[Ohio Casualty Corporation letterhead)
Michael A. Winner, CPA
Executive Vice President & Chief Financial Officer
January 17, 2006
Mr. Jim B. Rosenberg
Senior Assistant Chief Accountant
Division of Corporation Finance
Securities and Exchange Commission
100 F Street, N.E.
Mail Stop 6010
Washington DC 20549
Re: Ohio Casualty Corporation
Form 10-K for Fiscal Year Ended December 31, 2004
File No. 0-05544
Dear Mr. Rosenberg:
Ohio Casualty Corporation ("Corporation") has reviewed the comment letter
prepared by the Securities and Exchange Commission (Commission) dated
December 20, 2005 and submits the following in response. Please note for
ease of reference we have restated the Commission's comments within our
responses.
Form 10-K for the year ended December 31, 2004
Management's Discussion and Analysis, page 18
Results of Operations, page 18
------------------------------
1. We note that you have included in your disclosures a caption for the
non-GAAP measure operating income (loss). We believe that the use of this
measure must comply with Item 10e of Regulation S-K. This measure
eliminates certain recurring items such as realized gains (losses). The
acceptability of a non-GAAP financial measure that eliminates recurring
items from the most comparable GAAP measure depends on all facts and
circumstances. We note that excluded realized investment gains (losses)
have the following attributes:
9450 Seward Road, Fairfield, OH 45014 Telephone: 513-603-2267
Fax: 513-603-3134 mike.winner@ocas.com
- There is a past pattern of these items occurring in each reporting
period;
- The financial impact of these items will not disappear or become
immaterial in the future; and
- There is no unusual reason that a company can substantiate to identify
the special nature of these items.
These attributes raise significant questions as to the usefulness of this
measure for investors and the appropriateness of its presentation in
accordance with Item 10 of Regulation S-K. Please refer to Questions 8, 9
and 21 of "Frequently Asked Questions Regarding the Use of Non-GAAP
Financial Measures". Please tell us how this measure complies with the
guidance referred to above.
Response:
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The guidance in Question 8 states " while there is no per se prohibition
against removing a recurring item, companies must meet the burden of
demonstrating the usefulness of any measure that excludes recurring items,
especially if the non-GAAP financial measure is used to evaluate
performance." The Corporation discloses the non-GAAP measure of
consolidated operating income (loss) as management believes this is an
important performance measure that is useful in evaluating the overall
financial condition and performance of the Corporation. This measure is
used by management and members of the investment community to evaluate the
profitability of recurring insurance operations. Management reviews and
evaluates the performance of the operations on a monthly basis using
several financial measures, one of the most important being consolidated
operating income (loss). Additionally, consolidated operating income
(loss) is a key performance metric identified by the Corporation's Board of
Directors for use in determining incentive based compensation of the
Corporation's management. Realized investment gains (losses) are subject
to significant volatility within the investment markets and are not a true
measure of the performance of the operations of the Corporation. For these
reasons, it is common practice in the insurance industry, and a frequent
request by investment analysts who follow the insurance industry, to report
operating income (loss) defined as net income excluding realized investment
gains (losses). This measure is often referred to by the investment
community and used as a significant metric of performance when evaluating
companies within the industry. This measure is not intended to replace
GAAP net income nor is it presented with any more prominence, but is
included to enhance the investment community's understanding of the actual
performance of the operations. The Corporation provides a reconciliation
of operating income (loss) to net income (loss) and the reasons why
management uses the non-GAAP financial measure.
We realize and agree that the Corporation has had a past pattern of
realized investment gains (losses) occurring in each reporting period and
the financial impact of these items will not disappear in the future. The
Corporation does not infer, intend to infer or label these items as non-
recurring for these reasons. However with the explanations provided in the
previous paragraph, management believes that these items are of a special
nature that should not be included in an evaluation of the Corporation's
insurance operations and financial performance.
Despite the fact that the Corporation believes this non-GAAP measure to be
important to its investors, for the reasons cited above, on a prospective
basis beginning with the Form 10-K for the year ended December 31, 2005,
the Corporation will not include the non-GAAP measure of operating income
in its Management's Discussion and Analysis of Financial Condition and
Results of Operation.
