1 ================================================================================ SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-K [x] Annual Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 For the fiscal year ended DECEMBER 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 of (I.R.S. Employer Identification No.) 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 $.0625 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 ------ ------ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K [ ]. The aggregate market value as of March 1, 2000 of the voting stock held by non-affiliates of the registrant was $623,439,288 On March 1, 2000 there were 60,073,504 shares outstanding. Page 1 of 88 INDEX TO EXHIBITS ON PAGE 71 ================================================================================ 2 DOCUMENTS INCORPORATED BY REFERENCE The Company's definitive Proxy Statement for the Annual Shareholders meeting scheduled to be held April 26, 2000 is incorporated herein by reference for the following items: PART III Item 10. Directors and Executive Officers of the Registrant. Item 11. Executive Compensation. Item 12. Security Ownership of Certain Beneficial Owners and Management. Item 13. Certain Relationships and Related Transactions. 2 3 PART I ITEM 1. BUSINESS (a) GENERAL DEVELOPMENT OF BUSINESS Ohio Casualty Corporation (the Corporation) was incorporated under the laws of Ohio in August, 1969. The Corporation operates primarily as a holding company and is principally engaged, through its direct and indirect subsidiaries, in the business of property and casualty insurance and insurance premium finance. The Corporation has two industry segments: property and casualty insurance and insurance premium finance. The Corporation conducts its property and casualty insurance business through The Ohio Casualty Insurance Company ("Ohio Casualty"), an Ohio corporation organized in 1919, and Ohio Casualty's five operating property and casualty insurance subsidiaries: West American Insurance Company ("West American"), an Indiana corporation (originally incorporated under the laws of the state of California) acquired in 1945; Ohio Security Insurance Company ("Ohio Security"), an Ohio corporation acquired in 1962; American Fire and Casualty Company ("American Fire"), an Ohio corporation (originally incorporated under the laws of the state of Florida) acquired in 1969; Avomark Insurance Company ("Avomark"), an Indiana corporation created in 1996 and Ohio Casualty of New Jersey, Inc. ("OCNJ"), an Ohio corporation created in 1998. This group of six property-casualty companies that make up the Ohio Casualty Group (the Group) presently underwrites most forms of property and casualty insurance. The Corporation conducts its premium finance business through Ocasco Budget, Inc. ("Ocasco"), an Ohio corporation (originally incorporated under the laws of the state of California) organized in 1960. Ocasco is a direct subsidiary of Ohio Casualty. On December 1, 1998, Ohio Casualty acquired substantially all of the Commercial Lines Division of Great American Insurance Company ("GAI"), an insurance subsidiary of American Financial Group, Inc. As part of the transaction, the Group 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, general liability and commercial auto. Four commercial operations as well as all California business and all pre-1987 environmental claims were excluded from the transaction. Under the GAI asset purchase agreement, the Group assumed $645.8 million of commercial lines insurance liabilities, $62.6 million in other liabilities and acquired $287.9 million of investments, $1.5 million in cash and $119.1 million in other assets. This resulted in an assumption by the Group of a net statutory-basis liability of $300.0 million in addition to the Corporation's issuance of warrants to purchase 6 million shares (as adjusted for 1999 stock split) of Ohio Casualty Corporation common stock at a price of $22.505 per share. In addition, if the annualized production from the transferred agents at the end of eighteen months equals or exceeds the production in the twelve months prior to closing, GAI will receive an additional $40.0 million. This bonus payment grades down ratably where if eighteen-month annualized production equals 71% or less of previous production, no bonus payment is required. The bonus payment will be accrued as additional agent relationships when minimum contingency is achieved. Additional information related to the accounting treatment of the acquisition as well as proforma results are set forth in Item 14, Note 14, Acquisition of Commercial Lines Business, in the Notes to the Consolidated Financial Statements on pages 54 and 55 of this Form 10-K. 3 4 ITEM 1. CONTINUED During 1995, the Corporation's life insurance operations conducted through The Ohio Life Insurance Company (Ohio Life) subsidiary were discontinued. We found it increasingly difficult to achieve our targeted 16% rate of return in this segment of our business. It was determined that a 16% return could not be achieved without substantial capital contributions and a dramatic overhaul of the life operations. It was decided that this would not be a prudent use of our capital. Therefore, on October 2, 1995, the Corporation signed the final documents to reinsure the existing blocks of business and enter a marketing agreement with Great Southern Life Insurance Company. The existing blocks of business were reinsured through a 100% coinsurance treaty with Employer's Reassurance Corporation. During the fourth quarter of 1997, Great Southern Life Insurance Company replaced Ohio Life as the primary insurer for approximately 76% of the life insurance policies subject to the 1995 agreement. As a result of this assumption, fourth quarter 1997 net income was positively impacted by a partial recognition of unamortized ceding commission. The after-tax impact was an increase to net income of $5.3 million. 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 1998. During 1999, Great Southern Life Insurance Company replaced Employers' Reassurance Corporation on the 100% coinsurance treaty, and the Corporation recognized the remaining $1.1 million in unamortized ceding commission. On December 31 1999, the Corporation completed the sale of the Ohio Life shell, thereby transferring all remaining assets and liabilities, as well as reinsurance treaty obligations, to the buyer. The after-tax gain on this sale totaled $6.2 million, or $.11 per share. Net income from discontinued operations amounted to $4.3 million or $.07 per share in 1999, compared with $1.9 million or $.03 per share in 1998 and $8.7 million or $.13 per share in 1997. Additional information related to the discontinued life insurance operations is included in Item 14, Note 20, Discontinued Operations, in the Notes to the Consolidated Financial Statements on page 57 of this Form 10-K. (b) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS The revenues, operating profit and combined ratios of each industry segment for the three years ended December 31, 1999 are set forth in Item 14, Note 13, Segment Information, in the Notes to the Consolidated Financial Statements on pages 53 and 54 of this Form 10-K. 4 5 ITEM 1. CONTINUED PREMIUMS The following table shows the total net premiums written (gross premiums less premiums ceded pursuant to reinsurance treaties) by line of business by the Group and Ohio Life for the periods indicated. Net Premiums Written By Line of Business (in thousands) 1999 1998 1997 1996 1995 ----------- ----------- ----------- ----------- ----------- Auto liability $ 437,856 $ 403,179 $ 384,358 $ 386,121 $ 403,781 Auto physical damage 281,054 257,170 219,870 208,541 207,534 Homeowners multiple peril 181,905 180,697 168,168 166,457 160,444 Workers' compensation 191,688 100,150 97,176 115,398 140,558 Commercial multiple peril 229,999 157,103 141,931 132,808 131,553 Other liability 150,879 95,144 96,610 101,688 108,483 All other lines 113,285 105,668 98,708 97,059 96,842 ----------- ----------- ----------- ----------- ----------- Property and casualty premiums $ 1,586,666 $ 1,299,111 $ 1,206,821 $ 1,208,072 $ 1,249,195 =========== =========== =========== =========== =========== Premium finance revenues $ 804 $ 1,170 $ 1,511 $ 1,981 $ 2,314 =========== =========== =========== =========== =========== Discontinued operations- Statutory premiums: Individual life $ 0 $ 0 $ 0 $ 0 $ (126,979) Annuity 0 0 0 0 (195,870) Other 0 0 6 215 (22,012) ----------- ----------- ----------- ----------- ----------- Total 0 0 6 215 (344,861) FAS 97 adjustments 0 0 0 0 (1,533) ----------- ----------- ----------- ----------- ----------- Discontinued operations revenues $ 0 $ 0 $ 6 $ 215 $ (346,394) =========== =========== =========== =========== =========== Property and casualty net premiums written increased $287.6 million in 1999. $262.2 million of this increase reflects a full twelve months of results from the acquisition of GAI versus one month of activity in 1998. Net written premiums from the GAI acquisition were $293.8 million in 1999 and $31.6 million in 1998. Excluding the effects of GAI in 1998 and 1999, net premiums written increased 2.0%. Net premiums written distributions by state have shifted as a result of a full year of results from the GAI acquisition. Excluding the effects of the GAI acquisition, for comparison purposes, New Jersey net premiums written increased $9.2 million, primarily due to increased net premiums written in Urban Enterprise Zones and converting from six- to twelve-month policies. These increases in New Jersey are offset by a state mandated 15% rate rollback. Ohio and Kentucky 5 6 ITEM 1. CONTINUED net premiums written increased $1.9 million and $13.6 million, respectively. The results in Ohio are largely due to growth in our auto and homeowners lines of business. Increased premiums in Kentucky result from a personal lines acquisition adding $9.3 million to premiums. Premiums decreased $9.5 million in Pennsylvania and $1.8 million in Illinois. The decrease in Pennsylvania is driven by competitive pricing conditions in all lines. (c) NARRATIVE DESCRIPTION OF BUSINESS The Group is represented on a commission basis by approximately 7,503 independent insurance agents. In most cases, these agents also represent other unaffiliated companies which may compete with the Group. The six claim and eight underwriting and service offices operated by the Group assist these independent agents in producing and servicing the Group's business. The following table shows consolidated direct premiums written for the Group's ten largest states: Ten Largest States Direct Premiums Written From Continuing Operations (in thousands) Percent Percent Percent 1999 of Total 1998 of Total 1997 of Total ---- -------- ---- -------- ---- -------- New Jersey $230,652 17.4 New Jersey $219,518 17.0 New Jersey $220,588 18.0 Ohio 153,146 11.5 Ohio 147,285 11.4 Ohio 132,325 10.8 Kentucky 125,438 9.5 Kentucky 120,309 9.3 Pennsylvania 101,341 8.3 Pennsylvania 87,986 6.6 Pennsylvania 96,932 7.5 Kentucky 101,074 8.2 Illinois 77,035 5.8 Illinois 73,794 5.7 Illinois 63,347 5.2 Indiana 74,073 5.6 Indiana 65,681 5.1 Maryland 54,415 4.4 North Carolina 39,345 3.0 Maryland 41,526 3.2 Indiana 46,660 3.8 Maryland 38,851 2.9 Texas 40,537 3.1 Texas 42,005 3.4 Texas 37,894 2.9 North Carolina 37,856 2.9 Florida 37,383 3.0 Oklahoma 33,995 2.6 Florida 32,649 2.5 North Carolina 34,570 2.8 -------- ---- -------- ---- -------- ---- $898,415 67.8 $876,087 67.7 $833,708 67.9 ======== ==== ======== ==== ======== ==== INVESTMENT OPERATIONS Each of the companies in the Group must comply with the insurance laws of its domiciliary state and of the other states in which it is licensed for business. Among other things, these laws prescribe the kind, quality and concentration of investments which may be made by insurance companies. In general, these laws permit investments, within specified limits and subject to certain qualifications, in federal, state and municipal obligations, corporate bonds, preferred and common stocks, real estate mortgages and real estate. The distribution of invested assets of the Group is determined by a number of factors, including insurance law requirements, the Corporation's liquidity needs, tax position, and general market conditions. In addition, our business mix and liability payout patterns are considered. Adjustments are made to the asset allocation from time to time. During 1999, the Group reallocated its investment portfolio to adjust its asset mix. Outstanding growth in the equity portfolio caused the relationship of asset classes to fall outside of the Group's long-standing guidelines. The Group responded by selling approximately $200.0 million in equity securities, 6 7 ITEM 1. CONTINUED resulting in $145.0 million of realized gains in 1999. The Corporation has no real estate investments. Assets relating to property and casualty operations are invested to maximize after-tax returns with appropriate diversification of risk. The following table sets forth the carrying values and other data of the consolidated invested assets of the Corporation as of the end of the years indicated: Distribution of Invested Assets (in millions) 1999 Average % of % of % of Rating 1999 Total 1998 Total 1997 Total ------- -------- ----- -------- ----- -------- ----- U.S. government AAA $ 65.1 2.0 $ 79.8 2.2 $ 69.8 2.2 Tax exempt bonds and notes AA+ 461.4 14.5 839.6 23.3 875.7 27.8 Debt securities issued by foreign governments N/A 0.0 0.0 3.6 0.1 3.5 0.1 Corporate securities BBB+ 1,066.1 33.5 1,117.5 31.0 929.9 29.5 Mortgage backed securities U.S. government AAA 46.5 1.5 6.3 0.2 17.6 0.6 Other AA 737.9 23.2 369.1 10.2 329.5 10.4 -------- ----- -------- ----- -------- ----- Total bonds A+ 2,377.0 74.7 2,415.9 67.0 2,226.0 70.6 Common stocks 698.0 22.0 919.8 25.5 853.9 27.1 Preferred stocks 0.1 0.0 5.1 0.2 5.6 0.2 -------- ----- -------- ----- -------- ----- Total stocks 698.1 22.0 924.9 25.7 859.5 27.3 Short-term 104.4 3.3 262.9 7.3 65.9 2.1 -------- ----- -------- ----- -------- ----- Total investments $3,179.5 100.0 $3,603.7 100.0 $3,151.4 100.0 ======== ===== ======== ===== ======== ===== Total market value of investments $3,179.5 $3,603.7 $3,151.4 ======== ======== ======== Total amortized cost of investments $2,674.1 $2,815.8 $2,453.8 ======== ======== ======== The consolidated fixed income portfolio (identified as "Total bonds" in the foregoing table) of the Corporation had a weighted average rating of "A+" and an average stated maturity of 12.10 years as of December 31, 1999. Investments in below investment grade securities (Standard and Poor's rating below BBB-) and unrated securities are summarized as follows: 1999 1998 1997 ---- ---- ---- Below investment grade securities: Carrying value $ 175.2 $ 207.3 $ 141.4 Amortized cost 187.1 208.8 135.6 Unrated securities: Carrying value $ 303.2 $ 281.8 $ 242.8 Amortized cost 310.0 264.8 228.6 7 8 ITEM 1. CONTINUED 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: 1999 1998 1997 ---- ---- ---- Below investment grade securities at carrying value $ 175.2 $ 207.3 $ 141.4 Other rating agencies categorizing unrated securities as below investment grade 38.7 7.7 8.1 ------- ------- ------- Below investment grade securities at carrying value $ 213.9 $ 215.0 $ 149.5 All of the Corporation's below investment grade investments (based on carrying value) 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 63 corporate borrowers in approximately 45 industries. At December 31, 1999, the market value of the Corporation's five largest investments in below investment grade securities totaled $58.8 million, and had an approximate amortized cost of $60.8 million. None of these holdings individually exceeded $23.5 million. At December 31, 1999, the Group's fixed income portfolio totaled $2.4 billion which consisted of 91.0% investment grade securities and 9.0% below investment grade and/or unrated securities. Investments in below investment grade securities have greater risks than investments 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. 