==============================================================================
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 March 31, 2007.
[ ] 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 of (I.R.S. incorporation
Employer Identification No.) or organization)
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 May 7, 2007, there were 59,996,491 shares of common stock
outstanding.
Page 1 of 28
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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 12
Item 3. Quantitative and Qualitative Disclosures about
Market Risk 26
Item 4. Controls and Procedures 26
PART II OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 2. Unregistered Sales of Equity Securities and Use
of Proceeds 27
Item 6. Exhibits 27
Signature 28
Exhibit 10.11a First Amendment to Credit Agreement dated as of
March 15, 2007 between Ohio Casualty Corporation
and LaSalle Bank National Association as Agent.
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
March 31, December 31,
(in millions, except share data) 2007 2006
===========================================================================================
Assets (Unaudited)
Investments:
Fixed income securities:
Available-for-sale, at fair value
(amortized cost: $3,484.2 and $3,451.0) $ 3,550.9 $ 3,512.3
Held-to-maturity, at amortized cost
(fair value: $226.8 and $230.8) 230.0 235.8
Equity securities, at fair value
(cost: $252.1 and $232.1) 468.3 458.5
- -------------------------------------------------------------------------------------------
Total investments 4,249.2 4,206.6
Cash and cash equivalents 51.6 45.6
Premiums and other receivables, net of allowance 310.7 316.0
Deferred policy acquisition costs 151.7 150.2
Property and equipment, net of accumulated depreciation 83.4 80.5
Reinsurance recoverable, net of allowance 629.1 633.8
Agent relationships, net of accumulated amortization 93.4 96.9
Interest and dividends due or accrued 45.5 51.2
Deferred tax asset, net 4.2 -
Other assets 88.7 117.8
- -------------------------------------------------------------------------------------------
Total assets $ 5,707.5 $ 5,698.6
===========================================================================================
Liabilities
Insurance reserves:
Losses $ 2,390.6 $ 2,390.4
Loss adjustment expenses 521.6 521.9
Unearned premiums 656.4 663.0
Debt 199.5 199.6
Reinsuance treaty funds held 109.4 117.6
Deferred tax liability, net - 7.2
Other liabilities 233.2 243.2
- -------------------------------------------------------------------------------------------
Total liabilities 4,110.7 4,142.9
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 28.5 25.4
Accumulated other comprehensive income 190.7 194.1
Retained earnings 1,614.8 1,559.5
Treasury stock, at cost:
(Shares: 12,510,777; 12,095,652) (246.2) (232.3)
- -------------------------------------------------------------------------------------------
Total shareholders' equity 1,596.8 1,555.7
- -------------------------------------------------------------------------------------------
Total liabilities and shareholders' equity $ 5,707.5 $ 5,698.6
===========================================================================================
Accompanying notes are an integral part of these consolidated financial
statements. For complete disclosures see Notes to Consolidated Financial
Statements on pages 71-89 of the Corporation's 2006 Form 10-K.
3
ITEM 1. Continued
Ohio Casualty Corporation & Subsidiaries
CONSOLIDATED STATEMENTS OF INCOME
Three Months
Ended March 31,
(in millions, except share and per share data) (Unaudited) 2007 2006
- -------------------------------------------------------------------------------------------
Premiums and finance charges earned $ 349.6 $ 357.7
Investment income, less expenses 51.7 50.9
Investment gains realized, net 8.0 14.2
- -------------------------------------------------------------------------------------------
Total revenues 409.3 422.8
Losses and benefits for policyholders 161.9 189.0
Loss adjustment expenses 38.6 36.7
General operating expenses 117.4 116.7
Write-down and amortization of agent relationships 3.5 2.9
Amortization of deferred policy acquisition costs 81.5 82.9
Deferral of policy acquisition costs (83.0) (81.1)
Depreciation and amortization expense 3.2 2.5
- -------------------------------------------------------------------------------------------
Total expenses 323.1 349.6
- -------------------------------------------------------------------------------------------
Income before income taxes 86.2 73.2
Income tax expense/(benefit):
Current 32.3 8.2
Deferred (9.2) 13.1
- -------------------------------------------------------------------------------------------
Total income tax expense 23.1 21.3
- -------------------------------------------------------------------------------------------
Net income $ 63.1 $ 51.9
===========================================================================================
Average shares outstanding - basic 59,844,492 63,235,681
===========================================================================================
Earnings per share - basic:
Net income, per share $ 1.05 $ 0.82
===========================================================================================
Average shares outstanding - diluted 61,343,139 64,836,502
===========================================================================================
Earnings per share - diluted:
Net income, per share $ 1.03 $ 0.80
===========================================================================================
Accompanying notes are an integral part of these consolidated financial
statements. For complete disclosures see Notes to Consolidated Financial
Statements on pages 71-89 of the Corporation's 2006 Form 10-K.
4
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, 2006 $ 9.0 $ 18.8 $ 178.0 $ 1,360.6 $ (140.0) $ 1,426.4
Net income 51.9 51.9
Change in unrealized gain,
net of deferred income tax
benefit of $19.1 (35.7) (35.7)
------------
Comprehensive income 16.2
Unearned stock compensation (2.9) 2.9 -
Stock based compensation, including
income tax benefit of $1.2 2.6 2.6
Net issuance of treasury
stock (249,309 shares) (0.5) 3.8 3.3
Repurchase of treasury stock
(36,780 shares) (1.0) (1.0)
Cash dividend paid ($0.09 per share) (5.7) (5.7)
- ---------------------------------------------------------------------------------------------------------------
Balance,
March 31, 2006 $ 9.0 $ 18.0 $ 142.3 $ 1,409.7 $ (137.2) $ 1,441.8
===============================================================================================================
Balance
January 1, 2007 $ 9.0 $ 25.4 $ 194.1 $ 1,559.5 $ (232.3) $ 1,555.7
Net income 63.1 63.1
Change in unrealized gain,
net of deferred income tax
benefit of $1.7 (2.5) (2.5)
Change in prior service credit, net of
deferred income tax of $0.7 (1.3) (1.3)
Change in actuarial loss, net of
deferred tax of $0.3 0.4 0.4
------------
Comprehensive income 59.7
Stock based compensation, including
income tax benefit of $0.8 3.8 3.8
Net issuance of treasury
stock (163,479 shares) (0.7) 3.2 2.5
Repurchase of treasury stock
(578,604 shares) (17.1) (17.1)
Cash dividend paid ($0.13 per share) (7.8) (7.8)
- ---------------------------------------------------------------------------------------------------------------
Balance,
March 31, 2007 $ 9.0 $ 28.5 $ 190.7 $ 1,614.8 $ (246.2) $ 1,596.8
===============================================================================================================
Accompanying notes are an integral part of these consolidated financial
statements. For complete disclosures see Notes to Consolidated Financial
Statements on pages 71-89 of the Corporation's 2006 Form 10-K.
