==============================================================================
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 March 31, 2002.
--------------
[ ] 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 May 1, 2002 of the voting stock held by
non-affiliates of the registrant was $1,041,317,299.
On May 1, 2002 there were 60,372,250 shares outstanding.
Page 1 of 20
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PART I
ITEM 1. FINANCIAL STATEMENTS
Ohio Casualty Corporation & Subsidiaries
CONSOLIDATED BALANCE SHEET
March 31, December 31,
(In thousands, except per share data) (Unaudited) 2002 2001
- ----------------------------------------------------------------------------------
Assets
Investments:
Fixed maturities:
Available for sale, at fair value
(cost: $2,818,664 and $2,729,998) $2,814,801 $2,772,104
Equity securities, at fair value
(cost: $95,348 and $110,206) 453,750 488,988
Short-term investments, at fair value
(cost: $51,917 and $54,785) 51,917 54,785
- ----------------------------------------------------------------------------------
Total investments 3,320,468 3,315,877
Cash 22,339 37,499
Premiums and other receivables, net of allowance
for bad debts of $7,800 and $8,400, respectively 353,767 341,986
Deferred policy acquisition costs 171,075 166,759
Property and equipment, net of accumulated
depreciation of $136,245 and $133,213,
respectively 102,104 99,810
Reinsurance recoverable 237,951 237,688
Agent relationships, net of accumulated
amortization of $39,059 and $36,310, respectively 233,008 241,022
Interest and dividends due or accrued 40,178 43,319
Deferred income taxes 7,112 -
Other assets 28,772 40,659
- ----------------------------------------------------------------------------------
Total assets $4,516,774 $4,524,619
==================================================================================
Liabilities
Insurance reserves:
Losses $1,749,868 $1,746,828
Loss adjustment expenses 409,181 403,894
Unearned premiums 676,485 666,739
Notes payable 199,067 210,173
California Proposition 103 reserve 7,784 7,816
Deferred income taxes - 3,124
Other liabilities 408,289 406,013
- ----------------------------------------------------------------------------------
Total liabilities 3,450,674 3,444,587
Shareholders' Equity
Common stock, $.125 par value
Authorized shares: 150,000; 150,000
Issued shares: 72,418; 94,418 9,052 11,802
Preferred stock, No par value
Authorized: 2,000 shares; issued shares: 0 - -
Additional paid-in capital - 4,152
Common stock purchase warrants 21,138 21,138
Accumulated other comprehensive income: 231,233 274,359
Retained earnings 964,648 1,221,447
Treasury stock, at cost:
(Shares: 12,120; 34,312) (159,971) (452,866)
- ----------------------------------------------------------------------------------
Total shareholders' equity 1,066,100 1,080,032
- ----------------------------------------------------------------------------------
Total liabilities and shareholders'
equity $4,516,774 $4,524,619
==================================================================================
Accompanying notes are an integral part of these financial statements.
For complete disclosures see Notes to Consolidated Financial Statements
on pages 49-63 of the Corporation's 2001 Form 10-K.
2
Ohio Casualty Corporation & Subsidiaries
STATEMENT OF CONSOLIDATED INCOME
Three Months
Ended March 31,
(In thousands, except per share data) (Unaudited) 2002 2001
- -----------------------------------------------------------------------------------
Premiums and finance charges earned $ 361,007 $ 383,496
Investment income less expenses 50,902 51,280
Investment gains (losses) realized, net 22,831 12,613
- -----------------------------------------------------------------------------------
Total revenues 434,740 447,389
Losses and benefits for policyholders 211,769 267,673
Loss adjustment expenses 51,473 46,746
General operating expenses 26,244 31,627
Amortization of agent relationships 2,749 2,873
Write-off of agent relationships 5,265 4,405
Amortization of deferred policy acquisition costs 92,224 96,211
Depreciation expense 2,372 2,301
Amortization of software 1,518 1,233
- -----------------------------------------------------------------------------------
Total expenses 393,614 453,069
- -----------------------------------------------------------------------------------
Income (loss) before income taxes 41,126 (5,680)
Income tax (benefit) expense:
Current 1,267 -
Deferred 12,986 (1,585)
- -----------------------------------------------------------------------------------
Total income tax (benefit) expense 14,253 (1,585)
- -----------------------------------------------------------------------------------
Net income (loss) $ 26,873 $ (4,095)
===================================================================================
Average shares outstanding - basic* 60,187 60,073
===================================================================================
Earnings per share - basic:
Net income (loss), per share $ 0.45 $ (0.07)
Average shares outstanding - diluted* 61,062 60,073
===================================================================================
Earnings per share - diluted:
Net income (loss), per share $ 0.44 $ (0.07)
===================================================================================
Cash dividends, per share $ - $ -
===================================================================================
Accompanying notes are an integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on pages
49-63 of the Corporation's 2001 Form 10-K.
