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UNITED STATES SECURITIES AND
EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
[x] Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the quarterly period ended September 30, 2006.
[ ] 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 0-05544
OHIO CASUALTY CORPORATION
(Exact name of registrant as specified in its charter)
OHIO 31-0783294
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
9450 Seward Road, Fairfield, Ohio 45014
(Address of principal executive offices) (Zip Code)
(513) 603-2400
(Registrant's telephone number, including area code)
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 whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. See definition of
"accelerated filer and large accelerated filer" in Rule 12b-2 of the
Exchange Act.
Large accelerated filer X Accelerated filer Non-accelerated filer
-----
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act).
Yes No X
-----
On October 31, 2006, there were 60,992,517 shares of common stock
outstanding.
Page 1 of 34
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INDEX
Page
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PART I FINANCIAL INFORMATION
Item 1. Financial Statements 3
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 19
Item 3. Quantitative and Qualitative Disclosures about Market Risk 33
Item 4. Controls and Procedures 33
PART II OTHER INFORMATION
Item 2. Unregistered Sales of Equity Securities and Use
of Proceeds 33
Item 6. Exhibits 34
Signature 34
Exhibit 31.1 Certification of Chief Executive Officer of Ohio Casualty
Corporation in accordance with SEC Rule 13(a)-14(a) and
Rule 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) and
Rule 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
2
PART I FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
Ohio Casualty Corporation & Subsidiaries
CONSOLIDATED BALANCE SHEETS
September 30, December 31,
(in millions, except share data) (Unaudited) 2006 2005
- -------------------------------------------------------------------------------------------
Assets
Investments, at fair value:
Fixed maturities:
Available-for-sale, at fair value
(amortized cost: $3,483.9 and $3,453.5) $ 3,553.2 $ 3,527.7
Held-to-maturity, at amortized cost
(fair value: $245.7 and $260.5) 250.7 264.4
Equity securities, at fair value
(cost: $188.6 and $144.2) 404.4 375.1
- -------------------------------------------------------------------------------------------
Total investments 4,208.3 4,167.2
Cash and cash equivalents 18.6 54.5
Premiums and other receivables, net of allowance 338.5 309.2
Deferred policy acquisition costs 155.4 153.7
Property and equipment, net of accumulated depreciation 79.3 80.1
Reinsurance recoverable, net of allowance 703.7 741.8
Agent relationships, net of accumulated amortization 100.7 109.7
Interest and dividends due or accrued 47.4 55.0
Deferred tax asset, net 14.2 14.8
Other assets 125.5 77.1
- -------------------------------------------------------------------------------------------
Total assets $ 5,791.6 $ 5,763.1
===========================================================================================
Liabilities
Insurance reserves:
Losses $ 2,459.1 $ 2,435.0
Loss adjustment expenses 519.6 511.8
Unearned premiums 693.1 679.6
Debt 199.7 200.4
Reinsuance treaty funds held 121.9 150.4
Other liabilities 320.5 359.5
- -------------------------------------------------------------------------------------------
Total liabilities 4,313.9 4,336.7
Shareholders' Equity
Common stock, $.125 par value
Authorized: 150,000,000
Issued shares: 72,418,344; 72,418,344 9.0 9.0
Additional paid-in capital 22.6 18.8
Accumulated other comprehensive income 162.8 178.0
Retained earnings 1,489.4 1,360.6
Treasury stock, at cost:
(Shares: 11,214,271; 9,137,208) (206.1) (140.0)
- -------------------------------------------------------------------------------------------
Total shareholders' equity 1,477.7 1,426.4
- -------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 5,791.6 $ 5,763.1
===========================================================================================
Accompanying notes are an integral part of these consolidated financial
statements. For complete disclosures see Notes to Consolidated Financial
Statements on pages 67-84 of the Corporation's 2005 Form 10-K.
3
ITEM 1. Continued
Ohio Casualty Corporation & Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
Three Months
Ended September 30,
(in millions, except share and per share data) (Unaudited) 2006 2005
- -------------------------------------------------------------------------------------------
Premiums and finance charges earned $ 356.3 $ 362.5
Investment income, less expenses 51.3 51.4
Investment gains realized, net 11.4 22.4
- -------------------------------------------------------------------------------------------
Total revenues 419.0 436.3
Losses and benefits for policyholders 188.8 204.5
Loss adjustment expenses 35.8 42.5
General operating expenses 115.4 121.6
Write-down and amortization of agent relationships 1.6 2.4
Amortization of deferred policy acquisition costs 82.1 83.3
Deferral of policy acquisition costs (83.7) (87.4)
Depreciation and amortization expense 2.9 3.0
- -------------------------------------------------------------------------------------------
Total expenses 342.9 369.9
- -------------------------------------------------------------------------------------------
Income before income taxes 76.1 66.4
Income tax expense (benefit):
Current 22.8 11.2
Deferred (2.0) (0.3)
- -------------------------------------------------------------------------------------------
Total income tax expense 20.8 10.9
- -------------------------------------------------------------------------------------------
Net income $ 55.3 $ 55.5
===========================================================================================
Weighted average shares outstanding - basic 61,151,087 64,400,341
===========================================================================================
Earnings per share - basic:
Net income, per share $ 0.90 $ 0.86
===========================================================================================
Weighted average shares outstanding - diluted 62,441,227 65,656,774
===========================================================================================
Earnings per share - diluted:
Net income, per share $ 0.89 $ 0.85
===========================================================================================
Accompanying notes are an integral part of these consolidated financial
statements. For complete disclosures see Notes to Consolidated Financial
Statements on pages 67-84 of the Corporation's 2005 Form 10-K.
4
ITEM 1. Continued
Ohio Casualty Corporation & Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
Nine Months
Ended September 30,
(in millions, except share and per share data) (Unaudited) 2006 2005
- -------------------------------------------------------------------------------------------
Premiums and finance charges earned $ 1,069.5 $ 1,090.3
Investment income, less expenses 154.1 148.4
Investment gains realized, net 30.9 36.2
- -------------------------------------------------------------------------------------------
Total revenues 1,254.5 1,274.9
Losses and benefits for policyholders 577.1 587.3
Loss adjustment expenses 115.2 125.8
General operating expenses 348.8 355.3
Write-down and amortization of agent relationships 9.0 10.1
Amortization of deferred policy acquisition costs 247.7 255.1
Deferral of policy acquisition costs (249.4) (252.2)
Depreciation and amortization expense 8.0 8.7
Loss on retirement of convertible debt, including
debt conversion expenses - 9.0
- -------------------------------------------------------------------------------------------
Total expenses 1,056.4 1,099.1
- -------------------------------------------------------------------------------------------
Income before income taxes 198.1 175.8
Income tax expense:
Current 45.9 32.2
Deferred 9.4 8.2
- -------------------------------------------------------------------------------------------
Total income tax expense 55.3 40.4
- -------------------------------------------------------------------------------------------
Net income $ 142.8 $ 135.4
===========================================================================================
Average shares outstanding - basic 62,393,244 63,487,313
===========================================================================================
Earnings per share - basic:
Net income, per share $ 2.29 $ 2.13
===========================================================================================
Average shares outstanding - diluted 63,868,978 68,012,120
===========================================================================================
Earnings per share - diluted:
Net income, per share $ 2.24 $ 2.02
===========================================================================================
Accompanying notes are an integral part of these consolidated financial
statements. For complete disclosures see Notes to Consolidated Financial
Statements on pages 67-84 of the Corporation's 2005 Form 10-K.
5
ITEM 1. Continued
Ohio Casualty Corporation & Subsidiaries
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Accumulated
Additional other Total
(in millions, except Common paid-in comprehensive Retained Treasury shareholders'
share data) (Unaudited) Stock capital income earnings stock equity
- ---------------------------------------------------------------------------------------------------------
Balance
January 1, 2005 $ 9.0 $ - $ 259.1 $1,161.5 $(134.7) $1,294.9
Net income 135.4 135.4
Change in unrealized gain,
net of deferred income tax
benefit of $34.2 (63.1) (63.1)
---------
Comprehensive income 72.3
Net issuance of restricted stock
(26,828 shares) 0.2 0.4 0.6
Net issuance of treasury
stock (1,066,438 shares) 5.2 (0.2) 13.7 18.7
Repurchase of treasury stock
(570,115 shares) (14.6) (14.6)
Cash dividends paid ($0.06 per share) (7.7) (7.7)
Issuance of common stock pursuant
to Convertible Note transaction
(See Note VII) 11.2 17.3 28.5
- --------------------------------------------------------------------------------------------------------
Balance,
September 30, 2005 $ 9.0 $ 16.6 $ 196.0 $1,289.0 $(117.9) $1,392.7
========================================================================================================
Balance
January 1, 2006 $ 9.0 $ 18.8 $ 178.0 $1,360.6 $(140.0) $1,426.4
Net income 142.8 142.8
Change in unrealized gain,
net of deferred income tax
benefit of $8.8 (15.2) (15.2)
---------
Comprehensive income 127.6
Net issuance of restricted stock
(18,638 shares) 0.7 0.3 1.0
Unearned stock compensation (2.9) 2.9 -
Stock based compensation, including
income tax benefit of $1.8 5.9 5.9
Net issuance of treasury
stock (388,194 shares) 0.1 5.8 5.9
Repurchase of treasury stock
(2,483,895 shares) (72.2) (72.2)
Cash dividends paid ($0.27 per share) (16.9) (16.9)
- --------------------------------------------------------------------------------------------------------
Balance,
September 30, 2006 $ 9.0 $ 22.6 $ 162.8 $1,489.4 $(206.1) $1,477.7
========================================================================================================
Accompanying notes are an integral part of these consolidated financial
statements. For complete disclosures see Notes to Consolidated Financial
Statements on pages 67-84 of the Corporation's 2005 Form 10-K.
6
ITEM 1. Continued
Ohio Casualty Corporation & Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months
Ended September 30,
(in millions) (Unaudited) 2006 2005
- -------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities:
Net income $ 142.8 $ 135.4
Adjustments to reconcile net income to cash
from operations:
Changes in:
Insurance reserves 45.4 153.1
Reinsurance treaty funds held (28.5) (32.0)
Income taxes 7.4 (0.2)
Premiums and other receivables (29.3) 25.8
Deferred policy acquisition costs (1.7) 2.9
Reinsurance recoverable 38.1 (39.8)
Other assets (60.1) (9.0)
Other liabilities (19.9) (26.8)
Loss on retirement of convertible debt, including
debt conversion expenses - 9.0
Stock-based compensation expense 5.4 1.3
Income tax benefit from stock option exercises - 3.6
Write-down and amortization of agent relationships 9.0 10.1
Depreciation and amortization 8.0 8.7
Investment gains realized, net (30.9) (36.2)
- -------------------------------------------------------------------------------------------------
Net cash provided by operating activities 85.7 205.9
- -------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities:
Purchase of securities:
Fixed income, available-for-sale (685.7) (1,073.1)
Fixed income, held-to-maturity (0.5) (0.7)
Equity (72.8) (18.5)
Proceeds from sales of securities:
Fixed income, available-for-sale 543.4 745.3
Equity 70.7 34.2
Proceeds from maturities and calls of securities:
Fixed income, available-for-sale 100.7 58.7
Fixed income, held-to-maturity 13.0 26.6
Property and equipment
Purchases (7.5) (7.4)
Sales 0.3 1.2
- -------------------------------------------------------------------------------------------------
Net cash used in investing activities (38.4) (233.7)
- -------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities:
Debt:
Repayments (0.5) (160.2)
Payments for deferred financing costs (0.5) -
Loss on retirement of convertible debt,
including conversion expense - (3.6)
Proceeds from exercise of stock options 4.6 14.2
Repurchase of treasury stock (72.2) (13.3)
Income tax benefit from stock option exercises 2.3 -
Dividends paid to shareholders (16.9) (7.7)
- -------------------------------------------------------------------------------------------------
Net cash used in financing activities (83.2) (170.6)
- -------------------------------------------------------------------------------------------------
Net decrease in cash and cash equivalents (35.9) (198.4)
Cash and cash equivalents, beginning of period 54.5 252.6
- -------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 18.6 $ 54.2
=================================================================================================
Accompanying notes are an integral part of these consolidated financial
statements. For complete disclosures see Notes to Consolidated Financial
Statements on pages 67-84 of the Corporation's 2005 Form 10-K.
