1
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 quarter ended September 30, 1998
[ ] Transition Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission File Number 0-5544
OHIO CASUALTY CORPORATION
(Exact name of registrant as specified in its charter)
OHIO 31-0783294
(State or other jurisdiction (I.R.S. Employer Identification No.)
of incorporation or organization)
136 North Third Street, Hamilton, Ohio 45025
(Address of principal executive offices) (Zip Code)
(513) 867-3000
(Registrant's telephone number)
Securities registered pursuant to Section 12(g) of the Act:
Common Shares, Par Value $.125 Each
(Title of Class)
Common Share Purchase Rights
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
The aggregate market value as of November 2, 1998 of the voting stock held
by non-affiliates of the registrant was $1,140,864,677.
On November 2, 1998 there were 32,174,783 shares outstanding.
Page 1 of 15
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PART I
ITEM 1. FINANCIAL STATEMENTS
OHIO CASUALTY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(In thousands)
(Unaudited)
September 30, December 31,
1998 1997
- ------------------------------------------------------------------------------
Assets
Investments:
Fixed maturities:
Available for sale, at fair value
(Cost: $2,058,029 and $2,112,291) $2,187,935 $2,226,030
Equity securities, at fair value
(Cost: $256,301 and $275,637) 814,741 859,475
Short-term investments at cost 53,162 65,849
----------- -----------
Total investments 3,055,838 3,151,354
Cash 58,115 54,206
Premiums and other receivables 230,515 193,615
Deferred policy acquisition costs 136,883 126,063
Property and equipment 55,266 50,699
Reinsurance recoverable 127,108 108,962
Other assets 91,497 93,883
- ------------------------------------------------------------------------------
Total assets $3,755,222 $3,778,782
==============================================================================
Liabilities
Insurance reserves:
Unearned premiums $ 526,615 $ 495,076
Losses 1,171,258 1,176,614
Loss adjustment expenses 291,003 307,193
Future policy benefits 31,011 34,148
Note payable 35,000 40,000
California Proposition 103 reserve 69,597 66,908
Deferred income taxes 94,640 95,389
Other liabilities 265,097 248,625
----------- -----------
Total liabilities 2,484,221 2,463,953
Shareholders' equity
Common stock, $.125 par value
Authorized: 150,000,000 shares
Issued: 46,803,872 5,850 5,850
Additional paid-in capital 4,186 3,923
Accumulated other comprehensive income:
Unrealized gain on investments, net
of applicable income taxes 448,206 454,241
Retained earnings 1,179,004 1,158,308
Treasury stock, at cost:
(Shares: 14,499,189; 13,182,240) (366,245) (307,493)
----------- -----------
Total shareholders' equity 1,271,001 1,314,829
- ------------------------------------------------------------------------------
Total liabilities and shareholders'
equity $3,755,222 $3,778,782
==============================================================================
Accompanying notes are integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on pages
23-32 of the Corporation's 1997 Annual Report to shareholders.
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OHIO CASUALTY CORPORATION AND SUBSIDIARIES
STATEMENT OF CONSOLIDATED INCOME
(In thousands)
(Unaudited)
Three months
Ended September 30,
1998 1997
- ------------------------------------------------------------------------------
Premiums and finance charges earned $ 314,956 $ 300,252
Investment income less expenses 42,231 45,365
Investment gains realized 3,537 20,806
---------- ----------
Total income 360,724 366,423
Losses and benefits for policyholders 193,233 200,085
Loss adjustment expenses 28,533 30,097
General operating expenses 30,349 25,184
California Proposition 103 reserve 896 1,052
Amortization of deferred policy acquisition costs 79,255 76,399
---------- ----------
Total expenses 332,266 332,817
Income before income taxes 28,458 33,606
Income taxes
Current 4,663 6,602
Deferred 892 1,680
---------- ----------
Total income taxes 5,555 8,282
- ------------------------------------------------------------------------------
Income from continuing operations 22,903 25,324
Income from discontinued operations 278 (85)
- ------------------------------------------------------------------------------
Net income $ 23,181 $ 25,239
==============================================================================
Other comprehensive income, net of tax:
Net change in unrealized gains (losses), net
of income tax expense/(benefit) of $(36,665)
and $17,872, respectively (68,093) 37,789
Comprehensive income $ (44,912) $ 63,028
==============================================================================
Average shares outstanding - basic 32,753 34,025
Average shares outstanding - diluted 32,774 34,067
==============================================================================
Earnings per share (basic and diluted):
Income from continuing operations, per share $ 0.70 $ 0.74
Income from discontinued operations, per share 0.01 0.00
---------- ----------
Net income, per share $ 0.71 $ 0.74
Cash dividends, per share $ 0.44 $ 0.42
==============================================================================
Accompanying notes are integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on pages
23-32 of the Corporation's 1997 Annual Report to Shareholders.