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. Yield (based on cost of investments) for the taxable fixed income portfolio was 10.9% and 8.9% at December 31, 1999 and 1998, respectively. Below investment grade securities were yielding 9.1% and 8.8% at December 31, 1999 and 1998, respectively, while investment grade securities were yielding 11.0% in 1999 and 8.9% in 1998. Yield for tax exempt securities was 6.0% and 6.0% at December 31, 1999 and 1998, respectively; however, this yield is not directly comparable to taxable yield due to the complexity of federal taxation of insurance companies. The Corporation remains committed to a diversified common stock portfolio. As of December 31, 1999, the portfolio consisted of 49 separate issues, diversified across 37 different industries; and the largest single position was 15.39% of the portfolio. The portfolio strategy with respect to common stocks has been to invest in companies whose stocks have below average valuations, yet above average growth prospects. 8 9 ITEM 1. CONTINUED Investment income is affected by the amount of new investable funds and investable funds arising from maturities, prepayments, calls and exchanges as well as the timing of receipt of such funds. In addition, other factors such as interest rates at time of investment and the maturity, income tax status, credit status and other risks associated with new investments are reflected in investment income. Future changes in the distribution of investments and the factors described above could affect overall investment income in the future; however, the amount of any increase or decrease cannot be predicted. Further details regarding investment distribution and investment income are described in Item 14, Note 2, Investments, in the Notes to Consolidated Financial Statements on pages 46 and 47 this Form 10-K. Purchases of taxable fixed income securities in 1999 were as follows: $1,314.3 million of investment grade securities, $131.5 million of high yield securities and $125.8 million of unrated securities. Purchases of tax-exempt and equity securities in 1999 totaled $1.0 million and $26.7 million, respectively. Disposals (including maturities, calls, exchanges and scheduled prepayments) of taxable fixed income securities in 1999 were as follows: $883.0 million of investment grade securities, $155.6 million of high yield securities and $104.6 million of unrated securities. Dispositions of tax-exempt and equity securities in 1999 totaled $278.1 million and $305.4 million, respectively. The Corporation continues to have no exposure to futures, forwards, caps, floors, or similar derivative instruments as defined by Statement of Financial Accounting Standards No. 119. However, as noted in Item 14, Note 17, Bank Note Payable, in the Notes to the Consolidated Financial Statements on page 56 of this Form 10-K, we have an interest rate swap with Chase Manhattan Bank covering $10.0 million of the outstanding balance of the Corporation's revolving line of credit. This swap is not classified as an investment but rather as a hedge against a portion of the variable rate loan. Consolidated net realized investment gains (before taxes) in 1999 totaled $160.8 million, $2.63 per share. Included in this amount are approximately $8.5 million in writedowns of the carrying values of certain securities the Corporation determined had an other than temporary decline in value. SHARE REPURCHASES Since 1990, the Board of Directors of Ohio Casualty Corporation has authorized the purchase of as many as 13,800,000 (as adjusted for stock splits) shares of its common stock through open market or privately negotiated transactions. During 1999, the Corporation purchased 2,478,000 shares of its common stock at a cost of $46.1 million, compared with 4,725,800 shares for $100.0 million in 1998 and 3,089,376 shares for $64.9 million in 1997. This brings the remaining repurchase authorization to 1,649,824 shares as of December 31, 1999. LIABILITIES FOR UNPAID LOSS AND LOSS ADJUSTMENT EXPENSES Liabilities for loss and loss adjustment expenses are established for the estimated ultimate costs of settling claims for insured events, both reported claims and incurred but not reported claims, based on information known as of the evaluation date. As more information becomes available 9 10 ITEM 1. CONTINUED and claims are settled, the estimated liabilities are adjusted upward or downward with the effect of increasing or decreasing net income at the time of adjustments. Such estimated liabilities include direct costs of the loss under terms of insurance policies as well as legal fees and general expenses of administering the claims adjustment process. The liabilities for claims incurred in accident years 1998, 1997 and 1996 were reduced in the subsequent year as shown below: Accident Year Loss and Loss Adjustment Expense Liabilities Subsequent Year Adjustment (in millions) 1998 1997 1996 ---- ---- ---- Property $ 0 $12 $ 2 Auto 21 24 12 Workers' compensation and other liability 12 5 6 --- --- --- Total reduction $33 $41 $20 === === === The effect of catastrophes on the Group's results cannot be accurately predicted. As such, severe weather patterns could have a material adverse impact on the Group's results. In 1999, 1998 and 1997 there were 27, 37 and 25 catastrophes, respectively. The largest catastrophe in each of these years was $17.9 million, $7.3 million and $4.6 million in incurred losses. Additional catastrophes with over $1.0 million in incurred losses numbered 7, 14 and 3 in 1999, 1998 and 1997, respectively. For additional discussion of catastrophe losses, refer to Item 14, Note 9, Losses and Loss Reserves, in the Notes to the Consolidated Financial Statements on pages 51 and 52 of this Form 10-K. In the normal course of business, the Group is involved in disputes and litigation regarding terms of insurance contracts and the amount of liability under such contracts arising from insured events. The liabilities for loss and loss adjustment expenses include estimates of the amounts for which the Group may be liable upon settlement or other conclusion of such litigation. Because of the inherent future uncertainties in estimating ultimate costs of settling claims, actual loss and loss adjustment expenses may deviate substantially from the amounts recorded in the Corporation's consolidated financial statements. Furthermore, the timing, frequency and extent of adjustments to the estimated liabilities cannot be accurately predicted since conditions and events which established historical loss and loss adjustment expense