7
Ohio Casualty Corporation & Subsidiaries
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Ohio Casualty Corporation (the Corporation) is the holding company of The
Ohio Casualty Insurance Company (the Company), which is one of six property-
casualty insurance companies that make up the Ohio Casualty Group (the
Group), collectively the "Consolidated Corporation". All dollar amounts,
except per share data, presented in the Notes to Consolidated Financial
Statements are in millions unless otherwise noted.
NOTE I - INTERIM ADJUSTMENTS
We prepared the Consolidated Balance Sheet as of September 30, 2006 and the
Consolidated Statements of Income, Shareholders' Equity and Cash Flows for
the three and nine months ended September 30, 2006 and 2005, without an
audit. In the opinion of management, all adjustments necessary to fairly
present the financial position, results of operations and cash flows at
September 30, 2006 and for each period presented have been made.
We prepared the accompanying unaudited Consolidated Financial Statements in
accordance with accounting principles generally accepted in the United
States for interim financial information and with the instructions to the
Quarterly Report on Form 10-Q and Article 10 of Regulation S-X.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with accounting principles generally
accepted in the United States have been omitted. The unaudited
Consolidated Financial Statements should be read together with the
Consolidated Financial Statements and Notes thereto included in the
Corporation's 2005 Annual Report on Form 10-K. The results of operations
for the period ended September 30, 2006 are not necessarily indicative of
the results of operations for the full year.
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, the disclosure of contingent assets and liabilities at the
date of the financial statements and the reported amounts of revenues and
expenses during the reporting period. Actual results could differ from
those estimates.
The premiums receivable balance is presented net of bad debt allowances
determined by management of $1.8 at September 30, 2006 and $4.2 at December
31, 2005. Property and equipment are carried at cost less accumulated
depreciation of $184.1 and $177.2 at September 30, 2006 and December 31,
2005, respectively. Amounts recoverable from reinsurers are calculated in
a manner consistent with the reinsurance contract and are reported net of
allowance of $3.7 at September 30, 2006 and December 31, 2005.
8
NOTE II - EARNINGS PER SHARE
Basic and diluted earnings per share are summarized as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
- ---------------------------------------------------------------------------------------------
Net income $55.3 $55.5 $142.8 $135.4
Weighted average common shares
outstanding - basic (thousands) 61,151 64,400 62,393 63,487
Basic net income per weighted average share $0.90 $0.86 $2.29 $2.13
=============================================================================================
Net income $55.3 $55.5 $142.8 $135.4
Effect of EITF 04-8 on net income using
"if-converted" method - - - 1.8
Adjusted net income using "if-converted"
method 55.3 55.5 142.8 137.2
Weighted average common shares
outstanding - basic (thousands) 61,151 64,400 62,393 63,487
Effect of dilutive securities from stock
compensation plans (thousands) 1,290 1,257 1,476 1,259
Effect of EITF 04-8 (thousands) - - - 3,266
- ---------------------------------------------------------------------------------------------
Weighted average common shares
outstanding - diluted (thousands) 62,441 65,657 63,869 68,012
Diluted net income per weighted average
share $0.89 $0.85 $2.24 $2.02
=============================================================================================
In accordance with Emerging Issues Task Force (EITF) 04-8 "The Effect of
Contingently Convertible Debt on Diluted Earnings Per Share," the earnings
per share treatment of those securities that contain a contingent
conversion feature require all of the shares underlying the convertible
securities to be treated as outstanding using the "if-converted" method.
The "if-converted" method gives effect to the add back to net income of
interest expense and amortization of debt issuance costs, net of tax,
associated with the convertible instruments. As a result of this EITF, the
Consolidated Corporation has included 3.3 million shares into its diluted
earnings per share calculation using the "if-converted" method for the nine
months ended September 30, 2005. See Note VII for more information
regarding the convertible securities.
NOTE III - SEGMENT INFORMATION
The Consolidated 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, Specialty, and Personal
Lines. These segments generate revenues by selling a wide variety of
commercial, surety and personal insurance products. The Consolidated
Corporation also has an All Other segment which derives its revenues from
investment income of the Corporation. The other expenses included in this
segment consist primarily of interest expense.
Each of the segments of the Consolidated Corporation is managed separately.
The property and casualty segments are managed by assessing the performance
and profitability of the segments through analysis of industry financial
measurements determined on a GAAP basis, which includes loss, loss
adjustment and underwriting expense ratios, combined ratio, premiums
earned, underwriting gain/loss and statutory premiums written. The
following tables present information by segment as it is reported
internally to management. Asset information by reportable segment is not
reported, since the Consolidated Corporation does not produce such
information internally.
9
Three Months Ended September 30,
Commercial Lines Segment 2006 2005
- --------------------------------------------------------------------
Net premiums written $207.4 $207.1
% Change 0.1% 1.9%
Net premiums earned 209.2 206.1
% Change 1.5% 2.2%
Underwriting gain/(loss) (before tax) 4.9 (23.1)
Specialty Lines Segment 2006 2005
- --------------------------------------------------------------------
Net premiums written $ 37.6 $ 38.0
% Change (1.1)% 32.4%
Net premiums earned 36.1 36.3
% Change (0.6)% 13.4%
Underwriting gain (before tax) 7.5 1.8
Personal Lines Segment 2006 2005
- --------------------------------------------------------------------
Net premiums written $114.5 $123.9
% Change (7.6)% (3.7)%
Net premiums earned 111.0 120.1
% Change (7.6)% (2.2)%
Underwriting gain (before tax) 9.1 23.1
Total Property & Casualty 2006 2005
- --------------------------------------------------------------------
Net premiums written $359.5 $369.0
% Change (2.6)% 2.3%
Net premiums earned 356.3 362.5
% Change (1.7)% 1.7%
Underwriting gain (before tax) 21.5 1.8
All Other Segment 2006 2005
- --------------------------------------------------------------------
Revenues $ 4.0 $ 5.9
Write-down and amortization of agent
relationships (1.6) (2.4)
Other expenses (6.5) (6.8)
- --------------------------------------------------------------------
Loss before income tax $(4.1) $(3.3)
Reconciliation of Revenues 2006 2005
- --------------------------------------------------------------------
Net premiums earned for reportable segments $356.3 $362.5
Net investment income 47.5 47.6
Realized gains, net 11.2 20.3
- --------------------------------------------------------------------
Total property and casualty revenues 415.0 430.4
All other segment revenues 4.0 5.9
- --------------------------------------------------------------------
Total revenues $419.0 $436.3
====================================================================
Reconciliation of Underwriting Gain
(before tax) 2006 2005
- --------------------------------------------------------------------
Property and casualty underwriting
gain (before tax) $21.5 $ 1.8
Net investment income 51.3 51.4
Realized gains, net 11.4 22.4
Write-down and amortization of agent
relationships (1.6) (2.4)
Other expenses (6.5) (6.8)
- --------------------------------------------------------------------
Income before income tax 76.1 66.4
Income tax expense 20.8 10.9
- --------------------------------------------------------------------
Net income $55.3 $55.5
====================================================================
10
Nine Months Ended September 30,
Commercial Lines Segment 2006 2005
- --------------------------------------------------------------------
Net premiums written $643.7 $634.5
% Change 1.4% (0.2)%
Net premiums earned 620.3 618.4
% Change 0.3% 2.7%
Underwriting loss (before tax) (3.6) (41.4)
Specialty Lines Segment 2006 2005
- --------------------------------------------------------------------
Net premiums written $110.7 $116.8
% Change (5.2)% 13.8%
Net premiums earned 109.3 107.8
% Change 1.4% (5.8)%
Underwriting gain (before tax) 16.1 4.8
Personal Lines Segment 2006 2005
- --------------------------------------------------------------------
Net premiums written $332.0 $361.1
% Change (8.1)% (3.2)%
Net premiums earned 339.9 364.1
% Change (6.6)% (1.2)%
Underwriting gain (before tax) 30.0 70.6
Total Property & Casualty 2006 2005
- --------------------------------------------------------------------
Net premiums written $1,086.4 $1,112.4
% Change (2.3)% 0.1%
Net premiums earned 1,069.5 1,090.3
% Change (1.9)% 0.5%
Underwriting gain (before tax) 42.5 34.0
All Other Segment 2006 2005
- --------------------------------------------------------------------
Revenues $ 11.3 $ 18.0
Write-down and amortization of agent
relationships (9.0) (10.1)
Other expenses (20.4) (32.7)
- --------------------------------------------------------------------
Loss before income tax $(18.1) $(24.8)
Reconciliation of Revenues 2006 2005
- --------------------------------------------------------------------
Net premiums earned for reportable segments $1,069.5 $1,090.3
Net investment income 142.2 137.4
Realized gains, net 31.5 29.2
- --------------------------------------------------------------------
Total property and casualty revenues 1,243.2 1,256.9
All other segment revenues 11.3 18.0
- --------------------------------------------------------------------
Total revenues $1,254.5 $1,274.9
====================================================================
Reconciliation of Underwriting Gain
(before tax) 2006 2005
- --------------------------------------------------------------------
Property and casualty underwriting gain
(before tax) $ 42.5 $ 34.0
Net investment income 154.1 148.4
Realized gains, net 30.9 36.2
Write-down and amortization of agent
relationships (9.0) (10.1)
Other expenses (20.4) (32.7)
- --------------------------------------------------------------------
Income before income tax 198.1 175.8
Income tax expense 55.3 40.4
- --------------------------------------------------------------------
Net income $142.8 $135.4
====================================================================
Management of the Consolidated Corporation believes the significant
volatility of realized investment gains and losses limits the usefulness of
net income as a measure of current operating performance. Accordingly,
management uses the non-GAAP financial measure of operating income to
further evaluate current operating performance. Operating income is
reconciled to net income in the table below:
11
Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
- ------------------------------------------------------------------------------------
Net income $55.3 $55.5 $142.8 $135.4
After-tax net realized gains 7.5 22.8 20.1 31.8
- ------------------------------------------------------------------------------------
Operating income $47.8 $32.7 $122.7 $103.6
====================================================================================
NOTE IV - STOCK BASED COMPENSATION
The Consolidated Corporation has several stock based incentive programs
that are utilized to facilitate the Consolidated Corporation's long-term
financial success. Effective January 1, 2006, the Consolidated Corporation
began accounting for stock based incentive programs under Statement of
Financial Accounting Standard (SFAS) 123(R), "Share-Based Payment." SFAS
123(R) superseded Accounting Principles Board (APB) Opinion No. 25,
"Accounting for Stock Issued to Employees," and amends SFAS No. 95,
"Statement of Cash Flows." SFAS 123(R) requires all share-based payments
to employees, including grants of employee stock options, be recognized as
compensation expense in the income statement at fair value. Pro forma
disclosure is no longer an alternative. The Consolidated Corporation
adopted the provisions of SFAS 123(R) using the modified prospective method
in which compensation expense is recognized (a) based on the requirements
of SFAS 123(R) for all share-based payments granted after January 1, 2006
and (b) based on the requirements of SFAS 123 for all awards granted to
employees prior to January 1, 2006 that remained unvested on January 1,
2006. The adoption of SFAS 123(R) decreased the Consolidated Corporation's
net income by $0.6 and $1.4 for the three and nine months ended September
30, 2006. Basic and diluted earnings per share were reduced by $0.01 and
$0.02 for the three and nine months ended September 30, 2006, by the
adoption of SFAS 123(R). The Consolidated Corporation uses the straight-
line method of recording compensation expense relative to share-based
payments. SFAS 123(R) also requires the benefits of tax deductions in
excess of recognized compensation expense to be reported as a financing
cash flow, rather than as an operating cash flow as required under SFAS 95
prior to its amendment. This requirement reduced net operating cash flows
and increased net financing cash flows by $2.3 during the first nine months
of 2006.
The Consolidated Corporation has several share-based incentive programs
which are briefly described below. For a more detailed discussion of each
of these share-based incentive programs, see Note 5 in the Notes to the
Consolidated Financial Statements in the Annual Report on Form 10-K for the
year ended December 31, 2005.