3
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, 2001 $11,802 $ 4,180 $ 21,138 $ 409,904 $ 1,122,867 $ (453,300) $ 1,116,591
Net loss (4,095) (4,095)
Net change in unrealized gain
net of deferred income tax
of $(9,901) (18,387) (18,387)
-----------
Comprehensive loss (22,482)
Net issuance of treasury
stock under stock award
plan (1 share) (6) (8) (14)
- --------------------------------------------------------------------------------------------------------------------------
Balance,
March 31, 2001 $11,802 $ 4,174 $ 21,138 $ 391,517 $ 1,118,772 $ (453,308) $ 1,094,095
==========================================================================================================================
Balance
January 1, 2002 $11,802 $ 4,152 $ 21,138 $ 274,359 $ 1,221,447 $ (452,866) $ 1,080,032
Net income 26,873 26,873
Net change in unrealized gain
net of deferred income tax
of $(23,221) (43,126) (43,126)
-----------
Comprehensive loss (16,253)
Net issuance of treasury
stock under stock award
plan (192 shares) (124) (75) 2,520 2,321
Retirement of treasury
stock (22,000 shares) (2,750) (4,028) (283,597) 290,375 -
- --------------------------------------------------------------------------------------------------------------------------
Balance,
March 31, 2002 $ 9,052 $ - $ 21,138 $ 231,233 $ 964,648 $ (159,971) $ 1,066,100
==========================================================================================================================
Accompanying notes are an integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on pages
49-63 of the Corporation's 2001 Form 10-K.
4
Ohio Casualty Corporation & Subsidiaries
STATEMENT OF CONSOLIDATED CASH FLOWS
Three Months
Ended March 31,
(in thousands) (Unaudited) 2002 2001
- -------------------------------------------------------------------------------
Cash flows from:
Operations
Net income (loss) $ 26,873 $ (4,095)
Adjustments to reconcile net income (loss)
to cash from operations:
Changes in:
Insurance reserves 18,073 9,217
Income taxes 20,553 (1,585)
Premiums and other receivables (11,781) 7,700
Deferred policy acquisition costs (4,316) 4,364
Reinsurance recoverable (263) (10,650)
Other assets 2,682 4,575
Other liabilities (17,038) (3,057)
California Proposition 103 reserves (32) (7,190)
Amortization and write-off of agent
relationships 8,014 7,278
Depreciation and amortization 4,153 3,580
Investment (gains) losses (22,831) (12,613)
- -------------------------------------------------------------------------------
Net cash generated (used) by operating
activities 24,087 (2,476)
- --------------------------------------------------------------------------------
Investing
Purchase of securities:
Fixed income securities - available-for-sale (335,403) (517,297)
Equity securities - (2,588)
Proceeds from sales:
Fixed income securities - available-for-sale 265,628 492,397
Equity securities 42,148 18,710
Proceeds from maturities and calls:
Fixed income securities - available-for-sale 619 620
Equity securities - -
Property and equipment:
Purchases (6,432) (3,419)
Sales 119 127
- --------------------------------------------------------------------------------
Net cash used for investing activities (33,321) (11,450)
- --------------------------------------------------------------------------------
Financing
Notes payable:
Proceeds 194,042 -
Repayments (205,157) (10,156)
Proceeds from exercise of stock options 2,321 1
Dividends paid to shareholders - -
- --------------------------------------------------------------------------------
Net cash used in financing activities (8,794) (10,155)
- --------------------------------------------------------------------------------
Net change in cash and cash equivalents (18,028) (24,081)
Cash and cash equivalents, beginning of period 92,284 90,044
- --------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 74,256 $ 65,963
================================================================================
Accompanying notes are an integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on pages
49-63 of the Corporation's 2001 Form 10-K.
5
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 2001 Annual Report to Shareholders.
NOTE II - RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard (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 standards. Other intangible assets will continue to be
amortized over their useful lives. The Corporation adopted the new rules on
accounting for goodwill and other intangible assets beginning in the first
quarter of 2002. The adoption of the statement did not have an impact on the
Corporation's financial position and results of operations. The
Corporation's only current intangible asset, agent relationships, is reported
on the balance sheet in accordance with the standards and is being amortized
over its useful life. The agent relationships intangible asset is also
evaluated periodically for possible impairment.
In August 2001, the FASB issued SFAS 144, "Accounting for the Impairment or
Disposal of Long-Lived Assets", which addresses financial accounting and
reporting for the impairment or disposal of long-lived assets and supersedes
SFAS 121, "Accounting for the Impairment of Long-Lived Assets and for Long-
Lived Assets to be Disposed Of", and the accounting and reporting provisions
of APB Opinion No. 30, Reporting the Results of Operations for a disposal of
a segment of a business. SFAS 144 is effective for fiscal years beginning
after December 15, 2001. The adoption of the statement did not impact the
Corporation's financial position and results of operations.
6
NOTE III - EARNINGS PER SHARE
Basic and diluted earnings per share are summarized as follows (in thousands,
except per share data):
Three months ended
March 31
2002 2001
---- ----
Net income (loss) $26,873 $ (4,095)
Weighted average common shares
outstanding - basic 60,187 60,073
Basic earnings (loss) per weighted average
Share $ 0.45 $ (0.07)
=========================================================================
Weighted average common shares outstanding 60,187 60,073
Effect of dilutive securities 875 -
- -------------------------------------------------------------------------
Weighted average common shares
outstanding - diluted 61,062 60,073
Diluted earnings (loss) per weighted average
Share $ 0.44 $ (0.07)
=========================================================================
NOTE IV -- SEGMENT INFORMATION
The Corporation has determined its reportable segments based upon its method
of internal reporting, 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
Commercial Lines, Specialty Lines, and Personal Lines. Commercial Lines
includes workers' compensation, general liability, CMP, fire, inland marine,
and commercial auto. Specialty 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.