5
ITEM 1. Continued
Ohio Casualty Corporation & Subsidiaries
CONSOLIDATED STATEMENTS OF CASH FLOWS
Three Months
Ended March 31,
(in millions) (Unaudited) 2007 2006
- -------------------------------------------------------------------------------------------------
Cash Flows from Operating Activities:
Operating Activities
Net income $ 63.1 $ 51.9
Adjustments to reconcile net income to net cash
provided by operations:
Changes in:
Insurance reserves (6.7) (0.7)
Reinsurance treaty funds held (8.2) (3.8)
Income taxes 8.1 11.2
Premiums and other receivables 5.3 4.7
Deferred policy acquisition costs (1.5) 1.8
Reinsurance recoverable 4.7 9.5
Other assets 16.5 (11.7)
Other liabilities (28.6) (27.0)
Stock-based compensation expense 3.0 1.4
Amortization and write-down of agent relationships 3.5 2.9
Depreciation and amortization 3.2 2.5
Investment gains realized, net (8.0) (14.2)
- -------------------------------------------------------------------------------------------------
Net cash provided by operating activities 54.4 28.5
- -------------------------------------------------------------------------------------------------
Cash Flows from Investing Activities:
Purchase of securities:
Fixed income, available-for-sale (286.8) (272.8)
Fixed income, held-to-maturity - (0.2)
Equity (26.0) (13.1)
Proceeds from sales of securities:
Fixed income, available-for-sale 205.8 187.3
Equity 19.2 22.9
Proceeds from maturities and calls of securities:
Fixed income, available-for-sale 64.3 45.8
Fixed income, held-to-maturity 5.3 4.8
Property and equipment
Purchases (6.3) (1.9)
Sales 0.2 0.2
- -------------------------------------------------------------------------------------------------
Net cash used in investing activities (24.3) (27.0)
- -------------------------------------------------------------------------------------------------
Cash Flows from Financing Activities:
Debt:
Repayments (0.2) (0.2)
Payment for deferred financing costs - (0.3)
Proceeds from exercise of stock options 2.4 3.3
Repurchase of treasury stock (19.3) (1.0)
Income tax benefit from stock option exercises 0.8 1.0
Dividends paid to shareholders (7.8) (5.7)
- -------------------------------------------------------------------------------------------------
Net cash used in financing activities (24.1) (2.9)
- -------------------------------------------------------------------------------------------------
Net increase/(decrease) in cash and cash equivalents 6.0 (1.4)
Cash and cash equivalents, beginning of period 45.6 54.5
- -------------------------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 51.6 $ 53.1
=================================================================================================
Accompanying notes are an integral part of these consolidated financial
statements. For complete disclosures see Notes to Consolidated Financial
Statements on pages 71-89 of the Corporation's 2006 Form 10-K.
6
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 March 31, 2007 and the
Consolidated Statements of Income, Shareholders' Equity and Cash Flows for
the three months ended March 31, 2007 and 2006, without an audit. In the
opinion of management, all adjustments necessary to fairly present the
financial position, results of operations and cash flows at March 31, 2007
and for each period presented have been made.
We prepared the accompanying unaudited Consolidated Financial Statements in
accordance with U.S. generally accepted accounting principles (GAAP) 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 GAAP 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 2006 Annual Report on Form 10-K. The results of operations
for the period ended March 31, 2007 are not necessarily indicative of the
results of operations for the full year.
The preparation of financial statements in conformity with GAAP 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 $1.5 at both March 31, 2007 and December 31,
2006. Property and equipment are carried at cost less accumulated
depreciation of $185.8 and $183.0 at March 31, 2007 and December 31, 2006,
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 both March 31, 2007 and December 31, 2006.
NOTE II - EARNINGS PER SHARE
Basic and diluted earnings per share are summarized as follows:
Three Months Ended March 31,
2007 2006
- ------------------------------------------------------------------------------
Net income $63.1 $51.9
Weighted average common shares
outstanding - basic (thousands) 59,844 63,236
Basic net income per weighted average share $1.05 $0.82
==============================================================================
Net income $63.1 $51.9
Weighted average common shares
outstanding - basic (thousands) 59,844 63,236
Effect of dilutive securities from stock
compensation plans (thousands) 1,499 1,601
- ------------------------------------------------------------------------------
Weighted average common shares
outstanding - diluted (thousands) 61,343 64,837
Diluted net income per weighted average share $1.03 $0.80
==============================================================================
7
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.
Three Months Ended March 31,
Commercial Lines Segment 2007 2006
- -------------------------------------------------------------------
Net premiums written $209.4 $212.4
% change (1.4)% 3.3%
Net premiums earned 205.3 204.6
% change 0.3% (0.5)%
Underwriting gain/(loss) (before tax) 11.3 (3.6)
Specialty Lines Segment 2007 2006
- -------------------------------------------------------------------
Net premiums written $ 34.6 $ 35.8
% change (3.4)% (8.4)%
Net premiums earned 36.7 37.3
% change (1.6)% 6.3%
Underwriting gain (before tax) 13.4 9.2
Personal Lines Segment 2007 2006
- -------------------------------------------------------------------
Net premiums written $101.3 $105.9
% change (4.3)% (6.9)%
Net premiums earned 107.6 115.8
% change (7.1)% (4.8)%
Underwriting gain (before tax) 12.9 12.6
Total Property & Casualty 2007 2006
- -------------------------------------------------------------------
Net premiums written $345.3 $354.1
% change (2.5)% (1.2)%
Net premiums earned 349.6 357.7
% change (2.3)% (1.3)%
Underwriting gain (before tax) 37.6 18.2
All Other Segment 2007 2006
- -------------------------------------------------------------------
Revenues $ 3.6 $ 3.6
Write-down and amortization of
agent relationships (3.5) (2.9)
Other expenses (7.6) (7.2)
- -------------------------------------------------------------------
Net loss before income tax $ (7.5) $ (6.5)
Reconciliation of Revenues 2007 2006
- -------------------------------------------------------------------
Net premiums earned for reportable
segments $349.6 $357.7
Net investment income 47.2 47.2
Realized gains, net 8.9 14.3
- -------------------------------------------------------------------
Total property and casualty revenues 405.7 419.2
All other segment revenues 3.6 3.6
- -------------------------------------------------------------------
Total revenues $409.3 $422.8
===================================================================
8
Reconciliation of Underwriting Gain
(before tax) 2007 2006
- -------------------------------------------------------------------
Property and casualty underwriting gain
(before tax) $ 37.6 $ 18.2
Net investment income 51.7 50.9
Realized gains, net 8.0 14.2
Write-down and amortization of agent
relationships (3.5) (2.9)
Other expenses (7.6) (7.2)
- -------------------------------------------------------------------
Income before income tax 86.2 73.2
Income tax expense (23.1) (21.3)
- -------------------------------------------------------------------
Net income $ 63.1 $51.9
===================================================================
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:
Three Months Ended March 31,
2007 2006
- ----------------------------------------------------------------------------
Net income $63.1 $51.9
After-tax net realized gains 5.2 9.2
- ----------------------------------------------------------------------------
Operating income $57.9 $42.7
============================================================================
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) 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. For a 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, 2006.