2005 Incentive Plan
On May 18, 2005, the shareholders of the Corporation approved the
Consolidated Corporation's 2005 Incentive Plan (2005 Plan) which provides
for stock based compensation to employees and non-employee directors.
Approval of the 2005 Plan resulted in the termination of the then existing
stock incentive plans of the Consolidated Corporation.
At September 30, 2006, there were 1,865,965 shares available for issuance
under the 2005 Plan. Equity-based awards that may be granted under the
2005 Plan include stock options (incentive and non-qualified), restricted
stock, restricted stock units, stock appreciation rights and shares of the
Corporation's common stock as defined in the 2005 Plan document. In
addition to equity-based compensation, the 2005 Plan also authorizes grants
of performance based awards in the form of restricted stock, restricted
stock units, stock units and cash awards. The 2005 Plan limits the number
of shares of stock with respect to which awards may be issued to any
participant in a calendar year to 400,000.
Options granted under the 2005 Plan may be exercised at any time after the
vesting requirements are met, which ranges from immediate vesting to three
years. During the third quarter of 2006, there were no stock options
granted from the 2005 Plan. Total options outstanding, excluding
forfeitures, were 103,750 at September 30, 2006.
The 2005 Plan also provides for the grant of freestanding and/or tandem
stock appreciation rights (SARs) and restricted stock. At September 30,
2006, there were 350,000 outstanding freestanding SARs, none of which were
granted during the third quarter of 2006. There were no issued and
outstanding tandem SARs. The requisite service period for outstanding SARs
is three years.
12
During the nine months ended September 30, 2006 and 2005, there were 19,750
and 33,500 restricted shares issued, excluding forfeitures, under either
the 2005 Plan or a predecessor plan. At September 30, 2006, there are
128,000 restricted shares which are under the restriction period. SFAS
123(R) eliminated the presentation of the contra-equity account, unearned
compensation, on the face of the consolidated balance sheets. As a result,
$2.9 was reclassified to additional paid-in capital during the first
quarter of 2006 when SFAS 123(R) was implemented.
Long-term Incentive Plan
In July 2005, the Consolidated Corporation adopted a Long-Term Incentive
Plan (LTIP) award to better align officer interests with shareholders for
performance that promotes the long-term success of the Consolidated
Corporation. The 2005 LTIP award is a performance based award covering a
thirty-month period beginning July 1, 2005 and ending December 31, 2007
(the "performance period"). The 2006 LTIP award is a performance based
award with the final payout modified based upon achievement of a market
condition, comprised of total shareholder returns generated by the
Consolidated Corporation over the performance period relative to total
shareholder returns generated by a selected peer group over this same
performance period. The performance period began on January 1, 2006 and
will end on December 31, 2008. At the end of both performance periods,
payout, if any, will be made 50% in the form of Corporation common shares
and 50% in cash. There is no provision to pay the share portion of the
payout in cash.
Employee Stock Purchase Plan
The Consolidated 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 of
up to 10% 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 (currently three months) and the offering
price are subject to change. Participants may purchase no more than twenty-
five thousand dollars, prior to the stated discount, of the Corporation's
common stock in a calendar year. During the nine months ended September
30, 2006, there were 78,115 shares purchased under the plan compared to
81,106 shares purchased under the plan in the same period of 2005. At
September 30, 2006, there were 1,741,799 shares available for future
issuance under the plan.
Following is a summary of stock based compensation expense recognized by
the Consolidated Corporation:
Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
- ------------------------------------------------------------------------------------
2005 Incentive Plan
Stock Options $0.6 $ - $2.0 $ -
Stock Appreciation Rights 0.3 - 0.9 -
Restricted Stock 0.4 0.2 1.1 0.5
Long Term Incentive Plan 0.7 0.8 1.1 0.8
Employee Stock Purchase Plan - - 0.3 -
- ------------------------------------------------------------------------------------
Total Stock-Based Compensation $2.0 $1.0 $5.4 $1.3
====================================================================================
The following table summarizes information about the stock-based
compensation plans (options and SARs) as of September 30, 2006:
Weighted- Weighted- Aggregate
Avg Avg Intrinsic
Shares Exercise Remaining Value
(000) Price Contract Life ($ in 000)
--------------------------------------------------
Outstanding at January 1, 2006 3,958 $15.68
Granted 135 $31.05
Exercised (338) $14.31
Forfeited (7) $21.54
------
Outstanding at September 30, 2006 3,748 $16.41 6.0 $37,138
Exercisable at September 30, 2006 3,048 $14.31 5.5 $35,247
13
The total intrinsic value of stock options exercised was $0.2 and $1.7
during the three months ended September 30, 2006 and 2005, respectively,
and $5.4 and $10.9 for the nine months ended September 30, 2006 and 2005,
respectively.
The total fair value of shares vested for restricted stock was less than
$0.1 and $1.1 during the three and nine months ended September 30, 2006,
respectively. During the same periods in 2005, the total fair value of
shares vested for restricted stock was less than $0.1.
The following table summarizes information about the restricted stock
activity as of September 30, 2006:
Weighted-
Avg
Shares Grant Date
(000) Fair Value
-------------------------
Restricted stock awards at January 1, 2006 148 $25.49
Granted 20 30.32
Released (39) 19.35
Forfeited (1) 19.13
-----
Restricted stock awards at September 30, 2006 128 $28.16
=====
The per share weighted-average fair value of options and awards granted by
the Consolidated Corporation is as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
- ------------------------------------------------------------------------------------
Stock options N/A $ 9.31 $ 9.45 $ 9.18
Restricted stock N/A $25.12 $30.32 $24.64
SARs N/A N/A $ 9.80 N/A
Employee Stock Purchase Plan $4.80 $ 7.62 $ 7.54 $ 5.67
Under the provisions of SFAS 123(R), the Consolidated Corporation is
required to estimate on the date of grant the fair value of each option and
freestanding SAR using an option-pricing model. Accordingly, the Black-
Scholes option pricing model is used with the following weighted-average
assumptions:
September 30,
2006 2005
- ------------------------------------------------------------------------
Dividend yield 1.0% 1.8%
Expected volatility 32.0% 42.9%
Risk-free interest rate 4.6% 4.2%
Expected term 4.5 years 5.0 years
The dividend yield is determined by using the expected per share dividend
during 2006. In 2005, the dividend yield was based upon the average of
selected peer companies. The expected volatility is based on the
Corporation's stock price over a historical period which approximates the
expected term. The risk free interest rate is the implied yield currently
available on U.S. Treasury issues with a remaining term approximating the
expected term. The expected term is calculated as the historic weighted
average life of similar awards.
As of September 30, 2006, there was $6.5 of total unrecognized compensation
cost ($4.1 relating to options and freestanding SARs and $2.4 relating to
restricted stock) related to non-vested share-based compensation
arrangements granted under the Consolidated Corporation's share-based
payment plans. That cost is expected to be recognized over a weighted-
average period of 0.9 years for options and freestanding SARs and 2.9 years
for restricted stock.
In 2005, the Consolidated Corporation accounted for stock based
compensation issued to employees in accordance with APB 25, as was
permitted by SFAS 123. Under APB 25, the Consolidated Corporation
recognized compensation expense based on the intrinsic value of stock based
compensation. Had the Consolidated Corporation adopted the income
statement recognition requirements of SFAS 123 "Accounting for Stock Based
Compensation," the Consolidated Corporation's net income and earnings per
share would have been reduced to the pro forma amounts disclosed below:
14
Three Months Ended Nine Months Ended
September 30, 2005 September 30, 2005
- -------------------------------------------------------------------------------
Net income
As reported $55.5 $135.4
Add: Stock-based employee
compensation reported in net
income, net of related tax effect 0.6 0.9
Deduct: Total stock-based employee
compensation, net of related tax effect 1.6 4.2
- -------------------------------------------------------------------------------
Pro forma $54.5 $132.1
===============================================================================
Basic EPS
As reported $0.86 $2.13
Pro Forma $0.85 $2.08
Diluted EPS*
As reported $0.85 $2.02
Pro Forma $0.83 $1.97
===============================================================================
*Diluted EPS has been adjusted for the effect of EITF Issue No. 04-8 for
the nine months ending 2005. The three month period ended September 30,
2005 was not impacted due to the redemption/repurchase of the Convertible
Notes in the second quarter of 2005. Also See Note II.
NOTE V - 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 Consolidated 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.
Agent relationships are evaluated quarterly 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 $0.2 and $0.8 in the third quarter of 2006 and 2005,
respectively. For the nine months ended September 30, 2006 and 2005, the
asset was written down before tax by $4.5 and $5.3, respectively. The
write-downs are a result of agency cancellations and certain agents
determined to be impaired based on updated estimated future undiscounted
cash flows that were insufficient to recover the carrying amount of the
asset for the agent. The remaining portion of the agent relationships
asset will be amortized on a straight-line basis over the remaining useful
period of approximately 18 years. For the three and nine month period
ended September 30, 2006, the Consolidated Corporation recorded
amortization expense of $1.4 and $4.5 which compares to $1.6 and $4.8 for
the same periods of the prior year. At September 30, 2006 and December 31,
2005, the unamortized carrying value of the agent relationships asset was
$100.7 and $109.7, respectively. The agent relationships asset is recorded
net of accumulated amortization of $48.1 and $45.5 at September 30, 2006
and December 31, 2005, respectively.
Future cancellation of agents included in the agent relationships
intangible asset or a diminution of certain former GAI agents' estimated
future revenues or profitability is reasonably possible to cause further
impairment losses beyond the quarterly amortization of the remaining asset
value over the remaining useful lives.
NOTE VI - 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 Consolidated
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 value of the asset
exceeds the carrying value. Management evaluates the asset on an annual
basis for impairment. The costs associated with the software are amortized
on a straight-line basis over an estimated useful life not exceeding 10
years commencing when the software is substantially complete and ready for
its intended use.
15
Capitalized software costs and accumulated amortization amounts included in
the consolidated balance sheets within Property and Equipment were $62.0
and $19.2 at September 30, 2006 and $58.5 and $15.9 at December 31, 2005,
respectively.
NOTE VII - DEBT
The following table represents outstanding debt and deferred financing
costs of the Consolidated Corporation at September 30, 2006 and December 31,
2005:
September 30, December 31,
2006 2005
- -----------------------------------------------------------------------------
Senior Debt (net of discount and issuance
costs of $2.1 and $2.3, respectively) $197.9 $197.7
Ohio Loan 2.2 2.7
Deferred Financing Costs (0.4) -
- -----------------------------------------------------------------------------
Total Debt $199.7 $200.4
=============================================================================
On June 29, 2004, the Corporation issued $200.0 of 7.3% Senior Notes due
June 15, 2014 (Senior Notes) and received net proceeds after related fees
and discount of $198.0. The Corporation used a substantial majority of the
net proceeds to repurchase and redeem the Convertible Notes (see reference
to Note 15 below). As a result of the repurchase and redemption of the
Convertible Notes, the Corporation recorded a loss on retirement of $9.0
for the nine month period ended September 30, 2005, principally comprised
of the write-off of unamortized debt issuance cost and premium paid on
repurchases of the Convertible Notes during these periods and issued
1,305,585 shares of its common stock. See Note 15 included in the Notes to
Consolidated Financial Statements in the Corporation's Annual Report on
Form 10-K for the year ended December 31, 2005 for a detailed discussion
regarding the repurchase and redemption of the Convertible Notes. Interest
is payable on the Senior Notes on June 15 and December 15.
The Senior Notes are reported on the Consolidated Balance Sheets net of
unamortized issuance-related costs and discount totaling $2.1 at September
30, 2006 and $2.3 at December 31, 2005. The Corporation uses the effective
interest rate method to record interest expense, amortization of issuance-
related costs and amortization of the discount.
On February 16, 2006, the Corporation entered into a new revolving credit
agreement with an expiration date of March 16, 2011 and simultaneously
terminated its prior $80.0 revolving credit agreement. Under the terms of
the new revolving credit agreement, the lenders agreed to make loans to the
Corporation in an aggregate amount up to $125.0 for general corporate
purposes. Additionally, the new revolving credit agreement contains a
$50.0 "accordion feature" and provision for the issuance of letters of
credit up to the amount of the total facility. The accordion feature
permits the Corporation to increase the facility commitment from $125.0 to
$175.0 subject to a successful syndication of the requested increase.
