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SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-K
[x] Annual Report Pursuant to Section 13 or 15 (d) of the
Securities Exchange Act of 1934
For the fiscal year ended December 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(b) of the Act:
None
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
----- -----
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K [ ].
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act).
Yes X No
----- -----
The aggregate market value as of June 30, 2002 of the voting stock held
by non-affiliates of the registrant was $1,139,113,620 determined by
multiplying the price at which the common equity was last sold as of the
last business day of the Registrant's most recently completed second fiscal
quarter. Such determination shall not, however, be deemed to be an
admission that any person is an "affiliate" as defined in Rule 405 under
the Securities Act of 1933.
On February 28, 2003 there were 60,727,134 common shares outstanding.
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Documents Incorporated by Reference
Portions of the Registrant's definitive Proxy Statement for its Annual
Meeting of Shareholders to be held on April 16, 2003, are incorporated by
reference into Part III of this Annual Report on Form 10-K.
2
TABLE OF CONTENTS
Page
----
PART I
Item 1. Business 4
Item 2. Properties 19
Item 3. Legal Proceedings 19
Item 4. Submission of Matters to a Vote of Shareholders 19
PART II
Item 5. Market for Registrant's Common Equity and Related
Stockholder Matters 20
Item 6. Selected Financial Data 21
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations 23
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 48
Item 8. Financial Statements and Supplementary Data 49
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure 49
PART III
Item 10. Directors and Executive Officers of the Registrant 49
Item 11. Executive Compensation 51
Item 12. Security Ownership of Certain Beneficial Owners and
Management 51
Item 13. Certain Relationships and Related Transactions 51
Item 14. Controls and Procedures 51
Item 16. Principal Accountant Fees and Services 51
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on
Form 8-K 52
Signatures 72
Certifications 73
Index to Exhibits 83
Exhibit 3 Articles of Incorporation, as amended, filed August 3, 2000
Exhibit 3.1 Code of Regulations, as amended, filed August 3, 2000
Exhibit 10.1 Amendment to Director's Deferred Compensation Plan dated
April 18, 2001
Exhibit 10.2 Amendment to Supplemental Executive Savings Plan dated June
1, 2002
Exhibit 10.3 Amendment to The Ohio Casualty Insurance Company's Employee
Savings Plan dated January 1, 2000
Exhibit 10.4 Benefit Equalization Plan
Exhibit 10.5 Deferred Compensation Plan
Exhibit 10.6 Stock Option Agreement for Chief Financial Officer dated
September 19, 2001
Exhibit 21 Subsidiaries of the Registrant
Exhibit 23 Consent of Independent Auditors to incorporation of their
opinion by reference in Registration Statements on
Forms S-3 and Form S-8
Exhibit 23a Consent of Independent Accountants to incorporation of their
opinion by reference in Registration Statements on Forms S-3
and Form S-8
Exhibit 28 Information from Reports Furnished to State Insurance Regulation
Authorities
Exhibit 99.1 Certification of Chief Executive Officer of Ohio Casualty
Corporation in accordance with Section 906 of the Sarbanes-Oxley
Act of 2002
Exhibit 99.2 Certification of Chief Financial Officer of Ohio Casualty
Corporation in accordance with Section 906 of the Sarbanes-Oxley
Act of 2002
3
PART I
Item 1. Business
(a) Business Overview
Ohio Casualty Corporation ("the Corporation") was incorporated in Ohio in
1969. With its predecessors, the Corporation has been engaged in the
property and casualty insurance business since 1919 through a group of six
direct and indirect subsidiaries which are collectively known as the Ohio
Casualty Group ("the Group"). The Group consists of:
- - The Ohio Casualty Insurance Company ("the Company");
- - West American Insurance Company ("West American");
- - Ohio Security Insurance Company ("Ohio Security");
- - American Fire and Casualty Company ("American Fire");
- - Avomark Insurance Company ("Avomark"); and
- - Ohio Casualty of New Jersey, Inc. ("OCNJ").
On December 1, 1998, the Company acquired substantially all of the assets
of the commercial lines business of the Great American Insurance Company
("GAI") and its affiliates. The major lines of business included in the
acquisition were workers' compensation, commercial multi-peril, umbrella,
general liability and commercial auto.
Since late 1999, the property and casualty insurance industry has
experienced a general improvement in pricing conditions, especially in the
commercial lines business. While the industry tends to exhibit alternating
cycles of rising prices, followed by declining prices and poor underwriting
performance, the commercial lines business was in an unusually protracted
period of declining or inadequate prices from the late 1980s until
recently. The Group implemented renewal price increases in its Commercial
Lines operating segment averaging 16.3% during 2002 and 15.2% during 2001.
The commercial umbrella business in the Specialty Lines operating segment
average renewal price increases were 37.2% for 2002, compared with 20.3%
for 2001. The Group continues to seek additional renewal price increases
on its Commercial Lines and commercial umbrella business in 2003.
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 GAI
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.
In June of 2001, the Corporate Strategic Plan ("Plan") was announced. The
Plan introduced an organization structured around three operating segments:
Commercial Lines segment, Specialty Lines segment, and Personal Lines
segment and established measurable financial targets for each operating
segment and the Group. The Corporation also completed its senior
management team in 2001 with the additions of experienced officers in the
Chief Financial Officer, Chief Technology Officer and Chief Actuary
positions.
4
Item 1. Continued
During the fourth quarter of 2001, OCNJ entered into an agreement to
transfer its obligations to renew private passenger auto business in New
Jersey. This transaction allowed the Group to stop writing business in the
New Jersey private passenger auto market beginning in March of 2002. In
recent years, the market in New Jersey private passenger auto had become
more unstable due to the inability to control both the volume of writings
and the profitability. Under the terms of the transaction, OCNJ agreed to
pay $40.6 million to a third party, Proformance Insurance Company
("Proformance"), to transfer its renewal obligations. The before-tax
amount of $40.6 million was charged to income in the fourth quarter of 2001
with payments made over the course of twelve months beginning in early
2002. The contract stipulates that a premiums-to-surplus ratio of 2.5 to 1
must be maintained on the transferred business for approximately three
years beginning March 2002. The final measurement date is December 31,
2004 and will include use of the statutory insurance expense exhibit which
is due April 1, 2005.If this criteria is not met, OCNJ will have a
contingent liability of up to $15.6 million to be paid to Proformance to
maintain this premiums-to-surplus ratio. At December 31, 2002, the Group
has evaluated the contingency based upon financial data provided by
Proformance. The Group has concluded that it is not probable that the
liability will be incurred and therefore has not recognized a liability in
the financial statements. The Group will continue to monitor the
contingency for any future liability recognition.
The Corporation's internet website is www.ocas.com. Beginning November 15,
2002 through December 31, 2002, the Corporation did not make available on
or through its website, its annual report on Form 10-K, quarterly reports
on Form 10-Q, current reports on Form 8-K, and all amendments to those
reports ("SEC Reports") after such reports were electronically filed with
or furnished to the SEC since the Corporation was in the process of re-
designing its website during that time. On March 14, 2003 the
Corporation's website began providing a hyperlink to the website of the
Securities and Exchange Commission where the Corporation's SEC Reports are
available as soon as reasonably practicable after the Corporation has filed
the SEC Reports. Additionally, the information contained on the
corporation's website is not incorporated by reference into this Annual
Report on Form 10-K and should not be considered part of this report.
(b) Financial Information About Industry Segments
The revenues, operating profit and combined ratios of each industry segment
for the three years ended December 31, 2002 are set forth in Note 14,
Segment Information, in the Notes to the Consolidated Financial Statements
on pages 66 and 67 of this Form 10-K.
Segment Description
Commercial Lines Segment
The Group transacts business in over 40 states. The Group's Commercial
Lines segment, which accounted for 52.6% of net premiums written in 2002,
includes primarily:
- - commercial multi-peril insurance ("CMP"), which insures a business
against several risks, usually including property, liability, crime and
boiler and machinery explosion;
- - commercial automobile insurance, which insures policyholders against
third party liability related to the ownership and operation of motor
vehicles in the course of business and property damage to insured
vehicles. These policies may provide uninsured motorist coverage,
which provides coverage to insureds and their employees for bodily
injury and property damage caused by an uninsured party;
5
Item 1. Continued
- - workers' compensation insurance, which provides coverage to employers
for their obligations to provide workers' compensation benefits as
required by applicable statutes, including medical payments,
rehabilitation, lost wages, disability and death benefits. These
policies also provide coverage to employees for their liability
exposures under common law; and
- - general liability insurance, which insures policyholders against third
party liability for bodily injury and property damage, including
liability for products sold, and the defense of claims alleging such
damages.
Specialty Lines Segment
The Group's Specialty Lines segment, which accounted for 12.4% of net
premiums written in 2002 includes primarily:
- - commercial umbrella insurance, which insures policyholders against
liability and defense costs which exceed coverage provided within the
underlying policies, typically commercial automobile and general
liability policies, and provides coverage for some items not covered by
underlying policies; and
- - fidelity and surety, which insure against dishonest acts of bonded
employees and against the non-performance of parties under contracts,
respectively.
Personal Lines Segment
The Group's Personal Lines segment, which accounted for the remaining 35.0%
of net premiums written in 2002, includes primarily personal automobile and
homeowners' insurance sold to individuals.
The following table shows the Group's total property and casualty net
premiums written by operating segments and selected product lines for the
periods indicated. Net premiums written includes gross premiums less
premiums ceded pursuant to reinsurance programs.
OPERATING SEGMENTS and
SELECTED PRODUCT LINES Statutory Net Premiums Written
- ---------------------- ------------------------------
(in thousands)
2002 2001 2000
---- ---- ----
Commercial Lines $ 762,190 $ 689,596 $ 721,681
Workers' compensation 143,911 148,628 185,800
Auto - Commercial 213,364 186,726 178,727
General liability 84,474 79,034 80,663
CMP, fire & inland marine 320,441 275,207 276,491
Specialty Lines 179,879 136,085 107,255
Commercial umbrella 132,655 92,154 65,576
Fidelity & surety 45,599 38,739 37,600
Personal Lines 506,559 646,504 676,457
Auto - Agency 318,054 444,385 455,330
Auto - Direct 3,235 6,821 10,711
Homeowners 153,678 161,960 173,222
Total All Lines $1,448,628 $1,472,185 $1,505,393
6
Item 1. Continued
Property and casualty statutory net premiums written decreased to $1,448.6
million in 2002 from $1,472.2 million in 2001. The net premiums written
decrease in 2002 can be attributed primarily to the reduction in premiums
related to the non-renewal of the Group's New Jersey private passenger auto
business that began to be non-renewed in March of 2002.
The decrease in net premiums written in 2001 was primarily related to
implementing a more selective underwriting philosophy, therefore, resulting
in the cancellation of certain business. Actions taken in 2000 to cancel
the Managing General Agents and the Group's most unprofitable agents and
policies represented over $150 million in annual net premiums written. The
Group terminated its relationships with all managing general agents in the
first quarter of 2001. Managing general agents are granted wider latitude
to make underwriting decisions than the Group's other agents. The Group
concluded that this latitude was inconsistent with the emphasis on
strengthening underwriting guidelines for the business. The managing
general agent relationships were acquired as part of the GAI commercial
lines business.
(c) Narrative Description of Business
Marketing and Distribution
The Group is represented on a commission basis by approximately 3,300
independent insurance agencies with over 5,300 agents. In most cases,
these agents also represent other unaffiliated companies which may compete
with the Group. The six claim and eight underwriting and service offices
operated by the Group assist these independent agents in producing and
servicing the Group's business.
Certain agencies that meet established profitability and production targets
are eligible for "key agent" status. At December 31, 2002, these agencies
represented 16.0% of the Group's total agency force and wrote 38.3% of its
book of business. The policies placed by key agents have consistently
produced a lower statutory loss ratio for the Group than policies placed by
other agents.
Historically, the Group has targeted small business customers for its
product lines in its Commercial Lines segment. The Group's typical
commercial lines customer is a small business with minimal number of
employees and a need for a package of coverages which can be conveniently
purchased. For the year 2002, this commercial lines customer group,
categorized by commercial liability premium volume, included approximately
75% contractors/artisans, 9% building/premises, 10% mercantile and 6%
manufacturing. The Group believes that this small business customer group
offers the opportunity to develop strong customer and agent relationships,
apply its underwriting experience to this specific type of customer and
achieve superior underwriting results.
The Group markets personal automobile insurance primarily to standard and
preferred risk drivers. Standard and preferred risk drivers are those who
have met certain criteria, including a driving record which reflects a low
historical incidence of at-fault accidents and moving violations of traffic
laws. The Group does not target "non-standard" risk drivers who fall
outside these criteria. Because the Group's personal automobile insurance
product line has been more profitable than its homeowners' insurance
product line, the Group emphasizes writing a single customer's auto
insurance and homeowners' insurance and de-emphasizes the marketing of
homeowners' insurance to those customers who have not purchased automobile
insurance.
7
Item 1. Continued
The Group's business is geographically concentrated in the Mid-West and
Mid-Atlantic regions. The following table shows consolidated direct
premiums written for the Group's ten largest states:
Ten Largest States
Direct Premiums Written
(in thousands)
Percent Percent Percent
2002 of Total 2001 of Total 2000 of Total
---- -------- ---- -------- ---- --------
New Jersey* $186,611 12.1 New Jersey $ 264,866 17.1 New Jersey $221,965 15.6
Ohio 142,670 9.3 Ohio 150,635 9.6 Ohio 153,057 10.8
Pennsylvania 119,077 7.8 Kentucky 119,126 7.7 Kentucky 132,631 9.3
Kentucky 115,385 7.5 Pennsylvania 105,536 6.8 Pennsylvania 91,979 6.5
Illinois 79,452 5.2 Illinois 78,954 5.1 Illinois 81,747 5.8
North Carolina 75,211 4.9 North Carolina 70,910 4.6 Indiana 75,340 5.3
Indiana 63,192 4.1 Indiana 68,224 4.4 North Carolina 54,710 3.9
Maryland 61,790 4.0 Maryland 58,516 3.8 Maryland 45,496 3.2
New York 57,892 3.8 Texas 49,181 3.2 Texas 45,386 3.2
Texas 55,900 3.6 New York 41,446 2.7 Michigan 39,347 2.8
-------- ---- ---------- ---- -------- ----
$957,180 62.3 $1,007,394 65.0 $941,658 66.4
======== ==== ========== ==== ======== ====
*New Jersey private passenger auto and personal umbrella business
represented 14.6% of the total New Jersey direct premiums written in 2002.
Excluding the Group's New Jersey private passenger auto and personal
umbrella business, New Jersey would have represented 10.6% of the total
direct premiums written.
Investments
The distribution of the Corporation's and the Group's invested assets is
determined by a number of factors, including:
- - insurance law requirements;
- - liquidity needs;
- - tax planning;
- - general market conditions; and
- - business mix and liability payout patterns.
Periodically, the Corporation and the Group reallocate their investment
portfolios subject to the parameters set by the Investment Committee.
Throughout 2002 and 2001, the Corporation and the Group sold equity
securities, many of which had substantially appreciated in value compared
to earlier periods. This sale program was part of an investment management
decision to reduce equity holdings in favor of investment grade bonds.
Consolidated after-tax realized investment gains amounted to $29.4 million
in 2002 and $135.0 million in 2001. Realized investment losses were $1.5
million in 2000. The funds previously invested in equity securities were
reallocated to investment grade fixed maturity securities.
Due to poor insurance operating results, the Corporation and the Group
reduced their tax exempt bond portfolio significantly from 1999 to 2001.
The Corporation and the Group applied the funds previously invested in tax
exempt bonds to investment grade taxable bonds. Tax exempt bonds
8
Item 1. Continued
did increase slightly, as a percentage of amortized cost, to 1.5% of the
fixed maturity portfolio at December 31, 2002, versus 1.1% at December 31,
2001 and 3.2% at December 31, 2000. Assets relating to property and
casualty operations are invested to maximize after-tax returns with
appropriate diversification of risk.
The consolidated fixed maturity portfolio of the Corporation and the Group
has an intermediate duration and a laddered maturity structure. The
duration of the fixed maturity portfolio at December 31, 2002 was
approximately 4.5 years. The Corporation and the Group always remain fully
invested and do not time markets. The Corporation and the Group also have
no off-balance sheet investments or arrangements as defined by section
401(a) of the Sarbanes-Oxley Act of 2002.
The following table sets forth the carrying values and other data of the
Corporation's and the Group's invested assets as of the end of the years
indicated:
Distribution of Invested Assets
($ in millions)
2002
Average % of % of % of
Rating 2002 Total 2001 Total 2000 Total
------- ---- ----- ---- ----- ---- -----
U.S. government AAA $ 29.1 0.8 $ 29.4 0.9 $ 55.6 1.7
Tax exempt bonds
and notes
Investment grade AA- 45.0 1.3 29.6 0.9 77.4 2.2
Below investment
grade BB- 1.8 0.1 1.7 0.1 1.9 0.1
Corporate securities
Investment grade A 1,817.4 51.9 1,516.6 45.7 1,143.1 34.3
Below investment
grade BB- 92.2 2.6 87.0 2.6 111.8 3.4
Mortgage-backed
securities
Investment grade AA+ 1,143.0 32.6 1,102.2 33.2 1,110.2 33.4
Below investment
grade B 11.3 0.3 5.6 0.2 13.7 0.4
-------- ----- -------- ----- -------- -----
Total bonds 3,139.8 89.6 2,772.1 83.6 2,513.7 75.5
Common stocks 312.5 9.0 488.6 14.7 754.8 22.7
Preferred stocks - - 0.4 - 0.1 -
-------- ----- -------- ----- -------- -----
Total stocks 312.5 9.0 489.0 14.7 754.9 22.7
Short-term 49.9 1.4 54.8 1.7 59.7 1.8
-------- ----- -------- ----- -------- -----
Total investments $3,502.2 100.0 $3,315.9 100.0 $3,328.3 100.0
Total market value
of investments $3,502.2 $3,315.9 $3,328.3
======== ======== ========
Total amortized cost
of investments $3,109.9 $2,895.0 $2,698.8
======== ======== ========
9
Item 1. Continued
At December 31, 2002, the Corporation's and the Group's fixed maturity
portfolios totaled $3,139.8 million, which consisted of 96.6% investment
grade securities and 3.4% below investment grade securities. The market
value of the below investment grade portfolio was $105.3 million at
December 31, 2002. The Corporation and the Group classify securities as
below investment grade based upon the higher of the ratings provided by
Standard & Poor's Ratings Group (S&P) and Moody's Investors Service
(Moody's). When a security is not rated by either S&P or Moody's
securities are classified based upon the ratings of other agencies,
including the National Association of Insurance Commissioners. The market
value of split-rated fixed maturity investments (i.e., those having an
investment grade rating from one rating agency and a below investment grade
from another rating agency) was $45.8 million at December 31, 2002.
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, changes in control of the issuer or worse
than previously expected operating results. In most instances, investors
are unprotected with respect to these risks, the effects of which can be
substantial.
The following table shows yield, based on cost, of the Corporation's fixed
maturity portfolio as of the end of the years indicated:
2002 2001 2000
Investment grade 6.7% 7.3% 7.4%
Below investment grade 9.5% 9.1% 10.1%
Total taxable 6.8% 7.5% 7.6%
Tax exempt 6.2% 6.5% 5.4%
At December 31, 2002, the Corporation's and the Group's equity portfolios
had a market value of $312.5 million, or 9.0% of the total invested assets.
The Corporation and the Group mark the value of its equity portfolios to
fair 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 December 31, 2002, the equity portfolio consisted of
stocks in 47 companies in 34 industries. As of December 31, 2002, 33.0% of
the Corporation's and the Group's equity portfolios were invested in five
companies and the largest single position was 10.4% of the total equity
portfolio.
The portfolio strategy, with respect to common stocks, is to invest in
companies whose stocks have below average valuations but above average
growth prospects. The Corporation and the Group focus on large companies
with dominant market positions, excellent profitability and strong balance
sheets.
The Corporation and the Group are required by both accounting principles
generally accepted in the United States ("GAAP") and statutory accounting
principles to mark the value of their equity portfolios to market for
reporting on their balance sheets. As a result, GAAP shareholders' equity
and statutory surplus fluctuate with changes in the value of the equity
portfolio. The Corporation and the Group manages the effects of future
stock market volatility on GAAP shareholders' equity and statutory surplus
by maintaining an appropriate ratio of equity securities to GAAP
shareholders' equity and statutory surplus.
10
Item 1. Continued
Liabilities for Unpaid Loss and Loss Adjustment Expenses
Liabilities for loss and loss adjustment expenses are established for the
estimated ultimate costs of settling claims for insured events, both
reported claims and incurred but not reported claims, based on information
known as of the evaluation date. As more information becomes available and
claims are settled, the estimated liabilities are adjusted upward or
downward with the effect of increasing or decreasing net income at the time
of the adjustments. The effect of these adjustments on the Group's results
may have a material adverse effect on the Group's results. The estimated
liabilities include direct costs of the loss under terms of insurance
policies, as well as legal fees and general expenses of administering the
claims adjustment process.
The effect of catastrophes on the Group's results cannot be accurately
predicted and they may have a material adverse effect on the Group's
results. In 2002, 2001 and 2000 the Group was impacted by 25, 19 and 24
catastrophes, respectively. The largest catastrophe in each of these years
was $7.5 million, $17.8 million and $7.1 million, respectively, in incurred
losses. Additional catastrophes with over $1 million in incurred losses
numbered six in 2002, four in 2001 and nine in 2000. For additional
discussion of catastrophe losses, please refer to Item 15, Note 10, Losses
and Loss Reserves, in the Notes to the Consolidated Financial Statements on
page 65 of this Form 10-K.
In the normal course of business, the Group is involved in disputes and
litigation regarding the terms of insurance contracts and the amount of
liability under such contracts arising from insured events. The
liabilities for loss and loss adjustment expenses include estimates of the
amounts for which the Group may be liable upon settlement or other
conclusion of such litigation.
Because of the inherent future uncertainties in estimating ultimate costs
of settling claims, actual loss and loss adjustment expenses may deviate
substantially from the amounts recorded in the Corporation's consolidated
financial statements. Furthermore, the timing, frequency and extent of
adjustments to the estimated liabilities cannot be accurately predicted
since conditions and events which established historical loss and loss
adjustment expense development and which serve as the basis for estimating
ultimate claims cost may not occur in the future in exactly the same
manner, if at all.
The anticipated effect of inflation is implicitly considered when
estimating the liability for losses and loss adjustment expenses based on
historical loss development trends adjusted for anticipated changes in
underwriting standards, policy provisions and general economic trends.
The following tables present an analysis of losses and loss adjustment
expenses and related liabilities for the periods indicated. The first
table represents the impact of current and prior accident years on calendar
year loss and loss adjustment expenses. The second table displays the
development of loss and loss adjustment expense liabilities as of
successive year-end evaluations for each of the past ten years. The
accounting policies used to estimate liabilities for losses and loss
adjustment expenses are described in Note 1I, Summary of Significant
Accounting Policies and Note 10, Losses and Loss Reserves, in the Notes to
the Consolidated Financial Statements on pages 58 and 65 of this Form 10-K.
11
Item 1. Continued
Reconciliation of Liabilities for Losses and Loss Adjustment Expense
(in thousands)
2002 2001 2000
---- ---- ----
Net liabilities, beginning of year $1,981,985 $1,907,331 $1,823,329
Provision for current accident year
claims 1,045,361 1,145,545 1,237,319
Increase (decrease) in provision for
prior accident year claims 84,451 58,489 56,846
---------- ---------- ----------
1,129,812 1,204,034 1,294,165
Payments for claims occurring during:
Current accident year 423,634 520,232 596,114
Prior accident years 608,909 609,148 614,049
---------- ---------- ----------
1,032,543 1,129,380 1,210,163
Net liabilities, end of year 2,079,254 1,981,985 1,907,331
Reinsurance recoverable 354,396 168,737 96,188
---------- ---------- ----------
Gross liabilities, end of year $2,433,650 $2,150,722 $2,003,519
========== ========== ==========
12
Item 1. Continued
Analysis of Development of Loss and Loss Adjustment Expense Liabilities
(In thousands)
Year Ended December 31 1992 1993 1994 1995 1996
- ---------------------- ---- ---- ---- ---- ----
Net liability as originally
estimated: $1,673,868 $1,693,551 $1,606,487 $1,557,065 $1,486,622
Life Operations Liability 663 656 961 3,934 3,722
P&C Operations Liability $1,673,205 $1,692,895 $1,605,526 $1,553,131 $1,482,900
Net cumulative payments as of:
One year later 561,133 533,634 510,219 486,168 483,574
Two years later 869,620 833,399 803,273 772,670 747,374
Three years later 1,060,433 1,017,893 997,027 944,294 950,138
Four years later 1,176,831 1,147,266 1,106,361 1,080,373 1,058,300
Five years later 1,264,900 1,218,916 1,203,717 1,151,001 1,121,263
Six years later 1,316,756 1,288,148 1,257,334 1,198,340 1,171,201
Seven years later 1,369,889 1,331,291 1,293,461 1,239,323
Eight years later 1,405,107 1,363,089 1,328,977
Nine years later 1,433,612 1,393,018
Ten years later 1,459,849
Gross cumulative payments as of:
One year later 586,869 547,377 522,811 500,150 498,274
Two years later 904,911 859,142 827,232 798,078 781,853
Three years later 1,107,980 1,051,915 1,030,701 988,674 983,440
Four years later 1,231,386 1,190,466 1,158,798 1,123,163 1,098,738
Five years later 1,328,478 1,278,602 1,254,475 1,200,600 1,171,207
Six years later 1,394,890 1,347,025 1,314,586 1,257,360 1,223,212
Seven years later 1,446,560 1,396,505 1,359,925 1,300,632
Eight years later 1,487,891 1,437,481 1,397,651
Nine years later 1,524,506 1,469,875
Ten years later 1,553,126
Year Ended December 31 1997 1998 1999 2000 2001 2002
- ---------------------- ---- ---- ---- ---- ---- ----
Net liability as originally
estimated: $1,421,804 $1,865,643 $1,823,329 $1,907,331 $1,981,985 $2,079,254
Life Operations Liability 100 98 - - - -
P&C Operations Liability $1,421,704 $1,865,545 $1,823,329 $1,907,331 $1,981,985 $2,079,254
Net cumulative payments as of:
One year later 449,802 640,209 614,049 609,148 608,909
Two years later 751,179 999,069 960,503 1,002,742
Three years later 919,272 1,223,348 1,226,182
Four years later 1,016,871 1,385,215
Five years later 1,088,755
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Gross cumulative payments as of:
One year later 469,933 654,204 636,530 647,115 636,848
Two years later 775,371 1,022,220 1,007,084 1,060,618
Three years later 950,445 1,261,136 1,281,395
Four years later 1,057,505 1,426,524
Five years later 1,131,451
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
13
Item 1. Continued
Analysis of Development of Loss and Loss Adjustment Expense Liabilities
(continued)
(In thousands)
Year Ended December 31 1992 1993 1994 1995 1996 1997
- ---------------------- ---- ---- ---- ---- ---- ----
Net liability re-estimated as of:
One year later 1,601,406 1,539,178 1,500,528 1,474,795 1,427,992 1,355,586
Two years later 1,555,452 1,510,943 1,501,530 1,441,081 1,403,059 1,386,401
Three years later 1,524,054 1,515,114 1,486,455 1,445,738 1,439,008 1,400,662
Four years later 1,559,492 1,525,493 1,507,331 1,478,787 1,456,890 1,391,970
Five years later 1,561,763 1,551,024 1,546,849 1,497,573 1,447,959 1,441,667
Six years later 1,588,063 1,587,885 1,566,276 1,491,985 1,489,835
Seven years later 1,627,385 1,609,600 1,560,871 1,532,181
Eight years later 1,649,372 1,606,164 1,597,778
Nine years later 1,649,387 1,640,831
Ten years later 1,681,709
Decrease (increase) in
original estimates: $ (8,504) $ 52,064 $ 7,748 $ 20,950 $ (6,935) $ (19,963)
Net liability as originally
estimated: $1,673,205 $1,692,895 $1,605,526 $1,553,131 $1,482,900 $1,421,704
Reinsurance recoverable on
unpaid losses and LAE 80,114 75,738 65,336 71,066 64,695 59,952
Gross liability as originally
estimated: $1,753,982 $1,769,289 $1,671,823 $1,631,184 $1,556,670 $1,483,807
Life Operations Liability 663 656 961 6,987 9,075 2,150
P&C Operations Liability 1,753,319 1,768,633 1,670,862 1,624,197 1,547,595 1,481,657
One year later 1,693,958 1,611,032 1,574,177 1,546,001 1,496,100 1,447,044
Two years later 1,645,634 1,591,328 1,579,932 1,515,032 1,507,365 1,477,874
Three years later 1,623,559 1,601,354 1,565,580 1,561,675 1,537,356 1,495,816
Four years later 1,664,239 1,612,300 1,630,314 1,585,459 1,559,519 1,495,563
Five years later 1,666,556 1,680,806 1,657,037 1,608,296 1,558,160 1,571,129
Six years later 1,722,897 1,704,863 1,680,592 1,609,850 1,623,241
Seven years later 1,758,687 1,731,007 1,682,809 1,671,414
Eight years later 1,784,615 1,735,071 1,739,333
Nine years later 1,791,221 1,788,056
Ten years later 1,840,216
Decrease (increase) in
original estimates: (86,897) (19,423) (68,471) (47,217) (75,646) (89,473)
Year Ended December 31 1998 1999 2000 2001 2002
- ---------------------- ---- ---- ---- ---- ----
Net liability re-estimated as of:
One year later 1,888,387 1,880,174 1,965,820 2,066,435
Two years later 1,885,236 1,907,575 2,066,091
Three years later 1,901,776 1,997,645
Four years later 1,975,793
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Decrease (increase) in
original estimates: $ (110,248) $ (174,316) $ (158,760) $ (84,450)
Net liability as originally
estimated: $1,865,545 $1,823,329 $1,907,331 $1,981,985 $2,079,254
Reinsurance recoverable on
unpaid losses and LAE 80,215 85,126 96,188 168,737 354,396
Gross liability as originally
estimated: $1,956,939 $1,908,455 $2,003,519 $2,150,722 $2,433,650
Life Operations Liability 11,180 - - - -
P&C Operations Liability 1,945,759 1,908,455 2,003,519 2,150,722 2,433,650
One year later 1,972,890 1,981,093 2,129,865 2,346,873
Two years later 1,975,657 2,041,717 2,310,556
Three years later 2,006,064 2,189,898
Four years later 2,114,326
Five years later
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Decrease (increase) in
original estimates: (168,567) (281,443) (307,038) (196,151)
14
Item 1. Continued
Reinsurance
Reinsurance is a contract by which one insurer, called a reinsurer, agrees
to cover, under certain defined circumstances, a portion of the losses
incurred by a primary insurer in the event a claim is made under a policy
issued by the primary insurer. The Group purchases reinsurance to protect
against large or catastrophic losses. There are several programs that
provide reinsurance coverage and the programs in effect for 2002 are
summarized below.
