1
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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 March 31, 1999.
--------------
[ ] 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 May 3, 1999 of the voting stock held by
non-affiliates of the registrant was $975,799,672.
On May 3, 1999 there were 30,760,792 shares outstanding.
Page 1 of 16
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PART I
ITEM 1. FINANCIAL STATEMENTS
OHIO CASUALTY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(In thousands)
(Unaudited)
March 31, December 31,
1999 1998
- -----------------------------------------------------------------------------
Assets
Investments:
Fixed maturities:
Available for sale, at fair value
(cost: $2,384,266 and $2,307,734) $2,460,593 $2,415,904
Equity securities, at fair value
(cost: $237,867 and $245,129) 907,347 924,906
Short-term investments, at fair value
(cost: $67,812 and $262,939) 67,814 262,863
----------- -----------
Total investments 3,435,754 3,603,673
Cash 43,578 42,139
Premiums and other receivables, net of
allowance for bad debts of $9,039 and
$8,739, respectively 347,922 301,943
Deferred policy acquisition costs 174,559 176,606
Property and equipment, net of accumulated
depreciation of $101,673 and $97,991,
respectively 87,861 80,065
Reinsurance recoverable 170,271 186,861
Goodwill, net of accumulated amortization of
$3,094 and $1,031, respectively 305,267 308,206
Other assets 123,380 102,771
- ----------------------------------------------------------------------------
Total assets $4,688,592 $4,802,264
============================================================================
Liabilities
Insurance reserves:
Unearned premiums $ 693,367 $ 668,550
Losses 1,547,714 1,580,599
Loss adjustment expenses 368,031 376,340
Future policy benefits 20,883 25,518
Note payable 255,000 265,000
California Proposition 103 reserve 48,653 48,043
Deferred income taxes 125,509 140,730
Other liabilities 359,461 376,503
----------- -----------
Total liabilities 3,418,618 3,481,283
Shareholders' equity
Common stock, $.125 par value 5,850 5,850
Authorized: 150,000,000 shares
Issued: 47,209,172
Additional paid-in capital 4,312 4,186
Common stock purchase warrants 21,138 21,138
Accumulated other comprehensive income:
Unrealized gain on investments, net of
applicable income taxes 484,247 511,816
Retained earnings 1,182,255 1,185,349
Treasury stock, at cost:
(Shares: 16,448,380; 15,535,089) (427,828) (407,358)
---------- ----------
Total shareholders' equity 1,269,974 1,320,981
- ----------------------------------------------------------------------------
Total liabilities and shareholders'
equity $4,688,592 $4,802,264
============================================================================
Accompanying notes are an integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on pages
48-61 of the Corporation's 1998 Form 10-K, Item 14.
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OHIO CASUALTY CORPORATION AND SUBSIDIARIES
STATEMENT OF CONSOLIDATED INCOME
(In thousands)
(Unaudited)
Three Months
Ended March 31,
1999 1998
- ----------------------------------------------------------------------------
Premiums and finance charges earned $ 384,545 $ 309,627
Investment income less expenses 41,809 44,633
Investment gains realized, net 903 4,082
---------- ----------
Total revenues 427,257 358,342
Losses and benefits for policyholders 231,753 188,117
Loss adjustment expenses 34,061 26,380
General operating expenses 42,987 28,352
Amortization of goodwill 3,094 0
California Proposition 103 reserve,
including interest 611 897
Amortization of deferred policy acquisition costs 99,969 73,731
---------- ----------
Total expenses 412,475 317,477
Income from continuing operations
before income taxes 14,782 40,865
Income taxes
Current 2,237 7,457
Deferred 828 2,494
---------- ----------
Total income taxes 3,065 9,951
- ----------------------------------------------------------------------------
Income before discontinued operations 11,717 30,914
Income from discontinued operations net of taxes of
$(502) and $179, respectively 1,795 280
Cumulative effect of accounting change, net of taxes (2,255) 0
- ----------------------------------------------------------------------------
Net income $ 11,257 $ 31,194
============================================================================
Other comprehensive income, net of tax:
Net change in unrealized gains (losses), net
of income tax expense/benefit of $(14,844)
and $38,470, respectively (27,569) 71,445
---------- ----------
Comprehensive income $ (16,312) $ 102,639
============================================================================
Average shares outstanding - basic 31,145 33,621
Average shares outstanding - diluted 31,163 33,663
============================================================================
Earnings per share (basic and diluted):
Income from continuing operations, per share $ 0.38 $ 0.92
Income from discontinued operations, per share 0.05 0.01
Effect of change in accounting principle
(net of tax) (0.07) 0.00
---------- ----------
Net income, per share $ 0.36 $ 0.93
Cash dividends, per share $ 0.46 $ 0.44
============================================================================
Accompanying notes are an integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on pages
48-61 of the Corporation's 1998 Form 10-K, Item 14.
