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UNITED STATES 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, 2003
[ ] 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, 2003 of the voting stock held by
non-affiliates of the registrant was $727,504,083 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 March 1, 2004 there were 61,136,858 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 21, 2004, are incorporated by
reference into Parts II and III of this Annual Report on Form 10-K.
2
TABLE OF CONTENTS
Page
----
PART I
Item 1. Description of Business 4
Item 2. Properties 19
Item 3. Legal Proceedings 19
Item 4. Submission of Matters to a Vote of Security Holders 19
PART II
Item 5. Market for Registrant's Common Equity, Related
Stockholder Matters and Issuer Purchases of
Equity Securities 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 53
Item 8. Financial Statements and Supplementary Data 54
Item 9. Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure 54
Item 9A. Controls and Procedures 55
PART III
Item 10. Directors and Executive Officers of the Registrant 55
Item 11. Executive Compensation 56
Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters 56
Item 13. Certain Relationships and Related Transactions 56
Item 14. Principal Accountant Fees and Services 56
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports
on Form 8-K 57
Signatures 78
Index to Exhibits 87
Exhibit 1e Form of amended Change in Control Agreement
Exhibit 4 Amended and Restated Rights Agreement
Exhibit 4.1 Restated Agent Share Plan
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 28 Information from Reports Furnished to State Insurance
Regulation Authorities
Exhibit 31.1 Certification of Chief Executive Officer of Ohio
Casualty Corporation in accordance with SEC Rule
13(a)-14(a)/15(d)-14(a)
Exhibit 31.2 Certification of Chief Financial Officer of Ohio
Casualty Corporation in accordance with SEC Rule
13(a)-14(a)/15(d)-14(a)
Exhibit 32.1 Certification of Chief Executive Officer of Ohio
Casualty Corporation in accordance with Section 1350
of the Sarbanes-Oxley Act of 2002
Exhibit 32.2 Certification of Chief Financial Officer of Ohio
Casualty Corporation in accordance with Section 1350
of the Sarbanes-Oxley Act of 2002
3
PART I
Item 1. Description of Business
(a) General Development of Business
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. The Corporation has six direct and
indirect subsidiaries which are collectively known as the Ohio Casualty Group
(the Group). The Group writes both commercial and personal lines business
and is actively writing business in over 40 states. 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 and
certain liabilities of the commercial lines division of the Great American
Insurance Company (GAI) and certain of its affiliates. The major lines of
business included in the acquisition were workers' compensation, commercial
multi-peril, umbrella, general liability and commercial auto.
During the fourth quarter of 2001, OCNJ entered into an agreement to transfer
its obligation 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 unprofitable due
to state legal requirements which made it much more difficult to control both
the volume of writings and underwriting selection. 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 1.0 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 to pay up to
an additional $15.6 million to Proformance. At December 31, 2003, the Group
has evaluated the contingency based upon financial data provided by
Proformance and concluded that a payment is not probable and has not
recognized a liability in the consolidated financial statements. The Group
will continue to monitor the contingency for any future liability
recognition.
As part of its strategic planning process, the Corporation carefully
evaluated its competitive environment. This analysis indicated that some
insurance companies have achieved combined ratios in the 90% to 100% range.
Also, the surplus positions of many of these firms appear to be
strengthening, at the same time, investment income growth has been
constrained by the low yields on new investments. In addition, the industry
took less aggressive price increases in 2003 in most insurance product lines
and had an increased focus on the quality of reinsurers. Recognizing that
improved industry results may mean increased price competition, the
Corporation has taken steps in 2003 to achieve improved profitability through
expense reduction initiatives while maintaining quality underwriting and
pricing.
4
Item 1. Continued
In September 2003, the Corporation announced its Corporate Strategic Plan for
the 2004-2006 time frame. The plan brings together five broad objectives to
help achieve the Corporation's Vision to be a leading super regional Property
and Casualty carrier providing a broad range of products/services through
independent agents and brokers. The broad objectives include the ability to
generate above market real growth, produce competitive loss ratios, create a
competitive expense structure, achieve a competitive return on equity and
improve credit ratings and financial flexibility. Competitive advantages
include strong agency relationships, especially with key agents, and
technology platforms that will provide superior operating flexibility.
Technology is being leveraged to make it easier for agents to do business
with the Group and to increase pricing and underwriting sophistication.
(b) Financial Information About Segments
The revenues and operating profit of each reportable segment for the three
years ended December 31, 2003 are set forth in Item 15, Note 13, Segment
Information, in the Notes to the Consolidated Financial Statements on pages
72 and 73 of this Form 10-K. The combined ratios and component ratios for
each reportable segment for the three years ended December 31, 2003 are
presented in Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations on page 36 of this Form 10-K.
Segment Description
Commercial Lines Segment
The Group's Commercial Lines segment, which accounted for 55.0% of net
premiums written in 2003, includes primarily:
- - commercial multi-peril insurance (CMP), which insures a business against
risks from property, liability, crime and boiler and machinery explosion
losses;
- - commercial automobile insurance, which insures policyholders against
third party liability related to the ownership and operation of motor
vehicles used 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;
- - 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 costs,
lost wages, and disability and death benefits. These policies also
provide coverage to employees for their liability exposures under the
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 covers the cost of the defense of claims
alleging such damages.
Specialty Lines Segment
The Group's Specialty Lines segment, which accounted for 11.4% of net
premiums written in 2003 includes primarily:
- - commercial umbrella insurance, which indemnifies policyholders for
liability and defense costs which exceed coverage provided by the
underlying primary policies, typically commercial automobile and general
liability policies, and provides coverage for some items not covered by
underlying policies; and
5
Item 1. Continued
- - fidelity and surety, which insure against dishonest acts of bonded
employees and the non-performance of parties under contracts,
respectively.
Personal Lines Segment
The Group's Personal Lines segment, which accounted for the remaining 33.6%
of net premiums written in 2003, 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 include gross premiums less premiums
ceded pursuant to reinsurance programs.
Statutory Net Premiums Written
OPERATING SEGMENTS and ------------------------------
SELECTED PRODUCT LINES (in millions)
or MARKETS 2003 2002 2001
- ---------------------- ---- ---- ----
Commercial Lines $ 792.6 $ 762.2 $ 689.6
Workers' compensation 132.4 143.9 148.6
Commercial auto 228.3 213.4 186.7
General liability 83.4 84.5 79.0
CMP, BOP, fire and inland marine 348.5 320.4 275.2
Specialty Lines 164.9 179.9 136.1
Commercial umbrella 120.9 132.6 92.1
Fidelity and surety 43.9 45.6 38.7
Personal Lines 484.1 506.5 646.5
New Jersey personal auto (1.1) 24.2 120.2
Other personal lines 485.2 482.3 526.3
Other personal auto 293.8 297.1 330.8
Homeowners 157.2 153.7 162.0
Total All Lines $1,441.6 $1,448.6 $1,472.2
Property and casualty statutory net premiums written decreased $7.0 million
in 2003 from 2002. This decrease resulted from Personal Lines withdrawal
from selected markets, stricter underwriting guidelines for Commercial Lines,
including the non-renewal of certain construction-defect related risks and
workers' compensation risks in several states and higher reinsurance costs,
primarily for the commercial umbrella product line.
The net premiums written decrease in 2002 from 2001 can be attributed
primarily to the non-renewal of the Group's New Jersey private passenger auto
business that began in March of 2002. As of year-end 2003 there are no
remaining New Jersey private passenger auto policies.
6
Item 1. Continued
(c) Narrative Description of Business
Marketing and Distribution
The Group is represented by approximately 3,000 independent insurance
agencies with over 5,100 agents. These agents also represent other
unaffiliated companies which may compete with the Group. The six claim and
seven 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, 2003, these agencies
represented 16.2% 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.
The Group targets small business customers for its Commercial Lines segment.
The Group's typical Commercial Lines customer is a small business with
minimal number of employees and a need to conveniently purchase a package of
coverages. For the year 2003, this Commercial Lines customer group,
categorized by commercial liability premium volume, included approximately
75% contractors/artisans, 10% mercantile, 9% building/premises, and 6%
manufacturers. The Group believes this small business customer group offers
an opportunity to achieve superior underwriting results through development
and maintenance of strong agent and customer relationships and application of
the Group's underwriting and pricing expertise.
The Group markets its Specialty Lines segment predominately to policyholders
who have purchased commercial automobile and general liability policies and
have a need for additional coverage under umbrella policies to cover costs
which might exceed the underlying policies limits or are not covered under
such policies.
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.
7
Item 1. Continued
(d) Financial Information about Geographic Areas
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 millions)
Percent Percent Percent
2003 of Total 2002 of Total 2001 of Total
---- -------- ---- -------- ---- --------
New Jersey $166.9 10.6 New Jersey $186.6 12.1 New Jersey $ 265.0 17.1
Ohio 140.1 8.9 Ohio 142.7 9.3 Ohio 150.6 9.6
Pennsylvania 129.1 8.2 Pennsylvania 119.0 7.8 Kentucky 119.1 7.7
Kentucky 122.0 7.8 Kentucky 115.4 7.5 Pennsylvania 105.5 6.8
Illinois 81.1 5.2 Illinois 79.5 5.2 Illinois 79.0 5.1
North Carolina 77.7 4.9 North Carolina 75.2 4.9 North Carolina 70.9 4.6
Maryland 70.2 4.5 Indiana 63.2 4.1 Indiana 68.2 4.4
Texas 65.7 4.2 Maryland 61.8 4.0 Maryland 58.5 3.8
New York 63.3 4.0 New York 57.9 3.8 Texas 49.2 3.2
Indiana 60.9 3.9 Texas 55.9 3.6 New York 41.4 2.7
------ ----- ------ ----- -------- -----
$977.0 62.2 $957.2 62.3 $1,007.4 65.0
====== ==== ====== ==== ======== ====
Investments
The distribution of the Corporation's and the Group's invested assets is
determined by a number of factors, including:
- - rates of return;
- - investment risks;
- - insurance law requirements;
- - diversification;
- - liquidity needs;
- - tax planning;
- - general market conditions; and
- - business mix and liability payout patterns.
Periodically, the investment portfolios are reallocated subject to the
parameters set by the Investment Committee. Management evaluates the
investment portfolio on a regular basis to determine the optimal investment
strategy based upon the factors mentioned above. Throughout 2002 and 2001,
equity securities were sold, many of which had substantially appreciated in
value compared to earlier periods. This sale program was in response to a
decision to reduce equity holdings in favor of investment grade fixed
maturities.
Assets relating to property and casualty operations are invested to maximize
after-tax returns with appropriate diversification of risk. As a result of
improved underwriting profitability, the Corporation and the Group began
gradually increasing funds invested in tax exempt fixed maturities in 2003.
Tax exempt fixed maturity securities as a percentage of amortized cost,
increased to 2.7% of the fixed
8
Item 1. Continued
maturity available-for-sale portfolio at December 31, 2003, versus 1.5% at
December 31, 2002 and 1.1% at December 31, 2001. Assets relating to property
and casualty operations are invested to maximize after-tax returns with
appropriate diversification of risk.
The consolidated fixed maturity portfolio has an intermediate duration and a
laddered maturity structure. The duration of the fixed maturity portfolio at
December 31, 2003 was approximately 4.6 years. The Corporation and the Group
remain fully invested and do not build up large cash positions in
anticipation of changes in interest rates. 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 invested
assets as of the end of the years indicated:
Distribution of Invested Assets
($ in millions)
Average % % %
Rating 2003 Total 2002 Total 2001 Total
------- ---- ----- ---- ----- ---- -----
U.S. Government:
Available-for-sale AAA $ 43.2 1.2 $ 29.1 0.8 $ 29.4 0.9
States, municipalities
and political
subdivisions:
Investment grade:
Available-for-sale AA 79.1 2.1 45.0 1.3 29.6 0.9
Below investment
grade:
Available-for-sale - - - 1.8 0.1 1.7 0.1
Corporate securities:
Investment grade:
Available-for-sale A 2,001.4 53.4 1,817.4 51.9 1,516.6 45.7
Held-to-maturity A+ 167.7 4.5 - - - -
Below investment
grade:
Available-for-sale BB- 84.0 2.2 92.2 2.6 87.0 2.6
Mortgage-backed
securities:
Investment grade:
Available-for-sale AAA 799.8 21.3 1,143.0 32.6 1,102.2 33.2
Held-to-maturity AAA 188.4 5.0 - - - -
Below investment
grade:
Available-for-sale B 14.7 0.4 11.3 0.3 5.6 0.2
-------- ----- -------- ----- -------- -----
Total fixed maturities 3,378.3 90.1 3,139.8 89.6 2,772.1 83.6
Equity securities 329.0 8.8 312.5 9.0 489.0 14.7
Short-term investments 40.4 1.1 49.8 1.4 54.8 1.7
-------- ----- -------- ----- -------- -----
Total securities $3,747.7 100.0 $3,502.1 100.0 $3,315.9 100.0
======== ===== ======== ===== ======== =====
Total carrying value
of securities $3,747.7 $3,502.1 $3,315.9
======== ======== ========
Total amortized cost
of securities $3,325.6 $3,109.9 $2,895.0
======== ======== ========
9
Item 1. Continued
At December 31, 2003, the available-for-sale fixed maturity portfolio totaled
$3,022.2 million, which consisted of 96.7% investment grade securities and
3.3% below investment grade securities. The market value of the below
investment grade portfolio was $98.7 million at December 31, 2003. The held-
to-maturity fixed maturity portfolio totaled $356.1 million (carried at
amortized cost) at December 31, 2003 and consisted entirely of investment
grade securities. Investments are classified as below investment grade based
upon the higher of the ratings provided by Standard & Poor's Ratings Services
(S&P) and Moody's Investors Service (Moody's). When a security is not rated
by either S&P or Moody's, the 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 $24.0 million at
December 31, 2003.
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 significant 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 subordinated to other debt. Investment grade securities are
also subject to significant risks relating to the issuer, including
additional leveraging, changes in control 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 fixed maturity
portfolio as of the end of the years indicated:
2003 2002 2001
---- ---- ----
Investment grade 6.3% 6.7% 7.3%
Below investment grade 8.8% 9.5% 9.1%
Total taxable 6.4% 6.8% 7.5%
Tax exempt 5.0% 6.2% 6.5%
At December 31, 2003, the equity portfolio had a market value of $329.0
million, or 8.8% of the total invested assets. Equity securities are carried
at fair value on the consolidated balance sheet. As a result, shareholders'
equity and statutory surplus fluctuate with changes in the value of the
equity portfolio. As of December 31, 2003, the equity portfolio consisted of
stocks in 44 separate entities in 35 industries. As of December 31, 2003,
32.3% of the equity portfolio was invested in five companies and the largest
single position was 8.1% of the total equity portfolio. At December 31,
2002, the percentage represented by the top five holdings accounted for 33.0%
of the total equity portfolio, 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.
Equity securities are marked to fair value on the consolidated balance sheet.
As a result, shareholders' equity and statutory surplus fluctuate with
changes in the value of the equity portfolio. The effects of future stock
market volatility is managed by maintaining an appropriate ratio of equity
securities to shareholders' equity and statutory surplus.
10
Item 1. Continued
Liabilities for Unpaid Losses and Loss Adjustment Expenses
Liabilities for losses and loss adjustment expenses (LAE) 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 may have a material adverse
impact on the results of operations of the Group. 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 may have a material adverse effect on the Group's results. In
2003, 2002 and 2001, the Group was impacted by 21, 25 and 19 catastrophes,
respectively. The largest incurred catastrophe loss in each of these years
was $11.5 million, $7.5 million and $17.8 million, respectively. Additional
catastrophes with over $1 million in incurred losses numbered nine in 2003,
six in 2002 and four in 2001. For additional discussion of catastrophe
losses, please refer to Item 15, Note 9, Losses and Loss Reserves, in the
Notes to the Consolidated Financial Statements on pages 71 and 72 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 losses and LAE 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 losses and LAE 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, events and
trends which led to 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 LAE 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 LAE and related
liabilities for the periods indicated. The first table represents the impact
of current and prior accident years on calendar year losses and LAE. The
second table displays the development of losses and LAE liabilities as of
successive year-end evaluations for each of the past ten years. The
accounting policies used to estimate liabilities for losses and LAE are
described in Note 1J, Summary of Significant Accounting Policies and Note 9,
Losses and Loss Reserves, in the Notes to the Consolidated Financial
Statements on pages 63, 71 and 72 of this Form 10-K.
11
Item 1. Continued
Reconciliation of Liabilities for Losses and Loss Adjustment Expenses
(in millions)
2003 2002 2001
---- ---- ----
Net liabilities, balance as of
January 1 $2,079.3 $1,982.0 $1,907.3
Incurred related to:
Current year 993.3 1,045.4 1,145.5
Prior years 34.1 84.4 58.5
-------- -------- --------
Total incurred 1,027.4 1,129.8 1,204.0
Paid related to:
Current year 388.6 423.6 520.2
Prior years 586.9 608.9 609.1
-------- -------- --------
Total paid 975.5 1,032.5 1,129.3
Net liabilities, balance as of
December 31 2,131.2 2,079.3 1,982.0
Reinsurance recoverable 496.6 354.4 168.7
-------- -------- --------
Gross liabilities, balance as of
December 31 $2,627.8 $2,433.7 $2,150.7
======== ======== ========
12
Item 1. Continued
Analysis of Development of Loss and Loss Adjustment Expense Liabilities
(In millions)
Year Ended December 31 1993 1994 1995 1996 1997
- ------------------------------ ------ ------ ------ ------ ------
Net liability as originally
estimated: $ 1,693.6 $ 1,606.5 $ 1,557.1 $ 1,486.6 $ 1,421.8
Life Operations Liability 0.7 1.0 3.9 3.7 0.1
P&C Operations Liability $ 1,692.9 $ 1,605.5 $ 1,553.2 $ 1,482.9 $ 1,421.7
Net cumulative payments as of:
One year later 533.6 510.2 486.2 483.6 449.8
Two years later 833.4 803.3 772.7 747.4 751.2
Three years later 1,017.9 997.0 944.3 950.1 919.3
Four years later 1,147.3 1,106.4 1,080.4 1,058.3 1,016.9
Five years later 1,218.9 1,203.7 1,151.0 1,121.3 1,088.7
Six years later 1,288.1 1,257.3 1,198.3 1,171.2 1,137.6
Seven years later 1,331.3 1,293.5 1,239.3 1,207.0
Eight years later 1,363.1 1,329.0 1,271.2
Nine years later 1,393.0 1,357.4
Ten years later 1,418.8
Gross cumulative payments as of:
One year later 547.4 522.8 500.1 498.3 469.9
Two years later 859.1 827.2 798.1 781.9 775.4
Three years later 1,051.9 1,030.7 988.7 983.4 950.4
Four years later 1,190.5 1,158.8 1,123.2 1,098.7 1,057.5
Five years later 1,278.6 1,254.5 1,200.6 1,171.2 1,131.5
Six years later 1,347.0 1,314.6 1,257.4 1,223.2 1,187.0
Seven years later 1,396.5 1,359.9 1,300.6 1,265.3
Eight years later 1,437.5 1,397.7 1,338.8
Nine years later 1,469.9 1,432.4
Ten years later 1,501.9
Year Ended December 31 1998 1999 2000 2001 2002 2003
- ------------------------------ ------ ------ ------ ------ ------ ------
Net liability as originally
estimated: $ 1,865.6 $ 1,823.3 $ 1,907.3 $ 1,982.0 $ 2,079.3 $ 2,131.2
Life Operations Liability 0.1 - - - - -
P&C Operations Liability $ 1,865.5 $ 1,823.3 $ 1,907.3 $ 1,982.0 $ 2,079.3 $ 2,131.2
Net cumulative payments as of:
One year later 640.2 614.0 609.1 608.9 586.7
Two years later 999.1 960.5 1,002.7 1,015.2
Three years later 1,223.3 1,226.2 1,290.4
Four years later 1,385.2 1,399.5
Five years later 1,485.7
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Gross cumulative payments as of:
One year later 654.2 636.5 647.1 636.8 674.9
Two years later 1,022.2 1,007.1 1,060.6 1,122.7
Three years later 1,261.1 1,281.4 1,404.5
Four years later 1,426.5 1,492.0
Five years later 1,532.4
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 millions)
Year Ended December 31 1993 1994 1995 1996 1997
- ------------------------------ ------ ------ ------ ------ ------
Net liability re-estimated as of:
One year later 1,539.2 1,500.5 1,474.8 1,428.0 1,355.6
Two years later 1,510.9 1,501.5 1,441.1 1,403.1 1,386.4
Three years later 1,515.1 1,486.5 1,445.7 1,439.0 1,400.7
Four years later 1,525.5 1,507.3 1,478.8 1,456.9 1,392.0
Five years later 1,551.0 1,546.8 1,497.6 1,448.0 1,441.7
Six years later 1,587.9 1,566.3 1,492.0 1,489.8 1,459.7
Seven years later 1,609.6 1,560.9 1,532.2 1,504.2
Eight years later 1,606.2 1,597.8 1,548.0
Nine years later 1,640.8 1,614.6
Ten years later 1,657.2
Decrease (increase) in
original estimates: $ 35.7 $ (9.0) $ 5.1 $ (21.3) $ (38.0)
Net liability as originally
estimated: $ 1,692.9 $ 1,605.5 $ 1,553.1 $ 1,482.9 $ 1,421.7
Reinsurance recoverable on
unpaid losses and LAE 75.7 65.3 71.1 64.7 60.0
Gross liability as originally
estimated: $ 1,769.3 $ 1,671.8 $ 1,631.2 $ 1,556.7 $ 1,483.8
Life Operations Liability 0.7 1.0 7.0 9.1 2.2
P&C Operations Liability 1,768.6 1,670.9 1,624.2 1,547.6 1,481.7
One year later 1,611.0 1,574.2 1,546.0 1,496.1 1,447.0
Two years later 1,591.3 1,579.9 1,515.0 1,507.4 1,477.9
Three years later 1,601.4 1,565.6 1,561.7 1,537.4 1,495.8
Four years later 1,612.3 1,630.3 1,585.5 1,559.5 1,495.6
Five years later 1,680.8 1,657.0 1,608.3 1,558.2 1,571.1
Six years later 1,704.9 1,680.6 1,609.8 1,623.2 1,618.8
Seven years later 1,731.0 1,682.8 1,671.4 1,667.9
Eight years later 1,735.1 1,739.3 1,718.2
Nine years later 1,788.1 1,787.4
Ten years later 1,835.6
Decrease (increase) in
original estimates: (67.0) (116.6) (94.0) (120.4) (137.1)
Year Ended December 31 1998 1999 2000 2001 2002 2003
- ------------------------------ ------ ------ ------ ------ ------ ------
Net liability re-estimated as of:
One year later 1,888.4 1,880.2 1,965.8 2,066.4 2,115.2
Two years later 1,885.2 1,907.6 2,066.1 2,139.5
Three years later 1,901.8 1,997.6 2,131.1
Four years later 1,975.8 2,032.9
Five years later 1,993.4
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Decrease (increase) in
original estimates: $ (127.9) $ (209.5) $ (223.7) $ (157.5) $ (34.1)
Net liability as originally
estimated: $ 1,865.5 $ 1,823.3 $ 1,907.3 $ 1,982.0 $ 2,079.3 $ 2,131.2
Reinsurance recoverable on
unpaid losses and LAE 80.2 85.1 96.2 168.7 354.4 496.6
Gross liability as originally
estimated: $ 1,956.9 $ 1,908.5 $ 2,003.5 $ 2,150.7 $ 2,433.7 $ 2,627.8
Life Operations Liability 11.2 - - - - -
P&C Operations Liability 1,945.8 1,908.5 2,003.5 2,150.7 2,433.7 2,627.8
One year later 1,972.9 1,981.1 2,129.9 2,346.9 2,558.2
Two years later 1,975.7 2,041.7 2,310.6 2,502.4
Three years later 2,006.1 2,189.9 2,432.4
Four years later 2,114.3 2,261.6
Five years later 2,155.4
Six years later
Seven years later
Eight years later
Nine years later
Ten years later
Decrease (increase) in
original estimates: (209.7) (353.2) (428.9) (351.7) (124.5)
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 2003 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 retention on the property
per risk excess of loss treaty increased from $1.0 million in 2003 to $1.5
million in 2004. The Group's casualty per occurrence program covers
liability losses. Workers' compensation, umbrella and other casualty
reinsurance cover liability 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. Beginning in 2003, the Group retains 3.5% of
casualty losses applicable to the $5.0 million excess of $1.0 million layer.