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OHIO CASUALTY CORPORATION AND SUBSIDIARIES
STATEMENT OF CONSOLIDATED INCOME
(In thousands)
(Unaudited)
Nine Months
Ended September 30,
1998 1997
- -----------------------------------------------------------------------------
Premiums and finance charges earned $ 936,246 $ 910,519
Investment income less expenses 128,164 134,236
Investment gains (losses) realized 15,770 42,644
----------- -----------
Total income 1,080,180 1,087,399
Losses and benefits for policyholders 597,901 569,520
Loss adjustment expenses 85,001 90,226
General operating expenses 88,527 78,292
California Proposition 103 reserve 2,689 3,157
Amortization of deferred policy acquisition costs 228,112 228,180
----------- -----------
Total expenses 1,002,230 969,375
Income before income taxes 77,950 118,024
Income taxes
Current 11,926 25,693
Deferred 2,218 2,788
----------- -----------
Total income taxes 14,144 28,481
Income from continuing operations 63,806 89,543
Income from discontinued operations 903 2,516
- -----------------------------------------------------------------------------
Net income $ 64,709 $ 92,059
=============================================================================
Other comprehensive income, net of tax:
Net change in unrealized gains (losses), net
of income tax expense/(benefit) of $(3,250)
and $50,242, respectively (6,035) 93,304
Comprehensive income $ 58,674 $ 185,363
=============================================================================
Average shares outstanding - basic 33,263 34,380
Average shares outstanding - diluted 33,301 34,406
=============================================================================
Earnings per share (basic):
Income from continuing operations, per share $ 1.92 $ 2.61
Income from discontinued operations, per share 0.03 0.07
----------- -----------
Net income, per share $ 1.95 $ 2.68
Earnings per share (diluted):
Income from continuing operations, per share $ 1.91 $ 2.61
Income from discontinued operations, per share 0.03 0.07
----------- -----------
Net income, per share $ 1.94 $ 2.68
Cash dividends, per share $ 1.32 $ 1.26
=============================================================================
Accompanying notes are integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on pages
23-32 of the Corporation's 1997 Annual Report to Shareholders.
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OHIO CASUALTY CORPORATION AND SUBSIDIARIES
STATEMENT OF CONSOLIDATED
SHAREHOLDERS' EQUITY
(In thousands)
(Unaudited)
Additional Accumulated Total
Common paid-in other compre- Retained Treasury shareholders'
stock capital hensive income earnings stock equity
Balance
January 1, 1997 $5,850 $3,603 $332,042 $1,076,545 $(242,940) $1,175,100
Unrealized gain 143,546 143,546
Deferred income tax on
net unrealized gain (50,242) (50,242)
Net issuance of treasury
stock under stock option
plan and by charitable
donation (20,913 shares) 282 (478) 233 37
Repurchase of treasury
stock (1,217,888 shares) (50,179) (50,179)
Net income 92,059 92,059
Cash dividends paid
($1.26 per share) (43,306) (43,306)
- -------------------------------------------------------------------------------------------------------
Balance,
September 30, 1997 $5,850 $3,885 $425,346 $1,124,820 $(292,886) $1,267,015
=======================================================================================================
Balance
January 1, 1998 $5,850 $3,923 $454,241 $1,158,308 $(307,493) $1,314,829
Unrealized gain (9,285) (9,285)
Deferred income tax on
net unrealized gain 3,250 3,250
Net issuance of treasury
stock under stock option
plan and by charitable
donation (10,051 shares) 263 126 389
Repurchase of treasury
stock (1,327,000 shares) (58,878) (58,878)
Net income 64,709 64,709
Cash dividends paid
($1.32 per share) (44,013) (44,013)
- -------------------------------------------------------------------------------------------------------
Balance,
September 30, 1998 $5,850 $4,186 $448,206 $1,179,004 $(366,245) $1,271,001
=======================================================================================================
Accompanying notes are integral part of these financial statements. For complete disclosures see
Notes to Consolidated Financial Statements on pages 23-32 of the Corporation's 1997 Annual Report to
Shareholders.