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OHIO CASUALTY CORPORATION AND SUBSIDIARIES
STATEMENT OF CONSOLIDATED
SHAREHOLDERS' EQUITY
(In thousands)
(Unaudited)
Common Accumulated
Additional stock other Total
Common paid-in purchase comprehensive Retained Treasury shareholders'
Stock capital warrants income earnings stock equity
Balance
January 1, 1998 $ 5,850 $ 3,923 $ 0 $ 454,241 $ 1,158,308 $ (307,493) $ 1,314,829
Unrealized gain (loss) 109,915 109,915
Deferred income tax benefit on
net unrealized gain (loss) (38,470) (38,470)
Net issuance of treasury
stock under stock option
plan and by charitable
donation (8,276 shares) 195 193 388
Repurchase of treasury
stock (30,000 shares) (1,464) (1,464)
Net income 31,194 31,194
Cash dividends paid
($.44 per share) (14,797) (14,797)
- -----------------------------------------------------------------------------------------------------------------------------
Balance,
March 31, 1998 $ 5,850 $ 4,118 $ 0 $ 525,686 $ 1,174,705 $ (308,764) $ 1,401,595
=============================================================================================================================
Balance
January 1, 1999 $ 5,850 $ 4,186 $ 21,138 $ 511,816 $ 1,185,349 $ (407,358) $ 1,320,981
Unrealized gain (loss) (42,413) (42,413)
Deferred income tax benefit on
net realized gain (loss) 14,844 14,844
Net issuance of treasury
stock under stock option
plan and by charitable
donation (9,009 shares) 126 212 338
Repurchase of treasury
stock (517,100 shares) (20,682) (20,682)
Net income 11,257 11,257
Cash dividends paid
($.46 per share) (14,351) (14,351)
- -----------------------------------------------------------------------------------------------------------------------------
Balance,
March 31, 1999 $ 5,850 $ 4,312 $ 21,138 $ 484,247 $ 1,182,255 $ (427,828) $ 1,269,974
=============================================================================================================================
Accompanying notes are an integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on pages
48-61 of the Corporation's 1998 Form 10-K, Item 14.
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OHIO CASUALTY CORPORATION AND SUBSIDIARIES
STATEMENT OF CONSOLIDATED CASH FLOWS
(In thousands)
(Unaudited)
Three Months
Ended March 31,
1999 1998
- ----------------------------------------------------------------------------
Cash flows from:
Operations
Net income $ 11,257 $ 31,194
Adjustments to reconcile net income to
cash from operations:
Changes in:
Insurance reserves (21,013) 401
Income taxes 1,349 3,133
Premiums and other receivables (45,979) (11,822)
Deferred policy acquisition costs 2,046 (3,648)
Reinsurance recoverable 16,589 (9,160)
Other assets (12,399) 13,674
Other liabilities (25,689) (3,899)
Amortization of goodwill 2,939 0
Depreciation and amortization 8,318 3,463
Investment gains and losses (2,103) (4,042)
Cumulative effect of an accounting change 2,255 0
California Proposition 103 611 896
--------- ---------
Net cash generated (used) by operations (61,819) 20,190
Investments
Purchase of investments:
Fixed income securities - available for sale (255,146) (45,155)
Equity securities (6,395) (2,986)
Proceeds from sales:
Fixed income securities - available for sale 140,013 10,426
Equity securities 15,146 6,678
Proceeds from maturities and calls:
Fixed income securities - available for sale 27,998 39,640
Equity securities 3,000 0
Property and equipment
Purchases (11,612) (4,081)
Sales 135 164
--------- ---------
Net cash from investments (86,861) 4,686
Financing
Note payable (10,000) 0
Proceeds from exercise of stock options 103 1
Purchase of treasury stock (20,682) (1,686)
Dividends paid to shareholders (14,351) (14,797)
---------- ----------
Net cash used in financing activity (44,930) (16,482)
Net change in cash and cash equivalents (193,610) 8,394
Cash and cash equivalents, beginning of period 305,002 120,055
- -----------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 111,392 $ 128,449
=============================================================================
Accompanying notes are an integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on pages
48-61 of the Corporation's 1998 Form 10-K, Item 14.