Please refer to Note 15 included in the Notes to the Consolidated Financial
Statements in the Corporation's Annual Report on Form 10-K for the year
ended December 31, 2005 for a detailed discussion regarding the terms and
provisions of the new revolving credit agreement. At September 30, 2006,
the Corporation was in compliance with all financial covenants and other
provisions of this agreement. There were no borrowings outstanding under
the revolving line of credit at either September 30, 2006 or December 31,
2005.
Interest expense incurred for the nine month periods ended September 30,
2006 and 2005 was $11.0 and $14.1, respectively. Interest expense incurred
for both the three month periods ended September 30, 2006 and 2005 was
$3.7.
NOTE VIII - CONTINGENCIES
In the fourth quarter of 2001, Ohio Casualty of New Jersey, Inc. (OCNJ)
entered into an agreement to transfer its obligations to renew private
passenger auto business in New Jersey to Proformance Insurance Company
(Proformance). Please refer to Note 7 in the Notes to the Consolidated
Financial Statements in the Corporation's Annual Report on Form 10-K for
the year ended December 31, 2005 for a detailed discussion regarding this
agreement. Late in the first quarter of 2005, OCNJ, based on revised
information provided by Proformance subsequent to the Consolidated
Corporation filing its 2004 Annual Report on Form 10-K, reduced its
estimated liability by $4.4 which left a remaining liability of $4.4 at
March 31, 2005.
16
In June 2005, OCNJ reached a settlement with Proformance for the final
payment related to this obligation in the amount of $3.7 and in return
received from Proformance a release from any and all future obligations
related to this surplus guarantee. The total amount paid by OCNJ pursuant
to the surplus guarantee was $10.5, compared to the maximum cumulative
exposure of $15.6.
A proceeding entitled Carol Murray v. the Corporation, the Company, Avomark
Insurance Company (Avomark), Ohio Security Insurance Company (Ohio
Security), West American Insurance Company (West American), American Fire
and Casualty Insurance Company (American Fire), and OCNJ was filed in the
United States District Court for the District of Columbia on February 5,
2004. A motion to change venue was granted on May 25, 2004 with the
proceeding assigned to the U.S. District Court for the Southern District of
Ohio, Eastern Division, Columbus, Ohio. The plaintiff, a former automobile
physical damage claim adjuster, originally sought to certify a nationwide
collective action consisting of all current and former salaried employees
since February 5, 2001 who are/were employed to process claims by
policyholders and other persons for automobile property damage. The
plaintiff also filed motions to expand the definition to include claim
specialists, representative trainees, and representatives performing claims
adjusting services. The complaint sought overtime compensation for the
plaintiff and the class of persons plaintiff sought to represent. The U.S.
District Court dismissed the complaint against Avomark, Ohio Security, West
American, American Fire, and OCNJ on September 27, 2005. The U.S. District
Court also granted the motion for summary judgment of the Corporation and
the Company on September 27, 2005. The proceeding was ordered closed with
judgment in favor of the defendants. The decision has been appealed by
plaintiff to the U.S. Sixth Circuit Court of Appeals.
A proceeding entitled Carol Lazarus v. the Group was brought against West
American in the Court of Common Pleas Cuyahoga County, Ohio on October 25,
1999. The Court ordered the case to proceed solely against West American
on July 10, 2003. The complaint alleges West American improperly charged
for uninsured motorists coverage following an October 1994 decision of the
Supreme Court of Ohio in Martin v. Midwestern Insurance Company. The
Martin decision was overruled legislatively in September 1997. The Court
on April 13, 2006 granted a motion for class certification requested by
Carol Lazarus and denied West American's motion for summary judgment. The
decision regarding class certification has been appealed by West American.
A proceeding entitled Douglas and Carla Scott v. the Company, West
American, American Fire, and Ohio Security was filed in the District Court
of Tulsa County, State of Oklahoma and served on January 3, 2005. The
proceeding challenges the use of a certain vendor in valuing total loss
automobiles. Plaintiff alleges that use of the database results in
valuations to the detriment of the insureds. Plaintiff is seeking class
status and alleges breach of contract, fraud and bad faith. The lawsuit is
in its early stages and will be vigorously defended.
By 2001, the Company, American Fire, West American, Ohio Security and OCNJ
had sought refunds for retaliatory taxes paid to New Jersey in prior years
on the basis that New Jersey's calculation of premium and retaliatory taxes
deprived the Company, American Fire, West American, Ohio Security and OCNJ
of some or all of the benefit of New Jersey's premium tax cap. After the
refund requests were denied in a final determination issued by the New
Jersey Division of Taxation in July 2001, American Fire appealed to the New
Jersey Tax Court and in December 2003, the court affirmed the
determination. American Fire appealed to the Superior Court of New Jersey;
in March 2005, the court reversed the Tax Court, and the Director of the
Division of Taxation was ordered to recalculate the retaliatory tax as
proposed by American Fire. The New Jersey Division of Taxation appealed
the Superior Court decision to the New Jersey Supreme Court and the case
was argued in November 2005. In October 2006, the Supreme Court affirmed
the judgment of the Superior Court of New Jersey on statutory grounds and
instructed the Director of the Division of Taxation to recalculate refunds
due the Company, American Fire, West American, Ohio Security and OCNJ. No
amounts have been recorded in the Consolidated Financial Statements as of
September 30, 2006 or December 31, 2005. The Company, American Fire, West
American, Ohio Security and OCNJ will recognize the benefit of such refunds
upon receipt or settlement.
The proceedings described above and various other legal and regulatory
proceedings are currently pending that involve the Consolidated Corporation
and specific aspects of the conduct of its business. The outcome of these
proceedings is currently unpredictable. However, at this time, based on
their present status, it is the opinion of management that the ultimate
liability, if any, in one or more of these proceedings in excess of amounts
currently reserved is not expected to have a material adverse effect on the
financial condition, liquidity or results of operation of the Consolidated
Corporation.
17
NOTE IX - EMPLOYEE BENEFITS
The Company has a non-contributory defined benefit retirement plan and a
contributory health care plan. The net periodic pension cost for the
periods ended September 30 is determined as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
- -------------------------------------------------------------------------------
Service cost earned during the period $ 2.1 $ 1.8 $ 6.3 $ 5.4
Interest cost on projected benefit
obligation 4.4 4.3 13.0 12.9
Expected return on plan assets (6.5) (5.5) (19.5) (16.3)
Amortization of accumulated losses 1.1 1.0 3.1 2.7
Amortization of unrecognized prior
service cost (0.6) (0.5) (1.7) (1.7)
Settlement - - 1.0 -
- -------------------------------------------------------------------------------
Net periodic pension cost $ 0.5 $ 1.1 $ 2.2 $ 3.0
===============================================================================
During the second quarter of 2006, the Company's former CEO made a lump sum
benefit plan payment election, pursuant to the terms of the Benefit
Equalization Plan, which resulted in an increase to net periodic pension
cost of $1.0. This lump sum benefit plan payment is accounted for as a
"settlement" pursuant to the provisions of SFAS 88, "Employers' Accounting
for Settlements and Curtailments of Defined Benefit Pension Plans and
Termination Benefits."
The components of the Company's net periodic postretirement benefit cost
for the periods ended September 30:
Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
- -------------------------------------------------------------------------------
Service cost $ - $ - $ 0.2 $ 0.2
Interest cost 0.7 0.7 2.0 2.2
Amortization of accumulated losses - 0.1 - 0.1
Amortization of unrecognized prior
service cost (1.5) (1.5) (4.5) (4.5)
- -------------------------------------------------------------------------------
Net periodic postretirement
benefit cost $(0.8) $(0.7) $(2.3) $(2.0)
===============================================================================
NOTE X - INCOME TAX
At December 31, 2004, the Consolidated Corporation disclosed it had been
examined by the Internal Revenue Service (IRS) for tax years 1997 to 2001
and was then in the process of finalizing a settlement. On August 25,
2005, the IRS issued notification to the Consolidated Corporation that a
settlement agreement concerning its examination of these tax years was
approved. This settlement resulted in a $2.7 net tax benefit related to
realized capital gains, and interest income, before tax, of $0.9. In
conjunction with the IRS settlement, the Consolidated Corporation reduced
its book tax reserves by $9.1 ($8.0 related to realized capital gains and
$1.1 related to operations).
Additionally, on September 28, 2005, the IRS advised the Consolidated
Corporation that it accepted a protective claim for refund for the 1996 tax
year related to adjustments resulting from the 2003 settlement of the IRS
examination of the 1995 tax year. The acceptance of this protective refund
claim resulted in a $3.4 net tax benefit related to operations, and
interest income, before tax, of $1.6 million.
In the aggregate, when considering all of the above referenced items, net
income for the three and nine months ended September 30, 2005, was
favorably impacted by $16.8, comprised of a $15.2 net tax benefit ($4.5
related to operations and $10.7 related to capital gains) and $1.6 after-
tax interest income. This net tax benefit had the effect of lowering the
Consolidated Corporation's effective income tax rate for the nine months
ended September 30, 2005 by 6.6%.
The results of operations for both the three and nine month periods ended
September 30, 2006, do not include any similar type settlement adjustments
with the IRS.
18
NOTE XI - SHARE REPURCHASES
During the third quarter of 2006, the Corporation repurchased 249,186
shares of its common stock at an average cost of $25.87. These repurchases
completed the share repurchase program authorized by the Corporation's
Board of Directors in the third quarter of 2005. Under this program, four
million shares were repurchased at an average cost of $27.94. In September
2006, the Board of Directors approved another share repurchase program with
authorization to repurchase up to $100.0 of the Corporation's common stock.
Purchases may be made in the open market or in privately negotiated
transactions. Through October 31, 2006, the Corporation has repurchased
227,200 shares under the newly authorized share repurchase program at an
average cost of $27.19.
NOTE XII - RECENTLY ISSUED ACCOUNTING STANDARDS
In September 2006, the Financial Accounting Standards Board (FASB) issued
SFAS 158, "Employers' Accounting for Defined Benefit Pension and Other
Postretirement Plans an amendment of FASB Statements No. 87, 88, 106, and
132(R)." This Statement requires recognition of the overfunded or
underfunded status of a defined benefit postretirement plan as an asset or
liability on the balance sheet and to recognize changes in that funding
status in the year in which the changes occur through other comprehensive
income. This requirement is the first phase of implementing the standard
and is effective for the fiscal year ending after December 15, 2006. The
implementation of the first phase of this standard is expected to increase
Shareholders' Equity in the range of $2.0 to $6.0. As of December 31, 2006,
the Corportion expects total Shareholders' Equity to increase in the range
of $25.0 to $35.0, a result of favorable asset performance, contributions
to the plan and the effect of the adoption of SFAS 158. This impact could
change materially from this estimate based upon the completion of the
Consolidated Corporation's actuarial valuations as of the measurement date
for 2006.
The second phase of implementation of SFAS 158 requires the measurement
date of the funded status of a plan to coincide with the year end date of
the company, with limited exceptions. The effective date for implementing
this phase of SFAS 158 is for fiscal years ending after December 15, 2008.
Currently the Consolidated Corporation utilizes a measurement date of
September 30th. The Consolidated Corporation is currently evaluating the
impact this phase of the Standard will have on its consolidated financial
statements.
In July 2006, the FASB released FASB Interpretation No. (FIN) 48,
`Accounting for Uncertainty in Income Taxes, an interpretation of FASB
Statement No. 109.' This Interpretation clarifies the accounting for
uncertainty in income taxes recognized in the financial statements in
accordance with SFAS 109, `Accounting for Income Taxes.' This
Interpretation prescribes a recognition threshold and measurement attribute
for the financial statement recognition and measurement of a tax position
taken or expected to be taken in a tax return. This Interpretation also
provides guidance on derecognition, classification, interest and penalties,
accounting for interim periods, disclosure and transition. FIN 48 is
effective for fiscal years beginning after December 15, 2006. The
Consolidated Corporation currently is evaluating the impact of this
Interpretation.