The Group's property per risk program covers property losses in excess of
$1.0 million for a single insured, for a single event. This property per
risk program covers up to $14.0 million in losses in excess of the $1.0
million retention level for a single event. The Group's casualty per
occurrence program covers liability losses. Workers' compensation,
umbrella and other casualty reinsurance cover losses up to $59.0 million,
$24.0 million and $23.0 million, respectively, in excess of the $1.0
million retention level for a single insured event. The casualty
reinsurance treaty includes a layer of coverage of $5.0 million in excess
of $1.0 million that includes a fund managed by the Group and the Group
has title to the assets. Ceded premiums are paid by the Group into the
fund and reinsured losses are paid to the Group under the terms of the
reinsurance agreement with various reinsurers. The reinsurers bear the
risk of losses in excess of the fund. The Group's ability to manage the
investments of the fund reduces credit risk related to reinsurers. The
balance of the fund as of December 31, 2002 was approximately $129.0
million.
The property catastrophe reinsurance program protects the Group against an
accumulation of losses arising from one defined catastrophic occurrence or
series of events. This program provides $150.0 million of coverage in
excess of the Group's $25.0 million retention level. The treaty was
written on a multiple year basis for years 2001 - 2004 with only a portion
of the reinsurance layers expiring in a single year. This provides
continuity and maintains rates and each reinsurer's overall share of the
program. Over the last 20 years, two events triggered coverage under the
catastrophe reinsurance program. Losses and loss adjustment expenses from
the fires in Oakland, California in 1991 totaled $35.6 million and losses
and loss adjustment expenses from Hurricane Andrew in 1992 totaled $29.8
million. Both of these losses exceeded the prior retention amount of $13.0
million, resulting in significant recoveries from reinsurers. Reinsurance
limits are purchased to cover exposure to catastrophic events having the
probability of occurring every 150-250 years.
GAI agreed to maintain reinsurance on the commercial lines business that
the Group acquired from GAI and its affiliates in 1998 for loss dates prior
to December 1, 1998. GAI is obligated to reimburse the Group if GAI's
reinsurers are unable to pay claims with respect to the acquired commercial
lines business.
Reinsurance contracts do not relieve the Group of their obligations to
policyholders. The collectibility of reinsurance depends on the solvency
of the reinsurers at the time any claims are presented. The Group monitors
each reinsurer's financial health and claims settlement performance because
reinsurance protection is an important component of the Corporation's
financial plan. Each year, the Group reviews financial statements and
calculates various ratios used to identify reinsurers who no longer meet
appropriate standards of financial strength. Reinsurers who fail these
tests are reviewed and those that are determined by the Group to have
insufficient financial strength are removed from the program at renewal.
Additionally, a large base of reinsurers is utilized to mitigate
concentration of risk. The Group also records an
15
Item 1. Continued
estimated allowance for uncollectible reinsurance amounts as deemed necessary.
During the last three fiscal years, no reinsurer accounted for more than
15% of total ceded premiums. As a result of these controls, amounts of
uncollectible reinsurance have not been significant.
All of the Company's insurance subsidiaries, except OCNJ, have entered into
an intercompany reinsurance pooling agreement with the Company. The
purpose of this agreement is to:
- - pool or share proportionately the results of property and casualty
insurance underwriting operations through reinsurance;
- - reduce administration and executive expense; and
- - broaden each participating insurance subsidiary's distribution of risk.
Under the terms of the intercompany reinsurance pooling agreement, all of
the participants' outstanding underwriting liabilities as of January 1,
1984 and all subsequent insurance transactions were pooled. The
participating insurance subsidiaries share in losses based on the following
percentages:
Insurance Subsidiary Percentage of Losses
-------------------- --------------------
The Company 46.75
West American 46.75
American Fire 5.00
Ohio Security 1.00
Avomark 0.50
Competition
The property and casualty industry is highly competitive. The Group
competes on the basis of service, price and coverage. According to A.M.
Best, based on net insurance premiums written in 2001, the latest year for
which industry nationwide comparison statistics are available:
- - more than $300 billion of net premiums were written by property and
casualty insurance companies in the United States and no one company or
company group had a market share greater than approximately 11.5%; and
- - the Group ranked as the fortieth largest property and casualty
insurance group in the United States.
Regulation
State Regulation
The Corporation's insurance subsidiaries are subject to regulation and
supervision in the states in which they are domiciled and in which they are
licensed to transact business. The Company, American Fire, Ohio Security
and OCNJ are all domiciled in Ohio. West American and Avomark are
domiciled in Indiana. Collectively, the Corporation's subsidiaries are
licensed to transact business in all 50 states and the District of
Columbia. Although the federal government does not directly regulate the
insurance industry, federal initiatives can also impact the industry.
16
Item 1. Continued
The authority of state insurance departments extends to various matters,
including:
- - the establishment of standards of solvency, which must be met and
maintained by insurers;
- - the licensing of insurers and agents;
- - the imposition of restrictions on investments;
- - approval and regulation of premium rates and policy forms for property
and casualty insurance;
- - the payment of dividends and distributions;
- - the provisions which insurers must make for current losses and future
liabilities; and
- - the deposit of securities for the benefit of policyholders.
State insurance departments also conduct periodic examinations of the
financial and business affairs of insurance companies and require the
filing of annual and other reports relating to the financial condition of
insurance companies. Regulatory agencies require that premium rates not be
excessive, inadequate or unfairly discriminatory. In general, the
Corporation's insurance subsidiaries must file all rates for personal and
commercial insurance with the insurance department of each state in which
they operate.
State laws also regulate insurance holding company systems. Each insurance
holding company in a holding company system is required to register with
the insurance supervisory agency of its state of domicile and furnish
information concerning the operations of companies within the holding
company system that may materially affect the operations, management or
financial condition of the insurers. Pursuant to these laws, the
respective departments may examine the parent and the insurance
subsidiaries at any time and require prior approval or notice of various
transactions including dividends or distributions to the parent from the
subsidiary domiciled in that state.
These state laws also require prior notice or regulatory agency approval of
changes in control of an insurer or its holding company and of other
material transfers of assets within the holding company structure. Under
applicable provisions of Indiana and Ohio insurance statutes, the states in
which the members of the Group are domiciled, a person would not be
permitted to acquire direct or indirect control of the Corporation or any
of its insurance subsidiaries, unless that person had obtained prior
approval of the Indiana Insurance Commissioner and the Ohio Superintendent
of Insurance. For the purposes of Indiana and Ohio insurance laws, any
person acquiring more than 10% of the voting securities of a company is
presumed to have acquired "control" of that company.
New Jersey
New Jersey's private passenger auto net premiums written represented
approximately 7.5% of the Group's total private passenger auto book of
business in 2002.
Given the unfavorable regulatory environment in New Jersey and the
continued unprofitability of its private passenger auto business in the
state, the Group announced in the fourth quarter of 2001 the transaction
that allowed the Group to stop writing business in early 2002 in the
private passenger auto market in New Jersey. See discussion of this
transaction and the New Jersey regulatory environment for private passenger
automobile insurance in Management's Discussion and Analysis of Financial
Condition and Results of Operations on pages 24, 35 and 36 of this Form 10-K.
17
Item 1. Continued
National Association of Insurance Commissioners
The Group's insurance subsidiaries are subject to the general statutory
accounting practices and reporting formats established by the NAIC. The
NAIC also promulgates model insurance laws and regulations relating to the
financial condition and operations of insurance companies, including the
Insurance Regulating Information System.
NAIC model laws and rules are not usually applicable unless enacted into
law or promulgated into regulation by the individual states. The adoption
of NAIC model laws and regulations is a key aspect of the NAIC Financial
Regulations Standards and Accreditation Program, which also sets forth
minimum staffing and resource levels for all state insurance departments.
Ohio and Indiana are accredited. The NAIC intends to create an eventual
nationwide regulatory network of accredited states.
The NAIC has developed a "Risk-Based Capital" model for property and
casualty insurers. The model is used to establish standards, which relate
insurance company statutory surplus to risks of operations and assist
regulators in determining solvency requirements. The standards are
designed to assess capital adequacy and to raise the level of protection
that statutory surplus provides for policyholders. The Risk-Based Capital
model measures the following four major areas of risk to which property and
casualty insurers are exposed:
- - asset risk;
- - credit risk;
- - underwriting risk; and
- - off-balance sheet risk.
The Risk-Based Capital model law requires the calculation of a ratio of
total adjusted capital to Authorized Control Level. Insurers with a ratio
below 200% are subject to different levels of regulatory intervention and
action. Based upon their 2002 statutory financial statements, the Company
and each of its insurance subsidiaries had the following ratio of total
adjusted capital to the Authorized Control Level:
The Company 572.5%
American Fire 892.7%
Ohio Security 2181.4%
West American 520.1%
Avomark 1106.5%
OCNJ 356.4%
As of December 31, 2002, all insurance companies in the Group exceeded the
necessary capital.
In 1998, the NAIC adopted the Codification of Statutory Accounting
Principles guidance, which replaced the former Accounting Practices and
Procedures manual as the NAIC's primary guidance on statutory accounting.
The new principles provide guidance for areas where statutory accounting
had been silent and changed former statutory accounting in some areas. The
Group implemented the Codification guidance effective January 1, 2001. The
cumulative effect of adopting Codification reduced statutory policyholders'
surplus by $21.7 million on January 1, 2001.
18
Item 1. Continued
Regulations on Dividends
The Corporation is dependent on dividend payments from its insurance
subsidiaries in order to meet operating expenses, debt obligations and to
pay dividends. Insurance regulatory authorities impose various
restrictions and prior approval requirements on the payment of dividends by
insurance companies and holding companies. This regulation allows
dividends to equal the greater of (1) 10% of policyholders' surplus or (2)
100% of the insurer's net income, each determined as of the preceding year
end, without prior approval of the insurance department.
Dividend payments to the Corporation from the Company are limited to
approximately $112.5 million during 2003 without prior approval of the Ohio
insurance department based on 100% of the Company's net income for the year
ending December 31, 2002. Additional restrictions may result from the
minimum net worth and surplus requirements in the Corporation's credit
agreement.
The ratio of net premiums written to statutory surplus is one of the
measures used by insurance regulators to gauge the operating leverage of an
insurance company and indicates the ability of the Group to grow by writing
additional business. The ratio of premiums written to statutory surplus
for the Corporation's insurance subsidiaries was 2.0 to 1 at December 31,
2002. The ratio was 1.9 to 1 in 2001 and 2000.
Employees
At December 31, 2002, the Company had approximately 3,000 employees of
which approximately 1,423 were located in the Fairfield and Hamilton, Ohio
offices.
Item 2. Properties
The Corporation owns and leases office space in various parts of the
country. The principal office buildings consist of facilities owned in
Fairfield and Hamilton, Ohio.
Item 3. Legal Proceedings
There are no material pending legal proceedings against the Corporation or
its subsidiaries other than litigation arising in connection with
settlement of insurance claims as described on page 11 of this Form 10-K.
Item 4. Submission of Matters to a Vote of Shareholders
There were no matters submitted during the fourth quarter of the
Corporation's 2002 fiscal year to a vote of Shareholders through the
solicitation of proxies or otherwise.
19
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
(a) The Corporation's common shares, par value $.125 per share, are
traded on the Nasdaq Stock Market under the symbol OCAS. On February
28, 2003, the Corporation's common shares were held by 5,179
shareholders of record.
(b) The following table shows the high and low sales prices for the
Corporation's common shares for each quarterly period within the
Corporation's last three most recent fiscal years:
High/Low Market Price Per Share
(in dollars)
Quarter 1st 2nd 3rd 4th
2002 High 19.20 22.07 20.43 18.18
Low 15.80 18.66 16.01 11.22
2001 High 11.63 13.38 14.30 16.05
Low 8.38 8.47 10.93 12.43
2000 High 17.87 17.12 10.56 10.25
Low 11.06 10.94 6.34 6.50
(c) Quarterly cash dividends were paid by the Corporation to the holders
of its common shares in 2000. Cash dividends per share for 2000 were
$.23 for the first quarter and $.12 for each of the remaining
quarters in 2000. The Corporation's Board of Directors discontinued
the Corporation's regular quarterly dividend in February, 2001.
20
Item 6. Selected Financial Data
Ohio Casualty Corporation & Subsidiaries
TEN-YEAR SUMMARY OF OPERATIONS
(all amounts are in accordance with GAAP unless
otherwise noted; number of weighted average shares
and dollars in millions, except per share data)
2002 2001 2000 1999
- -----------------------------------------------------------------------------------------
Consolidated Operations
Premiums and finance charges earned $ 1,450.5 $ 1,506.7 $ 1,534.0 $ 1,555.0
Investment income less expenses 207.1 212.4 205.1 184.3
Investment gains (losses) realized, net 45.2 182.9 (2.4) 160.8
- -----------------------------------------------------------------------------------------
Total Revenues 1,702.8 1,902.0 1,736.7 1,900.1
Total Expenses 1,709.5 1,775.6 1,866.4 1,763.2
Income (loss) from continuing operations (0.9) 98.6 (79.2) 110.2
- -----------------------------------------------------------------------------------------
Gain on sale of discontinued operations - - - 6.2
Cumulative effect of accounting change - (2.3)
- -----------------------------------------------------------------------------------------
Net income (loss) (0.9) 98.6 (79.2) 114.1
=========================================================================================
Income (loss) after taxes per average share outstanding - diluted*
Income (loss) from continuing operations (0.01) 1.64 (1.32) 1.73
Discontinued operations - - - 0.07
Gain on sale of discontinued operations - - - 0.11
Cumulative effect of accounting changes - - - (0.04)
- -----------------------------------------------------------------------------------------
Net income (loss) (0.01) 1.64 (1.32) 1.87
=========================================================================================
Average shares outstanding - diluted* 61.3 60.2 60.1 61.1
Total assets 4,779.0 4,524.6 4,489.4 4,476.4
Total debt 198.3 210.2 220.8 241.4
Shareholders' equity 1,058.7 1,080.0 1,116.6 1,151.0
Book value per share* 17.43 17.97 18.59 19.16
Dividends per share* - - 0.59 0.92
Property and Casualty Operations
Net premiums written(1) 1,448.6 1,472.2 1,505.4 1,586.9
Net premiums earned 1,450.4 1,506.2 1,533.0 1,554.1
Statutory loss ratio(2) 62.2% 66.5% 72.8% 66.9%
Statutory loss adjustment expense ratio(3) 15.7% 13.4% 11.6% 10.7%
Statutory underwriting expense ratio(4) 34.9% 35.4% 34.8% 35.2%
Statutory combined ratio(5) 112.8% 115.3% 119.2% 112.8%
Property and casualty reserves
Unearned premiums 668.7 666.7 696.4 725.2
Losses 1,978.7 1,746.8 1,627.6 1,545.0
Loss adjustment expense 454.9 403.9 376.0 363.5
Statutory policyholders' surplus(6) 725.7 767.5 812.1 899.8
(1)Net premiums written are premiums for all policies sold during a specific
accounting period less premiums returned.
(2)Statutory loss ratio measures net losses incurred as a percentage of net
premiums earned.
(3)Statutory loss adjustment expense ratio measures loss adjustment expenses
as a percentage of net premiums earned.
(4)Statutory underwriting expense ratio measures underwriting expenses as a
percentage of net premiums written.
(5)Statutory combined ratio measures the percentage of premium dollars used
to pay insurance losses, loss adjustment expenses and underwriting
expenses.
(6)Statutory policyholders' surplus is equal to an insurance company's
admitted assets minus liabilities.
*Adjusted for 2 for 1 stock dividend effective July 22, 1999
21
Item 6. Continued
Ohio Casualty Corporation & Subsidiaries
TEN-YEAR SUMMARY OF OPERATIONS
(all amounts are in accordance with GAAP unless
otherwise noted; number of weighted average shares
and dollars in millions, except per share data)
1998 1997 1996 1995
- -----------------------------------------------------------------------------------------
Consolidated Operations
Premiums and finance charges earned $1,268.9 $1,209.0 $1,226.6 $1,268.3
Investment income less expenses 169.0 177.7 183.3 188.1
Investment gains (losses) realized, net 14.4 50.7 49.7 6.1
- -----------------------------------------------------------------------------------------
Total Revenues 1,452.3 1,437.4 1,459.6 1,462.5
Total Expenses 1,349.3 1,263.9 1,344.7 1,342.3
Income (loss) from continuing operations 84.9 139.1 102.5 99.7
- -----------------------------------------------------------------------------------------
Gain on sale of discontinued operations - - - -
Cumulative effect of accounting change - - - -
- -----------------------------------------------------------------------------------------
Net income (loss) 84.9 139.1 102.5 99.7
=========================================================================================
Income (loss) after taxes per average share outstanding - diluted*
Income (loss) from continuing operations 1.26 1.90 1.39 1.33
Discontinued operations 0.03 0.13 0.07 0.06
Gain on sale of discontinued operations - - - -
Cumulative effect of accounting changes - - - -
- -----------------------------------------------------------------------------------------
Net income (loss) 1.29 2.03 1.46 1.39
=========================================================================================
Average shares outstanding - diluted* 65.9 68.5 70.5 71.5
Total assets 4,802.3 3,778.8 3,890.0 3,980.1
Total debt 265.0 40.0 50.0 60.0
Shareholders' equity 1,321.0 1,314.8 1,175.1 1,111.0
Book value per share* 21.12 19.56 16.72 15.69
Dividends per share* 0.88 0.84 0.80 0.76
Property and Casualty Operations
Net premiums written(1) 1,299.6 1,207.6 1,209.0 1,250.6
Net premiums earned 1,267.8 1,204.3 1,223.4 1,264.6
Statutory loss ratio(2) 63.7% 62.7% 66.5% 61.2%
Statutory loss adjustment expense ratio(3) 9.1% 9.4% 9.7% 10.2%
Statutory underwriting expense ratio(4) 34.4% 33.2% 33.3% 32.6%
Statutory combined ratio(5) 107.2% 105.3% 109.5% 104.0%
Property and casualty reserves
Unearned premiums 668.4 494.9 491.4 505.8
Losses 1,569.5 1,174.5 1,215.8 1,268.1
Loss adjustment expense 376.3 307.2 331.8 356.1
Statutory policyholders' surplus(6) 1,027.1 1,109.5 984.9 876.9
Ohio Casualty Corporation & Subsidiaries
TEN-YEAR SUMMARY OF OPERATIONS
(all amounts are in accordance with GAAP unless
otherwise noted; number of weighted average shares
and dollars in millions, except per share data) 10-Year Compound
1994 1993 Annual Growth
- -----------------------------------------------------------------------------------
Consolidated Operations
Premiums and finance charges earned $1,298.8 $1,380.7 (0.6)%
Investment income less expenses 185.7 192.5 (0.6)%
Investment gains (losses) realized, net 21.9 47.0 (1.5)%
- -----------------------------------------------------------------------------------
Total Revenues 1,506.4 1,620.2 (0.6)%
Total Expenses 1,397.1 1,533.2 0.1%
Income (loss) from continuing operations 97.2 87.0 (100.0)%
- -----------------------------------------------------------------------------------
Gain on sale of discontinued operations - -
Cumulative effect of accounting change (0.3) -
- -----------------------------------------------------------------------------------
Net income (loss) 96.9 87.0 (100.0)%
===================================================================================
Income (loss) after taxes per average share outstanding - diluted*
Income (loss) from continuing operations 1.27 1.12 (101.0)%
Discontinued operations 0.08 0.09 (100.0)%
Gain on sale of discontinued operations - -
Cumulative effect of accounting changes - -
- -----------------------------------------------------------------------------------
Net income (loss) 1.35 1.21 (101.0)%
===================================================================================
Average shares outstanding - diluted* 72.0 72.0 (1.6)%
Total assets 3,739.0 3,816.8 2.4%
Total debt 70.0 103.0 5.2%
Shareholders' equity 850.8 862.3 2.5%
Book value per share* 11.82 11.97 4.0%
Dividends per share* 0.73 0.71 (100.0)%
Property and Casualty Operations
Net premiums written(1) 1,286.4 1,306.0 (0.4)%
Net premiums earned 1,297.7 1,379.4 (0.5)%
Statutory loss ratio(2) 61.6% 64.9% (0.2)%
Statutory loss adjustment expense ratio(3) 10.0% 11.8% 3.8%
Statutory underwriting expense ratio(4) 32.2% 33.6% 0.4%
Statutory combined ratio(5) 103.8% 110.3% 0.4%
Property and casualty reserves
Unearned premiums 517.8 529.6 1.2%
Losses 1,303.6 1,378.0 4.2%
Loss adjustment expense 367.3 390.6 2.3%
Statutory policyholders' surplus(6) 660.0 713.6 0.7%
(1)Net premiums written are premiums for all policies sold during a specific
accounting period less premiums returned.
(2)Statutory loss ratio measures net losses incurred as a percentage of net
premiums earned.
(3)Statutory loss adjustment expense ratio measures loss adjustment expenses
as a percentage of net premiums earned.
(4)Statutory underwriting expense ratio measures underwriting expenses as a
percentage of net premiums written.
(5)Statutory combined ratio measures the percentage of premium dollars used
to pay insurance losses, loss adjustment expenses and underwriting
expenses.
(6)Statutory policyholders' surplus is equal to an insurance company's
admitted assets minus liabilities.
*Adjusted for 2 for 1 stock dividend effective July 22, 1999
22
PAGE>
Item 7. 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).
Management's Discussion and Analysis (MD&A) of financial condition and
results of operations addresses the financial condition of the Corporation
and the Group as of December 31, 2002, compared with December 31, 2001 and
December 31, 2000 and the Corporation's and the Group's results of
operations for each of the three years. The supplementary financial
information should be read in conjunction with the consolidated financial
statements and related notes, all of which are integral parts of the
following analysis of the Corporation's and the Group's results of
operations and financial position.
OVERVIEW
During 2002, the Group continued to invest in its strategy to improve the
ease of use for agents doing business with the Group and demonstrated
improved loss ratios despite the negative impact of business written in
prior years. The Corporation also completed the refinancing of bank debt
with a convertible debt issuance that aggregated net proceeds of $194.0
million as discussed further under "Liquidity and Financial Strength." In
addition, substantial progress was made in 2002 toward implementing the
Corporation's strategic plan.
RESULTS OF OPERATIONS
Net Income
The Corporation reported an after-tax net loss of $.9 million, or $.01 per
share for the year 2002, compared with net income of $98.6 million, or
$1.64 per share in 2001, and a net loss of $79.2 million, or $1.32 per
share in 2000.
Operating Results
For the year 2002, the Corporation reported a net operating loss(1) of $30.2
million, compared with net operating losses of $36.4 million in 2001 and
$77.7 million in 2000. During 2002, the Group increased provisions for
prior accident years' losses and loss adjustment expenses (LAE) by $84.4
million before tax which was concentrated in the general liability,
commercial auto and personal auto product lines. Also during 2002,
operating results were negatively impacted by expenses totaling $79.7
million before tax related to the agent relationships identifiable
intangible asset. This asset represents the excess of cost over fair value
of net assets for the 1998 acquisition of the Great American Insurance
Company's (GAI) commercial lines division. The components of this non-cash
charge were $10.2 million before tax in amortization and $69.5 million
before tax in impairment charges related to agent cancellations or other
changes in estimated future cash flows. The impairment charges occurred
where estimated future cash flows of certain agents were less than the
carrying value. The larger than usual impairment charge in the third
quarter of 2002 was due primarily to recognition that certain agents
experienced sustained premium revenue trends that were significantly
different from prior estimates, resulting in changes in estimated future
cash flows for those agents. The determination of impairment involves the
use of management estimates and assumptions. Due to the inherent
uncertainties and judgments involved in making these assumptions and the
fact that the asset cannot be increased for any agent, further reductions
in the valuation of the agent relationships asset are
23
(1) Operating income (loss) differs from net income by the exclusion of
realized investment gains (losses), net of tax. It is not intended as a
substitute for net income prepared in accordance with accounting principles
generally accepted in the United States.
Item 7. Continued
likely to occur in the future and could be significant based on
uncertainties such as which agents will experience events such as changes
in revenue production or profitability. The total 2002 expense of $79.7
million before tax compares to $22.3 million before tax in 2001 and $57.7
million before tax in 2000.
Results for the year 2002 were negatively impacted by the losses and loss
adjustment expenses for prior accident years as described above. The
majority of the charge, $62.2 million before tax, occurred in the third
quarter and was primarily related to construction defect claims for
residential developers and contractors. The Group continues to address
this specific type of business for non-renewal. For further discussion,
refer to the "Loss and Loss Adjustment Expenses" section under "Liquidity
and Financial Strength."
Contributing to the 2001 operating loss was the effects of additions to the
Group's workers' compensation product line reserves and asbestos related
reserves and the impact of an early retirement plan. The 2000 operating
loss included the adverse effects of write-downs to the agent relationships
intangible asset, additions to reserves, the impact of inadequate pricing
and the negative effects of premium cessions on experience rated
reinsurance contracts. Positively impacting 2000 results was the
settlement of the California Proposition 103 liability.