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OHIO CASUALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE I - RECENTLY ISSUED ACCOUNTING STANDARDS
During the quarter, the Corporation adopted 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. In accordance with
SOP 97-3, the Corporation accrued a liability for insurance assessments of
$2.3 million net of tax. This was recorded as a change in accounting method.
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 - 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. Basic and diluted earnings per share are summarized as
follows:
Three months ended
March 31
1999 1998
---- ----
Income from continuing operations $11,717 $30,914
Weighted average common shares
outstanding - basic 31,145 33,621
Basic income from continuing
operations per weighted average share $ .38 $ .92
==============================================================================
Weighted average common shares outstanding 31,145 33,621
Effect of dilutive securities 18 42
- ------------------------------------------------------------------------------
Weighted average common shares
outstanding - diluted 31,163 33,663
Diluted income from continuing
operations per weighted average share $ .38 $ .92
==============================================================================
NOTE III - 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 1998 Form 10-K, Item 14.
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NOTE IV -- SEGMENT INFORMATION
In 1998, the Corporation adopted Statement of Financial Accounting Standard
131, "Disclosures about Segments of an Enterprise and Related Information."
This statement supersedes Statement of Financial Accounting Standard 14,
"Financial Reporting for Segments of a Business Enterprise" and replaces the
industry segment approach with a management segment approach in identifying
reportable segments. The management segment approach focuses on financial
information that the Corporation's decision makers use to make decisions about
the operating segments. The accounting policies of the property and casualty
segments are based upon statutory accounting practices. Statutory accounting
principles differ from generally accepted accounting principles primarily by
deferred policy acquisition costs, required statutory reserves, assets not
admitted for statutory reporting, California Proposition 103 reserve and
deferred federal income taxes.
The Corporation has determined its reportable segments based upon its
method of internal reporting which is organized by product line. The property
and casualty segments are personal automobile, commercial automobile,
homeowners, workers' compensation, fidelity and surety, general liability and
commercial property. These segments generate revenues by selling a wide
variety of personal, commercial and surety insurance products. The
Corporation also has an all other segment which derives its revenues from
premium financing, investment income, royalty income and discontinued life
insurance operations. The Corporation writes business in over 40 states in
conjunction with the independent agency system.
Each segment of the 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 including
loss and loss adjustment expense ratios, combined ratio, premiums written,
underwriting gain/loss and the effect of catastrophe losses on the segment.
The following tables present this information by segment as of March 31, 1999
and 1998 as it is reported internally to management. Asset information by
reportable segment is not reported, since the Corporation does not produce
such information internally.