development and which serve as the basis for estimating ultimate claims cost may not occur in the future in exactly the same manner, if at all. The anticipated effect of inflation is implicitly considered when estimating the liability for losses and loss adjustment expenses based on historical loss development trends adjusted for anticipated changes in underwriting standards, policy provisions and general economic trends. The following tables present an analysis of losses and loss adjustment expenses and related liabilities for the periods indicated. The accounting policies used to estimate liabilities for losses and loss adjustment expenses are described in Item 14, Note 1H, Accounting Policies and Note 9, Losses and Loss Reserves, in the Notes to Consolidated Financial Statements on pages 45, 51 and 52 of this Form 10-K. 10 11 ITEM 1. CONTINUED Reconciliation of Liabilities for Losses and Loss Adjustment Expense (in thousands) 1999 1998 1997 ---- ---- ---- Net liabilities, beginning of year $ 1,865,643 $ 1,421,804 $ 1,486,622 Addition related to acquisition 0 483,938 0 Provision for current accident year claims 1,176,072 989,114 922,065 Decrease in provisions for prior accident year claims (418) (66,119) (53,615) ----------- ----------- ----------- 1,175,654 922,995 868,450 Payments for claims occurring during: Current accident year 600,942 513,292 448,402 Prior accident years 617,026 449,802 484,866 ----------- ----------- ----------- 1,217,968 963,094 933,268 Net liabilities, end of year 1,823,329 1,865,643 1,421,804 Reinsurance recoverable 85,126 91,296 62,003 ----------- ----------- ----------- Gross liabilities, end of year $ 1,908,455 $ 1,956,939 $ 1,483,807 =========== =========== =========== 11 12 ITEM 1. CONTINUED Analysis of Development of Loss and Loss Adjustment Expense Liabilities (In thousands) Year Ended December 31 1989 1990 1991 1992 1993 1994 1995 - ---------------------- ---- ---- ---- ---- ---- ---- ---- Net liability as originally estimated: $ 1,370,054 $ 1,483,985 $ 1,566,139 $ 1,673,868 $ 1,693,551 $ 1,606,487 $ 1,557,065 Life Operations Liability 663 656 961 3,934 P&C Operations Liability $ 1,370,054 $ 1,483,985 $ 1,566,139 $ 1,673,205 $ 1,692,895 $ 1,605,526 $ 1,553,131 Net cumulative payments as of: One year later 489,562 506,246 526,973 561,133 533,634 510,219 486,168 Two years later 745,766 783,948 822,634 869,620 833,399 803,273 772,670 Three years later 902,081 955,666 1,007,189 1,060,433 1,017,893 997,027 944,294 Four years later 1,000,299 1,063,507 1,123,591 1,176,831 1,147,266 1,106,361 1,080,373 Five years later 1,061,173 1,131,012 1,201,317 1,264,900 1,218,916 1,203,717 Six years later 1,100,683 1,182,110 1,266,605 1,316,756 1,288,148 Seven years later 1,134,145 1,235,315 1,302,313 1,369,889 Eight years later 1,177,259 1,262,187 1,342,839 Nine years later 1,195,615 1,294,439 Ten years later 1,221,812 Gross cumulative payments as of: One year later 586,869 547,377 522,811 500,150 Two years later 904,911 859,142 827,232 798,078 Three years later 1,107,980 1,051,915 1,030,701 988,674 Four years later 1,231,386 1,190,466 1,158,798 1,123,163 Five years later 1,328,478 1,278,602 1,254,475 Six years later 1,394,890 1,347,025 1,446,560 Year Ended December 31 1996 1997 1998 1999 - ---------------------- ---- ---- ---- ---- Net liability as originally estimated: $ 1,486,622 $ 1,421,804 $ 1,865,643 $ 1,823,329 Life Operations Liability 3,722 100 98 - P&C Operations Liability $ 1,482,900 $ 1,421,704 $ 1,865,545 $ 1,823,329 Net cumulative payments as of: One year later 483,574 449,802 640,209 Two years later 747,374 751,179 Three years later 950,138 Four years later Five years later Six years later Seven years later Eight years later Nine years later Ten years later Gross cumulative payments as of: One year later 498,274 469,933 654,204 Two years later 781,853 775,371 Three years later 983,440 Four years later Five years later Six years later 12 13 ITEM 1. CONTINUED Analysis of Development of Loss and Loss Adjustment Expense Liabilities (continued) (In thousands) Year Ended December 31 1989 1990 1991 1992 1993 1994 1995 - ---------------------- ---- ---- ---- ---- ---- ---- ---- Net liability re-estimated as of: One year later 1,285,233 1,403,172 1,515,129 1,601,406 1,539,178 1,500,528 1,474,795 Two years later 1,299,428 1,407,197 1,500,890 1,555,452 1,510,943 1,501,530 1,441,081 Three years later 1,296,215 1,388,381 1,467,256 1,524,054 1,515,114 1,486,455 1,445,738 Four years later 1,281,246 1,368,530 1,449,789 1,559,492 1,525,493 1,507,331 1,478,787 Five years later 1,268,193 1,366,676 1,498,881 1,561,763 1,551,024 1,546,849 Six years later 1,270,734 1,423,277 1,499,009 1,588,063 1,587,885 Seven years later 1,327,228 1,420,105 1,526,136 1,627,385 Eight years later 1,325,938 1,444,589 1,558,571 Nine years later 1,342,741 1,472,173 Ten years later 1,367,216 Decrease (increase) in original estimates: $ 2,838 $ 11,812 $ 7,568 $ 45,820 $ 105,010 $ 58,677 $ 74,344 Net liability as originally estimated: $ 1,673,205 $ 1,692,895 $ 1,605,526 $ 1,553,131 Reinsurance recoverable on unpaid losses and LAE 80,114 75,738 65,336 71,066 Gross liability as originally estimated: $ 1,753,982 $ 1,769,289 $ 1,671,823 $ 1,631,184 Life Operations Liability 663 656 961 6,987 P&C Operations Liability 1,753,319 1,768,633 1,670,862 1,624,197 One year later 1,692,044 1,609,429 1,572,435 1,544,461 Two years later 1,644,586 1,590,205 1,578,905 1,515,032 Three years later 1,622,842 1,600,667 1,565,580 1,561,675 Four years later 1,663,734 1,612,300 1,630,314 1,585,459 Five years later 1,666,556 1,680,806 1,657,037 Six years later 1,722,897 1,704,863 1,758,687 Decrease (increase) in original estimates: (5,368) 63,770 13,825 38,738 Year Ended December 31 1996 1997 1998 1999 - ---------------------- ---- ---- ---- ---- Net liability re-estimated as of: One year later 1,427,992 1,355,586 1,888,387 Two years later 1,403,059 1,386,401 Three years later 1,439,008 Four years later Five years later Six years later Seven years later Eight years later Nine years later Ten years later Decrease (increase) in original estimates: $ 43,892 $ 35,304 $ (22,842) Net liability as originally estimated: $ 1,482,900 $ 1,421,704 $ 1,865,545 $ 1,823,329 Reinsurance recoverable on unpaid losses and LAE 64,695 59,952 80,215 85,126 Gross liability as originally estimated: $ 1,556,670 $ 1,483,807 $ 1,956,939 $ 1,908,455 Life Operations Liability 9,075 2,150 11,081 P&C Operations Liability 1,547,595 1,481,657 1,945,759 1,908,455 One year later 1,496,100 1,447,044 1,972,890 Two years later 1,507,365 1,477,874 Three years later 1,537,356 Four years later Five years later Six years later Decrease (increase) in original estimates: 10,239 3,783 (27,131) 13 14 ITEM 1. CONTINUED REINSURANCE In order to preserve capital and protect shareholder value, the Group purchases reinsurance against large or catastrophic losses. The Property Per Risk treaty covers the Group in the event that an insured sustains a property loss in excess of $1.0 million in a single insured event. Property reinsurance covers $29.0 million in excess of the retention. The Casualty Per Occurrence treaty covers the Group in the event an insured sustains a liability loss in excess of $1.0 million in a single insured event. Workers' compensation, umbrella and other casualty reinsurance covers $100.0 million, $50.0 million and $24.0 million, respectively, in excess of the retention. The Catastrophe reinsurance treaty protects the Group against an accumulation of losses arising from one defined catastrophic occurrence or series of events. This