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OHIO CASUALTY CORPORATION AND SUBSIDIARIES
STATEMENT OF CONSOLIDATED CASH FLOWS
(In thousands)
(Unaudited)
Nine Months
Ended September 30,
1998 1997
- ------------------------------------------------------------------------------
Cash flows from:
Operations
Net income $ 64,709 $ 92,059
Adjustments to reconcile net income to
cash from operations:
Changes in:
Insurance reserves 6,855 (48,480)
Income taxes (7,322) (7,471)
Premiums and other receivables (36,900) (19,366)
Deferred policy acquisition costs (10,820) (3,024)
Reinsurance recoverable (18,145) 25,668
Other assets 2,135 (11,529)
Other liabilities 26,533 4,592
Depreciation and amortization 12,092 16,216
Investment gains and losses (15,905) (43,507)
California Proposition 103 reserve 2,689 3,157
---------- ----------
Net cash generated by operations 25,921 8,315
---------- ----------
Investments
Purchase of investments:
Fixed income securities - available for sale (223,077) (265,441)
Equity securities (19,158) (21,812)
Proceeds from sales:
Fixed income securities - available for sale 189,480 261,926
Equity securities 42,003 86,225
Proceeds from maturities and calls:
Fixed income securities - available for sale 91,392 77,267
Equity securities 4,601 9,660
Property and equipment:
Purchases (12,227) (8,561)
Sales 399 580
---------- ----------
Net cash generated from investments 73,413 139,844
---------- ----------
Financing
Note payable (5,000) (5,000)
Proceeds from exercise of stock options 1 346
Purchase of treasury stock (59,100) (50,179)
Dividends paid to shareholders (44,013) (43,306)
---------- ----------
Net cash used in financing activity (108,112) (98,139)
---------- ----------
Net change in cash and cash equivalents (8,778) 50,020
---------- ----------
Cash and cash equivalents, beginning of period 120,055 61,624
- -----------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 111,277 $ 111,644
=============================================================================
Accompanying notes are integral part of thse financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on pages
23-32 of the Corporation's 1997 Annual Report to Shareholders.
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OHIO CASUALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE I - RECENTLY ISSUED ACCOUNTING STANDARDS
During 1997, the Corporation adopted Statement of Financial Accounting
Standard 128 "Earnings Per Share." Basic earnings per share is computed using
weighted average number of common shares outstanding. Diluted earnings per
share is computed similar to basic earnings per share except that the weighted
average number of shares outstanding is increased to include the number of
additional common shares that would have been issued if all dilutive
outstanding stock options would have been exercised. All prior periods were
recalculated under the new definition of basic and diluted earnings per share.
Basic and diluted earnings per share are summarized as follows:
Three months ended Nine months ended
September 30, 1998 September 30, 1998
1998 1997 1998 1997
---- ---- ---- ----
Income from continuing operations $22,903 $25,324 $63,806 $89,543
Average common shares
outstanding - basic 32,753 34,025 33,263 34,380
Basic income from continuing
operations per average share $ .70 $ .74 $ 1.92 $ 2.61
===========================================================================================
Average common shares 32,753 34,025 33,263 34,380
outstanding
Effect of dilutive securities 21 42 38 26
- --------------------------------------------------------------------------------------------
Average common shares
outstanding - diluted 32,774 34,067 33,301 34,406
Diluted income from continuing
operations per average share $ .70 $ .74 $ 1.92 $ 2.60
============================================================================================
In 1997 the SEC issued Financial Reporting Release 48 "Disclosures about
Derivatives and Other Financial Instruments." This statement requires
enhanced accounting policy disclosures for derivative instruments as well as
quantitative and qualitative disclosures about market risk inherent in
derivative instruments and other financial instruments. The Corporation has
provided the accounting policy disclosures in Note III. The quantitative and
qualitative disclosure information regarding market risk will be included in
the Corporation's 1998 10-K filing.
The Corporation adopted Statement of Financial Accounting Standard 130
"Reporting Comprehensive Income" during the first quarter of 1998.
Comprehensive income is defined as changes in equity of a business enterprise
during a period from transactions and other events from non-owner sources.
The Corporation has displayed comprehensive income on its Statement of
Consolidated Income on pages 3 and 4 of this Form 10-Q.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard 131 "Disclosures about Segments of an Enterprise
and Related Information." This statement requires selected information to be
reported on the Corporation's operating segments. Operating segments are
determined by the way management structures the segments in making operating
decisions and assessing performance. The Corporation is currently reviewing
what changes, if any, this will require on the presentation of the financial
statements for fiscal periods beginning after December 31, 1997.
In December 1997, the American Institute of Certified Public Accountants
issued Statement of Position 97-3 "Accounting by Insurance and Other
Enterprises for Insurance-Related Assessments." This statement provides
guidance on accounting for insurance related assessments and required
disclosure information.