Private Passenger Auto 1999 1998
- --------------------------------------------------------------
Net premiums written $153,148 $125,492
% Increase(decrease) 22.0% 9.3%
Net premiums earned 131,988 121,670
% Increase(decrease) 8.5% 9.8%
Underwriting gain/(loss)
(before tax) (6,012) (2,675)
Loss ratio 64.2% 66.6%
Loss expense ratio 10.8% 10.8%
Underwriting expense ratio 25.5% 24.0%
Combined ratio 100.5% 101.4%
Impact of catastrophe
losses on combined ratio 0.3% 0.2%
CMP, Fire, Inland Marine 1999 1998
- ---------------------------------------------------------------
Net premiums written $74,925 $52,627
% Increase(decrease) 42.4% -0.4%
Net premiums earned 73,793 51,647
% Increase(decrease) 42.9% 4.4%
Underwriting gain/(loss)
(before tax) (14,195) (2,198)
Loss ratio 69.8% 57.0%
Loss expense ratio 8.0% 3.6%
Underwriting expense ratio 40.8% 42.8%
Combined ratio 118.6% 103.4%
Impact of catastrophe losses
on combined ratio 2.1% 1.6%
General Liability 1999 1998
- ---------------------------------------------------------------
Net premiums written $32,162 $24,083
% Increase(decrease) 33.5% -9.0%
Net premiums earned 30,883 23,943
% Increase(decrease) 29.0% -4.8%
Underwriting gain/(loss)
(before tax) 6,105 2,085
Loss ratio 30.5% 33.6%
Loss expense ratio 0.1% 9.8%
Underwriting expense ratio 47.7% 47.6%
Combined ratio 78.3% 91.0%
Impact of catastrophe losses
on combined ratio N/A N/A
Workers' Compensation 1999 1998
- ---------------------------------------------------------------
Net premiums written $47,126 $25,190
% Increase(decrease) 87.1% -13.5%
Net premiums earned 50,428 24,665
% Increase(decrease) 104.5% -11.7%
Underwriting gain/(loss)
(before tax) 5,443 (7,840)
Loss ratio 48.4% 90.5%
Loss expense ratio 8.5% 8.7%
Underwriting expense ratio 34.6% 31.9%
Combined ratio 91.5% 131.1%
Impact of catastrophe losses
on combined ratio N/A N/A
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Commercial Auto 1999 1998
- --------------------------------------------------------------
Net premiums written $43,124 $35,571
% Increase(decrease) 21.2% -6.2%
Net premiums earned 42,502 34,456
% Increase(decrease) 23.4% -1.1%
Underwriting gain/(loss)
(before tax) (5,990) (780)
Loss ratio 67.1% 58.3%
Loss expense ratio 12.4% 9.7%
Underwriting expense ratio 34.1% 33.2%
Combined ratio 113.6% 101.2%
Impact of catastrophe losses
on combined ratio 0.2% 0.2%
Homeowners 1999 1998
- --------------------------------------------------------------
Net premiums written $37,478 $40,075
% Increase(decrease) -6.5% 4.6%
Net premiums earned 45,654 44,145
% Increase(decrease) 3.4% 5.7%
Underwriting gain/(loss)
(before tax) (10,603) (1,050)
Loss ratio 82.7% 60.4%
Loss expense ratio 8.8% 6.9%
Underwriting expense ratio 38.7% 38.6%
Combined ratio 130.2% 105.9%
Impact of catastrophe losses
on combined ratio 7.8% 4.3%
Fidelity & Surety 1999 1998
- ---------------------------------------------------------------
Net premiums written $9,401 $8,764
% Increase(decrease) 7.3% 5.2%
Net premiums earned 9,275 8,840
% Increase(decrease) 4.9% 0.3%
Underwriting gain/(loss)
(before tax) 1,812 1,191
Loss ratio 2.7% 15.0%
Loss expense ratio 4.6% 5.8%
Underwriting expense ratio 72.2% 66.3%
Combined ratio 79.5% 87.1%
Impact of catastrophe losses
on combined ratio N/A N/A
Total Property & Casualty 1999 1998
- ----------------------------------------------------------------
Net premiums written $397,364 $311,802
% Increase(decrease) 27.4% 1.3%
Net premiums earned 384,523 309,366
% Increase(decrease) 24.3% 3.6%
Underwriting gain/(loss)
(before tax) (23,440) (11,267)
Loss ratio 61.5% 61.1%
Loss expense ratio 8.9% 8.5%
Underwriting expense ratio 34.5% 33.8%
Combined ratio 104.9% 103.4%
Impact of catastrophe losses
on combined ratio 1.8% 1.0%
All other 1999 1998
- -----------------------------------------------------------------
Revenues $(376) $1,657
Expenses 4,973 1,975
- -----------------------------------------------------------------
Net income $(5,349) $(318)
Reconciliation of Revenues 1999 1998
- -------------------------------------------------------------
Net premiums earned for
reportable segments $384,523 $309,366
Investment income 42,467 43,230
Realized gains 1,078 4,236
Miscellaneous income 43 87
- -----------------------------------------------------------------
Total property and casualty
revenues (Statutory basis) 428,111 356,919
Property and casualty
statutory to GAAP adjustment (478) (234)
- -----------------------------------------------------------------
Total revenues property
and casualty (GAAP basis) 427,633 356,685
Other segment revenues (376) 1,657
- -----------------------------------------------------------------
Total revenues $427,257 $358,342
=================================================================
Reconciliation of Underwriting
gain/(loss) (before tax) 1999 1998
- -----------------------------------------------------------------
Property and casualty under-
writing gain/(loss) (before tax)
(Statutory basis) (23,440) (11,267)
Statutory to GAAP adjustment 77 5,307