Each segment of the Corporation is managed separately. 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 underwriting
expense ratio, 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.
7
Three Months Ended March 31
(in thousands)
Commercial Lines 2002 2001
- --------------------------------------------------------------
Net premiums written $192,815 $178,423
% Increase (decrease) 8.1% (9.8)%
Net premiums earned 174,176 182,419
% Increase (decrease) (4.5)% (0.4)%
Underwriting gain (loss)
(before tax) (21,172) (41,559)
Loss ratio 54.2% 73.3%
Loss expense ratio 18.0% 14.8%
Underwriting expense ratio 36.1% 35.5%
Combined ratio 108.3% 123.6%
Specialty Lines 2002 2001
- --------------------------------------------------------------
Net premiums written $39,450 $30,020
% Increase (decrease) 31.4% 18.8%
Net premiums earned 29,936 31,073
% Increase (decrease) 3.7% 31.5%
Underwriting gain (loss)
(before tax) 968 9,221
Loss ratio 36.6% 25.3%
Loss expense ratio 4.8% 4.7%
Underwriting expense ratio 42.0% 41.7%
Combined ratio 83.4% 71.7%
Personal Lines 2002 2001
- --------------------------------------------------------------
Net premiums written $142,636 $162,906
% Increase (decrease) (12.4)% (5.1)%
Net premiums earned 156,862 169,888
% Increase (decrease) (7.7)% (5.6)%
Underwriting gain (loss)
(before tax) (7,482) (21,911)
Loss ratio 67.8% 74.2%
Loss expense ratio 11.9% 10.8%
Underwriting expense ratio 27.6% 29.1%
Combined ratio 107.3% 114.1%
Total Property & Casualty 2002 2001
- --------------------------------------------------------------
Net premiums written $374,901 $371,349
% Increase (decrease) 1.0% (5.9)%
Net premiums earned 360,974 383,380
% Increase (decrease) (5.8)% (0.9)%
Underwriting gain (loss)
(before tax) (27,686) (54,249)
Loss ratio 58.7% 69.8%
Loss expense ratio 14.3% 12.2%
Underwriting expense ratio 33.5% 33.2%
Combined ratio 106.5% 115.2%
Impact of catastrophe losses
on combined ratio 0.9% 0.5%
All other 2002 2001
- --------------------------------------------------------------
Revenues $ (448) $ 1,027
Expenses 1,342 3,581
- --------------------------------------------------------------
Net income (loss) $(1,790) $(2,554)
Reconciliation of
Revenues 2001 2000
- --------------------------------------------------------------
Net premiums earned for
reportable segments $360,974 $383,380
Investment income 50,700 50,723
Realized gains (losses) 22,509 10,350
Miscellaneous income 30 46
- --------------------------------------------------------------
Total property and casualty
revenues (Statutory basis) 434,213 444,499
Property and casualty statutory
to GAAP adjustment 975 1,863
- --------------------------------------------------------------
Total revenues property and
casualty (GAAP basis) 435,188 446,362
Other segment revenues (448) 1,027
- --------------------------------------------------------------
Total revenues $434,740 $447,389
==============================================================
Reconciliation of
Underwriting gain (loss)
(before tax) 2002 2001
- --------------------------------------------------------------
Property and casualty under-
writing gain (loss)
(before tax)
(Statutory basis) $(27,686) $(54,249)
Statutory to GAAP adjustment (2,422) (10,390)
- --------------------------------------------------------------
Property and casualty under-
writing gain (loss) (before tax)
(GAAP basis) (30,108) (64,639)
Net investment income 50,902 51,280
Realized gains (losses) 22,831 12,613
Other income (losses) (2,499) (4,934)
- --------------------------------------------------------------
Income (loss) from continuing
operations before income taxes $ 41,126 $ (5,680)
==============================================================
8
NOTE V - AGENT RELATIONSHIPS
The agent relationship asset is an identifiable intangible asset acquired in
connection with the 1998 Great American Insurance Company (GAI) commercial
lines acquisition. The Corporation follows the practice of allocating
purchase price to specifically identifiable intangible assets based on their
estimated values as determined by appropriate valuation methods. In the GAI
acquisition, allocation of the purchase price was made to agent relationships
and deferred policy acquisition costs as the Corporation believes it did not
acquire any other significant specifically identifiable intangible assets.
Periodically, agent relationships are evaluated as events or circumstances
indicate a possible inability to recover their carrying amount. In the first
quarter of 2002, the Corporation wrote off the agent relationships asset by
$5.3 million for agency cancellations. The first quarter of 2001 included a
write off of $4.4 million to the agent relationship asset for agency
cancellations and for 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. The remaining
portion of the agent relationships asset will be amortized on a straight-line
basis over the remaining amortization period of approximately 21 years.
Additional information related to agent relationships is included in Note 1G,
Agent Relationships on page 29 of the Corporation's 2001 Annual Report to
Shareholders.