In addition, beginning in 2004, the Group retains 7 percent of all umbrella
losses applicable to the $20.0 million excess of $5.0 million layer. The
casualty reinsurance treaty includes a layer of coverage of $5.0 million in
excess of $1.0 million that consists of 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 holding title to the assets and
managing the investments of the fund reduces credit risk related to
reinsurers. The balance of the fund as of December 31, 2003 was
approximately $150.5 million.
The Group also has a surety excess of loss treaty which covers $14.0 million
excess of $1.0 million ultimate net loss each loss event, subject to a limit
of $42.0 million for any one contract year. The Group retains 5% of losses
in the $14.0 million excess of $1.0 million layer.
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 $100.0 million of coverage in excess
of the Group's $25.0 million retention level. In response to reduced
exposures to catastrophic events, the catastrophe excess of loss treaty
changed from $100.0 million in excess of $25.0 million in 2003 to $80.0
million in excess of $25.0 million in 2004. The treaty was written on a
multiple year basis for years 2001 - 2003 with only a portion of the
reinsurance layers expiring in a single year. This provides continuity,
maintains rates and preserves each reinsurer's share of the overall program.
Over the last 20 years, two events triggered coverage under the catastrophe
reinsurance program. Losses and LAE from the fires in Oakland, California in
1991 totaled $35.6 million and losses and LAE from Hurricane Andrew in 1992
totaled $29.8 million. Both of these losses exceeded the prior retention
level 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 100-250 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.
15
Item 1. Continued
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 number of reinsurers are 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, excluding the
Security Trust Fund. 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 expenses; 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 insurance 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 2002, the latest year
for which industry-wide comparison statistics are available:
- - more than $375 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 11.3%; and
- - the Group ranked as the forty-fifth largest property and casualty
insurance group in the United States.
16
Item 1. Continued
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 impact the industry.
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.
17
Item 1. Continued
New Jersey
Given the unfavorable regulatory environment in New Jersey and the continued
unprofitability of its private passenger auto business in the state, the
Group entered into a transaction in the fourth quarter of 2001 that allowed
the Group to stop writing business in March of 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
Item 7, Management's Discussion and Analysis of Financial Condition and
Results of Operations on pages 27, 28, 39 and 40 of this Form 10-K.
National Association of Insurance Commissioners (NAIC)
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 a 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 and liability 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 2003 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 653.6%
American Fire 856.0%
Ohio Security 2,119.8%
West American 588.5%
Avomark 1,193.8%
OCNJ 735.4%
As of December 31, 2003, all insurance companies in the Group exceeded the
necessary statutory capital requirements.
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 $86.8 million during 2004 without prior approval of the Ohio
insurance department based on 10% of the Company's policyholders' surplus for
the year ending December 31, 2003. Additional restrictions may result from
the minimum net worth and surplus requirements in the Corporation's credit
agreement as disclosed in Item 15, Note 16, Debt, on pages 74 and 75 of this
Form 10-K.
Employees
At December 31, 2003, the Company had 2,669 employees of which approximately
1,400 were located in the Fairfield and Hamilton, Ohio offices.
(e) Available Information
The Corporation's internet website is www.ocas.com. The Corporation provides
a hyperlink to the website of the Securities and Exchange Commission,
www.sec.gov, where the Corporation's annual report on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K, and all amendments to
these reports (SEC Reports) are available as soon as reasonably practicable
after the Corporation has electronically filed or furnished them to the SEC.
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 except as stated in Part III, Item 10.
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
The Corporation is involved in litigation and administrative proceedings
arising in the ordinary course of business, which, in the opinion of
management, after considering established reserves, are not expected to have
a material adverse effect on the financial condition, liquidity, or results
of operations of the Corporation. Current litigation includes three separate
proceedings making class action claims for which no class certification has
been sought or granted at this time. See also Item 15, Note 8, Other
Contingencies and Commitments on pages 70 and 71 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 2003 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, Related Stockholder Matters
and Issuer Purchases of Equity Securities
(a) The Corporation's common shares, par value $.125 per share, are traded
on the Nasdaq Stock Market under the symbol OCAS. 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
2003 High 13.12 14.57 14.99 17.64
Low 11.57 11.67 13.24 14.40
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
(b) On March 1, 2004, the Corporation's common shares were held by 5,060
shareholders of record.
(c) The Corporation's Board of Directors discontinued the Corporation's
regular quarterly dividend in February, 2001. For further discussion
regarding restrictions on the payment of dividends by the Corporation,
refer to Item 7, Management Discussion and Analysis on Financial
Condition and Results of Operations on page 41 of this Form 10-K.
(d) 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 heading "Equity Compensation Plans."
20
Item 6. Selected Financial Data
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)
2003 2002 2001 2000
=======================================================================================
Consolidated Operations
Premiums and finance charges earned $1,424.4 $1,450.5 $1,506.7 $1,534.0
Investment income less expenses 208.7 207.1 212.4 205.1
Investment gains (losses) realized, net 35.9 45.2 182.9 (2.4)
- ---------------------------------------------------------------------------------------
Total Revenues 1,669.0 1,702.8 1,902.0 1,736.7
Total Expenses 1,561.4 1,709.5 1,775.6 1,866.4
Income (loss) from continuing operations 75.8 (0.9) 98.6 (79.2)
- ---------------------------------------------------------------------------------------
Gain on sale of discontinued operations - - - -
Cumulative effect of accounting change - - - -
- ---------------------------------------------------------------------------------------
Net income (loss) 75.8 (0.9) 98.6 (79.2)
=======================================================================================
Income (loss) after taxes per average share outstanding - diluted*
Income (loss) from continuing operations 1.24 (0.01) 1.64 (1.32)
Discontinued operations - - - -
Gain on sale of discontinued operations - - - -
Cumulative effect of accounting changes - - - -
- ---------------------------------------------------------------------------------------
Net income (loss) 1.24 (0.01) 1.64 (1.32)
=======================================================================================
Average shares outstanding - diluted* 61.3 61.3 60.2 60.1
Total assets 5,168.9 4,779.0 4,524.6 4,489.4
Total debt 198.0 198.3 210.2 220.8
Shareholders' equity 1,145.8 1,058.7 1,080.0 1,116.6
Book value per share* 18.80 17.43 17.97 18.59
Dividends per share* - - - 0.59
Property and Casualty Operations
Net premiums written(1) 1,441.6 1,448.6 1,472.2 1,505.4
Net premiums earned 1,424.4 1,450.5 1,506.7 1,533.0
Statutory loss ratio(2) 59.7% 62.2% 66.5% 72.8%
Statutory loss adjustment expense ratio(3) 12.3% 15.7% 13.4% 11.6%
Statutory underwriting expense ratio(4) 34.1% 34.9% 35.4% 34.8%
Statutory combined ratio(5) 106.1% 112.8% 115.3% 119.2%
Property and casualty reserves
Unearned premiums 703.0 668.7 666.8 696.4
Losses 2,163.7 1,978.8 1,746.8 1,627.6
Loss adjustment expenses 464.1 454.9 403.9 376.0
Statutory policyholders' surplus(6) 867.6 725.7 767.5 812.1
21
Item 6. Continued
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)
1999 1998 1997 1996
======================================================================================
Consolidated Operations
Premiums and finance charges earned $1,555.0 $1,268.9 $1,209.0 $1,226.6
Investment income less expenses 184.3 169.0 177.7 183.3
Investment gains (losses) realized, net 160.8 14.4 50.7 49.7
- ---------------------------------------------------------------------------------------
Total Revenues 1,900.1 1,452.3 1,437.4 1,459.6
Total Expenses 1,763.2 1,349.3 1,263.9 1,344.7
Income (loss) from continuing operations 110.2 84.9 139.1 102.5
- ---------------------------------------------------------------------------------------
Gain on sale of discontinued operations 6.2 - - -
Cumulative effect of accounting change (2.3) - - -
- ---------------------------------------------------------------------------------------
Net income (loss) 114.1 84.9 139.1 102.5
=======================================================================================
Income (loss) after taxes per average share outstanding - diluted*
Income (loss) from continuing operations 1.73 1.26 1.90 1.39
Discontinued operations 0.07 0.03 0.13 0.07
Gain on sale of discontinued operations 0.11 - - -
Cumulative effect of accounting changes (0.04) - - -
- ---------------------------------------------------------------------------------------
Net income (loss) 1.87 1.29 2.03 1.46
=======================================================================================
Average shares outstanding - diluted* 61.1 65.9 68.5 70.5
Total assets 4,476.4 4,802.3 3,778.8 3,890.0
Total debt 241.4 265.0 40.0 50.0
Shareholders' equity 1,151.0 1,321.0 1,314.8 1,175.1
Book value per share* 19.16 21.12 19.56 16.72
Dividends per share* 0.92 0.88 0.84 0.80
Property and Casualty Operations
Net premiums written(1) 1,586.9 1,299.6 1,207.6 1,209.0
Net premiums earned 1,554.1 1,267.8 1,204.3 1,223.4
Statutory loss ratio(2) 66.9% 63.7% 62.7% 66.5%
Statutory loss adjustment expense ratio(3) 10.7% 9.1% 9.4% 9.7%
Statutory underwriting expense ratio(4) 35.2% 34.4% 33.2% 33.3%
Statutory combined ratio(5) 112.8% 107.2% 105.3% 109.5%
Property and casualty reserves
Unearned premiums 725.2 668.4 494.9 491.4
Losses 1,545.0 1,569.5 1,174.5 1,215.8
Loss adjustment expenses 363.5 376.3 307.2 331.8
Statutory policyholders' surplus(6) 899.8 1,027.1 1,109.5 984.9
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
1995 1994 Annual Growth
=====================================================================================
Consolidated Operations
Premiums and finance charges earned $1,268.3 $1,298.8 0.9%
Investment income less expenses 188.1 185.7 1.2%
Investment gains (losses) realized, net 6.1 21.9 5.1%
- -------------------------------------------------------------------------------------
Total Revenues 1,462.5 1,506.4 1.0%
Total Expenses 1,342.3 1,397.1 1.1%
Income (loss) from continuing operations 99.7 97.2 -2.5%
- -------------------------------------------------------------------------------------
Gain on sale of discontinued operations - -
Cumulative effect of accounting change - (0.3)
- -------------------------------------------------------------------------------------
Net income (loss) 99.7 96.9 -2.4%
=====================================================================================
Income (loss) after taxes per average share outstanding - diluted*
Income (loss) from continuing operations 1.33 1.27 -0.2%
Discontinued operations 0.06 0.08 -100.0%
Gain on sale of discontinued operations - -
Cumulative effect of accounting changes - -
- -------------------------------------------------------------------------------------
Net income (loss) 1.39 1.35 -0.8%
=====================================================================================
Average shares outstanding - diluted* 71.5 72.0 -1.6%
Total assets 3,980.1 3,739.0 3.3%
Total debt 60.0 70.0 11.0%
Shareholders' equity 1,111.0 850.8 3.0%
Book value per share* 15.69 11.82 4.8%
Dividends per share* 0.76 0.73 -100.0%
Property and Casualty Operations
Net premiums written(1) 1,250.6 1,286.4 1.1%
Net premiums earned 1,264.6 1,297.7 0.9%
Statutory loss ratio(2) 61.2% 61.6% -0.3%
Statutory loss adjustment expense ratio(3) 10.2% 10.0% 2.1%
Statutory underwriting expense ratio(4) 32.6% 32.2% 0.6%
Statutory combined ratio(5) 104.0% 103.8% 0.2%
Property and casualty reserves
Unearned premiums 505.8 517.8 3.1%
Losses 1,268.1 1,303.6 5.2%
Loss adjustment expenses 356.1 367.3 2.4%
Statutory policyholders' surplus(6) 876.9 660.0 2.6%
(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
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, 2003, compared with December 31, 2002 and
December 31, 2001 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
results of operations and financial position.
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 Footnote 1 on pages 62 through 64 of this Form 10-K.
Reserves for Losses and Loss Adjustment Expenses
The Group establishes reserves for losses and loss adjustment expenses (LAE)
equal to the estimated amount to settle both reported (case reserves) and
unreported claims (incurred but not yet reported, "IBNR"). 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 LAE 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 financial 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 LAE reserves,
revisions to estimated reserves could have a material impact on the results
of operations of the Group.
Investments
All investment securities are classified upon acquisition as held-to-maturity
or available-for-sale. Fixed maturity securities classified as held-to-
maturity are carried at amortized cost because management has the ability and
positive intent to hold the securities until maturity. 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 component of comprehensive income,
net of deferred tax. Transfers of fixed maturity securities into the held-to
maturity category from the available-for-sale category are made at fair value
at the date of transfer. The unrealized holding gain or loss at the date of
transfer is retained in other comprehensive income and in the carrying value
of the held-to-maturity securities. Such amounts are amortized over the
remaining life of the security. Equity securities are carried at quoted
market values
23
Item 7. Continued
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.
Mortgage-backed securities are amortized over a period based on estimated
future principal payments, including prepayments. Prepayment assumptions are
reviewed periodically and adjusted to reflect actual prepayments and changes
in expectations. Upon receipt of payments from such securities, the
Corporation and the Group determine the appropriate amount 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. Variations from
prepayment assumptions will affect the life and yield of these securities.
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 and 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. Quarterly, 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 Great American Insurance Company (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 Corporation and the Group evaluate the estimated useful life on an annual
basis or as events or circumstances arise that may impact the useful life of
the asset. The asset is evaluated quarterly as events or circumstances, such
as cancellation of agents, indicate a possible inability to recover the
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 the 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
involve 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
24
Item 7. Continued
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.
Executive-Level Overview
The Corporation earns revenue by providing businesses and consumers with
competitive insurance products with high quality service and by income on
funds invested. This year the Corporation achieved meaningful improvement in
financial performance. Net income increased in 2003 compared to 2002 as a
result of a better priced book of business through realization of double-
digit price increases in certain lines and an improved risk profile as a
result of tighter underwriting standards. The statutory expense ratio
continued to improve as a result of expense management initiatives. The year
ended with a strong capital position and the highest level of statutory
policyholders' surplus since 1999.
The 2003 All Lines statutory combined ratio improved to 106.1% compared to
112.8% in 2002 as a result of lower underwriting expenses and lower LAE.
These results for 2003 were slightly higher than the expected range due
primarily to an increase in reserves for environmental claims in the fourth
quarter of 2003, higher than expected catastrophe losses and large non-
catastrophe property losses.
Although full year premiums are below last year's levels, the Group's risk
profile has improved. The decline in net premiums written for the full year
reflects Personal Lines withdrawal from selected markets, stricter
underwriting guidelines for Commercial Lines, including the non-renewal of
certain construction-defect related risks, stricter underwriting of workers'
compensation risks in several states and higher reinsurance costs, primarily
for the commercial umbrella product line.
Besides improving the Group's risk profile in 2003, the Group also focused on
reducing expenses through a Cost Structure Efficiency program. Some of the
specific areas that were addressed include more effective management of
claims litigation efforts; improved procurement practices, including a
reduction in telecommunications expenses; the use of emerging technologies to
streamline, simplify and speed up processes and management of staff levels,
including a steady reduction in employee count and a focus on increased
skills training to improve products and services. In the fourth quarter of
2003 a new phase of the Cost Structure Efficiency program was initiated.
This new phase focuses on process improvements, increased productivity and
appropriate staffing to deliver high levels of service to agents and
policyholders. As a result of company-wide process reengineering
initiatives, the Corporation announced on February 11, 2004 an immediate 260
staff and managerial position reduction with an additional reduction of 150-
250 positions expected to be announced by the end of
25
Item 7. Continued
the second quarter of 2004. The reduction of 260 positions will result in
net savings of approximately $5.5 million before tax in 2004 and annual
savings of $14.9 million before tax beginning in 2005. The Corporation will
record in the first quarter of 2004 approximately $4.6 million before tax for
severance and other related expenses for the 260 positions reduced.
As part of its strategic planning process, the Corporation evaluated
insurance industry trends over the past couple of years. These trends show
some insurance companies performing at combined ratios in the 90% to 100%
range with lower investment income due to lower market yields. In addition,
the industry took less aggressive price increases in 2003 in most insurance
product lines and an increased focus on the quality of reinsurers.
Recognizing that improved industry results may mean increased price
competition, the Corporation has taken steps in 2003 to achieve improved
profitability through expense reduction initiatives while maintaining quality
underwriting and pricing.
During 2004, much of the focus will be on driving operational efficiencies
and expense reductions throughout the organization. The reduction in
personnel is expected to result in expense savings in the near future.
Management acknowledges that the reengineering activities may cause
disruptions to operations and has proactively taken actions to mitigate this
risk.
In September 2003, the Corporation announced its Corporate Strategic Plan for
the 2004-2006 time frame. The plan brings together five broad objectives to
help achieve the Corporation's Vision to be a leading super regional Property
and Casualty carrier providing a broad range of products/services through
independent agents and brokers. The broad objectives include abilities to
generate above market real growth, produce competitive loss ratios, create a
competitive expense structure, achieve a competitive return on equity and
improve credit ratings and financial flexibility. Competitive advantages
include strong agency relationships, especially with key agents, and
technology platforms that provide operating flexibility. Technology is being
leveraged to make it easier for agents to do business with the Group and to
increase pricing and underwriting sophistication.
The key financial indicators management utilizes consist of statutory
combined ratios and component ratios on both a calendar year and accident
year basis, gross and net written premium growth, impact of catastrophes,
renewal price increases and investment income growth.
RESULTS OF OPERATIONS
Net Income
The Corporation reported net income of $75.8 million, or $1.24 per share,
compared with a net loss of $.9 million, or $.01 per share, for the year
2002, and net income of $98.6 million, or $1.64 per share, in 2001.
Management of the Corporation believes the significant volatility of realized
investment gains and losses limits the usefulness of net income as a measure
of current operating performance. Management uses the non-GAAP financial
measure of net income before realized gains and losses to further evaluate
current operating performance. Net income before realized gains and losses
is reconciled to net income in the table below:
26
Item 7. Continued
Reconciliation of Net Income (Loss)
before Realized Gains and Losses
($ in millions) 2003 2002 2001
- ---------------------------------------------------------------------------
Net income (loss) before realized
gains and losses $52.5 $(30.3) $(36.4)
After-tax realized gains and losses 23.3 29.4 135.0
Net income (loss) $75.8 $ (0.9) $ 98.6
The improved financial results for 2003 are the result of expense reductions
and an improved loss ratio. Decreases in personnel and sales related
expenses led to the improved results for 2003 compared with 2002. Staff
reductions of 11.2% in 2003 compared to 2002 were the result of the claim
department reorganization and the Lexington and Indianapolis underwriting
offices being consolidated into other locations. Additional savings are
anticipated to occur in 2004 as additional workflow re-engineering will occur
in the first half of 2004. The loss ratio improvement in 2003 is due to
tighter underwriting standards and an improved risk profile. In addition,
development on prior accident years' losses and LAE decreased $50.3 million
before tax from 2002 to $34.1 million before tax in 2003. During 2002, the
increase in provision for prior accident years' losses and LAE totaled $84.4
million before tax and was concentrated in the general liability, commercial
auto and personal auto product lines. These improved results were offset by
increased catastrophe losses during 2003. The catastrophe losses before tax
more than doubled to $43.8 million in 2003 from $20.8 million in 2002
resulting from storms that swept through the midwest and the effects of
Hurricane Isabel.
Results in 2003 were also favorably impacted as a result of reduced costs
associated with the agent relationships identifiable intangible asset. In
2003, the before-tax amortization and impairment costs were $18.7 million
compared with $79.7 million in 2002 and $22.3 million in 2001. This asset
represents the excess of cost over fair value of net assets for the 1998
acquisition of the GAI commercial lines division. The impairment charges
occurred when estimated future cash flows of certain agents were less than
the carrying value. At December 31, 2003, the largest individual agent asset
carrying value is $5.9 million, which represents the maximum future
impairment charge for an individual agent. Based upon historical performance
of this agent, it is unlikely the agent will become impaired or cancelled in
the near term. For the approximately 300 individual agents that represent
the total agent relationships intangible asset, the average asset carrying
value as of December 31, 2003 is $.5 million. The larger than usual
impairment charge in the third quarter of 2002 was due primarily to the
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 relationship asset are likely to
occur in the future and could be significant based on uncertainties such as
changes in an agent's revenue production or profitability.
In 2002, results were negatively impacted by the losses and LAE 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."
Net income for 2001 was negatively impacted by prior accident year adverse
development in the Group's workers' compensation product line and asbestos
related claims as well as the impact of an early retirement plan. 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
27
Item 7. Continued
passenger auto business in New Jersey to Proformance Insurance Company
(Proformance). In recent years, the market in New Jersey private passenger
auto had become unstable due to the inability to control both the volume of
writings and the profitability. The Group decided to eliminate future
uncertainty and risks related to the New Jersey private passenger automobile
market in order to achieve its long-term strategic objectives. Management
determined that it was uncertain whether profitability would return to the
New Jersey private passenger auto business, 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. As a result, the Group
concluded that it was prudent 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 private passenger auto
business in New Jersey beginning in March of 2002. Under the terms of the
transaction, OCNJ agreed to pay $40.6 million to Proformance to transfer its
renewal obligations. The before-tax amount of $40.6 million was charged to
income in the fourth quarter of 2001, reducing net income by $26.8 million on
an after-tax basis. The contract stipulates that a premiums-to-surplus ratio
of 2.5 to 1.0 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 to pay up to
$15.6 million to Proformance to maintain this premiums-to-surplus ratio. At
December 31, 2003, the Group evaluated the contingency based upon financial
data provided by Proformance and concluded that a payment is not probable,
and has not recognized a liability in the financial statements. The Group
will continue to monitor the contingency for possible future liability
recognition.
During 2001, loss and LAE reserves for prior accident years 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 that impacted 147 employees and resulted in a one-time after-tax charge
of $4.0 million.