treaty provides $150.0 million of coverage in excess of the Group's $25.0 million retention. In 1999, a portion of the catastrophe program was again renewed with a multi-year placement. The multi-year placements maintain rates, continuity and each reinsurer's overall share of the program. Over the last 20 years, there were two events that triggered coverage under our catastrophe reinsurance treaty. Losses and loss adjustment expenses from the Oakland Fires in 1991 and Hurricane Andrew in 1992 totaled $35.6 million and $29.8 million, respectively. Both of these losses exceeded our prior retention amount of $13.0 million. The Group recovered $33.9 million from reinsurers as a result of these events. Our reinsurance limits are designed to cover exposure to a catastrophic event expected to occur once every 300 years. The Aggregate Excess of Loss treaty covers the Group in the event that aggregate losses and allocated loss adjustment expenses exceed a 64% gross loss ratio subject to a $100 million aggregate limit. The Group also carries various treaties covering specialty lines of business brought about from the GAI transaction as well as facultative reinsurance contracts protecting certain individual risks. Reinsurance contracts do not relieve the Group of its obligation to the policyholders. The collectibility of reinsurance is subject to the solvency of the reinsurers. Since the Group's reinsurance protection is an important component in our financial plan, we closely monitor the financial health and claims settlement performance of each of our reinsurers. Annually, financial statements are reviewed and various ratios calculated to identify reinsurers who have ceased to meet our standards of financial strength. If any reinsurers fail these tests, they are removed from the program at renewal. Currently, all of our domestic reinsurers have an AM Best rating of "A-" or better, and the financial condition of all of our international reinsurers meet the Group's pre-established standards. Additionally, the Group utilizes a large base of reinsurers to mitigate its concentration risk. In 1999, 1998 and 1997, no reinsurer accounted for more than 10% of total ceded premiums. As a result of the Group's controls over reinsurance, uncollectible amounts have not been significant. COMPETITION More than 2,400 property and casualty insurance companies compete in the United States and no one company or company group has a market share greater than approximately 13.0%. The Group ranked as the thirty-sixth largest property and casualty insurance group in the United States based on net insurance premiums written in 1998, the latest year for which statistics are available. The Group competes with other companies on the basis of service, price and coverage. Competition in the property and casualty industry is intense, as reflected in the weak pricing environment in the industry. 14 15 ITEM 1. CONTINUED STATE INSURANCE REGULATION GENERAL. The Corporation and the members of the Group are subject to regulation under the insurance statutes, including the holding company statutes, of various states. Ohio Casualty, American Fire, Ohio Security and OCNJ are all domiciled in Ohio. West American and Avomark are domiciled in Indiana. Collectively, the Group is authorized to transact the business of insurance in the District of Columbia and all states. The Group is subject to examination of their affairs by the insurance departments of the jurisdictions in which they are licensed. State laws also require prior notice or regulatory agency approval of changes in control of an insurer or its holding company and of certain material intercorporate transfers of assets within the holding company structure. Under applicable provisions of the Indiana insurance statutes ("Indiana Insurance Law") and the Ohio insurance statutes (the "Ohio Insurance Law"), a person would not be permitted to acquire direct or indirect control of the Corporation or any of the Group's companies domiciled in such state, unless such person had obtained prior approval of the Indiana Insurance Commissioner and the Ohio Superintendent of Insurance, respectively, for such acquisition. For the purposes of the Indiana Insurance Law and the Ohio Insurance Law, any person acquiring more than 10% of the voting securities of a company is presumed to have acquired "control" of such company. 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 have been less than what would be considered "fair" by any reasonable standard. During the fourth quarter of 1994, the state of California assessed the Group $59.9 million for Proposition 103. In February 1995, California revised this billing to $47.3 million. 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. Thus far the Commissioner has not made a ruling. The asserted rollbacks to date have ranged from $24.4 million to $61.1 million. The Administrative Law Judge indicates clearly in her ruling that by her calculation the Group 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 Group's Constitutional argument that this rollback is confiscatory. The Group does not believe it is possible to pinpoint a specific rollback that may be required that is the most probable. The Group 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 $50.5 million at December 31, 1999. To date, the Group has paid $5.1 million in legal costs related to the withdrawal, Proposition 103, and Fair Plan assessments. In December 1992, the Group 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. 15 16 ITEM 1. CONTINUED The state of New Jersey, our largest state with 15.8% of total net premiums written during 1999, has historically been a profitable state for the Group. In recent years, however, the legislative environment in that state has become more difficult. Due to legislative rules and regulations designed to make insurance less expensive and more easily obtainable for New Jersey residents, our results have been adversely impacted. New Jersey passed the Fair Automobile Insurance Reform Act which was an eight year assessment that began in 1990 and ended in 1997. In order to meet our state imposed assessment obligations under the Fair Automobile Insurance Reform Act the Group incurred expenses of $3.3 million in 1997 and $3.6 million in 1996. The Group's future obligations related to this act are minimal as only true-up payments are remaining, and any future true-ups are anticipated to be immaterial to the Group's results of operations, financial position and liquidity in future years. The Unsatisfied Claim and Judgment Fund is another assessment made by the state of New Jersey. This assessment is based upon estimated future direct premium written in that state. The Group paid $3.4 million in 1999, $3.2 million in 1998 and $4.2 million in 1997. The Group anticipates the future assessments to be between $3.0 and $4.0 million dollars annually. The Group anticipates future assessments will not materially affect the Group's results of operations, financial position or liquidity. The New Jersey State Senate passed an auto insurance reform bill effective March 22, 1999 that mandates a 15% rate reduction for personal auto policies based on a reduction in medical expense benefits, limitations on lawsuits and enhanced fraud prevention provisions. All new and renewal policies written on or after March 22, 1999 reflect the 15% rate reduction. The anticipated impact on the Group is a tradeoff of lower premium rates on personal auto policies for presumably lower losses but the degree of offset, if any, is uncertain at