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This statement is effective for fiscal years beginning after December 15,
1998. The Corporation does not believe that this statement will materially
affect the Corporation's financial statements or disclosures.
The Corporation adopted Statement of Position 98-1 "Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use." This statement
provides guidance on accounting for the costs of computer software developed
or obtained for internal use and allows for certain costs associated with
developing/obtaining software for internal use to be capitalized. Pursuant to
this, the Corporation capitalized $1.2 million during the third quarter of
1998 and has capitalized $3.7 million year to date. Prior to this Statement
of Position, this amount would have been expensed as incurred.
In February 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard 132 "Employers' Disclosures about Pensions and
Other Postretirement Benefits." The purpose of this statement is to
standardize the disclosure requirements for pensions and other postretirement
benefits. The only impact to the Corporation will be the modification of its
footnote disclosure. The Corporation will make these modifications beginning
with the Annual Report to Shareholders for the year ended December 31, 1998.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard 133 "Accounting for Derivative Instruments and
Hedging Activities." This statement standardizes the accounting for
derivative instruments by requiring those items to be recognized as assets or
liabilities with changes in fair value reported in earnings or other
comprehensive income in the current period. The Corporation expects the
adoption of FAS 133 to have an immaterial impact on the financial results due
to its limited use of derivative instruments. This statement is effective for
fiscal quarters of fiscal years beginning after June 15, 1999 (January 1, 2000
for the Corporation).
NOTE II - INTERIM ADJUSTMENTS
It is believed that all material adjustments necessary to present a fair
statement of the results of the interim period covered are reflected in this
report. The operating results for the interim periods are not necessarily
indicative of the results to be expected for the full year. These statements
should be read in conjunction with the financial statements and notes thereto
in the Corporation's Annual Report to Shareholders.
NOTE III - ACCOUNTING POLICY ON DERIVATIVES
The Corporation has outstanding an interest rate swap on its revolving line of
credit. The effect of the swap agreement is to establish a hedge against
future interest rate changes. Net proceeds or payments from the swap are
charged to interest expense in the current period.
Covered call options are written on stocks and bonds held in the investment
portfolio. Changes in the values of the covered call options are recognized
in shareholders equity as unrealized appreciation or depreciation.
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ITEM 2. Management's Discussion and Analysis of Financial Condition
- ------- and Results of Operations
-----------------------------------------------------------------
Property and casualty pre-tax underwriting loss for the nine months ended
September 30, 1998 was $61.9 million, $1.86 per share, compared with $55.4
million, $1.61 per share for the same period in 1997. Gross premiums for the
first nine months of 1998 increased 4.9%. Commercial lines decreased 2.8% and
personal lines increased 10.7% for the first nine months of 1998.
Property and casualty net premium written increased 9.8% for the third quarter
of 1998 and 4.8% year to date. Premium from key agents grew 7.4% for the
quarter and increased 7.9% year to date. Key agents work closely with the
Corporation to establish goals to increase profitability, growth, and
retention. Non-key active agents grew 6.7% during the third quarter with year
to date growth of 3.2% over 1997. These together with new appointments brings
total active agent premium growth to 11.2% for the third quarter and 8.1% year
to date.
During the third quarter the Corporation announced that it will acquire
substantially all of the commercial lines division of Great American Insurance
Company, an insurance subsidiary of American Financial Group. Under the
agreement, Great American will transfer certain commercial lines insurance
liabilities and related assets to the Corporation in exchange for the
assumption of net liabilities of $300 million, plus warrants to purchase 3
million shares of Ohio Casualty common stock at an exercise price of $45.00
per share. American Financial Group will also have the opportunity to receive
up to an additional $40 million based upon the retention and growth of the
acquired insurance business. This transaction is anticipated to close
sometime during the fourth quarter of 1998 and integration planning is
currently underway. For additional information please refer to the
Corporation's 8-K filing on September 24, 1998.
New Jersey is our largest state with 16.9% of total premiums written during
the year. Legislation passed in 1992 requires automobile insurers operating
in the state to accept all risks that meet underwriting guidelines regardless
of risk concentration. This leads to a greater risk concentration in the
state than the Corporation would otherwise accept. New Jersey also requires
assessments to be paid for the New Jersey Unsatisfied Claim and Judgment Fund
(UCJF). The assessment for 1998 is approximately $3.2 million compared with
$4.2 million in 1997. Recently, the New Jersey State Senate passed an auto
insurance reform bill that mandates a 15% rate reduction for personal auto
policies for drivers who agree not to sue for "pain and suffering" unless they
suffer permanent injury in an accident. The bill was passed by the Assembly
and signed by the governor. It is currently uncertain what effective date the
state will use to implement the rollback. The anticipated impact on the
Corporation is a tradeoff of lower premium rates on personal auto policies for
presumably lower losses on these policies. As of September 30, 1998 the
Corporation had personal auto net premium written of $84.6 million or 51.9% of
total premium that the Corporation writes in New Jersey. The maximum impact
of this reform bill on the Corporation would have been a decrease of $12.7
million through September 1998 in premium if all policyholders made this
election on their policies.