Following is a summary of stock based compensation expense recognized by
the Consolidated Corporation:
Three Months Ended March 31,
2007 2006
- ----------------------------------------------------------------------------
2005 Incentive Plan
Stock Options $0.5 $ 0.7
Stock Appreciation Rights 0.3 0.3
Restricted Stock 0.2 0.4
Long Term Incentive Plans 1.9 (0.3)
Employee Stock Purchase Plan 0.1 0.3
- ----------------------------------------------------------------------------
Total Stock-Based Compensation $3.0 $ 1.4
============================================================================
NOTE V - INCOME TAXES
Effective January 1, 2007, the Consolidated Corporation adopted the
recognition and disclosure provisions of SFAS Interpretation No. 48,
"Accounting for Uncertainties in Income Taxes, an Interpretation of SFAS
109, Accounting for Income Taxes" (FIN 48). FIN 48 requires the
Consolidated Corporation to account for and disclose uncertainty in tax
positions, along with related interest and penalties, that meet a minimum
recognition threshold. As of December 31, 2006 and March 31, 2007, the
total amount of unrecognized tax benefits were $1.5. If recognized, the
entire amount of unrecognized tax benefits would affect the Consolidated
Corporation's effective tax rate. There were no interest or penalties
recognized in the Consolidated Corporation's statements of income and
consolidated balance sheets. It is reasonably possible that none of the
unrecognized tax benefits will significantly increase or decrease within
twelve months. In February 2007, the Internal Revenue Service (IRS) issued
the final report on its examination of the Consolidated Corporation for tax
years 2002 and 2003. There is one matter for which the Consolidated
Corporation has filed a written protest with the IRS Appeals Office. The
ultimate settlement of this matter is not expected to have a significant
adverse impact on the Consolidated Corporation's financial position or
results of operations. During 2007, the IRS is expected to commence its
examination of the Consolidated Corporation's tax years 2004 and 2005.
9
The Consolidated Corporation's policy under FIN 48 with respect to interest
and penalties related to tax uncertainties is to classify such amounts in
its statement of income as income tax expense, consistent with its policy
prior to the adoption of FIN 48.
NOTE VI - 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 primarily to agent relationships. 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 $2.1 and $1.3
in the first quarter of 2007 and 2006, 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 17
years. For the three month period ended March 31, 2007, the Consolidated
Corporation recorded amortization expense of $1.4 which compares to $1.6
for the same period of the prior year. At March 31, 2007 and December 31,
2006, the unamortized carrying value of the agent relationships asset was
$93.4 and $96.9, respectively. The agent relationships asset is recorded
net of accumulated amortization of $48.8 and $48.4 at March 31, 2007 and
December 31, 2006, 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 VII - DEBT
The following table represents outstanding debt and deferred financing
costs of the Consolidated Corporation at March 31, 2007 and December 31,
2006:
March 31, December 31,
2007 2006
- ----------------------------------------------------------------------------
Senior Debt (net of discount and
issuance costs of $2.0) $198.0 $198.0
Ohio Loan 1.9 2.0
Deferred Financing Costs (0.4) (0.4)
- ----------------------------------------------------------------------------
Total Debt $199.5 $199.6
============================================================================
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 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,
2006 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 $2.0 at both March
31, 2007 and December 31, 2006. 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. In March 2007, the
Corporation extended the expiration by one year to March 16, 2012. 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.
10
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, 2006 for a detailed discussion
regarding the terms and provisions of the new revolving credit agreement.
At March 31, 2007, 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 March 31, 2007 or
December 31, 2006.
Interest expense incurred for both the three month periods ended March 31,
2007 and 2006 was $3.7.
NOTE VIII - CONTINGENCIES
A proceeding entitled Carol Lazarus v. the Group was brought against West
American Insurance Company (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 to the Court of Appeals
for the Eighth Appellate District, Cuyahoga County, Ohio.
A proceeding entitled Douglas and Carla Scott v. the Company, West
American, American Fire Insurance Company (American Fire), and Ohio
Security Insurance Company (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.
A proceeding entitled Georgia Hensley, et al. v. Computer Sciences
Corporation, et al. was brought against several defendants, including the
Company, American Fire, Ohio Casualty of New Jersey (OCNJ), Ohio Security,
and West American in the Circuit Court of Miller County, Arkansas in May,
2005. The proceeding alleged the defendants (involving approximately 400
different entities) improperly reduced uninsured/underinsured motorist
coverage payments to persons insured under private passenger automobile
insurance policies by consulting a computer software program in determining
the amount of damages payable to the insured for bodily injury claims. The
Corporation has been dismissed without prejudice from the Hensley
proceeding. A separate class action complaint entitled Dusty Easley, et
al. v. the Company, American Fire, Avomark Insurance Company (Avomark), the
Corporation, Ohio Security, and West American was filed in the Circuit
Court of Miller County, Arkansas in March, 2007. The Easley proceeding
alleges substantially the same counts alleged in the Hensley proceeding and
includes the same putative class. Plaintiffs and defendants in the Easley
proceeding have filed a Stipulation of Settlement and Motion for
Preliminary Approval seeking approval of a settlement of the case. If the
proposed settlement is approved in the Easley matter then plaintiffs in the
Hensley action will also seek to amend the dismissal of the Corporation
with prejudice.
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.
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 as of March 31
is determined as follows:
11
Three Months Ended March 31,
2007 2006
- ----------------------------------------------------------------------------
Service cost earned during the period $ 2.1 $ 2.1
Interest cost on projected benefit obligation 4.7 4.3
Expected return on plan assets (7.0) (6.5)
Amortization of accumulated losses 0.7 1.0
Amortization of prior service credit (0.6) (0.6)
- ----------------------------------------------------------------------------
Net periodic pension (benefit)/cost $(0.1) $ 0.3
============================================================================
The components of the Company's net periodic postretirement benefit cost as
of March 31:
2007 2006
- ----------------------------------------------------------------------------
Service cost $ 0.1 $ 0.1
Interest cost 0.6 0.7
Amortization of prior service credit (1.5) (1.5)
- ----------------------------------------------------------------------------
Net periodic postretirement benefit $(0.8) $(0.7)
============================================================================
The Company adopted the recognition and disclosure provisions of SFAS 158,
"Employers' Accounting for Defined Benefit Pension and Other Postretirement
Plans as amendment of SFAS Statements No. 87, 88, 106, and 132(R)" as of
December 31, 2006. Please refer to Note 4 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, 2006 for a detailed discussion.
NOTE X - SHARE REPURCHASES
During 2006, the Corporation completed the share repurchase program
previously authorized by the Corporation's Board of Directors in 2005.
Under this program, four million shares were repurchased (2,483,895 in 2006
and 1,516,105 in 2005) 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. During the first quarter of 2007, the Corporation
repurchased 578,604 shares under the newly authorized share repurchase
program at an average cost of $29.63. The Corporation has remaining
authority to repurchase $54.9 of the Corporation's common stock.
NOTE XI - RECENTLY ISSUED ACCOUNTING STANDARDS
In February 2007, the Financial Accounting Standards Board (FASB) issued
SFAS No. 159, "The Fair Value Option for Financial Assets and Financial
Liabilities - Including an amendment of FASB Statement No. 115." This
Statement permits an entity to choose to measure certain financial assets
and financial liabilities at fair value, however, does not require an
entity to adopt the Statement. Entities that elect the fair value option
will report unrealized gains and losses in earnings at each subsequent
reporting date. The Statement establishes presentation and disclosure
requirements to assist the financial statement users in understanding the
effect of the entity's election on its earnings. This Statement is
effective as of the beginning of the first fiscal year that begins after
November 15, 2007. The Consolidated Corporation is still evaluating the
effect this Statement, if adopted, could have on the Consolidated
Corporation's overall results of operations and financial position, as well
as whether or not it will adopt this Statement at all.