ITEM 2. Management's Discussion and Analysis of Financial Condition and
Results of Operation
Ohio Casualty Corporation (the Corporation) is the holding company of The
Ohio Casualty Insurance Company (the Company), which is one of six property-
casualty insurance companies that make up the Ohio Casualty Group (the
Group), collectively the "Consolidated Corporation." All dollar amounts in
this Management Discussion and Analysis (MD&A) are in millions unless
otherwise noted.
RESULTS OF OPERATIONS
Net Income
The Consolidated Corporation reported net income of $55.3, or $0.89 per
share and $55.5, or $0.85 per share for the three months ended September
30, 2006 and 2005, respectively, which included after-tax realized
investment gains of $7.5 ($0.12 per share) and $22.8 ($0.35 per share) for
the three months ended September 30, 2006 and 2005, respectively. For the
nine months ended September 30, 2006 and 2005,
19
net income was $142.8, or $2.24 per share and $135.4 or $2.02 per share,
respectively, which included after-tax realized investment gains of $20.1
($0.32 per share) and $31.8 ($0.47 per share) for the nine months ended
September 30, 2006 and 2005, respectively.
During the third quarter 2005, the Consolidated Corporation favorably
concluded settlements with the Internal Revenue Service (IRS) for tax years
1996 through 2001. As a result of the IRS settlement, net income was
favorably impacted for the three and nine months ended September 30, 2005
by $16.8 ($0.26 per share for the three months and $0.25 per share for the
nine months). For additional information regarding this IRS settlement in
2005, see Note X in the Notes to the Consolidated Financial Statements on
page 18 of this Quarterly Report on Form 10-Q.
The Consolidated Corporation adopted the provisions of SFAS 123(R) as of
January 1, 2006. For further information on the impact of the adoption of
SFAS 123(R) in 2006, see Note IV to the unaudited interim consolidated
financial statements included in Item 1. "Financial Statements" of this
Quarterly Report on Form 10-Q.
Operating Results
Insurance industry regulators require the Group to report its financial
condition and results of operations, among other things, using statutory
accounting principles. Management uses industry standard financial
measures determined on a statutory basis, as well as those determined on a
GAAP basis to analyze the Group's property and casualty operations. These
insurance industry financial measures include loss and loss adjustment
expense (LAE) ratios, underwriting expense ratio, combined ratio, net
premiums written and net premiums earned. The combined ratio is a commonly
used gauge of underwriting performance measuring the percentage of premium
dollars used to pay insurance losses and related expenses. The combined
ratio is the sum of the loss, LAE and underwriting expense ratios. All
references to combined ratio or its components in this MD&A are calculated
on a GAAP basis, unless otherwise indicated, and are calculated on a
calendar year basis unless specified as calculated on an accident year
basis. Insurance industry financial measures are included in the next
several sections of this MD&A that discuss results of operations. A
discussion of the differences between statutory accounting and generally
accepted accounting principles in the United States is included in Item 15,
page 82 of the Corporation's 2005 Annual Report on Form 10-K.
At September 30, 2006 and December 31, 2005, statutory surplus, a financial
measure that is required by insurance regulators and used to monitor
financial strength, was $1,030.5 and $1,004.5, respectively. The ratio of
twelve months ended net premiums written to statutory surplus as of both
September 30, 2006 and December 31, 2005, was 1.4 to 1.0.
Premium Revenue Results
Gross premium written differs from net premiums written by the amount of
premiums ceded to reinsurers. Management analyzes premium revenues
primarily by premiums written in the current period, which is a better
indicator of current production levels. Net premiums written are
recognized into revenue on a monthly pro rata basis over the coverage term
of the policy which is reflected in the consolidated income statements as
earned premium.
The table below summarizes property and casualty premium on a gross and net
basis compared with the same periods of the prior year:
Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 % Chg 2006 2005 % Chg
---- ---- ----- ---- ---- -----
Gross Premiums Written
- ----------------------
Commercial Lines $212.7 $212.5 0.1% $ 660.7 $ 647.7 2.0%
Specialty Lines 49.9 53.0 (5.8)% 148.5 160.4 (7.4)%
Personal Lines 116.1 125.3 (7.3)% 336.3 363.4 (7.5)%
------ ------ -------- --------
All Lines $378.7 $390.8 (3.1)% $1,145.5 $1,171.5 (2.2)%
====== ====== ======== ========
20
Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 % Chg 2006 2005 % Chg
---- ---- ----- ---- ---- -----
Net Premiums Written
- --------------------
Commercial Lines $207.4 $207.1 0.1% $ 643.7 $ 634.5 1.4%
Specialty Lines 37.6 38.0 (1.1)% 110.7 116.8 (5.2)%
Personal Lines 114.5 123.9 (7.6)% 332.0 361.1 (8.1)%
------ ------ -------- --------
All Lines $359.5 $369.0 (2.6)% $1,086.4 $1,112.4 (2.3)%
====== ====== ======== ========
All Lines gross premiums written declined for the three and nine months
periods ended September 30, 2006 when compared with the same periods of the
prior year, due primarily to lower in-force policy counts and rate
reductions. This decline was partially offset by an increase in new
business premium production and improving policy renewal rates in all three
segments. Net premiums written for the nine months ended September 30,
2005 were favorably impacted by $5.5 return of ceded premium on experience
based reinsurance contracts. The return of ceded premium benefited all
three operating segments in 2005. There was not a comparable return of
ceded premium during the periods presented in 2006.
For Commercial Lines, the increase in gross premiums written for both the
three and nine month periods ended September 30, 2006 is the result of an
increase in new business premium of 6.4% and 12.7%, respectively, coupled
with a slight improvement in policy renewal rates for these same periods.
These improvements were offset by involuntary assumed workers' compensation
premium adjustments due to various reapportionments, which had the effect
of reducing gross and net premiums written by $1.9 compared to the third
quarter of 2005.
For Specialty Lines, the decline in gross premiums written for both the
three and nine month periods ended September 30, 2006 is primarily the
result of declines in the commercial umbrella product line of 13.7% and
14.9% respectively, as both in-force policies and new business premium
production are lower than the same periods of the prior year. This decline
is primarily in the unsupported lead umbrella and excess capacity products,
the result of our efforts to improve the overall profitability of the
commercial umbrella product line. This decline is partially offset by
strong growth of 9.8% and 12.2% in our fidelity and surety bond product
line for the three and nine month periods ended September 30, 2006,
respectively, as we continue to leverage our market knowledge and strong
producer base.
For Personal Lines, the decline in gross premiums written for both the
three and nine month periods ended September 30, 2006 is the result of rate
reductions previously taken in a number of states in both the personal auto
and homeowners product lines and lower in-force policy counts when compared
to the same periods of the prior year. However, the rate of decline in
policy count has lessened throughout 2006. This decline is partially
offset by an increase in new business premium production of 10.1% and 5.9%
for the three and nine month periods ended September 30, 2006 and slightly
improved policy renewal rates for the same respective periods.
Commercial Lines average renewal prices have been essentially flat
throughout 2006, compared to increases of 1.5% and 2.3% in the third
quarter and year-to-date periods ended September 30, 2005. For the
commercial umbrella product line, we have seen average renewal price
increase of 1.9% and 1.2% compared to 2.9% and 5.0% for the three and nine
month periods ended September, 30, 2006 and 2005, respectively. This
decrease, period over period, in both Commercial Lines and the commercial
umbrella product line is the result of a broad market trend of increased
competitive pricing pressure. Renewal price increase means the average
increase in premium for policies renewed by the Group. The average
increase in premium for each renewed policy is calculated by comparing the
total expiring premium for the policy with the total renewal premium for
the same policy. Renewal price increases include, among other things, the
effects of rate increases and changes in the underlying insured exposures
of the policy. Only policies issued by the Group in the previous policy
term with the same policy identification codes are included. Therefore,
renewal price increases do not include any effects of reinsurance.
21
All Lines Discussion
The following table provides key financial measures for All Lines:
Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
---- ---- ---- ----
All Lines
- ---------
Loss ratio 53.0% 56.4% 54.0% 53.9%
Loss adjustment expense ratio 10.0% 11.7% 10.8% 11.5%
Underwriting expense ratio 30.9% 31.4% 31.3% 31.5%
----- ----- ----- -----
Combined ratio 93.9% 99.5% 96.1% 96.9%
The improvement in the All Lines combined ratio for the third quarter is
primarily the result of a decrease of $10.6 (2.8 points) in catastrophe
losses, an increase of $16.8 (4.7 points) in favorable prior year reserve
development, as reflected in the table below and continued favorable claim
frequency trends. These improvements were partially offset by an increase
in current accident year large loss activity (losses over $250 thousand)
for the quarter, which increased the loss ratio by 1.9 points, as presented
in the table below. Large loss activity can be volatile from year to year
as indicated by the Group's experience over the last four years. The
current accident year large loss impact on the loss ratio in each of these
years, evaluated at September 30 for each of the respective years, is as
follows:
2005 3.7%
2004 3.6%
2003 5.0%
2002 3.3%
All Lines Loss Ratio Analysis
We monitor incurred losses by operating segment, product line, risk
classification, geographic region and agency addressing loss ratio issues
or trends as part of our ongoing business operations. We also track
current accident year large losses, as defined, to monitor severity trends.
We do not believe the increases for the three and nine months ended
September 30, 2006 are indicative of a new trend.
The following table provides a reconciliation of significant changes to the
All Lines loss ratio for the three and nine month periods ended September
30, 2006 and 2005, respectively.
Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 Pt Chg 2006 2005 Pt Chg
---- ---- ------ ---- ---- ------
Ratios as a % of premiums
earned
- -------------------------
Current accident year
large losses, as defined 6.3% 4.4% 1.9 5.0% 3.7% 1.3
Catastrophe losses -
calendar year basis 2.1% 4.9% (2.8) 2.5% 2.4% 0.1
Loss development from
prior accident years -2.9% 0.8% (3.7) -3.0% -0.2% (2.8)
All other losses 47.5% 46.3% 1.2 49.5% 48.0% 1.5
----- ----- ----- -----
Total losses 53.0% 56.4% (3.4) 54.0% 53.9% 0.1
===== ===== ===== =====
An effect of a continuing soft Commercial and Personal Lines market is the
upward pressure placed upon the combined ratio, as reflected in "All other
losses" in the table above, which is the result of loss cost trends
increasing at a rate faster than increases in premium rates (both new and
renewal).
22
The following table summarizes reserve development, net of reinsurance, by
operating segment:
Three Months Ended Nine Months Ended
September 30, September 30,
(Favorable)/Unfavorable 2006 2005 2006 2005
Operating Segment ---- ---- ---- ----
- ------------------------
Commercial Lines $ (2.8) $12.7 $ (4.6) $ 29.9
Specialty Lines (9.3) (3.0) (20.5) (7.3)
Personal Lines (1.6) (6.6) (12.3) (26.2)
------- ------ ------- -------
Total Prior Accident Years'
Development $(13.7) $ 3.1 $(37.4) $ (3.6)
======= ====== ======= =======
The loss and LAE ratio components of the accident year combined ratio
measure 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. The table
below summarizes the impact of changes in provision for all prior accident
year losses and LAE:
Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
---- ---- ---- ----
Statutory net liabilities,
beginning of period $2,305.8 $2,228.2 $2,258.5 $2,183.8
(Decrease)/increase in provision
for prior accident year claims $(13.7) $3.1 $(37.4) $(3.6)
(Decrease)/increase in provision
for prior accident year claims
as % of premiums earned (3.8)% 0.9% (3.5)% (0.3)%
The underwriting expense ratio improved 0.5 points for the three month
period ended September 30, 2006, primarily the result of decreased
incentive accruals, the recovery and recognition of premium tax credits and
ongoing expense management initiatives offset partially by a decrease in
net premiums earned, which puts upward pressure on the ratio. For the nine
month period ended September 30, 2006, the underwriting expense ratio
improved slightly, a result of decreased incentive accruals, the recovery
and recognition of premium tax credits and a reduction in the allowance for
bad debt of premium receivables, offset partially by the pension settlement
charge discussed in Note IX in the Notes to the Consolidated Financial
Statements on page 18 of this Quarterly Report on Form 10-Q. In addition,
the 2005 nine month underwriting expense ratio was favorably impacted by a
$5.1 reduction to the surplus guarantee accrual, which reduced the 2005
underwriting expense ratio by 0.5 points.