During the fourth quarter of 2001, a member of the Group, Ohio Casualty of
New Jersey, Inc. (OCNJ), entered into an agreement to transfer its
obligations to renew private passenger auto business in New Jersey. The
Group decided to eliminate future uncertainty and risks related to the New
Jersey private passenger automobile market in order to achieve long-term
strategic objectives. In 2001, management determined that it was uncertain
whether profitability would return as there were indications that some
insurance companies were receiving premium rate increase approval from
regulators while others were not. The Group's inability to determine the
future impact of insurance reform legislation created additional
uncertainty. Both premium rate increases and insurance reform legislation
might have returned OCNJ's private passenger auto business to
profitability, but it was uncertain as to if and when that would occur.
The Group concluded that it was a prudent business decision to pay a fee to
transfer the obligation to renew OCNJ's New Jersey private passenger auto
policies in order to eliminate the future uncertainty associated with that
business.
The transaction allowed the Group to stop writing business in the New
Jersey private passenger auto market beginning in March of 2002. In recent
years, the market in New Jersey private passenger auto had become more
unstable due to the inability to control both the volume of writings and
the profitability. Under the terms of the transaction, OCNJ agreed to pay
$40.6 million to a third party, Proformance Insurance Company
(Proformance), to transfer its renewal obligations. The before-tax amount
of $40.6 million was charged to income in the fourth quarter of 2001 with
payments made over the course of twelve months beginning in early 2002.
The contract stipulates that a premiums-to-surplus ratio of 2.5 to 1 must
be maintained on the transferred business during the three year period
beginning March 2002. The final measurement date is December 31, 2004 and
will include use of the statutory insurance expense exhibit which is due
April 1, 2005. If this criteria is not met, OCNJ will have a contingent
liability of up to $15.6 million to be paid to Proformance to maintain this
premiums-to-surplus ratio. At December 31, 2002, the Group has evaluated
the contingency based upon financial data provided by Proformance. The
Group has concluded that it is not probable that the liability will be
incurred, and therefore has not recognized a liability in the financial
statements. The Group will continue to monitor the contingency for any
future liability recognition.
24
Item 7. Continued
During 2001, loss and loss adjustment expense reserves were strengthened by
$29.6 million before tax for the workers' compensation product line and
$17.6 million before tax for asbestos related claims development in other
product lines. Also in 2001, the Corporation adopted an early retirement
plan. Of the approximately 330 employees eligible to retire under the
program, 147 accepted. The early retirement plan resulted in a one-time
after-tax charge of $4.0 million for the year.
In the first quarter of 2000, the Group made the decision to discontinue
its relationship with all Managing General Agents. The business written by
the Managing General Agents was acquired in the 1998 purchase of the GAI
commercial lines division. The result of the decision was a before-tax
write-down of $42.2 million to the agent relationships intangible asset.
The asset was also written down in 2000 by $3.8 million before tax as a
result of additional agent cancellations for a total write-down of $46.0
million before tax for the year. In 2001, the Corporation further wrote
down the agent relationships intangible asset by $11.0 million before tax
as a result of additional agency cancellations and for certain agents
determined to be impaired.
The 2000 operating results were also impacted negatively by $23.2 million
before tax for ceded premiums on certain experience rated reinsurance
contracts covering losses exceeding $1.0 million. The premium cessions
reflect changes in estimated loss experience, and have resulted in the
maximum premium cessions under these contracts for business written through
year 2000. During 2000, loss and loss adjustment expense reserves were
strengthened by $56.8 million before tax, primarily for the workers'
compensation and general liability product lines.
Investment Results
Consolidated after-tax realized investment gains amounted to $29.4 million
in 2002, $135.0 million in 2001 and realized investment losses were $1.5
million in 2000. Throughout 2002 and 2001 the Corporation and the Group
sold equities, many of which had substantially appreciated in earlier
periods. This sale program was part of an investment management decision
to reduce equity holdings in favor of investment grade bonds. The 2001
realized gains included a non-recurring tax benefit of $16.1 million
related to the sale of a minority interest in stock of OCNJ.
Consolidated before-tax investment income decreased 2.5% to $207.1 million
in 2002, compared with $212.4 million in 2001 and $205.1 million in 2000.
The decrease in investment income of $5.3 million before tax in 2002 was
attributable to the significant decline in reinvestment rates on the high
quality bonds in which the Corporation and the Group invest. This decrease
in 2002 was partially offset by the reallocation of the equity portfolio in
2002 and 2001. The reallocation in the investment portfolio reduced equity
securities and increased investment grade fixed maturity securities. The
increase in investment income of $7.3 million before tax in 2001 was
attributable to the reallocation in the investment portfolio noted above.
Also contributing to the increase in before-tax investment income in 2001
was the reallocation of investments from tax exempt municipal bonds to
taxable bonds. After-tax investment income totaled $136.9 million in 2002,
compared with $141.3 million in 2001 and $140.3 million in 2000.
During 2001, the Corporation and the Group realized a loss of approximately
$6.8 million before tax on the sale of bonds issued by Enron Corporation.
These securities had been purchased in prior periods and were sold both
prior and subsequent to Enron Corporation's filing for bankruptcy in
December 2001. Prior to 2001, these securities were not in an unrealized
loss position.
25
Item 7. Continued
Management believes that it will recover the cost basis in the securities
held with unrealized losses as it has both the intent and ability to hold
the securities until they mature or recover in value. Securities are sold
to achieve management's investment goals, which include the diversification
of credit risk, the maintenance of adequate portfolio liquidity and the
management of interest rate risk. In order to achieve these goals, sales
of investments are based upon current market conditions, liquidity needs
and estimates of the future market value of the individual securities.
The largest assets of the Corporation and the Group are their invested
assets. Consequently, accounting policies related to investments are
critical. See further discussion of important investment accounting
policies in the "Critical Accounting Policies" section and in Note 1C.
The Corporation and the Group continually evaluate all of their investments
based on current economic conditions, credit loss experience and other
developments. The Corporation and the Group evaluate the difference
between the cost and estimated fair value of their investments to determine
whether a decline in value is temporary or other than temporary in nature.
This determination involves a degree of uncertainty. If a decline in the
fair value of a security is determined to be temporary, the decline is
recorded as an unrealized loss in shareholders' equity. If there is a
decline in a security's fair value that is considered to be other than
temporary, the security is written down to the estimated fair value with a
corresponding realized loss recognized in the statement of consolidated
income.
The assessment of whether a decline in fair value is considered temporary
or other than temporary includes management's judgement as to the financial
position and future prospects of the entity issuing the security. It is
not possible to accurately predict when it may be determined that a
specific security will become impaired. Future impairment charges could be
material to the results of operations of the Corporation and the Group.
The amount of impairment charge before tax was $10.9 million in 2002,
compared to $12.0 million and $16.7 million in 2001 and 2000, respectively.
The impairment charge in 2002 represents .3% of the market value at
December 31, 2002 of the investment portfolio, compared to .3% in 2001 and
..5% in 2000.
The following table summarizes the total gross unrealized losses, excluding
gross unrealized gains, by investment category as of December 31:
(in thousands) 2002 2001 2000
- ---------------------------------------------------------------------------
Fixed maturities $32,667 $35,613 $26,587
Equities 10,277 2,798 12,700
- ---------------------------------------------------------------------------
Total unrealized loss $42,944 $38,411 $39,287
As part of the evaluation of the entire $42.9 million aggregate unrealized
loss on the investment portfolio, management performed a more intensive
review of securities with a relatively higher degree of unrealized loss.
In the review for permanently impaired securities as of December 31, 2002,
management concluded that of this group of securities with a relatively
higher degree of difference between cost and estimated fair value, sixteen
securities, with an aggregate unrealized loss of $15.2 million, were
suffering only temporary declines in fair value. Of this unrealized loss
amount, $3.8 million represented unrealized losses in the securities of
Delta Air Lines, Inc. and $5.2 million represented unrealized losses in
investment in AMR Corporation. All securities are monitored by portfolio
managers who consider many factors such as a company's degree of financial
flexibility, management competence and industry fundamentals in evaluating
whether the decline in fair value is temporary. Should management
subsequently conclude the decline in fair value is other than temporary,
the book value of the security is written down to fair value with the
realized loss recognized in the statement of consolidated income.
26
Item 7. Continued
The following table summarizes, for all securities in an unrealized loss
position, the gross unrealized loss by length of time the securities have
continuously been in an unrealized loss position at December 31, 2002:
Amortized Fair Unrealized
(in thousands) Cost Value Loss
- -----------------------------------------------------------------------------
Fixed maturities:
0-6 months $178,279 $167,589 $(10,690)
7-12 months 54,514 51,168 (3,346)
Greater than 12 months 153,490 134,859 (18,631)
- -----------------------------------------------------------------------------
Total $386,283 $353,616 $(32,667)
Amortized Fair Unrealized
(in thousands) Cost Value Loss
- -----------------------------------------------------------------------------
Equities:
0-6 months $28,885 $26,612 $ (2,273)
7-12 months 13,379 11,122 (2,257)
Greater than 12 months 21,733 15,986 (5,747)
- -----------------------------------------------------------------------------
Total $63,997 $53,720 $(10,277)
Of the securities in an unrealized loss position as of December 31, 2002,
the only material concentration by industry segment was in the airline
industry. The amount of this concentration as of December 31, 2002 was
$9.5 million.
The amortized cost and estimated fair value of debt securities in an
unrealized loss position at December 31, 2002, by contractual maturity are
shown below. Expected maturities will differ from contractual maturities
because borrowers may have the right to call or prepay obligations with or
without call or prepayment penalties.
Amortized Estimated Unrealized
(in thousands) Cost Fair Value Loss
- -----------------------------------------------------------------------------
Due in one year or less $ 5,105 $ 4,610 $ 495
Due after one year through
five years 53,702 47,862 5,841
Due after five years through
ten years 131,355 121,060 10,295
Due after ten years 196,120 180,084 16,036
- -----------------------------------------------------------------------------
Total $386,282 $353,616 $32,667
Reinsurance Results
The Group renewed all of its reinsurance programs for 2002 with only
moderate changes in the program structure and pricing. The enactment of
the Federal Terrorism Act (the Act) in November 2002 has resulted in the
Federal Government acting as a reinsurer on foreign terrorism losses,
defined in the Act as a "certified loss" that has been approved by the
Secretary of Treasury. The Group has dedicated resources to ensure
compliance with the Act. Although the terrorist events of September 11,
2001 had a significant impact on the reinsurance market, the Group's
reinsurance contracts do include coverage for acts of terrorism. Instead
of being
27
Item 7. Continued
unlimited as in the past, terrorism coverage in the 2002 contracts was
modified to exclude or limit coverage for certain upper layers of
reinsurance. The Group believes that the terrorism coverage in its
reinsurance programs is adequate to protect its financial health. The
pricing of our 2002 reinsurance program increased only moderately from
prior years. The Group has renewed its reinsurance programs for 2003
except for the bond reinsurance treaty that is expected to be renewed at
the April 1, 2003 expiration date. The 2003 program experienced moderate
increases in pricing and no significant changes in structure or coverages.
Internally Developed Software
In 2001, the Group introduced into limited production a new internally
developed application for issuing and maintaining insurance policies named
P.A.R.I.S. sm , a policy administration, rating and issuance system. The
Group continued the roll out of the new application during 2002 to include
all product lines in the Commercial Lines operating segment. The roll out
is currently on target for completion in 2003 for the Commercial and
Specialty segments. The Group capitalizes costs incurred during the
application development stage, primarily relating to payroll and payroll-
related costs for employees, along with costs incurred for external
consultants who are directly associated with the internal-use software
project. 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, the new application
should impact results by approximately $4.0 million to $6.0 million before
tax per year in amortization expense until 2012. Although management
believes the carrying value of 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.
Statutory 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
the sum of the statutory loss ratio, the statutory loss adjustment expense
ratio, and the statutory underwriting expense ratio. 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. All references to combined ratio or its components
in the MD&A are calculated on a statutory accounting basis and are
calculated on a calendar year basis unless specified on an accident year
basis. The combined ratios and component ratios presented for the year
ended December 31, 2002 exclude a $7.3 million before-tax charge for the
statutory additional minimum pension liability related to the underfunded
status of the retirement plan. A discussion of the differences between
statutory accounting and accounting principles generally accepted in the
United States is included in Note 16.
All Lines Discussion
Statutory net premiums written decreased $23.6 million in 2002 to $1.45
billion. This slight decline of net premiums written over 2001 is
primarily attributable to the reduction in premiums related to the non-
renewal of the Group's New Jersey private passenger auto business that
began to be non-renewed in March of 2002. Net premiums written totaled
$1.47 billion in 2001 and $1.51 billion in 2000. The net premiums written
decrease in 2001 and 2000 can be attributed
28
Item 7. Continued
primarily to a more selective underwriting philosophy that led to the
elimination and cancellation of certain business and the cancellation of a
number of agents. Actions taken in 2000 to cancel the Managing General
Agents and the Group's most unprofitable agents and policies represented
over $150.0 million in annual net premiums written.
The Group's business is geographically concentrated in the Mid-West and
Mid-Atlantic regions. The following table shows consolidated net premiums
written for the Group's five largest states:
ALL LINES NET PREMIUMS WRITTEN
DISTRIBUTED BY TOP STATES
2002 2001 2000
---- ---- ----
New Jersey 12.5% 17.4% 14.9%
Ohio 9.4% 9.8% 9.7%
Pennsylvania 7.9% 6.8% 6.2%
Kentucky 7.7% 7.9% 8.5%
Illinois 5.3% 5.1% 5.2%
New Jersey is the Group's largest state with 12.5% of the total net
premiums written during 2002. In recent years, New Jersey's legislative
and regulatory environments for private passenger automobile insurance have
become less favorable to the insurance industry. The state requires
insurance companies to accept all risks that meet underwriting guidelines
for private passenger automobile while rigidly controlling the rates
charged. In the fourth quarter of 2001, OCNJ entered into an agreement to
transfer its New Jersey private passenger auto renewal obligations to
Proformance. This transaction allowed the Group to stop writing business
in the New Jersey private passenger auto and personal umbrella markets in
early 2002. New Jersey private passenger auto made up 13.1%, 46.5%, and
43.2% of the Group's New Jersey net premiums written in 2002, 2001, and
2000, respectively. Excluding the Group's New Jersey private passenger
auto net premiums written, New Jersey would have represented 10.8%, 9.3%,
and 8.5% of the total all lines net premiums written in 2002, 2001, and
2000. The Group expects to continue writing all of its other lines of
business in the state.
The All Lines combined ratio increased .2 points to 112.8% in 2002,
compared with 112.6% in 2001 and 119.2% in 2000. The 2001 combined ratio
of 112.6% excludes the New Jersey transfer fee of $40.6 million, or 2.7
point impact. Further excluding New Jersey private passenger auto results
in total, the combined ratio improved 1.8 points in 2002 to 110.3%,
compared to 112.1% in 2001. The improvement in the combined ratio in 2002
over 2001 when excluding the $40.6 million New Jersey transfer fee and New
Jersey private passenger auto business was due primarily to improvement in
the Personal Lines loss ratio. The 2002 Personal Lines loss ratio improved
to 64.9% from 71.2% in 2001 excluding the New Jersey transfer fee and New
Jersey private passenger auto business.
The improvement in the combined ratio in 2001 over 2000 was due to
improvement in the Commercial Lines loss ratio and all lines underwriting
expense ratio when excluding the $40.6 million New Jersey transfer fee.
The 2001 Commercial Lines loss ratio improved to 64.5% from 78.6% in 2000.
The 2000 combined ratio was impacted adversely by increases in the loss and
loss adjustment expense ratios. The 2000 loss ratio was impacted by
adverse development in the workers' compensation and general liability
product lines for 1999 and prior accident years. Workers' compensation
added 6.8 points to the overall 2000 loss ratio.
29
Item 7. Continued
The All Lines combined ratio for accident year 2002 was 106.9%. The All
Lines combined ratio for the year 2002 of 112.8% reflects losses and LAE
recorded during 2002 for all accident years in aggregate and is therefore
5.8 points higher than the All Lines combined ratio for accident year 2002.
The All Lines combined ratio for accident year 2002 is .8 points lower than
the 107.7% All Lines combined ratio for accident year 2001, excluding the
2.7 point impact of the New Jersey renewal obligation transfer fee, based
on accident year data as of December 31, 2002. Excluding the impact of New
Jersey private passenger auto business, the 2002 and 2001 accident year
numbers would have been 105.2% and 107.6%, respectively, an improvement of
2.4 points.
The loss and loss adjustment expense (LAE) ratios, which measure losses and
LAE as a percentage of net earned premiums, were impacted negatively in
2002 by adjustments to estimated losses related to prior years' business.
The loss and LAE ratio component of the accident year combined ratio
measures losses and LAE arising from insured events that occurred in the
respective accident year. The current accident year excludes losses and
LAE for insured events that occurred in prior accident years. In total,
this increase in provisions for prior accident years' losses and LAE
recognized during the year 2002 was $84.4 million before tax.
The table below summarizes the impact of changes in provision for all prior
accident year losses and LAE:
(in millions)
Including NJ private passenger auto: 2002 2001 2000
- ------------------------------------------------------------------------------
Statutory net liabilities,
beginning of period $1,982.0 $1,907.3 $1,823.3
Increase (decrease) in provision
for prior accident year claims $84.4 $58.5 $56.8
Increase (decrease) in provision for
prior accident year claims as % of
premiums earned 5.8% 3.9% 3.7%
The combined ratio impact of this adverse development for prior accident
years' losses and LAE was 5.8 points for the year 2002. For the year 2002,
this was concentrated in the general liability and commercial auto product
lines of the Commercial Lines operating segment and in the personal auto
product line of the Personal Lines operating segment. Prior year losses
and LAE for construction defect related claims were within the range
expected for the fourth quarter 2002 after recognizing approximately $46.0
million before tax in the third quarter 2002.
The total provision for prior years' losses and LAE of $84.4 million
recognized during the year 2002 represents 4.3% of loss and loss adjustment
expense reserves as of year-end 2001. The comparable amount of provision
for prior years' losses and LAE recognized during the year 2001 was $58.5
million before tax representing 3.1% of loss and loss adjustment expense
reserves as of year-end 2000. This was concentrated in the workers'
compensation product line and the general liability product line of the
Commercial Lines operating segment. The comparable amount for provisions
for prior years' losses and loss adjustment expenses recognized during the
year 2000 was $56.8 million before tax. This represents 3.1% of loss and
loss adjustment expense reserves as of year-end 1999. This was
concentrated primarily in the workers' compensation and general liability
product lines.
The 2002 combined ratio includes a reallocation of loss adjustment expense
reserve estimates related to claims adjuster salaries, benefits and similar
costs from Commercial and Specialty segments to the Personal Lines segment.
This increased the 2002 Personal Lines segment combined ratio by 1.5 points
and decreased the Commercial Lines segment and Specialty Line segment
combined ratio by .6 points and 2.4, respectively.
30
Item 7. Continued
At year-end 2000, the Group reallocated its carried bulk reserves in
anticipation of Statement of Statutory Accounting Principles No. 55 under
Statutory Accounting Codification, which requires that companies carry
their best estimate of loss reserves for each line of business, while
previous requirements focused on the overall reserves. The reallocation
did not affect the All Lines 2000 combined ratio and did not have a
material impact on most lines of business other than workers' compensation
and general liability. The reallocation added 9.6 points to the workers'
compensation combined ratio and reduced the general liability combined
ratio by 4.7 points.
Catastrophe losses in 2002 totaled $20.8 million, compared with $34.6
million in 2001 and $36.2 million in 2000. The Group was impacted by 25
separate catastrophes in 2002, compared with 19 catastrophes in 2001 and 24
in 2000. Catastrophe losses added 1.4 points to the combined ratio in
2002, compared with 2.3 points in 2001 and 2.4 points in 2000. The effects
of catastrophes on the Corporation's results cannot be accurately
predicted. As such, severe weather patterns, acts of war or terrorist
activities could have a material adverse impact on the Corporation's
results, reinsurance pricing and availability of reinsurance.
Catastrophe losses, net of reinsurance, for each of the last three years
were:
Catastrophe Losses
(before-tax)
2002 2001 2000
- --------------------------------------------------------------------
Dollar Impact (in millions) $20.8 $34.6 $36.2
Statutory Combined
Ratio Impact 1.4% 2.3% 2.4%
The underwriting expense ratio, which measures underwriting expenses as a
percentage of net premiums written, decreased by .5 points in 2002 to
34.9%, compared with 35.4% in 2001 and 34.8% in 2000. The 2001
underwriting expense ratio includes 2.7 points from the $40.6 million
charge for the New Jersey transfer fee. The underwriting expense ratio for
the year 2002 increased compared to the year 2001, after excluding the 2.7
point impact of the New Jersey transfer fee, in part due to two factors
with a total impact of approximately 1.6 points. These two factors were
the non-renewal of the New Jersey private passenger auto business, which
had lower commission rates and lower variable processing costs than most
other business, and the elimination of ceding commissions received in
previous years on umbrella premiums ceded to reinsurers. The 2002
commission expense ratio, a component of the underwriting expense ratio,
was 17.8% or 1.2 points higher than expected due to higher than expected
umbrella net premiums written, which has a relatively high commission rate
on a net of reinsurance basis, and more importantly, due to higher than
expected accruals for agent bonus commissions, as certain agents were more
profitable than expected. This higher commission expense reflected the
improved loss ratio for 2002, which at 62.2% for the year 2002 was a 4.3
point improvement over the year 2001 of 66.5%. Excluding the New Jersey
transfer fee, the 2.1 point improvement in the 2001 underwriting expense
ratio compared with the ratio in 2000 was the result of actions to lower
commissions, eliminate workers' compensation policyholder dividends and
decrease the employee count. The actions to lower commissions to current
market levels for selected product lines improved the 2001 underwriting
expense ratio .5 points. The actions to eliminate workers' compensation
policyholders dividends on new and renewal business and changes in reserves
for dividends of issued policies improved the 2001 underwriting ratio .7
points. Reductions in employee count continued to improve results in 2002.
The employee count was 3,004 as of December 31, 2002, compared with 3,365
at December 31, 2001 and 3,470 at December 31, 2000.
31
Item 7. Continued
The 2002 and 2001 underwriting expenses also included $2.6 million and $.5
million of software amortization expense before tax, respectively, related
to the rollout of a new internally developed software application. On a
statutory accounting basis, the new application is being amortized over a
five-year period in accordance with statutory accounting principles. For
year 2003, the Group will substantially complete the rollout of the new
application for Commercial and Specialty segments. Upon full
implementation, the impact on statutory expenses is expected to be
approximately $8.0 million to $12.0 million in annual amortization expense
before tax through 2007. The additional cost is expected to be offset in
part by reduced labor costs related to underwriting and policy processing.
Segment Discussion
In June of 2001, the Corporation introduced an organizational structure
around three business units: Commercial Lines, Specialty Lines, and
Personal Lines. These business units represent the Corporation's operating
segments as well as its reportable segments. Within each operating segment
are distinct insurance product lines that generate revenues by selling a
variety of personal, commercial, and surety insurance products. The
Commercial Lines operating segment sells commercial multiple peril,
commercial auto, general liability, and workers' compensation insurance as
its primary products. The Specialty Lines operating segment sells
commercial umbrella and bond insurance as its primary products. The
Personal Lines operating segment sells personal automobile and homeowners
insurance as its primary products. The Corporation also has an all other
segment, which derives its revenue from investment income and premium
financing.
Statutory Combined Ratios
(by operating segment, Accident Accident Accident
including Year Year Year
selected major product lines) 2002(a) 2002(f) 2001 2001(f) 2000 2000(f)
=====================================================================================
Commercial Lines 115.1% 104.9% 116.2% 109.1% 130.0% 122.8%
Workers' Compensation 129.2% 123.0% 138.6% 115.1% 165.6% 138.9%
Auto Commercial 110.2% 101.7% 107.6% 105.1% 121.5% 119.1%
General Liability 171.3% 113.4% 120.8% 124.3% 126.9% 104.0%
CMP, Fire & Inland Marine 95.8% 96.1% 106.4% 102.7% 111.1% 119.1%
Specialty Lines 94.0% 95.4% 90.8% 85.1% 79.8% 89.3%
Commercial Umbrella 97.7% 98.8% 93.6% 85.1% 81.9% 90.6%
Fidelity & Surety 81.7% 84.4% 76.8% 77.1% 70.7% 80.6%
Personal Lines(e) 114.1% 111.8% 112.9% 110.4% 113.5% 117.3%
Auto(b)(c) 116.3% 113.6% 109.9% 108.0% 111.9% 114.9%
Homeowners 110.3% 111.3% 120.5% 118.8% 119.6% 125.7%
- ------------------------------------------------------------------------------------
Total All Lines(d) 112.8% 106.9% 112.6% 107.7% 119.2% 118.1%
====================================================================================
(a) All combined ratios and all component ratios presented for the year 2002
exclude $7.3 million before-tax charge for statutory additional minimum
pension liability.
(b) Personal Automobile includes both Auto-Agency and Auto-Direct.
(c) Accident Year 2001 and Calendar Year 2001 exclude 9.0 point impact of
New Jersey renewal obligation transfer fee. Including the transfer fee,
the Automobile-Personal Accident Year 2001 and Calendar Year 2001
statutory combined ratios would have been 117.0% and 118.9%, respectively.
(d) Accident Year 2001 and Calendar Year 2001 exclude 2.7 point impact of
New Jersey renewal obligation transfer fee. Including the transfer fee,
the All Lines Accident Year 2001 and Calendar Year 2001 statutory
combined ratios would have been 110.4% and 115.3%, respectively.
(e) Accident Year 2001 and Calendar Year 2001 exclude 6.3 point impact of
New Jersey renewal obligation transfer fee. Including the transfer fee,
the Personal Lines Accident Year 2001 and Calendar Year 2001 combined
ratios would have been 116.7% and 119.2%, respectively.
(f) The measurement date for Accident Year data is December 31, 2002.
32
Item 7. Continued
Commercial Lines Segment
Commercial Lines combined ratio for the year 2002 decreased 1.1 points to
115.1% from 116.2% in 2001. This improvement was not as great as expected
due to $73.9 million of development in loss and loss adjustment expenses
from prior years adding 10.2 points to the combined ratio. Of this amount,
approximately $51.6 million of development from prior years was related to
construction defect issues which added 7.1 points to the combined ratio for
2002. The 2000 combined ratio was 130.0%. Renewal price increases had a
positive impact during 2002 and 2001. The 2002 average renewal price
increase2 was 16.3% for the Commercial Lines direct premiums written,
compared with a 15.2% average renewal price increase in 2001.
While improving, the workers' compensation product line in the Commercial
Lines segment negatively impacted this year's All Lines results. Workers'
compensation combined ratio decreased 9.4 points in 2002 to 129.2%,
compared with 138.6% and 165.6% for 2001 and 2000, respectively. The loss
ratio was the main component driving the high combined ratio. The 2002
workers' compensation loss ratio was 80.6%, compared with 95.8% and 118.8%
in 2001 and 2000, respectively. Adverse development of prior year losses
due to an increase in claims severity contributed to the poor 2002 and 2001
results. The 2002 accident year loss ratio of 78.3% was 2.3 points lower
than the calendar year loss ratio, and the 2001 accident year loss ratio of
76.9% is 18.9 points lower than the calendar year loss ratio. The poor
results in the workers' compensation product line in 2000 added 6.8 points
to the All Lines loss ratio, when including the year-end reserve
reallocation mentioned in the "All Lines Discussion" section.
In response to the deterioration of results, the Group took action in 2000
to begin non-renewing its most unprofitable workers' compensation policies.
This business had a loss ratio of approximately 10 points higher than the
total workers' compensation product line and is referred to as unsupported
workers' compensation as it is the only product in the customer's account.
As mentioned in the "Operating Results" section, the Group also took action
to discontinue its relationship with Managing General Agents. These
Managing General Agents accounted for $29.0 million in annual workers'
compensation premium. The runoff of the unsupported workers' compensation
business and Managing General Agent business was substantially completed by
the end of 2001.
The Group continued to achieve average renewal price increases for workers'
compensation of 20.1% for 2002, compared with increases of 16.6% and 12.4%
for 2001 and 2000, respectively. Net premiums written for 2002, 2001 and
2000 totaled $143.9 million, $148.6 million and $185.8 million,
respectively.
Due to continued underwriting and pricing actions, workers' compensation
loss ratios should continue to show improvement. In 2002, the loss ratio
decreased 15.2 points from 2001. Accident year claim count for 2002
decreased 18.0% from 2001. New and renewal pricing remains strong for this
line of business.