Investment Results
Consolidated before-tax net investment income was $208.7 million in 2003,
compared with $207.1 million in 2002 and $212.4 million in 2001. The 2003
increase in consolidated before-tax net investment income of $1.6 million is
attributable to an increase in investment assets held, partially offset by
increased investment expenses attributable to the implementation of a new
investment accounting system, lower average yields on its fixed income
portfolio, and increased investment management fees from expanded use of
outside investment managers. As part of a conversion to a new investment
accounting system in 2003, $5.9 million before tax expense was recorded for a
change in accounting estimate relating to amortization of interest only
mortgage-backed securities and asset-backed securities. Offsetting most of
this charge was a $5.3 million credit for interest received on a federal
income tax settlement.
The decrease in investment income of $5.3 million before tax in 2002 was
attributable to the significant decline in reinvestment rates on fixed
maturity investments. This decline in rates in 2002 was partially offset by
increased investment in fixed maturities following the reallocation of the
equity portfolio in 2002 and 2001. The reallocation in the investment
portfolio reduced holdings of equity securities and increased holdings of
investment grade fixed maturity securities. After-tax investment income
totaled $138.4 million in 2003 compared with $136.9 million in 2002 and
$141.3 million in 2001.
28
Item 7. Continued
Consolidated before-tax realized net investment gains amounted to $35.9
million in 2003, $45.2 million in 2002 and $182.9 million in 2001.
Throughout 2002 and 2001 equity securities were sold, many of which had
substantially appreciated in value in earlier periods. These sales were part
of a program to reduce exposure to the market volatility of equity
securities.
During 2003 and 2002, there were no significant realized losses on sales of
securities. In 2001, a loss of approximately $6.8 million before tax was
realized on the sale of fixed maturity securities 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.
In the first quarter of 2003, management decided to transfer a portion of its
fixed maturity securities from the available-for-sale classification into the
held-to-maturity classification. This transfer was made as the Corporation
and the Group have both the ability to hold the securities to maturity and
the positive intent to do so. At December 31, 2003, the amortized cost of
the held-to-maturity portfolio was $356.1 million.
Invested assets comprise a majority of the consolidated 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 Footnote 1C on page 62 of this
Form 10-K. The Corporation and the Group continually evaluate all of
their investments based on current economic conditions, credit loss
experience and other developments. The difference between the cost and
estimated fair value of investments is continually evaluated 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 consolidated statements of
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. The amount of impairment charge before tax was
$10.5 million in 2003, compared to $10.9 million and $12.0 million in 2002
and 2001, respectively. The impairment charge represents .3% of the market
value at December 31, 2003, 2002 and 2001, respectively of the investment
portfolio. During 2003, certain AMR Corporation and Delta Air Lines, Inc.
fixed maturity investments were written down by $3.9 million and $2.0
million, respectively. The write-down amounts were determined by the
difference between fair value and cost of the securities at the time of the
write-down. Management determined that these securities have an other-than-
temporary impairment of value based on its review, which is described above.
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, a competitive
investment yield 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 following tables summarize for all available-for-sale securities and
held-to-maturity securities, the total gross unrealized losses, excluding
gross unrealized gains, by investment category and length of time the
securities have continuously been in an unrealized loss position as of
December 31, 2003:
29
Item 7. Continued
Available-for-sale with unrealized losses:
(in millions)
Less than 12 months 12 months or longer Total
---------------------- ---------------------- ----------------------
Fair Value Unrealized Fair Value Unrealized Fair Value Unrealized
Losses Losses Losses
---------------------- ---------------------- ----------------------
Securities:
U.S. Government $ 14.8 $ (.1) $ - $ - $ 14.8 $ (.1)
States, municipal-
ities and political
subdivisions 9.0 (.2) - - 9.0 (.2)
Corporate securities 248.4 (6.5) 37.0 (1.9) 285.4 (8.4)
Mortgage-backed
securities:
Other 242.2 (6.8) 19.2 (1.2) 261.4 (8.0)
- --------------------------------------------------------------------------------------------
Total fixed maturities 514.4 (13.6) 56.2 (3.1) 570.6 (16.7)
Equity securities .7 - 1.6 - 2.3 -
- --------------------------------------------------------------------------------------------
Total temporarily
impaired securities $515.1 $(13.6) $57.8 $(3.1) $572.9 $(16.7)
============================================================================================
Held-to-maturity with unrealized losses:
(in millions)
Less than 12 months 12 months or longer Total
---------------------- ---------------------- ----------------------
Fair Value Unrealized Fair Value Unrealized Fair Value Unrealized
Losses Losses Losses
---------------------- ---------------------- ----------------------
Securities:
Corporate securities $106.0 $(1.8) $ 5.0 $ (.2) $111.0 $(2.0)
Mortgage-backed
securities:
Other 115.7 (1.9) 27.7 (.6) 143.4 (2.5)
- ---------------------------------------------------------------------------------------------
Total temporarily
impaired securities $221.7 $(3.7) $32.7 $ (.8) $254.4 $(4.5)
=============================================================================================
As part of the evaluation of the entire $21.2 million aggregate unrealized
loss on the investment portfolio, management performed a more intensive
review of securities with a relatively higher degree of unrealized loss.
Based on a review of each security, management believes that unrealized
losses on these securities were temporary declines in value at December 31,
2003. In the table above, there are approximately 190 securities
represented. Of this total, 31 securities have unrealized loss positions
greater than 5% of their market values at December 31, 2003 with none
exceeding 20%. This group represents $10.0 million, or 47% of the total
unrealized loss position. Of this group, 22 securities representing
approximately $7.1 million in unrealized losses have been in an unrealized
loss position for less than twelve months. Of the remaining nine securities
in an unrealized loss position for longer than twelve months totaling $2.9
million, management believes that they will recover the cost basis of these
securities, and have both the intent and ability to hold the securities until
they mature or recover in value. All securities are monitored by portfolio
managers who consider many factors such as an issuer's degree of financial
flexibility, management competence and industry fundamentals in evaluating
whether the decline in fair value is temporary. In addition, management
considers whether it is probable that all contract terms of the security will
be satisfied and whether the unrealized loss position is due to changes in
the interest rate environment. Should management
30
Item 7. Continued
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 consolidated statements of income.
The amortized cost and estimated fair value of available-for-sale and held-
to-maturity fixed maturity securities in an unrealized loss position at
December 31, 2003, 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.
Available-for-sale: Amortized Estimated Unrealized
(in millions) Cost Fair Value Loss
- --------------------------------------------------------------------------------
Due in one year or less $ 7.0 $ 6.3 $ (0.7)
Due after one year through
five years 12.5 12.0 (0.5)
Due after five years through
ten years 108.7 106.4 (2.3)
Due after ten years 459.1 445.9 (13.2)
- --------------------------------------------------------------------------------
Total $587.3 $570.6 $(16.7)
Held-to-maturity: Amortized Estimated Unrealized
(in millions) Cost Fair Value Loss
- --------------------------------------------------------------------------------
Due in one year or less $ - $ - $ -
Due after one year through
five years 5.5 5.4 (0.1)
Due after five years through
ten years 74.7 73.5 (1.2)
Due after ten years 178.7 175.5 (3.2)
- --------------------------------------------------------------------------------
Total $258.9 $254.4 $(4.5)
Reinsurance Programs
The Group renewed all of its reinsurance programs for 2003 with only moderate
changes in the program structure. Although the terrorist events of September
11, 2001 had a significant impact on the reinsurance market, the Group's
reinsurance contracts continue to include coverage for acts of terrorism.
Instead of being unlimited as in the past, terrorism coverage in the 2003
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 Group
has renewed its reinsurance programs for 2004 except for the bond reinsurance
treaty that is expected to be renewed at the April 1, 2004 expiration date.
The 2004 program maintains a $1.0 million loss retention level for most
risks, but the property per risk treaty has a $1.5 million loss retention
level. In addition, beginning in 2004, the Group retains 7 percent of all
umbrella losses applicable to the $20.0 million excess of $5.0 million layer.
The top layer of the property catastrophe treaty was reduced from $50 million
excess of $75 million to $30 million excess of $75 million, reflecting
reduced exposure for personal lines of business. Pricing for the 2004
program reflected flat pricing for the property treaties on average and
double digit increases for the casualty treaties on average.
Internally Developed Software
In 2001, the Group introduced into limited production an internally developed
software application for issuing and maintaining insurance policies named
P.A.R.I.S.sm, a policy administration, rating and issuance system. During
2003, the Group began capitalizing application development costs associated
with the Personal Lines segment, which are expected to begin roll out in 2005
and continued capitalization for the Specialty Lines segment which are
expected to be rolled out beginning in 2005. During 2002, the Group
substantially completed the rollout for the Commercial Lines operating
segment. A rollout begins when the application has been placed into service
for one or more states for an individual major product line and ends when the
application is placed into service
31
Item 7. Continued
for the final state. The rollout period can exceed one year for an
individual major product line. 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 with before tax amortization expense of $2.6 million,
$1.3 million and $.2 million for 2003, 2002 and 2001, respectively. Upon
full implementation of all major product lines, the new application should
impact results by approximately $4.0 million to $6.0 million before tax per
year in amortization expense until 2015. Capitalized internally developed
software costs (including P.A.R.I.S.sm and other internally developed
software) and accumulated amortization are summarized in the table below:
(in millions) 2003 2002 2001
- -----------------------------------------------------------------------------
Cost $52.0 $50.3 $41.4
Accumulated amortization 7.2 3.7 1.0
- -----------------------------------------------------------------------------
Carrying value $44.8 $46.6 $40.4
Management believes the carrying value of the asset is appropriate. 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. The Group periodically reviews the asset for
impairment as events or circumstances arise that may affect the carrying
value.
Statutory Results
Management uses statutory financial criteria to analyze the Group's property
and casualty results and insurance industry regulators require the Group to
report statutory financial measures. Management analyzes statutory results
through the use of insurance industry financial measures including statutory
loss and LAE ratios, statutory underwriting expense ratio, statutory combined
ratio, net premiums written and net premiums earned. The statutory combined
ratio is a commonly used gauge of underwriting performance measuring the
percentages of premium dollars used to pay insurance losses and related
expenses. The combined ratio is the sum of the loss ratio, the loss
adjustment expense ratio and the underwriting expense ratio. 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
as calculated on an accident year basis. A discussion of the differences
between statutory accounting and generally accepted accounting principles in
the United States is included in Footnote 15 on pages 73 and 74 of this
Form 10-K.
Insurance industry financial measures are included in the next several
sections of this MD&A that discuss results of operations. Statutory surplus,
a financial measure that is required by insurance regulators and used to
monitor financial strength, is discussed in the "Statutory Surplus" section
of the "Liquidity and Financial Strength" portion of this MD&A.
All Lines Discussion
Statutory net premiums written decreased $7.0 million in 2003 to $1,441.6
million. The decline in statutory net premiums written over 2002 reflects
the Group's efforts to restructure its risk profile as Personal Lines
withdrew from select markets and Commercial Lines implemented stricter
underwriting guidelines, including the non-renewal of certain construction
defect related risks. In addition, the decline in net premiums written from
last year also reflects the impact of higher reinsurance costs. Net premiums
written totaled $1,448.6 million in 2002 and $1,472.2 million in 2001. The
slight decline of net premiums written in 2002 when compared to 2001 is
primarily attributable to the reduction in premiums related to the non-
renewal of the Group's New Jersey private passenger auto business which began
to be non-renewed in March of 2002.
32
Item 7. Continued
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
2003 2002 2001
- ------------------------------------------------------------
New Jersey 11.1% 12.5% 17.4%
Ohio 9.2% 9.4% 9.8%
Pennsylvania 8.5% 7.9% 6.8%
Kentucky 8.2% 7.7% 7.9%
Illinois 5.3% 5.3% 5.1%
New Jersey is the Group's largest state with 11.1% of the total net premiums
written during 2003. 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.
The All Lines combined ratio improved 6.7 points to 106.1% in 2003, compared
with 112.8% in 2002 and 115.3% in 2001. An improved underwriting expense
ratio and lower losses and LAE contributed to the All Lines combined ratio
improvement in 2003. The combined ratio benefited from a reduction in
personnel and sales related expenses. These two items, somewhat offset by
increased expenses for technology including amortization of internally
developed software, contributed to the .8 point reduction in the underwriting
expense ratio from 34.9% in 2002 to 34.1% in 2003. The loss and LAE ratio
decreased 5.8 points from 77.9% in 2002 to 72.1% in 2003. The loss and LAE
ratio was impacted by $34.1 million and $84.4 million of before tax prior
accident year reserve development in 2003 and 2002, respectively, which added
2.4 points and 5.8 points to the 2003 and 2002 All Lines combined ratio,
respectively. The remaining improvement of 2.4 points in the 2003 loss and
LAE ratio over 2002 was due to significant improvement in the Personal Lines
loss ratio primarily related to the withdrawal from New Jersey personal auto
and a decrease in non-catastrophe experience for the personal property
product lines.
The All Lines combined ratio improved 2.5 points in 2002 compared to 2001 due
primarily to improvement in the Personal Lines and Commercial Lines loss and
LAE ratio. The positive improvements resulted from tighter underwriting
standards, lower catastrophe losses and large losses offset by increases in
loss and LAE reserves due to adverse prior years development, primarily
related to construction defect losses.
The loss and LAE ratios were impacted negatively in 2003, 2002 and 2001 by
adjustments to estimated losses related to prior years' business. The loss
and LAE ratio components 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 2003, the All Lines accident year combined ratio was 103.7%, which is 2.4
points better than the All Lines calendar year combined ratio of 106.1%. The
All Lines combined ratio for accident years 2002 and 2001, measured as of
December 31, 2003, were 104.2% and 110.9%, respectively.
33
Item 7. Continued
The table below summarizes the impact of changes in provision for all prior
accident year losses and LAE:
(in millions) 2003 2002 2001
- ----------------------------------------------------------------------------
Statutory net liabilities,
beginning of period $2,078.7 $1,982.0 $1,907.3
Increase in provision for prior
accident year claims $34.1 $84.4 $58.5
Increase in provision for prior
accident year claims as % of
premiums earned 2.4% 5.8% 3.9%
In 2003, the impact of this adverse development for prior accident years'
losses and LAE was concentrated in the commercial multi-peril product line of
the Commercial Lines operating segment and in the personal auto product line
of the Personal Lines operating segment. The commercial umbrella product
line experienced significant favorable development for prior years' losses
and LAE, primarily due to a reduction in estimated future costs for claims
adjuster related expenses. The total provision for prior years' losses and
LAE of $34.1 million before tax represents 1.6% of loss and LAE reserves as
of year-end 2002.
The comparable amount of provision for prior years' losses and LAE recognized
during the year 2002 was $84.4 million before tax representing 4.3% of loss
and LAE reserves as of year-end 2001. This was concentrated in the
commercial auto and general liability product lines of the Commercial Lines
operating segment.
The comparable amount for provisions for prior years' losses and LAE
recognized during the year 2001 was $58.5 million before tax. This
represents 3.1% of loss and LAE reserves as of year-end 2000. This was
concentrated primarily in the workers' compensation and general liability
product lines.
The 2002 combined ratio includes a reallocation of LAE reserve estimates
related to claims adjuster salaries, benefits and similar costs from the
Commercial and Specialty Lines segments to the Personal Lines segment. This
increased the 2002 Personal Lines segment combined ratio by 1.5 points and
decreased the Commercial and Specialty Lines segments combined ratios by .6
points and 2.4 points, respectively.
Catastrophe losses in 2003 totaled $43.8 million, compared with $20.8 million
in 2002 and $34.6 million in 2001. The Group was impacted by 21 separate
catastrophes in 2003, compared with 25 catastrophes in 2002 and 19 in 2001.
Catastrophe losses added 3.1 points to the combined ratio in 2003, compared
with 1.4 points in 2002 and 2.3 points in 2001. 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) 2003 2002 2001
- ------------------------------------------------------------------------
Dollar Impact (in millions) $43.8 $20.8 $34.6
Statutory Combined
Ratio Impact 3.1% 1.4% 2.3%
34
Item 7. Continued
The seven-year historical catastrophe impact on the loss ratio compared to
2003 actual for all lines of business were:
Loss Ratio Point Impact Q1 Q2 Q3 Q4 Annual
- -----------------------------------------------------------------------------
1997-2003 Historical Average 1.6 4.7 3.1 0.8 2.6
2003 Actual 3.2 4.0 4.5 0.7 3.1
The underwriting expense ratio, which measures underwriting expenses as a
percentage of net premiums written, decreased by .8 points in 2003 to 34.1%
compared with 34.9% in 2002 and 35.4% in 2001. The 2003 underwriting expense
ratio was favorably impacted by a reduction in employee related costs and
lower sales related expenses as a percentage of premiums, and was partially
offset by higher expenses related to investments in technology. Sales
related expenses for 2003 included the resumption of a ceding commission for
certain layers of commercial umbrella reinsurance and also agent bonus
commission levels more similar to years prior to 2002. The employee count
continued to decline in 2003 with an 11.2% decline over 2002, resulting in
part from claim staff reorganization and underwriting facility
consolidations. The employee count was 2,669, 3,004 and 3,365 as of December
31, 2003, 2002 and 2001, respectively.
The underwriting expense ratio for the year 2002 decreased compared to 2001
due primarily to the 2001 impact of 2.7 points related to the $40.6 million
New Jersey transfer fee. The year 2002 underwriting expense ratio
experienced upward pressure 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 at a relatively high level due to higher than
expected umbrella net premiums written, which had a relatively high
commission rate on a net of reinsurance basis and to higher than expected
accruals for agent bonus commissions.
The 2003, 2002 and 2001 statutory underwriting expenses also included $5.2
million, $2.6 million and $.5 million of software amortization expense before
tax, respectively, related to the rollout of P.A.R.I.S.sm, a new internally
developed software application. On a statutory accounting basis, the new
application is being amortized over a five-year period (compared to ten-year
period under GAAP) in accordance with statutory accounting principles.
During 2002, the Group substantially completed the rollout of the new
application for the Commercial Lines segment. During 2003, the Group began
capitalizing application development costs associated with the Personal Lines
segment which are expected to begin rollout in 2005. The Specialty Lines
segment is on target for rollout in the beginning of 2005. 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 2010. 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, excess
35
Item 7. Continued
insurance and fidelity and surety 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. The following tables provide key financial measures for each of
the property and casualty reportable segments:
Commercial Lines Segment
(in millions) 2003 2002 2001
- --------------------------------------------------------------------------
Net premiums written $792.6 $762.2 $689.6
Net premiums earned $777.4 $725.6 $707.6
Loss ratio 61.4% 60.8% 64.5%
Loss expense ratio 14.5% 18.0% 15.3%
Underwriting expense ratio 36.4% 36.3% 36.4%
Specialty Lines Segment
(in millions) 2003 2002 2001
- --------------------------------------------------------------------------
Net premiums written $164.9 $179.9 $136.1
Net premiums earned $162.7 $158.5 $130.6
Loss ratio 28.7% 39.0% 42.0%
Loss expense ratio 5.0% 11.0% 10.4%
Underwriting expense ratio 43.5% 44.1% 38.4%
Personal Lines Segment
(in millions) 2003 2002 2001
- --------------------------------------------------------------------------
Net premiums written $484.1 $506.5 $646.5
Net premiums earned $484.3 $566.3 $668.0
Loss ratio 67.5% 70.5% 73.4%
Loss expense ratio 11.0% 14.0% 12.1%
Underwriting expense ratio 27.1% 29.6% 33.7%
Commercial Lines Segment
The Commercial Lines combined ratio for the year 2003 decreased 2.8 points to
112.3% from 115.1% in 2002. The improvement in the combined ratio occurred
in spite of 5.3 points of adverse development on loss and LAE reserves
primarily in the workers' compensation and commercial multiple peril product
lines. The combined ratio improved from 2001 to 2002 by 1.1 points. This
improvement was less than expected due to $73.9 million of adverse
development in loss and LAE reserves from prior years adding 10.2 points to
the 2002 combined ratio. Of this amount, approximately $51.6 million related
to construction defect issues which added 7.1 points to the combined ratio
for 2002. Renewal price increases had a positive impact during 2003, 2002
and 2001. The 2003 average renewal price increase was 11.4% for Commercial
Lines direct premiums written, compared with 16.3% and 15.2% average renewal
price increases(1) in 2002 and 2001, respectively. The 2003 average renewal
price increase is lower than in prior years due to a broad trend indicating
that Commercial Lines policies are approaching price adequacy and competitive
pricing pressures in the marketplace are increasing.
(1)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.
36
Item 7. Continued
Commercial Lines results for 2003 included higher than expected catastrophe
losses and large non-catastrophe losses compared to 2002. Catastrophe losses
added 2.6 points in 2003 to the Commercial Lines combined ratio, compared to
0.5 points in 2002 and 1.0 point in 2001. Large non-catastrophe losses
related to current accident year losses measured as of December 31 added 7.2
points, 4.6 points and 5.5 points to the combined ratio for 2003, 2002 and
2001, respectively.
The workers' compensation product line combined ratio decreased 6.2 points in
2003 to 123.0%, despite 7.1 points of adverse prior years loss and LAE
reserve development, 3.8 points of which was due to increased reserves on two
lifetime workers' compensation claims. Although this line continues to
experience adverse development on prior accident years', the combined ratio
has decreased for the third year in a row. In 2002, the combined ratio
decreased 9.4 points to 129.2%, compared to 138.6% in 2001. The loss ratio
was the main component driving the high combined ratios in all three years.
The 2003 workers' compensation loss ratio was 78.3% compared to 80.6% in 2002
and 95.8% in 2001. Adverse development of prior year losses due to an
increase in claims severity contributed to the poor results for all three
years. The 2003 accident year loss ratio of 69.0% was 9.3 points lower than
the 2003 calendar year loss ratio. The 2002 and 2001 accident year loss
ratios were 72.5% and 73.3%, respectively, which were 8.1 points and 22.5
points lower than the respective calendar year loss ratios.
Although the Group has taken actions to improve workers' compensation
results, including a more conservative underwriting appetite in states where
there is rate inadequacy despite the attainment of double-digit renewal
increases for the year, the product line continues to be negatively impacted
by assessments for the National Workers' Compensation residual market pool.
The impact of the National Workers' Compensation residual market pool added
4.5 points to the workers' compensation combined ratio in 2003, compared to
1.5 points in 2002 and decreased the ratio 1.9 points in 2001.
The Group continued to achieve average renewal price increases for workers'
compensation of 14.7% for 2003, compared with increases of 20.1% and 16.6%
for 2002 and 2001, respectively. Net premiums written for 2003, 2002 and
2001 totaled $132.4 million, $143.9 million, and $148.6 million,
respectively. The continued decrease in net premiums written for workers'
compensation is the result of the Group's initiative to responsibly price and
underwrite this product line in order to make the line more profitable.
The commercial auto product line net premiums written increased $14.9 million
or 7.0% to $228.3 million in 2003. During 2002, net premiums written for
this line increased $26.7 million, or 14.3% to $213.4 million, compared with
$186.7 million in 2001. The 2003, 2002 and 2001 increases were driven by
renewal price increases, averaging 11.0%, 15.2% and 15.5%, respectively.