Loss and Loss Adjustment Expenses, page 39
------------------------------------------
2. We noticed that the Company's actuaries determine a point estimate by
product which management adjusts based upon its best estimate of the
liability for loss and loss adjustment expense (LAE) reserves. For each
product line, please provide to us, in disclosure-type format, a
description of the method used by the actuary to determine the point
estimate for each product line and what specific factors/justifications,
management used to adjust the point estimates provided by the actuaries.
Response:
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Our actuaries utilize various generally accepted actuarial reserving
methods to establish our incurred but not reported (IBNR) and LAE reserves
for each product line. The principal methods include, but are not limited
to:
1. Paid loss development - payment patterns of prior claims are used to
estimate future payment patterns which are applied to current payments
to derive an estimate of ultimate losses.
2. Incurred loss development - case incurred patterns of prior claims are
used to estimate future incurred patterns which are applied to current
incurred losses to derive an estimate of ultimate losses.
3. Expected loss ratio - loss ratios are determined for recent accident
years based on historical accident year loss ratios, recent economic
trends and changes in the book of business including rate levels. The
expected loss ratio for each accident year is then applied to the actual
earned premiums to calculate ultimate losses.
4. Bornhuetter-Ferguson estimates - blends the expected loss ratio method
with either the paid or incurred loss development method using weights
based on the maturity of the accident year.
5. Claim count and severity estimates - ultimate claim counts and average
claim severities are developed separately and then multiplied to derive
an estimate of ultimate losses.
Reserves for losses and allocated LAE for asbestos and environmental
exposures are especially difficult to determine because of the high amount
of legal costs and the extended period of time required to settle these
claims. Methods used by the Company's actuaries to estimate these reserves
include survival ratio funding, S-curves applied to both paid and case
incurred losses and allocated loss adjustment expenses (ALAE), and
frequency and severity estimates. Point estimates are selected based on the
estimates from these methods.
The merits of each method are evaluated given the facts at hand. An
estimate of the ultimate losses is then made based upon the particular
method or combination of methods that is deemed most appropriate. The
various assumptions, estimates and other factors that may have an impact on
our ultimate losses are discussed with management to determine the
company's best estimate of the ultimate losses and LAE, and our estimate of
IBNR is then recorded.
Management relies heavily on the actuarial estimates and recognizes that
the actuaries exercise a considerable degree of judgment in selecting these
estimates. It is also recognized that there is a great deal of uncertainty
in the reserve estimates due to the factors described in the third
paragraph of the section entitled "Loss and Loss Adjustment Expenses"on
page 39 of the 2004 Form 10-K, and that unforeseen events can have
unfavorable impacts on the reserve estimates. This uncertainty is
illustrated by the reserve development presented in the Analysis of
Development of Loss and LAE liabilities schedule which appears on pages 11
and 12 under Item 1 of the 2004 Form 10-K. Management considers the
actuarial estimates as well as all of these factors in determining its best
estimate.
The Corporation will include disclosure similar to that presented above in
the Form 10-K for the year ended December 31, 2005.
3. We note your sensitivity analysis disclosure related to changes in the
stable loss inflation assumption. Please explain to us whether this
assumption is the key variable in your loss reserving methodology and
whether you believe the hypothetical one percent increase in the
inflationary trend is reasonably likely to occur. If not true, please
provide us in disclosure-type format which assumptions are key to your
reserving process and the impact of reasonably likely changes in these
assumptions.
Response:
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An unexpected change in the loss cost trend implicitly built into the
reserve estimates could be caused by one or more of the factors described
in the third paragraph of the section entitled "Loss and Loss Adjustment
Expenses" on page 39 of the 2004 Form 10-K. The reserve estimates assume
consistency of these factors without making explicit assumptions as to the
values or levels of these factors. The hypothetical one percent increase in
the loss cost trend is presented merely to illustrate the variability
introduced by such a change which could be due to a change in any of these
factors.
It is difficult, if not impossible, to predict which direction the trend
rate will change, if at all, and by how much. It is possible that more
than one of these factors could change concurrently, or consecutively, and
in favorable or unfavorable directions. It is possible that many of these
factors could change simultaneously and all go in one direction (favorable
or unfavorable), or that they offset each other. It is reasonably likely
that one or more changes in factors will occur, but impossible to know
which and to what degree.