- --------------------------------------------------------------
Property and casualty under-
writing gain/(loss) (before tax)
(GAAP basis) (23,363) (5,960)
Net investment income 41,809 44,634
Realized gains 903 4,082
Other income (4,567) (1,891)
- --------------------------------------------------------------
Income from continuing
operations before income taxes $14,782 $40,865
==============================================================
NOTE V - ACQUISITION OF COMMERCIAL LINES BUSINESS
On December 1, 1998, the Corporation acquired substantially all of the
Commercial Lines Division of Great American Insurance Company ("GAI"), an
insurance subsidiary of the American Financial Group, Inc. As part of the
transaction, the Corporation assumed responsibility for 650 employees of GAI's
Commercial Lines Division, as well as relationships with 1,700 agents. The
major lines of business included in the sale were workers' compensation,
commercial multi-peril, umbrella and commercial auto. Four commercial
operations as well as all California business and all pre-1987 environmental
claims were excluded from the transaction.
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The transaction was accounted for using the purchase method of accounting.
The following table presents the unaudited quarterly proforma results of
operations had the acquisition occurred at the beginning of first quarter
1998.
(Unaudited) 1999 1998
- ----------------------------------------------------
Revenues $427,257 $452,326
Net income 11,257 32,642
Diluted earnings per share .36 .97
NOTE VI - RESTRUCTURING CHARGE
During December 1998, the Corporation adopted a plan to restructure its branch
operations. To continue in the Corporation's efforts to reduce expenses,
personal lines business centers will be reduced from five to three locations.
Underwriting branch locations will be reduced from seventeen to eight
locations and claims branches will be reduced from thirty-eight to six
locations. The Corporation recognized $10,000 in expenses in its income
statement to reflect one-time charges related to its branch office
consolidation plan. These charges consisted solely of future contractual
lease payments related to abandoned facilities. The activities under the plan
are expected to be completed by year-end 1999
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ITEM 2. Management's Discussion and Analysis of Financial Condition
- ------- and Results of Operations
-----------------------------------------------------------------
Property and casualty pre-tax underwriting losses for the quarter ended March
31, 1999 were $23.4 million, $.75 per share, compared with $6.0 million, $.18
per share for the same period in 1998. Gross premiums for the first three
months of 1999 increased 12.3% for all lines of business excluding the effect
of $76.5 million in gross premium written from the GAI acquisition. Commercial
lines decreased .3% and personal lines increased 21.6% from the same period
last year excluding the effects of the GAI acquisition. Property and casualty
net premiums increased 6.3% for the first quarter of 1999 from the same period
a year ago excluding $65.8 million related to the GAI acquisition.
Premium from Key Agents grew 9.5% over the same period of 1998. Key Agents
work closely with the Corporation to establish goals to increase profitability,
growth and retention. Non-key active agents grew 8.2% over 1998. These
together with new appointments brings total active agent premium growth to
11.4% for 1999.
New Jersey is our largest state with 18.8% of total net premiums written
during the quarter. 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). This assessment is based upon estimated future direct
premium written in that state. The Corporation has paid $3.4 million in 1999
for fiscal year 2000 assessment and has paid $3.2 million in 1998. The
Corporation anticipates future assessments will not materially affect the
Corporation's results of operations, financial position or liquidity.
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 reform bill became effective on March 22, 1999, and all
new policies and renewal policies written on or after that date reflect the
15% rate reduction. Current policyholders electing to cancel their current
policy and renew with the effects of the rate rollback have so far been
insignificant. The anticipated impact on the Corporation is a tradeoff of
lower premium rates on personal auto policies for presumably lower losses on
these policies but the degree of offset, if any, is uncertain at present. As
of March 31, 1999, the Corporation had personal auto net premium written of
$46.2 million or 62.0% of total premium that the Corporation writes in New
Jersey compared with $114.5 million or 53.1% at year-end 1998. The projected
impact of this reform bill on the Corporation would have been a decrease in
premium of $6.9 million and $17.2 million for the periods ended March 31, 1999
and December 31, 1998 respectively.