The 2003 commercial auto combined ratio improved 4.7 points to 105.5%
compared to 110.2% in 2002. This improvement is largely due to improved
underwriting, the effect of renewal price increases and less adverse loss and
LAE reserve development from prior years. The 2002 commercial auto combined
ratio increased to 110.2%, from 107.6% in 2001. The increase in the combined
ratio from 2001 is due to greater than expected average settlement amounts
(loss severity) from prior years. The accident year combined ratios for this
line were 104.6% in 2003, 99.0% in 2002 and 105.2% in 2001. The increase in
the accident year combined ratio from 2002 is due to an increase in the
number of large losses as measured by higher average paid losses and case
reserves.
Net premiums written for the commercial multiple peril, fire and inland
marine product lines increased 8.7% to $348.4 million in 2003. These product
lines also experienced an increase in 2002 of 16.4% to $320.4 million,
compared with $275.2 million in 2001. The combined ratio increased in 2003
to 109.7% as a result of higher than expected catastrophe losses, large
property losses and adverse
37
Item 7. Continued
prior years loss development. Catastrophe losses added 6.3 points to the
combined ratio in 2003, compared to 1.5 and 2.9 points in 2002 and 2001,
respectively. Large property losses were $22.5 million in 2003, which added
6.7 points to the combined ratio compared with $16.2 million in 2002, adding
5.4 points to the 2002 combined ratio. Adverse development in 2003 added 7.1
points to the 2003 combined ratio compared to .6 points in 2002. In 2002,
the combined ratio decreased to 95.8% from 106.4% in 2001. The improvement
from 2001 to 2002 resulted from strong new and renewal pricing and more
selective and focused underwriting.
Net premiums written for the monoline general liability product line
decreased slightly to $83.4 million compared to $84.5 million in 2002 and
$79.0 million in 2001. The small decrease in 2003 is a result of actions
taken on classes of business potentially subject to construction defect
losses. The increase from 2001 to 2002 is due to higher new and renewal
pricing levels.
The general liability product line combined ratio decreased 48.7 points in
2003 to 122.6%, compared to 171.3% in 2002. The large decrease is due to a
higher than desired 2002 loss ratio, which is attributable to 57.8 points of
adverse development in 2002 compared to 8.2 points of adverse development in
2003. The 2001 combined ratio was 120.8%. The accident year combined ratio
for 2003 was 114.4% compared to 108.8% and 122.9% in 2002 and 2001,
respectively. The increase in the 2003 accident year combined ratio is a
result of higher severity for this line of business. The difference between
the accident and calendar year results in 2002 is primarily due to increases
in residential general contractors and developers related construction defect
reserves established for prior accident years 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 classes of business that are more prone to construction defect
claims.
Statutory Earned Premium
and Combined Ratios
Combined Ratios
------------------------------------------------------
(by operating segment, 2003 Accident Accident Accident
including selected Earned Year Year Year
major product lines) Premium 2003 2003(a) 2002 2002(a) 2001 2001(a)
===============================================================================================
Commercial Lines $ 777.4 112.3% 107.1% 115.1% 101.3% 116.2% 109.8%
Workers' Compensation 134.7 123.0% 115.9% 129.2% 116.1% 138.6% 111.2%
Auto Commercial 221.2 105.5% 104.6% 110.2% 99.0% 107.6% 105.2%
General Liability 84.4 122.6% 114.4% 171.3% 108.8% 120.8% 122.9%
CMP, Fire & Inland Marine 337.1 109.7% 103.3% 95.8% 93.8% 106.4% 107.6%
Specialty Lines 162.7 77.2% 90.3% 94.0% 89.4% 90.8% 82.3%
Commercial Umbrella 120.5 80.5% 93.3% 97.7% 94.5% 93.6% 81.6%
Fidelity & Surety 41.8 68.1% 81.1% 81.7% 74.2% 76.8% 76.5%
Personal Lines 484.3 105.6% 102.7% 114.1% 111.2% 119.2% 117.6%
New Jersey personal
auto (b) 1.2 648.1% 257.3% 154.8% 138.3% 152.2% 143.4%
Other personal lines 483.1 104.0% 102.1% 107.9% 107.1% 111.8% 111.8%
Other personal auto 295.2 105.2% 102.6% 107.1% 106.7% 107.1% 108.8%
Homeowners 154.6 106.9% 105.8% 110.3% 111.4% 120.5% 119.3%
- -----------------------------------------------------------------------------------------------
Total All Lines $1,424.4 106.1% 103.7% 112.8% 104.2% 115.3% 110.9%
===============================================================================================
(a) 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. Accident year 2003
as of December 31, 2003 measures insured events for the twelve months of
2003. Accident year 2002 as of December 31, 2003 measures insured events for
the twelve months of 2002 with remaining related liabilities estimated as of
December 31, 2003. Accident year 2001 as of December 31, 2003 measures
insured events for the twelve months of 2001 with remaining related
liabilities estimated as of December 31, 2003. Accident periods may not be
comparable due to seasonality, claim reporting and development patterns,
claim settlement rates and other factors.
(b) The Group exited the New Jersey private passenger automobile market in
March 2002 which was completed in March 2003. The combined ratio in 2003
for New Jersey personal auto is larger than normal due to prior year loss
development in relation to significantly reduced premium levels from this
business.
38
Item 7. Continued
Specialty Lines Segment
Specialty Lines combined ratio for 2003 improved 16.8 points to 77.2%
compared to 94.0% and 90.8% for 2002 and 2001, respectively. The improvement
in the 2003 combined ratio is due primarily to overall favorable development
on prior accident year loss and LAE reserves of $21.3 million compared to
favorable development in 2002 of $2.2 million and adverse development of $4.1
million in 2001.
The fidelity and surety product lines in the Specialty Lines segment
contributed to the favorable results for this segment. Fidelity and surety
net premiums written decreased slightly to $43.9 million, compared to $45.6
million and $38.7 million in 2002 and 2001, respectively. Despite lower net
premiums written in 2003, the combined ratio improved to 68.1% in 2003,
compared with 81.7% in 2002 and 76.8% in 2001. The improvement in the 2003
fidelity and surety combined ratio was the result of favorable development on
prior accident year loss and LAE reserves of $5.5 million and overall lower
losses for this product line. During the fourth quarter of 2002, there was a
return of ceded premium of $5.3 million before tax for the fidelity and
surety 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 decreased $11.8
million, or 8.9% in 2003 to $120.9 million, compared with $132.7 million in
2002 and $92.2 million in 2001. Higher reinsurance costs in 2003, driven by
the addition of a ceding commission and by increased reinsurance rates per
dollar of premium, had a negative impact on net premiums written. The
addition of ceding commissions on the current reinsurance contract causes a
corresponding increase to ceded premiums. Average renewal price increases
were 18.1%, compared to 37.6% in 2002 and 20.3% in 2001. The 2003 combined
ratio was 80.5% compared to 97.7% and 93.6% in 2002 and 2001, respectively.
The improved combined ratio in 2003 was largely attributable to favorable
development on prior accident year loss and LAE reserves due largely to a
reduction in estimated future costs for commercial umbrella claims adjuster
related expenses that favorably impacted the Specialty Lines combined ratio
by 6.8 points.
Personal Lines Segment
The Personal Lines combined ratio for 2003 decreased 8.5 points to 105.6%
compared to 114.1% in 2002 and 119.2% in 2001. Every product line in the
Personal Lines operating segment registered an improved combined ratio in
2003 compared to 2002. The improvement is driven by the withdrawal from New
Jersey private passenger auto market which began in 2002, premium rate
increases, a significant improvement in the non-catastrophe experience for
homeowners and a decline in the underwriting expense ratio. The 5.1 point
improvement in 2002 is attributable to the implementation of price increases,
insurance scoring, enhanced claims management procedures, withdrawal from
states that have proven unprofitable and lower than average losses from
catastrophes. The Group continued to narrow its geographic focus in Personal
Lines during 2003. The Group has received all necessary approvals from
regulators to withdraw its Personal Lines business from Florida, Georgia and
Texas. These three states contributed approximately $3.0 million to net
premiums written in 2003. Personal lines excluding New Jersey private
passenger auto results and the effects of the withdrawal states and cancelled
agents would have grown by approximately 9.0% in 2003. The Group does not
write any lines of business in California.
Net premiums written for private passenger auto decreased in 2003 by $28.6
million to $292.7 million compared to $321.3 million in 2002 and $451.2
million in 2001. This product line has decreased, as expected, due to the
Group's strategy to withdraw from certain states. Agency cancellations also
contributed to the decline in premiums in 2003, 2002 and 2001. The combined
ratio for private
39
Item 7. Continued
passenger auto improved during 2003 by 8.6 points to 107.7% compared to 116.3%
in 2002 and 118.9% in 2001. The Group is implementing price increases and
claims management procedures to further improve results.
Given the unfavorable regulatory environment and uncertainty over the future
profitability for private passenger auto in New Jersey, 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 "Results of Operations - Net Income" section,
has allowed the Group to complete its exit from the New Jersey personal lines
auto market in early 2003. 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. 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 contributed to 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.
Homeowners product line net premiums written increased 2.3% in 2003 to $157.2
million compared to $153.7 million in 2002 and $162.0 million in 2001. The
Group has placed emphasis on price increases, coverage restrictions,
insurance scoring and agency management. Average implemented rate increases
were 22.0%, 10.1% and 2.8% in 2003, 2002 and 2001, respectively.
The 2003 homeowners combined ratio decreased 3.4 points to 106.9% compared to
a 10.2 point decrease in 2002 to 110.3%. This compares with a combined ratio
of 120.5% in 2001. The improvement in 2003 is attributable to improved
underwriting discipline and aggressive pricing. Combined ratios are heavily
impacted by catastrophe losses which added 11.8 points to the combined ratio
in 2003, 8.7 points in 2002 and 12.3 points in 2001.
LIQUIDITY AND FINANCIAL STRENGTH
Cash Flow
Net cash generated from operations was $168.7 million compared with cash
generated of $148.2 million in 2002 and $70.2 million in 2001. The increase
for the year 2003 compared to 2002 is due primarily to a $57.2 million
reduction in paid losses and LAE as operating revenues for the two years were
roughly equal. This increase in cash was partially offset by an increase in
payments to reinsurers for premium cessions, contingent commission bonus
payments to agents and the final payments of the replacement carrier fee for
New Jersey private passenger auto business. The increase in the reinsurance
recoverable asset did not significantly impact cash flow in 2003 since there
was a corresponding increase in liabilities for most of the increase in this
asset. The reinsurance recoverable asset increased $172.8 million with
$141.9 million due to increases in loss reserves for future loss payments
expected to be paid by reinsurers along with other components as shown in
Footnote 7 on page 70 of this Form 10-K. The increase in reinsurance
recoverables is due primarily to the Group writing more commercial umbrella
business, most of which the premiums and losses are ceded to reinsurers,
resulting in an increase in the reinsurance recoverable asset and a
corresponding increase in ceded loss, LAE and unearned premium reserves.
The increase in cash generated from operations in 2002 was also due primarily
to a reduction in paid losses and paid LAE offset partially by payments of
the replacement carrier fee for New Jersey private passenger auto business.
40
Item 7. Continued
Investing activities used net cash of $175.6 million in 2003, compared with
net cash used of $173.7 million in 2002 and $57.4 million in 2001. The
Corporation and the Group purchased fewer fixed maturity securities in 2003
as prepayments on mortgage backed securities were reduced in 2003 compared to
2002, leaving less cash flow to reinvest. Proceeds from the sale of equity
and fixed maturity securities also continues to decline as the Corporation
and the Group are maintaining the current portfolio which contains primarily
investment grade corporate and mortgage backed securities. Cash inflows from
the sale of property and equipment increased over 2002 as the Group sold a
building located in Lexington, Kentucky including the related office
equipment and land for sales proceeds of $4.6 million.
Total cash generated in financing activities was $1.6 million in 2003,
compared to cash used of $4.6 million and $10.5 million in 2002 and 2001,
respectively. Cash generated by financing in 2003 resulted from the exercise
of stock options partially offset by principal payments on the low interest
rate loan from the State of Ohio. This compares to cash used for financing
activities in 2002, which included the repayment of the Corporation's $205.0
million credit facility and issuance of new convertible debt with net
proceeds of $194.0 million.
Overall, total cash used in 2003 was $5.3 million, compared to $30.1 million
in 2002 and cash generated of $2.3 million in 2001. To further strengthen
its financial position, the Corporation did not pay any shareholder dividends
for the years presented. On a regular basis management analyzes the
profitability and capital position of the Group and the liquidity of the
Corporation, including the Corporation's evaluation of whether to reinstitute
a dividend to shareholders of the Corporation or a share repurchase program.
The Corporation is dependent on dividend payments from its insurance
subsidiaries in order to meet operating expenses and debt obligations.
Insurance regulatory authorities impose various restrictions and prior
approval requirements on the payment of dividends by insurance companies. As
of December 31, 2003, approximately $86.8 million of statutory surplus was
not subject to prior dividend approval requirements. Additional restrictions
may result from the minimum net worth and surplus requirements in the credit
agreement as disclosed in Footnote 16 on pages 74 and 75 of this Form 10-K.
Off-Balance Sheet Arrangements and Contractual Obligations
As of December 31, 2003, 2002 and 2001, the Corporation did not have any off-
balance sheet arrangements as defined by Financial Release - 67, "Disclosure
in Management's Discussion and Analysis about Off-Balance Sheet Arrangements
and Aggregate Contractual Obligations."
The following table presents the Corporation's obligations to make future
payments under contractual obligations:
41
Item 7. Continued
($ in millions) Payments Due by Period
- --------------------------------------------------------------------------------
Less More
than 1-3 3-5 than 5
Contractual Obligations Total 1 year years years years
- ----------------------- ----- ------ ----- ----- ------
Long-term debt* $ 4.4 $ .7 $ 1.5 $ 1.5 $ .7
Operating leases 18.2 4.5 7.1 4.7 1.9
Purchase obligations 80.2 35.7 33.3 11.2 -
Other long-term
Liabilities** 94.7 71.4 14.0 2.9 6.4
- --------------------------------------------------------------------------------
Total contractual cash
obligations $197.5 $112.3 $55.9 $20.3 $9.0
*Excluded from long-term debt obligations are the convertible notes with
outstanding principal of $201.3 million which is due on March 19, 2022 and
semi-annual interest payments of $5.0 million. The notes may be converted
into common stock under certain conditions described in Footnote 16 on pages
74 and 75 of this Form 10-K and disclosed separately below.
**Excluded from other long-term liabilities are pension obligations which are
described in Footnote 5 on pages 67 through 69 of this Form 10-K and
disclosed separately below. Also excluded are loss and LAE reserves as the
timing of payout is uncertain. For further discussion on loss and LAE
reserves, refer to the loss and LAE discussion below.
In December 2003, the FASB issued a revised Interpretation No. 46 -
Consolidation of Variable Interest Entities (FIN 46), an interpretation of
Accounting Research Bulletin No. 51. FIN 46 requires a variable interest
entity (VIE) to be consolidated by the primary beneficiary of the entity if
certain criteria are met. Some provisions of FIN 46 require certain Special
Purpose Entity's (SPE) to be consolidated as of December 31, 2003. The
Corporation does not have any investments that qualify as SPE's under these
provisions. FIN 46 also requires consolidation of all variable interests
held no later than the end of the first reporting period that ends after
March 15, 2004 (as of March 31, 2004 for the Corporation). The Corporation
currently holds one equity investment, which represents a 49% interest in the
entity, which will require consolidation in accordance with FIN 46. The
expected loss upon adoption will be immaterial to the Corporation's
consolidated financial statements. See Footnote 18 on page 75 of this
Form 10-K for further discussion.
Debt
As of December 31, 2003, the Corporation had $205.2 million of principal
outstanding on debt that includes a $3.9 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 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.
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, 2003, 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
42
Item 7. Continued
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.
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 $650.0 million. Additionally, other covenants
and customary provisions are included in the agreement. The Corporation has
not been in violation of the covenants contained in the agreement and does
not foresee any difficulties in meeting the covenant requirements in the near
future. The Corporation has not drawn on the revolver as of December 31,
2003. The credit agreement expires on March 15, 2005 and the Corporation
plans to either renew or replace the revolving credit facility. Prior to the
expiration of the current revolver, the Corporation will determine if the
principal amount of the facility should be adjusted.
Pension and Other Postretirement Benefits
The Company sponsors a defined benefit pension plan and other postretirement
benefit plans that cover substantially all employees. Several statistical and
other factors, which attempt to anticipate future events, are used in
calculating the expense and liability related to the plans. Key factors
include assumptions about the expected rates of return on plan assets,
discount rates, rate of compensation increases and health care cost trend
rates, as determined by the Company, within certain guidelines. The Company
considers market conditions, including changes in investment returns,
interest rates and inflation in making these assumptions.
The Company determines the expected long-term rate of return on plan assets
based on the geometric method, which represents the average compound return
of the plan assets. Plan assets are comprised primarily of investments in
mutual funds, common stocks, corporate bonds, U.S. government securities,
real estate investment trusts and other investments. The Company considers
the current level of expected returns on risk free investments, primarily
government bonds, the historical level of the risk premium associated with
the other asset classes and the expectations for future returns of each asset
class when developing the expected long-term rate of return on assets
assumption. The expected return for each asset class is weighted based on
the target asset allocation to develop the expected long-term rate of return
on assets assumption for the portfolio. This resulted in the selection of
the 8.75% assumption for 2003. The expected rate of return on plan assets is
a long-term assumption and generally does not change annually. The discount
rate reflects the market rate for high-quality fixed income debt instruments
on the plan's annual measurement date
43
Item 7. Continued
(September 30) and is subject to change each year. For example, holding all
other assumptions constant, a one-percentage-point increase or decrease in
the assumed rate of return on plan assets would decrease or increase,
respectively, 2004 net periodic pension expense by approximately $2.4
million.
Unrecognized losses of approximately $37.8 million are being recognized over
approximately a 14-year period, which represents the average future service
period of active participants. Unrecognized gains and losses arise from
several factors including experience and assumption changes in the
obligations and from the difference between expected returns and actual
returns on plan assets. These unrecognized losses will be systematically
recognized as an increase in future net periodic pension expense in
accordance with FASB Statement No. 87, "Employers' Accounting for Pensions."
The Company expects to contribute approximately $7.6 million to fund the
pension plan during 2004. The source for the funding will be cash flow from
operating activities.
Key assumptions used in determining the amount of the obligation and expense
recorded for postretirement benefits other than pensions (OPEB), under FASB
Statement No. 106, "Employers' Accounting for Postretirement Benefits Other
Than Pensions", include the assumed discount rate and the assumed rate of
increases in future health care costs. The discount rate used to determine
the obligation for these benefits has matched the discount rate used in
determining our pension obligations in each year presented. In estimating the
health care cost trend rate, the Company considers its actual health care
cost experience, future benefit structures, industry trends and advice from
its third-party actuaries. The Company assumes that the relative increase in
health care costs will generally trend downward over the next several years,
reflecting assumed increases in efficiency in the health care system and
industry-wide cost containment initiatives. At December 31, 2003, the
expected rate of increase in future health care costs was 10 percent for
2004, declining to 5 percent in 2013 and thereafter. 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, 2003 by
approximately $18.9 million and increase the postretirement benefit cost for
2003 by $1.7 million. 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, 2003 by approximately
$16.4 million and decrease the postretirement benefit cost for 2003 by $1.5
million.
The actuarial assumptions used by the Company in determining its pension and
OPEB retirement benefits may differ materially from actual results due to
changing market and economic conditions, higher or lower turnover and
retirement rates or longer or shorter life spans of participants. While the
Company believes that the assumptions used are appropriate, differences in
actual experience or changes in assumptions may materially affect the
Company's financial position or results of operations.
In March 2004, the Company announced changes to its defined benefit, defined
contribution and health insurance plans. The Company's traditional defined
benefit plan will be amended to freeze accrued benefits effective June 30,
2004 and to incorporate a new pension equity plan benefit formula beginning
July 2004. Also effective in July 2004, eligibility for subsidized retiree
medical and dental coverage will be restricted to then current retirees and
employees with 25 or more years of continuous service. Other employees will
be eligible for access to unsubsidized retiree medical and dental coverage.
These changes will result in a decrease in expenses of approximately $7.9
million before tax in 2004 and $5.6 million before tax in 2005 when compared
to the 2003 expense.
44
Item 7. Continued
In January 2004, the Financial Accounting Standards Board (FASB) issued FASB
Staff Position (FSP) FAS 106-1, regarding the accounting for the effects of
the Medicare Prescription Drug, Improvement and Modernization Act of 2003
(MMA). The FSP allows companies an opportunity to either assess the effect
of MMA on their retirement-related benefit costs and obligations or to defer
accounting for the effects of MMA until authoritative guidance is issued.
The Corporation has elected to defer accounting for the effects of MMA, in
accordance with the FSP. The Corporation does not expect the adoption of the
FSP to have a material impact on the financial statements.
For more information on the Company's pension and other postretirement
benefit plans, please refer to Footnote 5 on pages 67 through 69 of this
Form 10-K.
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 September 6, 2002, A.M. Best Company (A.M. Best) affirmed the Group's
financial strength rating of "A-" and assigned a positive outlook. In
addition, A.M. Best assigned an initial rating of "bbb" to Ohio Casualty
Corporation's convertible notes. On August 22, 2003, A.M. Best revised its
debt rating criteria and assigned a "bbb-" to Ohio Casualty Corporation's
convertible notes. On December 8, 2003 A.M. Best affirmed the Group's "A-"
financial strength rating and the Corporation's "bbb-" senior unsecured debt
rating and assigned stable outlooks on the ratings.
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 January 21,
2004, Fitch assigned a financial strength rating of "A-" to the Group and
also affirmed its "BBB-" senior debt and long term issuer ratings.
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 June 16, 2003,
Moody's affirmed its "Baa3" rating on the convertible notes and affirmed the
"A3" insurance financial strength ratings on the Group's intercompany pool.
Moody's also placed a stable outlook on its ratings. In addition, Moody's
also assigned prospective ratings to the $500 million universal shelf
registration filed on May 8, 2003. The prospective ratings for senior
unsecured debt, subordinated debt and preferred stock were "Baa3", "Ba1" and
"Ba2", respectively.
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 to the Corporation's convertible notes. Following the Corporation's
announcement of third quarter 2002 results, S&P revised its outlook to
negative from stable and indicated that the Group's financial strength rating
would be reviewed for possible downgrade. On April 30, 2003, S&P affirmed
its "BBB" financial strength rating for the Group and maintained its negative
outlook. On May 13, 2003 S&P assigned prospective ratings to Ohio Casualty's
universal shelf. The prospective ratings for senior unsecured debt,
subordinated debt and preferred stock were "BB", "B+" and "B", respectively.
On February 13, 2004 S&P revised its outlook to stable and affirmed its
financial strength and credit ratings on the Group and the Corporation.
45
Item 7. Continued
Generally, credit ratings affect the cost and availability of debt financing.
Often, borrowers with investment grade credit ratings can borrow at lower
rates than those available to similarly situated companies with ratings that
are below investment grade, and the availability of certain debt products may
be greater for borrowers with investment grade credit ratings. Currently,
the Corporation is a "split-rated" borrower, having investment grade ratings
from A.M. Best, Fitch and Moody's and below investment grade credit rating
from S&P. While influenced by conditions in the credit markets, it is
reasonable to anticipate that the Corporation's split rating will result in a
higher cost of borrowing as compared to borrowers with only investment grade
credit ratings. The recent improvement in the rating outlook by S&P is a
positive development in the Corporation's rating profile.