The combined ratio for the first nine months increased 1 point to 107.1% from
106.1% from the same period last year. The nine month combined ratio for
homeowners increased 7.2 points to 124.3% from 117.1% in the same period last
year. The results for homeowners was largely impacted by Hurricane Bonnie and
the severe storm losses that occurred throughout the country during the second
and third quarters of 1998. Personal automobile, the Corporation's largest
line, recorded a 1998 nine month combined ratio of 102.0%, down 2.0 points
from 104.0% in 1997. Workers' compensation combined ratio for the first nine
months of 1998 increased 21.1 points to 113.8% from 92.7% during the same
period last year. This deterioration is the result of reserve increases
resulting from unexpected adverse development of pre-existing claims.
The general liability combined ratio for the third quarter decreased 17.8
points to 93.7% from 111.5% in 1997. The nine month combined ratio decreased
7 points to 97.1% from 104.1% in the same period of 1997. The nine month
combined ratio for CMP, fire and inland marine increased 3 points to 111.8%
from 108.8% in 1997 due primarily to weather related losses.
Third quarter catastrophe losses were $12.7 million and accounted for 4.0
points on the combined ratio. This compares with $9.0 million and 3.0 points
for the same period in 1997. Year to date catastrophe
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losses increased $20.7 million from $18.8 million in 1997 to $39.5 million in
1998. This increase is a direct result of Hurricane Bonnie and severe storm
losses during the second and third quarters of 1998.
Estimated asbestos and environmental reserves are composed of case reserves,
incurred but not reported reserves and reserves for loss adjustment expense.
The total asbestos and environmental reserves as of September 30, 1998 were
$40.1 million compared with $41.0 million at September 30, 1997.
For the quarter, property and casualty before tax investment income was $39.3
million, $1.20 per share, decreasing from $44.1 million, $1.30 per share, for
the same period last year. This decline comes as the result of increased
share repurchases during the third quarter. Also, third quarter 1997 net
investment income was increased by $1.4 million as a result of an agreement
where Ohio Casualty had agreed to manage an investment portfolio for Americo
and guarantee a 7.25% return. Any return above this amount was recorded as
income to Ohio Casualty. During the fourth quarter of 1997, this portfolio
was transferred out of the property and casualty business and into the holding
company, and therefore is no longer included in property and casualty
investment income. The effective tax rate on investment income for the third
quarter of 1998 was 25.9% compared with 25.6% for the comparable period in
1997. Additional discussion of the Corporation's investment taxation is
included in the 1997 Form 10-K.
Net cash generated by operations was $25.9 million for the first nine months
of the year compared with net cash generated of $8.3 million from operations
for the same period in 1997. Net cash generated by operations differs from
net income of $64.7 million mainly due to $15.9 million of realized investment
gains for the year, an increase in premium receivables of $36.9 million over
December 31, 1997, and an increase in reinsurance recoverables of $18.1
million. Shareholder dividend payments were $44.0 million in the first nine
months of 1998 compared with $43.3 million for the same period of 1997.
During the first nine months of 1998, Ohio Casualty continued its share
repurchase program. The total number of shares acquired during the period was
1,327,000, or 4.1% of outstanding shares, at an average price of $44.37 per
share for a total cash outflow of $58.9 million. The Company has remaining
authorization to repurchase 2,099,812 additional shares.
In 1995 the Corporation reinsured substantially all of its life insurance and
related businesses to Great Southern Life Insurance Company. During the
fourth quarter of 1997, Great Southern Life Insurance Company legally replaced
Ohio Life as the primary insurer for approximately 76% of the life insurance
policies subject to the 1995 agreement. As a result, 76% of the unamortized
ceding commission was recognized during the fourth quarter of 1997. There
remains approximately $2.0 million in unamortized ceding commission. This
will continue to be amortized over the remaining life of the underlying
policies.