The combined ratio for the first three months increased 1.5 points to 104.9%
from 103.4% from the same period last year. The three-month combined ratio
for homeowners increased 24.3 points to 130.2% from 105.9% in the same period
last year. This increase is due to an increase in non-catastrophe weather
related losses in 1999 compared with the same period of 1998. Personal
automobile, the Corporation's largest line, recorded a 1999 three-month
combined ratio of 100.5% decreasing from 101.4% in 1998. Workers' compensation
combined ratio for the first three months of 1999 decreased 39.6 points to
91.5% from 131.1% during the same period last year. The decrease in the
workers' compensation ratio is due to reserve increases in 1998 from the
additional development of certain pre-existing claims that have leveled off in
the first quarter 1999.
The general liability combined ratio decreased during the first quarter 1999
to 78.3% from 91.0% in 1998. This reduction is largely due to favorable loss
development during the first quarter of 1999. The combined ratio for CMP,
fire and inland marine increased 15.2 points to 118.6% from 103.4% during
March 1999. This increase is due largely to an increase in frequency due to
non-catastrophe weather related losses as well as adverse development in the
first quarter of 1999 compared with the same period last year.
The first quarter catastrophe losses were $5.6 million and accounted for 1.8
points on the combined ratio. This compares with $3.0 million and 1.0 point
for the same period in 1998. The effect of catastrophes on
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the Corporation's results cannot be accurately predicted. Severe weather
patterns can have a material adverse impact on the Corporation's results.
During the first quarter of 1999 there were 5 catastrophes compared with 8
catastrophes in the first quarter of 1998. The largest catastrophe in each
quarter was $2.4 million and $1.7 million, respectively, in incurred losses.
For additional disclosure of catastrophe losses, refer to Item 14, Note 9,
Losses and Loss Reserves in the Notes to the Consolidated Financial Statements
on pages 54 and 55 of the Corporation's 1998 Form 10-K.
For the quarter, property and casualty before tax investment income was $42.5
million, $1.36 per share, decreasing slightly from $43.2 million, $1.29 per
share, for the same period last year. The effective tax rate on investment
income for the first quarter of 1999 was 25.1% compared with 24.4% for the
comparable period in 1998.
Net cash used by operations was $61.8 million for the first three months of
the year compared with net cash generated of $20.2 million for the same period
in 1998. This change is due to a decrease in net income of $19.9 million from
the same period last year, an increase in agents balances receivable, largely
caused by a shift from a six month billing period to a twelve month billing
period and payment of $40.0 million for other liabilities assumed from GAI.
Shareholder dividend payments were $14.4 million in the first three months of
1999 compared with $14.8 million for the same period of 1998.
In 1995, the Corporation reinsured substantially all of its life insurance and
related businesses to Great Southern Life Insurance Company. At December 31,
1998, Great Southern had assumed 95% of the life insurance policies subject to
the 1995 agreement. As a result, the Corporation recognized an additional
amount of unamortized ceding commission of $1.1 million before tax during the
fourth quarter of 1998. There remains approximately $1.1 million in
unamortized ceding commission. This will continue to be amortized over the
remaining life of the underlying policies. Additional information related to
the discontinued life insurance operations is included in Item 14, Note 20
Discontinued Operations on page 60 of the Corporation's 1998 Form 10-K.
Investments in below investment grade securities (Standard and Poor's rating
below BBB-) and unrated securities are summarized as follows:
March 31, December 31,
1999 1998
- ------------------------------------------------------------------------------
Below investment grade securities:
Carrying value $194.5 $207.3
Amortized cost 199.5 208.8
Unrated securities:
Carrying value $328.6 $281.8
Amortized cost 317.5 264.8
Utilizing ratings provided by other agencies, such as the NAIC, categorizes
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:
March 31, December 31,
1999 1998
- ------------------------------------------------------------------------------
Below investment grade securities at
carrying value $194.5 $207.3
Other rating agencies categorizing unrated
securities as below investment grade 9.7 7.7
------ ------
Below investment grade securities at
carrying value $204.2 $215.0
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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 62 corporate borrowers in approximately 39
industries.