NOTE XII - SUBSEQUENT EVENT
On May 6, 2007, the Corporation entered into an Agreement and Plan of
Merger (the "Merger Agreement"), among Liberty Mutual Insurance
Company ("Liberty") and Waterfall Merger Corp. a wholly
owned direct subsidiary of Liberty ("Waterfall").
The Merger Agreement provides for a business combination whereby Waterfall
will merge with and into the Corporation (the "Merger"). As a result of
the Merger, the separate corporate existence of Waterfall will cease and
the Corporation will continue as the surviving corporation in the Merger.
At the effective time of the Merger, each common share, par value $.0125
per share, of the Corporation (other than shares owned by the Corporation,
Liberty and Waterfall) will be converted into the right to receive $44.00
in cash, without interest. Each Corporation stock option and other share
purchase rights outstanding at the time of the closing will be cancelled in
the Merger and the holder thereof will be entitled to an amount of cash,
without
12
interest, equal to the difference between $44.00 and the exercise price
of such stock option or purchase right.
The Merger is subject to the approval of a majority of the Corporation's
outstanding shares. In addition, the Merger is subject to clearance under
the Hart-Scott-Rodino Antitrust Improvements Acts and other regulatory laws
applicable to the Merger, including state insurance laws and regulation, as
well as other customary closing conditions. The Merger Agreement contains
certain termination rights for both the Corporation and Liberty and further
provides that upon termination of the Merger Agreement under certain
circumstances, the Corporation may be obligated to pay Liberty a
termination fee of $62.0.
Also, on May 6, 2007 the Corporation entered into a Second Amendment (the
"Second Amendment") to its Amended and Restated Rights Agreement, dated as
of February 19, 1998, between the Corporation and Computershare Trust
Company, N.A. (f/k/a Equiserve Trust Company, N.A.) as successor to First
Chicago Trust Company of New York, as amended on November 8, 2001 (the
"Rights Agreement") for the purpose of amending the Rights Agreement to
render it inapplicable to the Merger Agreement, the Merger and the
transactions contemplated thereby.
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 $63.1, or $1.03 per
share and $51.9, or $0.80 per share for the three months ended March 31,
2007 and 2006, respectively, which included after-tax realized investment
gains of $5.2 ($0.09 per share) and $9.2 ($0.14 per share) for the three
months ended March 31, 2007 and 2006, respectively.
All Lines Discussion
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 GAAP is
included in Item 15, page 87 of the Corporation's 2006 Annual Report on
Form 10-K.
At March 31, 2007 and December 31, 2006, statutory surplus, a financial
measure that is required by insurance regulators and used to monitor
financial strength, was $1,092.8 and $1,082.7, respectively. The ratio of
twelve months ended net premiums written to statutory surplus as of both
March 31, 2007 and December 31, 2006 was 1.3 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
13
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 March 31,
2007 2006 % Chg
---- ---- -----
Gross Premiums Written
- ----------------------
Commercial Lines $215.2 $218.0 (1.3)%
Specialty Lines 45.6 47.5 (4.0)%
Personal Lines 102.6 107.2 (4.3)%
------ ------
All Lines $363.4 $372.7 (2.5)%
====== ======
Three Months Ended March 31,
2007 2006 % Chg
---- ---- -----
Net Premiums Written
- --------------------
Commercial Lines $209.4 $212.4 (1.4)%
Specialty Lines 34.6 35.8 (3.4)%
Personal Lines 101.3 105.9 (4.3)%
------ ------
All Lines $345.3 $354.1 (2.5)%
====== ======
All Lines gross and net premiums written declined for the three month
period ended March 31, 2007 when compared with the same period of the prior
year, due primarily to a decline in new business premium production in the
Commercial Lines segment and the commercial umbrella/other product line, a
decline in premium rates for both Personal and Commercial Lines, lower
Commercial Lines assumed premiums from mandatory workers' compensation and
commercial auto pools as well as lower in-force policy counts in the Personal
Lines segment and commercial umbrella/other product line. This decline was
partially offset by improved retention rates in the Personal Lines segment
and commercial umbrella/other product line, while the retention rate for
Commercial Lines segment was substantially unchanged when compared to the
same period of the prior year.
The table below summarizes supplemental information which is useful to
understand the Company's premium trends:
Three Months Ended March 31,
2007 2006
----------------------------
New Business Gross Premiums Written
- -----------------------------------
Commercial Lines $36.9 $43.5
Commercial umbrella/other 6.1 7.4
Personal Lines 9.5 8.9
Average Renewal Price Increase/(Decrease)1
- ------------------------------------------
Commercial Lines (0.5)% (0.1)%
Commercial umbrella/other 2.1% 1.5%
Policy Retention Ratio2
- -----------------------
Commercial Lines 78.5% 78.6%
Commercial umbrella/other 72.5% 71.1%
Personal Lines 84.9% 84.0%
1 When used in this Quarterly Report on Form 10-Q, renewal price
increase/(decrease) means the average increase in premium for policies
renewed by the Group. The Group revised its methodology for calculating
the average renewal price change for the Commercial Lines segment in 2006.
Previously the Company calculated this amount by comparing the total
expiring premium for the policy with the total renewal premium for the same
policy, including endorsement and audit premium on those policies
subsequent to the renewal date. The revised methodology is calculated by
comparing the total expiring premium for the policy with the total renewal
premium for the same policy at the renewal date. Endorsements and audit
premium subsequent to the renewal date are excluded from the calculation.
The amounts presented in the table above have been restated for all periods
to present the percentage using the revised methodology. Renewal price
increases include, among other things, the effects of rate increases and
changes in the underlying insured exposures of the policy. Only policies
issued by the Group in the previous policy term with the same policy
identification codes are included. Therefore, renewal price increases do
not include changes in premiums for newly issued policies and business
assumed through reinsurance agreements. Renewal price increases also do
not reflect the cost of any reinsurance purchased on the policies issued.
2 When used in this Quarterly Report on Form 10-Q, policy retention ratio
is calculated by dividing policies in force as of March 31 of the current
year that were also in force as of March 31 of the prior year by policies
in force as of March 31 of the prior year.
14
For Commercial Lines, the decrease in gross and net premiums written for
the three month period ended March 31, 2007 is principally the result of
lower new business premium production and a reduction in assumed premiums
from mandatory workers' compensation and commercial auto pools, while the
policy retention ratio remained relatively flat with the first quarter of
the prior year. Partially offsetting this decline in new business is an
increase of 1.5% in in-force policies. Commercial Lines average renewal
prices declined slightly during the first quarter 2007 and 2006, a result
of a broad market trend of increased competitive pricing pressure.
For Specialty Lines, gross and net premiums written declined for the three
month period ended March 31, 2007, primarily the result of declines in the
commercial umbrella/other product line as new business premium production
was lower than the same period of 2006. This decline is primarily in the
unsupported lead umbrella and excess capacity product lines, resulting from
our efforts to improve the overall profitability of the commercial
umbrella/other product line. Average renewal price increases were 2.1%
compared to 1.5% in the first quarter of 2006. The decline in the
commercial umbrella/other product line is partially offset by continued
growth in the fidelity and surety bond product line during the first
quarter, as we continue to leverage our market knowledge and strong
producer base.