Ohio Casualty Corporation Quarterly High/Low Market Price Per Share
First Second Third Fourth
- --------------------------------------------------------------------------
2003
High 13.12 14.57 14.99 17.64
Low 11.57 11.67 13.24 14.40
- --------------------------------------------------------------------------
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
- --------------------------------------------------------------------------
Statutory Surplus
Statutory surplus, a traditional insurance industry measure of financial
strength and underwriting capacity, was $867.6 million at December 31, 2003,
compared with $725.7 million at December 31, 2002 and $767.5 million at
December 31, 2001. Statutory surplus increased 19.6% from 2002 resulting
principally from statutory net income and an increase in the market value of
equity investments. These positive factors were partially offset by $21.2
million and $4.8 million after-tax charge in 2003 and 2002, respectively for
an increase in the additional minimum liability for the pension plan. The
decline in statutory surplus during 2002 was due primarily to a decrease in
the market value of the equity investment portfolio. Statutory surplus
benefited in 2001 from the sale of a minority interest in the stock of a
subsidiary, which caused a tax benefit of $16.1 million.
The ratio of net 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, 2003, the Group's net premiums written to surplus
ratio was 1.7 to 1, compared to 2.0 to 1 in 2002 and 1.9 to 1 in 2001. The
2003 result is the strongest ratio for premiums to surplus since 1998.
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 and liability structure and product mix of the
company. As of December 31, 2003, all insurance companies in the Group
exceeded the necessary capital requirements.
46
Item 7. 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 2003 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 retention on the property
per risk excess of loss treaty increased from $1.0 million in 2003 to $1.5
million in 2004. The casualty reinsurance treaty includes a layer of
coverage of $5.0 million in excess of $1.0 million that consists of 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, 2003 was
approximately $150.5 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 $100.0 million of coverage in excess
of the Group's $25.0 million retention level. The catastrophe excess of loss
treaty changed from $100.0 million in excess of $25.0 million in 2003 to
$80.0 million in excess of $25.0 million in 2004. The treaty was written on
a multiple year basis for years 2001 - 2003 with only a portion of the
reinsurance layers expiring in a single year. This provides continuity,
maintains rates and preserves each reinsurer's share of the overall program.
Over the last 20 years, two events triggered coverage under the catastrophe
reinsurance program. Losses and LAE from the fires in Oakland, California in
1991 totaled $35.6 million and losses and LAE 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 100-250 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 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, excluding the Security Trust Fund.
As a result of these controls, amounts of uncollectible reinsurance have not
been significant. For more discussion on the reinsurance recoverable asset,
see Footnote 7 on page 70 of this Form 10-K.
47
Item 7. Continued
Loss and Loss Adjustment Expenses
The Group's largest liabilities are reserves for losses and LAE. The
accounting policies related to the loss and LAE reserves are considered
critical. Loss and LAE reserves are established for all incurred claims and
are carried on an undiscounted basis before any credits for reinsurance
recoverable. Actual losses and LAE are adjusted upward or downward as new
information is received. These reserves amounted to $2.6 billion at December
31, 2003, $2.4 billion at December 31, 2002 and $2.1 billion at December 31,
2001. As of December 31, 2003, the reserves by operating segment were as
follows: $1.6 billion Commercial Lines, $.5 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 LAE 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 management
records its best estimate of the liability for loss and LAE 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; and 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 LAE 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 asbestos
reserves because of the expansion of litigation to these types of business.
The Group's exposure to environmental liability is due to policies written
prior to the introduction of the absolute pollution endorsement in the mid-
80's, and to the underground storage tank leaks mostly from New Jersey
homeowners policies in recent
48
Item 7. Continued
years. The Group has limited exposures to the national priority list, a list
of known or threatened releases of hazardous substances, pollutants, or
contaminants throughout the United States. In 2003, the Group increased
losses and LAE by $16.0 million for environmental claims from prior accident
years. In 2002, the Group re-classified approximately $5.0 million of
homeowners reserves related to underground storage tanks as environmental
reserves. For 2003, 2002 and 2001, respectively, the asbestos and
environmental reserves, excluding the impact of reinsurance, were $78.0
million, $64.3 million and $53.5 million. Asbestos reserves were $37.6
million, $35.9 million and $31.8 million and environmental reserves were
$40.4 million, $28.4 million and $21.7 million for those respective years.
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 2003, 2002 and 2001,
respectively, were 271, 224 and 157. The paid losses, net of reinsurance, in
2003 were $16.5 million, compared to $11.4 million in 2002 and $6.7 million
in 2001. The paid claims legal related LAE, net of reinsurance, for
construction defect claims were $4.3 million in 2003, compared with $4.1
million in 2002 and $1.9 million in 2001. 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 its 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 80% of this business written during 2003 begins when losses or
LAE on an individual claim reach $10.0 million or more. The Group's limit of
coverage on an individual claim for approximately two-thirds of this business
written during 2003 is $25.0 million. For losses occurring in 2003,
reinsurance purchased by the Group limits its retention of losses to $1.0
million and 3.5% of $4.0 million excess of $1.0 million. During 2003, the
Group wrote approximately 1,900 of these excess capacity liability policies,
representing an annual growth of approximately 15% since 2001.
Results for the year 2003 were negatively impacted by losses and LAE reserves
for prior accident years totaling $34.1 million before tax on an All Lines
basis. Losses and LAE reserves for prior accident years were recognized
during the year 2003 due to new information that caused a revision to prior
estimates for loss and LAE reserves as described above. The following table
provides the before-tax expense of prior accident year loss and LAE reserve
development by reportable segment:
2003 2002 2001
- ----------------------------------------------------------------------
Commercial Lines $ 41.0 $73.9 $44.6
Specialty Lines (21.3) (2.2) 4.1
Personal Lines 14.4 12.7 9.8
- ----------------------------------------------------------------------
Total Accident Year Development $ 34.1 $84.4 $58.5
49
Item 7. Continued
For the Commercial Lines operating segment, the losses and LAE for prior
accident years recorded during 2003 were concentrated in the commercial
multi-peril, workers' compensation and general liability product lines. In
2002, the development was concentrated in the general liability, commercial
automobile and worker's compensation product lines. In 2001, the development
was concentrated in the workers' compensation and general liability product
lines.
For the Specialty Lines operating segment, the losses and LAE for prior
accident years recorded during 2003 was concentrated in the commercial
umbrella product line. Roughly half of this amount, or $11.1 million, was a
reduction in estimated future costs for commercial umbrella claims adjuster
related expenses. In 2002 and 2001, the development was concentrated in the
commercial umbrella product line.
For the Personal Lines operating segment, the losses and LAE for prior
accident years recorded during 2003 and 2002 were concentrated in the
personal automobile product line. In 2001, the development occurred in the
homeowners product line.
The reserve study in third quarter 2002 revealed that average severity (loss
per claim) and the amount of legal expense for certain types of construction
defect claims 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 LAE for this exposure was increased. For these three product lines
combined, the impact of construction defect in 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.
In 2002 the Group 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 LAE was increased by $17.0 million.
The following table provides prior year development for loss and LAE by
accident year:
2003 2002 2001
- ------------------------------------------------------------------------
Accident Year 2002 $(39.0)
Accident Year 2001 8.0 $(15.8)
Accident Year 2000 29.8 10.2 $31.1
Accident Year 1999 17.6 16.1 10.9
Accident Year 1998 & prior 17.7 73.9 16.5
- ------------------------------------------------------------------------
Total Accident Year Development $ 34.1 $ 84.4 $58.5
The amount of loss and LAE reserves by accident year at the beginning of 2003
was $621.2 million for accident year 2002, $394.2 million for accident year
2001 and $1,063.3 million for accident year 2000 and prior.
Because of the inherent uncertainties in estimating ultimate costs of claims,
actual loss and LAE 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 LAE reserve development and which serve as the basis for
estimating ultimate claim cost may not occur in exactly the same manner, if
at all.
50
Item 7. Continued
Investment Portfolio
At year-end 2003, total consolidated investments had a carrying value of $3.7
billion. The excess of market value over cost was $422.1 million, compared
with $392.2 million at year-end 2002 and $420.9 million at year-end 2001.
The increase in 2003 was attributable to the increase in the market value of
certain equity securities. The decrease in 2002 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.
At December 31, 2003, the available-for-sale fixed maturity portfolio had a
market value of $3.0 billion, which consisted of 96.7% investment grade
securities. The held-to-maturity fixed maturity portfolio is accounted for
at amortized cost, which was $356.1 million at December 31, 2003 and consists
entirely of investment grade securities.
The consolidated fixed maturity portfolio has an intermediate duration and a
laddered maturity structure. The duration of the fixed maturity portfolio is
approximately 4.6 years as of December 31, 2003. The Corporation and the
Group 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 fixed maturity securities increased, as a percentage of amortized
cost, to 2.7% of the fixed maturity portfolio at year-end 2003 versus 1.5%
and 1.1% at December 31, 2002 and 2001, respectively. The increase in 2003
and 2002 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. In 2004, as underwriting
profitability improves the Corporation and the Group plan to invest more
funds into tax exempt fixed maturity securities.
As of December 31, 2003, the Corporation and the Group held a total of
$1,002.9 million in mortgage-backed securities, compared with $1,154.3
million and $1,107.9 million at December 31, 2002 and 2001, respectively. As
of December 31, 2003, $188.4 million of these mortgage-backed securities are
held at amortized cost in the held-to-maturity portfolio. In the first
quarter of 2003, management decided to transfer a portion of its fixed
maturity securities from available-for-sale to held-to-maturity
classification. This transfer was made, as management believes the
Corporation and the Group have both the ability to hold securities to
maturity and the intent to do so. The majority of mortgage-backed security
holdings are in sequential structures, planned amortization class and agency
pass-through securities. Of this portfolio, $6.2 million, $7.8 million and
$10.0 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) at December 31, 2003, 2002 and 2001,
respectively.
Securities are classified as investment grade or non-investment grade based
upon the higher of the ratings provided by S&P and Moody's. When a security
is not rated by either S&P or Moody's, the classification is based on other
rating services, including the Securities Valuation Office of the National
Association of Insurance Commissioners. The market value of available-for-
sale split-rated fixed maturity securities (i.e., those having an investment
grade rating from one rating agency and a below investment grade rating from
another rating agency) was $24.0 million at December 31, 2003 compared to
$45.8 million and $27.8 million at December 31, 2002 and 2001, respectively.
51
Item 7. Continued
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 negative effects of which can be
substantial.
At December 31, 2003, the fixed maturity portfolio included non-investment
grade securities and non-rated securities that had a fair value of $98.7
million and comprised 3.3% of the available-for-sale fixed maturity
investment portfolio and 2.9% of the total fixed maturity investment
portfolio. This compares to a fair value of $105.3 million and $94.3 million
at December 31, 2002 and 2001, respectively. These securities comprised 3.0%
and 2.8% of the available-for-sale investment portfolio at December 31, 2002
and 2001, respectively. The held-to-maturity securities are all investment
grade. Following is a table displaying available-for-sale non-investment
grade and non-rated securities in an unrealized loss position at December 31:
Amortized Fair Unrealized
Cost Value Loss
- ---------------------------------------------------------------------
2003 $23.5 $22.6 $ (.9)
2002 73.0 60.9 (12.1)
2001 61.5 55.0 (6.5)
The investment portfolio includes 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
provide the most accurate price. The carrying value of this portfolio at
December 31, 2003 was $318.8 million compared to $319.4 million at December
31, 2002 and $326.1 million at December 31, 2001.
At December 31, 2003, the Group's equity portfolio was $329.0 million, or
8.8% of the total investment portfolio. Equity investments have decreased,
as a percentage of market value of the consolidated portfolio, from 14.7% at
year-end 2001 to 8.8% at year-end 2003. This decrease is primarily
attributable to the Corporation's and the Group's 2002 and 2001 actions which
reduced assets invested in equities. Equity securities are marked to fair
value on the balance sheet. As a result, shareholders' equity and statutory
surplus fluctuate with changes in the value of the equity portfolio. As of
December 31, 2003, the equity portfolio consisted of stocks in 44 separate
entities in 35 different industries. As of December 31, 2003, 32.3% of the
Group's equity portfolio was invested in five companies and the largest
single position was 8.1% of the equity portfolio.
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.
52
Item 7. Continued
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 MD&A 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 in this release.
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 to appoint and/or retain agents; ability to
achieve targeted expense savings; ability to achieve premium targets and
profitability goals; and general economic and market conditions.
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 the 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 fixed maturity investment portfolio 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, 2003, 2002 and 2001, respectively. The changes selected
above reflect management'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.
53
Item 7A. Continued
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 income, cash flow or
shareholders' equity. In addition, the analysis does not take into account
any actions that may be taken to reduce the exposure in response to market
fluctuations.
Estimated Adjusted Market Value
December 31, 2003 Fair Value as indicated above
- -----------------------------------------------------------------------
Interest Rate Risk:
Fixed maturities $3,379 $3,223
Short-term investments 40 40
Equity Price Risk:
Equity securities 329 296
- -----------------------------------------------------------------------
Totals $3,748 $3,559
=======================================================================
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
=======================================================================
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
========================================================================
Certain assumptions are inherent in the above analysis. An instantaneous and
parallel shift in interest rates and a simultaneous decline of 10% in equity
prices at December 31, 2003, 2002 and 2001 are assumed. Also, it is assumed
that 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 57 of this Form 10-K.
Item 9. Changes In and Disagreements with Accountants on Accounting and
Financial Disclosure
None.
54
Item 9A. Controls and Procedures
(a) The Company's Chief Executive Officer and Chief Financial Officer
evaluated the disclosure controls and procedures (as defined under
Rules 13(a)-14(a)/15(d)-14(a) of the Securities Exchange Act of 1934,
as amended) as of 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.
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," "Other Matters," "Meetings
of the Board of Directors and Committees of the Board," "Shareholder
Proposals and Nominations" and "Section 16(a) Beneficial Ownership Reporting
Compliance." Additionally, incorporated by reference is the "Code of Ethics
for Senior Financial Officers" disclosed on the Corporation's website at
www.ocas.com.
- ------------
The following table provides information for executive officers of the
Corporation who are not separately reported in the Corporation's Proxy
Statement:
Executive Officers of the Registrant
Position with Company and/or
Principal Occupation or Employment
Name Age During Last Five Years
- ---- --- ----------------------
Debra K. Crane 46 Senior Vice President, General Counsel and Secretary of
the Corporation since April 2002 and Senior Vice President
and General Counsel 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 58 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 42 Senior Vice President and Chief Technology Officer of the
Corporation's insurance subsidiaries 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.
55
Item 10. Continued
Position with Company and/or
Principal Occupation or Employment
Name Age During Last Five Years
- ---- --- ----------------------
Richard B. Kelly 49 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 53 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 47 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.
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
2004 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 and
Related Stockholder Matters
Incorporated by reference herein from those portions of the Corporation's
Proxy Statement for the Annual Meeting of Shareholders of the Corporation for
2004 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
None
Item 14. Principal Accountant Fees and Services
Incorporated by reference herein from those portions of the Corporation's
Proxy Statement from the Annual Meeting of Shareholders of the Corporation
for 2004 under the heading "Principal Accountant Fees" and "Policies and
Procedures Regarding Pre-Approval of Accountant Fees."
56
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, 2003,
2002 and 2001 58
Consolidated Statements of Income for the years
ended December 31, 2003, 2002 and 2001 59
Consolidated Statements of Shareholders' Equity
for the years ended December 31, 2003, 2002
and 2001 60
Consolidated Statements of Cash Flows for the
years ended December 31, 2003, 2002 and 2001 61
Notes to Consolidated Financial Statements 62-75
Report of Independent Auditors 76
(2) The following financial statement schedules are
included herein:
Schedule I - Consolidated Summary of Investments
Other than Investments in Related Parties at
December 31, 2003 79
Schedule II - Condensed Financial Information of
Registrant for the years ended December 31, 2003,
2002 and 2001 80
Schedule III - Consolidated Supplementary Insurance
Information for the years ended December 31, 2003,
2002 and 2001 81-83
Schedule IV - Consolidated Reinsurance for the
years ended December 31, 2003, 2002 and 2001 84
Schedule V - Valuation and Qualifying Accounts for
the years ended December 31, 2003, 2002 and 2001 85
Schedule VI - Consolidated Supplemental Information
Concerning Property and Casualty Insurance Operations
for the years ended December 31, 2003, 2002 and 2001 86
57
Item 15. Continued
CONSOLIDATED BALANCE SHEETS
December 31 (in millions, except share data) 2003 2002 2001
=====================================================================================================
Assets
Investments, at fair value:
Fixed maturities:
Available for sale, at fair value
(amortized cost: $2,851.2; $2,967.5; $2,730.0) $3,022.2 $3,139.8 $2,772.1
Held-to-maturity, at amortized cost
(fair value: $354.2) 356.1 - -
Equity securities, at fair value
(cost: $77.9; $92.6; $110.2) 329.0 312.5 489.0
Short-term investments, at fair value 40.4 49.8 54.8
- ----------------------------------------------------------------------------------------------------
Total investments 3,747.7 3,502.1 3,315.9
Cash 16.5 12.4 37.5
Premiums and other receivables, net of allowance for bad
debts of $4.2, $4.3, and $8.4, respectively 347.9 324.7 342.0
Deferred policy acquisition costs 169.3 181.3 166.8
Property and equipment, net of accumulated depreciation of
$152.9, $145.9, and $133.2, respectively 89.2 97.8 99.8
Reinsurance recoverable 592.7 419.9 237.7
Agent relationships, net of accumulated amortization of
$39.1, $34.1, and $36.3, respectively 142.6 161.3 241.0
Interest and dividends due or accrued 47.5 46.0 43.3
Deferred income taxes - 2.4 -
Other assets 15.5 31.1 40.6
- ----------------------------------------------------------------------------------------------------
Total assets $5,168.9 $4,779.0 $4,524.6
=====================================================================================================
Liabilities
Insurance reserves:
Losses $2,163.7 $1,978.8 $1,746.8
Loss adjustment expenses 464.1 454.9 403.9
Unearned premiums 703.0 668.7 666.8
Debt 198.0 198.3 210.2
Reinsurance treaty funds held 150.5 129.4 107.1
Deferred income taxes 12.8 - 3.1
Other liabilities 331.0 290.2 306.7
- ----------------------------------------------------------------------------------------------------
Total liabilities 4,023.1 3,720.3 3,444.6
- ----------------------------------------------------------------------------------------------------
Shareholders' Equity
Common stock, $.125 par value
Authorized shares: 150,000,000 - - -
Issued shares: 72,418,344; 72,418,344; 94,418,344 9.0 9.0 11.8
Additional paid-in capital - - 4.2
Common stock purchase warrants - 21.1 21.1
Accumulated other comprehensive income 254.7 246.2 274.4
Retained earnings 1,033.4 936.7 1,221.5
Treasury stock, at cost:
(Shares: 11,461,301; 11,692,976; 34,312,259) (151.3) (154.3) (453.0)
- ----------------------------------------------------------------------------------------------------
Total shareholders' equity 1,145.8 1,058.7 1,080.0
- ----------------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $5,168.9 $4,779.0 $4,524.6
=====================================================================================================
See notes to consolidated financial statements
58
Item 15. Continued
CONSOLIDATED STATEMENTS OF INCOME
Year ended December 31 (in millions, except share data) 2003 2002 2001
- ------------------------------------------------------------------------------------------------
Premiums and finance charges earned $1,424.4 $1,450.5 $1,506.7
Investment income less expenses 208.7 207.1 212.4
Investment gains realized, net 35.9 45.2 182.9
- ------------------------------------------------------------------------------------------------
Total revenues 1,669.0 1,702.8 1,902.0
Losses and benefits for policyholders 852.5 902.7 1,001.6
Loss adjustment expenses 174.9 227.1 202.4
General operating expenses 116.7 108.7 111.8
Amortization of agent relationships 7.4 10.2 11.3
Write-down of agent relationships 11.3 69.5 11.0
Early retirement charge - - 6.0
New Jersey renewal obligation transfer fee - - 40.6
Amortization of deferred policy acquisition costs 384.0 376.2 375.7
Depreciation and amortization expense 14.6 15.1 15.2
- ------------------------------------------------------------------------------------------------
Total expenses 1,561.4 1,709.5 1,775.6
- ------------------------------------------------------------------------------------------------
Income (loss) before income taxes 107.6 (6.7) 126.4
Income tax (benefit) expense:
Current 21.2 (13.9) 17.3
Deferred 10.6 8.1 10.5
- ------------------------------------------------------------------------------------------------
Total income tax (benefit) expense 31.8 (5.8) 27.8
- ------------------------------------------------------------------------------------------------
Net income (loss) $ 75.8 $ (0.9) $ 98.6
================================================================================================
Average shares outstanding - basic 60,848,718 60,494,104 60,076,207
================================================================================================
Earnings per share - basic:
Net income (loss), per share $ 1.25 $ (0.01) $ 1.64
================================================================================================
Average shares outstanding - diluted 61,326,692 61,284,255 60,208,573
================================================================================================
Earnings per share - diluted
Net income (loss), per share $ 1.24 $ (0.01) $ 1.64
================================================================================================
See notes to consolidated financial statements
59
Item 15. Continued
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Common Accumulated
Additional stock other Total
(in millions, except per Common paid-in purchase comprehensive Retained Treasury shareholders'
share data) stock capital warrants income earnings stock equity
===========================================================================================================================
Balance,
December 31, 2000 $ 11.8 $ 4.2 $ 21.1 $ 409.9 $ 1,122.9 $ (453.3) $ 1,116.6
Net income 98.6 98.6
Change in unrealized gain,
net of deferred income tax
benefit of $73.0 (135.5) (135.5)
-----------
Comprehensive loss (36.9)
Net forfeiture of treasury
stock (33,566 shares) 0.3 0.3
- ---------------------------------------------------------------------------------------------------------------------------
Balance,
December 31, 2001 $ 11.8 $ 4.2 $ 21.1 $ 274.4 $ 1,221.5 $ (453.0) $ 1,080.0
Net loss (0.9) (0.9)
Change in unrealized gain,
net of deferred income tax
benefit of $10.0 (18.6) (18.6)
Minimum pension liability,
net of tax $5.2 (9.6) (9.6)
----------
Comprehensive loss (29.1)
Net issuance of treasury
stock (619,283 shares) (0.1) (0.3) 8.2 7.8
Retirement of treasury stock
(22,000,000 shares) (2.8) (4.1) (283.6) 290.5 -
- ---------------------------------------------------------------------------------------------------------------------------
Balance,
December 31, 2002 $ 9.0 $ - $ 21.1 $ 246.2 $ 936.7 $ (154.3) $ 1,058.7
Net income 75.8 75.8
Change in unrealized gain,
net of deferred income tax
expense of $14.8 27.4 27.4
Minimum pension liability,
net of tax $10.2 (18.9) (18.9)
----------
Comprehensive income 84.3
Expiration of warrants (21.1) 21.1 -
Net issuance of treasury
stock (231,675 shares) (0.2) 3.0 2.8
- ---------------------------------------------------------------------------------------------------------------------------
Balance,
December 31, 2003 $ 9.0 $ - $ - $ 254.7 $ 1,033.4 $ (151.3) $ 1,145.8
===========================================================================================================================
See notes to consolidated financial statements
60
Item 15. Continued
CONSOLIDATED STATEMENTS OF CASH FLOWS
Year ended December 31 (in millions) 2003 2002 2001
=====================================================================================================
Cash flows from Operating Activities:
Operating Activities
Net income (loss) $ 75.8 $ (0.9) $ 98.6
Adjustments to reconcile net income (loss) to cash
from operating activities:
Changes in:
Insurance reserves 228.4 284.9 117.4
Reinsurance treaty funds held 21.1 22.3 17.8
Income taxes 11.5 2.9 31.9
Premiums and other receivables (23.2) 17.2 15.1
Deferred policy acquisition costs 12.0 (14.5) 8.3
Reinsurance recoverable (172.8) (182.2) (89.1)
Other assets 0.5 2.5 3.0
Other liabilities 12.5 (34.7) 17.7
Amortization and write-down of agent relationships 18.7 79.7 22.4
Depreciation and amortization 20.1 16.2 10.0
Investment gains (35.9) (45.2) (182.9)
- -----------------------------------------------------------------------------------------------------
Net cash provided by operating activities 168.7 148.2 70.2
- -----------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities:
Purchase of securities:
Fixed maturity, available-for-sale (1,207.9) (1,249.2) (1,571.5)
Fixed maturity, held-to-maturity (7.7) - -
Equity (6.1) (19.5) (55.5)
Proceeds from sales of securities:
Fixed maturity, available-for-sale 883.5 948.3 1,215.6
Equity 39.8 100.9 298.6
Proceeds from maturities and calls of securities:
Fixed maturity, available-for-sale 95.5 62.4 77.5
Fixed maturity, held-to-maturity 17.4 - -
Equity 13.7 - -
Property and equipment:
Purchases (9.9) (17.0) (22.9)
Sales 6.1 0.4 0.8
- -----------------------------------------------------------------------------------------------------
Net cash used in investing activities (175.6) (173.7) (57.4)
- -----------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities:
Debt:
Proceeds from the issuance of convertible notes - 201.3 -
Payments (0.6) (205.6) (10.6)
Payment for deferred financing costs - (0.4) -
Payment of issuance costs - (7.4) -
Proceeds from exercise of stock options 2.2 7.5 0.1
- -----------------------------------------------------------------------------------------------------
Net cash provided by (used) in financing activities 1.6 (4.6) (10.5)
- -----------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (5.3) (30.1) 2.3
Cash and cash equivalents, beginning of year 62.2 92.3 90.0
- -----------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of year $ 56.9 $ 62.2 $ 92.3
=====================================================================================================
Additional disclosures:
Interest and related fees paid $ 10.3 $ 14.9 $ 14.3
Income taxes paid (refunded) 4.4 (7.0) (1.5)
See notes to consolidated financial statements
61
Item 15. Continued
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(All dollar amounts in millions, except per 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 28.8% of its 2003 net premiums written generated in the states
of New Jersey (11.1%), Ohio (9.2%) and Pennsylvania (8.5%).