Investments in below investment grade securities have greater risks than
investment in investment grade securities. The risk of default by borrowers
which issue securities rated below investment grade is significantly greater
because these securities are generally unsecured and often subordinated to
other debt and these borrowers are often highly leveraged and are more
sensitive to adverse economic conditions such as a recession or a sharp
increase in interest rates. Current liquidity needs are expected to be met by
scheduled bond maturities, even if the below investment grade and unrated
securities are excluded. Investment grade securities are also subject to
significant adverse risks including the risks of re-leveraging and changes
in control of the issuer. In most instances, investors are unprotected with
respect to such risks, the effects of which can be substantial.
For further discussion of the Corporation's investments, see Item 1 of the
Corporation's 1998 Form 10-K for the year ended December 31, 1998.
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 are in excess of the necessary capital to
conform with the risk-based capital model.
Proposition 103 was passed in the State of California in 1988 in an attempt to
legislate premium rates for that state. As construed by the California
Supreme Court, the proposition requires premium rate rollbacks for 1989
California policyholders while allowing for a "fair" return for insurance
companies. Even after considering investment income, total returns in
California were less than what would be considered "fair" by any reasonable
standard. During the fourth quarter of 1994, the State of California assessed
the Corporation $59.9 million for Proposition 103. In February 1995,
California revised this billing to $47.3 million due to California Senate Bill
905 which permitted reduction of the rollback due to actual commissions and
premium taxes paid. The assessment was revised again in August 1995 to $42.1
million plus interest. In December 1997, during Administrative Law hearings,
the California Department of Insurance filed two revised rollback
calculations. These calculations indicated rollback liabilities of either
$35.9 million or $39.9 million plus interest.
In 1998, the Administrative Law Judge finally issued a proposed ruling with a
rollback liability of $24.4 million plus interest. Her ruling was sent to the
California Commissioner of Insurance to be accepted, rejected or modified.
The Corporation expected the commissioner to rule sometime after the election
in November, but he has so far failed to do so. In light of this failure to
rule, the Corporation consulted extensively with outside counsel to determine
the range of liability asserted by the Department. The asserted rollbacks to
date have ranged from $24.4 million to $61.2 million. The Administrative Law
Judge indicates clearly in her ruling that by her calculation the Corporation
would have lost approximately $1.0 million on 1989 operations if a rollback of
$24.4 million were imposed. Given that conclusion, it is clear that any
assessment greater than $24.4 million would strengthen the Corporation's
Constitutional argument that this rollback is confiscatory. Since the
Corporation does not believe it is possible to pinpoint a specific rollback
within the California Department of Insurance's asserted range that is the
most probable, the Corporation has established a contingent liability for
Proposition 103 rollback at $24.4 million plus simple interest at 10% from May
8, 1989. This brings the total reserve to $48.7 million at March 31, 1999.
In December 1992, the Corporation stopped writing business in California due
to a lack of profitability and a difficult regulatory environment. In April
1995, the California Department of Insurance gave final approval for
withdrawal. Currently, subsidiary American Fire and Casualty remains in the
state to wind down the affairs of the group.
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During the first quarter, Ohio Casualty continued its share repurchase
program. The total number of shares acquired during the quarter was 517,100,
at an average price of $40 per share. The Company has remaining authorization
to repurchase 546,812 additional shares.
The Corporation is proceeding on schedule in its phased approach to convert
its computer systems to be Year 2000 compliant. The four phases included in
this approach are: awareness, planning, execution/testing and compliance. All
phases, including awareness, planning, execution/testing and compliance
verification are complete; however, we continue testing to ensure utmost
preparedness.
The Corporation began the awareness phase early in the 1990s, 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 Systems 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 completed on time.
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
computer 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 involves individual and integrated
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 was
performed 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, and at this time, all have
completed the LPAR compliance testing.
All systems will undergo integrated testing of the production environment. In
1999, contingency plans include compliance reverification of this integrated
test early in the third quarter 1999 and again early in the fourth quarter
1999.