For Personal Lines, approximately half the decline in gross and net
premiums written for the three month period ended March 31, 2007 is the
result of the continued effect of premium rate reductions. In addition,
premiums were further impacted by lower in-force policy counts, partially
offset by improved policy retention rates and an increase in new business
premiums. During the second half of 2006 and continuing into the first
quarter of 2007, an effort has been underway to write new personal
auto policies on a 12 month basis rather than a six month basis, which has
resulted in an increase in new business premiums. However, new business
policy counts for first quarter 2007 are down approximately 8% compared to
the same period last year due to increased competition. This transition
effort only impacted new policies and does not include the renewals of
currently existing six month policies.
The following table provides key financial measures for All Lines:
Three Months Ended March 31,
2007 2006
---- ----
All Lines
- ---------
Loss ratio 46.3% 52.8%
Loss adjustment expense ratio 11.0% 10.3%
Underwriting expense ratio 31.9% 31.8%
----- -----
Combined ratio 89.2% 94.9%
===== =====
The improvement in the All Lines combined ratio for the first quarter is
primarily the result of 5.8 point improvement in the loss and LAE ratio, a
result of increased favorable prior year reserve development and a
reduction in large losses (losses over $250,000, excluding catastrophe
losses) partially offset by increased catastrophe losses and loss cost
trends continuing to increase at a rate faster than premium rate increases.
The underwriting expense ratio was impacted by lower earned premium and
increased commission and incentive accruals, partially offset by lower
premium taxes, assessments and legal expenses.
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.
The following table provides a reconciliation of significant changes to the
All Lines loss and LAE ratio for the three month periods ended March 31,
2007 and 2006, respectively.
Three Months Ended March 31,
2007 2006 Pt Chg
---- ---- ------
Ratios as a % of premiums earned
- --------------------------------
Current accident year large losses,
as defined 3.7% 3.9% (0.2)
Catastrophe losses -
calendar year basis 1.5% 1.0% 0.5
Loss and LAE development from
prior accident years (10.8)% (3.6)% (7.2)
All other losses and LAE 62.9% 61.8% 1.1
------- ----- -----
Total loss and LAE ratio 57.3% 63.1% (5.8)
======= ===== =====
15
An effect of a continuing soft Commercial and Personal Lines market is the
upward pressure placed upon the loss and LAE ratio, as reflected in "All
other losses" in the table above, which is the result of loss cost trends
increasing while premium rates are declining slightly (both new and
renewal).
Large loss activity can be volatile from year to year as indicated by the
Group's experience over the last five years. The current accident year
large loss impact on the loss ratio in each of these years, evaluated at
March 31 for each of the respective years, is as follows:
2007 3.7%
2006 3.9%
2005 2.5%
2004 2.3%
2003 2.7%
The following table summarizes reserve development, net of reinsurance, by
operating segment:
Three Months Ended March 31, Year
(Favorable)/Unfavorable 2007 2006 2006
Operating Segment ---- ---- ----
- -----------------------
Commercial Lines $(16.3) $ 0.5 $ (7.4)
Specialty Lines (12.5) (9.8) (31.8)
Personal Lines (8.9) (3.6) (13.0)
------- ------- -------
Total Prior Accident Years'
Development $(37.7) $(12.9) $(52.2)
======= ======= =======
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
favorable development is primarily attributable to actual severity being
lower than expected, much of which is occurring in the casualty product
lines, a result of our more disciplined underwriting and improved claims
handling practices which commenced in the 2000/2001 timeframe. The table
below summarizes the impact of changes in provision for all prior accident
year losses and LAE:
Three Months Ended March 31,
2007 2006
---- ----
Net liabilities, beginning of period $2,912.3 $2,946.8
(Decrease) in provision for prior
accident year claims $(37.7) $(12.9)
(Decrease) in provision for prior accident
year claims as % of premiums earned (10.8)% (3.6)%
Catastrophe losses for the first quarter 2007 were $5.2 compared to $3.6 in
the first quarter 2006. 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 pages 84 and 85 of the
Corporation's 2006 Annual Report on Form 10-K.
The table below summarizes the catastrophe loss ratios by operating
segment.
Three Months Ended March 31,
2007 2006
---- ----
Catastrophe Loss Ratio
- ----------------------
Commercial Lines 1.1% 0.9%
Specialty Lines 0.0% 0.0%
Personal Lines 2.8% 1.5%
Total All Lines 1.5% 1.0%
16
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 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 March 31,
Commercial Lines Segment 2007 2006
- -------------------------------------------------------------------------
Loss ratio 48.2% 57.2%
Loss adjustment expense ratio 13.3% 11.6%
Underwriting expense ratio 32.9% 33.0%
----- ------
Combined Ratio 94.4% 101.8%
===== ======
The Commercial Lines combined ratio improved for the three month period
ended March 31, 2007, a result of a 7.3 point improvement in the loss and
LAE ratio driven primarily by favorable prior year reserve development
which decreased the ratio by 7.9 points in the first quarter 2007 compared
to adverse prior year reserve development of 0.3 points in the same period
of the prior year. Also contributing to the improvement in the loss and
LAE ratio is a decrease in current accident year large loss activity.
These improvements were partially offset by margin compression driven by
increasing loss cost trends and premium rates that are declining slightly,
as indicated in the below table in the All other losses and LAE line. The
underwriting expense ratio was impacted by increased commission and
incentive accruals, offset by a decrease in premium taxes and assessments.
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.
The following table provides a reconciliation of significant changes to the
Commercial Lines loss and LAE ratio for the three month period ended March
31, 2007 and 2006, respectively.
Three Months Ended March 31,
2007 2006 Pt Chg
---- ---- ------
Ratios as a % of premiums earned
- --------------------------------
Current accident year large losses,
as defined 4.3% 5.1% (0.8)
Catastrophe losses -
calendar year basis 1.1% 0.9% 0.2
Loss and LAE development from
prior accident years (7.9)% 0.3% (8.2)
All other losses and LAE 64.0% 62.5% 1.5
----- ----- -----
Total loss and LAE ratio 61.5% 68.8% (7.3)
===== ===== =====
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 March 31
for each of the respective years, has been as follows:
2007 4.3%
2006 5.1%
2005 2.3%
2004 2.3%
2003 3.7%
17
The 2007 favorable reserve development described above was primarily
concentrated in the commercial multiple peril (CMP) and general liability
product lines offset by adverse development in the workers' compensation
product line. In 2006, the adverse development was primarily concentrated
in the workers' compensation and general liability product lines partially
offset by favorable development in the commercial auto and CMP product
lines.
Specialty Lines Segment
Three Months Ended March 31,
Specialty Lines Segment 2007 2006
- -------------------------------------------------------------------------
Loss ratio 18.7% 31.4%
Loss adjustment expense ratio 5.2% 5.1%
Underwriting expense ratio 39.7% 38.7%
----- -----
Combined Ratio 63.6% 75.2%
===== =====
The Specialty Lines combined ratio improved due to 12.6 point improvement
in the loss and LAE ratio partially offset by a 1.0 point increase in the
underwriting expense ratio. The improvement in the loss and LAE ratio was
primarily driven by an 8.0 point increase in favorable prior year reserve
development primarily in the commercial umbrella product line and lower
than expected severity. Underwriting expenses increased due primarily to
lower earned premium, which puts upward pressure on the ratio and increased
incentive and commission accruals.