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 into one of the following categories:
(1) held-to-maturity securities
(2) available-for-sale securities
Fixed maturity securities classified as held-to-maturity are carried
at amortized cost because management has the ability and positive intent to
hold the securities until maturity. 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 component of comprehensive income, net of deferred
tax. Mortgage-backed securities are amortized over a period based on
estimated future principal payments, including prepayments. Prepayment
assumptions are reviewed periodically and adjusted to reflect actual
prepayments and changes in expectations. Variations from prepayment
assumptions will affect the life and yield of these securities. Transfers of
fixed maturity securities into the held-to-maturity category from the
available-for-sale category are made at fair value at the date of transfer.
The unrealized holding gain or loss at the date of transfer is retained in
other comprehensive income and in the carrying value of the held-to-maturity
securities. Such amounts are amortized over the remaining life of the
security. Equity securities are carried at quoted market values and include
nonredeemable preferred stocks and common stocks. Fair values of fixed
maturities 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.
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. Fair Value of Financial Instruments
-----------------------------------
The carrying amounts of the Corporation's financial instruments include cash
and short-term investments which approximate fair value at December 31, 2003,
2002 and 2001. The fair value of the convertible debt is based on quoted
market prices and was $210.3 at December 31, 2003, compared to the carrying
value of $198.0. The fair value as of December 31, 2002 was $186.5, compared
to a carrying value of $198.3.
E. 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.
F. 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. Quarterly, 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.
62
Item 15. Continued
G. 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.
H. Internally Developed Software
-----------------------------
In accordance with Statement of Position 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 life of 10 years commencing when the software is
substantially complete and ready for its intended use. Capitalized software
costs and accumulated amortization in the consolidated balance sheet were
$52.0 and $7.2 at December 31, 2003, $50.3 and $3.7 at December 31, 2002 and
$41.4 and $1.0 at December 31, 2001, respectively.
I. 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 quarterly in accordance with FASB 144 "Accounting for the
Impairment or Disposal of Long-Lived Assets," 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 involves
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 14).
J. Loss Reserves
-------------
The reserves for unpaid losses and loss adjustment expenses (LAE) are based
on estimates of ultimate claim costs, including claims incurred but not
reported (IBNR), salvage and subrogation and inflation without discounting.
For reported losses, a case reserve is established within the parameters of
coverage provided in the insurance policy. Reserves are reviewed quarterly
using generally accepted actuarial techniques, and any resulting adjustments
are reflected in earnings currently. The estimates are developed using the
facts in each case, experience with similar cases and the effects of current
developments and anticipated trends. Accordingly there can be no assurance
that the ultimate liability will not vary from such estimates.
K. 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 its ceded reinsurance transactions on a gross basis and
records an asset as reinsurance recoverable for estimates of paid and unpaid
losses, including estimates for losses incurred but not reported. 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. The
Group is also required to maintain a reinsurance treaty fund as stipulated by
the first layer casualty treaty. The reinsurance treaty contains a provision
for a security trust fund. The Corporation deposits premium into the fund
and makes withdrawals to pay claims that qualify for that contract of
reinsurance. Interest from the securities is shared with the reinsurers.
The securities are recorded as assets and there is a corresponding liability.
The ceded reinsurance transactions are recorded in the same manner as all
other cessions.
L. Income Taxes
------------
The Corporation files a consolidated federal income tax return. 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. The principal assets and liabilities
giving rise to such differences are net unrealized gains/losses on
securities, loss reserves, unearned premiums reserves, deferred acquisition
costs and non-deductible accruals. The Corporation reviews its deferred tax
assets and liabilities for recoverability. At December 31, 2003, the
Corporation is able to demonstrate that the benefit of its deferred tax
assets is fully realizable.
63
Item 15. Continued
M. 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:
2003 2002 2001
- -----------------------------------------------------------------
Net income (loss)
As reported: $75.8 $ (.9) $98.6
Add: Stock-based
employee compensation
reported in net income,
net of related tax
effect 0.1 0.1 -
Deduct: Total stock-based
employee compensation,
net of related tax effects 5.8 4.6 4.2
Pro Forma: 70.1 (5.4) 94.4
Basic EPS
As reported: $1.25 $(.01) $1.64
Pro Forma: $1.15 $(.09) $1.57
Diluted EPS
As reported: $1.24 $(.01) $1.64
Pro Forma: $1.14 $(.09) $1.57
N. Insurance Assessments
---------------------
The Group accrues a liability for insurance related assessments in accordance
with SOP 97-3 "Accounting by Insurance and Other Enterprises for Insurance-
Related Assessments." As of December 31, 2003, 2002 and 2001 the liability
for these assessments was $8.9, $7.4 and $6.6, respectively.
O. 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.
P. Cash and Cash Equivalents
-------------------------
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. As of December 31, 2003, 2002
and 2001, the Group had $4.0, $2.3 and $0.5, respectively, of cash held in
escrow which is subject to withdrawal restrictions.
Q. 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 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:
2003 2002 2001
- -------------------------------------------------------------------------
Investment income from:
Fixed maturities $210.9 $207.0 $208.0
Equity securities 8.4 8.6 10.7
Short-term securities .5 .8 3.2
- --------------------------------------------------------------------------
Total investment income 219.8 216.4 221.9
Investment expenses 11.1 9.3 9.5
- --------------------------------------------------------------------------
Net investment income $208.7 $207.1 $212.4
==========================================================================
The gross realized gains and gross realized losses from sales of
securities were as follows:
Gross Gross Net
Realized Realized Realized
December 31 Gains (Losses) Gains
- --------------------------------------------------------------------------
2003 $ 57.3 $(21.4) $ 35.9
2002 92.3 (47.1) 45.2
2001 202.7 (19.8) 182.9
Included in realized losses were the write-down of securities for
other than temporary declines in market value of $10.5, $10.9 and $12.0, in
2003, 2002 and 2001, respectively. The large realized gains in 2002 and 2001
were 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.
In the first quarter of 2003, the Corporation transferred $368.8 of
its fixed maturity securities from the available-for-sale classification into
the held-to-maturity classification, which resulted in a $12.3 unrealized
gain. The unrealized holding gain of $12.3 as of December 31, 2003 is
retained in other comprehensive income and in the carrying value of the held-
to-maturity securities. This transfer was made as the Corporation has both
the ability to hold investments to maturity and the positive intent to do so.
As of December 31, 2003, the amortized cost of the held-to-maturity portfolio
was $356.1. The reduction for the year was a result of scheduled payments
and maturities on the securities held in this classification.
64
Item 15. Continued
Changes in unrealized gains (losses) on investments in securities are
summarized as follows:
2003 2002 2001
- -------------------------------------------------------------------------
Unrealized gains (losses):
Securities available-for-sale $ 29.9 $(28.6) $(208.5)
Transfer of securities to
held-to-maturity 12.3 - -
Deferred tax benefit (loss) (14.8) 10.0 73.0
- --------------------------------------------------------------------------
Net unrealized gains (losses) $ 27.4 $(18.6) $(135.5)
==========================================================================
The amortized cost and estimated fair values of investments in
available-for-sale fixed maturity and equity securities are as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
2003 Cost Gains Losses Value
- ----------------------------------------------------------------------------
Securities:
U.S. Government $ 40.9 $ 2.4 $ (.1) $ 43.2
States, municipalities
and political
subdivisions 76.8 2.5 (.2) 79.1
Corporate securities 1,941.1 152.7 (8.4) 2,085.4
Mortgage-backed
securities:
U.S. Government
Agency 12.6 .6 - 13.2
Other 779.8 29.5 (8.0) 801.3
- ----------------------------------------------------------------------------
Total fixed maturities 2,851.2 187.7 (16.7) 3,022.2
Equity securities 77.9 251.1 - 329.0
Short-term investments 40.4 - - 40.4
- ----------------------------------------------------------------------------
Total securities $2,969.5 $438.8 $(16.7) $3,391.6
============================================================================
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
2002 Cost Gains Losses Value
- ----------------------------------------------------------------------------
Securities :
U.S. Government $ 26.1 $ 3.0 $ - $ 29.1
States, municipalities
and political
subdivisions 44.2 2.6 - 46.8
Corporate securities 1,779.0 156.0 (25.5) 1,909.6
Mortgage-backed
securities:
U.S. Government
Agency 52.8 2.3 - 55.1
Other 1,065.4 41.0 (7.2) 1,099.2
- ---------------------------------------------------------------------------
Total fixed maturities 2,967.5 204.9 (32.7) 3,139.8
Equity securities 92.6 230.2 (10.2) 312.5
Short-term investments 49.8 - - 49.8
- ---------------------------------------------------------------------------
Total securities $3,109.9 $435.1 $(42.9) $3,502.1
===========================================================================
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
2001 Cost Gains Losses Value
- ----------------------------------------------------------------------------
Securities :
U.S. Government $ 27.8 $ 1.6 $ - $ 29.4
States, municipalities
and political
subdivisions 30.1 1.3 - 31.3
Corporate securities 1,577.9 48.0 (22.3) 1,603.5
Mortgage-backed
securities:
U.S. Government
Agency 56.3 .2 (.5) 56.1
Other 1,037.9 26.6 (12.8) 1,051.8
- ----------------------------------------------------------------------------
Total fixed maturities 2,730.0 77.7 (35.6) 2,772.1
Equity securities 110.2 381.6 (2.8) 489.0
Short-term investments 54.8 - - 54.8
- -----------------------------------------------------------------------------
Total securities $2,895.0 $459.3 $(38.4) $3,315.9
=============================================================================
The amortized cost and estimated fair values of investments in held-
to-maturity fixed maturity securities are as follows:
Gross Gross Estimated
Amortized Unrealized Unrealized Fair
2003 Cost Gains Losses Value
- ----------------------------------------------------------------------------
Securities:
Corporate securities $167.7 $ 2.1 $(2.0) $167.8
Mortgage-backed
securities:
Other 188.4 .5 (2.5) 186.4
- ----------------------------------------------------------------------------
Total fixed maturities $356.1 $ 2.6 $(4.5) $354.2
============================================================================
For securities in an unrealized loss position, the Group evaluates
the difference between the cost/amortized cost and estimated fair value of
the security to determine whether a decline in value is temporary or other
than temporary in nature. Securities that had a relatively high degree of
decline in value and/or securities that had been in unrealized loss positions
for longer, continuous periods of time are more closely reviewed. This
assessment includes many factors such as the issuing entity's financial
position, financial flexibility, future prospects, management competence, and
industry fundamentals. Based on this review, the Corporation makes a
judgement as to whether the decline in value is temporary or other than
temporary. The following table summarizes, for all securities in an
unrealized loss position, the gross unrealized loss by the length of time the
securities have continuously been in an unrealized loss position as of
December 31, 2003:
65
Item 15. Continued
Available-for-sale:
Less than 12 months 12 months or longer Total
---------------------- ---------------------- ----------------------
Fair Value Unrealized Fair Value Unrealized Fair Value Unrealized
Losses Losses Losses
---------------------- ---------------------- ----------------------
Securities:
U.S. Government $ 14.8 $ (.1) $ - $ - $ 14.8 $ (.1)
States, municipal-
ities and political
subdivisions 9.0 (.2) - - 9.0 (.2)
Corporate securities 248.4 (6.5) 37.0 (1.9) 285.4 (8.4)
Mortgage-backed
securities:
Other 242.2 (6.8) 19.2 (1.2) 261.4 (8.0)
- -----------------------------------------------------------------------------------------------
Total fixed maturities 514.4 (13.6) 56.2 (3.1) 570.6 (16.7)
Equity securities .7 - 1.6 - 2.3 -
- ------------------------------------------------------------------------------------------------
Total temporarily
impaired securities $515.1 $(13.6) $57.8 $(3.1) $572.9 $(16.7)
================================================================================================
Held-to-maturity:
Less than 12 months 12 months or longer Total
---------------------- ---------------------- ----------------------
Fair Value Unrealized Fair Value Unrealized Fair Value Unrealized
Losses Losses Losses
---------------------- ---------------------- ----------------------
Corporate securities $106.0 $(1.8) $ 5.0 $ (.2) $111.0 $(2.0)
Mortgage-backed
securities:
Other 115.7 (1.9) 27.7 (.6) 143.4 (2.5)
- -----------------------------------------------------------------------------------------------
Total temporarily
impaired securities $221.7 $(3.7) $32.7 $ (.8) $254.4 $(4.5)
===============================================================================================
Based on a review of each security, the Corporation believes that
unrealized losses on these securities were temporary declines in value at
December 31, 2003. In the tables above, there are approximately 190
securities represented. Of this total, 31 securities have unrealized loss
positions greater than 5% of their market values at December 31, 2003 with
none exceeding 20%. This group represents $10.0, or 47% of the total
unrealized loss position of the Corporation. Of this group, 22 securities,
representing approximately $7.1 in unrealized losses, have been in an
unrealized loss position for less than twelve months. Of the remaining nine
securities in an unrealized loss position for longer than twelve months
totaling $2.9 million, the Corporation believes that it is probable that all
contract terms of the security will be satisfied; the unrealized loss
position is due to the changes in the interest rate environment; and that the
Corporation and the Group have positive intent and the ability to hold the
securities until they mature or recover in value.
Gross gains of $19.7, $15.7 and $39.8 and gross losses of $18.2,
$40.9 and $35.2 were realized on the sales of fixed maturity securities in
2003, 2002 and 2001, respectively.
The Group is required to hold investments on deposit with regulatory
authorities in various states. As of December 31, 2003, 2002 and 2001, these
investments had a fair value of $59.6, $59.0 and $55.2, respectively.
The amortized cost and estimated fair value of fixed maturity
securities at December 31, 2003, 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.
Available-for-sale
Estimated
Amortized Fair
Cost Value
- ----------------------------------------------------------------------------
Due in one year or less $ 13.5 $ 13.2
Due after one year through five years 421.1 460.0
Due after five years through ten years 1,064.6 1,147.6
Due after ten years 559.6 586.9
Mortgage-backed securities:
U.S. Government Agency 12.6 13.2
Other 779.8 806.3
- ----------------------------------------------------------------------------
Total fixed maturities $2,851.2 $3,022.2
============================================================================
Held-to-maturity
Estimated
Amortized Fair
Cost Value
- ----------------------------------------------------------------------------
Due in one year or less $ - $ -
Due after one year through five years 16.6 16.6
Due after five years through ten years 100.7 99.8
Due after ten years 50.4 51.4
Mortgage-backed securities:
Other 188.4 186.4
- -----------------------------------------------------------------------------
Total fixed maturities $356.1 $354.2
=============================================================================
NOTE 3 -- Deferred Policy Acquisition Costs
Changes in deferred policy acquisition costs are summarized as follows:
2003 2002 2001
- ----------------------------------------------------------------------------
Deferred, January 1 $181.3 $166.8 $175.1
- ----------------------------------------------------------------------------
Additions:
Commissions and brokerage 243.6 254.5 237.4
Salaries and employee benefits 56.2 57.7 57.6
Other 72.2 78.5 72.3
- ----------------------------------------------------------------------------
Deferral of expense 372.0 390.7 367.3
- ----------------------------------------------------------------------------
Amortization to expense 384.0 376.2 375.6
- ----------------------------------------------------------------------------
Deferred, December 31 $169.3 $181.3 $166.8
============================================================================
NOTE 4 -- Income Tax
The effective income tax rate is less than the statutory corporate tax rate
of 35% for 2003, 2002 and 2001 for the following reasons:
2003 2002 2001
- ----------------------------------------------------------------------------
Tax at statutory rate $37.7 $(2.3) $ 44.2
Tax exempt interest (1.3) (.9) (.8)
Dividends received deduction
(DRD) (2.1) (2.2) (2.7)
Proration of DRD and tax
exempt interest .4 .2 .3
Loss on disposition of subsidiary
stock - - (16.1)
Other (2.9) (.6) 2.9
- ----------------------------------------------------------------------------
Actual tax expense (benefit) $31.8 $(5.8) $ 27.8
============================================================================
66
Item 15. Continued
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.
The components of the net deferred tax asset (liability) were as
follows:
2003 2002 2001
- ----------------------------------------------------------------------------
Unearned premium proration $ 35.3 $ 34.1 $ 34.3
Accrued expenses 39.9 35.5 39.2
NOL and AMT carryforward 1.8 22.6 9.6
Postretirement benefits 37.7 35.9 33.9
Discounted loss and loss
expense reserves 83.9 75.0 85.6
- ----------------------------------------------------------------------------
Total deferred tax assets 198.6 203.1 202.6
- ----------------------------------------------------------------------------
Deferred policy acquisition costs (59.3) (63.4) (58.4)
Unrealized gains on investments (152.1) (137.3) (147.3)
- ----------------------------------------------------------------------------
Total deferred tax liabilities (211.4) (200.7) (205.7)
- ----------------------------------------------------------------------------
Net deferred tax asset (liability) $ (12.8) $ 2.4 $ (3.1)
============================================================================
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 5 -- Employee Benefits
The Corporation has a non-contributory defined benefit retirement plan, a
contributory health care plan, life and disability insurance plans and a
savings plan covering substantially all employees. Benefit expenses are as
follows:
2003 2002 2001
- -----------------------------------------------------------------------------
Employee benefit costs:
Pension plan $ 4.2 $ .2 $ (3.8)
Health care 14.4 18.2 15.5
Life and disability
insurance 1.9 1.7 .8
Savings plan 3.0 2.8 2.9
- -----------------------------------------------------------------------------
Total $ 23.5 $ 22.9 $ 15.4
=============================================================================
The pension cost (benefit) is determined as follows:
2003 2002 2001
- -----------------------------------------------------------------------------
Service cost earned during the
year $ 7.2 $ 6.7 $ 6.3
Interest cost on projected
benefit obligation 18.4 17.9 17.4
Expected return on plan assets (21.6) (22.9) (24.0)
Amortization of unrecognized
net asset - (1.7) (2.9)
Amortization of accumulated gains - - (.8)
Amortization of unrecognized
prior service cost .2 .2 .2
- -----------------------------------------------------------------------------
Net pension cost (benefit) $ 4.2 $ .2 $ (3.8)
=============================================================================
Changes in the benefit obligation during the year:
2003 2002 2001
- -----------------------------------------------------------------------------
Benefit obligation at beginning
of year $270.9 $247.6 $224.6
- -----------------------------------------------------------------------------
Service cost 7.2 6.7 6.3
Interest cost 18.4 17.9 17.4
Actuarial loss 39.1 15.1 6.3
Benefits paid (17.4) (16.5) (16.0)
Amendments - .1 -
Curtailments - - 9.0
- -----------------------------------------------------------------------------
Benefit obligation at end of year $318.2 $270.9 $247.6
=============================================================================
Changes in pension plan assets during the year:
2003 2002 2001
- -----------------------------------------------------------------------------
Fair value of plan assets at
beginning of year $235.1 $257.1 $273.4
- -----------------------------------------------------------------------------
Actual return on plan assets 24.0 (5.7) (1.3)
Benefits paid (17.4) (16.3) (15.0)
- -----------------------------------------------------------------------------
Fair value of plan assets at
end of year $241.7 $235.1 $257.1
=============================================================================
2003 2002 2001
- -----------------------------------------------------------------------------
Projected benefit obligation $318.2 $270.9 $247.6
Accumulated benefit obligation 284.8 245.0 244.6
Fair value of plan assets 241.7 235.1 257.1
The Corporation expects to contribute approximately $7.6 to its pension
plan during 2004. Pension plan funding at December 31:
2003 2002 2001
- -----------------------------------------------------------------------------
Funded status $(76.5) $(35.7) $ 9.5
Unrecognized net gain (loss) (77.3) (40.5) 3.3
Unrecognized net assets - - 1.7
Unrecognized prior
service cost (1.3) (1.5) (1.7)
- -----------------------------------------------------------------------------
Accrued pension asset $ 2.1 $ 6.3 $ 6.2
=============================================================================
Expected long-term return on
plan assets 8.75% 8.50% 8.50%
Discount rate on plan benefit
obligations 6.15% 7.00% 7.50%
Expected future rate of salary
increases 4.00% 4.00% 5.25%
The Corporation considers the current level of expected returns on
risk free investments, primarily government bonds, the historical level of
the risk premium associated with the other asset classes and the expectations
for future returns of each asset class when developing the expected long-term
rate of return on assets assumption. The expected return for each asset
class is weighted based on the target asset allocation to develop the
expected long-term rate of return on assets assumption for the portfolio.
