratio for the first six months of 2001 was 114.1%,
decreasing from 122.3% in the same period of 2000. The improvement in the
statutory combined ratio is attributable to the actions taken in 2000 to
reduce expenses and improve the loss results. Both periods were negatively
impacted by high losses in the workers' compensation line of business.
The year-to-date June 30, 2001 all lines accident year loss ratio of 67.7%
was better than the calendar year-to-date loss ratio of 70.0%.
The second quarter catastrophe losses were $18.9 million before tax and
accounted for 5.0 points on the statutory combined ratio. This compares with
$20.8 million and a 5.6 point catastrophe impact for the same period in 2000.
The effect of future catastrophes on the Corporation's results cannot be
accurately predicted. Severe weather patterns can have a material adverse
impact on the Corporation's results. During the second quarter of 2001,
there were 9 additional catastrophes with the largest catastrophe generating
$12.4 million in incurred losses as compared with 10 additional catastrophes
in the second quarter of 2000 with the largest catastrophe generating $4.2
million in incurred losses. For additional disclosure of catastrophe losses,
refer to Note 9, Losses and Loss Reserves in the Notes to the Consolidated
Financial Statements on pages 35 and 36 of the Corporation's 2000 Annual
Report to Shareholders.
The statutory underwriting expense ratio through June 30, 2001, was 32.2%
compared with 35.2% in the same period of 2000. The second quarter 2001
statutory underwriting expense ratio improved to 31.3% from 35.8% in the same
quarter of 2000. The second quarter decrease is due mostly to lower
commissions and policyholder dividend expenses in addition to decreased
advertising expenditures. The early retirement incentive program one-time
charge added $1.5 million, or 0.4 points, to the second quarter 2001
statutory underwriting expense ratio. As of June 30, 2001, the employee
count was 3,459 compared with 3,470 at year-end 2000. The retirements will
effect the employee count over the course of the next 14 months.
Segment Discussion
Personal Lines
The personal lines statutory combined ratio for the first six months of 2001
decreased 7.2 points to 114.4% from 121.6% during the same period last year.
The six-month statutory combined ratio for homeowners increased 1.9 points to
129.9% from 128.0% in the same period of last year. Catastrophe losses
resulting primarily from a series of severe storms added 14.3 points to the
line's loss ratio for the first six months of both 2001 and 2000.
13
Private passenger auto-agency, the Group's largest line, recorded a 2001 six-
month statutory combined ratio of 108.0%, decreasing from 117.4% in 2000.
The private passenger auto-agency statutory loss ratio decreased 8.5 points
to 70.9% from 79.4% in 2000. Although the results improved in 2001 from
2000, poor underwriting results in New Jersey business continue to impact
this line's performance, adding 3.8 points to the statutory loss ratio in the
first six months of 2001, compared with reducing the line's statutory loss
ratio by .4 points in the first six months of 2000. The poor New Jersey
private passenger automobile results are driven by regulatory restraints in
the state which restrict insurers' ability to raise rates. In addition, the
New Jersey State Senate passed an auto insurance reform bill effective in
early 1999 that mandated a 15% rate reduction for personal auto policies
based on legal reform intended to provide a reduction in medical expense
benefits, limitations on lawsuits and enhanced fraud prevention. While the
rate reduction was immediate, many of the reforms have not yet been
implemented, resulting in inadequate rate levels for the Group.
Since 1999, New Jersey has also required insurance companies to write a
portion of their personal auto premiums in Urban Enterprise Zones (UEZ).
These zones are generally higher risk urban areas. The Group is required
to write one policy in an UEZ for every seven policies written outside
an UEZ. The Group is assigned policies if it does not write the required
quota. As of June 30, 2001, the Group has written $4.7 million year to
date in UEZ premiums, with $3.4 million in additional assigned premiums.
The 2001 year-to-date loss ratio on the UEZ premiums was 178.1% and the loss
ratio on the assigned business was 247.8%.