NOTE VI - INTERNALLY DEVELOPED SOFTWARE
In 2001, the Corporation introduced into limited production a new internally
developed application for issuing and maintaining insurance policies. The
Corporation continued the roll out of the new application for additional
lines of business in the first quarter of 2002. The Corporation is
capitalizing the costs incurred to develop this software used in the
Corporation's operations. The cost associated with this application is
amortized on a straight-line basis over the estimated useful life of ten
years from the date placed into service. Upon full implementation in 2003,
the new application should impact results by approximately $4 to $5 million
per year in amortization expense until 2012. Although management believes
the asset represents its fair value, the useful life of the internally
developed software was determined by using certain assumptions and estimates.
Inherent changes in these assumptions could result in an immediate impairment
to the asset and a corresponding charge to net income. For all internally
developed software, unamortized software costs and accumulated amortization
in the consolidated balance sheet were $45.0 million and $1.5 million at
March 31, 2002, and $41.4 million and $1.0 million at December 31, 2001.
NOTE VII - CONVERTIBLE DEBT
In 2002, the Corporation completed an offering of 5.00% convertible notes, in
an aggregate principal amount of $201.3 million, due March 19, 2022 and
generated net proceeds of $194.0 million. The issuance and related costs are
being amortized over the life of the bonds and are being recorded as interest
expense. The Corporation uses the effective interest rate method to record
the interest and related interest amortization. Interest is payable on March
19 and September 19 of each year, beginning September 19, 2002. The notes
may be converted into shares of the Corporation's common stock under certain
conditions, including: if the sale price of the Corporation's common stock
reaches specific thresholds; if the credit rating of the notes is below a
specified level or withdrawn, or if the notes have no credit rating during
any period; or if specified corporate transactions have occurred. The
conversion rate is 44.2112 shares per each $1,000 principal amount of notes,
subject to adjustment in certain circumstances. The convertible debt impact
on earnings per share will be based on the "if-converted" method. The impact
on diluted earnings per share is contingent on whether or not certain
criteria has been met for conversion. On or after March 23, 2005, the
Corporation has the option to redeem all or a portion of the notes that have
not been previously converted at the following redemption prices (expressed
as percentage of principal amount):
During the twelve months commencing Redemption Price
- ----------------------------------- ----------------
March 23, 2005 102%
March 19, 2006 101%
March 19, 2007 until maturity of the notes 100%
9
The holders of the notes may require the Corporation to purchase all or a
portion of their notes on March 19 of 2007, 2012 and 2017 at 100% of the
principal amount of the notes. In addition, upon a change in control of the
Corporation occurring anytime prior to maturity, holders may require the
Corporation to purchase for cash all or a portion of their notes at 100% of
the principal amount.
NOTE VIII - CONTINGENCIES
In the fourth quarter of 2001, Ohio Casualty of New Jersey, Inc. (OCNJ)
entered into an agreement to transfer its obligations to renew private
passenger auto business in New Jersey to Proformance Insurance Company
(Proformance). Under the terms of the transaction, OCNJ may have a
contingent liability of up to $15.6 million to be paid to Proformance to
maintain a premiums-to-surplus ratio of 2.5 to 1 on the transferred business
during the next three years. At March 31, 2002, it is not possible to
determine the likelihood of this liability and, therefore, has not been
recognized in the financial statements.
NOTE IX - TREASURY STOCK
In the first quarter of 2002, the Corporation retired 22 million shares of
its treasury stock. The retirement did not have a net impact on total
shareholders' equity.
10
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
Net income
The Corporation reported net income of $26.9 million, or $0.44 per share for
the first quarter ending March 31, 2002. In the same quarter of 2001, the
Corporation reported a net loss of $4.1 million, or $0.07 per share.
Operating Income
For the first quarter of 2002, the Corporation reported net operating income,
which differs from net income by the exclusion of realized investment gains
(losses), of $12.0 million, or $0.20 per share, compared with an operating
loss of $12.3 million, or $0.20 per share for the first three months of 2001.
The improvement was due to overall improved loss results driven by
underwriting actions and improved pricing. Improved loss results are
discussed further in the Statutory Results section below and improved pricing
is discussed further in the Segment Discussion section below.
Premium Revenue Results
Net income and operating income reflect premiums earned by the Group. The
Group's premiums are earned principally on a monthly pro rata basis over the
term of the policy. Management analyzes premium revenues primarily by
premiums written in the current period. Net premiums written differs from
gross premiums written by premiums ceded to reinsurers.
The table below summarizes the increase (decrease) in property and casualty
premium results compared with same period prior year results:
2002 increase (decrease) from 2001 ($ in millions)
Gross Premiums Net Premiums
Written Written
First Quarter First Quarter
------------- -------------
Business Units
- --------------
Commercial Lines $13.4 $14.4
Specialty Lines 13.0 9.5
Personal Lines (19.8) (20.3)
------ ------
All Lines 6.6 3.6
Agency cancellations, withdrawal from certain states, and the exit from the
New Jersey private passenger auto market led to the 12.5% decrease in
personal lines net premiums written for the current quarter compared to the
same quarter one year ago. The Commercial Lines increase was driven by
renewal price increases. Renewal price increases in the umbrella line of
business in the Specialty Lines contributed to the increase in premiums in
the current quarter. Renewal price increase means the average increase in
premium for policies renewed by the Group. The average increase in premium
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
11
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 or business assumed through reinsurance agreements,
including policies previously issued through Great American's systems.