As of March 31, 1999, the total amount spent to date for I/S related costs on
the Year 2000 project is $2.4 million and the Corporation anticipates minimal
additional I/S related expenses. 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
1990s 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
has identified all significant vendors, suppliers and agents of the
Corporation and has completed 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. 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 disruption in service to its customers,
notwithstanding the Corporation's intention
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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. The Year 2000 team has completed an assessment
of the non-IT assets; and, identified 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 reported on the identified
non-IT assets in December 1998 to the Corporation's Executive Management Team.
Remediation and contingency planning is scheduled throughout 1999 with regular
updates required to be given to the Executive Management Team.
The Corporation is currently assessing the status of Year 2000 readiness of
the business and assets that it acquired in the acquisition of substantially
all the Commercial Lines Division of Great American Insurance Company on
December 1, 1998. For a period of at least 24 months from the date of the
acquisition, GAI 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 GAI
to address and remediate Year 2000 issues with respect to the information
technology systems utilized for the business being acquired by the
Corporation. The failure of GAI 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 products and policies. The Corporation is
managing this concern by directly providing educational information on Year
2000 to insureds and agents; adding clarification and exclusionary language to
certain policies; and by adjusting underwriting practices. The Corporation
believes that no coverage exists; however, minimal coverage may be interpreted
to exist under some current liability and product policies. The Corporation has
historically avoided 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, where approved by regulators, to 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 where approved by regulators. 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 $.5 million in premiums written in 1998. 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.
Management of the Corporation believes it has an effective program in place to
resolve the Year 2000 issue in a timely manner. However, since it is not
possible to anticipate all possible future outcomes, especially when third
parties are involved, there could be "worst-case scenarios" in which the
Corporation could experience interruptions in normal business operations.
These "worst-case scenarios" include: disruption
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or delay in premium and claim processing; disruption in service to customers;
litigation for Year 2000 related claims, adverse affects on the Corporation's
ability to integrate the acquired business from Great American and loss of
electrical, water and other utility services which could result in a disruption
in the Corporation's services. The amount of potential liability and lost
revenue cannot be reasonably estimated.
From time to time, the Company may publish 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 of Financial Condition and
Results of Operations 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. In order to comply with the terms of
the safe harbor, the Company notes that a variety of factors could cause the
Company's actual results and experience to differ materially from the
anticipated results or other expectations expressed in the Company's forward-
looking statements. The risks and uncertainties that may affect the
operations, performance, development and results of the Company's business
include the following: changes in property and casualty reserves; catastrophe
losses; premium and investment growth; product pricing environment;
availability of credit; changes in government regulation; performance of
financial markets; fluctuations in interest rates; availability and pricing of
reinsurance; litigation and administrative proceedings 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 -
At the annual meeting on April 21, 1999, shareholders voted on board
of director seats for three year terms. Those elected were:
Arthur Bennert: For 28,103,879; against 126,743;
abstentions 277,003
Catherine Dolan: For 28,053,210; against 169,345;
abstentions 285,070
Lauren Patch: For 27,961,350; against 193,691;
abstentions 352,584
Those directors whose term of office continued after the meeting
were: Jack E. Brown, Wayne Embry, Vaden Fitton, Joseph L. Marcum,
Stephen Marcum, Stanley Pontius, Howard L. Sloneker III and Bill
Woodall.
Jeffery D. Lowe whose term expired in 1999, decided not to run for
re-election and resigned from the Board of Directors effective April
21, 1999.
Item 5. Other Information - None
Item 6. Exhibits and reports on Form 8-K -
The Corporation filed a Form 8-K on February 16, 1999, to file the
Corporation's 1998 financial statements.
The Corporation filed Form 8-K/A on February 16, 1999, to amend Form
8-K filed on December 15, 1998, to include pro forma financial
statements required for the GAI acquisition.
The Corporation filed Form 8-K/A on March 26, 1999, to amend the 8-K
filing on February 16, 1999.
The Corporation filed Form 8-K/A on March 26, 1999, to amend the 8-K
filing on December 15, 1998.
Attached hereto as Exhibit No. 27 is the Financial Data Schedule.
Attached hereto as Exhibits 10.1, 10.2 and 10.3 are management
contracts.
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 17, 1999 --------------------------------
Barry S. Porter, CFO/Treasurer
(on behalf of Registrant and
as Principal Accounting Officer)
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