The commercial auto product line net premiums written increased $26.7
million, or 14.3% in 2002 to $213.4 million, compared with $186.7 million
in 2001 and $178.7 million in 2000. The 2002 and 2001 increase was driven
by renewal price increases, averaging 15.2% and 15.5%, respectively.
33
(2)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.
Item 7. Continued
The 2002 commercial auto combined ratio increased to 110.2%, from 107.6% in
2001. The combined ratio was 121.5% in 2000. The increase in the combined
ratio from 2001 is due to greater than expected average settlement amounts
(loss severity) from prior years. The improvement in 2001 was largely due
to better underwriting and risk selection and the effect of renewal price
increases. The year 2000 was hindered by increased severity combined with
inadequate pricing. The accident year loss ratios for this line of business
continue to show significant improvement from 74.0% in 2000 to 61.5% in
2001 to 57.6% in 2002, resulting in accident year combined ratios of 119.1%
in 2000, 105.1% in 2001 and 101.7% in 2002.
Net premiums written for the commercial multiple peril, fire and inland
marine product lines increased 16.4% to $320.4 million in 2002, compared
with $275.2 million in 2001 and $276.5 million in 2000. The combined ratio
decreased to 95.8% in 2002 from 106.4% in 2001 and 111.1% in 2000. The
improvement resulted from strong new and renewal pricing and more selective
and focused underwriting.
Net premiums written for the monoline general liability product line
increased $5.4 million, or 6.9% in 2002 to $84.5 million, compared with
$79.0 million in 2001 and $80.7 million in 2000. The increase is due to
higher new and renewal pricing levels. The 2001 decrease reflected the
Group's focus on fundamental underwriting strategies.
The general liability combined ratio increased 50.5 points in 2002 to
171.3%, compared with 120.8% in 2001 and 126.9% in 2000. The higher than
desired 2002 loss ratio is attributable to 57.8 points of adverse
development from prior accident years. The accident year combined ratio
for 2002 was 113.4%. The difference between the accident and calendar year
results is primarily due to increases in residential general contractors
and developers related construction defect reserves established for prior
accident years in 2002 due to greater than expected frequency and loss
severity. The construction defect issues are being addressed by continuing
and expanding previous underwriting actions on certain segments that are
more prone to construction defect claims.
Specialty Lines Segment
Specialty Lines combined ratio for the year 2002 was higher, but still
profitable, at 94.0%, compared with 90.8% and 79.8% for 2001 and 2000,
respectively.
The fidelity & surety product lines in the Specialty Lines segment
contributed to the favorable results for the segment. Fidelity & surety
net premiums written increased $6.9 million, or 17.8% in 2002 to $45.6
million, compared with $38.7 million in 2001 and $37.6 million in 2000.
The combined ratio was 81.7% in 2002, compared with 76.8% in 2001 and 70.7%
in 2000. During the fourth quarter 2002, there was a return of ceded
premium of $5.3 million before tax for the bond business in the Specialty
Lines operating segment. This return of ceded premium was due to the
exercise of a contractual option on the bond reinsurance treaty based on
highly favorable bond combined ratios over the past fourteen years.
Net premiums written for the commercial umbrella product line increased
$40.5 million, or 43.9% in 2002 to $132.7 million, compared with $92.2
million in 2001 and $65.6 million in 2000. The 2002 and 2001 increases
were primarily generated by renewal price increases in 2002, 2001 and 2000.
The average renewal price increase in 2002 was 37.2%, compared with 20.3%
in 2001 and 8.9% in 2000. The 2002 combined ratio was 97.7%, compared with
93.6% in 2001 and 81.9% in 2000. Although the combined ratio increased,
the results were still profitable for the Group.
34
Item 7. Continued
Personal Lines Segment
The Personal Lines combined ratio for the year 2002 decreased 5.1 points to
114.1% in 2002, compared with 119.2% in 2001 and 113.5% in 2000. Excluding
the 1.5 point impact in 2002 on Personal Lines from the reallocation of
loss adjustment expense reserve estimates described in the "All Lines
Discussion," and excluding the 6.3 point impact of the New Jersey transfer
fee in 2001, the Personal Lines combined ratio would have been 112.6% for
2002 and 112.9% for 2001. This small improvement for 2002 is attributable
to the implementation of price increases, insurance scoring, enhanced
claims management procedures, withdrawal from states that have proven
unprofitable to the Group's operations, and lower than average losses from
catastrophes. The Group continued to narrow its geographic focus in
Personal Lines during 2002. The Group recently received all necessary
approvals from regulators to withdraw its Personal Lines business from
Florida, Georgia and Texas. The 2002 net premiums written in Florida,
Georgia and Texas were approximately $15.0 million. The Group does not
write Personal Lines business in California.
Net premiums written for the private passenger auto - agency (excluding New
Jersey and direct) product line decreased, as expected due to the Group's
strategy to withdraw from certain states, by $30.1 million, or 9.3% to
$293.9 million in 2002, compared with $324.0 million in 2001 and $347.6
million in 2000. Selective underwriting and agency cancellations
contributed to the decline in premiums in 2002 and 2001. Private passenger
auto - New Jersey and direct net premiums decreased $99.8 million, or 78.5%
to $27.4 million in 2002, compared with $127.2 million in 2001 and $107.7
million in 2000.
Given the unfavorable regulatory environment for private passenger auto in
New Jersey and uncertainty over the future profitability of the Group's
private passenger auto business in the state, the Group announced in the
fourth quarter of 2001 the transaction to allow the Group in early 2002 to
stop writing private passenger auto business in New Jersey. The
transaction, described in the "Operating Results" section, has effectively
exited the Group from New Jersey personal lines auto business in 2002 and
future years. New Jersey's private passenger auto net premiums written
represented approximately 7.5% of the Group's total private passenger auto
book of business in 2002, compared to 27.0% in 2001 and 20.8% in 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 eliminated the Group's
ability to control the volume and selection of writings in the state. Poor
underwriting results in New Jersey was the primary cause of the poor
performance in 2002 and 2001. The New Jersey private passenger auto
results added 6.2 and 7.1 points to the 2002 and 2001 Personal Lines loss
ratio, respectively. 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.
Companies are also assigned premiums if they do not write the required
quota. In 2002, the Group wrote $3.7 million in UEZ and assigned premiums,
compared with $12.4 million in UEZ and assigned premiums in 2001. In 2000,
the Group wrote $11.4 million in UEZ and assigned premiums. Excluding the
discontinued New Jersey business and the impact of the reallocation of loss
adjustment expense reserves, the Personal Lines combined ratio improved 5.6
points to 106.2% in 2002, compared to 111.8% in 2001. The Group is
implementing price increases, coverage restrictions and claims management
procedures to improve results.
The Group began direct marketing of personal auto coverage in January 1998.
In 2000, the Corporation first restructured its private passenger auto -
direct product line operations with an Internet-only strategy, and later
discontinued private passenger auto - direct in the fourth quarter
35
Item 7. Continued
of 2000. The product line was discontinued in order to focus on the
independent agency system as the distribution channel for the Group. As a
result of the restructuring, net premiums written dropped from $6.8 million
in 2001 to $3.2 million in 2002. The Group wrote $10.7 million of net
premiums in 2000. Combined ratios were 162.0%, 155.2% and 167.9% for 2002,
2001 and 2000, respectively. The 2001 underwriting expense ratio for the
private passenger auto - direct product line included $2.0 million, or 29.3
points, in expenses for fees for the removal of certain obligations related
to assigned private passenger auto policies in New York.
Although the Group discontinued the private passenger auto - direct product
line, the Group remains committed to expanding its Internet capabilities
that focus on full service options for our agents and convenience options
for our policyholders.
Homeowners product line net premiums written fell 5.1% in 2002 to $153.7
million from $162.0 million in 2001 and $173.2 million in 2000. The Group
has placed emphasis on price increases, insurance scoring and agency
management. Average implemented rate increases were 10.1%, 2.8%, and 6.6%
in 2002, 2001 and 2000, respectively. The Group introduced an Insurance-
To-Value program in 2000, which addressed underinsured homeowner properties
and emphasized adequate replacement cost values.
The 2002 homeowners combined ratio decreased 10.2 points to 110.3%. This
compares with a combined ratio of 120.5% in 2001 and 119.6% in 2000.
Combined ratios are heavily impacted by catastrophe losses which added 8.7
points to the combined ratio in 2002, 12.3 points in 2001 and 10.3 points
in 2000.
Critical Accounting Policies
Management of the Corporation has identified the policies listed below as
significant accounting policies that are critical to the Corporation's
business operations and influence the consolidated results of operations
and financial performance. The policies listed below were selected as they
require a higher degree of complexity or use subjective judgements or
assessments. These policies follow accounting principles generally
accepted in the United States. A brief summary of each critical accounting
policy follows. For a complete discussion on the application of these and
other accounting policies, see Note 1, "Summary of Significant Accounting
Policies."
Reserves for Loss and Loss Adjustment Expenses
The Group establishes reserves for losses and loss adjustment expenses
equal to the estimated amount to settle both reported (case reserves) and
unreported claims (Incurred But Not yet Reported). For reported losses, a
case reserve is established within the parameters of coverage provided in
the insurance policy. For IBNR losses, reserves are estimated using
established actuarial methods. An estimate of the loss and loss adjustment
expense for each claim is developed using the facts in each case, the
Group's experience with similar cases, the effects of current developments
and anticipated trends. The methods and assumptions of making such
estimates are continually reviewed and updated when considered appropriate.
Any resulting adjustments are reflected in the consolidated statements of
income for the period in which such estimates are changed. Reserves
established in prior years are adjusted as loss experience develops and new
information becomes available. Adjustments to previously estimated
reserves, both positive and negative, are reflected in the consolidated
statements in the periods in which they are made and are referred to as
prior period development. Because of the high degree of uncertainty
involved in estimating loss and loss adjustment expense reserves, revisions
to estimated reserves could have a material impact on the results of
operations of the Group.
36
Item 7. Continued
Investments
All investment securities are classified upon acquisition as held-to-
maturity, trading or available-for-sale. At December 31, 2002, all of the
Corporation's and the Group's fixed maturity securities are classified as
available-for-sale and are carried at fair value and may be sold prior to
their contractual maturity. The difference between amortized cost and fair
value, net of deferred taxes, is classified as other comprehensive income
in the Corporation's consolidated statement of shareholders' equity.
Equity securities are carried at quoted market values and include non-
redeemable preferred stocks and common stocks. The difference between cost
and quoted market value, net of deferred taxes, is classified as other
comprehensive income. The Corporation and the Group closely monitor their
fixed maturity and equity portfolios for declines in value that are deemed
to be other than temporary. The portfolios are regularly evaluated based
on current economic conditions, credit loss experience and other specific
developments. When a decline in value is deemed to be other than
temporary, the Corporation and the Group recognize a realized loss and the
security is written down to its estimated fair value. The Corporation and
the Group follow EITF 99-20 "Recognition of Interest Income and Impairment
on Purchased and Retained Beneficial Interests in Securitized Financial
Assets" in accounting for the securitized financial assets rated below AAA
and interest-only securities, regardless of rating. Upon receipt of
payments from such securities, the Corporation and the Group determine the
appropriate amounts of the funds to be allocated as a reduction of
principal and interest income. In making this allocation decision,
investment personnel consider such factors as the original estimated
average life of the investment, the amount of funds received to date and
the timing of future cash flows. These securities are evaluated for
impairment by computing the net-present-value of expected future cash flows
and comparing this to the prior period estimate of expected future cash
flows from the security. When the timing and/or amount of cash expected to
be received from the security has changed materially and adversely from the
previous valuation, the security is considered to be other than temporarily
impaired and the amortized cost is written down to the estimated fair value
with a realized loss recorded in the consolidated statement of income.
Deferred Policy Acquisition Costs
The Group establishes a deferred asset for costs that vary with and are
primarily related to acquiring property or casualty business. The
acquisition costs deferred consist of commissions, brokerage fees, salaries
and benefits and other underwriting expenses to include allocations for
inspections, taxes, rent and other expenses that vary directly with the
acquisition of insurance contracts. These costs are amortized over the
life of the underlying policies. Periodically, an analysis of the asset is
performed in relation to the expected recognition of revenues including
investment income to determine if any deficiency exists. No deficiencies
have been indicated for the periods presented.
Agent Relationships
The Corporation and the Group have recorded an asset, which it refers to as
agent relationships, for the excess of cost over the fair value of net
assets acquired in connection with the 1998 GAI commercial lines
acquisition. The Corporation and the Group followed the practice of
allocating purchase price to specifically identifiable intangible assets
based on their estimated values as determined by appropriate valuation
models. The agent relationships asset is amortized on a straight-line
basis over an estimated useful life of twenty-five years. The estimated
useful life was based on the Group's actual experience for agency
appointment terms for similar agents, which averaged approximately twenty-
five years in length. The asset is evaluated periodically as events
37
Item 7. Continued
or circumstances, such as cancellation of agents, indicate a possible
inability to recover their carrying amount. Cancellation of certain agents
for reasons such as lack of revenue production or poor quality of business
produced does not necessarily change the estimated useful life of remaining
agents representing the agent relationships intangible asset. Such
evaluation is based on various analyses, including cash flow and
profitability projections that incorporate, as applicable, the impact on
existing company businesses. The analyses necessarily involves significant
management judgments to evaluate the capacity of an acquired business to
perform within projections. If future undiscounted cash flows are
insufficient to recover the carrying amount of the asset, an impairment
loss is recognized in income in the period in which the future cash flows
are identified to be insufficient in comparison to the carrying amount of
the asset. The Corporation and the Group anticipate that based on future
events or circumstances additional write-downs for impairment will be made
in future periods.
Internally Developed Software
In accordance with SOP 98-1, "Accounting for the Costs of Computer Software
Developed or Obtained for Internal Use" the Group capitalizes costs
incurred during the application development stage for the development of
internal-use software. These costs primarily relate to payroll and
payroll-related costs for employees along with costs incurred for external
consultants who are directly associated with the internal-use software
project. Costs such as maintenance, training, data conversion, overhead
and general and administrative are expensed as incurred. Management
believes the expected future cash flows of the asset exceed the carrying
value. The expected future cash flows are determined using various
assumptions and estimates. Changes in these assumptions could result in an
immediate impairment to the asset and a corresponding charge to net income.
The costs associated with the software are amortized on a straight-line
basis over the estimated useful life of ten years commencing when the
software is substantially complete and ready for its intended use.
LIQUIDITY AND FINANCIAL STRENGTH
Cash Flow
Net cash generated from operations was $148.2 million in 2002, compared
with cash generated of $70.2 million in 2001 and $99.6 million in 2000.
The increase in 2002 over 2001 was due primarily to a reduction in paid
losses and loss adjustment expenses. The increase in cash generated from
operations in 2001 was also due primarily to a reduction in paid losses and
paid loss adjustment expenses. Investing activities used net cash of
$173.7 million in 2002, compared with net cash used of $57.4 million in
2001 and $103.5 million in 2000. Total cash used for financing activities
was $4.6 million, $10.6 million and $56.0 million in 2002, 2001 and 2000,
respectively. Cash used for financing decreased year over year due to
gross proceeds of $201.3 million received from the convertible debt
offering that occurred in the first quarter of 2002 which was partially
offset by repayment of the previous bank debt. During 2001, the decrease
from prior year was a result of the elimination of shareholder dividends.
Overall, total cash used in 2002 was $30.0 million, compared with cash
generated of $2.2 million in 2001 and cash used of $59.9 million in 2000.
To further strengthen its financial position, the Corporation did not pay
any shareholder dividends in 2002 or 2001, compared with dividend payments
of $35.4 million in 2000. Quarterly cash dividends per share for 2000 were
$.23 for the first quarter and $.12 for each of the remaining quarters in
2000.
38
Item 7. Continued
The Corporation is dependent on dividend payments from its insurance
subsidiaries in order to meet operating expenses, debt obligations and to
pay dividends. Insurance regulatory authorities impose various
restrictions and prior approval requirements on the payment of dividends by
insurance companies and holding companies. As of December 31, 2002,
approximately $112.5 million of statutory surplus was not subject to prior
dividend approval requirements. Additional restrictions may result from
the minimum net worth and surplus requirements in the credit agreement.
The following table presents the Corporation's obligations (other than
obligations relating to its ordinary insurance operations) to make future
payments under contractual obligations:
($ in millions) Payments Due by Period
- ----------------------------------------------------------------------------------
Less 1-3 4-5 After 5
Contractual Obligations Total than 1 year years years years
- ----------------------- ----- ----------- ----- ----- -----
Debt $205.8 $ .6 $1.9 $1.4 $201.9
Operating leases 11.4 5.4 6.0 - -
New Jersey transfer fee 6.8 6.8 - - -
- -----------------------------------------------------------------------------------
Total contractual cash
obligations $224.0 $12.8 $7.9 $1.4 $201.9
Debt
As of December 31, 2002, the Corporation had $205.8 million of principal
outstanding on debt that includes a $4.5 million low interest loan with the
state of Ohio. During the year 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
notes and are being recorded as related fees. The liability for debt is
reported on the balance sheet net of the unamortized fees. The Corporation
uses the effective interest rate method to record the interest and related
fee 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 price per share 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. If all outstanding notes are
converted, the total outstanding common shares would increase by 8.9
million shares. The convertible debt impact on earnings per share is based
on the "if-converted" method. The impact on diluted earnings per share is
contingent on whether or not certain criteria have been met for conversion.
As of December 31, 2002, the common share price criterion had not been met
and, therefore, no adjustment to the number of diluted shares on the
earnings per share calculation was made for the convertible debt. 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 a percentage of principal
amount):
During the twelve Redemption
months commencing Price
- ----------------- -----
March 23, 2005 102%
March 19, 2006 101%
March 19, 2007 until maturity of the notes 100%
39
Item 7. Continued
The holders of the notes have the option to 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 plus accrued interest.
Additionally, on July 31, 2002 the Corporation entered into a revolving
credit agreement. Under the terms of the credit agreement, the lenders
agreed to make loans to the Corporation in an aggregate amount up to $80.0
million for general corporate purposes. The agreement requires the
Corporation to maintain minimum net worth of $800.0 million. The credit
agreement also includes a minimum statutory surplus requirement for The
Ohio Casualty Insurance Company of $625.0 million through September 30,
2003, increasing to $650.0 million thereafter. Additionally, other
covenants and customary provisions are included in the agreement. The
credit agreement expires on March 15, 2005. The Corporation has not drawn
on the revolver as of December 31, 2002.
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 (S&P)
removed its negative outlook and placed a stable outlook on the Group's
"BBB" financial strength rating. S&P also announced that it assigned its
"BB" senior debt rating on the Corporation's convertible notes. Following
the Corporation's announcement of third quarter 2002 results, S&P indicated
that financial strength rating would be reviewed for possible downgrade,
however to date there has been no change. S&P revised its outlook to
negative from stable based upon the Corporation's announcement of third
quarter 2002 results. On March 13, 2002, Moody's Investor Services
(Moody's) assigned its "Baa2" rating to the Corporation's convertible
notes. On November 27, 2002, Moody's downgraded the Group's "A2" financial
strength rating to "A3" and placed a stable outlook on the Group's rating.
Moody's also announced that it placed a "Baa3" rating on the Corporation's
convertible notes. On March 14, 2002, Fitch, Inc. (Fitch) assigned its
"BBB-" rating to the Corporation's convertible notes and placed a stable
outlook on its rating. On November 5, 2002, Fitch, affirmed its "BBB-"
rating on the Corporation's convertible notes and placed a stable outlook
on its rating. On September 6, 2002, A.M. Best Company affirmed the
Group's financial strength rating of "A-" and assigned a positive outlook.
In addition, A.M. Best Company assigned an initial rating of "bbb" to Ohio
Casualty Corporation's convertible notes. On November 4, 2002, A.M. Best
Company affirmed its financial strength rating of "A-" for the Group and
maintained its positive outlook.
Ohio Casualty Corporation Quarterly High/Low Market Price Per Share
First Second Third Fourth
- ---------------------------------------------------------------------
2002
High 19.20 22.07 20.43 18.18
Low 15.80 18.66 16.01 11.22
- ---------------------------------------------------------------------
2001
High 11.63 13.38 14.30 16.05
Low 8.38 8.47 10.93 12.43
- ---------------------------------------------------------------------
2000
High 17.87 17.12 10.56 10.25
Low 11.06 10.94 6.34 6.50
- ---------------------------------------------------------------------
40
Item 7. Continued
Statutory Surplus
Statutory surplus, a traditional insurance industry measure of strength and
underwriting capacity, was $725.7 million at December 31, 2002, compared
with $767.5 million at December 31, 2001 and $812.1 million at December 31,
2000. Statutory surplus decreased 5.4% from 2001 resulting from the
decline in the market value of its equity investment portfolio offset by
statutory income and other surplus changes. On January 1, 2001, statutory
surplus was reduced by $21.7 million to $790.4 million for the cumulative
effect of adopting new required statutory accounting principles. The 2001
surplus was further reduced by the $26.8 million after-tax charge
associated with the New Jersey private passenger auto transfer and a
decrease in the market value of the equity investment portfolio. Statutory
surplus increased in 2001 due to the sale of a minority interest in the
stock of a subsidiary, which caused a non-recurring tax benefit of $16.1
million.
The ratio of premiums written to statutory surplus is one of the measures
used by insurance regulators to gauge the financial strength of an
insurance company and indicates the ability of the Group to grow by writing
additional business. At December 31, 2002, the Group's premiums written to
surplus ratio is 2.0 to 1, compared to 1.9 to 1 in 2001 and 2000.
The National Association of Insurance Commissioners (NAIC) has developed a
"Risk-Based Capital" formula for property and casualty insurers and life
insurers. The formula is intended to measure the adequacy of an insurer's
capital given the asset structure and product mix of the company. As of
December 31, 2002, all insurance companies in the Group exceeded the
necessary capital requirements.
The NAIC adopted the Codification of Statutory Accounting Principles
guidance in 1998, which replaced the former Accounting Practices and
Procedures manual as the NAIC's primary guidance on statutory accounting.
The new policies provide guidance for areas where statutory accounting had
been silent and changed former statutory accounting in some areas. The
Group implemented the Codification guidance effective January 1, 2001. The
cumulative effect of changes in accounting principles adopted to conform to
the Codification guidance were reported as an adjustment to statutory
policyholders' surplus as of January 1, 2001. The cumulative effect of
adopting Codification reduced statutory policyholders' surplus by $21.7
million on January 1, 2001.
Reinsurance
Reinsurance is a contract by which one insurer, called a reinsurer, agrees
to cover, under certain defined circumstances, a portion of the losses
incurred by a primary insurer in the event a claim is made under a policy
issued by the primary insurer. The Group purchases reinsurance to protect
against large or catastrophic losses. There are several programs that
provide reinsurance coverage and the programs in effect for 2002 are
summarized below.
The Group's property per risk program covers property losses in excess of
$1.0 million for a single insured, for a single event. This property per
risk program covers up to $14.0 million in losses in excess of the $1.0
million retention level for a single event. The Group's casualty per
occurrence program covers liability losses. Workers' compensation,
umbrella and other casualty reinsurance cover losses up to $59.0 million,
$24.0 million and $23.0 million, respectively, in excess of the $1.0
million retention level for a single insured event. The casualty
reinsurance treaty includes a layer of coverage of $5.0 million in excess
of $1.0 million that includes a fund managed by the Group and the Group
has title to the assets. Ceded premiums are paid into the
41
Item 7. Continued
fund and reinsured losses are paid to the Group under the terms of the
reinsurance agreement with various reinsurers. The reinsurers bear the
risk of losses in excess of the fund. The Group's ability to manage the
investments of the fund reduces credit risk related to reinsurers. The
balance of the fund as of December 31, 2002 was approximately $129.0
million.
The property catastrophe reinsurance program protects the Group against an
accumulation of losses arising from one defined catastrophic occurrence or
series of events. This program provides $150.0 million of coverage in
excess of the Group's $25.0 million retention level. The treaty was
written on a multiple year basis for years 2001 - 2004 with only a portion
of the reinsurance layers expiring in a single year. This provides
continuity and maintains rates and each reinsurer's overall share of the
program. Over the last 20 years, two events triggered coverage under the
catastrophe reinsurance program. Losses and loss adjustment expenses from
the fires in Oakland, California in 1991 totaled $35.6 million and losses
and loss adjustment expenses from Hurricane Andrew in 1992 totaled $29.8
million. Both of these losses exceeded the prior retention amount of $13.0
million, resulting in significant recoveries from reinsurers. Reinsurance
limits are purchased to cover exposure to catastrophic events having the
probability of occurring every 150-250 years.
GAI agreed to maintain reinsurance on the commercial lines business that
the Group acquired from GAI and its affiliates in 1998 for loss dates prior
to December 1, 1998. GAI is obligated to reimburse the Group if GAI's
reinsurers are unable to pay claims with respect to the acquired commercial
lines business.
Reinsurance contracts do not relieve the Group of their obligations to
policyholders. The collectibility of reinsurance depends on the solvency
of the reinsurers at the time any claims are presented. The Group monitors
each reinsurer's financial health and claims settlement performance because
reinsurance protection is an important component of the Corporation's
financial plan. Each year, the Group reviews financial statements and
calculates various ratios used to identify reinsurers who no longer meet
appropriate standards of financial strength. Reinsurers who fail these
tests are reviewed and those that are determined by the Group to have
insufficient financial strength are removed from the program at renewal.
Additionally, a large base of reinsurers is utilized to mitigate
concentration of risk. The Group also records an estimated allowance for
uncollectible reinsurance amounts as deemed necessary. During the last
three fiscal years, no reinsurer accounted for more than 15% of total ceded
premiums. As a result of these controls, amounts of uncollectible
reinsurance have not been significant.
Loss and Loss Adjustment Expenses
The Group's largest liabilities are reserves for losses and loss adjustment
expenses. The accounting policies related to the loss and loss adjustment
expense reserves are considered critical. Loss and loss adjustment expense
reserves are established for all incurred claims and are carried on an
undiscounted basis before any credits for reinsurance recoverable. Actual
losses and loss adjustment expenses may change with further developments.
These reserves amounted to $2.4 billion at December 31, 2002, $2.1 billion
at December 31, 2001 and $2.0 billion at December 31, 2000. As of December
31, 2002, the reserves by operating segment were as follows: $1.5 billion
Commercial Lines, $.4 billion Specialty Lines and $.5 billion Personal
Lines.
The Group's actuaries conduct a reserve study using generally accepted
actuarial methods each quarter from which point estimates of ultimate
losses and loss adjustment expenses by product line or coverage within
product line are selected. In selecting the point estimates, thousands of
data points are reviewed and the judgment of the actuaries is applied
broadly. Each quarter
42
Item 7. Continued
management records its best estimate of the liability for loss and loss
adjustment expense reserves by considering the actuaries' point estimates.
Management's best estimate recognizes that there is uncertainty underlying
the actuarial point estimates. Reasonable range estimates around the point
estimates are used by management to validate its best estimate of the
liability.
There are several key assumptions supporting the point estimate including
those summarized below. The fundamental assumption is that actuarial
reserving methods, using historical loss experience organized by line of
business, or coverage within line, and accident year at successive
evaluation points, applied by experienced reserving actuaries, produces
reasonable estimates of future loss development on prior insured events.
Supporting assumptions internal to company operations are as follows:
recording of premium and loss statistics in the appropriate detail has been
accurate and consistent; claims handling, including the recording of
claims, payment and closure rates, and case reserving has been consistent;
the quality of business written and the mix of business (e.g. states,
limits, coverages, and deductibles) have been consistent; rate changes and
changes in policy provisions have been measured accurately; reinsurance
coverage has been consistent and reinsured losses are collectible. To the
extent any of the above factors have changed over time, attempts must be
made to quantify and adjust for the changes. Supporting assumptions
related to the external environment are as follows: tort law and the legal
environment have been consistent; coverage interpretation by the courts has
been consistent; regulations regarding coverage provisions have been
consistent; loss inflation has been relatively steady. To the extent any
of the above factors have changed over time, attempts must be made to
quantify and adjust for the changes. The more the inconsistency, the
greater the uncertainty of the loss reserve estimates.