Renewal price increases also do not reflect the cost of any reinsurance
purchased on the policies issued.
New Jersey is the Group's largest state with 16.7% of the total net premiums
written in the first quarter of 2002. In recent years, New Jersey's
legislative and regulatory environments have become less favorable to the
Group. The state requires insurance companies to accept all risks that meet
underwriting guidelines for private passenger automobile. In the fourth
quarter of 2001, OCNJ entered into an agreement to transfer its New Jersey
private passenger auto renewal obligations to Proformance Insurance Company.
The Group began to cease writing new and renewal business in the New Jersey
private passenger auto and personal umbrella markets in March 2002. New
Jersey private passenger auto and personal umbrella made up 39.1% of the
Group's New Jersey net premiums written in the first quarter of 2002. The
Group continues to write all of its other lines of business in the state.
Investment Results
First quarter consolidated before-tax investment income was $50.9 million, or
$0.83 per share, decreasing from $51.3 million, or $0.85 per share, for the
same period last year. The effective tax rate for the first quarter of 2002
was 32.9% compared with 32.7% for the comparable period in 2001. Although
invested assets have increased over the past year, a decline in interest
rates led to the slight decrease in investment income.
For the first quarter 2002, consolidated after-tax realized gain was $14.8
million, or $0.24 per share, compared with $8.2 million, or $0.13 per share,
for the first three months of 2001. The Group continues to reduce its equity
holdings in order to reduce the effect on statutory surplus of future stock
market volatility.
Statutory Results
Management uses statutory financial criteria to analyze the property and
casualty results. Management analyzes statutory results through the use of
insurance industry financial measures including statutory loss and loss
adjustment expense ratios, statutory underwriting expense ratio, statutory
combined ratio, net premiums written and net premiums earned. The statutory
combined ratio is a commonly used gauge of underwriting performance measuring
the percentages of premium dollars used to pay insurance losses and related
expenses. A discussion of the differences between statutory accounting and
accounting principles generally accepted in the United States is included in
Item 14 pages 59 and 60 of the Corporation's Form 10-K for the year ended
December 31, 2001.
All Lines Discussion
The statutory combined ratio for the first quarter was 106.5%, decreasing
from 115.2% in the 2001 first quarter. The improvement in the statutory
combined ratio is attributable to price increases and more favorable loss
results as discussed further in Segment Discussion below.
The statutory loss and loss adjustment expense ratios were impacted
negatively in the first quarter of 2002 for adjustments to the provision for
prior years' business. In total, this increase in provisions for prior
years' losses and loss adjustment expenses added 1.2 points to the statutory
combined ratio.
The statutory loss adjustment expense ratio for the first three months of
2002 was 14.3%, 2.1 points higher than the first quarter 2001 loss adjustment
expense ratio of 12.2%. The increase is partially the result of expenditures
made to implement loss cost savings initiatives in order to improve loss
results while providing superior claims service to policyholders. A portion
of the increase is also due to increased estimates of legal costs on claims
from prior years.
The first quarter catastrophe losses were $3.3 million and accounted for 0.9
points on the statutory combined ratio. This compares with $1.8 million and
a 0.5 point catastrophe impact on the statutory combined ratio for the same
period in 2001. The effect of future catastrophes on the Corporation's
results
12
cannot be accurately predicted. Severe weather patterns can have a material
adverse impact on the Corporation's results. During the first quarter of
2002, there were 3 additional catastrophes with the largest catastrophe
generating $2.0 million in incurred losses as compared with 3 additional
catastrophes in the first quarter of 2001 with the largest catastrophe
generating $0.3 million in incurred losses. For additional disclosure of
catastrophe losses, refer to Item 14, Losses and Loss Reserves in the Notes
to the Consolidated Financial Statements on pages 56 and 57 of the
Corporation's 2001 Form 10-K.
The first quarter 2001 statutory underwriting expense as a percent of net
premiums written was 33.5% compared with 33.2% in the same quarter of 2001.
Although the Corporation continues to monitor and manage expenses closely, an
increase in commission expense caused a slight increase in the underwriting
expense ratio. The increase in commission expense was partially the result
of higher than projected bonuses paid due to more favorable than expected
2001 results from the Group's key agents. The elimination of ceding
commissions received on umbrella premiums ceded to reinsurers, as previously
announced in the 2002 Corporate Strategic Plan update, also contributed to
the increase in commission expense. The increase in commission expense was
partially offset by a decrease in policyholder dividends incurred. The
employee count of 3,233 at March 31, 2002 was down from 3,365 at year-end
2001 and down from 3,450 at March 31, 2001.
Segment Discussion
In June of 2001, the Corporation introduced an organizational structure
around three business units: Commercial Lines, Specialty Lines, and Personal
Lines.
Commercial Lines
Commercial Lines statutory combined ratio for the first quarter of 2002
decreased 15.3 points to 108.3% from 123.6% in the first quarter of 2001.