Personal Lines Segment
Three Months Ended March 31,
Personal Lines Segment 2007 2006
- -------------------------------------------------------------------------
Loss ratio 52.1% 52.0%
Loss adjustment expense ratio 8.6% 9.6%
Underwriting expense ratio 27.2% 27.6%
----- -----
Combined Ratio 87.9% 89.2%
===== =====
The Personal Lines combined ratio decreased for the three month period
ended March 31, 2007, the result of 0.9 point improvement in the loss and
LAE ratio and 0.4 point improvement in the underwriting ratio when compared
to the prior year. The loss and LAE ratio improved due to favorable prior
year reserve development being 5.2 points higher in the first quarter 2007
partially offset by an increase in catastrophe losses of 1.3 points and
margin compression driven by increasing loss cost trends and declining
premium rates, as indicated in the below table in the All other losses and
LAE line. The underwriting expense ratio improved, primarily due to a
reduction in premium taxes, commissions and legal expenses partially offset
by increased incentive accruals.
The following table provides a reconciliation of significant changes to the
Personal Lines loss and LAE ratio for the three month period ended March
31, 2007 and 2006, respectively.
Three Months Ended March 31,
2007 2006 Pt Chg
---- ---- ------
Ratios as a % of premiums earned
- --------------------------------
Current accident year large losses,
as defined 2.8% 2.9% (0.1)
Catastrophe losses -
calendar year basis 2.8% 1.5% 1.3
Loss and LAE development from
prior accident years (8.3)% (3.1)% (5.2)
All other losses and LAE 63.4% 60.3% 3.1
----- ----- -----
Total loss and LAE ratio 60.7% 61.6% (0.9)
===== ===== =====
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 Personal Lines loss ratio, evaluated at March 31
for each of the respective years, has been as follows:
2007 2.8%
2006 2.9%
2005 3.2%
2004 2.8%
2003 2.1%
18
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
March 31, March 31, March 31, Year Year
(By operating segment) 2007 2007 2007(a) 2006 2006(a)
- ---------------------------------------------------------------------------------------
Commercial Lines $205.3 95.5% 103.5% 98.7% 99.3%
Specialty Lines 36.7 66.7% 100.8% 78.2% 99.3%
Personal Lines 107.6 89.8% 98.1% 92.4% 94.7%
- ---------------------------------------------------------------------------------------
Total All Lines $349.6 90.8% 101.6% 94.5% 97.8%
=======================================================================================
(a) The measurement date for accident year data is March 31, 2007.
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 month periods ended March 31, 2007 , consolidated pre-tax
investment income increased modestly to $51.7 vs. $50.9 for the same three
month period in 2006. For the three month period ended March 31, 2007, net
realized gains were $8.0 versus $14.2 for the comparable period in 2006.
The Consolidated Corporation realized $9.0 in gross gains and $(1.0) in
gross losses for the three month period ended March 31, 2007, respectively.
During the three month period ending March 31, 2006, the Consolidated
Corporation realized $20.7 in gross gains and $(6.5) in gross losses,
respectively.
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 45 of the Corporation's 2006 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.
The following table summarizes, for all available-for-sale 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 March 31, 2007.
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 $ 17.7 $(0.2) $ - $ - $ 17.7 $ (0.2)
States, municipalities and
political subdivisions 145.2 (1.0) 65.3 (0.6) 210.5 (1.6)
Corporate securities 109.8 (1.1) 143.7 (2.9) 253.5 (4.0)
Mortgage and asset-backed
securities 100.7 (0.5) 132.8 (0.9) 233.5 (1.4)
- ----------------------------------------------------------------------------------------------
Subtotal 373.4 (2.8) 341.8 (4.4) 715.2 (7.2)
Equity securities 39.1 (2.6) 11.0 (0.4) 50.1 (3.0)
- ----------------------------------------------------------------------------------------------
Total $412.5 $(5.4) $352.8 $(4.8) $765.3 $(10.2)
==============================================================================================
19
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 $ - $ - $116.5 $(3.4) $116.5 $(3.4)
Mortgage-backed
securities - - 69.0 (1.4) 69.0 (1.4)
- ----------------------------------------------------------------------------------------------
Total $ - $ - $185.5 $(4.8) $185.5 $(4.8)
==============================================================================================
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 $15.0 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 March 31, 2007. In
the tables above, there are approximately 312 securities represented. Of
this total, 21 securities have unrealized loss positions greater than 5% of
their book values at March 31, 2007, with two exceeding 15%. This group
represents $4.0, or 26.7% of the total unrealized loss position. Of this
group, 12 securities, representing approximately $2.3 in unrealized losses,
have been in an unrealized loss position for less than twelve months. The
remaining nine securities have been in an unrealized loss position for
longer than twelve months and total $1.7 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 March
31, 2007, 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 $ 29.0 $ 28.9 $(0.1)
Due after one year through five years 71.1 70.5 (0.6)
Due after five years through ten years 206.1 203.5 (2.6)
Due after ten years 181.3 178.8 (2.5)
Mortgage and asset-backed securities 234.9 233.5 (1.4)
- ----------------------------------------------------------------------------
Total $722.4 $715.2 $(7.2)
============================================================================
Held-to-maturity: Amortized Estimated Unrealized
Cost Fair Value Loss
- ----------------------------------------------------------------------------
Due in one year or less $ 2.6 $ 2.6 $ -
Due after one year through five years 35.9 35.1 (0.8)
Due after five years through ten years 78.2 75.8 (2.4)
Due after ten years 3.2 3.0 (0.2)
Mortgage-backed securities 70.4 69.0 (1.4)
- ----------------------------------------------------------------------------
Total $190.3 $185.5 $(4.8)
============================================================================
For additional discussion relative to the Consolidated Corporation's
investment portfolio, see the "Investment Portfolio" section under
"Liquidity and Capital Resources" below and continuing on pages 21 and 22
of this MD&A.
LIQUIDITY AND CAPITAL RESOURCES
Investment Portfolio
The following table sets forth the distribution and other data related to
investments at March 31, 2007 and December 31, 2006, respectively.
20
March 31, 2007 December 31, 2006
-------------- -----------------
Average Amortized Carrying % of Amortized Carrying % of
Rating Cost Value Total Cost Value Total
--------------------------------------------------------------------
U.S. Government:
Available-for-sale AAA $ 25.2 $ 25.1 0.6 $ 25.2 $ 25.1 0.6
States,
municipalities, and
political
subdivisions:
Investment grade:
Available-for-sale AA+ 1,401.9 1,418.8 33.0 1,388.0 1,408.2 33.1
Corporate securities:
Investment grade:
Available-for-sale A 1,377.9 1,423.1 33.1 1,407.1 1,445.8 34.0
Held-to-maturity A+ 145.4 145.4 3.4 147.7 147.7 3.5
Below Investment grade:
Available-for-sale BB 74.7 77.2 1.8 75.6 77.9 1.8
----------------------------------------------------------
Total corporate
securities 1,598.0 1,645.7 38.3 1,630.4 1,671.4 39.3
----------------------------------------------------------
Mortgage and asset-backed
securities:
Investment grade:
Available-for-sale AAA 604.5 606.7 14.1 555.1 555.3 13.0
Held-to-maturity AAA 84.6 84.6 1.9 88.1 88.1 2.1
----------------------------------------------------------
Total mortgage and
asset-backed
securities 689.1 691.3 16.0 643.2 643.4 15.1
----------------------------------------------------------
Total fixed income
securities AA- 3,714.2 3,780.9 87.9 3,686.8 3,748.1 88.1
Equity securities 252.1 468.3 10.9 232.1 458.5 10.8
Cash and cash equivalents 51.6 51.6 1.2 45.6 45.6 1.1
----------------------------------------------------------
Total investment
portfolio, cash and
cash equivalents $4,017.9 $4,300.8 100.0 $3,964.5 $4,252.2 100.0
==========================================================
* Included in the available-for-sale category of the mortgage and asset-
backed securities allocation at March 31, 2007 are mortgage-backed
securities with a cost of $438.2 and carrying value of $440.3. Included in
the available-for-sale category of the mortgage and asset-backed securities
allocation at December 31, 2006 are mortgage-backed securities with a cost
of $397.3 and carrying value of $397.9. The remaining balance within this
category for both 2007 and 2006 are asset-backed securities. All of the
securities at both March 31, 2007 and December 31, 2006 within the held-to-
maturity category of this security allocation are mortgage-backed
securities.