New Jersey's private passenger auto net premiums written represented
approximately 26.3% of the Group's total private passenger auto-agency book
of business in the first six months of 2001, compared with approximately
23.0% in the first six months of 2000. New Jersey regulation mandates
private passenger automobile insurers in the state to provide insurance
to all eligible consumers with limited exceptions. This "take-all-comers"
regulation effectively eliminates the Group's ability to control the
volume of writings in the state.
Given the unfavorable regulatory environment in New Jersey and the continued
unprofitability of its private passenger auto business in the state, the
Group is evaluating its options for the New Jersey private passenger
automobile book of business.
Standard Commercial Lines
The standard commercial lines statutory combined ratio for the first six
months of 2001 decreased 6.7 points to 120.7% from 127.4% during the same
period of 2000. Average renewal price increases for standard commercial
lines direct premiums written were 13.9% for the first six months of 2001,
compared with an average renewal price increase of 5.7% for the first six
months of 2000.
Commercial auto reported a year-to-date statutory combined ratio of 109.9%, a
decrease of 14.0 points over the same period of 2000 statutory combined ratio
of 123.9%. For this line, as well as other commercial lines, the impact of
price increases are beginning to be realized in earned premiums.
Workers' compensation statutory combined ratio for the first six months of
2001 increased 11.6 points to 152.8% from 141.2% during the same period last
year. The increase is a result of adverse development in prior year
reserves. Prior year development added 25.3 points to the year-to-date 2001
combined ratio. In response to the deterioration in workers' compensation
results, the Group is eliminating dividends on new and renewal policies,
implementing price and rate increases where permitted and instituting more
restrictive renewal underwriting guidelines. These actions are expected to
begin having a positive impact on results by year-end 2001.
The general liability year-to-date statutory combined ratio decreased in 2001
to 120.2% from 137.3% in 2000.
The statutory combined ratio for CMP, fire and inland marine decreased 7.5
points to 106.9% from 114.4% during the first six months of 2001. The line
has experienced an improved statutory combined ratio partially driven by
better catastrophe experience.
14
Specialty Commercial Lines
Specialty commercial lines reported a six-month statutory combined ratio of
74.7% in 2001, compared with 86.9% in 2000.
The umbrella line of business statutory combined ratio for the first six
months of 2001 decreased to 76.4% from 90.5% in 2000. The decrease is
largely due to the impact of price increases being realized in earned
premiums. Average renewal price increases for the umbrella business in the
specialty commercial lines business unit were 19.5% for the first half of
2001, compared with an average renewal price increase of 5.8% for the first
half of 2000.
The fidelity and surety line of business year-to-date statutory combined
ratio decreased in 2001 to 64.7% from 73.5% in 2000.
Investments
At June 30, 2001, the Corporation's fixed income portfolio totaled $2.6
billion, which consisted of 95.6% investment grade and 4.4% below investment
grade securities. The Corporation classifies securities as below investment
grade based upon ratings provided by Standard & Poor's Ratings Group, Moody's
Investors Service or other rating agencies, including the National
Association of Insurance Commissioners (NAIC). Below investment grade
securities are summarized as follows:
June 30, December 31,
(in millions) 2001 2000
- -----------------------------------------------------------------------------
Below investment grade securities:
Carrying value $111.4 $127.4
Amortized cost 112.4 133.6
Investments in below investment grade securities have greater risks than
investments in investment grade securities. The risk of default by borrowers
that issue below investment grade securities is significantly greater because
these borrowers are often highly leveraged and more sensitive to adverse
economic conditions, including a recession or a sharp increase in interest
rates. Additionally, investments in below investment grade securities are
generally unsecured and subordinate to other debt. Investment grade
securities are also subject to significant risks, including additional
leveraging or changes in control of the issuer. In most instances, investors
are unprotected with respect to these risks, the effects of which can be
substantial.
The Corporation marks the value of its equity portfolio to fair market value
on its balance sheet. As a result, shareholders' equity and statutory
surplus fluctuate with changes in the value of the equity portfolio. As of
June 30, 2001, the equity portfolio consisted of stock of 46 separate
entities in 34 different industries. As of that date, 45.7% of the
Corporation's equity portfolio was invested in five companies and the largest
single position was 14.8% of the equity portfolio.