The 2002 statutory combined ratio improvement was due to favorable loss
results. The first quarter 2002 Commercial Lines loss ratio improved 19.1
points compared with the same period of 2001. Achieving price increases,
eliminating and canceling unprofitable business and focusing on underwriting
targeted business contributed to the Commercial Lines statutory loss ratio
improvement. The Commercial Lines average renewal price increases for direct
premiums written improved to 14.9% in the current quarter from 12.3% in the
first quarter of 2001.
Negatively impacting the Commercial Lines results were increases in
provisions for the general liability and workers' compensation lines of
business.
The general liability statutory combined ratio increased in the first quarter
of 2002 to 144.4% from 104.8% in the same period of 2001. The line of
business was impacted in 2002 by additions to construction defect related
reserves and increased estimates of legal costs on claims from prior years.
Construction defect claims filed under general liability insurance policies
involve allegations of defective work on construction projects, such as
condominiums, apartment complexes, housing developments, and office
buildings. These claims usually involve multiple parties and carriers. The
loss estimates for these claims are based on currently available information.
However, given the expansion of coverage and liability by the courts and
legislatures, there is substantial uncertainty as to the ultimate liability.
The 2002 accident year statutory combined ratio for general liability was
111.7%, 32.7 points lower than the calendar year results. The loss and loss
adjustment expense (LAE) ratio component of the all lines statutory accident
year combined ratio measures losses and claims expenses arising from insured
events during the year. The loss and LAE ratio component of the all lines
statutory calendar year combined ratio includes loss and LAE payments made
during the current year and changes in the provision for future loss and LAE
payments.
Workers' compensation statutory combined ratio for the first three months of
2002 was 131.4%, compared with 167.4% during the same period last year.
Although the Group has taken actions to improve workers' compensation
results, assessments for the National Workers' Compensation Pool contributed
to the unfavorable first quarter of 2002 results.
13
Specialty Lines
Specialty Lines statutory combined ratio for the first quarter of 2002 was
83.4%, compared with 71.7% in the same period of 2001. Although the
statutory combined ratio increased in 2002, the results are still favorable.
Renewal price increases in the umbrella line of business averaged 38.4% in
the first quarter of 2002, compared with 17.6% for the same quarter in 2001.
Personal Lines
The Personal Lines statutory combined ratio improved to 107.3% in the first
quarter of 2002 from 114.1% in the first three months of 2001. The
improvement was driven by the results of the homeowners and private passenger
auto lines of business.
The statutory combined ratio for homeowners decreased 15.8 points to 107.5%
from 123.3%. Catastrophe losses added 8.3 points to the statutory combined
ratio in the first quarter of 2002, and 2.8 points in the same period of
2001. The improvement in the homeowners line of business results is
partially due to the introduction of insurance scoring, elimination of
unprofitable business, improved claims practices and the implementation of
rate increases where possible.
Private passenger auto-agency, the Group's largest line, recorded a 2002
three-month statutory combined ratio of 106.0%, decreasing from 110.8% in the
first quarter of 2001. The first quarter 2002 private passenger auto-agency
loss ratio decreased 5.4 points to 66.6% from 72.0% in the same quarter of
2001. The line's results are also benefiting positively by the
implementation of insurance scoring, elimination of unprofitable business,
the withdrawal from the New Jersey market and targeted underwriting.
Although the results for the quarter improved in 2002 from 2001, poor
underwriting results in New Jersey business continue to impact the line's
performance, adding 4.6 points to the statutory loss ratio in the first
quarter of 2002, compared with adding 6.4 points in the first three months of
2001.
Since 1999, New Jersey has 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 March
31, 2002, the Group has written $1.8 million year to date in UEZ premiums,
with $1.7 million in additional assigned premiums compared with $2.9 million
in UEZ premiums and $2.5 million in additional assigned premiums through the
first three months of 2001. The 2002 first quarter loss ratio on the UEZ
premiums was 152.7% and the loss ratio on the assigned business was 194.5%,
compared with a loss ratio of 174.6% on UEZ premiums and 255.4% on assigned
business for the same period last year.
LIQUIDITY AND FINANCIAL STRENGTH
Investments
At March 31, 2002, the Corporation's fixed income portfolio totaled $2.8
billion, which consisted of 96.5% investment grade and 3.5% below investment
grade securities. The fair value of the below investment grade portfolio was
$94.8 million at March 31, 2002, compared with $94.3 million at December 31,
2001. 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).
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
14
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.
At March 31, 2002, the Corporation's equity portfolio was 13.7%, or $453.8
million, of the total investment portfolio. 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 March 31, 2002, the equity
portfolio consisted of stocks of 45 separate entities in 35 different
industries. As of March 31, 2002, 37.9% of the Corporation's equity
portfolio was invested in five companies and the largest single position was
11.2% of the equity portfolio.
For further discussion of the Corporation's investments, see Item 1 pages 8
through 10 of the Corporation's Form 10-K for the year ended December 31,
2001.
Cash Flow
Net cash generated by operations was $24.1 million for the first three months
of the year compared with cash used of $2.5 million for the same period in
2001. Improved underwriting profitability contributed to the increase in
2002. Current operational liquidity needs of the Group are expected to be
met by scheduled bond maturities, dividend payments, interest payments, and
cash balances. Cash used in financing operations was $8.8 million in the
first three months of 2002 compared with cash used of $10.2 million in the
first quarter of 2001. The 2002 cash includes the repayment of the
Corporation's $205.0 million credit facility and issuance of new convertible
debt with net proceeds of $194.0 million.