present. For 1999, the Group had personal auto net premiums written in New Jersey of $124.4 million. The estimated reduction in net premiums written stemming from this reform bill for 1999 is approximately $11.3 million. The projected impact in 2000 is a further reduction of approximately $5.7 million in net premiums. In 1999, New Jersey also began to require insurance companies to write a portion of their premiums in Urban Enterprise Zones (UEZ). These zones are urban areas frequently having high loss ratios. The Group is assigned premiums if it does not write the required amount on its own. For the year ended December 31, 1999, the Group wrote $5.7 million in UEZ premiums, with $6.7 million in additional assigned premiums. The 1999 loss ratio on UEZ premiums is 132.1%, and the loss ratio on the assigned business is 142.9%. NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS. The National Association of Insurance Commissioners (the "NAIC") annually calculates a number of financial ratios to assist state insurance regulators in monitoring the financial condition of insurance companies. A "usual range" of results for each ratio is used as a benchmark. Departure from the usual range on four or more of the ratios could lead to inquiries from individual state insurance commissioners as to certain aspects of a company's business. All of the companies in the Group are within the usual range for the last five calendar years. 16 17 ITEM 1. CONTINUED The NAIC has developed a "Risk-Based Capital" model for property and casualty insurers. The model is used to establish standards which relate insurance company statutory surplus to 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 reserves and premiums written risks. Based on current calculations, all insurance companies in the Group are in excess of levels that would require regulatory action. The states of Ohio and Indiana have adopted the NAIC model law limiting dividend payments by insurance companies. This law allows dividends to equal the greater of 10% of policyholders' surplus or net income determined as of the preceding year end without prior approval of the Insurance Department. At the end of 1999, $98.3 million of policyholders' surplus is not subject to restrictions or prior dividend approval. In 1998, the NAIC adopted the Codification of Statutory Accounting Principles guidance, which will replace the current Accounting Practices and Procedures manual as the NAIC's primary guidance on statutory accounting. The Codification provides guidance for areas where statutory accounting has been silent and changes current statutory accounting in some areas, e.g. deferred income taxes are recorded. The Ohio and Indiana Insurance Departments have adopted the Codification guidance, effective January 1, 2001. The Company has not estimated the potential effect of the Codification guidance. EMPLOYEES At December 31, 1999, Ohio Casualty had approximately 3,900 employees of which approximately 1,760 were located in the Fairfield and Hamilton, Ohio offices. YEAR 2000 The Corporation successfully moved into the Year 2000 without impact or interruption to the business as a result of Year 2000 computer problems. Though no Year 2000 problems have occurred or are anticipated, the Corporation continues to monitor the situation. In 1999, the Corporation concluded its phased approach to convert its computer systems to be Year 2000 compliant. The four phases included in this approach were: awareness, planning, execution/ testing, and compliance. All phases were completed on schedule; however, we continued testing throughout 1999 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 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 ensure that the conversion was completed on time. 17 18 ITEM 1. CONTINUED 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 included 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. In this environment, data was migrated forward and tested as the internal date in the computer was changed to critical dates in 1999 and 2000. This provided an excellent environment to test applications, system software and hardware. This involved individual and integrated compliance testing. The first step verified that the systems are compliant when they run independently. The second step verified compliance when they are integrated with all other systems with which they interface. Testing was performed throughout 1998 and 1999, 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 completed LPAR compliance testing. Following the completion of LPAR compliance testing, all systems underwent integrated testing of the production environment. This integrated testing, as was called for in our contingency plans, was repeated in the third and fourth quarters of 1999. 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 did not have to make an expensive effort to identify and remedy its Year 2000 issues and does not anticipate that it will be required to make further substantial expenditures to address any Year 2000 issues. As of December 31, 1999, the total amount spent for I/S related costs on the Year 2000 project is $2.8 million. These amounts do not include any costs associated with efforts made to contact third parties or related to contingency planning. During 1997, the Corporation began the compliance phase. The Year 2000 team identified all significant vendors, suppliers and agents of the Corporation and completed the initial contact to obtain written statements of their readiness and commitment to a date for their Year 2000 compliance. The Corporation monitored the Year 2000 status of these entities and developed contingency plans to reduce the possible disruption in business operations that may have resulted 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 had a system failure due to not being Year 2000 compliant, the Corporation believes this could have resulted in a delay in processing or reporting transactions of the Corporation, or a potential disruption in service to its customers, notwithstanding the Corporation's contingency plans to respond to these potential system failures by such third parties. The Corporation assessed the status of Year 2000 readiness of the business and assets that Ohio Casualty acquired in the acquisition of substantially all the Commercial Lines Division of Great American Insurance Companies ("GAI") on December 1, 1998. For a period of at least 24 months from the date of the acquisition, GAI is providing computer processing and communication services to the Group in connection with the acquired business pursuant to an Information Systems Agreement. Thus, the Corporation was 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 18 19 ITEM 1. CONTINUED Group. The failure of GAI to have satisfactorily corrected a material Year 2000 problem in the computer processing systems being used to provide services to the Group in connection with the acquired business could have resulted in a material adverse effect on the ability of the Group to integrate the acquired business and to operate it on a profitable basis. The failure to correct a material Year 2000 problem could have resulted 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 have resulted in an interruption in the normal business operations. Due to the general uncertainty inherent in the Year 2000 problem, such failures could have materially and adversely affected 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 Group took various steps to manage this concern including providing educational information on Year 