The Group has three categories of loss and loss adjustment expense reserves
that it considers highly uncertain, and therefore, could have a material
impact on future financial results and financial position: asbestos and
environmental liability exposures, construction defect exposures, and
excess capacity liability exposures. These categories are described below
with relevant historical data.
In recent years, asbestos and environmental liability claims have expanded
greatly in the insurance industry. Historically, the Group has written
small commercial accounts and has not sold policies with significant
manufacturing liability coverages. Within the manufacturing category, the
Group has concentrated on the light manufacturers, which further limits
exposure to environmental claims. Consequently, the Group believes it does
not have exposure to the primary defendants involved in major asbestos
litigation. The Group's exposure to asbestos is related to installers and
distributors as opposed to the large manufacturers. In 2001, the Group
increased reserves because of the expansion of litigation to these types of
business. A significant part of the Group's exposure to environmental
liability is related to underground storage tanks. The Group has limited
exposures to the national priority list. In 2002 the Group re-classified
approximately $5.0 million of homeowners reserves related to underground
storage tanks as environmental reserves. Due to the relatively small
exposure to asbestos and environmental liability and the unique nature of
this exposure, the Group does not rely on claim count data in determining
reserves. For 2002, 2001 and 2000, respectively, the asbestos and
environmental reserves, net of reinsurance, were $54.1 million, $49.1
million and $40.4 million. Asbestos reserves were $27.9 million, $29.4
million and $13.5 million and environmental reserves were $26.2 million,
$19.7 million and $26.9 million for those respective years.
43
Item 7. Continued
The Group defines construction defect exposure as liability for allegations
of defective work and completed operations losses from general liability,
commercial multiple peril liability and umbrella liability policies
involving multiple-units (condos/townhouses/apartments/tracts of single
family homes), multiple defendants (e.g. developers, sub-contractors),
usually with multiple defect issues, and often involving multiple insurance
carriers. The Group excludes from the definition claims related to
individual single family homes, apartments/townhomes or other residential
properties if the defect issues are limited in scope and volume.
The number of construction defect claims reported in 2002, 2001 and 2000,
respectively, were 213, 169 and 118. The paid losses, net of reinsurance,
in 2002 were $10.1 million, compared to $6.3 million in 2001 and $1.8
million in 2000. The paid allocated loss adjustment expenses, net of
reinsurance, for construction defect claims were $4.6 million in 2002,
compared with $2.1 million in 2001 and $2.0 million in 2000. These totals
exclude construction defect losses from the state of California. Although
the Group has construction defect losses from California exposure, it
excludes California from this data because the Group stopped writing in the
state in 1993 and the remaining claims are minimal and of a different
nature than our exposure in the rest of the country. This data also
includes claims assumed from the GAI acquisition beginning in November
2001, slightly distorting the 2001 numbers.
The Group writes excess capacity liability business with large policy
limits that are heavily reinsured. There have been very few losses to date
on this business, but the large policy limits increase the uncertainty of
future losses before the application of reinsurance. There is a relatively
small amount of loss data available for this business. The Group's
coverage for approximately three-fourths of this business written during
2002 begins when losses or loss adjustment expenses on an individual claim
reaches $10.0 million or more. The Group's limit of coverage on an
individual claim for approximately two-thirds of this business written
during 2002 is $25.0 million. Reinsurance purchased by the Group limits
its retention of losses to $1.0 million. During 2002, the Group wrote
approximately 1,700 of these excess capacity liability policies,
representing an annual growth of approximately 20% since 2000.
Results for the year 2002 were negatively impacted by losses and loss
adjustment expenses for prior accident years totaling $84.4 million before
tax on an All Lines basis. For the Commercial Lines operating segment, the
losses and loss adjustment expenses for prior accident years recorded
during 2002 were $73.9 million before tax and were concentrated in the
general liability, commercial automobile and workers' compensation product
lines. Comparable Commercial Lines amounts for 2001 and 2000 were $44.6
million and approximately $62.1 million, respectively. In both 2001 and
2000, this was concentrated in the workers' compensation and general
liability product lines. The 2000 amount included the commercial umbrella
product line as it was combined with the general liability product line at
that time for purposes of accident year analyses.
For the Specialty Lines operating segment, the losses and loss adjustment
expenses for prior accident years recorded during 2002 was $(2.2) million
and was concentrated in the commercial umbrella product line. Comparable
amounts for 2001 and 2000 were $4.1 million and approximately $(3.5)
million, respectively. In 2001, this was concentrated in the commercial
umbrella product line. For 2000, the favorable development was from the
bond product line. For 2000, the commercial umbrella product line was
included with the general liability product line in accident year analyses.
44
Item 7. Continued
For the Personal Lines operating segment there was $12.7 million losses or
loss adjustment expenses for prior accident years recorded during 2002.
Comparable amounts for 2001 and 2000 were $9.8 million and approximately
$(1.8) million, respectively. In 2001, this was concentrated in the
homeowners product line. In 2000, favorable development occurred in the
personal automobile product line.
The losses and loss adjustment expenses on prior accident years totaling
$84.4 million reflect an update to estimates for reserves based on new
information during the year 2002, resulting in recognition during 2002.
Each quarter during 2000 through 2002 a thorough loss reserve study was
conducted using data and other information updated and available as of the
end of each quarter. Based on these studies, liabilities for loss and loss
adjustment expenses are established for the estimated ultimate costs of
settling claims for insured events, for both reported claims and incurred
but not reported claims. As more information becomes available and claims
are settled in subsequent periods, the estimated liabilities are adjusted
upward or downward.
For each reserve study, several generally accepted actuarial reserving
techniques were applied to determine estimates of ultimate loss and loss
adjustment expense by product line by accident year. For each accident
year and product line, two or more estimates of ultimate loss were
determined and a final estimate was selected. Key assumptions were applied
consistently during 2000 through 2002.
The reserve study of third quarter 2002 revealed the average severity (loss
per claim) and the amount of legal expense for certain types of
construction defect claims that were much greater than previously seen or
anticipated. The study also indicated that more of these severe claims had
been reported and were expected to be reported in the future than
previously anticipated, despite a decrease in frequency of other types of
general liability claims. It was concluded that these construction defect
claims impacted the general liability, commercial multiple peril and
commercial umbrella product lines. As a result of this third quarter 2002
review, the estimate of ultimate loss and loss adjustment expense for this
exposure was increased. For these three product lines combined, the impact
of construction defect in the year 2002 was $62.2 million before tax. 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 year 2002 also experienced greater than expected loss activity from
older accident years for the commercial automobile product line. This was
due to greater than expected severity on bodily injury claims. As a
result, the estimate of ultimate loss and loss adjustment expense was
increased by $17.0 million.
Reserve development in the year 2002 occurred as follows: $(15.8) million
for accident year 2001, $10.2 million for accident year 2000, $16.1 million
for accident year 1999, and $73.9 million for accident years 1998 and
prior. Reserve development in the year 2001 occurred as follows: $31.1
million for accident year 2000, $10.9 million for accident year 1999 and
$16.5 million for accident years 1998 and prior. Reserve development in
the year 2000 occurred by accident year as follows: $60.0 million for
accident year 1999 and ($3.2) for accident years 1998 and prior. The
amount of the loss and loss adjustment expense reserves by accident year at
the beginning of 2002 was $625.3 million for accident year 2001, $409.6
million for accident year 2000, and $268.6 million for accident year 1999.
45
Item 7. Continued
Losses and loss adjustment expenses for prior accident years were
recognized during the year 2002 due to new information that caused a
revision to prior estimates for loss and loss reserves as described above.
There is considerable uncertainty in these estimates for reasons such as:
the external environment including coverage litigation, judicial decisions,
legislative changes, claimants and juries attitudes with respect to
settlements; claim frequency and severity; the emergence of unusual types
or sizes of claims; changes in underwriting quality of the book of business
over time; and changes in claims handling which affects the payment rate or
case reserve adequacy.
Because of the inherent uncertainties in estimating ultimate costs of
claims, actual loss and loss adjustment expenses may deviate substantially
from the amounts recorded. Furthermore, the timing, frequency and extent
of adjustments to the estimated liabilities cannot be predicted since
conditions and events which established historical loss and loss adjustment
expense development and which serve as the basis for estimating ultimate
claim cost may not occur in exactly the same manner, if at all.
Investment Portfolio
At year-end 2002, consolidated investments had a carrying value of $3.5
billion. The excess of market value over cost was $392.2 million, compared
with $420.9 million at year-end 2001 and $629.4 million at year-end 2000.
The decrease in 2002 and 2001 was largely due to the recognition of
realized gains in connection with the sale of appreciated equity securities
and declines in the market value of certain equity securities. The
reduction in unrealized gains related to equity securities in 2002 was
somewhat offset by an increase in unrealized gains in the fixed maturity
portfolio of $130.0 million.
The consolidated fixed maturity portfolio of the Corporation and the Group
has an intermediate duration and a laddered maturity structure. The
Corporation and the Group always remain fully invested and do not time
markets. The Corporation and the Group also have no off-balance sheet
investments or arrangements as defined by section 401(a) of the Sarbanes-
Oxley Act of 2002.
Tax exempt bonds increased, as a percentage of amortized cost, to 1.5% of
the fixed maturity portfolio at year-end 2002 versus 1.1% at December 31,
2001. This increase reflects a decision at the end of 2002 to add to
municipal holdings in anticipation of improved underwriting results and to
take advantage of unique municipal market opportunities. At December 31,
2000, the tax-exempt bonds represented 3.2% of the amortized cost of the
consolidated fixed maturity portfolios. Due to poor underwriting results
over the past few years, the Corporation and the Group had reduced their
holdings of tax exempt municipal bonds in 2000 and 2001 to maximize after-
tax income.
As of December 31, 2002, the Corporation and the Group held $1,154.3 in
mortgage-backed securities, compared with $1,107.8 million and $1,124.0
million at December 31, 2001 and 2000, respectively. The majority of
mortgage-backed security holdings are in sequential structures, planned
amortization class and agency pass-through securities. Of this portfolio,
$7.8 million, $10.0 million and $13.1 million were invested in more
volatile bond classes (e.g. interest-only securities which do not return
principal at maturity, super-floater securities which pay interest at a
formula rate that is a function of LIBOR and inverse-floater securities
which pay interest per a formula that adjusts inversely to changes in LIBOR
rates) in 2002, 2001 and 2000, respectively.
46
Item 7. Continued
The investment portfolio of the Corporation and the Group include non-
publicly traded securities such as private placements, non-exchange traded
equities and limited partnerships which are carried at fair value. Fair
values are based on valuations from pricing services, brokers and other
methods as determined by management to give the most accurate price. The
carrying value of this portfolio at December 31, 2002 was $319.4 million.
This compares to $295.9 million in 2001 and $317.4 million in 2000.
At December 31, 2002, the fixed maturity portfolio included non-investment
grade securities and non-rated securities that had a fair value of $105.3
and comprised 3.0% of the investment portfolio. This compares to a fair
value of $94.3 million and $127.4 million at December 31, 2001 and 2000,
respectively. These securities comprised 2.8% and 3.8% of the investment
portfolio at December 31, 2001 and 2000, respectively. Following is a
table displaying non-investment grade and non-rated securities in an
unrealized loss position at December 31:
Amortized Fair Unrealized
Cost Value Loss
- -------------------------------------------------------
2002 $72,981 $60,898 $12,083
2001 61,500 55,000 6,500
2000 61,361 53,247 8,114
At year-end 2002, consolidated equity investments had a market value of
$312.5 million. Equity investments have decreased, as a percentage of
market value of the consolidated portfolio, from 22.7% at year-end 2000 to
8.9% at year-end 2002. This decrease is primarily attributable to the
Corporation's and the Group's 2002 and 2001 actions which reduced assets
invested in equities.
The Corporation and the Group use assumptions and estimates when valuing
certain investments and related income. These assumptions include
estimations of cash flows and interest rates. Although the Corporation and
the Group believe the values of its investments represent fair value,
certain estimates could change and lead to changes in fair values due to
the inherent uncertainties and judgements involved with accounting
measurements.
FORWARD-LOOKING STATEMENTS
Ohio Casualty Corporation publishes 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 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. The operations, performance and development of the
Corporation's business are subject to risks and uncertainties which may
cause actual results to differ materially from those contained in or
supported by the 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; rating agency actions; acts of war and
terrorist activities; ability of Ohio Casualty to retain business acquired
from the Great American Insurance Company; ability to achieve targeted
expense savings; changes in estimated future cash flows and related
impairment charges for the agent relationships intangible asset; ability to
achieve premium targets and profitability goals; and general economic and
market conditions.
47
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
Market Risk Disclosures for Financial Instruments
Market risk is the risk of loss resulting from adverse changes in interest
rates. In addition to market risk, the Corporation and the Group are
exposed to other risks such as equity price risk, credit, reinvestment and
liquidity risk. Credit risk refers to the financial risk that an
obligation will not be paid and a loss will result. Reinvestment risk is
the risk that interest rates will fall causing the reinvestment of interim
cash flows to earn less than the original investment. Liquidity risk
describes the ease with which an investment can be sold without
substantially affecting the asset's price. The sensitivity analysis below
summarizes only the exposure to market risk and equity price risk.
The Corporation and the Group strive to produce competitive returns by
investing in a diversified portfolio of securities issued by high-quality
companies.
Market Risk - The Corporation and the Group have exposure to losses
resulting from potential volatility in interest rates. The Corporation and
the Group attempt to mitigate its exposure to interest rate risk through
active portfolio management, periodic reviews of asset and liability
positions and through maintaining a laddered maturity bond portfolio with
an intermediate duration. Estimates of cash flows and the impact of
interest rate fluctuations relating to the Corporation's and the Group's
fixed maturity investment portfolios are modeled quarterly and reviewed
regularly.
Equity Price Risk - Equity price risk can be separated into two
elements. The first, systematic risk, is the portion of a portfolio or
individual security's price movement attributed to stock market movement as
a whole. The second element, nonsystematic risk, is the portion of price
movement unique to the individual portfolio or security. This risk can be
further divided between characteristics of the industry and of the
individual issuer. The Corporation and the Group attempt to manage
nonsystematic risk by maintaining a portfolio that is diversified across
industries.
The following tables illustrate the hypothetical effect of an increase
in interest rates of 100 basis points (1%) and a 10% decrease in equity
values at December 31, 2002, 2001 and 2000, respectively. The changes
selected above reflect the Corporation's and the Group's view of shifts in
rates and values that are quite possible over a one-year period. These
rates should not be considered a prediction of future events. Interest
rates may, in fact, be much more volatile in the future. This analysis is
not intended to provide a precise forecast of the effect of changes in
interest rates and equity prices on the Corporation's and the Group's
income, cash flow or shareholders' equity. In addition, the analysis does
not take into account any actions the Corporation or the Group may take to
reduce its exposure in response to market fluctuations.
Estimated Adjusted Market Value
December 31, 2002 Fair Value as indicated above
- ---------------------------------------------------------------------
Interest Rate Risk:
Fixed maturities $3,140 $2,998
Short-term investments 49 49
Equity Price Risk:
Equity securities 313 281
- ---------------------------------------------------------------------
Totals $3,502 $3,328
=====================================================================
48
Item 7A. Continued
Estimated Adjusted Market Value
December 31, 2001 Fair Value as indicated above
- ---------------------------------------------------------------------
Interest Rate Risk:
Fixed maturities $2,772 $2,633
Short-term investments 55 55
Equity Price Risk:
Equity securities 489 440
- ---------------------------------------------------------------------
Totals $3,316 $3,128
=====================================================================
Estimated Adjusted Market Value
December 31, 2000 Fair Value as indicated above
- ---------------------------------------------------------------------
Interest Rate Risk:
Fixed maturities $2,514 $2,419
Short-term investments 60 60
Equity Price Risk:
Equity securities 755 679
- ---------------------------------------------------------------------
Totals $3,320 $3,158
=====================================================================
Certain assumptions are inherent in the above analysis. The Corporation
and the Group assume an instantaneous and parallel shift in interest rates
and a simultaneous decline of 10% in equity prices at December 31, 2002,
2001 and 2000. Also, the Corporation and the Group assume the change in
interest rates is reflected uniformly across all financial instruments. The
adjusted market values are estimated using discounted cash flow analysis and
duration modeling.
Item 8. Consolidated Financial Statements and Supplementary Data
See Item 15 for Index to Consolidated Financial Statements, including the
Notes to Consolidated Financial Statements and the Report of Independent
Accountants, and Schedules on page 52 of this Form 10-K.
Item 9. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
Incorporated by reference herein from those portions of the Corporation's
Proxy Statement for the Annual Meeting of Shareholders of the Corporation
for 2003 under the headings "Election of Directors," and "Related
Transactions" and "Section 16(a) Beneficial Ownership Reporting
Compliance."
The following table provides information for executive officers of the
Corporation who are not separately reported in the Corporation's Proxy
Statement:
49
Item 10. Continued
Executive Officers of the Registrant
Position with Company and/or
Principal Occupation or Employment
Name Age During Last Five Years
- ---- --- ----------------------
John E. Bade, Jr. 48 Senior Vice President of the Corporation's
insurance subsidiaries since February 2000. Mr.
Bade served as Vice President of the Corporation's
insurance subsidiaries from January 1997 through
January 2000.
Debra K. Crane 45 Senior Vice President, General Counsel and
Secretary of the Corporation since September 2000
and Senior Vice President of the Corporation's
subsidiaries since April 2000. Ms. Crane served
as Vice President of the Corporation's subsidiaries
from May 1999 through March 2000 and as Assistant
Treasurer of the Corporation's subsidiaries from
February 1996 through April 1999.
Ralph G. Goode 57 Senior Vice President of the Corporation's
insurance subsidiaries since December 1998. Mr.
Goode served as Vice President of the Corporation's
insurance subsidiaries from October 1995 through
November 1998.
John S. Kellington 41 Senior Vice President and Chief Technology
Officer of the Corporation since December 2002.
Chief Technology Officer of the Corporation's
insurance subsidiaries since April 2001. Mr.
Kellington served as Chief Architect and
Principal, National Insurance Practice of IBM
Global Services from 1996 to April 2001.
Richard B. Kelly 48 Senior Vice President of the Corporation's
insurance subsidiaries since February 2000. Mr.
Kelly served as Vice President of the Corporation's
insurance subsidiaries from November 1996 through
January 2000.
Thomas E. Schadler 52 Senior Vice President and Chief Actuary of the
Corporation's insurance subsidiaries since
April 2001. Mr. Schadler served as Vice President
and Chief Actuary of Grange Insurance Company from
September 1997 to April 2001 and as Vice President
and Chief Actuary of Shelby/Anthem/Vesta Companies
from September 1988 to September 1997.
Howard L. Sloneker III 46 Senior Vice President of the Corporation's
insurance subsidiaries since December 1998. Mr.
Sloneker also served as Senior Vice President of
the Corporation from December 1998 to April 2002
and as Secretary of the Corporation and its
subsidiaries since April 1988 to April 2002.
50
Item 11. Executive Compensation
Incorporated by reference herein from those portions of the Corporation's
Proxy Statement for the Annual Meeting of Shareholders of the Corporation
for 2003 under the headings "Executive Compensation," "Employment
Agreement," "Change in Control Agreements," "Pension Plans," "Report of the
Executive Compensation Committee," and "Report of the Audit Committee."
Item 12. Security Ownership of Certain Beneficial Owners and Management
Incorporated by reference herein from those portions of the Corporation's
Proxy Statement for the Annual Meeting of Shareholders of the Corporation
for 2003 under the headings "Principal Shareholders," and "Shareholdings of
Directors, Executive Officers and Nominees for Election as Director," and
"Equity Compensation Plans."
Item 13. Certain Relationships and Related Transactions
Incorporated by reference herein from those portions of the Corporation's
Proxy Statement from the Annual Meeting of Shareholders of the Corporation
for 2003 under the heading "Related Transactions."
Item 14. Controls and Procedures
(a) The Company's Chief Executive Officer and Chief Financial Officer
evaluated the disclosure controls and procedures (as defined under Rules
13a-14(c) and 15d-14(c) of the Securities Exchange Act of 1934, as
amended) as o a date within ninety days of the filing date of this annual
report. Based upon that evaluation, the Chief Executive Officer and
Chief Financial Officer have concluded that the Company's disclosure
controls and procedures are effective.
(b) There were no significant changes in the Company's internal controls
or in other factors that could significantly affect these controls
subsequent to the date of their evaluation.
Item 16. Principal Accountant Fees and Services
Incorporated by reference herein from those portions of the Proxy Statement
from the Annual Meeting of Shareholders of the Corporation for 2003 under
the heading "Principal Accountant Fees" and "Policies and Procedures
Regarding Pre-Approval of Accountant Fees."
51
PART IV
Item 15. Exhibits, Financial Statements Schedules, and Reports on Form 8-K
(a) Financial statements and financial statement schedules required
to be filed by Item 8 of this Form and Regulation S-X
(1) The following statements are included herein:
Page Number
in this Report
--------------
Consolidated Balance Sheets at December 31, 2002,
2001 and 2000 53
Consolidated Statements of Income for the years
ended December 31, 2002, 2001 and 2000 54
Consolidated Statements of Shareholders' Equity for
the years ended December 31, 2002, 2001 and 2000 55
Consolidated Statements of Cash Flows for the years
ended December 31, 2002, 2001 and 2000 56
Notes to Consolidated Financial Statements 57-69
Report of Independent Accountants 70
(2) The following financial statement schedules are
included herein:
Schedule I - Consolidated Summary of Investments
Other Than Investments in Related Parties at
December 31, 2002 75
Schedule II - Condensed Financial Information of
Registrant for the years ended December 31,
2002, 2001 and 2000 76
Schedule III - Consolidated Supplementary
Insurance Information for the years ended
December 31, 2002, 2001 and 2000 77-79
Schedule IV - Consolidated Reinsurance for the
years ended December 31, 2002, 2001 and 2000 80
Schedule V - Valuation and Qualifying Accounts
for the years ended December 31, 2002, 2001 and
2000 81
Schedule VI - Consolidated Supplemental Information
Concerning Property and Casualty Insurance Operations
for the years ended December 31, 2002, 2001 and 2000 82
52
Item 15. Continued
Ohio Casualty Corporation & Subsidiaries
CONSOLIDATED BALANCE SHEETS
December 31 (in thousands, except per share data) 2002 2001 2000
========================================================================================
Assets
Investments, at fair value:
Fixed maturities $3,139,774 $2,772,104 $2,513,654
(Cost: $2,967,504; $2,729,998; $2,470,375)
Equity securities 312,537 488,988 754,919
(Cost: $92,574; $110,206; $168,779)
Short-term investments 49,839 54,785 59,679
----------------------------------------------------------------------------------------
Total investments 3,502,150 3,315,877 3,328,252
Cash 12,384 37,499 30,365
Premiums and other receivables, net of
allowance for bad debts of $4,300, $8,400,
and $10,700, respectively 324,759 341,986 357,108
Deferred policy acquisition costs 181,276 166,759 175,071
Property and equipment, net of accumulated
depreciation of $145,863, $133,213, and
$122,040, respectively 97,798 99,810 91,259
Reinsurance recoverable 419,870 237,688 148,633
Agent relationships, net of accumulated
amortization of $34,100, $36,310, and
$25,013, respectively 161,323 241,022 263,379
Interest and dividends due or accrued 45,961 43,319 38,227
Deferred income taxes 2,411 - -
Other assets 31,062 40,659 57,071
- -----------------------------------------------------------------------------------------
Total assets $4,778,994 $4,524,619 $4,489,365
=========================================================================================
Liabilities
Insurance reserves:
Losses $1,978,743 $1,746,828 $1,627,568
Loss adjustment expenses 454,907 403,894 375,951
Unearned premiums 668,707 666,739 696,513
Debt 198,288 210,173 220,798
Deferred income taxes - 3,124 65,613
Other liabilities 419,646 413,829 386,331
- -----------------------------------------------------------------------------------------
Total liabilities 3,720,291 3,444,587 3,372,774
- -----------------------------------------------------------------------------------------
Shareholders' Equity
Common stock, $.125 par value
Authorized shares: 150,000
Issued shares: 72,418; 94,418; 94,418 9,052 11,802 11,802
Additional paid-in capital - 4,152 4,180
Common stock purchase warrants 21,138 21,138 21,138
Accumulated other comprehensive income 246,160 274,359 409,904
Retained earnings 936,687 1,221,447 1,122,867
Treasury stock, at cost:
(Shares: 11,693; 34,312; 34,346) (154,334) (452,866) (453,300)
- -----------------------------------------------------------------------------------------
Total shareholders' equity 1,058,703 1,080,032 1,116,591
- -----------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $4,778,994 $4,524,619 $4,489,365
=========================================================================================
See notes to consolidated financial statements
53
Item 15. Continued
Ohio Casualty Corporation & Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
Year ended December 31 (in thousands,
except per share) 2002 2001 2000
=========================================================================================
Premiums and finance charges earned $1,450,467 $1,506,678 $1,533,998
Investment income less expenses 207,133 212,385 205,062
Investment gains (losses) realized, net 45,192 182,940 (2,391)
- -----------------------------------------------------------------------------------------
Total revenues 1,702,792 1,902,003 1,736,669
Losses and benefits for policyholders 902,731 1,001,590 1,116,271
Loss adjustment expenses 227,081 202,444 177,894
General operating expenses 108,651 111,833 103,912
Amortization of agent relationships 10,189 11,297 11,715
Write-down of agent relationships 69,510 10,966 45,971
Early retirement charge - 6,016 -
New Jersey renewal obligation transfer fee - 40,600 -
Amortization of deferred policy acquisition costs 376,223 375,650 394,515
Depreciation expense 11,164 10,220 12,308
Amortization of software 3,949 4,999 3,785
- -----------------------------------------------------------------------------------------
Total expenses 1,709,498 1,775,615 1,866,371
- -----------------------------------------------------------------------------------------
Income (loss) before income taxes (6,706) 126,388 (129,702)
Income tax (benefit) expense:
Current (13,885) 17,311 (9,850)
Deferred 8,070 10,497 (40,603)
- -----------------------------------------------------------------------------------------
Total income tax (benefit) expense (5,815) 27,808 (50,453)
- -----------------------------------------------------------------------------------------
Net income (loss) $ (891) $ 98,580 $ (79,249)
=========================================================================================
Average shares outstanding - basic 60,494 60,076 60,075
=========================================================================================
Average shares outstanding - diluted 61,284 60,209 60,075
=========================================================================================
Earnings per share - basic and diluted
Net income (loss), per share $ (0.01) $ 1.64 $ (1.32)
=========================================================================================
See notes to consolidated financial statements
54
Item 15. Continued
Ohio Casualty Corporation & Subsidiaries
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Common Accumulated
Additional stock other Total
(in thousands, except Common paid-in purchase comprehensive Retained Treasury shareholders'
per share data) stock capital warrants income earnings stock equity
- ---------------------------------------------------------------------------------------------------------------------
Balance,
December 31, 1999 $11,802 $ 4,286 $21,138 $ 329,354 $1,237,562 $(453,155) $1,150,987
Net loss (79,249) (79,249)
Net change in unrealized gain,
net of deferred income tax
expense of $43,374 80,550 80,550
-----------
Comprehensive income 1,301
Net forfeiture of treasury
stock (11 shares) (106) (145) (251)
Cash dividends paid
($.59 per share) (35,446) (35,446)
- --------------------------------------------------------------------------------------------------------------------
Balance,
December 31, 2000 $11,802 $ 4,180 $21,138 $ 409,904 $1,122,867 $(453,300) $1,116,591
Net income 98,580 98,580
Net change in unrealized gain,
net of deferred income tax
benefit of $72,986 (135,545) (135,545)
------------
Comprehensive loss (36,965)
Net forfeiture of treasury
stock (34 shares) (28) 434 406
- --------------------------------------------------------------------------------------------------------------------
Balance,
December 31, 2001 $11,802 $ 4,152 $21,138 $ 274,359 $1,221,447 $(452,866) $1,080,032
Net loss (891) (891)
Net change in unrealized gain,
net of deferred income tax
benefit of $10,029 (18,626) (18,626)
Minimum pension liability,
net of tax $5,155 (9,573) (9,573)
------------
Comprehensive loss (29,090)
Net issuance of treasury
stock (619 shares) (124) (272) 8,157 7,761
Retirement of treasury stock
(22,000 shares) (2,750) (4,028) (283,597) 290,375 -
- ---------------------------------------------------------------------------------------------------------------------
Balance,
December 31, 2001 $ 9,052 $ - $21,138 $ 246,160 $ 936,687 $(154,334) $1,058,703
====================================================================================================================
See notes to consolidated financial statements
55
Item 15. Continued
Ohio Casualty Corporation & Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31 (in thousands) 2002 2001 2000
========================================================================================
Cash flows from Operating Activities:
Net income (loss) $ (891) $ 98,580 $ (79,249)
Adjustments to reconcile net income (loss) to
cash from operations:
Changes in:
Insurance reserves 284,896 117,429 66,178
Income taxes 2,935 31,951 (36,193)
Premiums and other receivables 17,227 15,122 9,094
Deferred policy acquisition costs (14,517) 8,312 2,674
Reinsurance recoverable (182,183) (89,055) (9,612)
Other assets 2,458 2,967 80,105
Other liabilities (12,429) 35,452 (8,938)
Amortization and write-down of agent
relationships 79,699 22,357 57,686
Depreciation and amortization 16,240 9,978 15,510
Investment (gains) losses (45,192) (182,940) 2,391
- ----------------------------------------------------------------------------------------
Net cash provided by operating activities 148,243 70,153 99,646
- ----------------------------------------------------------------------------------------
Cash Flows from Investing Activities:
Purchase of securities:
Fixed income (1,249,160) (1,571,538) (1,131,406)
Equity (19,498) (55,446) (80,375)
Proceeds from sales of securities:
Fixed income 948,300 1,215,596 990,390
Equity 100,947 298,659 54,817
Proceeds from maturities and calls of securities:
Fixed income 62,399 77,542 57,930
Equity - - 10,200
Property and equipment:
Purchases (17,040) (22,940) (9,511)
Sales 366 764 4,423
- ----------------------------------------------------------------------------------------
Net cash used in investing activities (173,686) (57,363) (103,532)
- ----------------------------------------------------------------------------------------
Cash Flows from Financing Activities:
Debt:
Proceeds from the issuance of
convertible notes 201,250 - -
Payments (205,629) (10,625) (20,648)
Payment for deferred financing costs (400) - -
Payment of issuance costs (7,337) - -
Proceeds from exercise of stock options 7,498 75 67
Dividends paid to shareholders - - (35,446)
- ----------------------------------------------------------------------------------------
Net cash used in financing activities (4,618) (10,550) (56,027)
- ----------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (30,061) 2,240 (59,913)
Cash and cash equivalents, beginning of year 92,284 90,044 149,957
- ----------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 62,223 $ 92,284 $ 90,044
========================================================================================
Additional disclosures:
Interest and related fees paid $ 14,887 $ 14,271 $ 15,953
Income taxes refunded (7,024) (1,549) (14,248)
See notes to consolidated financial statements
56
Item 15. Continued
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All dollar amounts in thousands, except share data, unless otherwise stated)
NOTE 1 -- Summary of Significant Accounting Policies
A. Nature of Business
------------------
Ohio Casualty Corporation (the Corporation) is the holding company of The
Ohio Casualty Insurance Company, which is one of six property-casualty
companies that make up Ohio Casualty Group (the Group), whose primary
products consist of insurance for personal auto, commercial property,
homeowners, commercial auto, workers' compensation and other miscellaneous
lines. The Group operates through the independent agency system in over
40 states, with 29.8% of its 2002 net premiums written generated in the
states of New Jersey (12.5%), Ohio (9.4%), and Pennsylvania (7.9%).