Debt
As of March 31, 2002, the Corporation had $199.1 million of outstanding notes
payable, compared with $210.2 million at year-end 2001. On March 19, 2002,
the Corporation completed an offering of 5.00% convertible notes, in an
aggregate principal amount of $201.3 million, due March 19, 2022. The net
proceeds of the offering, along with $10.5 million of cash, were used to pay
off the balance of the outstanding credit facility. In addition, the
Corporation terminated the credit facility that made available a $250.0
million revolving line of credit. Interest on the convertible notes is
payable on March 19 and September 19 of each year, beginning September 19,
2002. The notes may be converted into shares of the Corporation's common
stock under certain conditions, including: if the sale price of the
Corporation's common stock reaches specific thresholds; if the credit rating
of the notes is below a specified level or withdrawn, or in which the notes
have no credit rating during any period; or if specified corporate
transactions have occurred. The conversion rate is 44.2112 shares per each
$1,000 principal amount of notes, subject to adjustment in certain
circumstances. On or after March 23, 2005, the Corporation has the option to
redeem all or a portion of the notes that have not been previously converted
at the following redemption prices (expressed as percentage of principal
amount):
During the twelve months commencing Redemption Price
- ----------------------------------- ----------------
March 23, 2005 102%
March 19, 2006 101%
March 19, 2007 until maturity of the notes 100%
The Corporation also had $5.0 million of debt at March 31, 2002 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.
Rating Agencies
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. These agencies may also place an outlook on the
Group's rating. On March 11, 2002, Standard & Poor's Rating Services removed
its negative outlook and placed a stable outlook on the Group's "BBB" rating.
Standard and Poor's Rating Services also announced that it assigned its "BB"
senior debt rating on the Corporation's convertible notes. On March 13,
2002, Moody's Investor Services confirmed the Group's "A2" rating and placed
a stable
15
outlook on the Group's rating. Moody's Investor Services also
announced that it placed a "Baa2" rating on the Corporation's convertible
notes. On March 14, 2002, Fitch, Inc. announced that it placed a "BBB-"
rating on the Corporation's convertible notes. Fitch, Inc. also placed a
stable outlook on its rating.
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. 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 agreed to pay $17.5 million in refunded premiums to
eligible 1989 California policyholders. The Group began to make payments in
the first quarter of 2001. The remaining liability was $7.8 million as of
March 31, 2002.
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
Corporation notes that a variety of factors could cause the Corporation's
actual results and experience to differ materially from the anticipated
results or other expectations expressed in the Corporation's forward-looking
statements.
The risks and uncertainties that may affect the operations, performance,
development and results of the Corporation'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; acts of war and terrorist
activities; rating agency actions; ability of Ohio Casualty to retain the
business acquired from the Great American Insurance Company; ability to
achieve targeted expense savings; 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 14 of this Form 10-Q regarding California Proposition 103.
16
ITEM 2. Changes in Securities - On March 19, 2002, the Corporation issued
and sold, in a private placement, $201.3 million aggregate
principal amount of 5.00% Convertible Notes (the Notes) due 2022.
The Notes were sold to Merrill Lynch & Co., Merrill Lynch,
Pierce, Fenner & Smith Incorporated, Salomon Smith Barney Inc.
and McDonald Investments Inc., as "accredited investors" within
the meaning of Rule 501 under the Securities Act of 1933 (the
Act), in reliance upon the private placement exemption afforded
by Section 4(2) of the Act, and were offered and sold to "qualified
institutional buyers" under Rule 144A of the Act. Pursuant to a
registration rights agreement entered into in connection with the
private offering, the Corporation has agreed to file a registration
statement under the Act to permit registered resales of the Notes
and the common shares issuable upon conversion of the Notes.
The aggregate offering price of the Notes was $201.3 million,
100% of the principal amount thereof. The purchase price paid to
the Corporation by the initial purchasers was the initial
offering price less a discount of 3.333% of the principal amount
of the Notes. The net proceeds of $194.0 million from the sale
of the Notes were used to repay borrowings under the Corporation's
revolving credit facility.
The Notes are convertible, upon the occurrence of certain events,
into common shares of the Corporation at an initial conversion
rate of 44.2112 common shares per $1,000 principal amount of the
Notes, which is equivalent to an initial conversion price of
approximately $22.62 per share. The conversion rate is subject
to adjustment in certain circumstances. The Corporation's common
shares are traded on the Nasdaq National Market under the symbol
"OCAS". The conversion rights include:
1. Conversion Rights Based on Common Share Price. If, as of the
last day of any calendar quarter beginning with the quarter
ending June 30, 2002, the sale price of the Corporation's
common shares for at least 20 trading days in a period of 30
consecutive trading days ending on the last trading day of
such quarter is more than 110% of the conversion price, then
on or after the first day of the following quarter holders
may surrender Notes for conversion into common shares at any
time at their option until the close of business for that
calendar quarter.