2000 to agents; adding clarification and exclusionary language to certain policies; and by evaluating underwriting practices. The Group believes that no coverage exists; however, minimal coverage may be interpreted to exist under some current liability and product policies. The Group has historically avoided manufacturing risks which produce computer or computer-dependent products. The Insurance Services Office (ISO) 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 Group addressed the Year 2000 issue by attaching the ISO exclusionary language, where approved by regulators, to general liability policies with a rating classification the Group believes could potentially have had Year 2000 losses. The ISO exclusionary language endorsement is included on all property policies where approved by regulators. These actions minimized the Group's potential exposure to Year 2000 underwriting 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 their company. The Group has written directors' and officers' (D&O) liability policies since 1995, with approximately $.6 million in premiums written in 1999. The Group managed its D&O Year 2000 exposure through underwriting guidelines which address Year 2000 issues in the application process. The Corporation had an effective program in place to resolve Year 2000 issues in a timely manner and has contingency plans to continue operations should an unforeseen situation arise. However, since it is not possible to anticipate all possible future outcomes, especially when third parties are involved, there could be scenarios in which the Corporation could experience interruptions in normal business operations. These scenarios include: disruption or delay in premium and claim processing; disruption in service to customers; litigation for Year 2000-related claims and adverse affects on the Group's ability to integrate the acquired business from GAI. The amount of potential liability and lost revenue cannot be reasonably estimated. 19 20 ITEM 1. CONTINUED CHANGE IN ACCOUNTING METHOD During the first quarter of 1999, 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 has accrued a total liability for insurance assessments of $2.3 million net of tax, as of January 1, 1999. This was recorded as a change in accounting method. IMPACT OF RECENTLY ISSUED ACCOUNTING STANDARDS 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, 2000 (January 1, 2001 for the Corporation). ITEM 2. PROPERTIES The Corporation owns and leases office space in various parts of the country. The principal office buildings consist of facilities owned in Fairfield and Hamilton, Ohio. ITEM 3. LEGAL PROCEEDINGS There are no material pending legal proceedings against the Corporation or its subsidiaries other than litigation arising in connection with settlement of insurance claims as described on page 10 and Proposition 103 hearings described on page 56. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS There were no matters submitted during the fourth quarter of the fiscal year covered by this report to a vote of Shareholders through the solicitation of proxies or otherwise. 20 21 ITEM 4. CONTINUED EXECUTIVE OFFICERS OF THE REGISTRANT The following information is related to executive officers who are not separately reported in the Corporation's Proxy Statement: Position with Company and/or Principal Occupation or Employment Name Age (1) During Last Five Years ---- --- ---------------------- John S. Busby 54 Senior Vice President of The Ohio Casualty Insurance Company, American Fire and Casualty Company, Ohio Security Insurance Company and West American Insurance Company; prior thereto, Vice President of The Ohio Casualty Insurance Company, American Fire and Casualty Company, Ohio Security Insurance Company and West American Insurance Company since May 1991. Frederick W. Wendt 59 Senior Vice President of The Ohio Casualty Insurance Company, American Fire and Casualty Company, Ohio Security Insurance Company, West American Insurance Company and Avomark Insurance Company; prior thereto, Vice President of The Ohio Casualty Insurance Company, American Fire and Casualty Company, Ohio Security Insurance Company and West American Insurance Company since 1991. Coy Leonard, Jr. 55 Senior Vice President of The Ohio Casualty Insurance Company, American Fire and Casualty Company, Ohio Security Insurance Company, West American Insurance Company, Ocasco Budget, Inc. and Avomark Insurance Company; prior thereto, Vice President of The Ohio Casualty Insurance Company, American Fire and Casualty Company, Ocasco Budget, Inc., Ohio Security Insurance Company and West American Insurance Company; prior thereto, Assistant Vice President of The Ohio Casualty Insurance Company, American Fire and Casualty Company, Ocasco Budget, Inc., Ohio Security Insurance Company and West American Insurance Company; prior thereto, Manager of Strategic Planning and Technology. Elizabeth M. Riczko 33 Senior Vice President of The Ohio Casualty Insurance Company, Ohio Security Insurance Company, American Fire and Casualty Company, West American Insurance Company and Vice President of Avomark Insurance Company; prior thereto, Vice President of The Ohio Casualty Insurance Company, American Fire and Casualty Company, Ocasco Budget, Inc., Ohio Security Insurance Company and West American Insurance Company since May 1996; prior thereto, Assistant Secretary of The Ohio Casualty Insurance Company, American Fire and Casualty Company, Ocasco Budget, Inc., Ohio Security Insurance Company and West American Insurance Company; prior thereto, Corporate Actuarial Manager. 21 22 ITEM 4. CONTINUED Position with Company and/or Principal Occupation or Employment Name Age (1) During Last Five Years ---- --- ---------------------- Ralph G. Goode 54 Senior Vice President of The Ohio Casualty Insurance Company, American Fire and Casualty Company, Ohio Security Insurance Company and West American Insurance Company, Vice President of Avomark Insurance Company, prior thereto, Vice President of The Ohio Casualty Insurance Company, American Fire and Casualty Company, Ohio Security Insurance Company and West American Insurance Company; prior thereto, Assistant Vice President of The Ohio Casualty Insurance Company, American Fire and Casualty Company Ohio Security Insurance Company and West American Insurance Company Richard B. Kelly 45 Senior Vice President of The Ohio Casualty Insurance Company, American Fire and Casualty Company, Ohio Security Insurance Company, West American Insurance Company, Ocasco Budget, Inc. and Avomark Insurance Company; prior thereto, Vice President of The Ohio Casualty Insurance Company, American Fire and Casualty Company, Ohio Security Insurance Company, The Ohio Life Insurance Company, West American Insurance Company, Ocasco Budget, Inc. and Avomark Insurance Company; prior thereto, Assistant Vice President of The Ohio Casualty Insurance Company, American Fire and Casualty Company, Ohio Security Insurance Company, West American Insurance Company, Avomark Insurance Company and The Ohio Life Insurance Company John E. Bade, Jr. 45 Senior Vice President of The Ohio Casualty Insurance Company, American Fire and Casualty Company, Ohio Security Insurance Company, West American Insurance Company and Avomark Insurance Company; prior thereto, Vice President of The Ohio Casualty Insurance Company, American Fire and Casualty Company, Ohio Security Insurance Company, West American Insurance Company and Avomark Insurance Company; prior thereto, Assistant Vice President of The Ohio Casualty Insurance Company, American Fire and Casualty Company, Ohio Security Insurance Company, West American Insurance Company and Avomark Insurance Company; prior thereto, Branch Manager of Greensboro, NC - --------------------------------- (1) Ages listed are as of the annual meeting. 