B. Principles of Consolidation
---------------------------
The consolidated financial statements have been prepared on the basis of
accounting principles generally accepted in the United States and include
the accounts of Ohio Casualty Corporation and its subsidiaries (The Ohio
Casualty Insurance Company, West American Insurance Company, Ohio Security
Insurance Company, American Fire and Casualty Company, Avomark Insurance
Company, and Ohio Casualty of New Jersey, Inc.). Certain
reclassifications have been made to prior years to conform to the current
year's presentation. All significant inter-company transactions have been
eliminated.
C. Investments
-----------
Investment securities are classified upon acquisition into one of the
following categories:
(1) held to maturity securities
(2) trading securities
(3) available-for-sale securities
At December 31, 2002, all of the Corporation's investments are held as
available-for-sale securities. Available-for-sale securities are those
securities that would be available to be sold in the future in response to
liquidity needs, changes in market interest rates and asset-liability
management strategies, among others. Available-for-sale securities are
reported at fair value, with unrealized gains and losses excluded from
earnings and reported as a separate component of shareholders' equity, net
of deferred tax. Equity securities are carried at quoted market values
and include nonredeemable preferred stocks and common stocks. Fair values
of fixed maturities and equity securities are determined on the basis of
dealer or market quotations or comparable securities on which quotations
are available.
The Corporation regularly evaluates all investments based on current
economic conditions, credit loss experience and other specific
developments. The Corporation monitors the difference between the cost
and estimated fair value of investments to determine whether a decline in
value is temporary or other than temporary in nature. The assessment of
whether a decline in fair value is considered temporary or other than
temporary includes management's judgement as to the financial position and
future prospects of the entity issuing the security. If a decline in the
net realizable value of a security is determined to be other than
temporary, it is treated as a realized loss and the cost basis of the
security is reduced to its estimated fair value. The Corporation follows
EITF 99-20 "Recognition of Interest Income and Impairment on Purchased and
Retained Beneficial Interests in Securitized Financial Assets" in
accounting for the securitized financial assets of the Corporation.
Short-term investments include securities with original maturities of
90 days or less and are stated at fair value, which approximates cost.
Realized gains or losses on disposition of investments are determined
on the basis of the cost of specific investments sold.
D. Premiums
--------
Property and casualty insurance premiums are earned principally on a
monthly pro rata basis over the term of the policy; the premiums
applicable to the unexpired terms of the policies are included in unearned
premium reserve. Premiums receivable represents amounts due on insurance
policies. The premiums receivable balance is presented net of allowances
determined by management.
E. Deferred Policy Acquisition Costs
---------------------------------
Acquisition costs incurred at policy issuance net of applicable
reinsurance ceding commissions are deferred and amortized over the term of
the policy. Acquisition costs deferred consist of commissions, brokerage
fees, salaries and benefits, and other underwriting expenses to include
allocations for inspections, taxes, rent and other expenses which vary
directly with the acquisition of insurance contracts. Periodically, an
analysis of the deferred policy acquisition costs is performed in relation
to the expected recognition of revenues including investment income to
determine if any deficiency exists. No deficiencies have been indicated
in the periods presented.
F. Property and Equipment
----------------------
Property and equipment are carried at cost less accumulated depreciation.
Depreciation is computed principally on the straight-line method over the
estimated lives of the assets. Buildings are depreciated over an
estimated useful life of 32 years, furniture and equipment over a three to
seven year life.
G. Internally Developed Software
-----------------------------
In accordance with SOP 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use," the Corporation
capitalizes costs incurred during the application development stage for
the development of internal-use software. These costs primarily relate to
payroll and payroll-related costs for employees along with costs incurred
for external consultants who are directly associated with the internal-use
software project. Costs such as maintenance, training, data conversion,
overhead and general and administrative are expensed as incurred.
Management believes the expected future cash flows of the asset exceed the
carrying value. The expected future cash flows are determined using
various assumptions and estimates, changes in these assumptions could
result in an impairment of the asset and a corresponding charge to net
income. The costs associated with the software are amortized on a
straight-line basis over an estimated useful
57
Item 15. Continued
life of 10 years commencing when the software is substantially complete and
ready for its intended use. Unamortized software costs and accumulated
amortization in the consolidated balance sheet were $50,250 and $3,655 at
December 31, 2002, $41,410 and $1,035 at December 31, 2001 and $28,764 and
$552 at December 31, 2000, respectively.
H. Agent Relationships
-------------------
The agent relationships asset is an identifiable intangible asset acquired
in connection with the 1998 Great American Insurance Company (GAI)
commercial lines acquisition. The asset represents the excess of cost
over the fair value of net assets acquired. Agent relationships are
amortized on a straight-line basis over a twenty-five year period. Agent
relationships are evaluated periodically as events or circumstances, such
as cancellation of agents, indicate a possible inability to recover their
carrying amount. Such evaluation is based on various analyses, including
cash flow and profitability projections that incorporate, as applicable,
the impact on existing company businesses. The analyses necessarily
involve significant management judgments to evaluate the capacity of an
acquired agent relationship to perform within projections. If future
undiscounted cash flows are insufficient to recover the carrying amount of
the asset, an impairment loss will be recognized (See Note 15 for further
details).
I. Loss Reserves
-------------
The reserves for unpaid losses and loss adjustment expenses are based on
estimates of ultimate claim costs, including claims incurred but not
reported, salvage and subrogation and inflation without discounting.
Reserves are reviewed quarterly using generally accepted actuarial
techniques, and any resulting adjustments are reflected in earnings
currently. The estimates are based on future rates of inflation and other
factors, and accordingly there can be no assurance that the ultimate
liability will not vary from such estimates.
J. Reinsurance
-----------
In the normal course of business, the Group seeks to diversify risk and
reduce the loss that may arise from catastrophes or other events that
cause unfavorable underwriting results by reinsuring certain levels of
risk in various areas of exposure with other insurance enterprises or
reinsurers. The Group records an asset as reinsurance recoverable for
estimates of paid and unpaid losses, including estimates for losses
incurred but not reportable, that have been ceded to reinsurers. The
Group evaluates the financial condition of its reinsurers and monitors
concentrations of credit risk to minimize exposure to significant losses
from reinsurer insolvencies. To the extent that any reinsuring companies
are unable to meet obligations under the agreements covering the
reinsurance ceded, the Group would remain liable. Amounts recoverable
from reinsurers are calculated in a manner consistent with the reinsurance
contract.
K. Income Taxes
------------
The Corporation files consolidated federal income tax returns. The
Corporation records deferred tax assets and liabilities based on temporary
differences between the financial statement and tax bases of assets and
liabilities using enacted tax rates in effect in the year in which the
differences are expected to reverse.
L. Stock Options
-------------
The Corporation accounts for stock options issued to employees in
accordance with Accounting Principles Board Opinion (APB) No. 25,"
Accounting for Stock Issued to Employees." Under APB 25, the Corporation
recognizes expense based on the intrinsic value of options. Had the
Corporation adopted FAS 123 "Accounting for Stock Based Compensation," the
Corporation's net income and earnings per share would have been reduced to
the pro forma amounts disclosed below:
2002 2001 2000
- ------------------------------------------------------------------------
Net income (loss)
As reported: $ (891) $98,580 $(79,249)
Compensation expense,
net of tax 4,535 4,178 3,208
Pro Forma: (5,426) 94,402 (82,457)
Basic and diluted EPS
As reported: $(.01) $1.64 $(1.32)
Pro Forma: $(.09) $1.57 $(1.37)
M. Insurance Assessments
---------------------
The Group accrues a liability for insurance related assessments in
accordance with Statement of Position 97-3 "Accounting by Insurance and
Other Enterprises for Insurance-Related Assessments." As of December 31,
2002, 2001 and 2000 the liability for these assessments was $7,405,
$6,582, and $4,278, respectively.
N. Earnings Per Share
------------------
Earnings per share of common stock is presented using basic and diluted
earnings per share. Basic earnings per share is calculated using the
weighted average number of common stock shares outstanding during the
period. Diluted earnings per share include the effect of the assumed
exercise of dilutive common stock options.
O. Statement of Cash Flows
-----------------------
Short-term investments are comprised of highly liquid investments that are
readily convertible into known amounts of cash. Such investments have
maturities of 90 days or less from the date of purchase. Short-term
investments are deemed to be cash equivalents.
P. Use of Estimates
----------------
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to
make estimates and assumptions that affect the reported amounts of assets
and liabilities and disclosure of contingent assets and liabilities at the
date of financial statements, and the reported amounts of
58
Item 15. Continued
revenues and expenses during the reporting period. Actual results could
differ from those estimates.
The insurance industry is subject to regulation that differs by state.
A dramatic change in regulation in a given state may have a material
adverse impact on the Corporation.
NOTE 2 -- Investments
Investment income is summarized as follows:
2002 2001 2000
- ------------------------------------------------------------------------
Investment income from:
Fixed maturities $207,025 $208,042 $199,474
Equity securities 8,634 10,676 11,234
Short-term securities 777 3,188 5,352
- ------------------------------------------------------------------------
Total investment income 216,436 221,906 216,060
Investment expenses 9,303 9,521 10,998
- ------------------------------------------------------------------------
Net investment income $207,133 $212,385 $205,062
========================================================================
The gross realized gains and gross realized losses from sales of
available-for-sale securities were as follows:
Gross Gross Net
Realized Realized Realized
December 31 Gains (Losses) Gains(Losses)
- -------------------------------------------------------------------------
2002 $ 92,346 $(47,154) $ 45,192
2001 202,758 (19,818) 182,940
2000 18,728 (21,119) (2,391)
The increase in realized gains in 2002 and 2001 was due to the partial
reallocation of the Corporation's equity portfolio to fixed income
holdings. Significant appreciation in the equity holdings sold as part of
the reallocation, contributed to the realized gains in 2002 and 2001.
Changes in unrealized gains (losses) on investments in securities are
summarized as follows:
2002 2001 2000
- ------------------------------------------------------------------------
Unrealized gains (losses):
Securities $(28,655) $(208,531) $123,924
Deferred tax 10,029 72,986 (43,374)
- ------------------------------------------------------------------------
Net unrealized gains (losses) $(18,626) $(135,545) $ 80,550
The amortized cost and estimated fair values of investments in debt
and equity securities are as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
2002 Cost Gains Losses Value
- ------------------------------------------------------------------------------
Securities:
U.S. Government $ 26,121 $ 2,963 $ (2) $ 29,082
States,
municipalities
and political
subdivisions 44,249 2,570 (31) 46,788
Corporate securities 1,778,993 156,045 (25,457) 1,909,581
Mortgage-backed
securities:
U.S. Government
Agency 52,773 2,302 (2) 55,073
Other 1,065,368 41,057 (7,175) 1,099,250
- ------------------------------------------------------------------------------
Total fixed maturities 2,967,504 204,937 (32,667) 3,139,774
Equity securities 92,574 230,240 (10,277) 312,537
Short-term investments 49,839 - - 49,839
- ------------------------------------------------------------------------------
Total securities $3,109,917 $435,177 $(42,944) $3,502,150
==============================================================================
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
2001 Cost Gains Losses Value
- ------------------------------------------------------------------------------
Securities:
U.S. Government $ 27,775 $ 1,611 $ (5) $ 29,381
States,
municipalities
and political
subdivisions 30,057 1,271 - 31,328
Corporate securities 1,577,939 47,945 (22,325) 1,603,559
Mortgage-backed
securities:
U.S. Government
Agency 56,307 243 (488) 56,062
Other 1,037,920 26,649 (12,795) 1,051,774
- ------------------------------------------------------------------------------
Total fixed maturities 2,729,998 77,719 (35,613) 2,772,104
Equity securities 110,206 381,580 (2,798) 488,988
Short-term investments 54,785 - - 54,785
- ------------------------------------------------------------------------------
Total securities $2,894,989 $459,299 $(38,411) $3,315,877
==============================================================================
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
2001 Cost Gains Losses Value
- ------------------------------------------------------------------------------
Securities:
U.S. Government $ 54,290 $ 1,530 $ (212) $ 55,608
States,
municipalities
and political
subdivisions 78,049 1,322 (128) 79,243
Corporate securities 1,233,418 40,427 (18,994) 1,254,851
Mortgage-backed
securities:
U.S. Government
Agency 25,764 199 (136) 25,827
Other 1,078,854 26,388 (7,117) 1,098,125
- ------------------------------------------------------------------------------
Total fixed maturities 2,470,375 69,866 (26,587) 2,513,654
Equity securities 168,779 598,840 (12,700) 754,919
Short-term investments 59,679 - - 59,679
- ------------------------------------------------------------------------------
Total securities $2,698,833 $668,706 $(39,287) $3,328,252
==============================================================================
59
Item 15. Continued
The following table summarizes, for all securities in an unrealized
loss position, the gross unrealized loss by length of time the securities
have continuously been in an unrealized loss position at December 31,
2002:
Amortized Fair Unrealized
Cost Value Loss
- -----------------------------------------------------------------------
Fixed maturities:
0-6 months $178,279 $167,589 $(10,690)
7-12 months 54,514 51,168 (3,346)
Greater than 12
months 153,490 134,859 (18,631)
- -----------------------------------------------------------------------
Total $386,283 $353,616 $(32,667)
Amortized Fair Unrealized
Cost Value Loss
- -----------------------------------------------------------------------
Equities:
0-6 months $28,885 $26,612 $ (2,273)
7-12 months 13,379 11,122 (2,257)
Greater than 12
months 21,733 15,986 (5,747)
- -----------------------------------------------------------------------
Total $63,997 $53,720 $(10,277)
Certain securities were determined to have other than temporary
declines in market value and were written down through realized investment
losses. The before-tax realized loss was impacted by the write-down of
securities for other than temporary declines in market value by $10,891,
$11,951, and $16,720 in 2002, 2001 and 2000, respectively.
Gross gains of $15,716, $39,821 and $14,179 and gross losses of
$40,909, $35,160 and $35,858 were realized on the sales of debt securities
in 2002, 2001 and 2000, respectively.
The Group is required to hold investments on deposit with regulatory
authorities in various states. As of December 31, 2002, 2001 and 2000,
these investments had a fair value of $59,007, $55,222, and $50,863,
respectively.
The amortized cost and estimated fair value of debt securities at
December 31, 2002, by contractual maturity are shown below. Expected
maturities will differ from contractual maturities because borrowers may
have the right to call or prepay obligations with or without call or
prepayment penalties.
Estimated
Amortized Fair
Cost Value
- ----------------------------------------------------------------------------
Due in one year or less $ 12,047 $ 11,712
Due after one year through five years 378,683 405,360
Due after five years through ten years 978,118 1,054,139
Due after ten years 480,515 514,240
Mortgage-backed securities:
U.S. Government Agency 52,773 55,073
Other 1,065,368 1,099,250
- ----------------------------------------------------------------------------
Total fixed maturities $2,967,504 $3,139,774
============================================================================
NOTE 3 -- Fair Value of Financial Instruments
The carrying amounts of the Corporation's financial instruments includes
cash and short-term investments which approximate fair value at December
31, 2002, 2001 and 2000. The Corporation believes that the fair value of
notes payable for 2001 and 2000 approximates the carrying value due to the
market based variable interest rates associated with the debt. The fair
value of the convertible debt is based on quoted market prices and was
$186,492 million at December 31, 2002, compared to the carrying value of
$198,288.
NOTE 4 -- Deferred Policy Acquisition Costs
Changes in deferred policy acquisition costs are summarized as follows:
2002 2001 2000
- ------------------------------------------------------------------------
Deferred, January 1 $166,759 $175,071 $177,745
Additions:
Commissions and brokerage 254,523 237,435 249,940
Salaries and employee benefits 57,652 57,559 61,067
Other 78,565 72,344 80,834
- ------------------------------------------------------------------------
Deferral of expense 390,740 367,338 391,841
- ------------------------------------------------------------------------
Amortization to expense 376,223 375,650 394,515
- ------------------------------------------------------------------------
Deferred, December 31 $181,276 $166,759 $175,071
========================================================================
NOTE 5 -- Income Tax
The effective income tax rate is less than the statutory corporate tax
rate of 35% for 2002, 2001 and 2000 for the following reasons:
2002 2001 2000
- ------------------------------------------------------------------------
Tax at statutory rate $(2,347) $ 44,236 $(45,396)
Tax exempt interest (852) (875) (5,578)
Dividends received deduction
(DRD) (2,187) (2,677) (1,399)
Proration of DRD and tax
exempt interest 229 275 1,012
Loss on disposition of
subsidiary stock - (16,100) -
Other (658) 2,949 908
- ------------------------------------------------------------------------
Actual tax expense
(benefit) $(5,815) $ 27,808 $(50,453)
========================================================================
The loss on disposition of subsidiary stock in 2001 was a non-
recurring tax benefit related to the sale of a minority interest in stock
of the Ohio Casualty of New Jersey, Inc. subsidiary.
On December 31, 2002, the Corporation had net operating loss
carryforwards of $22,110, which originated in 2000. The carryforwards
will expire, if unused, in 2020.
The components of the net deferred tax asset (liability) were as
follows:
60
Item 15. Continued
2002 2001 2000
- ------------------------------------------------------------------------
Unearned premium proration $ 34,138 $ 34,260 $ 36,640
Accrued expenses 35,526 39,228 42,515
NOL and AMT carryforward 22,634 9,612 23,250
Postretirement benefits 35,850 33,873 32,905
Discounted loss and loss
expense reserves 74,991 85,579 80,647
- ------------------------------------------------------------------------
Total deferred tax assets 203,139 202,552 215,957
- ------------------------------------------------------------------------
Deferred policy acquisition
costs (63,447) (58,366) (61,275)
Unrealized gains on
investments (137,281) (147,310) (220,295)
- ------------------------------------------------------------------------
Total deferred tax liabilities (200,728) (205,676) (281,570)
- ------------------------------------------------------------------------
Net deferred tax asset
(liability) $ 2,411 $ (3,124) $ (65,613)
========================================================================
The Corporation is required to establish a valuation allowance for any
portion of the deferred tax asset that management believes will not be
realized. Management has determined that no such valuation allowance is
necessary.
NOTE 6 -- Employee Benefits
The Corporation has a non-contributory defined benefit retirement plan, a
contributory health care plan, a life and disability insurance plan and a
savings plan covering substantially all employees. A short-term
disability plan was implemented in 2002. Benefit expenses are as follows:
2002 2001 2000
- ------------------------------------------------------------------------
Employee benefit costs:
Pension plan $ 159 $(3,826) $(2,816)
Health care 18,160 15,569 16,718
Life and disability
insurance 1,743 773 741
Savings plan 2,835 2,867 2,787
- ------------------------------------------------------------------------
Total $22,897 $15,383 $17,430
========================================================================
The pension cost (benefit) is determined as follows:
2002 2001 2000
- ------------------------------------------------------------------------
Service cost earned during
the year $ 6,662 $ 6,334 $ 6,556
Interest cost on projected
benefit obligation 17,951 17,359 17,167
Expected return on plan assets (22,914) (24,010) (23,348)
Amortization of unrecognized
net asset (1,735) (2,946) (2,946)
Amortization of accumulated
gains - (762) (444)
Amortization of unrecognized
prior service cost 195 199 199
- ------------------------------------------------------------------------
Net pension cost (benefit) $ 159 $ (3,826) $ (2,816)
========================================================================
Changes in the benefit obligation during the year:
2002 2001 2000
- ------------------------------------------------------------------------
Benefit obligation at
beginning of year $247,613 $224,556 $229,094
- ------------------------------------------------------------------------
Service cost 6,662 6,334 6,556
Interest cost 17,951 17,359 17,167
Actuarial loss (gain) 15,124 6,352 (12,176)
Benefits paid (16,531) (16,020) (16,085)
Amendments 54 - -
Curtailments - 9,032 -
- ------------------------------------------------------------------------
Benefit obligation at
end of year $270,873 $247,613 $224,556
========================================================================
Changes in pension plan assets during the year:
2002 2001 2000
- ------------------------------------------------------------------------
Fair value of plan assets
at beginning of year $257,119 $273,469 $277,588
- ------------------------------------------------------------------------
Actual return on plan assets (5,709) (1,319) 11,850
Benefits paid (16,309) (15,031) (15,969)
- ------------------------------------------------------------------------
Fair value of plan assets
at end of year $235,101 $257,119 $273,469
========================================================================
Pension plan funding at December 31:
2002 2001 2000
- ------------------------------------------------------------------------
Funded status $(35,772) $ 9,506 $48,913
Unrecognized net gain (loss) (40,523) 3,284 37,558
Unrecognized net assets - 1,735 5,892
Unrecognized prior service
cost (1,531) (1,672) (1,896)
- ------------------------------------------------------------------------
Accrued pension asset $ 6,282 $ 6,159 $ 7,359
========================================================================
Expected long-term return on
plan assets 8.50% 8.50% 9.00%
Discount rate on plan benefit
obligations 7.00% 7.50% 8.00%
Expected future rate of salary
increases 4.00% 5.25% 5.25%
For the Company's defined benefit plan, the fair value of plan assets
was less than the accumulated benefit obligation as of October 1, 2002,
resulting in the recognition of a minimum pension liability of
approximately $16.2 million of which $1.5 million is recognized as an
intangible asset. The remaining $14.7 million before tax represents other
comprehensive loss reported in the December 31, 2002 Statement of
Shareholders' Equity. As of December 31, 2001 and 2000, the fair value of
plan assets exceeded the accumulated benefit obligation for the plan.
Pension benefits are based on credited service years and final average
compensation for the five consecutive calendar years of highest salary
during the last ten years of service immediately prior to termination or
retirement or, if greater, the average annual compensation paid during the
60 consecutive month period immediately preceding termination or
retirement. Such retirement benefits are calculated considering the
individual's Social Security
61
Item 15. Continued
covered compensation. The pension plan measurement date is October 1,
2002, 2001 and 2000. Plan assets at December 31, 2002 include $17,314 of
the Corporation's common stock at market value compared to $27,142 and
$18,066 at December 31, 2001 and 2000, respectively. The Plan holds
1,336,964, 1,684,464 and 1,684,464 shares of the Corporation's common
stock at December 31, 2002, 2001 and 2000, respectively. Plan assets also
include investments in mutual funds, common stock, corporate bonds,
common/collective trusts, separate accounts, U.S. government securities and
other investments.
The Corporation's postretirement benefit cost at December 31:
2002 2001 2000
- ------------------------------------------------------------------------
Service cost $ 2,821 $1,946 $2,333
Interest cost 7,580 6,703 6,563
Amortization of unrecognized
prior service costs 174 215 240
- ------------------------------------------------------------------------
Net periodic postretirement
benefit cost $10,575 $8,864 $9,136
========================================================================
Changes in the postretirement benefit obligation during the year:
2002 2001 2000
- ------------------------------------------------------------------------
Benefit obligation at
beginning of year $85,160 $86,973 $92,239
- ------------------------------------------------------------------------
Service cost 2,821 1,946 2,333
Interest cost 7,580 6,703 6,563
Plan participants'
contributions (5,935) (5,361) (5,719)
Increase due to actuarial
loss (gain), change in
discount rate, or other
assumptions 18,607 (5,101) (8,443)
- ------------------------------------------------------------------------
Benefit obligation at end
of year $108,233 $85,160 $86,973
========================================================================
Accrued postretirement benefit liability at December 31:
2002 2001 2000
- ------------------------------------------------------------------------
Accumulated postretirement
benefit obligation $108,233 $85,160 $86,973
Unrecognized net (loss)
gain (4,414) 9,116 8,847
Unrecognized prior service
(cost) benefit (1,392) 2,505 (1,806)
- ------------------------------------------------------------------------
Accrued postretirement
benefit liability $102,427 $96,781 $94,014
========================================================================
Postretirement benefit weighted average rate assumptions at January 1:
2002 2001 2000
- ------------------------------------------------------------------------
Medical trend rate 10% 8% 8%
Dental trend rate 5% 5% 5%
Ultimate health care trend rate 5% 5% 5%
Discount rate 7.00% 7.50% 8.00%
The above medical trend rates for 2002, 2001 and 2000 were assumed to
decrease to the ultimate rate of 5% in nine years. The postretirement
benefit plan measurement date is January 1 for 2002, 2001 and 2000.
Increasing the assumed health care cost trend by one percentage point
in each year would increase the accumulated postretirement benefit
obligation as of December 31, 2002 by approximately $14,622 and increase
the postretirement benefit cost for 2002 by $1,753. Likewise, decreasing
the assumed health care cost trend by one percentage point in each year
would decrease the accumulated postretirement benefit obligation as of
December 31, 2002 by approximately $12,882 and decrease the postretirement
benefit cost for 2002 by $1,500.