2. Conversion Rights Based on Credit Ratings Downgrade. Holders
may also surrender Notes for conversion during any period in
which the credit rating assigned to the Notes is a Ba2 or
lower by Moody's or B+ or lower by Standard & Poor's, the
Notes are no longer rated by either Moody's or Standard &
Poor's, or the credit ratings assigned to the Notes have
been suspended or withdrawn by either Moody's or Standard &
Poor's. The Notes will cease to be convertible pursuant to
this paragraph during any period or periods in which all of
the credit ratings are increased above such levels.
3. Conversion Rights Upon Occurrence of Certain Corporate
Transactions. If the Corporation is party to a consolidation,
merger or binding share exchange pursuant to which the
Corporation's common shares would be converted into cash,
securities or other property, the Notes may be surrendered for
conversion at any time from and after the date which is 15 days
prior to the anticipated effective date of the transaction until
15 days after the actual date of such transaction and, at the
effective time, the right to convert Notes into common shares
will be changed into a right to convert it into the kind and
amount of cash, securities or other property
17
which the holder would have received if the holder had converted
the holder's Notes immediately prior to the transaction. If such
transaction also constitutes a change in control, the holder will
be able to require the Corporation to purchase all or a potion of
such holder's Notes.
ITEM 3. Defaults Upon Senior Securities - None
ITEM 4. Submission of Matters to a Vote of Security Holders -
At the annual meeting on April 17, 2002, shareholders voted on
board of director seats.
Elected for terms expiring in 2005 included:
Terrence J. Baehr For 47,349,458; votes withheld 4,881,430
Dan R. Carmichael For 47,343,115; votes withheld 4,887,773
Catherine E. Dolan For 46,869,999; votes withheld 5,360,889
Philip G. Heasley: For 47,314,616; votes withheld 4,916,272
Elected for terms expiring in 2004 included:
Ralph S. Michael III: For 47,317,781; votes withheld 4,913,107
Elected for terms expiring in 2003 included:
Jan H. Suwinski: For 47,334,013; votes withheld 4,896,875
Three directors retired at the meeting. They included: Vaden
Fitton, Arthur J. Bennert, and Wayne R. Embry.
The other directors whose term of office continued after the
meeting were: Jack E. Brown, Stephen S. Marcum, Stanley N. Pontius,
Edward T. Roeding and Howard L. Sloneker III.
At the annual meeting on April 17, 2002, shareholders approved a
proposal for the 2002 Stock Incentive Plan. The plan was approved
with a final vote of:
For 36,894,995; Against 8,495,154; Abstentions 518,195
At the annual meeting on April 17, 2002, shareholders approved a
proposal for the 2002 Employees Stock Purchase Plan. The plan was
approved with a final vote of:
For 43,331,616; Against 2,101,393; Abstentions 475,335
ITEM 5. Other Information - The Corporation announced on May 7, 2002 the
election of General Counsel Debra K. Crane, JD, for corporate
secretary of Ohio Casualty Corporation, replacing Senior Vice
President and Director Howard L. Sloneker III. Howard retains his
position as a Senior Vice President and a Director on the
Corporation's Board of Directors.
18
ITEM 6. Exhibits and reports on Form 8-K -
I. Reports on Form 8-K:
(a) The Corporation filed a Form 8-K on January 4, 2002 to report
under Items 5 and 7, the Corporation's agreement to transfer
its private passenger automobile business renewal obligations
from Ohio Casualty of New Jersey, Inc. to Proformance
Insurance Company. An exhibit to the Form 8-K consisted of a
press release dated December 19, 2001, announcing the
transaction.
(b) The Corporation filed a Form 8-K on March 6, 2002 to report
on Items 5 and 7, the filing of a press release announcing an
update to the projected financial results of the
Corporation's Corporate Strategic Plan. An exhibit to the
Form 8-K consisted of that press release dated February 5, 2002.
(c) The Corporation filed a Form 8-K on March 11, 2002 to report
under Items 5 and 7, the Corporation's intention to commence
a private offering of convertible notes. An exhibit to the
Form 8-K consisted of a press release dated March 11, 2002,
announcing the intended private placement.
(d) The Corporation filed a Form 8-K on March 14, 2002 to report
under Items 5 and 7, the pricing of the Corporation's
convertible notes to be issued in a private placement. An
exhibit to the Form 8-K consisted of a press release dated
March 14, 2002, announcing the pricing.
(e) The Corporation filed a Form 8-K on March 19, 2002 to report
under Items 5 and 7, the sale of the Corporation's
convertible notes in a private placement. An exhibit to the
Form 8-K consisted of a press release dated March 19, 2002,
announcing the completion of the private placement.
II. Exhibits:
4 Registration Rights Agreement between the registrant and
Merrill Lynch & Co., Merrill Lynch, Pierce, Fenner & Smith
Incorporated, Salomon Smith Barney Inc. and McDonald
Investments, Inc. dated as of March 29, 2002.
10.1 First Amendment to Ohio Casualty Corporation 1999 Warrant
Agreement between the registrant and Great American Insurance
Company effective April 15, 2002.
10.2 Ohio Casualty Corporation 2002 Stock Incentive Program.
10.3 Ohio Casualty Corporation 2002 Employee Stock Purchase Plan.
19
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)
May 14, 2002 /s/ Donald F. McKee
-----------------------------------
Donald F. McKee, Chief Financial
Officer (on behalf of Registrant and
as Principal Accounting Officer).
20