This resulted in the selection of the 8.75% assumption.
67
Item 15. Continued
The Corporation's targeted ranges of asset allocation for the pension
plan at December 31, 2003, 2002, and 2001 by asset category are as follows:
Equity securities 55-79%
Debt securities 22-30%
Real estate 4-10%
Other 0-5%
The Corporation's weighted-average pension asset allocation at
September 30, 2003, 2002 and 2001 by asset category is as follows:
2003 2002 2001
- -----------------------------------------------------------------------------
Equity securities 61.4% 50.8% 54.7%
Debt securities 21.8% 35.3% 30.2%
Real estate 9.3% 12.3% 11.4%
Other 7.5% 1.6% 3.7%
- -----------------------------------------------------------------------------
Total 100.0% 100.0% 100.0%
=============================================================================
Investments are diversified among capitalization and style within the
equity portfolio. Up to 18% of the equity portfolio may be invested in
financial markets outside of the United States. In order to minimize equity
risk, limitations are placed on the overall amount that can be invested in a
single stock at both cost and market value. Equity investments are also
diversified across the various economic sectors. Approximately 10% of the
portfolio is allocated to real estate to further diversify risk.
For the Corporation's defined benefit plan, the fair value of plan
assets was less than the accumulated benefit obligation as of September 30,
2003 and 2002, resulting in the recognition of a minimum pension liability of
approximately $45.2 and $16.2 of which $1.3 and $1.5 is recognized as an
intangible asset, respectively. The remaining $43.9 and $14.7 represents
before tax other comprehensive loss reported in the December 31, 2003 and
2002 Statement of Shareholders' Equity.
Pension benefits are based on credited service years and final
average compensation for the five consecutive calendar years of highest
compensation 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 covered compensation. The pension plan
measurement date is September 30, 2003, 2002 and 2001. Plan assets at
December 31, 2003 include $13.5 of the Corporation's common stock at market
value compared to $17.3 and $27.1 at December 31, 2002 and 2001,
respectively. The Plan holds 771,964, 1,336,964 and 1,684,464 shares of the
Corporation's common stock at December 31, 2003, 2002 and 2001, respectively.
The components of the Corporation's net periodic postretirement
benefit cost at December 31:
2003 2002 2001
- -----------------------------------------------------------------------------
Service cost $ 2.9 $ 2.8 $ 1.9
Interest cost 7.4 7.6 6.7
Amortization of unrecognized
prior service costs .2 .2 .2
- ----------------------------------------------------------------------------
Net periodic postretirement
benefit cost $10.5 $10.6 $ 8.8
============================================================================
Changes in the postretirement benefit obligation during the year:
2003 2002 2001
- -----------------------------------------------------------------------------
Benefit obligation at
beginning of year $108.2 $ 85.2 $ 87.0
- -----------------------------------------------------------------------------
Service cost 2.9 2.8 1.9
Interest cost 7.4 7.6 6.7
Benefits paid net of plan
participants' contributions (5.2) (6.0) (5.3)
Increase due to actuarial loss
(gain), change in discount rate,
or other assumptions 13.1 18.6 (5.1)
- -----------------------------------------------------------------------------
Benefit obligation at end of year $126.4 $108.2 $ 85.2
=============================================================================
Accrued postretirement benefit liability at December 31:
2003 2002 2001
- -----------------------------------------------------------------------------
Accumulated postretirement
benefit obligation $126.4 $108.2 $ 85.2
Unrecognized net (loss) gain (17.6) (4.4) 9.1
Unrecognized prior service
(cost) benefit (1.2) (1.4) 2.5
- -----------------------------------------------------------------------------
Accrued postretirement benefit
liability $107.6 $102.4 $ 96.8
=============================================================================
Postretirement benefit weighted average rate assumptions at September 30,
2003 and December 31, 2002 and 2001:
2003 2002 2001
- -----------------------------------------------------------------------------
Medical trend rate 10% 10% 8%
Dental trend rate 5% 5% 5%
Ultimate health care trend rate 5% 5% 5%
Discount rate 6.15% 7.00% 7.50%
The above medical trend rates for 2003, 2002 and 2001 were assumed to
decrease to the ultimate rate of 5% in nine years. The postretirement
benefit plan measurement date is September 30, 2003 and December 31, 2002 and
2001.
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, 2003 by approximately $18.9 and increase the
postretirement benefit cost for 2003 by $1.7. 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,
2003 by approximately $16.4 and decrease the postretirement benefit cost for
2003 by $1.5.
The Corporation's health care plan is a predominately managed care
plan. Retired employees continue to be
68
Item 15. Continued
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 2,800
active employees and 1,850 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 $6.0, or $4.0 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 $3.0, $2.8 and $2.8 in 2003, 2002 and
2001, respectively for the employee match.
NOTE 6 - 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 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, 2003, there are 259,950 and 2,220,194 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, 2003, there were no outstanding stock
appreciation rights.
In 2002 and 2001, the Corporation also granted stock options to
purchase 400,000 and 600,000 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 Corporation has an employee stock purchase plan that is available
to eligible employees as defined in the plan. Under the plan, shares of the
Corporation's common stock may be purchased at a discount up to 85% of the
lesser of the closing price of the Corporation's common stock on the first
trading day or the last trading day of the offering period. The offering
period is six months in duration but is subject to change. Participants may
purchase no more than twenty-five thousand dollars of Corporation stock in a
calendar year. During 2003, 43,618 shares have been purchased under the plan
and 1,956,382 shares have been reserved for future issuance.
The following table summarizes information about the stock-based
compensation plan as of December 31, 2003, 2002 and 2001, and changes that
occurred during the year:
2003 2002 2001
------------------------------------------------------------------
Weighted Weighted Weighted
Avg Avg Avg
Shares Exercise Shares Exercise Shares Exercise
(000) Price (000) Price (000) Price
------------------- ------------------ ------------------
Outstanding
Beginning
of year 4,491 $13.40 4,230 $12.87 3,212 $13.91
Granted 936 12.44 1,088 15.85 1,352 10.96
Exercised (175) 12.08 (611) 12.42 (34) 12.27
Forfeited (144) 14.91 (216) 17.83 (300) 15.56
------ ------ ------
Outstanding end
of year 5,108 $13.26 4,491 $13.40 4,230 $12.87
===== ===== =====
Options
exercisable
at year end 3,174 $13.28 2,479 $13.41 1,690 $14.64
Avg Remaining
contractual life 7.43 yrs 8.00 yrs 8.37 yrs
Weighted-Avg fair
value of options
granted during
the year $6.32 $8.36 $5.73
69
Item 15. Continued
The following table summarizes the status of stock options outstanding
and exercisable at December 31, 2003:
--------------------------------------------------------
Stock Options Outstanding Stock Options Exercisable
------------------------- -------------------------
Weighted-
Range of Avg Weighted- Weighted-
Exercise Remaining Avg Avg
Prices Per Shares Contractual Exercise Shares Exercise
Share (000) Life (Yrs.) Price (000) Price
- -----------------------------------------------------------------------------------
$8.60 - $8.60 12 7.31 $ 8.60 12 $ 8.60
$8.99 - $8.99 558 7.42 8.99 363 8.99
$9.19 - $11.20 635 7.21 10.18 557 10.08
$11.46 - $12.26 802 9.10 12.25 7 11.46
$12.38 - $12.38 1,035 6.16 12.38 1,035 12.38
$12.82 - $13.26 518 8.47 13.22 238 13.19
$13.45 - $14.71 531 8.34 14.44 294 14.38
$14.88 - $17.70 613 7.49 17.28 280 17.21
$18.42 - $23.47 392 5.13 20.68 376 20.75
$23.63 - $23.63 12 4.41 23.63 12 23.63
- -----------------------------------------------------------------------------------
$8.60 - $23.63 5,108 7.43 $13.26 3,174 $13.28
===================================================================================
Under the provisions of FAS 123, as amended by FAS 148, 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%, expected volatility of 52.81% for 2003, 54.98% for
2002 and 53.01% for 2001, risk free interest rate of 3.81% for 2003, 4.74%
for 2002 and 5.10% for 2001, 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 2003, 2002 and 2001 was $7.6, $6.2 and
$5.8, respectively.
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 provided for the purchase
of the Corporation's common stock at $22.505 per share and expired in
November 2003 unexercised.
NOTE 7 -- 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
- ----------------------------------------------------------------------------
2003
- ----
Premiums written $1,570.4 $ 20.0 $(148.8) $1,441.6
Premiums earned 1,539.7 16.4 (131.7) 1,424.4
Losses incurred 1,039.1 38.0 (224.6) 852.5
2002
- ----
Premiums written $1,536.1 $ 16.3 $(103.8) $1,448.6
Premiums earned 1,535.9 14.5 (100.1) 1,450.4
Losses incurred 1,081.2 28.3 (206.8) 902.7
2001
- ----
Premiums written $1,551.0 $ 15.1 $(94.0) $1,472.2
Premiums earned 1,510.9 85.0 (89.7) 1,506.2
Losses incurred 959.3 149.8 (107.5) 1,001.6
The following components of the reinsurance recoverable asset are:
2003 2002 2001
- -----------------------------------------------------------------------------
Reserve for unearned premiums $ 60.6 $ 43.4 $ 39.7
Reserve for losses 473.3 331.4 151.1
Reserve for loss adjustment
expenses 25.7 23.5 17.6
Allowance for reinsurance
recoverable (2.4) (.5) -
Reinsurance recoveries on paid
losses 35.5 22.1 29.3
- ----------------------------------------------------------------------------
Reinsurance recoverable $592.7 $419.9 $237.7
============================================================================
NOTE 8 -- 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
consolidated balance sheet. The total amount of unpaid annuities was $19.4,
$20.4 and $21.5 at December 31, 2003, 2002 and 2001, respectively.
The Corporation leases many of its operating and office facilities
for various terms under long-term, cancelable and non-cancelable operating
lease agreements. The leases expire at various dates through 2010 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 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 $5.0, $5.8 and $6.5 during 2003, 2002 and 2001,
respectively.
The following is a schedule by year of future minimum rental payments
required under the operating lease agreements:
Year Ending
December 31 Amount
---------------------------------------------
2004 $ 4.5
2005 3.6
2006 3.5
2007 2.8
2008 and thereafter 3.8
----------------------------------------------
Total rental payments $18.2
==============================================
Total minimum lease payments do not include contingent rentals that
may be paid under certain leases. Contingent rental payments were not
significant in 2003, 2002, or 2001.
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
70
Item 15. Continued
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 $40.6 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 periods of March 2002
through March 2005. If this criteria is not met, OCNJ will have to pay up to
$15.6 to Proformance to maintain this premiums-to-surplus ratio. As of
December 31, 2003, the Group has evaluated the contingency based upon
financial data provided by Proformance. The Group has concluded that it is
not probable a payment will be made and, therefore, has not recognized a
liability in the consolidated financial statements. The Group will continue
to monitor the contingency for any future liability recognition.
The Corporation is involved in litigation and administrative
proceedings arising in the ordinary course of business, which, in the opinion
of management, after considering established reserves, are not expected to
have a material adverse effect on the financial condition, liquidity, or
results of operations of the Corporation. Current litigation includes three
separate proceedings making class action claims for which no class
certification has been sought or granted at this time.
NOTE 9 -- Losses and Loss Reserves
The following table presents a reconciliation of liabilities for losses and
loss adjustment expenses:
2003 2002 2001
- -----------------------------------------------------------------------------
Balance as of January 1, net of
reinsurance recoverables of
$354.4, $168.7 and $96.2 $2,079.3 $1,982.0 $1,907.3
Incurred related to:
Current year 993.3 1,045.4 1,145.5
Prior years 34.1 84.4 58.5
- ----------------------------------------------------------------------------
Total incurred 1,027.4 1,129.8 1,204.0
- ----------------------------------------------------------------------------
Paid related to:
Current year 388.6 423.6 520.2
Prior years 586.9 608.9 609.1
- ----------------------------------------------------------------------------
Total paid 975.5 1,032.5 1,129.3
- ----------------------------------------------------------------------------
Balance as of December 31, net of
reinsurance recoverables of
$496.6, $354.4 and $168.7 $2,131.2 $2,079.3 $1,982.0
============================================================================
The 2003, 2002 and 2001 incurred loss and loss adjustment expenses
for prior years changed due to an increase in severity as losses developed.
For the year 2003, this development was concentrated in the workers'
compensation and commercial multiple peril product lines of the Commercial
Lines operating segment and in the personal auto product line of the Personal
Lines operating segment. 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 $62.2 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. These developments have
been considered in establishing the December 31, 2003 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:
2003 2002 2001
- -----------------------------------------------------------------------------
Incurred losses $43.8 $20.8 $34.6
Statutory loss ratio effect 3.1% 1.4% 2.3%
In 2003, 2002 and 2001 there were 21, 25 and 19 catastrophes,
respectively. The largest catastrophe in each year was $11.5, $7.5 and $17.8
in incurred losses. Additional catastrophes with over $1.0 in incurred
losses numbered nine, six and four in 2003, 2002 and 2001, respectively. The
additional catastrophes with over $1.0 in incurred losses in 2001 included
$3.0 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. Included in the loss and loss reserve tables
above is an increase in 2003 for losses and loss adjustment expense reserves
of $16.0 for environmental claims from prior accident years. In 2002, the
Corporation reclassified approximately $5.0 of homeowners reserves
71
Item 15. Continued
related to underground storage tanks as environmental reserves. For 2003,
2002 and 2001, respectively, total case, incurred but not reported and loss
adjustment expense reserves were $78.0, $64.3 and $53.5, respectively.
Asbestos reserves were $37.6, $35.9 and $31.8 and environmental reserves were
$40.4, $28.4 and $21.7 for those respective years.
NOTE 10 -- Earnings Per Share
Basic and diluted earnings per share are summarized as follows:
2003 2002 2001
- -----------------------------------------------------------------------------
Net income (loss) $ 75.8 $ (.9) $ 98.6
Average common shares
outstanding - basic 60,848,718 60,494,104 60,076,207
Basic income (loss) per
average share $1.25 $(.01) $1.64
=============================================================================
Average common shares
outstanding 60,848,718 60,494,104 60,076,207
Effect of dilutive securities 477,974 790,151 132,366
- -----------------------------------------------------------------------------
Average common shares
outstanding - diluted 61,326,692 61,284,255 60,208,573
Diluted income (loss)
per average share $1.24 $(.01) $1.64
=============================================================================
At December 31, 2003, 1,485,388 stock options were not included in
earnings per share calculations for 2003 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 2003 as they were antidilutive.
NOTE 11 -- Quarterly Financial Information (Unaudited)
2003 First Second Third Fourth
- ----------------------------------------------------------------------------
Premiums and finance
charges earned $349.3 $351.2 $360.4 $363.5
Net investment income 53.2 51.4 51.0 53.1
Investment gains realized 19.3 6.8 5.9 3.9
Net income 19.9 11.0 17.2 27.7
Basic net income per share 0.33 0.18 0.28 0.46
Diluted net income per share 0.33 0.18 0.28 0.45
2002 First Second Third Fourth
- ----------------------------------------------------------------------------
Premiums and finance
charges earned $361.0 $364.7 $357.0 $367.8
Net investment income 50.9 50.7 51.7 53.8
Investment gains (loss)
realized 22.8 9.5 (5.5) 18.4
Net income (loss) 26.9 13.1 (69.9) 29.1
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
NOTE 12 -- Comprehensive Income
Other comprehensive income consists of changes in unrealized gains (losses)
on securities and a minimum pension liability and is detailed below:
2003 Gross Tax Net
- -----------------------------------------------------------------------------
Net income $107.6 $ 31.8 $ 75.8
- -----------------------------------------------------------------------------
Components of other
comprehensive income:
Unrealized gains arising
during the period 76.5 26.8 49.7
Reclassification
adjustment for gains
included in net income (34.3) (12.0) (22.3)
Minimum pension liability (29.1) (10.2) (18.9)
- -----------------------------------------------------------------------------
Other comprehensive income 13.1 4.6 8.5
- -----------------------------------------------------------------------------
Comprehensive income $120.7 $ 36.4 $ 84.3
=============================================================================
2002 Gross Tax Net
- -----------------------------------------------------------------------------
Net loss $ (6.7) $ (5.8) $ (0.9)
- -----------------------------------------------------------------------------
Components of other
comprehensive income:
Unrealized gains arising
during the period 54.7 19.1 35.6
Reclassification
adjustment for gains
included in net income (83.4) (29.2) (54.2)
Minimum pension liability (14.8) (5.2) (9.6)
- -----------------------------------------------------------------------------
Other comprehensive loss (43.5) (15.3) (28.2)
- -----------------------------------------------------------------------------
Comprehensive loss $(50.2) $(21.1) $(29.1)
=============================================================================
2001 Gross Tax Net
- -----------------------------------------------------------------------------
Net income $ 126.4 $ 27.8 $ 98.6
- -----------------------------------------------------------------------------
Components of other
comprehensive income:
Unrealized losses
arising during the period (1.0) (0.4) (0.6)
Reclassification
adjustment for gains
included in net income (207.5) (72.6) (134.9)
- -----------------------------------------------------------------------------
Other comprehensive loss (208.5) (73.0) (135.5)
- -----------------------------------------------------------------------------
Comprehensive loss $ (82.1) $(45.2) $ (36.9)
=============================================================================
NOTE 13 -- Segment Information
The Corporation has determined its reportable segments based upon its method
of internal reporting, which is 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
72
Item 15. Continued
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 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 2003 2002 2001
- -----------------------------------------------------------------------------
Net premiums written $ 792.6 $ 762.2 $ 689.6
% Increase (decrease) 4.0% 10.5% (4.4)%
Net premiums earned 777.4 725.6 707.6
% Increase (decrease) 7.1% 2.5% (4.3)%
Underwriting loss (before tax) (101.4) (123.1) (107.8)
Specialty Lines Segment 2003 2002 2001
- -----------------------------------------------------------------------------
Net premiums written $164.9 $179.9 $136.1
% Increase (decrease) (8.3)% 32.2% 26.9%
Net premiums earned 162.7 158.5 130.6
% Increase 2.6% 21.4% 25.1%
Underwriting gain (before tax) 36.1 - 9.9
Personal Lines Segment 2003 2002 2001
- -----------------------------------------------------------------------------
Net premiums written $484.1 $506.5 $646.5
% Decrease (4.4)% (21.6)% (4.4)%
Net premiums earned 484.3 566.3 668.0
% Decrease (14.5)% (15.2)% (3.0)%
Underwriting loss(before tax) (27.0) (62.0) (120.7)
Total Property & Casualty 2003 2002 2001
- ----------------------------------------------------------------------------
Net premiums written $1,441.6 $1,448.6 $1,472.2
% Decrease (0.5)% (1.6)% (2.2)%
Net premiums earned 1,424.4 1,450.4 1,506.2
% Decrease (1.8)% (3.7)% (1.8)%
Underwriting loss (before tax) (92.3) (185.1) (218.7)
All Other 2003 2002 2001
- -----------------------------------------------------------------------------
Revenues $ 4.8 $ 1.2 $ 8.0
Other expenses (12.1) (10.5) (14.2)
Write-down and amortization of
agent relationships (18.7) (79.7) (22.3)
- -----------------------------------------------------------------------------
Net loss before income tax $(26.0) $(89.0) $(28.5)
Reconciliation of Revenues 2003 2002 2001
- -----------------------------------------------------------------------------
Net premiums earned for
reportable segments $1,424.4 $1,450.4 $1,506.2
Net investment income 204.9 205.8 211.0
Realized gain 31.9 53.0 198.3
Miscellaneous income - - .4
- -----------------------------------------------------------------------------
Total property and casualty
revenues (Statutory basis) 1,661.2 1,709.2 1,915.9
Property and casualty statutory
to GAAP adjustment 3.0 (7.6) (21.9)
- -----------------------------------------------------------------------------
Total revenues property and
casualty (GAAP basis) 1,664.2 1,701.6 1,894.0
Other segment revenues 4.8 1.2 8.0
- -----------------------------------------------------------------------------
Total revenues $1,669.0 $1,702.8 $1,902.0
=============================================================================
Reconciliation of Underwriting
Loss (before tax) 2003 2002 2001
- ----------------------------------------------------------------------------
Property and casualty under-
writing loss (before tax)
(Statutory basis) $ (92.3) $(185.1) $(218.7)
Statutory to GAAP adjustment (13.9) 16.3 (13.7)
- ----------------------------------------------------------------------------
Property and casualty under-
writing loss (before tax)
(GAAP basis) (106.2) (168.8) (232.4)
Net investment income 208.7 207.1 212.4
Realized gain 35.9 45.2 182.9
Write-down and amortization of
agent relationships (18.7) (79.7) (22.3)
Other loss (12.1) (10.5) (14.2)
- ----------------------------------------------------------------------------
Income (loss) before income taxes $ 107.6 $ (6.7) $ 126.4
============================================================================
NOTE 14 -- 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. Quarterly, agent relationships are
evaluated as events or circumstances indicate a possible inability to recover
their carrying amount. As a result of the evaluation, the agent relationship
asset was written down before tax by $11.3, $69.5 and $11.0 in 2003, 2002 and
2001, 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 20 years.
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 15 -- 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.
2003 2002 2001
- -----------------------------------------------------------------------------
Statutory net income $119.1 $ 75.1 $172.5
Statutory policyholders' surplus 867.6 725.7 767.5
73
Item 15. Continued
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 accounting practices encompass all accounting practices not so
prescribed.
For statutory purposes, the agent relationships asset related to the
GAI acquisition was taken as a direct charge to surplus.
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 and liability structure
and product mix of the company. As of December 31, 2003, all insurance
companies in the Group exceeded the necessary capital requirements.
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, 2003, approximately $86.8
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 $2.9 in 2003, compared
to $5.6 and $8.8 in 2002 and 2001, respectively.
NOTE 16 -- Debt
In 2002, the Corporation completed an offering of 5.00% convertible notes, in
an aggregate principal amount of $201.3, due March 19, 2022 and generated
net proceeds of $194.0. The net proceeds of the offering, along with $10.5
of cash, were used to pay off the balance and terminate the credit facility
which was signed in 1997. 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 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, 2003 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 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 $.4 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 and facility fees of up to
$.2 annually. These fees are expensed when incurred by the Corporation. The
agreement requires the Corporation to maintain minimum net worth of $800.0.
The credit facility agreement also includes a minimum statutory surplus for
The Ohio Casualty Insurance Company of $650.0. 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, 2003.
During 1999, the Corporation signed a $6.5 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, 2003, 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 $.6 and expires
in November 2009. The remaining balance at December 31, 2003 was $3.9.
74
Item 15. Continued
Total interest expense of $10.1, $9.5 and $11.7 was charged to income
for the periods ending December 31, 2003, 2002 and 2001, respectively.
NOTE 17 -- 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 18 -- Recently Issued Accounting Standards
In May 2003, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 150, Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity (FAS 150),
effective for interim reporting periods beginning after June 15, 2003. Under
the new rules, certain financial instruments classified as equity will be
required to be presented as liabilities. The provisions of FAS 150 do not
have a material impact on the financial statements.