** Included in equity securities as of March 31, 2007 are common stock with
a cost of $150.8 and carrying value of $364.2 and preferred stock with a
cost of $101.3 and carrying value of $104.1. Included in equity securities
as of December 31, 2006 are common stock with a cost of $135.8 and carrying
value of $360.4 and preferred stock with a cost of $96.3 and carrying value
of $98.1.
The fixed income portfolio is allocated between available-for-sale and held-
to-maturity as follows:
March 31, 2007 December 31, 2006
-------------- -----------------
Amortized Carrying % of Amortized Carrying % of
Cost Value Fixed Cost Value Fixed
---------------------------------------------------------------
Total available-for-sale
fixed income securities $3,484.2 $3,550.9 93.9 $3,451.0 $3,512.3 93.7
Total held-to-maturity
fixed income securities 230.0 230.0 6.1 235.8 235.8 6.3
income securities
The fixed income portfolio is allocated between investment grade and below
investment grade securities as follows:
March 31, 2007 December 31, 2006
-------------- -----------------
Amortized Carrying % of Amortized Carrying % of
Cost Value Fixed Cost Value Fixed
---------------------------------------------------------------
Total investment grade $3,639.5 $3,703.7 98.0 $3,611.2 $3,670.2 98.0
Total below investment grade 74.7 77.2 2.0 75.6 77.9 2.0
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.
21
A primary return objective of the fixed income portfolio is to maximize
after tax investment income within approved risk criteria inclusive of
quality, duration, diversification and liquidity requirements within the
overall portfolio. The duration of the fixed income portfolio, which for
this purpose includes short-term securities, was approximately 4.9 years at
March 31, 2007 compared with 4.8 years at December 31, 2006. To mitigate
interest rate risk to the fixed income portfolio, maturities are laddered
across the yield curve. Additionally, the Consolidated Corporation remains
fully invested and does not attempt to time the markets.
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 March
31, 2007, the equity portfolio consisted of stocks in a total of 89
separate entities covering all ten major S&P industry sectors. Of this
total, 17.1% was invested in five companies and the largest single position
was 4.9% of the equity portfolio. At December 31, 2006, the equity
portfolio consisted of stocks in 83 separate entities in ten major S&P
industry sectors. Of this total, 19.0% were invested in five companies and
the largest single position was 4.9% of the equity portfolio.
In addition to fixed income and equity securities which have a readily
available market value, the investment portfolio also includes securities
that do not have a readily available market value such as private
placements, non-exchange traded equities and limited partnerships which are
carried at fair value. Fair values for these types of securities 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 March 31, 2007 was $204.3 compared to $229.3 at
December 31, 2006.
The excess of carrying value over cost of the available-for-sale investment
portfolio was $282.9 at March 31, 2007 compared with $287.7 at December 31,
2006. The decrease in unrealized gains in the first quarter 2007 is
primarily the result of the sale of certain highly appreciated equity
securities, partially offset by an increase in the market values of fixed
income securities, the result of a modest decline in short and intermediate
interest rates.
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 $2.9
billion at both March 31, 2007 and December 31, 2006, respectively. As of
March 31, 2007, the loss reserves by operating segment were as follows:
$1,919.8 Commercial Lines, $626.0 Specialty Lines and $366.4 Personal
Lines. The Group purchases reinsurance to mitigate the impact of large
losses and catastrophic events. Loss reserves ceded to reinsurers amounted
to $587.3 and $585.7 at March 31, 2007 and December 31, 2006, 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,
2006 and records its best estimate each quarter based on that review. In
the opinion of management, the reserves recorded at March 31, 2007
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 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, 2006, for a
22
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 March 31, 2007 and December 31, 2006:
March 31, 2007
- --------------
Gross Total Total
Operating Segment Case IBNR LAE Total Ceded Net
- -----------------------------------------------------------------------------------------
Commercial Lines $ 756.6 $ 791.8 $371.4 $1,919.8 $200.9 $1,718.9
Workers' compensation 422.5 364.8 71.0 858.3 164.3 694.0
Commercial auto 113.4 109.9 43.2 266.5 10.0 256.5
General liability 66.6 119.2 98.1 283.9 6.3 277.6
CMP, fire & inland marine 154.1 197.9 159.1 511.1 20.3 490.8
Specialty Lines 113.9 421.7 90.4 626.0 318.2 307.8
Commercial umbrella/other 104.9 420.9 85.2 611.0 314.2 296.8
Fidelity & surety 9.0 0.8 5.2 15.0 4.0 11.0
Personal Lines 186.5 120.1 59.8 366.4 68.2 298.2
Personal auto & umbrella 158.3 84.8 44.1 287.2 68.1 219.1
Personal property 28.2 35.3 15.7 79.2 0.1 79.1
Total All Lines $1,057.0 $1,333.6 $521.6 $2,912.2 $587.3 $2,324.9
- -----------------------------------------------------------------------------------------
23
December 31, 2006
- -----------------
Gross Total Total
Operating Segment Case IBNR LAE Total Ceded Net
- -----------------------------------------------------------------------------------------
Operating Segment
Commercial Lines $ 743.9 $ 784.6 $369.2 $1,897.7 $185.3 $1,712.4
Workers' compensation 413.7 352.1 70.8 836.6 149.3 687.3
Commercial auto 112.4 105.2 43.8 261.4 7.2 254.2
General liability 64.2 124.6 96.1 284.9 6.0 278.9
CMP, fire & inland marine 153.6 202.7 158.5 514.8 22.8 492.0
Specialty Lines 122.3 429.3 90.3 641.9 334.7 307.2
Commercial umbrella/other 112.3 428.6 84.8 625.7 330.2 295.5
Fidelity & surety 10.0 0.7 5.5 16.2 4.5 11.7
Personal Lines 191.0 119.3 62.4 372.7 65.7 307.0
Personal auto & umbrella 162.5 83.5 45.9 291.9 65.5 226.4
Personal property 28.5 35.8 16.5 80.8 0.2 80.6
Total All Lines $1,057.2 $1,333.2 $521.9 $2,912.3 $585.7 $2,326.6
- -----------------------------------------------------------------------------------------
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. However, substantial variability exists on a net
of reinsurance basis. The estimate of reinsurance recoverables is
considered a critical accounting estimate and is discussed on pages 45 and
46 of the Annual Report on Form 10-K for the year ended December 31, 2006.