For further discussion of the Corporation's investments, see Item 1 pages 6
through 9 of the Corporation's Form 10-K for the year ended December 31,
2000.
Liquidity and Financial Strength
Net cash generated by operations was $15.8 million for the first six months
of the year compared with cash generated of $44.5 million for the same period
in 2000. This change is due in part to payments made in first quarter of
2001 related to the settlement of California Proposition 103 (see Legal
Proceedings below) and payment received in first quarter of 2000 as part of
the commutation of a reinsurance treaty in the fourth quarter of 1999.
Current operational liquidity needs of the Group are expected to be met by
scheduled bond maturities, dividend payments, interest payments, and cash
balances.
The Corporation had no shareholder dividend payments in the first six months
of 2001 compared with payments of $21.0 million for the same period in 2000.
On February 8, 2001, the Corporation eliminated its
15
quarterly dividend in order to further strengthen the Corporation's financial
position. Ohio Casualty Corporation did not repurchase any of its shares
during the first six months of the year. The Corporation has remaining
authorization to repurchase 1,649,824 additional shares.
As of June 30, 2001, the Corporation had $210.5 million of outstanding notes
payable. Of the $210.5 million, $5.5 million related to a low interest loan
outstanding with the state of Ohio used in conjunction with the purchase of a
new home office located in Fairfield, Ohio. The remaining $205.0 million is
related to a 1997 credit facility that provided a $300.0 million revolving
line of credit available to the Corporation. On March 19, 2001, the
Corporation elected to reduce the aggregate amount available under the line
of credit from $300.0 million to $250.0 million. The credit facility
agreement contains financial covenants and provisions customary for such
arrangements. The most restrictive covenants include a maximum permissible
consolidated funded debt that cannot exceed 30% of consolidated tangible net
worth and a minimum statutory surplus. The original minimum statutory
surplus was required to be at least $750.0 million. Effective March 30,
2001, the covenant was amended to require a minimum statutory surplus of
$675.0 million for the quarters ending March 31, 2001 and June 30, 2001,
returning to minimum statutory surplus of $750.0 million for subsequent
quarters. As of June 30, 2001, the Corporation is in compliance with these
covenants. However, further deterioration of operating results, reductions
in the equity portfolio valuation or other changes in surplus, including the
effects of adopting new statutory accounting principles (such as the
Codification of Statutory Accounting Principles guidance adopted by the NAIC
in 1998), could lead to violations and ultimately result in default. The
Corporation continues to review its financial covenants in the credit
agreement in light of its operating losses. The 1997 credit facility expires
in October 2002, with any outstanding loan balance due at that time. The
Corporation may be required to obtain additional external funding, either in
the form of debt or equity funding, to support its insurance operations in
the future. While the Corporation believes that it should be able to obtain
such external funding, if needed, the availability of such funding cannot be
assured nor can the cost of such funding be evaluated at this time.
Additional information related to bank notes payable is included in Note 17
Bank Note Payable on page 39 of the Corporation's 2000 Annual Report to
Shareholders.
Regularly the Group's financial strength is reviewed by independent rating
agencies. These agencies may upgrade, downgrade, or affirm their previous
ratings of the Group. On July 25, 2001, A.M. Best announced that their
rating of our group of companies is now "A-" (Excellent) from "A" previously.
The rating action reflects the sharp deterioration in the Group's earnings
and the significant reduction in policyholders' surplus over recent years.
A.M. Best stated the "Excellent" rating was due to solid capitalization and
strategic initiatives put in place by management to improve earnings. A.M.
Best has placed a silent outlook on the Group's rating. On May 7, 2001,
Standard & Poor's (S&P) Rating Services downgraded the Group's financial
strength rating. The Group's S&P rating moved from "BBB+" to "BBB". S&P
cited operating performance, declining capitalization, and limited financial
flexibility as reasons for the rating change. S&P recognized the Group's
improved strategic focus and re-underwriting actions as positive attributes.