Investments in below investment grade securities (Standard and Poor's rating
below BBB-) and unrated securities are summarized as follows:
September 30, December 31,
1998 1997
- ----------------------------------------------------------------------------
Below investment grade securities:
Carrying value $176.7 $141.4
Amortized cost 175.9 135.6
Unrated securities:
Carrying value $263.3 $242.8
Amortized cost 243.6 228.6
Ratings provided by other agencies, such as the NAIC, categorize additional
unrated securities into below investment grade ratings. The following
summarizes the additional unrated securities that are rated in the below
investment grade category by other rating agencies:
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September 30, December 31,
1998 1997
- -----------------------------------------------------------------------------
Below investment grade securities at $176.7 $141.4
carrying value
Other rating agencies categorizing unrated 8.5 8.1
securities as below investment grade
Total below investment grade securities at
carrying value $185.2 $149.5
All of the Corporation's below investment grade securities are performing in
accordance with contractual terms and are making principal and interest
payments as required. The securities in the Corporation's below investment
grade portfolio have been issued by 56 corporate borrowers in approximately 35
industries.
For further discussion of the Corporation's investments, see Item 1 of the
Corporation's Form 10-K for the year ended December 31, 1997.
In 1994, the National Association of Insurance Commissioners developed a risk-
based capital model to establish standards which will compare insurance
company statutory surplus to required minimum capital based on risks of
operations and assist regulators in determining solvency requirements. The
model is based on four risk factors in two categories: asset risk consisting
of investment risk and credit risk; and underwriting risk composed of loss
reserve and premiums written risks. Based on current calculations, all of the
Ohio Casualty Group companies have at least twice the necessary capital to
conform with the risk-based capital model.
Proposition 103 was passed by the State of California in 1988 in an attempt to
legislate premium rates for that state. That statute included a provision
requiring the rollback of premium rates for 1989. The Corporation is
currently involved in hearings with the California Department of Insurance to
determine the Corporation's rate rollback liability under Proposition 103.
In 1997, the Administrative Law Judge presiding over the hearings requested a
submission from the Department showing revised rollback calculations. The
Department filed two revised rollback calculations in December 1997. These
alternatives, based on its concession of certain issues were $35.9 million
plus interest, and $39.9 million plus interest. After consultation with
outside counsel, the Corporation determined that $35.9 million plus interest
was the more reasonable of the two Department calculations should the
Department prevail. As a result the Corporation's reserve for this alleged
liability (including interest) is $69.6 million.
In June 1998, the Administrative Law Judge issued a proposed decision that the
Corporation's rollback liability is $24.4 million plus interest. The
Commissioner of Insurance may affirm, modify or reject the proposed decision
in whole or in part, and his determination will be subject to independent
judgment review by a California superior court. The Corporation will continue
to challenge the validity of any rollback, and asserts that the proposed $24.4
million rollback, if adopted, would be confiscatory.
The proceedings concerning the Corporation's potential rollback liability
remain ongoing, and it is uncertain when this matter will ultimately be
resolved. The Corporation anticipates further negotiations with the
California Department of Insurance. For further discussion of the
Corporation's withdrawal from California, see footnote 15 in the Corporation's
financial statements included in the Corporation's 1997 Form 10-K.
The Corporation is proceeding on schedule with efforts to convert its computer
systems to be Year 2000 compliant. The Corporation has implemented a phased
approach to transition our computer systems to be year 2000 compliant. The
four phases included in this approach are awareness, planning, execution/
testing
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and compliance. Two of the phases, awareness and planning, are complete.
The execution/testing phase is anticipated to be complete by the end of 1998.
The Corporation began the awareness phase early in the 1990's, recognizing
that its systems and applications would need significant changes. From that
time forward all system development and major enhancements to existing
systems took Year 2000 processing requirements into consideration. This
approach resulted in some of our systems being converted and compliant long
before there was any business requirement or exposure to processing problems.
During 1995, the Information System Department ("I/S") began the planning
phase. At that time Year 2000 compliance became a priority project with
Project Managers assigned specifically for converting our systems to be
compliant. A comprehensive inventory of our systems was completed,
identifying the critical date that each system must be compliant and an action
plan was put together to outline that the conversion was complete and tested
by our target date of December 31, 1998. The Corporation is currently on
schedule with this action plan.