Catastrophe losses for the third quarter 2006 were $7.3 compared to $17.9
in the third quarter 2005. For the nine months ended September 30, 2006,
catastrophe losses were $27.0 compared to $26.0 in the same period of the
prior year. The effect of future catastrophes on the Group's results of
operations cannot be accurately predicted. As such, severe weather
patterns, acts of war or terrorist activities could have a material adverse
impact on the Group's results of operations, future reinsurance pricing and
availability of reinsurance. For additional disclosure of catastrophe
losses, please refer to Item 15, Losses and LAE Reserves in the Notes to
the Consolidated Financial Statements on page 79 of the Corporation's 2005
Annual Report on Form 10-K.
The table below summarizes the catastrophe loss ratios by operating
segment.
Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
---- ---- ---- ----
Commercial Lines 1.2% 8.2% 1.9% 3.4%
Specialty Lines 0.1% 0.0% 0.0% 0.0%
Personal Lines 4.4% 0.8% 4.5% 1.3%
Total All Lines 2.1% 4.9% 2.5% 2.4%
Segment Discussion
The Consolidated Corporation's organizational structure consists of three
reportable segments: Commercial, Specialty and Personal Lines. These
reportable segments represent the Consolidated Corporation's operating
segments. The Consolidated Corporation also has an all other segment,
which
23
derives its revenue from investment income of the Corporation. The
following tables provide key financial measures for each of the property
and casualty reportable segments:
Commercial Lines Segment
Three Months Ended Nine Months Ended
September 30, September 30,
Commercial Lines Segment 2006 2005 2006 2005
- ----------------------------------------------------------------------------
Net premiums earned $209.2 $206.1 $620.3 $618.4
Loss ratio 54.8% 63.5% 56.1% 58.8%
Loss adjustment expense ratio 11.1% 15.3% 12.2% 14.5%
Underwriting expense ratio 31.7% 32.4% 32.3% 33.4%
----- ------ ------ ------
Combined ratio 97.6% 111.2% 100.6% 106.7%
The Commercial Lines combined ratio improved for both the three and nine
month periods ended September 30, 2006, a result of a significant decline
in catastrophe losses and favorable prior year reserve development, as
reflected in the tables above. These improvements were partially offset by
increased current accident year large loss activity which added 2.3 points
to the loss ratio for the quarter and 1.6 points year to date compared to
the same period last year as presented in the table below.
Commercial Lines Loss Ratio Analysis
We monitor incurred losses by product line, risk classification, geographic
region and agency addressing loss ratio issues or trends as part of our
ongoing business operations. We also track current accident year large
losses, as defined, to monitor severity trends. We do not believe the
increases for the three and nine months ended September 30, 2006 are
indicative of a new trend.
The following table provides a reconciliation of significant changes to the
All Lines loss ratio for the three and nine month periods ended September
30, 2006 and 2005, respectively.
Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 Pt Chg 2006 2005 Pt Chg
---- ---- ------ ---- ---- ------
Ratios as a % of premiums
earned
- -------------------------
Current accident year large
losses, as defined 7.0% 4.7% 2.3 5.9% 4.3% 1.6
Catastrophe losses -
calendar year basis 1.2% 8.2% (7.0) 1.9% 3.4% (1.5)
Loss development from
prior accident years -0.3% 4.7% (5.0) -0.3% 3.8% (4.1)
All other losses 46.9% 45.9% 1.0 48.6% 47.3% 1.3
----- ----- ----- -----
Total losses 54.8% 63.5% (8.7) 56.1% 58.8% (2.7)
===== ===== ===== =====
As indicated in the All Lines section, current accident year large loss
activity can be volatile from year to year. The current accident year
large loss impact on the Commercial Lines loss ratio, evaluated at
September 30 for each of the respective years, has been as follows:
2005 4.3%
2004 5.0%
2003 7.1%
2002 3.6%
The 2006 favorable reserve development described above was primarily
concentrated in the commercial auto and commercial multiple peril (CMP)
product lines offset by adverse development in the workers' compensation
product line. In 2005, the adverse development was primarily concentrated
in the workers' compensation and CMP product lines. The underwriting
expense ratio improvement is due to the same reasons outlined in the All
Lines sections on pages 22 and 23 of this MD&A. The nine month period in
2005 also included a $2.8 return of ceded premium on experienced based
reinsurance contracts, which favorably impacted all of the above ratios for
that period.
24
Specialty Lines Segment
Three Months Ended Nine Months Ended
September 30, September 30,
Specialty Lines Segment 2006 2005 2006 2005
- ----------------------------------------------------------------------------
Net premiums earned $36.1 $36.3 $109.3 $107.8
Loss ratio 33.2% 49.1% 37.8% 44.6%
Loss adjustment expense ratio 7.4% 5.4% 8.2% 7.7%
Underwriting expense ratio 38.6% 40.7% 39.2% 43.3%
----- ----- ----- -----
Combined ratio 79.2% 95.2% 85.2% 95.6%
The Specialty Lines combined ratio improved due to favorable prior year
reserve development of $9.3 (25.6 points) primarily concentrated in the
commercial umbrella product line, partially offset by two newly reported
large losses. The same period in 2005 included favorable development of
$3.0 (8.2 points). For the nine month period ended September 30, 2006, the
combined ratio improved 10.4 points primarily driven by $20.5 (18.8 points)
of favorable prior year reserve development partially offset by an increase
in large loss activity. The same period in 2005 experienced $7.3 (6.8
points) of favorable prior year reserve development. The nine month period
of 2005 included a $1.3 return of ceded premium on experience based
reinsurance contracts which favorably impacted all of the above ratios.
Underwriting expenses continue to be favorably impacted by increased ceding
commissions on reinsurance contracts and lower incentive accruals for both
the three and nine month periods of 2006 when compared to the same periods
in 2005.
Personal Lines Segment
Three Months Ended Nine Months Ended
September 30, September 30,
Personal Lines Segment 2006 2005 2006 2005
- ----------------------------------------------------------------------------
Net premiums earned $111.0 $120.1 $339.9 $364.1
Loss ratio 56.0% 46.4% 55.3% 48.2%
Loss adjustment expense ratio 8.8% 7.5% 9.1% 7.7%
Underwriting expense ratio 27.0% 26.9% 26.9% 24.7%
----- ----- ----- -----
Combined ratio 91.8% 80.8% 91.3% 80.6%
The Personal Lines combined ratios increased for the three and nine month
periods ended September 30, 2006, primarily as a result of increased
catastrophe losses and favorable prior year reserve development that was
lower than in the same periods of the prior year as reflected in the tables
above. Decreases in net premiums earned for the quarter and year to date
when compared to the same periods in 2005, which relate to rate reductions
taken in the last half of 2005 and first half of 2006, have also put upward
pressure on the combined ratio. The nine month period in 2005 was
favorably impacted by a return of ceded premium on experience based
reinsurance contracts of $1.4. The underwriting expense ratio increased by
2.2 points for the nine month period ended September 30, 2006, due
primarily to the favorable Proformance surplus guarantee adjustments which
reduced the 2005 underwriting expense ratio by 1.4 points.
The table below presents the calendar year and accident year combined
ratios calculated on a statutory basis. The loss and LAE ratio components
of the accident year combined ratio measure 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.
Earned Premium and Statutory Combined Ratios
Combined Ratios
---------------------------------------------------
Earned
Premium Calendar Year Accident Year
Year to Date Year to Date Year to Date Calendar Accident
September 30, September 30, September 30, Year Year
(By operating segment) 2006 2006 2006(a) 2005 2005(a)
- -------------------------------------------------------------------------------------------
Commercial Lines $ 620.3 100.9% 101.7% 102.3% 98.5%
Specialty Lines 109.3 85.7% 104.2% 89.9% 99.5%
Personal Lines 339.9 91.8% 95.3% 81.2% 87.3%
- -------------------------------------------------------------------------------------------
Total All Lines $1,069.5 96.6% 100.0% 94.2% 94.9%
===========================================================================================
(a) The measurement date for accident year data is September 30, 2006.
Partial and complete accident periods may not be comparable due to
seasonality, claim reporting and development patterns, claim settlement
rates and other factors.
Investment Results
For the three and nine month periods ended September 30, 2006 and 2005,
consolidated pre-tax investment income was $51.3 and $154.1 and $51.4 and
$148.4, respectively. However, included in 2005's third quarter and year
to date pre-tax investment income is $2.5 of interest income on favorable
tax settlements with the IRS. See Note X in the Notes to the Consolidated
Financial Statements on page 18 of
25
this Quarterly Report on Form 10-Q for additional information. After
giving consideration in both of these periods for this amount, pre-tax
investment income increased in the current year periods by 4.9% and 5.6%,
respectively, over the prior year. This increase is the result of reduced
investment related expenses, positive operating cash flows and a modest
improvement in reinvestment yields resulting from the recent upward
movement in interest rates when compared with the prior year. For the
three and nine month periods ended September 30, 2006, net realized gains
were $11.4 and $30.9 versus $22.4 and $36.2 for the comparable periods in
2005. The Consolidated Corporation realized $13.8 and $49.3 in gross gains
and $2.4 and $18.4 in gross losses for the three and nine month periods
ended September 30, 2006, respectively. During both the three and nine
month periods ending September 30, 2005, the Consolidated Corporation
realized $25.5 and $44.6 in gross gains and $3.1 and $8.4 in gross losses,
respectively. Included in these realized losses are write downs of
securities for other than temporary decline in market value of $2.2 and
$11.8 for the three and nine month periods ended September 30, 2006 and
$0.9 for both periods of 2005.
Invested assets comprise a majority of the consolidated assets.
Consequently, accounting policies related to investments are critical. For
further discussion of investment accounting policies, see the "Critical
Accounting Policies" section on page 41 of the Corporation's 2005 Annual
Report on Form 10-K. Investments are continually evaluated based on
current economic conditions (including the interest rate environment),
market value changes and developments specific to each issuer. The
difference between the cost/amortized 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 a decline in a security's fair
value 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 current consolidated statement of income. All securities
are monitored by portfolio managers who consider many factors such as an
issuer's financial and operating performance, degree of financial
flexibility and industry fundamentals in evaluating whether the decline in
fair value is temporary.
On November 3, 2005, the FASB released FASB Staff Position (FSP) SFAS 115-1
and SFAS 124-1 replacing Emerging Issues Task Force (EITF) 03-1. The final
language on FSP SFAS 115-1 / SFAS 124-1 requires investors to recognize an
impairment loss when the impairment is deemed other-than-temporary and when
the investor no longer has the positive intent and ability to hold the
security until recovery in value, even if a decision to sell the security
has not been made. The FSP applies to reporting periods beginning after
December 15, 2005.
The following table summarizes, 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
September 30, 2006.
Available-for-sale securities with unrealized losses:
Less than 12 months 12 months or longer Total
------------------- ------------------- -----------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
------------------- ------------------- -----------------
Fixed income securities:
U.S. government $ 17.6 $ (0.3) $ - $ - $ 17.6 $ (0.3)
States, municipalities and
political subdivisions 38.7 (0.1) 100.9 (0.8) 139.6 (0.9)
Corporate securities 189.3 (2.1) 89.0 (2.8) 278.3 (4.9)
Mortgage-backed
securities
Other 188.9 (1.1) 99.2 (1.5) 288.1 (2.6)
- --------------------------------------------------------------------------------------------
Total fixed income securities 434.5 (3.6) 289.1 (5.1) 723.6 (8.7)
Equity securities 22.6 (1.3) 8.8 (0.3) 31.4 (1.6)
- --------------------------------------------------------------------------------------------
Total temporarily impaired
securities $457.1 $(4.9) $297.9 $(5.4) $755.0 $(10.3)
============================================================================================
26
Held-to-maturity securities with unrealized losses:
Less than 12 months 12 months or longer Total
------------------- ------------------- -----------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
------------------- ------------------- -----------------
Fixed income securities:
Corporate securities $11.0 $(0.3) $117.6 $(4.3) $128.6 $(4.6)
Mortgage-backed
securities 9.4 (0.2) 64.8 (1.8) 74.2 (2.0)
- --------------------------------------------------------------------------------------------
Total temporarily impaired
securities $20.4 $(0.5) $182.4 $(6.1) $202.8 $(6.6)
============================================================================================
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.