S&P has placed a negative outlook on the Group's rating. On May 2, 2001,
Moody's Investors Services affirmed the Group's "A2" rating based on new
executive leadership, ongoing expense reduction and re-underwriting
initiatives, reduction or elimination of its shareholder dividends, and
strength of its independent agency relationships. Moody's has revised the
outlook for the Group's rating from negative to stable.
Legal Proceedings
California voters passed Proposition 103 in 1988 in an attempt to legislate
premium rates for that state. The proposition required premium rate rollbacks
for 1989 California policyholders while allowing for a "fair" return for
insurance companies. In 1998, an Administrative Law Judge issued a proposed
ruling with a rollback liability for the Group of $24.4 million plus simple
interest at 10% per annum from May 8, 1989. This brought the total reserve to
$52.3 million at September 30, 2000. On October 25, 2000, the Group announced
a settlement agreement for California Proposition 103 that was approved by the
California Insurance Commissioner. Under the terms of the settlement, the
members of the Group will pay $17.5 million in refunded premiums to eligible
1989 California policyholders. With this development, the total reserve was
decreased to $17.5 million as of December 31, 2000. The Corporation began to
make payments in the first quarter of 2001. The remaining liability was $8.8
million as of June 30, 2001.
16
Forward Looking Statements
From time to time, the Company may publish forward looking statements relating
to such matters as anticipated financial performance, business prospects and
plans, regulatory developments and similar matters. The statements contained
in this Management's Discussion and Analysis of Financial Condition and
Results of Operations that are not historical information, are forward looking
statements. The Private Securities Litigation Reform Act of 1995 provides a
safe harbor under the Securities Act of 1933 and the Securities Exchange Act
of 1934 for forward-looking statements. In order to comply with the terms of
the safe harbor, the Company notes that a variety of factors could cause the
Company's actual results and experience to differ materially from the
anticipated results or other expectations expressed in the Company's forward-
looking statements.
The risks and uncertainties that may affect the operations, performance,
development and results of the Company's business include the following:
changes in property and casualty reserves; catastrophe losses; premium and
investment growth; product pricing environment; availability of credit;
changes in government regulation; performance of financial markets;
fluctuations in interest rates; availability and pricing of reinsurance;
litigation and administrative proceedings; rating agency actions; ability of
Ohio Casualty to integrate and to retain the business acquired from the Great
American Insurance Company; ability to achieve targeted expense savings;
ability to refinance indebtedness; ability to achieve premium targets and
profitability goals; and general economic and market conditions.
ITEM 3. Quantitative And Qualitative Disclosures About Market Risk
There have been no material changes in the information about market risk set
forth in the Corporation's Annual Report on Form 10-K.
PART II
ITEM 1. Legal Proceedings - Refer to Legal Proceedings as described on
Page 16 of this Form 10-Q regarding California Proposition 103.
ITEM 2. Changes in Securities - None
ITEM 3. Defaults Upon Senior Securities - None
ITEM 4. Submission of Matters to a Vote of Security Holders - None
ITEM 5. Other Information - None
17
ITEM 6. Exhibits and reports on Form 8-K -
(a) The Corporation filed on Form 8-K on June 18, 2001, as Exhibit
99.1 the press release announcing the appointment of Edward T.
Roeding to the Corporation's Board of Directors.
Also filed on Form 8-K on June 18, 2001, as Exhibit 99.2 was
the press release announcing details of the new Corporate
Strategic Plan.
(b) The Ohio Casualty Insurance Company Employee Savings Plan (the
"Plan") filed Form 8-K/A on June 26, 2001, amending Form 8-K
filed on March 1, 2001 in which the Plan reported in Item 4 the
appointment of Ernst & Young LLP as independent public account
for the Plan, replacing PricewaterhouseCoopers LLP.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
OHIO CASUALTY CORPORATION
---------------------------------
(Registrant)
August 14, 2001 /s/ Dan R. Carmichael
---------------------------------
Dan R. Carmichael, President and
CEO (on behalf of Registrant and
as Principal Accounting Officer)
18