As a result of the planning phase, dedicated staff and resources were assigned
to work on the Year 2000 project. This began our execution/testing phase of
the project which includes addressing the remediation of Year 2000 problems
identified in the planning phase and logical partition (LPAR) compliance
testing. LPAR compliance testing requires an isolated partition within the
mainframe that runs independently. Essentially it can be considered an
entirely separate computer. The Corporation's LPAR has a dedicated processor,
disk and tape storage. In this environment, data can be migrated forward and
tested as the internal date in the computer is changed to critical dates in
1999 and 2000. This provides an excellent environment to test applications,
system software and hardware. This testing involves individual system
compliance testing and integrated system compliance testing. The first step
verifies that the systems are compliant when they run independently. The
second step verifies compliance when they are integrated with all other
systems with which they interface. Testing is scheduled throughout 1998
focusing initially on systems critical to the daily business operation and
followed by all others. The Corporation has six major system areas:
commercial lines, claims, auto, personal property, management/financial
reporting and human resources. All of these areas are required to undergo
LPAR compliance testing. At this time, the commercial lines, claims, and
personal property system have completed the LPAR compliance testing. The
remaining systems including the Corporation's auto system, human resource
system and management/financial reporting system are scheduled to complete
compliance testing by year end 1998.
Following the completion of LPAR compliance testing, all systems will undergo
integrated testing of the production environment. Contingency plans include
compliance reverification of this integrated test early third quarter 1999 and
again early fourth quarter 1999.
As of September 30, 1998, the total amount spent to date for I/S related costs
on the Year 2000 project is $1.9 million. The Corporation estimates it will
incur an additional $.4 million in I/S related costs to complete Year 2000
readiness efforts. These amounts do not include any costs associated with
efforts made to contact third parties or related to contingency planning. As
a result of the Corporation's efforts early in the 1990's to begin making
changes to systems and existing hardware and software, the Corporation to date
has not had to make an expensive effort to identify and remedy its Year 2000
issues and does not anticipate that it will be required to make substantial
expenditures to address Year 2000 compliance in the future.
During 1997, the Corporation began the compliance phase. The Year 2000 team
is currently in the process of identifying all significant vendors,
suppliers and agents of the Corporation and is completing the initial contact
to obtain written statements of their readiness and commitment to a date for
their Year 2000 compliance. The Corporation will continue to monitor the Year
2000 status of these entities and develop contingency plans to reduce the
possible disruption in business operations that may result from the failure of
third parties with which the Corporation has business relationships to address
their Year 2000 issues. Identification and initial contact for all
significant third-parties is expected to be complete by first quarter 1999
with follow-up reviews scheduled throughout 1999. Should a third-party with
whom the Corporation transacts business have a system failure due to not being
Year 2000 compliant, the Corporation believes this could result in a delay in
processing or reporting transactions of the Corporation, or a potential
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disruption in service to its customers, notwithstanding the Corporation's
intention to develop contingency plans to respond to these potential system
failures by such third parties.
The Corporation is also addressing non information technology ("non-IT") to
ensure Year 2000 compliance. At September 30, 1998, the Year 2000 team had
completed a preliminary assessment of the non-IT assets. The team will
identify the material items that have a risk involving the safety of
individuals, or that may cause damage to property or the environment, or
affect revenues. The team is scheduled to report on the identified non-IT
assets and develop plans for remediation to the Corporation's Executive
Management Team by year end 1998. The team will continue to monitor and
update the Year 2000 status as well as begin developing contingency plans.
The Corporation is currently assessing the status of Year 2000 readiness of
the business and assets that it will acquire from the American Financial Group
as described above. The Corporation intends to complete this review before
closing of the transaction. For a period of at least 24 months from the date
of the acquisition, the American Financial Group will provide computer
processing and communication services to the Corporation in connection with
the acquired business pursuant to an Information Systems Agreement. Thus, the
Corporation will be dependent on American Financial Group to address and
remediate Year 2000 issues with respect to the information technology systems
utilized for the business being acquired by the Corporation. The Corporation
is meeting regularly with personnel from the Amercian Financial Group to
assess Year 2000 readiness and the status of efforts to address any issues.
The failure of the American Financial Group to satisfactorily correct a
material Year 2000 problem in the computer processing systems being used to
provide services to the Corporation in connection with the acquired business
could result in a material adverse effect on the ability of the Corporation to
integrate the acquired business and to operate it on a profitable basis.
The failure to correct a material Year 2000 problem could result in an
interruption in, or a failure of, the normal business operations of the
Corporation including the disruption or delay in premium or claim processing
and the disruption in service to its customers. Also the inability to be Year
2000 compliant of significant third-party providers of the Corporation could
result in an interruption in the normal business operations. Due to the
general uncertainty inherent in the Year 2000 problem, such failures could
materially and adversely affect the Corporation's financial position, results
of operations or liquidity.
The year 2000 issue is also a concern from an underwriting standpoint
regarding the extent of liability for coverage under various general
liability, property and directors and officers liability and product policies.