In December 2003, the FASB issued a revised Interpretation No. 46 -
Consolidation of Variable Interest Entities (FIN 46), an interpretation of
ARB No. 51. FIN 46 requires a variable interest entity (VIE) to be
consolidated by the primary beneficiary of the entity if certain criteria are
met. Some provisions of FIN 46 require certain Special Purpose Entity's
(SPE's) to be consolidated as of December 31, 2003. The Corporation does not
have any investments that qualify as SPE's under these provisions. FIN 46
also requires consolidation of all variable interests held no later than the
end of the first reporting period that ends after March 15, 2004 (as of March
31, 2004 for the Corporation). The Corporation is currently evaluating any
investments that may fall under the criteria to be consolidated under FIN 46.
The Corporation currently holds one equity investment, which represents a 49%
interest in the entity, which will require consolidation in accordance with
FIN 46. The expected loss upon consolidation will be immaterial to the
Corporation's financial statements. The Corporation was party to an
agreement in 1984 which created a corporation, APM Spring Grove, Inc., whose
largest asset is an office building in Cincinnati, Ohio. APM Spring Grove's
only source of revenue is derived from leasing the office building. The
rental income on the office building is used by APM to repay principal and
interest on bonds that were issued to purchase the building. The Corporation
is the owner of bonds which are carried on the Corporation's financial
statements at fair market value which was $2.6 as of December 31, 2003. The
Corporation's maximum exposure to loss as a result of its involvement with
APM Spring Grove, Inc. is $3.6. As of June 30, 2003, APM Spring Grove Inc.
had total assets and total liabilities of $.4 and $2.3, respectively.
In January 2004, the FASB issued FASB Staff Position (FSP) FAS106-1,
regarding the accounting for the effects of the Medicare Prescription Drug,
Improvement and Modernization Act of 2003 (MMA). The FSP allows companies an
opportunity to either assess the effect of MMA on their retirement-related
benefit costs and obligations or to defer accounting for the effects of MMA
until authoritative guidance is issued. The Corporation has elected to defer
accounting for the effects of MMA, in accordance with the FSP. As a result,
the accumulated postretirement benefit obligation and net periodic
postretirement benefit cost discussed in Note 5 do not reflect the effects of
MMA on the postretirement benefit plan. The Corporation does not expect the
adoption of the FSP to have a material impact on the financial statements.
NOTE 19 -- Subsequent Events
As a result of company-wide reengineering initiatives, the Corporation
announced on February 11, 2004 an immediate reduction of 260 staff positions
with an additional reduction of 150-250 positions to be announced by the end
of the second quarter of 2004. The Corporation will record in the first
quarter of 2004 approximately $4.6 for severance pay and other related
expenses.
75
Item 15. Continued
Report of Independent Auditors
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, 2003, 2002 and 2001 and the
related consolidated statements of income, shareholders' equity, and cash
flows for the years then ended. Our audits also included the financial
statement schedules listed in the Index at Item 15(a)(2) of this Form 10-K.
These financial statements and schedules are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements and schedules 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, 2003, 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 12, 2004
76
Item 15. Continued
(b) Reports on Form 8-K or 8-K/A
(a) The Corporation filed a Form 8-K on November 6, 2003 to report
under Items 7 and 12, the filing of a press release announcing
the Corporation's third quarter 2003 results and Supplemental
Financial Information. Exhibits to the Form 8-K consisted of
the press release dated November 6, 2003 and Supplemental
Financial Information.
(b) The Corporation filed a Form 8-K on December 19, 2003 to report
under Item 5 the resignation of Myra C. Selby from its Board of
Directors. Exhibits to the Form 8-K consisted of the press
release dated December 19, 2003.
(c) Exhibits.
See Index to Exhibits on pages 87, 88 and 89 of this Form 10-K.
77
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 12, 2004 By: /s/ Dan R. Carmichael
-----------------------------------
Dan R. Carmichael
President, Chief Executive Officer
and 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 12, 2004 /s/ Stanley N. Pontius
-----------------------------------------------------------
Stanley N. Pontius, Lead Director
March 12, 2004 /s/ Dan R. Carmichael
-----------------------------------------------------------
Dan R. Carmichael, President, Chief Executive Officer
and Director
March 12, 2004 /s/ Terrence J. Baehr
-----------------------------------------------------------
Terrence J. Baehr, Director
March 12, 2004 /s/ William P. Boardman
-----------------------------------------------------------
William P. Boardman, Director
March 12, 2004 /s/ Jack E. Brown
-----------------------------------------------------------
Jack E. Brown, Director
March 12, 2004 /s/ Catherine E. Dolan
-----------------------------------------------------------
Catherine E. Dolan, Director
March 12, 2004 /s/ Philip G. Heasley
-----------------------------------------------------------
Philip G. Heasley, Director
March 12, 2004 /s/ Stephen S. Marcum
-----------------------------------------------------------
Stephen S. Marcum, Director
March 12, 2004 /s/ Ralph S. Michael III
-----------------------------------------------------------
Ralph S. Michael III, Director
March 12, 2004 /s/ Robert A. Oakley
-----------------------------------------------------------
Robert A. Oakley, Director
March 12, 2004 /s/ Jan H. Suwinski
-----------------------------------------------------------
Jan H. Suwinski, Director
March 12, 2004 /s/ Donald F. McKee
-----------------------------------------------------------
Donald F. McKee, Executive Vice President and Chief
Financial Officer
78
Schedule I
Ohio Casualty Corporation and Subsidiaries
Consolidated Summary of Investments
Other than Investments in Related Parties
(In millions)
December 31, 2003
Amount shown
Type of investment Cost Value in balance sheet
- ----------------- ---- ----- ----------------
Fixed maturities: Available-for-sale
Bonds:
U.S. Government $ 40.9 $ 43.2 $ 43.2
States, municipalities and
political subdivisions 76.8 79.1 79.1
Corporate securities 1,932.6 2,076.1 2,076.1
Mortgage-backed securities:
U.S. government guaranteed 12.6 13.2 13.2
Other 788.3 810.6 810.6
----------- ----------- -----------
Total fixed maturities
Available-for-sale 2,851.2 3,022.2 3,022.2
Fixed maturities: Held-to-maturity
Corporate securities 167.7 167.8 167.7
Mortgage-backed securities:
Other 188.4 186.4 188.4
----------- ----------- -----------
Total fixed maturities
Held-to-maturity 356.1 354.2 356.1
Equity securities:
Common stocks:
Banks, trust and insurance
companies 21.0 109.0 109.0
Industrial, miscellaneous and
all other 56.9 220.0 220.0
----------- ----------- -----------
Total equity securities 77.9 329.0 329.0
Short-term investments 40.4 40.4 40.4
----------- ----------- -----------
Total investments $ 3,325.6 $ 3,745.8 $ 3,747.7
=========== =========== ===========
79
Schedule II
Ohio Casualty Corporation
Condensed Financial Information of Registrant
(In millions)
2003 2002 2001
---- ---- ----
Condensed Balance Sheet:
- -----------------------
Investment in wholly-owned
subsidiaries, at equity $ 1,285.0 $ 1,197.8 $ 1,242.7
Investment in fixed maturities and equity
securities, at fair value 44.2 40.7 18.9
Cash and other assets 18.8 21.0 31.8
------------ ------------ ------------
Total assets 1,348.0 1,259.5 1,293.4
Notes payable 198.0 198.3 210.2
Other liabilities 4.2 2.5 3.2
------------ ------------ ------------
Total liabilities 202.2 200.8 213.4
------------ ------------ ------------
Shareholders' equity $ 1,145.8 $ 1,058.7 $ 1,080.0
============ ============ ============
Condensed Statement of Income:
- -----------------------------
Dividends from subsidiaries $ - $ 25.0 $ 5.2
Undistrbuted earnings of subsidiaries 79.8 (19.3) 103.0
Operating expenses (4.0) (6.6) (9.6)
------------ ------------ ------------
Net income (loss) $ 75.8 $ (0.9) $ 98.6
============ ============ ============
Condensed Statement of Cash Flows:
- ---------------------------------
Operating activities
Net distributed income (loss) $ (4.0) $ 18.4 $ (4.5)
Other 5.4 1.6 2.1
------------ ------------ ------------
Net cash provided by (used in)
operating activities 1.4 20.0 (2.4)
Investing activities
Purchase of fixed maturity and equity
securities (29.1) (55.5) (6.0)
Sales of fixed maturities and equity
securities 26.1 30.5 19.4
------------ ------------ ------------
Net cash (used in) provided by
investing activities (3.0) (25.0) 13.4
Financing activities
Debt:
Proceeds - 201.3 -
Payments (0.6) (205.6) (10.6)
Payment for deferred financing cost - (0.4) -
Payment for issuance costs - (7.4) -
Proceeds from exercise of stock options 2.2 7.5 0.1
------------ ------------ ------------
Net cash provided by (used in)
financing activities 1.6 (4.6) (10.5)
Net change in cash - (9.6) 0.4
------------ ------------ ------------
Cash, beginning of year 0.4 10.0 9.6
------------ ------------ ------------
Cash, end of year $ 0.4 $ 0.4 $ 10.0
============ ============ ============
80
Schedule III
Ohio Casualty Corporation and Subsidiaries
Consolidated Supplementary Insurance Information
(In millions)
December 31, 2003
Deferred Reserves for
policy unpaid Net
acquisition losses and Unearned Earned investment
costs loss expenses premiums premiums income
----------- ------------- -------- -------- ----------
Segment
- -------
Property and
casualty insurance:
Underwriting
Commercial Lines $ 100.7 $ 2,145.6 $ 385.3 $ 777.4 $ -
Specialty Lines 30.2 27.3 135.8 162.7 -
Personal Lines 38.4 454.9 181.9 484.3 -
Allowance for reinsurance
recoverable - - - - -
Investment - - - - 204.9
----------- ----------- ----------- ----------- -----------
Total property and
casualty insurance 169.3 2,627.8 703.0 1,424.4 204.9
Corporation - - - - 3.8
----------- ----------- ----------- ----------- -----------
Total $ 169.3 $ 2,627.8 $ 703.0 $ 1,424.4 $ 208.7
=========== =========== =========== =========== ===========
Amortization
Losses of deferred
and loss policy General
expenses acquisition operating Premiums
incurred costs expenses written
-------- ----------- --------- --------
Segment
- -------
Property and
casualty insurance:
Underwriting
Commercial Lines $ 590.3 $ 212.6 $ 80.2 $ 792.6
Specialty Lines 54.8 62.8 11.9 164.9
Personal Lines 380.4 108.6 27.1 484.1
Allowance for reinsurance
recoverable 1.9 - - -
Investment - - - -
----------- ----------- ----------- -----------
Total property and
casualty insurance 1,027.4 384.0 119.2 1,441.6
Corporation - - 30.8 -
----------- ----------- ----------- -----------
Total $ 1,027.4 $ 384.0 $ 150.0 $ 1,441.6
=========== =========== =========== ===========
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. Amortization and
impairment write-downs of the agent relationships asset are classified
as corporate expenses as management believes these costs do not relect
current underwriting profitability.
81
Schedule III
Ohio Casualty Corporation and Subsidiaries
Consolidated Supplementary Insurance Information
(In millions)
December 31, 2002
Deferred Reserves for
policy unpaid Net
acquisition losses and Unearned Earned investment
costs loss expenses premiums premiums income
----------- ------------- -------- -------- ----------
Segment
- -------
Property and
casualty insurance:
Underwriting
Commercial Lines $ 92.8 $ 1,710.2 $ 370.0 $ 725.6 $ -
Specialty Lines 33.2 231.7 116.4 158.4 -
Personal Lines 55.3 491.8 182.3 566.4 -
Miscellaneous income - - - 0.1 -
Allowance for reinsurance
recoverable - - - - -
Investment - - - - 205.8
----------- ----------- ----------- ----------- -----------
Total property and
casualty insurance 181.3 2,433.7 668.7 1,450.5 205.8
Corporation - - - - 1.3
----------- ----------- ----------- ----------- -----------
Total $ 181.3 $ 2,433.7 $ 668.7 $ 1,450.5 $ 207.1
=========== =========== =========== =========== ===========
Amortization
Losses of deferred
and loss policy General
expenses acquisition operating Premiums
incurred costs expenses written
-------- ------------ --------- --------
Segment
- -------
Property and
casualty insurance:
Underwriting
Commercial Lines $ 571.9 $ 187.7 $ 80.6 $ 762.2
Specialty Lines 79.2 52.1 15.2 179.9
Personal Lines 478.2 136.4 17.5 506.5
Miscellaneous income - - - -
Allowance for reinsurance
recoverable 0.5 - - -
Investment - - - -
----------- ----------- ----------- -----------
Total property and
casualty insurance 1,129.8 376.2 113.3 1,448.6
Corporation
----------- ----------- ----------- -----------
Total $ 1,129.8 $ 376.2 $ 203.5 $ 1,448.6
=========== =========== =========== ===========
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. Amortization and
impairment write-downs of the agent relationships asset are classified as
corporate expenses as management believes these costs do not reflect
current underwriting profitability.
82
Schedule III
Ohio Casualty Corporation and Subsidiaries
Consolidated Supplementary Insurance Information
(In millions)
December 31, 2001
Deferred Reserves for
policy unpaid Net
acquisition losses and Unearned Earned investment
costs loss expenses premiums premiums income
----------- ------------- -------- -------- ----------
Segment
- -------
Property and
casualty insurance:
Underwriting
Commercial Lines $ 91.0 $ 1,482.1 $ 331.9 $ 707.6 $ -
Specialty Lines 21.1 188.3 88.8 130.6 -
Personal Lines 54.7 480.3 246.1 668.0 -
Miscellaneous income - - - 0.4 -
Investment - - - - 211.1
----------- ----------- ----------- ----------- -----------
Total property and
casualty insurance 166.8 2,150.7 666.8 1,506.6 211.1
Premium finance - - - 0.1 0.1
Corporation - - - - 1.2
----------- ----------- ----------- ----------- -----------
Total $ 166.8 $ 2,150.7 $ 666.8 $ 1,506.7 $ 212.4
=========== =========== =========== =========== ===========
Amortization
Losses of deferred
and loss policy General
expenses acquisition operating Premiums
incurred costs expenses written
----------- ----------- ----------- -----------
Segment
- -------
Property and
casualty insurance:
Underwriting
Commercial Lines $ 564.5 $ 192.5 $ 67.8 $ 689.6
Specialty Lines 68.4 37.7 11.5 136.1
Personal Lines 571.1 145.5 79.9 646.5
Miscellaneous income - - - -
Investment - - - -
----------- ----------- ----------- -----------
Total property and
casualty insurance 1,204.0 375.7 159.2 1,472.2
Premium finance - - 0.3 -
Corporation - - 36.4 -
----------- ----------- ----------- -----------
Total $ 1,204.0 $ 375.7 $ 195.9 $ 1,472.2
=========== =========== =========== ===========
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. Amortization and
impairment write-downs of the agent relationships asset are classified as
corporate expenses as management believes these costs do not reflect
current underwriting profitability.
83
Schedule IV
Ohio Casualty Corporation and Subsidiaries
Consolidated Reinsurance
(In millions)
December, 2003, 2002 and 2001
Percent of
amount
Ceded to Assumed assumed
Gross other from other Net to net
amount companies companies amount amount
------ --------- ---------- ------ ----------
Year Ended December 31, 2003
Premiums
Property and casualty insurance $1,570.3 $ 148.7 $ 20.0 $1,441.6 1.4%
Accident and health insurance 0.1 0.1 - - -
-------- ------- -------- --------
Total premiums 1,570.4 148.8 20.0 1,441.6 1.4%
Premium finance charges -
--------
Total premiums and finance charges written 1,441.6
Change in unearned premiums and finance charges (17.2)
---------
Total premiums and finance charges earned 1,424.4
Miscellaneous income -
---------
Total premiums & finance charges earned $1,424.4
========
Year Ended December 31, 2002
Premiums
Property and casualty insurance $1,536.0 $ 103.6 $ 16.3 $1,448.6 1.1%
Accident and health insurance 0.1 0.2 - (0.1) -
-------- -------- -------- --------
Total premiums 1,536.1 103.8 16.3 1,448.6 1.1%
Premium finance charges -
--------
Total premiums and finance charges written 1,448.6
Change in unearned premiums and finance charges 1.7
--------
Total premiums and finance charges earned 1,450.3
Miscellaneous income 0.2
--------
Total premiums & finance charges earned $1,450.5
========
Year Ended December 31, 2001
Premiums
Property and casualty insurance $1,550.9 $ 93.8 $ 15.1 $1,472.2 1.0%
Accident and health insurance 0.1 0.1 - - -
-------- -------- -------- --------
Total premiums 1,551.0 93.9 15.1 1,472.2 1.0%
Premium finance charges -
---------
Total premiums and finance charges written 1,472.2
Change in unearned premiums and finance charges 34.1
---------
Total premiums and finance charges earned 1,506.3
Miscellaneous income 0.4
---------
Total premiums & finance charges earned $1,506.7
=========
84
Schedule V
Ohio Casualty Corporation and Subsidiaries
Valuation and Qualifying Accounts
(in millions)
Balance at Balance at
beginning Charged to end of
of period expenses period
Year ended December 31, 2003
Reserve for bad debt $4.3 ($0.1) $4.2
Year ended December 31, 2002
Reserve for bad debt $8.4 ($4.1) $4.3
Year ended December 31, 2001
Reserve for bad debt $10.7 ($2.3) $8.4
85
Schedule VI
Ohio Casualty Corporation and Subsidiaries
Consolidated Supplemental Information Concerning
Property and Casualty Insurance Operations
(In millions)
Reserves for
Deferred unpaid claims
policy and claim Net
Affiliation with acquisition adjustment Unearned Earned investment
registrant costs expenses premiums premiums income
------------ ------------ ------------ ------------ ------------
Property and casualty
subsidiaries
Year ended December 31,
2003 $ 169.3 $2,627.8 $ 703.0 $1,424.4 $ 204.9
======== ======== ======== ======== ========
Year ended December 31,
2002 $ 181.3 $2,433.7 $ 668.7 $1,450.5 $ 205.8
======== ======== ======== ======== ========
Year ended December 31,
2001 $ 166.8 $2,150.7 $ 666.8 $1,506.7 $ 211.1
======== ======== ======== ======== ========
Claims and claim
adjustment expenses Amortization Paid
incurred related to of deferred claims
--------------------------- policy and claim
Affiliation with Current Prior acquisition adjustment Premiums
registrant year years costs expenses written
------------ ------------ ------------ ------------ ------------
Property and casualty
subsidiaries
Year ended December 31,
2003 $ 993.3 $ 34.1 $ 384.0 $ 975.5 $1,441.6
======== ======== ======== ======== ========
Year ended December 31,
2002 $1,045.4 $ 84.4 $ 376.2 $1,032.5 $1,448.6
======== ======== ======== ======== ========
Year ended December 31,
2001 $1,145.5 $ 58.5 $ 375.7 $1,129.3 $1,472.2
======== ======== ======== ======== ========
86
Form 10-K
Ohio Casualty Corporation
Index to Exhibits
Exhibit 1e Form of amended Change in Control Agreement entered into between
the Registrant and each of the following executive officers:
John S. Busby, Debra K. Crane, Ralph G. Goode, Jeffrey L.
Haniewich, John S. Kellington, Richard B. Kelly, Elizabeth M.
Riczko, Thomas E. Schadler and Howard L. Sloneker III
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
Exhibit 4.1 Restated Ohio Casualty Corporation Agent Share Plan, filed on
Registrant's Form S-3 (333-39483) on June 18, 1997
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
(Nos. 333-70761, 333-29483, 333-88532, and 333-105092)
and Form S-8 (Nos. 333-69895, 333-87413, 333-42942,
333-88398, 333-91906, 333-97987, 333-42944, 333-73738 and
333-73740)
Exhibit 28 Information from Reports Furnished to State Insurance
Regulation Authorities
Exhibit 31.1 Certification of Chief Executive Officer of Ohio Casualty
Corporation in accordance with SEC Rule 13(a)-14(a)/15(d)-14(a)
Exhibit 31.2 Certification of Chief Financial Officer of Ohio Casualty
Corporation in accordance with SEC Rule 13(a)-14(a)/15(d)-14(a)
Exhibit 32.1 Certification of Chief Executive Officer of Ohio Casualty
Corporation in accordance with Section 1350 of the
Sarbanes-Oxley Act of 2002
Exhibit 32.2 Certification of Chief Financial Officer of Ohio Casualty
Corporation in accordance with Section 1350 of the
Sarbanes-Oxley Act of 2002
Exhibits incorporated by reference:
Exhibit 3 Articles of Incorporation, as amended, filed as Exhibit 3 to
the Registrant's SEC Form 10-K on March 27, 2003
Exhibit 3.1 Code of Regulations, as amended, filed as Exhibit 3.1 to the
Registrant's SEC Form 10-Q on May 13, 2003
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
87
Form 10-K
Ohio Casualty Corporation
Index to Exhibits, Continued
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 for debt
securities filed on Form S-3 (333-70761) on January 19, 1999
Exhibit 4e First Amendment to the Ohio Casualty Corporation's Registration
Statement for debt securities filed on Form S-3A (333-70761) on
March 31, 1999
Exhibit 4f Second Amendment to the Ohio Casualty Corporation's Registration
Statement for debt securities filed on Form S-3A (333-70761) on
May 11, 1999
Exhibit 4g Third Amendment to the Ohio Casualty Corporation's Registration
Statement for debt securities filed on Form S-3A (333-70761) on
June 1, 1999
Exhibit 4h Ohio Casualty Corporation's Registration Statement for
Convertible Notes due 2002 filed on Form S-3 (333-88532) on
May 17, 2002
Exhibit 4i First Amendment to the Ohio Casualty Corporation's Registration
Statement for Convertible Notes due 2002 filed on Form S-3A
(333-88532) on June 4, 2002
Exhibit 4j Ohio Casualty Corporation' Registration Statement for Universal
Shelf Filed on Form S-3 (333-105092) on May 8, 2003
Exhibit 10a 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 10b 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 10c 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 10d 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 2002, 2001 and 2000)
Exhibit 10e Stock Option Agreement for Executive Vice President and Chief
Financial Officer dated September 19, 2001, filed as Exhibit
10.6 to the Registrant's SEC Form 10-K on March 27, 2003
Exhibit 10f 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
88
Form 10-K
Ohio Casualty Corporation
Index to Exhibits, continued
Exhibit 10g 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 10h 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 10i 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
Exhibit 10j Amended and Restated Ohio Casualty Corporation Director's
Deferred Compensation Plan filed as Exhibit 10.1 to the
Registrant's SEC Form 10-K on March 27, 2003
Exhibit 10k The Ohio Casualty Insurance Company Supplemental Executive
Savings Plan, amended effective June 1, 2002 filed as Exhibit
10.2 to the Registrant's SEC Form 10-K on March 27, 2003
Exhibit 10l The Ohio Casualty Insurance Company 2002 Officer Annual
Incentive Program filed as Exhibit 10.3 to the Registrant's
SEC Form 10-K on March 27, 2003
Exhibit 10m The Ohio Casualty Insurance Company Benefit Equalization Plan
filed as Exhibit 10.4 to the Registrant's SEC Form 10-K on
March 27, 2003
Exhibit 10n The Ohio Casualty Insurance Company Deferred Compensation
Plan (Dan R. Carmichael) filed as Exhibit 10.5 to the
Registrant's SEC Form 10-K on March 27, 2003
89