The Corporation will take into consideration your comment and our response,
to determine if additional disclosure or clarifying language, similar to
the above, is necessary for incorporation into the Form 10-K for the year
ended December 31, 2005.
4. As IBNR reserves estimates are more imprecise, for each line of your
business, please tell us, in disclosure-type format, the amounts of your
loss reserves for IBNR claims.
Response:
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The following table displays case reserves, IBNR loss reserves (defined
below) and LAE reserves by line of business, on a net of reinsurance basis.
The IBNR loss reserves include provisions for incurred but not reported
claims, increases on known cases, and claims to be reopened. The IBNR
provision also includes an offset for anticipated salvage and subrogation
recoveries.
Reserves in millions of dollars as of December 31, 2004*
Case IBNR LAE
Line of Business Reserves Reserves Reserves Total
- ---------------- -------- -------- -------- -----
Personal property $ 30 $ 39 $ 17 $ 86
Personal auto incl.
personal umbrella 145 82 58 285
Commercial auto 96 121 44 261
Workers compensation 290 280 71 641
CMP, fire & inland
marine 130 164 123 417
General liability 53 104 89 245
Commercial umbrella 29 168 39 236
Fidelity & surety 9 1 4 14
Total $780 $959 $444 $2,184
==== ==== ==== ======
* Net of reinsurance excluding provision for uncollectible reinsurance
The Corporation will include disclosure similar to that presented above in
the Form 10-K for the year ended December 31, 2005.
Financial Statements, page 49
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Note 1C, page 54, Investments
-----------------------------
5. Please explain to us why you include cash equivalents under paragraph 8
of SFAS 95 as short-term investments.
Response:
- ---------
The Corporation's short-term investments are comprised of treasury bills,
commercial paper and money market funds, all types of cash equivalents
listed in paragraph 9 of Statement of Financial Accounting Standards (SFAS)
95. These investments are readily convertible to known amounts of cash and
so near maturity that they present insignificant risk of changes in value
because of interest rate changes. Cash purchases and sales of these
investments have historically been part of the Corporation's cash
management activities, rather than part of its operating, investing and
financing activities and therefore have been treated as cash equivalents in
the Statement of Cash Flows. As noted in Note 1c, maturities of short-term
investments are within 90 days or less at the date of acquisition, as
defined in paragraph 8 of SFAS 95.
At December 31, 2004, the Corporation's increase in short-term investments
from December 31, 2003 was related to the issuance of $200 million of
Senior Notes in June 2004, as described in Note 16, pages 69-70, Debt.
Proceeds from the Senior Notes were used in the first half of 2005 to
redeem the Corporation's existing Convertible Notes. The proceeds from the
Senior Notes were invested in short-term marketable securities (as
described above) until the funds were used to repay the Convertible Notes.
Since these proceeds were invested in the same type of short-term
investments as the Corporation had historically invested in, these
investments were also treated as cash equivalents. The Corporation did not
change it's accounting policy regarding short-term investments due to the
increased investment in these types of securities as of December 31, 2004
and accordingly treated them as cash equivalents in the Statement of Cash
Flows as of December 31, 2004.
The Corporation will revise the caption "Cash and cash equivalents" to
"Cash and short term investments" in its Consolidated Statement of Cash
Flows for each of the three years presented in the Form 10-K for the year
ended December 31, 2005.
In response to your request to include the following, please be advised the
Corporation acknowledges:
- that it is responsible for the adequacy and accuracy of the disclosure
in the filing;
- that staff comments or changes to disclosure in response to staff
comments do not foreclose the Commission from taking any action with
respect to the filing; and that the Corporation may not assert staff
comments as a defense in any proceeding initiated by the Commission or any
person under the federal securities laws of the United States.
You may contact Debra K. Crane, Senior Vice President, General Counsel and
Secretary, by telephone at (513) 603-2213 or via fax at (513) 603-2208 or
email at Debra.Crane@ocas.com if you have questions or comments on the
responses of the Corporation.
Sincerely,
/s/Michael A. Winner
Michael A. Winner
Executive Vice President and
Chief Financial Officer