The Corporation's health care plan is a predominately managed care
plan. Retired employees continue to be eligible to participate in the
health care and life insurance plans. Employee contributions to the
health care plan have been established as a flat dollar amount with
periodic adjustments as determined by the Corporation. The health care
plan is unfunded. Benefit costs are accrued based on actuarial
projections of future payments. There are approximately 3,000 active
employees and 1,710 retired employees covered by these plans.
During the second quarter of 2001, the Corporation adopted a special
early retirement program. The special early retirement program was
available to approximately 330 employees. Of the employees eligible to
retire under the program, 147 accepted. The special early retirement
program resulted in a one-time before-tax charge of $6,016, or $3,971
after tax to 2001 results.
Employees may contribute a percentage of their compensation to a
savings plan. A portion of employee contributions is matched by the
Corporation and invested based upon the investment direction chosen by the
employee. The Corporation contributed $2,761, $2,813 and $2,802 in 2002,
2001 and 2000, respectively for the employee match.
NOTE 7 - Stock Options and Warrants
The Corporation has several incentive programs that are utilized to
facilitate the Corporation's long-term financial success which are
described below. The Corporation is authorized under provisions of the
1999 Broad-based Employee Stock Option Plan to grant options to purchase
1,500,000 shares of the Corporation's common stock to full time employees
and certain part time employees at a price not less than the fair market
value of the shares on dates the options are granted. The 2002 Stock
Incentive Plan was established by the Corporation and is available to
Officers and Directors of the Corporation. Concurrent with the
establishment of the 2002 Stock Incentive Plan, the remaining options
available for grant under the 1993 Stock Incentive Program were rolled
over to the 2002 plan. Shares authorized for grant under the 2002 plan
total 3,000,000 plus the shares transferred from the 1993 Stock Incentive
62
Item 15. Continued
Program which total 327,458. Options are no longer available to grant
under the 1993 plan.
The options granted under the 2002 program may be either incentive or
non-qualified options as defined by the Internal Revenue Code; the
difference in the option plans affects treatment of the options for income
tax purposes by the individual employee and the Corporation. The options
granted under the 1999 program are nonqualified options. The options
under both plans are exercisable at any time after the vesting
requirements are met. The options under the 1999 plan are non-transferable
whereas the options under the 2002 plan are transferable pending certain
conditions as defined in the plan documents. Option expiration dates are
ten years from the grant date. Options vest under the 1999 plan at 50%
per year for two consecutive years from the date of the grant. Vesting
under the 2002 plan ranges from six months to three years. The options
also have accelerated vesting periods for participant retirement, death,
or disability, subject to a holding period of twelve months for the 1999
program. The holding period for the 2002 plan is three months for
retirement and twelve months for death or disability.
As of December 31, 2002, there are 172,550 and 3,148,109 remaining
options available to be granted for the 1999 and 2002 Stock Incentive
Programs, respectively.
In addition, the 2002 Stock Incentive Program provides for the grant
of Stock Appreciation Rights. Stock Appreciation Rights provide the
recipient with the right to receive payment in cash or stock equal to
appreciation in value of the optioned stock from the date of grant in lieu
of exercise of the stock options held. At December 31, 2002, there were no
outstanding stock appreciation rights.
In 2002, 2001 and 2000, the Corporation also granted stock options to
purchase 400,000, 600,000 and 570,000 shares, respectively, of the
Corporation's common stock to key executive employees and directors in
accordance with Market Place Rules available under NASDAQ Stock Market
regulations. The options were granted as either incentive options or
nonqualified options. Option expiration dates are ten years from the
grant date. The stock options granted vest at either 50% per year for two
consecutive years, or at 33% per year for three consecutive years.
The following table summarizes information about the stock-based
compensation plan as of December 31, 2002, 2001 and 2000, and changes that
occurred during the year:
2002 2001 2000
------------------------------------------------------------------
Weighted Weighted Weighted
Shares Avg Shares Avg Shares Avg
(000) Exercise (000) Exercise (000) Exercise
------------------- ------------------ ------------------
Outstanding
Beginning
of year 4,230 $12.87 3,212 $13.91 1,324 $20.28
Granted 1,088 15.85 1,352 10.96 2,679 12.05
Exercised (611) 12.42 (34) 12.27 -
Forfeited (216) 17.83 (300) 15.56 (791) 18.25
------ ------ ------
Outstanding end
of year 4,491 $13.40 4,230 $12.87 3,212 $13.91
===== ===== =====
Options
exercisable
at year end 2,479 $13.41 1,690 $14.64 590 $19.28
Avg Remaining
Contractual Life 8.00 yrs 8.37 yrs 8.73 yrs
Weighted-Avg fair
Value of options
Granted during
the year $8.36 $5.73 $3.15
The following table summarizes the status of stock options outstanding
and exercisable at December 31, 2002:
--------------------------------------------------------
Stock Options Outstanding Stock Options Exercisable
------------------------- -------------------------
Weighted-
Range of Avg Weighted-
Exercise Remaining Avg Avg
Prices Per Shares Contractual Exercise Shares Exercise
Share (000) Life (Yrs.) Price (000) Price
- -----------------------------------------------------------------------------------
$8.60 - $8.60 12 8.31 $ 8.60 12 $ 8.60
$8.99 - $8.99 594 8.42 8.99 188 8.99
$9.19 - $11.20 635 8.21 10.18 345 10.01
$11.46 - $11.46 10 8.46 11.46 3 11.46
$12.38 - $12.38 1,189 7.16 12.38 1,190 12.38
$12.82 - $13.26 563 9.31 13.21 131 13.13
$13.45 - $16.51 592 8.70 14.99 171 14.64
$17.06 - $17.70 474 8.57 17.67 49 17.42
$18.42 - $23.47 410 6.14 20.68 378 20.83
$23.63 - $23.63 12 5.41 23.63 12 23.63
- -----------------------------------------------------------------------------------
$8.60 - $23.63 4,491 8.00 $13.40 2,479 $13.41
===================================================================================
Under the provision of FAS 123 the Corporation is required to estimate
on the date of grant the fair value of each option using an option-pricing
model. Accordingly, the Black-Scholes option pricing model is used with
the following weighted-average assumptions: dividend yield of 1.8% for
2002, 1.8% for 2001 and 4.5% for 2000, expected volatility of 54.98% for
2002, 53.01% for 2001 and 31.1% for 2000, risk free interest rate of 4.74%
for 2002, 5.10% for 2001 and 5.87% for 2000, and expected life of eight
years. Had the Corporation adopted FAS 123, the amount of before-tax
compensation expense that would have been recognized in 2002, 2001 and
2000 was $6,193, $5,795 and $4,367, respectively. The Corporation's net
income and earnings per share would have been reduced to the pro forma
amounts disclosed below:
63
Item 15. Continued
2002 2001 2000
- ------------------------------------------------------------------------
Net income (loss)
As Reported: $ (891) $98,580 $(79,249)
Pro Forma: (5,426) $94,402 $(82,457)
Basic and diluted earnings
per share
As Reported: $(.01) $1.64 $(1.32)
Pro Forma: $(.09) $1.57 $(1.37)
In connection with the 1998 acquisition of substantially all of the
Commercial Lines Division of Great American Insurance Companies (GAI), an
insurance subsidiary of the American Financial Group, Inc. (AFG), the
Corporation issued warrants to AFG to purchase six million shares of Ohio
Casualty Corporation common stock. The warrants provide for the purchase
of the Corporation's common stock at $22.505 per share and expire in
November 2003. The warrants may be settled through physical or net share
settlement and thus have been recorded as equity in the financial
statements at their estimated fair value. Estimated fair value was
determined based on a third party appraisal of the warrants.
NOTE 8 -- Reinsurance
A reconciliation of direct to net premiums, on both a written and earned
basis and a reconciliation of incurred losses is as follows:
Direct Assumed Ceded Net
- ------------------------------------------------------------------------------
2002
- ----
Premiums written $1,536,098 $ 16,308 $(103,778) $1,448,628
Premiums earned 1,535,912 14,526 (100,062) 1,450,377
Losses incurred 1,081,237 28,329 (206,835) 902,731
2001
- ----
Premiums written $1,551,030 $ 15,139 $(93,984) $1,472,185
Premiums earned 1,510,859 84,984 (89,664) 1,506,179
Losses incurred 959,334 149,800 (107,544) 1,001,590
2000
- ----
Premiums written $1,419,054 $208,021 $(121,682) $1,505,393
Premiums earned 1,341,864 314,080 (122,923) 1,533,021
Losses incurred 919,305 235,716 (38,750) 1,116,271
The following components of the reinsurance recoverable asset are:
2002 2001 2000
- ------------------------------------------------------------------------
Reserve for unearned
premiums $ 43,397 $ 39,681 $ 35,361
Reserve for losses 331,400 151,111 83,897
Reserve for loss adjustment
expenses 23,527 17,626 12,291
Allowance for reinsurance
recoverable (530) - -
Reinsurance recoveries on paid
losses 22,076 29,270 17,084
- ------------------------------------------------------------------------
Reinsurance recoverable $419,870 $237,688 $148,633
========================================================================
NOTE 9 -- Other Contingencies and Commitments
Annuities are purchased from other insurers to pay certain claim
settlements. These payments are made directly to the claimants; should
such insurers be unable to meet their obligations under the annuity
contracts, the Group would be liable to claimants for the remaining amount
of annuities. The claim reserves are presented net of the related
annuities on the Corporation's balance sheet. The total amount of unpaid
annuities was $20,438, $21,509 and $22,505 at December 31, 2002, 2001 and
2000, respectively.
The Corporation leases many of its operating and office facilities for
various terms under long-term, non-cancelable operating lease agreements.
The leases expire at various dates through 2007 and provide for renewal
options ranging from one to five years. The leases provide for increases
in future minimum annual rental payments based on such measures as defined
increases in the Consumer Price Index, increases in operating expenses,
and pre-negotiated rates. Also, the agreements generally require the
Corporation to pay executory costs (utilities, real estate taxes,
insurance, and repairs). Lease expense and related items totaled $5,770,
$6,500, and $5,900 during 2002, 2001 and 2000, respectively.
The following is a schedule by year of future minimum rental payments
required under the operating lease agreements:
Year Ending
December 31 Amount
- ---------------------------------------------
2003 $ 5,374
2004 3,838
2005 1,120
2006 1,038
2007 74
- ---------------------------------------------
Total rental payments $11,444
=============================================
Total minimum lease payments do not include contingent rentals that
may be paid under certain leases because of use in excess of specified
amounts. Contingent rental payments were not significant in 2002, 2001,
or 2000.
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). The transaction effectively exited the Group from
the New Jersey private passenger auto market. The Group continues to
write private passenger auto in other markets. Under the terms of the
transaction, the Group member OCNJ agreed to pay Proformance $40,600 to
assume its renewal obligations. The amount was taken as a charge in the
fourth quarter of 2001 with payments made over the course of twelve months
beginning in early 2002. The contract stipulates that a premiums-to-
surplus ratio of 2.5 to 1 must be maintained on the transferred business
during the next three years. If this criteria is not met, OCNJ will have
a contingent liability of up to $15,600 to be paid to Proformance to
maintain this
64
Item 15. Continued
premiums-to-surplus ratio. As of December 31, 2002, the Group has evaluated
the contingency based upon financial data provided by Proformance. The Group
has concluded that it is not probable the liability will be incurred and,
therefore, has not recognized a liability in the financial statements. The
Group will continue to monitor the contingency for any future liability
recognition.
In the normal course of business, the Corporation and its subsidiaries
are involved in lawsuits related to their operations. In each of the
matters, the Corporation believes the ultimate resolution of such
litigation will not result in any material adverse impact to operations or
financial condition of the Corporation.
NOTE 10 -- Losses and Loss Reserves
The following table presents a reconciliation of liabilities for losses
and loss adjustment expenses:
2002 2001 2000
- ------------------------------------------------------------------------
Balance as of January 1,
net of reinsurance
recoverables of $168,737,
$96,188 and $85,126 $1,981,985 $1,907,331 $1,823,329
Incurred related to:
Current year 1,045,361 1,145,545 1,237,319
Prior years 84,451 58,489 56,846
- ------------------------------------------------------------------------
1,129,812 1,204,034 1,294,165
Paid related to:
Current year 423,634 520,232 596,114
Prior years 608,909 609,148 614,049
- ------------------------------------------------------------------------
Total paid 1,032,543 1,129,380 1,210,163
- ------------------------------------------------------------------------
Balance as of December 31,
net of reinsurance
recoverables of $354,396,
$168,737 and $96,188 $2,079,254 $1,981,985 $1,907,331
========================================================================
The 2002, 2001 and 2000 incurred loss and loss adjustment expenses for
prior years changed due to an increase in severity as losses developed.
For the year 2002, this was concentrated in the general liability and
commercial auto product lines of the Commercial Lines operating segment
and in personal auto product line of the Personal Lines operating segment.
Approximately $62,200 before tax was recognized in the third quarter of
2002 which relates primarily to increased severity on construction defect
claims. The 2001 change was concentrated in the workers' compensation and
general liability product lines whereas the 2000 change was concentrated
primarily in the workers' compensation and general liability product
lines. These developments have been considered in establishing the
December 31, 2002 loss and loss adjustment expense reserves reflected on
the balance sheet.
The following table presents before-tax catastrophe losses incurred
and the respective impact on the statutory loss ratio:
2002 2001 2000
- ------------------------------------------------------------------------
Incurred losses $20,826 $34,577 $36,181
Statutory loss
ratio effect 1.4% 2.3% 2.4%
In 2002, 2001 and 2000 there were 25, 19 and 24 catastrophes,
respectively. The largest catastrophe in each year was $7,500, $17,800
and $7,095 in incurred losses. Additional catastrophes with over $1,000
in incurred losses numbered six, four and nine in 2002, 2001 and 2000.
The additional catastrophes with over $1,000 in incurred losses in 2001
included $3,000 net of reinsurance losses related to the September 11,
2001 terrorist attacks.
The effect of catastrophes on the Corporation's results cannot be
accurately predicted. As such, severe weather patterns, acts of war or
terrorist activities could have a material adverse impact on the
Corporation's results.
Inflation has historically affected operating costs, premium revenues
and investment yields as business expenses have increased over time. The
long-term effects of inflation are considered when estimating the ultimate
liability for losses and loss adjustment expenses. The liability is based
on historical loss development trends which are adjusted for anticipated
changes in underwriting standards, policy provisions and general economic
trends. It is not adjusted to reflect the effect of discounting.
Reserves for asbestos-related illnesses and toxic waste cleanup claims
cannot be estimated with traditional loss reserving techniques. In
establishing liabilities for claims for asbestos-related illnesses and for
toxic waste cleanup claims, management considers facts currently known and
the current state of the law and coverage litigation. However, given the
expansion of coverage and liability by the courts and the legislatures in
the past and the possibilities of similar interpretations in the future,
there is uncertainty regarding the extent of remediation. Accordingly,
additional liability could develop. Estimated asbestos and environmental
reserves are composed of case reserves, incurred but not reported reserves
and reserves for loss adjustment expense. For 2002, 2001 and 2000,
respectively, total case, incurred but not reported and loss adjustment
expense reserves were $64,286, $53,497 and $42,813. Asbestos reserves
were $35,870, $31,792 and $15,921 and environmental reserves were $28,416,
$21,705 and $26,892 for those respective years. The increase in 2001
asbestos reserves related to additional claim development.
NOTE 11 -- Earnings Per Share
Basic and diluted earnings per share are summarized as follows:
65
Item 15. Continued
2002 2001 2000
- ------------------------------------------------------------------------
Net income (loss) $ (891) $98,580 $(79,249)
Average common shares
outstanding - basic 60,494 60,076 60,075
Basic income (loss) per
average share $(.01) $1.64 $(1.32)
========================================================================
Average common shares
outstanding 60,494 60,076 60,075
Effect of dilutive securities 790 133 -
- ------------------------------------------------------------------------
Average common shares
outstanding - diluted 61,284 60,209 60,075
Diluted income (loss) per
average share $(.01) $1.64 $(1.32)
========================================================================
At December 31, 2002, 6,000,000 purchase warrants and 860,860 stock
options were not included in earnings per share calculations for 2002 as
they were antidilutive. The convertible debt impact of 8,897,504 shares
calculated based on the "if converted" method were also not included in
the earnings per share calculation for 2002 as they were antidilutive.
NOTE 12 -- Quarterly Financial Information (Unaudited)
2002 First Second Third Fourth
- -----------------------------------------------------------------------------
Premiums and finance
charges earned $361,007 $364,708 $356,959 $367,793
Net investment income 50,902 50,700 51,767 53,764
Investment gains realized 22,831 9,491 (5,539) 18,409
Net income (loss) 26,873 13,064 (69,935) 29,107
Basic net income (loss)
per share 0.45 0.21 (1.15) 0.48
Diluted net income (loss)
per share 0.44 0.21 (1.14) 0.48
2001 First Second Third Fourth
- -----------------------------------------------------------------------------
Premiums and finance
charges earned $383,496 $376,574 $374,327 $372,281
Net investment income 51,280 52,120 53,068 55,917
Investment gains realized 12,613 42,419 71,033 56,875
Net income (loss) (4,095) 16,651 44,228 41,796
Basic net income (loss)
per share (0.07) 0.28 0.74 0.70
Diluted net income (loss)
per share (0.07) 0.28 0.73 0.69
NOTE 13 -- Comprehensive Income
Other comprehensive income consists of changes in unrealized gains
(losses) on securities and a minimum pension liability and are detailed
below:
2002 2001 2000
- ------------------------------------------------------------------------
Unrealized gains (losses)
arising during the period,
net of taxes $ 35,581 $ (678) $152,472
Less: Reclassification
adjustment for gains
included in net income,
net of taxes 54,207 134,867 71,922
Minimum pension liability,
net of taxes (9,573) - -
- ------------------------------------------------------------------------
Comprehensive income (loss),
net of taxes $(28,199) $(135,545) $ 80,550
========================================================================
NOTE 14 -- Segment Information
The Corporation has determined its reportable segments based upon its
method of internal reporting, which was organized by product line. The
property and casualty segments are Commercial Lines, Specialty Lines, and
Personal Lines. 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 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 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.
Commercial Lines Segment 2002 2001 2000
- ------------------------------------------------------------------------
Net premiums written $762,189 $689,596 $721,681
% Increase (decrease) 10.5% (4.4)% 0.1%
Net premiums earned 725,633 707,635 739,698
% Increase (decrease) 2.5% (4.3)% 5.0%
Underwriting loss
(before tax) (123,102) (107,828) (215,193)
Loss ratio 60.8% 64.5% 78.6%
Loss expense ratio 18.0% 15.3% 13.2%
Underwriting expense ratio 36.3% 36.4% 38.2%
Combined ratio 115.1% 116.2% 130.0%
Specialty Lines Segment 2002 2001 2000
- ------------------------------------------------------------------------
Net premiums written $179,879 $136,085 $107,255
% Increase 32.2% 26.9% 4.6%
Net premiums earned 158,435 130,559 104,384
% Increase 21.4% 25.1% 1.7%
Underwriting gain
(before tax) 1 9,880 19,841
Loss ratio 39.0% 42.0% 30.0%
Loss expense ratio 11.0% 10.4% 5.4%
Underwriting expense ratio 44.1% 38.4% 44.4%
Combined ratio 94.0% 90.8% 79.8%
66
Item 15. Continued
Personal Lines Segment 2002 2001 2000
- ------------------------------------------------------------------------
Net premiums written $506,559 $646,504 $676,457
% Decrease (21.6)% (4.4)% (11.4)%
Net premiums earned 566,309 667,985 688,939
% Decrease (15.2)% (3.0)% (7.8)%
Underwriting loss
(before tax) (62,008) (120,740) (89,268)
Loss ratio 70.5% 73.4% 73.1%
Loss expense ratio 14.0% 12.1% 10.8%
Underwriting expense ratio 29.6% 33.7% 29.6%
Combined ratio 114.1% 119.2% 113.5%
Total Property & Casualty 2002 2001 2000
- ------------------------------------------------------------------------
Net premiums written $1,448,628 $1,472,185 $1,505,393
% Decrease (1.6)% (2.2)% (5.1)%
Net premiums earned 1,450,377 1,506,179 1,533,021
% Decrease (3.7)% (1.8)% (1.4)%
Underwriting loss
(before tax) (185,109) (218,688) (284,620)
Loss ratio 62.2% 66.5% 72.8%
Loss expense ratio 15.7% 13.4% 11.6%
Underwriting expense ratio 34.9% 35.4% 34.8%
Combined ratio 112.8% 115.3% 119.2%
Impact of catastrophe losses
on combined ratio 1.4% 2.3% 2.4%
All Other Segment 2002 2001 2000
- ------------------------------------------------------------------------
Revenues $ 1,161 $ 8,036 $ 4,146
Expenses 7,689 14,159 14,366
- ------------------------------------------------------------------------
Net loss $(6,528) $(6,123) $(10,220)
Reconciliation of
Revenues 2002 2001 2000
- ------------------------------------------------------------------------
Net premiums earned for
reportable segments $1,450,377 $1,506,179 $1,533,021
Investment income 205,794 211,017 201,812
Realized gain (loss) 53,011 198,298 (5,904)
Miscellaneous income 86 382 444
- ------------------------------------------------------------------------
Total property and casualty
revenues (Statutory basis) 1,709,268 1,915,876 1,729,373
Property and casualty
statutory to GAAP
adjustment (7,637) (21,909) 3,150
- ------------------------------------------------------------------------
Total revenues property and
casualty (GAAP basis) 1,701,631 1,893,967 1,732,523
Other segment revenues 1,161 8,036 4,146
- ------------------------------------------------------------------------
Total revenues $1,702,792 $1,902,003 $1,736,669
========================================================================
Reconciliation of
Loss (before tax) 2002 2001 2000
- ------------------------------------------------------------------------
Property and casualty under-
writing loss (before tax)
(Statutory basis) $(185,109) $(218,688) $(284,620)
Statutory to GAAP adjustment (62,554) (35,091) (28,175)
- ------------------------------------------------------------------------
Property and casualty under-
writing loss (before tax)
(GAAP basis) (247,663) (253,779) (312,795)
Net investment income 207,133 212,385 205,062
Realized gain (loss) 45,192 182,940 (2,391)
Other loss (11,368) (15,158) (19,578)
- ------------------------------------------------------------------------
Income (loss) from continuing
operations before income
taxes $ (6,706) $ 126,388 $(129,702)
========================================================================
NOTE 15 -- Agent Relationships
The agent relationships 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, the purchase price was allocated to
agent relationships and deferred policy acquisition costs. Periodically,
agent relationships are evaluated as events or circumstances indicate a
possible inability to recover their carrying amount. 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-down of
the agent relationships asset by $42,170. In 2002, 2001 and 2000, the
Corporation further wrote down the agent relationships asset by $69,510,
$10,966 and $3,801, respectively, for additional 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 useful period of approximately 21 years. Amortization
expense for the periods 2003 through 2007 is expected to approximate $8.0
million before tax per year.
Based on historical data the remaining agents have been profitable.
Future cancellation of agents included in the agent relationships
intangible asset or a diminution of certain former Great American agents'
estimated future revenues or profitability is likely to cause further
impairment losses beyond the quarterly amortization of the remaining asset
value over the remaining useful lives.
NOTE 16 -- Statutory Accounting Information
The following information has been prepared on the basis of statutory
accounting principles which differ from generally accepted accounting
principles. The principal differences relate to deferred acquisition
costs, reinsurance, assets not admitted for statutory reporting, agent
relationships and the treatment of deferred federal income taxes.
2002 2001 2000
- ------------------------------------------------------------------------
Statutory net income (loss) $ 75,148 $172,513 $ (81,223)
Statutory policyholders'
surplus 725,748 767,503 812,133
The Ohio Casualty Insurance Company (the Company), domiciled in Ohio,
prepares its statutory financial statements in accordance with the
accounting practices prescribed or permitted by the Ohio Insurance
Department. Prescribed statutory accounting practices include a variety
of publications of the National Association of Insurance Commissioners
(NAIC), as well as state laws, regulations and general administrative
rules. Permitted statutory
67
Item 15. Continued
accounting practices encompass all accounting practices not so prescribed.
For statutory purposes, agent relationships related to the GAI
acquisition were taken as a direct charge to surplus.
In 1998, the NAIC adopted the Codification of Statutory Accounting
Principles guidance, which replaced the former Accounting Practices and
Procedures manual as the NAIC's primary guidance on statutory accounting.
The new principles provide guidance for areas where statutory accounting
had been silent and changed former statutory accounting in some areas.
The Group implemented the Codification guidance effective January 1, 2001.
The cumulative effect of adopting Codification reduced statutory
policyholders' surplus by $21,694 on January 1, 2001.
The NAIC has developed a "Risk-Based Capital" formula for property and
casualty insurers and life insurers. The formula is intended to measure
the adequacy of an insurer's capital given the asset structure and product
mix of the company. As of December 31, 2002, all insurance companies in
the Group exceeded the necessary capital.
The Corporation is dependent on dividend payments from its insurance
subsidiaries in order to meet operating expenses, debt obligations, and to
pay dividends. Insurance regulatory authorities impose various
restrictions and prior approval requirements on the payment of dividends
by insurance companies and holding companies. At December 31, 2002,
approximately $112,467 of statutory surplus is not subject to restriction
or prior dividend approval requirements. Additional restrictions may
result from the minimum net worth and surplus requirements in the credit
agreement.
The Group paid dividends to policyholders of $5,644 in 2002, compared
to $8,793 and $8,825 in 2001 and 2000, respectively.
NOTE 17 -- Debt
During 1997, the Corporation signed a credit facility that made available
a $300.0 million revolving line of credit. The line of credit was used in
1997 to refinance the outstanding term loan balance the Corporation had at
that time. In 1998, the line of credit was used for capital infusion into
the property and casualty subsidiaries due to the GAI acquisition. The
credit agreement contains financial covenants and provisions customary for
such arrangements. Interest on the borrowings under the line of credit
was calculated at a periodically adjustable rate. The interest rate was
determined on various bases including prime rates, certificates of deposit
rates and the London Interbank Offered Rate. Interest incurred and
related fees on borrowings on the line of credit were $1,760, $13,549 and
$16,075 in 2002, 2001 and 2000, respectively.
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 net proceeds of
the offering, along with $10.5 million of cash, were used to pay off the
balance and terminate the outstanding credit facility. The issuance and
related costs are being amortized over the life of the bonds and are being
recorded as related fees. The Corporation uses the effective interest rate
method to record the interest and related fee amortization. Interest is
payable on March 19 and September 19 of each year, beginning September 19,
2002. The Corporation made the first scheduled interest payment of $5.0
million in the third quarter 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 one thousand dollar 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 have been met for conversion. As of December 31, 2002,
the common share price criterion had not been met and, therefore, no
adjustment to the number of diluted shares on the earnings per share
calculation was made for the convertible debt. 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 a percentage of principal amount):
During the twelve Redemption
months commencing Price
- ------------------------------------------------------------------
March 23, 2005 102%
March 19, 2006 101%
March 19, 2007 until maturity of the notes 100%
The holders of the notes have the option to 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 plus accrued interest.
On July 31, 2002, the Corporation entered into a revolving credit
agreement. Under the terms of the credit agreement, the lenders agreed to
make loans to the Corporation in an aggregate amount up to $80.0 million
for general corporate purposes. Interest is payable in arrears, and the
interest rate on borrowings under the credit agreement is based on a
margin over LIBOR or the LaSalle Bank Prime Rate, at the option of the
Corporation. The Corporation has capitalized approximately $400 in fees
related to establishing the line of credit and amortizes the fees over the
term of the agreement. In addition, the Corporation is obligated to pay
agency fees of $10 and facility fees of up to $160 annually. These fees
are
68
Item 15. Continued
expensed when incurred by the Corporation. The agreement requires the
Corporation to maintain minimum net worth of $800.0 million. The credit
facility agreement also includes a minimum statutory surplus for The Ohio
Casualty Insurance Company of $625.0 million through September 30, 2003,
increasing to $650.0 million thereafter. The credit agreement will expire
on March 15, 2005. Additionally, financial covenants and other customary
provisions, as defined in the agreement, exist. The outstanding loan
amount of the revolving line of credit was zero at December 31, 2002.