As part of the evaluation of the entire $16.9 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 September 30, 2006.
In the tables above, there are approximately 295 securities represented.
Of this total, 18 securities have unrealized loss positions greater than 5%
of their book values at September 30, 2006, with two exceeding 15%. This
group represents $3.7, or 21.8% of the total unrealized loss position. Of
this group, 10 securities, representing approximately $1.8 in unrealized
losses, have been in an unrealized loss position for less than twelve
months. The remaining eight securities have been in an unrealized loss
position for longer than twelve months and total $1.9 in unrealized losses.
Management 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 it has positive intent
and the ability to hold the securities until they mature or recover in
value.
The amortized cost and estimated fair value of available-for-sale and held-
to-maturity fixed income securities in an unrealized loss position at
September 30, 2006, 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
Cost Fair Value Loss
- -------------------------------------------------------------------------------
Due in one year or less $ 18.5 $ 18.4 $(0.1)
Due after one year through five years 107.5 106.4 (1.1)
Due after five years through ten years 201.4 198.6 (2.8)
Due after ten years 114.2 112.1 (2.1)
Mortgage-backed securities 290.7 288.1 (2.6)
- -------------------------------------------------------------------------------
Total $732.3 $723.6 $(8.7)
===============================================================================
Held to maturity: Amortized Estimated Unrealized
Cost Fair Value Loss
- -------------------------------------------------------------------------------
Due in one year or less $ 2.4 $ 2.4 $ -
Due after one year through five years 36.0 35.0 (1.0)
Due after five years through ten years 91.7 88.2 (3.5)
Due after ten years 3.1 3.0 (0.1)
Mortgage-backed securities 76.2 74.2 (2.0)
- -------------------------------------------------------------------------------
Total $209.4 $202.8 $(6.6)
===============================================================================
For additional discussion relative to the Consolidated Corporation's
investment portfolio, see the "Investment Portfolio" section under
"Liquidity and Capital Resources" on pages 28 and 29 of this MD&A.
Agent Relationships
The agent relationships asset is an identifiable intangible asset
representing the excess of cost over fair value of net assets acquired in
connection with the acquisition of the commercial lines business from Great
American Insurance Company (GAI) in 1998. For information regarding agent
relationships asset, please
27
refer to Note V in the Notes to the Consolidated Financial Statements on
page 15 in this Quarterly Report on Form 10-Q and the Corporation's Annual
Report on Form 10-K for the year ended December 31, 2005 - Critical
Accounting Policies.
LIQUIDITY AND CAPITAL RESOURCES
Investment Portfolio
The following table sets forth the distribution and other data of
investments at September 30, 2006 and December 31, 2005, respectively.
September 30, 2006 December 31, 2005
------------------ -----------------
Average Amortized Carrying % of Amortized Carrying % of
Rating Cost Value Total Cost Value Total
----------------------------------------------------------------------
U.S. Government:
Available-for-sale AAA $ 27.3 $ 27.2 0.6 $ 25.8 $ 25.9 0.6
States, municipalities,
and political
subdivisions:
Investment grade:
Available-for-sale AA+ 1,402.2 1,423.3 33.7 1,269.7 1,277.4 30.2
Corporate securities:
Investment grade:
Available-for-sale A 1,422.1 1,467.3 34.7 1,489.0 1,552.4 36.8
Held-to-maturity A+ 158.6 158.6 3.8 160.1 160.1 3.8
Below Investment grade:
Available-for-sale BB 79.2 81.8 1.9 65.5 68.5 1.6
-----------------------------------------------------------
Total corporate
securities 1,659.9 1,707.7 40.4 1,714.6 1,781.0 42.2
-----------------------------------------------------------
Mortgage-backed
securities:
Investment grade:
Available-for-sale AAA 553.1 553.6 13.1 601.6 601.6 14.3
Held-to-maturity AAA 92.1 92.1 2.2 104.3 104.3 2.5
Below Investment grade:
Available-for-sale 1.9 1.9
-----------------------------------------------------------
Total mortgage-backed
securities 645.2 645.7 15.3 707.8 707.8 16.8
-----------------------------------------------------------
Total fixed income
securities 3,734.6 3,803.0 90.0 3,717.9 3,792.1 89.8
Equity securities* 188.6 404.4 9.6 144.2 375.1 8.9
Cash and cash
equivalents 18.6 18.6 0.4 54.5 54.5 1.3
-----------------------------------------------------------
Total investment
securities, cash
and cash equivalents $3,941.8 $4,226.9 100.0 $3,916.6 $4,221.7 100.0
===========================================================
* Included in equity securities as of September 30, 2006 are common stock
with a cost of $126.7 and carrying value of $341.7 and preferred stock with
a cost of $61.9 and carrying value of $62.7. Included in equity securities
as of December 31, 2005 are common stock with a cost of $97.3 and carrying
value of $327.9 and preferred stock with a cost of $46.9 and carrying value
of $47.2.
The fixed income portfolio is allocated between investment grade and
below investment grade securities as follows:
September 30, 2006 December 31, 2005
------------------ -----------------
Amortized Carrying % of Amortized Carrying % of
Cost Value Fixed Cost Value Fixed
-------------------------------------------------------------
Total investment grade $3,655.4 $3,722.1 97.9 $3,650.5 $3,721.7 98.1
Total below investment grade 79.2 81.8 2.1 67.4 70.4 1.9
The fixed income portfolio is allocated between available-for-sale
and held-to-maturity securities as follows:
Total available-for-sale
fixed incme securities $3,483.9 $3,553.2 93.4 $3,453.5 $3,527.7 93.0
Total held-to-maturity
fixed income securities 250.7 250.7 6.6 264.4 264.4 7.0
The excess of carrying value over cost was $285.1 at September 30, 2006
compared with $305.1 at December 31, 2005. The decrease in unrealized
gains in 2006 was attributable to declining market values of fixed income
securities as a result of an increase in interest rates and the sale of
certain highly appreciated equity securities.
28
The consolidated fixed income portfolio, including short-term securities,
has an intermediate duration and a laddered maturity structure. The
duration of the fixed maturity portfolio was approximately 5.0 and 5.2
years at September 30, 2006 and December 31, 2005, respectively. The
Consolidated Corporation remains fully invested and does not time markets.
Fixed income securities are classified as investment grade or non-
investment grade based upon the higher of the ratings provided by Standard
and Poor's (S&P) and Moody's Investor Service (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 income securities (i.e., those having an investment
grade rating from one rating agency and a below investment grade rating
from another rating agency) was $14.2 and $35.2 at September 30, 2006 and
December 31, 2005, respectively.
Following is a table displaying available-for-sale non-investment grade and
non-rated securities in an unrealized loss position at September 30, 2006
and December 31, 2005:
Amortized Fair Unrealized
Cost Value Loss
- --------------------------------------------------------------------
September 30, 2006 $20.2 $19.7 $(0.5)
December 31, 2005 13.6 13.2 (0.4)
Equity securities are carried at fair market value on the consolidated
balance sheets. As a result, shareholders' equity and statutory surplus
fluctuate with changes in the value of the equity portfolio. As of
September 30, 2006, the equity portfolio consisted of stocks in a total of
78 separate entities covering all ten major S&P industry sectors. Of this
total, 20.0% was invested in five companies and the largest single position
was 4.4% of the equity portfolio. At December 31, 2005, the equity
portfolio consisted of stocks in 60 separate entities in ten different
industries. Of this total, 24.2% were invested in five companies and the
largest single position was 5.4% of the equity portfolio.
The investment portfolio also includes securities that do not have a
readily available market price 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 September 30, 2006 was
$259.3 compared to $285.3 at December 31, 2005.
Losses and Loss Adjustment Expenses
The Group's largest liabilities are reserves for losses and LAE. Loss and
LAE reserves (collectively "loss reserves") are established for all
incurred claims without discounting for the time value of money. Before
credit for reinsurance recoverables, these reserves amounted to $3.0
billion and $2.9 billion at September 30, 2006 and December 31, 2005,
respectively. As of September 30, 2006, the loss reserves by operating
segment were as follows: $1,882.6 Commercial Lines, $717.6 Specialty Lines
and $378.5 Personal Lines. The Group purchases reinsurance to mitigate the
impact of large losses and catastrophic events. Loss reserves ceded to
reinsurers amounted to $649.7 and $684.6 at September 30, 2006 and December
31, 2005, respectively.
The Group conducts a quarterly review of loss reserves using the methods
described in its Annual Report on Form 10-K for the year ended December 31,
2005 and records its best estimate each quarter based on that review. In
the opinion of management, the reserves recorded at September 30, 2006
represent the Group's best estimate of its ultimate liability for losses
and LAE. However, due to the inherent complexity of the estimation process
and the potential variability of the assumptions used, final claim
settlements may vary significantly from the amounts recorded. Furthermore,
the timing, frequency and extent of adjustments to the estimated
liabilities cannot be predicted with certainty since conditions and events
which established historical loss reserve development and which serve as
the basis for estimating ultimate claim costs may not occur in exactly the
same manner, if at all.
Loss reserves are an estimate of ultimate unpaid costs of losses and LAE
for claims that have been reported and claims that have been incurred but
not yet reported. Loss reserves do not represent an exact calculation of
liability, but instead represent estimates, generally utilizing actuarial
expertise and reserving methods, at a given accounting date. These loss
reserve estimates are expectations of what the ultimate
29
settlement and administration of claims will cost upon final resolution in
the future, based on the Group's assessment of facts and circumstances then
known. In establishing reserves, the Group also takes into account
estimated recoveries for reinsurance, salvage and subrogation.
The process of estimating loss reserves involves a high degree of judgment
and is subject to a number of risk factors. These risk factors can be
related to both internal and external events, such as changes in claims
handling procedures, economic inflation, legal trends and legislative
changes, among others. Please refer to the Corporation's Annual Report on
Form 10-K for the year ended December 31, 2005, for a detailed discussion
of these risk factors. The impact of these items on ultimate costs for
loss and LAE is difficult to estimate. Loss reserve estimation differs by
product line due to differences in claim complexity, the volume of claims,
the potential severity of individual claims, the determination of
occurrence date for a claim and reporting lags (the time between the
occurrence of the policyholder loss event and when it is actually reported
to the insurer). Informed judgment is applied throughout the process. The
Group continually refines its loss reserve estimates in a regular ongoing
process as historical loss experience develops and additional claims are
reported and settled. The Group considers all significant facts and
circumstances known at the time loss reserves are established. Due to the
inherent uncertainty underlying loss reserve estimates, final resolution of
the estimated liability will be different from that anticipated at the
reporting date. Therefore, actual paid losses in the future may yield a
materially different amount than currently reserved--favorable or
unfavorable. The Group reflects adjustments to loss reserves in the
results of operations in the period the estimates are changed.
The following table displays case, IBNR and LAE reserves by product line
gross of reinsurance recoverables. Case reserves represent amounts
determined for each claim based on the known facts regarding the claim and
the parameters of the coverage that our policy provides. The IBNR reserves
include provisions for incurred but not reported claims, provisions for
losses in excess of the case reserves on previously reported claims, claims
to be reopened and a provision for uncertainty in recognition of the
variability and risk factors described below. The IBNR provision also
includes an offset for anticipated salvage and subrogation recoveries. LAE
reserves are an estimate of the expenses related to resolving and settling
claims. Reserves ceded to reinsurers and reserves net of reinsurance are
also shown.