The Corporation believes that minimal coverage could exist under some current
liability and product policies. This exposure should be minimal as our
commercial lines business has historically excluded any manufacturing risks
which produce computer or computer dependent products.
The Insurance Services Office (ISO) recently developed policy language that
clarifies that there is no coverage for certain year 2000 occurrences. The
liability exclusion has been accepted in over 40 states and a companion filing
for property has been accepted in at least 20 states at this time. Several
states have not adopted or approved the property exclusion form citing
specifically that there is no coverage under the current property contracts
and therefore, there is no reason to accept a clarifying endorsement. The
Corporation is currently addressing the year 2000 issue by attaching the ISO
exclusionary language to all general liability policies with a rating
classification the Corporation believes could potentially have year 2000
losses. The ISO exclusionary language endorsement is included on all property
policies. These actions should minimize the Corporation's exposure to year
2000 losses.
Directors and officers could be held liable if a company in their control
fails to take necessary actions to address any year 2000 problems and that
failure results in a material financial loss to the Company. The Corporation
has written directors' and officers' liability policies since 1995, with
approximately $.9 million in premiums written in 1997. The Corporation is
managing its D&O Year 2000 exposure through a combination of underwriting
guidelines which address Year 2000 issues in the application process and
reinsurance policies which provide coverage for any loss in excess of $.3
million.
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During the first quarter of 1998, the Corporation was in violation of one of
its loan covenants for its revolving line of credit. The covenant states that
no more than 30% of the Corporation's investment portfolio at market value may
be invested in equity securities. At March 31, 1998 the actual percentage of
equity securities to consolidated investments was 30.2% at market value. This
violation occurred solely because of appreciation in the Corporation's equity
portfolio. The Corporation has not allocated any new funds to the equity
portfolio in the last three years. The syndicate of banks under the credit
agreement have all signed waivers of default for this occurrence.
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 filing that are not historical information, are forward-looking
statements. The Private Securities Litigation Reform Act of 1995 provides a
safe harbor under The Securities Act of 1933 and The Securities Exchange Act
of 1934 for forward-looking statements. The risks and the uncertainties that
may affect the operations, performance, development and results of the
Corporation's business and the results of the acquisition described herein,
include the following: changes in property and casualty reserves; catastrophe
losses; premium and investment growth; product pricing environment;
availability of credit; changes in government regulation; performance of
financial markets; fluctuations in interest rates; availability and pricing of
reinsurance; litigation and administrative proceedings; Year 2000 issues,
including the Corporation's ability to successfully identify and remediate
Year 2000 system issues with its own IT and non-IT assets, the ability of
third parties with which the Corporation has business relationships to address
and resolve their Year 2000 issues and the ability of the Corporation to
identify these third party issues; Year 2000 issues relating to the commercial
lines business being acquired from the American Financial Group and the
ability of the Corporation to implement appropriate contingency plans to
address Year 2000 problems which are not successfully remediated; ability of
Ohio Casualty to integrate the acquired business and to retain the acquired
insurance business; and general economic and market conditions.
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PART II
Item 1. Legal Proceedings - None
Item 2. Changes in Securities - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information -
As discussed in the Corporation's Proxy Statement for the 1998 Annual
Meeting of Shareholders, if an eligible shareholder of the Corporation
wishes to present a proposal for action at the 1999 Annual Meeting of
Shareholders (the "1999 Meeting") it must be received by the
Corporation no later than November 13, 1998 to be considered for
inclusion in the Corporation's Proxy Statement and form of proxy
(the "Proxy Materials") relating to that meeting. If a shareholder
intends to present a proposal at the 1999 Annual Meeting of
Shareholders, but has not sought the inclusion of such proposal in the
Company's Proxy Materials, such proposal must be received by the
Corporation no later than January 27, 1999 or the Company's management
proxies for the 1999 Annual Meeting will be entitled to use their
discretionary voting authority should such proposal then be raised,
without any discussion of the matter in the Company's Proxy Material.
Item 6. Exhibits and reports on Form 8-K -
The Corporation filed a Form 8-K on September 24, 1998, announcing the
acquisition of the Great American Commercial Lines Division.
Attached hereto as Exhibit No. 2, is the Asset Purchase Agreement
between Ohio Casualty Corporation and Great American Insurance Company.
Attached hereto as Exhibit No. 27 is the Financial Data Schedule.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
OHIO CASUALTY CORPORATION
-------------------------------
(Registrant)
November 13, 1998 /s/ Barry S. Porter
-------------------------------
Barry S. Porter, CFO/Treasurer
(on behalf of Registrant and as
Principal Accounting Officer)
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