Loss reserve uncertainty is illustrated by the variability in reserve
development presented in the Analysis of Development of Loss and LAE
Liabilities schedule which appears on pages 11 and 12 under Item 1 of the
Annual Report on Form 10-K for the year ended December 31, 2006.
To illustrate the uncertainty by operating segment, the table presented in
the All Lines discussion of this MD&A on page 16 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 March 31,
2007 and 2006. 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 three months ended March 31, 2007, the Workers Compensation
product line had adverse development of $8.0 while the CMP product line had
favorable development of $14.9.
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 March 31, Year
2007 2006 2006
------------------ ----
(Favorable)/Unfavorable
- -----------------------
Accident Year 2006 $ (5.2) $ - $ -
Accident Year 2005 (12.1) (2.8) (21.2)
Accident Year 2004 and Prior (20.4) (10.1) (31.0)
------- ------- -------
Total Prior Accident Years'
Development $(37.7) $(12.9) $ 52.2
======= ======= =======
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. Please
refer to the Corporation's Annual Report on Form 10-K for the year ended
December 31, 2006, for a broader discussion of reserve variability and
uncertainty.
24
Cash Flow
Net cash provided by operating activities increased to $54.4 for the first
three months of 2007 compared with $28.5 for the same period in 2006,
driven primarily by improved operating results. Net cash used in investing
activities was $24.3 compared with $27.0 during the first three months of
2006. Cash used in financing activities was $24.1 in the first three
months of 2007 compared with $2.9 in the first three months of 2006.
Repurchases of the Corporation's common stock and an increase in the
shareholder dividend were the primary reasons for the increase in cash used
in financing activities during 2007. See Part II, Item 2, for additional
information regarding the share repurchase program. 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 pages 10 and
11 of this Quarterly Report on Form 10-Q.
On March 5, 2007 the Corporation filed a universal shelf registration
statement on Form S-3 with the Securities and Exchange Commission with
respect to the issuance of securities, including debt securities, common
and preferred shares, warrants and share purchase contracts and units, as
well as trust preferred securities or a combination of the above. This
registration statement replaced the Corporation's previously filed shelf.
While the Corporation has no intention currently to issue securities from
the new filing, the new registration statement provides the Corporation
flexibility in accessing the capital markets in the future.
At March 31, 2007, the Corporation had cash and marketable securities,
totaling $355.7, which compared to $326.6 at December 31, 2006. 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 2007, dividend payments from the Company to
the Corporation are limited to approximately $206.0 without prior approval
from the Ohio Department of Insurance. During the first three months of
2007, the Company paid dividends of $45.0 to the Corporation resulting in a
dividend payment limitation of $161.0 for the remainder of 2007.
Book Value Per Share
At March 31, 2007, the book value per share of the Consolidated Corporation
increased $0.86 per share from $25.79 per share to $26.65 per share when
compared to book value at December 31, 2006. 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 March
31, 2007 and December 31, 2006 there were 59,907,567 and 60,322,692 actual
shares outstanding, respectively. Below is a table reconciling the changes
in book value per share from December 31, 2006 to March 31, 2007.
December 31, 2006 $25.79
Activity year-to-date March 2007:
Net income 1.05
Change in unrealized gains (0.04)
Impact of share repurchase program (0.03)
Dividend to shareholders (0.13)
Other 0.01
------
March 31, 2007 $26.65
======
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
25
March 20, 2007, A.M. Best announced that it upgraded the financial strength
rating to A for the Group and upgraded the Corporation's senior unsecured
debt rating to bbb. At this time, the rating outlook is 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 Stable 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 2006 Annual Report on Form 10-K for the
year ended December 31, 2006.
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; changes in government regulation; performance of financial
markets; fluctuations in interest rates; availability and pricing of
reinsurance; litigation and administrative proceedings; rating agency
actions; acts of war and terrorist activities; ability to appoint and
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 2006 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 1. Legal Proceedings
Reference is made to the fourth paragraph of Part I, Item 3 Legal
Proceedings to the Corporation's Form 10-K for the fiscal year ended
December 31, 2006 regarding the matter captioned Georgia Hensley, et al. v.
Computer Sciences Corporation, et al. The Hensley proceeding (involving
approximately 400 different entities) has been dismissed without prejudice
as to the Corporation. A separate class action complaint entitled Dusty
Easley, et al. v. The Ohio Casualty Insurance Company, American Fire and
Casualty
26
Company, Avomark Insurance Company, Ohio Casualty Corporation, Ohio Security
Insurance Company, and West American Insurance Company was filed in the
Circuit Court of Miller County, Arkansas in March, 2007. The Easley
proceeding alleges substantially the same counts alleged in the Hensley
proceeding and includes the same putative class. Plaintiffs and Defendants
in the Easley proceeding have filed a Stipulation of Settlement and Motion
for Preliminary Approval seeking approval of a settlement of the case. If
the proposed settlement is approved in the Easley matter then plaintiffs in
the Hensley proceeding will also seek to amend the dismissal of the
Corporation with prejudice. The settlement, if approved and after giving
effect to 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.
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 negotiated transactions from
time to time and are funded from available working capital. During the
first quarter of 2007, the Corporation repurchased 578,904 shares under the
new program at an average cost of $29.63. The table below summarizes the
status of share repurchases during the first quarter ended March 31, 2007
under the program.
ISSUER PURCHASES OF EQUITY SECURITIES
- --------------------------------------------------------------------------
(c) Total
Number (d) Maximum
of Shares Number of
Purchased Dollars that
as Part of May Yet Be
(a) Total Publicly Used
Number of (b) Average Announced Under the
Shares Cost Paid Plans or Plans or
Period Purchased per Share Programs Programs
- --------------------------------------------------------------------------
January 1 - 31, 2007 454,774 $29.54 454,774 58,581,347
February 1 - 28, 2007 123,830 29.96 123,830 54,871,877
March 1 - 31, 2007 - - - 54,871,877
------- -------
Total 578,604 $29.63 578,604 54,871,877
ITEM 5. Other Information
On May 7, 2007, the Corporation filed with the SEC a Current Report on Form
8-K announcing it had entered into an Agreement and Plan of Merger (the
"Merger Agreement"), among Liberty Mutual Insurance Company ("Liberty") and
Waterfall Merger Corp., a wholly owned direct subsidiary of Liberty. For
more details about the above referenced transaction, see Note XII -
Subsequent Events in the Notes to the Consolidated Financial Statements
included in this Form 10-Q and the above referenced Current Report on Form
8-K filed with the SEC.
ITEM 6. Exhibits
Exhibits:
10.11a First Amendment to Credit Agreement dated as of March 15, 2007
between Ohio Casualty Corporation and LaSalle Bank National
Association as Agent.
31.1 Certification of Chief Executive Officer of Ohio Casualty
Corporation in accordance with SEC Rule 13(a) and Rule 15(d).
27
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.
Exhibits incorporated by reference:
4f Ohio Casualty Corporation's Registration Statement filed on
Form S-3 (333-141070).
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
OHIO CASUALTY CORPORATION
-------------------------
(Registrant)
May 9, 2007 /s/Michael A. Winner
--------------------------------------
Michael A. Winner, Executive Vice
President and Chief Financial Officer
28