During 1999, the Corporation signed a $6,500 low interest loan with
the state of Ohio used in conjunction with the home office purchase. The
Ohio Casualty Insurance Company granted a mortgage on its home office
property as security for the loan. As of December 31, 2002, the loan
bears a fixed interest rate of 2%, increasing to the maximum rate of 3% in
December 2004. The loan requires annual principal payments of
approximately $630 and expires in November 2009. The remaining balance at
December 31, 2002 was $4,544.
Total interest expense of $9,482, $11,708 and $15,632 was charged to
income for the periods ending December 31, 2002, 2001 and 2000,
respectively.
NOTE 18 -- Shareholders Rights Plan
In February 1998, the Board of Directors adopted an amended and restated
Shareholders Rights Agreement (the Agreement). The Agreement is designed
to deter coercive or unfair takeover tactics and to prevent a person(s)
from gaining control of the Corporation without offering a fair price to
all shareholders.
Under the terms of the Agreement, each outstanding common share is
associated with one half of one common share purchase right, expiring in
2009. Currently, each whole right, when exercisable, entitles the
registered holder to purchase one common share of the Corporation at a
purchase price of $125 per share.
The rights become exercisable for a 60 day period commencing eleven
business days after a public announcement that a person or group has
acquired shares representing 20 percent or more of the outstanding shares
of common stock, without the prior approval of the board of directors; or
eleven business days following commencement of a tender or exchange of 20
percent or more of such outstanding shares of common stock.
If after the rights become exercisable, the Corporation is involved in
a merger, other business consolidation or 50 percent or more of the assets
or earning power of the Corporation is sold, the rights will then entitle
the rightholders, upon exercise of the rights, to receive shares of common
stock of the acquiring company with a market value equal to twice the
exercise price of each right.
The Corporation can redeem the rights for $0.01 per right at any time
prior to becoming exercisable.
NOTE 19 -- California Proposition 103
California voters passed Proposition 103 in 1998 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 $17,500 in refunded
premiums to eligible 1989 California policyholders. Accordingly, in
October 2000, the Group reduced its recorded liability from $50,486 by
$32,986 to $17,500. This decrease in the reserve resulted in an increase
in operating income and net income for the third quarter 2000, and had no
effect on the statutory combined ratio reported. The Group began to make
payments in the first quarter of 2001. The Group escheated the remaining
payments to the state of California in the fourth quarter of 2002.
Therefore, no remaining liability existed at December 31, 2002.
69
Item 15. Continued
Reports of Independent Accountants
The Board of Directors and Shareholders, Ohio Casualty Corporation
We have audited the accompanying consolidated balance sheets of Ohio Casualty
Corporation and subsidiaries as of December 31, 2002 and 2001 and the related
consolidated statements of income, shareholders' equity, and cash flows for
the years then ended. Our audit also included the financial statement
schedules listed in the Index at Item 15(a)(2) of this Form 10-K. These
consolidated financial statements and schedules are the responsibility of
the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the
financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Ohio
Casualty Corporation and subsidiaries at December 31, 2002 and 2001 and the
consolidated results of their operations and their cash flows for the years
then ended in conformity with accounting principles generally accepted in the
United States. Also, in our opinion, the related financial statement
schedules, when considered in relation to the basic financial statements
taken as a whole, present fairly in all material respects the information
set forth therein.
/s/ Ernst & Young LLP
Ernst & Young LLP
Cincinnati, Ohio
February 14, 2003
To the Board of Directors and Shareholders of Ohio Casualty Corporation
In our opinion, the consolidated financial statements as of December 31, 2000
and for the year then ended, listed in the index appearing under Item 15(a)(1)
on page 52, present fairly, in all material respects, the financial
position of Ohio Casualty Corporation and its subsidiaries at December 31,
2000 and the results of their operations and their cash flows for the
year ended, in conformity with accounting principles generally accepted
in the United States of America. In addition, in our opinion, the
financial statement schedules listed in the index appearing under
Item 15(a)(2) on page 52, for the year ended December 31, 2000,
present fairly, in all material respects the information set forth
therein when read in conjunction with the related consolidated financial
statements. These financial statements and financial statement schedules
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements and financial statement
schedules based on our audit. We conducted our audit of these statements in
accordance with auditing standards generally accepted in the United States
of America, which require that we plan an perform the audit to obtain
reasonable assurance about whether the financial statements are free of
material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audit provides a reasonable basis for our opinion.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Cincinnati, Ohio
February 16, 2001
70
Item 15. Continued
(b) Reports on Form 8-K or 8-K/A
(a) The Corporation filed a Form 8-K on November 5, 2002 to report
under Items 5 and 7, the filing of a press release announcing the
Corporation's third quarter 2002 results; and a press release
reporting there would be no changes in the current financial
strength rating and outlook from the A. M. Best Company. Exhibits
to the Form 8-K consisted of the press releases dated October 30,
2002 and November 4, 2002.
(c) Exhibits.
See Index to Exhibits on pages 83, 84 and 85 of this Form 10-K.
71
Signatures
Pursuant to the requirements of Section 13 or 15(d) 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)
March 27, 2003 By: /s/ Dan R. Carmichael
-------------------------------
Dan R. Carmichael
President
Chief Executive Officer
Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
March 27, 2003 /s/ Stanley N. Pontius
-----------------------------------------------------------
Stanley N. Pontius, Chairman of the Board
March 27, 2003 /s/ Dan R. Carmichael
-----------------------------------------------------------
Dan R. Carmichael, President, Chief Executive Officer and
Director
March 27, 2003 /s/ Terrence J. Baehr
-----------------------------------------------------------
Terrence J. Baehr, Director
March 27, 2003 /s/ Jack E. Brown
-----------------------------------------------------------
Jack E. Brown, Director
March 27, 2003 /s/ Catherine E. Dolan
-----------------------------------------------------------
Catherine E. Dolan, Director
March 27, 2003 /s/ Philip G. Heasley
-----------------------------------------------------------
Philip G. Heasley, Director
March 27, 2003 /s/ Stephen S. Marcum
-----------------------------------------------------------
Stephen S. Marcum, Director
March 27, 2003 /s/ Ralph S. Michael III
-----------------------------------------------------------
Ralph S. Michael III, Director
March 27, 2003 /s/ Howard L. Sloneker III
-----------------------------------------------------------
Howard L. Sloneker III, Senior Vice President and Director
March 27, 2003 /s/ Jan H. Suwinski
-----------------------------------------------------------
Jan H. Suwinski, Director
March 27, 2003 /s/ Donald F. McKee
-----------------------------------------------------------
Donald F. McKee, Executive Vice President and Chief
Financial Officer
72
CERTIFICATION
I, Dan R. Carmichael, certify that:
1. I have reviewed this annual report on Form 10-K of Ohio Casualty
Corporation;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition,
results of operations and cash flows of the registrant as of,
and for, the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior
to the filing date of this annual report (the "Evaluation
Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based
on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and report
financial data and have identified for the registrant's
auditors any material weaknesses in internal controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 27, 2003 /s/Dan R. Carmichael
-------------- ----------------------------
Dan R. Carmichael
President and Chief Executive
Officer
73
CERTIFICATION
I, Donald F. McKee, certify that:
1. I have reviewed this annual report on Form 10-K of Ohio Casualty
Corporation;
2. Based on my knowledge, this annual report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other
financial information included in this annual report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for,
the periods presented in this annual report;
4. The registrant's other certifying officers and I are responsible
for establishing and maintaining disclosure controls and procedures
(as defined in Exchange Act Rules 13a-14 and 15d-14) for the
registrant and we have:
a) designed such disclosure controls and procedures to ensure
that material information relating to the registrant,
including its consolidated subsidiaries, is made known to us
by others within those entities, particularly during the
period in which this annual report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to
the filing date of this annual report (the "Evaluation
Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures
based on our evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent function):
a) all significant deficiencies in the design or operation of
internal controls which could adversely affect the
registrant's ability to record, process, summarize and
report financial data and have identified for the
registrant's auditors any material weaknesses in internal
controls; and
b) any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officers and I have indicated in
this annual report whether or not there were significant changes
in internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most recent
evaluation, including any corrective actions with regard to
significant deficiencies and material weaknesses.
Date: March 27, 2003 /s/Donald F. McKee
-------------- ----------------------------
Donald F. McKee
Executive Vice President and
Chief Financial Officer
74
Schedule I
Ohio Casualty Corporation and Subsidiaries
Consoliated Summary of Investments
Other than Investments in Related Parties
(In thousands)
December 31, 2002
Amount
shown in
balance
Type of investment Cost Value sheet
- ---------------- ---- ----- --------
Fixed maturities
Bonds:
United States govt. and
govt. agencies with auth. $ 26,121 $ 29,082 $ 29,082
States, municipalities and
political subdivisions 44,249 46,788 46,788
Corporate securities 1,778,993 1,909,581 1,909,581
Mortgage-backed securities:
U.S. government guaranteed 52,773 55,073 55,073
Other 1,065,368 1,099,250 1,099,250
---------- ---------- ----------
Total fixed maturities 2,967,504 3,139,774 3,139,774
Equity securities:
Common stocks:
Banks, trust and insurance
companies 23,638 104,297 104,297
Industrial, miscellaneous and
all other 68,936 208,240 208,240
Preferred stocks:
Non-redeemable - - -
Convertible - - -
---------- ---------- ----------
Total equity securities 92,574 312,537 312,537
Short-term investments 49,839 49,839 49,839
---------- ---------- ----------
Total investments $3,109,917 $3,502,150 $3,502,150
========== ========== ==========
75
Schedule II
Ohio Casualty Corporation
Condensed Financial Information of Registrant
(In thousands)
2002 2001 2000
---- ---- ----
Condensed Balance Sheet:
Investment in wholly-owned
subsidiaries, at equity $1,197,765 $1,242,718 $1,269,563
Investment in bonds/stocks, at fair value 40,734 18,870 34,767
Cash and other assets 20,960 31,859 35,456
---------- ---------- ----------
Total assets 1,259,459 1,293,447 1,339,786
Notes payable 198,288 210,173 220,798
Other liabilities 2,468 3,242 2,397
---------- ---------- ----------
Total liabilities 200,756 213,415 223,195
---------- ---------- ----------
Shareholders' equity $1,058,703 $1,080,032 $1,116,591
========== ========== ==========
Condensed Statement of Income:
Dividends from subsidiaries $ 24,993 $ 5,175 $ 59,571
Equity in subsidiaries (19,345) 103,050 (128,681)
Operating expenses (6,539) (9,645) (10,139)
----------- ----------- -----------
Net income (loss) $ (891) $ 98,580 $ (79,249)
=========== ========== ===========
Condensed Statement of Cash Flows:
Cash flows from operations
Net distributed income $ 18,454 $ (4,470) $ 49,432
Other 1,625 2,069 (16,255)
---------- ---------- ----------
Net cash provided (used in)
operating activities 20,079 (2,401) 33,177
Investing
Purchase of bonds/stocks (55,615) (6,037) (46,937)
Sales of bonds/stocks 30,541 19,392 69,525
---------- ---------- ----------
Net cash used in (provided by)
investing activities (25,074) 13,355 22,588
Financing
Debt:
Proceeds 201,250 - -
Payments (205,629) (10,625) (20,648)
Payment for deferred financing costs (400) - -
Payment for issuance costs (7,337) - -
Proceeds from exercise of stock options 7,498 75 67
Dividends paid to shareholders - - (35,446)
---------- ---------- ----------
Net cash used in financing activities (4,618) (10,550) (56,027)
Net change in cash (9,613) 404 (262)
---------- ---------- ----------
Cash, beginning of year 9,977 9,573 9,835
---------- ---------- ----------
Cash, end of year $ 364 $ 9,977 $ 9,573
========== ========== ==========
76
Schedule III
Ohio Casualty Corporation and Subsidiaries
Consolidated Supplementary Insurance Information
(In thousands)
December 31, 2002
Deferred Future policy
policy benefits Net
acquisition losses and Unearned Premium investment
costs loss expenses premiums revenue income
------------ ------------- -------- ------- ----------
Segment
- -------
Property and
casualty insurance:
Underwriting
Commercial Lines $ 92,843 $1,712,466 $ 370,018 $ 725,633
Specialty Lines 33,211 231,558 116,439 158,435
Personal Lines 55,222 489,626 182,250 566,309
Miscellaneous income 90
Allowance for reinsurance
recoverable
Investment $205,794
-------- ---------- ---------- ---------- --------
Total property and
casualty insurance $181,276 $2,433,650 $ 668,707 $1,450,467 $205,794
Premium finance 15
Corporation 1,324
-------- ---------- ---------- ---------- --------
Total $181,276 $2,433,650 $ 668,707 $1,450,467 $207,133
Benefits, Amortization
losses and of deferred General
loss acquisition operating Premiums
expenses costs expenses written
---------- ------------ --------- --------
Segment
Property and
casualty insurance:
Underwriting
Commercial Lines $ 571,894 $ 187,766 $ 149,000 $ 762,190
Specialty Lines 79,169 52,076 25,570 179,879
Personal Lines 478,219 136,381 17,525 506,559
Miscellaneous income
Allowance for reinsurance
recoveable 530
Investment
---------- ---------- ---------- ----------
Total property and
casualty insurance $1,129,812 $ 376,223 $ 192,095 $1,448,628
Premium finance (7)
Corporation 11,375
---------- ---------- ---------- ----------
Total $1,129,812 $ 376,223 $ 203,463 $1,448,628
========== ========== ========== ==========
1. Net investment income has been allocated to principal business segments
on the basis of separately identifiable assets.
2. The principal portion of general operating expenses has been directly
attributed to business segment classifications incurring such expenses
with the remainder allocated based on premium revenue.
77
Schedule III
Ohio Casualty Corporation and Subsidiaries
Consolidated Supplementary Insurance Information
(In thousands)
December 31, 2001
Deferred Future policy
policy benefits Net
acquisition losses and Unearned Premium investment
costs loss expenses premiums revenue income
------------ ------------- -------- ------- ----------
Segment
- -------
Property and
casualty insurance:
Underwriting
Standard Lines $ 90,989 $1,467,331 $ 331,948 $ 707,635
Specialty Lines 21,095 188,340 88,782 130,559
Personal Lines 54,675 495,051 246,009 667,985
Miscellaneous income 389
Investment $211,114
-------- ---------- ---------- ---------- --------
Total property and
casualty insurance $166,759 $2,150,722 $ 666,739 $1,506,568 $211,114
Premium finance 110 126
Corporation 1,145
-------- ---------- ---------- ---------- --------
Total $166,759 $2,150,722 $ 666,739 $1,506,678 $212,385
Benefits, Amortization
losses and of deferred General
loss acquisition operating Premiums
expenses costs expenses written
---------- ------------ --------- --------
Segment
Property and
casualty insurance:
Underwriting
Standard Lines $ 564,468 $ 192,542 $ 86,926 $ 689,596
Specialty Lines 68,450 37,662 13,797 136,085
Personal Lines 571,116 145,446 79,938 646,504
Miscellaneous income
Investment
---------- ---------- ---------- ----------
Total property and
casualty insurance $1,204,034 $ 375,650 $ 180,661 $1,472,185
Premium finance 345 9
Corporation 14,925
---------- ---------- ---------- ----------
Total $1,204,034 $ 375,650 $ 195,931 $1,472,194
========== ========== ========== ==========
1. Net investment income has been allocated to principal business segments
on the basis of separately identifiable assets.
2. The principal portion of general operating expenses has been directly
attributed to business segment classifications incurring such expenses
with the remainder allocated based on premium revenue.
78
Schedule III
Ohio Casualty Corporation and Subsidiaries
Consolidated Supplementary Insurance Information
(In thousands)
December 31, 2000
Deferred Future policy
policy benefits Net
acquisition losses and Unearned Premium investment
costs loss expenses premiums revenue income
------------ ------------- -------- ------- ----------
Segment
Property and
casualty insurance:
Underwriting
Standard Lines $ 97,985 $1,434,735 $ 351,506 $ 739,698
Specialty Lines 17,347 83,763 76,940 104,384
Personal Lines 59,739 485,021 267,967 688,939
Miscellaneous income 409
Investment $202,002
-------- ---------- ---------- ---------- --------
Total property and
casualty insurance $175,071 $2,003,519 $ 696,413 $1,533,430 $202,002
Premium finance 100 568 167
Corporation 2,893
-------- ---------- ---------- ---------- --------
Total $175,071 $2,003,519 $ 696,513 $1,533,998 $205,062
Benefits, Amortization
losses and of deferred General
loss acquisition operating Premiums
expenses costs expenses written
---------- ------------ --------- --------
Segment
Property and
casualty insurance:
Underwriting
Standard Lines $ 679,432 $ 191,133 $ 113,532 $ 721,681
Specialty Lines 36,950 34,544 17,602 107,255
Personal Lines 577,783 168,838 26,415 676,457
Miscellaneous income
Investment
---------- ---------- ---------- ----------
Total property and
casualty insurance $1,294,165 $ 394,515 $ 157,549 $1,505,393
Premium finance 857 480
Corporation 19,285
---------- ---------- ---------- ----------
Total $1,294,165 $ 394,515 $ 177,691 $1,505,873
========== ========== ========== ==========
1. Net investment income has been allocated to principal business segments
on the basis of separately identifiable assets.
2. The principal portion of general operating expenses has been directly
attributed to business segment classifications incurring such expenses
with the remainder allocated based on premium revenue.
79
Schedule IV
Ohio Casualty Corporation and Subsidiaries
Consolidated Reinsurance
(In thousands)
December, 2002, 2001 and 2000
Percent of
amount
Ceded to Assumed assumed
Gross other from other Net to net
amount companies companies amount amount
------ --------- ---------- ------ ---------
Year Ended December 31, 2002
Premiums
Property and casualty insurance $1,535,960 $103,640 $16,308 $1,448,628 1.1%
Accident and health insurance 138 138 - - -
---------- -------- ------- ----------
Total premiums $1,536,098 $103,778 $16,308 $1,448,628 1.1%
Premium finance charges -
----------
Total premiums and finance charges written 1,448,628
Change in unearned premiums and finance charges 1,749
----------
Total premiums and finance charges earned 1,450,377
Miscellaneous income 90
----------
Total premiums & finance charges earned $1,450,467
==========
Year Ended December 31, 2001
Premiums
Property and casualty insurance $1,550,873 $ 93,827 $15,139 $1,472,185 1.0%
Accident and health insurance 157 157 - - -
---------- -------- ------- ----------
Total premiums 1,551,030 93,984 15,139 1,472,185 1.0%
Premium finance charges 9
----------
Total premiums and finance charges written 1,472,194
Change in unearned premiums and finance charges 34,092
----------
Total premiums and finance charges earned 1,506,286
Miscellaneous income 392
----------
Total premiums & finance charges earned $1,506,678
==========
Year Ended December 31, 2000
Premiums
Property and casualty insurance $1,418,876 $121,504 $208,021 $1,505,393 13.8%
Accident and health insurance 178 178 - - -
---------- -------- -------- ----------
Total premiums 1,419,054 121,682 208,021 1,505,393 13.8%
Premium finance charges 480
----------
Total premiums and finance charges written 1,505,873
Change in unearned premiums and finance charges 27,641
----------
Total premiums and finance charges earned 1,533,514
Miscellaneous income 484
----------
Total premiums & finance charges earned $1,533,998
==========
80
Schedule V
Ohio Casualty Corporation and Subsidiaries
Valuation and Qualifying Accounts
(In thousands)
Balance at Balance at
beginning Charged to end of
of period expenses period
Year ended December 31, 2002
Reserve for bad debt $ 8,400 $(4,100) $ 4,300
Year ended December 31, 2001
Reserve for bad debt $10,700 $(2,300) $ 8,400
Year ended December 31, 2000
Reserve for bad debt $ 9,338 $ 1,362 $10,700
81
Schedule VI
Ohio Casualty Corporation and Subsidiaries
Consolidated Supplemental Information Concerning
Property and Casualty Insurance Operations
(In thousands)
Reserves for
Deferred unpaid claims
policy and claim Discount Net
Affiliation with acquisition adjustment of Unearned Earned investment
registrant costs expenses reserves premiums premiums income
- ---------------- ----------- ------------- -------- -------- -------- ----------
Property and casualty
subsidiaries
Year ended December 31,
2002 $181,276 $2,433,650 $ - $668,707 $1,450,467 $205,794
======== ========== ======= ======== ========== ========
Year ended December 31,
2001 $166,759 $2,150,722 $ - $666,739 $1,506,568 $211,114
======== ========== ======= ======== ========== ========
Year ended December 31,
2000 $175,071 $2,003,519 $ - $696,413 $1,533,430 $202,002
======== ========== ======= ======== ========== ========
Claims and claim Amortization Paid
adjustment expenses of deferred claims
incurred related to policy and claim
Affiliation with Current Prior acquisition adjustment Premiums
registrant year years costs expenses written
- ---------------- ------- ----- ----------- ---------- --------
Property and casualty
subsidiaries
Year ended December 31,
2002 $1,045,361 $ 84,451 $376,223 $1,032,543 $1,448,628
========== ======== ======== ========== ==========
Year ended December 35,
2001 $1,145,545 $58,489 $375,650 $1,129,380 $1,472,185
========== ======== ======== ========== ==========
Year ended December 31,
2000 $1,237,319 $56,846 $394,515 $1,210,163 $1,505,393
========== ======== ======== ========== ==========
82
Form 10-K
Ohio Casualty Corporation
Index to Exhibits
Exhibit 3 Articles of Incorporation, as amended.
Exhibit 3.1 Code of Regulations, as amended
Exhibit 10.1 Amended and Restated Ohio Casualty Corporation Director's
Deferred Compensation Plan
Exhibit 10.2 The Ohio Casualty Insurance Company Supplemental Executive
Savings Plan, amended effective June 1, 2002
Exhibit 10.3 The Ohio Casualty Insurance Company 2002 Officer Annual
Incentive Program
Exhibit 10.4 The Ohio Casualty Insurance Company Benefit Equalization Plan
Exhibit 10.5 The Ohio Casualty Insurance Company Deferred Compensation
Plan (Dan R. Carmichael)
Exhibit 10.6 Stock Option Agreement for Executive Vice President and
Chief Financial Officer dated September 19, 2001
Exhibit 21 Subsidiaries of the Registrant
Exhibit 23 Consent of Independent Auditors to incorporation of their
opinion by reference in Registration Statements on Forms S-3
and Form S-8
Exhibit 23a Consent of Independent Accountants to incorporation of their
opinion by reference in Registration Statements on Forms S-3
and Form S-8
Exhibit 28 Information from Reports Furnished to State Insurance
Regulation Authorities
Exhibit 99.1 Certification of Chief Executive Officer of Ohio Casualty
Corporation in accordance with Section 906 of the Sarbanes-
Oxley Act of 2002
Exhibit 99.2 Certification of Chief Financial Officer of Ohio Casualty
Corporation in accordance with Section 906 of the Sarbanes-
Oxley Act of 2002
Exhibits incorporated by reference:
Exhibit 2 Asset Purchase Agreement between Ohio Casualty Corporation
and Great American Insurance Company, filed as Exhibit 2 to
the Registrant's SEC Form 10-Q on November 13, 1998
Exhibit 4 Amended and Restated Rights Agreement between the Registrant
and First Chicago Trust Company of New York as Rights Agent
dated as of February 19, 1998, filed as Exhibit 4(g) to the
Registrant's SEC Form 8-A/A amendment no. 3 on March 5, 1998
83
Form 10-K
Ohio Casualty Corporation
Index to Exhibits, Continued
Exhibit 4a Certificate of Adjustment by the Registrant dated as of July 1,
1999, filed as Exhibit 9 to the Registrant's SEC Form 8-A/A
amendment no. 4 on July 2, 1999
Exhibit 4b First amendment to the Amended and Restated Rights Agreement
dated as of February 19, 1998, signed November 8, 2001, filed as
Exhibit 4b to the Registrant's SEC Form 10-K on March 5, 2002
Exhibit 4c Ohio Casualty Corporation Agent Share Plan, filed on
Registrant's Form S-3 (333-39483) on June 18, 1997
Exhibit 4d Ohio Casualty Corporation's Registration Statement filed on
Form S-3 (333-70761) on January 19, 1999
Exhibit 4e First Amendment to the Ohio Casualty Corporation's Registration
Statement filed on Form S-3A (333-70761) on March 31, 1999
Exhibit 4f Second Amendment to the Ohio Casualty Corporation's Registration
Statement filed on Form S-3A (333-70761) on May 11, 1999
Exhibit 4g Third Amendment to the Ohio Casualty Corporation's Registration
Statement filed on Form S-3A (333-70761) on June 1, 1999
Exhibit 4h Ohio Casualty Corporation's Registration Statement filed on
Form S-3 (333-88532) on May 17, 2002
Exhibit 4i First Amendment to the Ohio Casualty Corporation's Registration
Statement filed on Form S-3A (333-88532) on June 4, 2002
Exhibit 10a Ohio Casualty Corporation amended 1993 Stock Incentive Program,
filed as Exhibit 10.a1 to the Registrant's SEC Form 10-Q on
May 14, 1997
Exhibit 10b Coinsurance Life, Annuity and Disability Income Reinsurance
Agreement between Employer's Reassurance Corporation and The Ohio
Life Insurance Company dated as of October 2, 1995, filed as
Exhibit 10b to the Registrant's SEC Form 10-K on March 26, 1996
Exhibit 10c Employment Agreement with Dan R. Carmichael dated December 12,
2000, filed as Exhibit 10 to the Registrant's SEC Form 10-K on
March 30, 2001
Exhibit 10d Employment Agreement with Donald F. McKee dated September 19,
2001, filed as Exhibit 10.1 to the Registrant's SEC Form 10-Q on
November 14, 2001
Exhibit 10e Change in Control Agreement with Howard L. Sloneker III, as
amended, dated July 24, 2002, filed as Exhibit 10.2 to the
Registration's SEC Form 10-Q on November 4, 2000
84
Form 10-K
Ohio Casualty Corporation
Index to Exhibits, continued
Exhibit 10f Information regarding Omitted Exhibits: (Schedule to Exhibit
10.2) concerning Change in Control Agreements entered into by
and between the Corporation and each of the following executive
officers: John E. Bade, Jr., John S. Busby, Debra K. Crane,
Ralph G. Goode, Jeffrey L. Haniewich, Richard B. Kelly, John S.
Kellington, Elizabeth M. Riczko and Thomas E. Schadler filed as
Exhibit 10.3 to the Registrant's SEC Form 10-Q on November 14,
2000
Exhibit 10g Stock Option Agreement for Directors' year 2000 grant, filed as
Exhibit 10.1 to the Registrant's SEC Form 10-Q on May 15, 2000
Exhibit 10h Stock Option Agreement for Chief Executive Officer year 2000
grant, filed as Exhibit 10.2 to the Registrant's SEC Form 10-Q
on May 15, 2000, (the same form used in 2001 and 2000)
Exhibit 10i Ohio Casualty Corporation 1999 Warrant Registration, filed on
Registrant's Form S-3 (333-90231) on November 3, 1999, filed as
Exhibit 2 to the Registrant's SEC Form 10-Q on November 13, 1998
Exhibit 10j Replacement carrier agreement between Ohio Casualty of New
Jersey, Inc. and Proformance Insurance Company and its parent,
National Atlantic Holdings Corporation, filed as Exhibit 10k to
the Registrant's SEC Form 10-K on March 5, 2002
Exhibit 10k First Amendment to Ohio Casualty Corporation 1999 Warrant
Agreement between the registrant and Great American Insurance
Company effective April 15, 2002, filed as Exhibit 10.1 to the
Registrant's SEC Form 10-Q on May 14, 2002
Exhibit 10l Ohio Casualty Corporation 2002 Stock Incentive Program, filed as
Exhibit 10.2 to the Registrant's SEC Form 10-Q on May 14, 2002
Exhibit 10m Ohio Casualty Corporation 2002 Employee Stock Purchase Plan,
filed as Exhibit 10.3 to the Registrant's SEC Form 10-Q on
May 14, 2002
Exhibit 10n Credit Agreement dated as of July 31, 2002 between Ohio Casualty
Corporation and LaSalle Bank National Association and certain
other lenders, filed as Exhibit 10 to the Registrant's SEC Form
10-Q on August 14, 2002
85