Loss and LAE Reserves as of September 30, 2006 and December 31, 2005:
September 30, 2006
- ------------------
Gross Total Total
Operating Segment Case IBNR LAE Total Ceded Net
- ------------------------------------------------------------------------------------
Commercial Lines $ 743.1 $ 778.7 $360.8 $1,882.6 $173.6 $1,709.0
Workers' compensation 410.1 346.0 70.8 826.9 141.0 685.9
Commercial auto 111.2 107.6 44.0 262.8 7.2 255.6
General liability 64.8 120.2 94.4 279.4 4.9 274.5
CMP, fire & inland marine 157.0 204.9 151.6 513.5 20.5 493.0
Specialty Lines 133.4 489.0 95.2 717.6 408.1 309.5
Commercial umbrella 121.8 488.5 89.5 699.8 402.2 297.6
Fidelity & surety 11.6 0.5 5.7 17.8 5.9 11.9
Personal Lines 195.8 119.1 63.6 378.5 68.0 310.5
Personal auto & umbrella 165.3 83.3 47.0 295.6 67.3 228.3
Personal property 30.5 35.8 16.6 82.9 0.7 82.2
Total All Lines $1,072.3 $1,386.8 $519.6 $2,978.7 $649.7 $2,329.0
- ------------------------------------------------------------------------------------
30
December 30, 2006
- ------------------
Gross Total Total
Operating Segment Case IBNR LAE Total Ceded Net
- ------------------------------------------------------------------------------------
Commercial Lines $ 700.9 $ 762.2 $351.5 $1,814.6 $165.4 $1,649.2
Workers' compensation 387.1 344.0 69.2 800.3 131.4 668.9
Commercial auto 103.2 109.7 44.6 257.5 6.0 251.5
General liability 59.4 117.3 92.6 269.3 5.2 264.1
CMP, fire & inland marine 151.2 191.2 145.1 487.5 22.8 464.7
Specialty Lines 134.8 516.2 92.9 743.9 454.1 289.8
Commercial umbrella 116.4 516.1 85.9 718.4 442.4 276.0
Fidelity & surety 18.4 0.1 7.0 25.5 11.7 13.8
Personal Lines 194.8 126.1 67.4 388.3 65.1 332.2
Personal auto & umbrella 164.1 91.3 50.6 306.0 64.1 241.9
Personal property 30.7 34.8 16.8 82.3 1.0 81.3
Total All Lines $1,030.5 $1,404.5 $511.8 $2,946.8 $684.6 $2,262.2
- ------------------------------------------------------------------------------------
Reserve variability and uncertainty
- -----------------------------------
There is a great deal of uncertainty in the loss reserve estimates and
unforeseen events can have unfavorable impacts on the loss reserve
estimates. Reinsurance is purchased to mitigate the impact of large losses
and catastrophic events.
To illustrate the uncertainty by operating segment, the table presented in
the All Lines discussion of this MD&A on page 22 provides the before-tax
amount of prior accident years' loss reserve development by operating
segment on a net of reinsurance basis for the three-months ended September
30, 2006 and 2005, and year ended December 31, 2005. This table
illustrates the variability of reserves between operating segments, and
from period to period. Within each operating segment, development can also
be favorable or adverse by product line within the same period. For
example, for the Commercial Lines operating segment in the nine months
ended September 30, 2006, the workers' compensation product line had
adverse development of $16.8 while the commercial auto product line had
favorable development of $16.6.
Reserve estimates are also uncertain by accident period. To illustrate
this, the following table provides the before-tax amount of prior accident
years' loss and LAE reserve development by accident year on a net of
reinsurance basis for all lines combined:
Three Months Ended Nine Months Ended
September 30, September 30, Year
2006 2005 2006 2005 2005
---- ---- ---- ---- ----
(Favorable)/Unfavorable
- -----------------------
Accident Year 2005 $ (5.3) $ - $ (9.8) $ - $ -
Accident Year 2004 (2.3) (3.2) (15.4) (19.1) (30.8)
Accident Year 2003 and Prior (6.1) 6.3 (12.2) 15.5 10.7
------- ------ ------- ------- -------
Total Prior Accident Years'
Development $(13.7) $ 3.1 $(37.4) $ (3.6) $(20.1)
======= ====== ======= ======= =======
Please refer to the Corporation's Annual Report on Form 10-K for the year
ended December 31, 2005, for a broader discussion of reserve variability
and uncertainty. The Group does not prepare loss reserve ranges, nor does
it project future variability, when determining its best estimate, although
the above examples of actual historical changes in loss reserve estimates
provide a measure of the uncertainty underlying the current loss reserve
estimates. The Loss Reserve process takes all risk factors into account,
but no one risk factor has been bifurcated to perform a sensitivity or
variability analysis because the risk factors were considered in the
aggregate. As a result, the Group is not in a position to quantify the
impact of reasonably likely changes to significant assumptions at this
time. Nevertheless, the Group is undertaking an assessment to evaluate the
sensitivity or variability of changes in significant assumptions related to
the Group's estimate of loss reserves in the aggregate and/or by product
line, to the extent material. Upon completion of such sensitivity or
variability assessment, and to the extent that management believes the
information to be reasonably accurate and credible and would be beneficial,
in the opinion of management,
31
to the understanding of the Group's financial statements, the Corporation
will include the outcome of this sensitivity/variability analysis either in
the aggregate or by product line, as appropriate, in the first practicable
periodic filing of the Corporation that follows the completion of this
assessment and continuing thereafter.
Cash Flow
Net cash provided by operations was $85.7 for the first nine months of
2006, compared with $205.9 for the same period in 2005. The decline in
cash provided by operations is primarily the result of increased income tax
payments, incentive plan payments, contributions to the Company's
retirement plan and the purchase of company owned life insurance to help
offset the increase in future benefit costs. The decline in net cash used
in investing of $38.4, compared with $233.7 during the first nine months of
2005 primarily relates to a reduction in the cash generated by operations,
as discussed above. Cash used by financing operations was $83.2 in the
first nine months of 2006, compared with $170.6 in the first nine months of
2005. The reinstatement of the shareholder dividend and the repurchase of
the Corporation's common stock contributed to the cash used in financing
activities during 2006. See Part II, Item 2, for additional information
regarding the share repurchase program. For the same period in 2005, cash
used in financing activities was attributed to the repurchase and
redemption of the Corporation's Convertible Notes. Liquidity needs of the
Group are expected to be met by net cash generated from operations,
maturities of investments, interest and dividend receipts and current cash
balances. For additional information regarding Liquidity of the
Corporation, please see below.
Debt
For a discussion regarding Debt of the Corporation, please refer to Note
VII in the Notes to the Consolidated Financial Statements on page 16 of
this Quarterly Report on Form 10-Q.
At September 30, 2006, the Corporation had cash and marketable securities,
totaling $297.0, which compared to $253.2 at December 31, 2005. In
addition to investment income, the Corporation is dependent on dividend
payments from the Company for additional liquidity. Insurance regulatory
authorities impose various restrictions on the payment of dividends by
insurance companies. During 2006, dividend payments from the Company to
the Corporation are limited to approximately $415.0 without prior approval
from the Ohio Department of Insurance. During the first nine months of
2006, the Company paid dividends of $125.0 to the Corporation resulting in
a dividend payment limitation of $290.0 for the remainder of 2006.
Book Value Per Share
At September 30, 2006, the book value per share of the Consolidated
Corporation increased $1.60 per share from $22.54 per share to $24.14 per
share when compared to book value at December 31, 2005. This increase is
principally the result of improved profitability offset by declines in
unrealized gains and the affects of the share repurchase and dividend
programs. At September 30, 2006 and December 31, 2005 there were
61,204,073 and 63,281,136 actual shares outstanding, respectively. Below
is a table reconciling the changes in book value per share from December
31, 2005 to September 30, 2006.
December 31, 2005 $22.54
Activity year-to-date September 2006:
Net income 2.26
Change in unrealized gains (0.21)
Impact of share repurchase program (0.20)
Dividend to shareholders (0.27)
Other 0.02
-------
September 30, 2006 $24.14
=======
Rating Agencies
Regularly the financial condition of the Consolidated Corporation and the
Group is reviewed by four independent rating agencies, A. M. Best Company
(A.M. Best), Fitch, Inc. (Fitch), Moody's and S&P. These agencies assign
ratings and rating outlooks reflecting the agencies' opinions of the
Group's financial strength and the ability of the Corporation to meet its
financial obligations to its debt security holders. On September 18, 2006,
Fitch announced that it upgraded the senior unsecured debt rating of Ohio
Casualty to
32
BBB and the insurance financial strength rating of its operating
subsidiaries to A. At this time, the rating outlook was changed from
positive to stable. Following are the Consolidated Corporation's current
ratings and rating outlooks.
A.M. Best Fitch Moody's S&P
--------- ----- ------- ---
Financial strength rating (Group) A- A A3 A-
Senior unsecured debt rating
(Corporation) bbb- BBB Baa3 BBB-
Rating outlook Positive Stable Positive Stable
For more information on the rating agency actions, please refer to Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations in the Corporation's 2005 Annual Report on Form 10-K for the
year ended December 31, 2005.
Forward Looking Statements
Ohio Casualty Corporation publishes forward-looking statements relating to
such matters as anticipated financial performance, business prospects and
plans, regulatory developments and similar matters. The statements
contained in this Management's Discussion and Analysis that are not
historical information, are forward-looking statements within the meaning
of The Private Securities Litigation Reform Act of 1995. The operations,
performance and development of the Consolidated Corporation's business are
subject to risks and uncertainties which may cause actual results to differ
materially from those contained in or supported by the forward looking
statements. The risks and uncertainties that may affect the operations,
performance, development and results of the Consolidated 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 achieve targeted expense savings; ability to appoint and retain
agents; ability to achieve premium targets and profitability goals; and
general economic and market conditions.
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk
There have been no material changes in the information about market risk
set forth in the Corporation's 2005 Annual Report on Form 10-K.
ITEM 4. Controls and Procedures
(a) The Corporation's Chief Executive Officer and Chief Financial
Officer evaluated the disclosure controls and procedures (as
defined under Rules 13a-15(e) and 15d-15(e) of the Securities
Exchange Act of 1934, as amended) as of the end of the period
covered by this report. Based upon that evaluation, the Chief
Executive Officer and Chief Financial Officer have concluded that
the Corporation's disclosure controls and procedures are
effective.
(b) There were no significant changes in the Corporation's internal
control over financial reporting identified in connection with the
foregoing evaluation that occurred during the Corporation's last
fiscal quarter that have affected, or are reasonably likely to
materially affect, the Corporation's internal control over
financial reporting.
PART II Other Information
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
During the third quarter of 2006, the Corporation completed the share
repurchase program which was authorized by the Corporation's Board of
Directors in the third quarter of 2005. In September 2006, the Board of
Directors approved another share purchase program with authorization to
repurchase up to $100.0 of the Corporation's common stock. The repurchases
may be made in the open market or in privately
33
negotiated transactions from time to time and are funded from available
working capital. As of October 31, 2006, the Corporation has repurchased
227,200 shares under the new program at an average cost of $27.19. The
table below summarizes the status of share repurchases during the third
quarter ended September 30, 2006 under the previously authorized program.
ISSUER PURCHASES OF EQUITY SECURITIES
- -------------------------------------------------------------------------------
(c) Total (d) Maximum
Number Number of
of Shares Shares that
Purchased as May Yet Be
(a) Total Part of Publicly Purchased
Number of (b) Average Announced Under the
Shares Price Paid Plans or Plans or
Period Purchased per Share Programs Programs
- -------------------------------------------------------------------------------
July 1 - 31, 2006 78,000 $25.96 78,000 171,186
August 1 - 31, 2006 171,186 25.83 171,186 -
September 1 - 30, 2006 - - - -
------- -------
Total 249,186 $25.87 249,186 -
ITEM 6. Exhibits
Exhibits:
31.1 Certification of Chief Executive Officer of Ohio Casualty
Corporation in accordance with SEC Rule 13(a) and Rule 15(d)
31.2 Certification of Chief Financial Officer of Ohio Casualty
Corporation in accordance with SEC Rule 13(a) and Rule 15(d)
32.1 Certification of Chief Executive Officer of Ohio Casualty
Corporation in accordance with Section 1350 of the
Sarbanes-Oxley Act of 2002
32.2 Certification of Chief Financial Officer of Ohio Casualty
Corporation in accordance with Section 1350 of the
Sarbanes-Oxley Act of 2002
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
OHIO CASUALTY CORPORATION
-------------------------
(Registrant)
November 1, 2006 /s/Michael A. Winner
-----------------------------------
Michael A. Winner, Executive Vice
President and Chief Financial Officer
34