22 23 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS See Item 14 on pages 25, 26 and 30 of this Form 10-K. ITEM 6. SELECTED FINANCIAL DATA See Item 14 on pages 27 and 28 of this Form 10-K. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS See Item 14 on pages 29-40 of this Form 10-K. SAFE HARBOR FOR FORWARD LOOKING STATEMENTS The 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 report 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 uncertainties that may affect 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 of pricing 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 acquired from GAI and the ability of the Corporation to implement appropriate contingency plans to address Year 2000 problems which are not successfully remediated; ability of the Group to integrate the acquired GAI business and to retain the acquired insurance business; and general economic and market conditions. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK See Item 14 on page 37 of this Form 10-K ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Financial Statements and Schedules. See Item 14 on pages 41-44 of this Form 10-K. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. 23 24 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Incorporated by reference herein from those portions of the Company's definitive Proxy Statement for the Annual Meeting of Shareholders of the Company for 2000 under the headings "Election of Directors," and "Other Directorships and Related Transactions and Relationships." ITEM 11. EXECUTIVE COMPENSATION Incorporated by reference from those portions of the Company's definitive Proxy Statement for the Annual Meeting of Shareholders of the Company for 2000 under the headings "Executive Compensation," "Employment Contracts and Termination of Employment Agreements," and "Executive Compensation Committee Interlocks and Insider Participation." ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Incorporated by reference from those portions of the Company's definitive Proxy Statement for the Annual Meeting of Shareholders of the Company for 2000 under the headings "Principal Shareholders," and "Shareholdings of Directors, Executive Officers and Nominees for Election as Director." ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Incorporated by reference from those portions of the Company's definitive Proxy Statement for the Annual Meeting of Shareholders of the Company for 2000 under the heading "Other Directorships and Related Transactions and Relationships." PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENTS SCHEDULES, AND REPORTS ON FORM 8-K (A) FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULES REQUIRED TO BE FILED BY ITEM 8 OF THIS FORM AND REGULATION S-X 24 25 ITEM 14. CONTINUED SHAREHOLDER INFORMATION AUTOMATIC DIVIDEND REINVESTMENT PLAN The Corporation offers an automatic dividend reinvestment plan for all registered holders of common stock. Under the plan, shareholders may reinvest their dividends to buy additional shares of common stock, and may also make voluntary cash payments of up to $60,000 yearly toward the purchase of Ohio Casualty Corporation shares. Participation is entirely voluntary. More information on the plan can be obtained by contacting the Transfer Agent listed below. FORM 10-K ANNUAL REPORT The Form 10-K Annual Report for 1999, as filed with the Securities and Exchange Commission, is available without charge upon written request to: Ohio Casualty Corporation Office of the Chief Financial Officer 9450 Seward Road Fairfield, OH 45014-5456 TRANSFER AGENT AND REGISTRAR First Chicago Trust Company of New York, a division of EquiServe P. O. Box 2500 Jersey City, NJ 07303-2500 1-800-317-4445 ANNUAL MEETING The Annual Meeting of Shareholders will be held at 10:30 a.m. on Wednesday, April 26, 2000, in the OCU Auditorium of the Ohio Fairfield facility, 9450 Seward Road, Fairfield, OH 45014-5456. VISIT THE OHIO CASUALTY GROUP INTERNET WEB SITE - www.ocas.com The site includes current financial data about Ohio Casualty Corporation, as well as other corporate, product and service information. 2000 ANTICIPATED DIVIDEND SCHEDULE DECLARATION DATE RECORD DATE PAYABLE DATE - ------------------------------------------------------------------- February 17, 2000 March 1, 2000 March 10, 2000 May 18, 2000 June 1, 2000 June 10, 2000 August 17, 2000 September 1, 2000 September 10, 2000 November 16, 2000 December 1, 2000 December 10, 2000 25 26 ITEM 14. CONTINUED OHIO CASUALTY CORPORATION & SUBSIDIARIES FINANCIAL HIGHLIGHTS (IN THOUSANDS, EXCEPT PER SHARE AND NUMBER OF SHAREHOLDERS DATA) 1999 1998 1997 ==================================================================================================================== Premiums and finance charges earned $ 1,554,966 $ 1,268,824 $ 1,208,974 Investment income, less expenses 184,287 169,024 177,700 Income before investment gains 1,399 73,644 97,406 Realized investment gains, after taxes 104,537 9,367 32,986 Income from discontinued operations, after taxes 4,270 1,916 8,655 Gain on sale of discontinued operations, after taxes 6,190 0 0 Cumulative effect of accounting changes (2,255) 0 0 Net income 114,141 84,927 139,047 Property and casualty combined ratio 112.8% 107.2% 105.3% BASIC AND DILUTED EARNINGS PER COMMON SHARE* Income before investment gains $ 0.02 $ 1.12 $ 1.42 Realized investment gains, after taxes 1.71 0.14 0.48 Income from discontinued operations, after taxes 0.07 0.03 0.13 Gain on sale of discontinued operations, after taxes 0.11 0.00 0.00 Cumulative effect of accounting changes (0.04) 0.00 0.00 Net income 1.87 1.29 2.03 Book value 19.16 21.12 19.56 Dividends 0.92 0.88 0.84 FINANCIAL CONDITION Assets $ 4,476,444 $ 4,802,264 $ 3,778,782 Shareholders' equity 1,150,987 1,320,981 1,314,829 Average shares outstanding - basic* 61,126 65,808 68,456 Average shares outstanding - diluted* 61,139 65,870 68,514 Shares outstanding on December 31* 60,083 62,538 67,244 Number of shareholders 6,200 6,100 6,200 *Adjusted for 2 for 1 stock split effective July 22, 1999 (See Note 23) 26 27 ITEM 14. CONTINUED OHIO CASUALTY CORPORATION & SUBSIDIARIES TEN-YEAR SUMMARY OF OPERATIONS (IN MILLIONS, EXCEPT PER SHARE DATA) 1999 1998 1997 1996 ============================================================================================================================ CONSOLIDATED OPERATIONS Income after taxes Operating income $ 1.4 $ 73.6 $ 97.4 $ 64.9 Realized investment gains (losses) 104.5 9.4 33.0 32.3 - ---------------------------------------------------------------------------------------------------------------------------- Income from continuing operations 105.9 83.0 130.4 97.2 Discontinued operations 4.3 1.9 8.7 5.3 Gain on sale of discontinued operations 6.2 0.0 0.0 0.0 Cumulative effect of accounting changes (2.3) 0.0 0.0 0.0 - ---------------------------------------------------------------------------------------------------------------------------- Net income 114.1 84.9 139.1 102.5 ============================================================================================================================ Income after taxes per average share outstanding - BASIC* Operating income 0.02 1.12 1.42 0.93 Realized investment gains (losses) 1.71 0.14 0.48 0.46 Discontinued operations 0.07 0.03 0.13 0.07 Gain on sale of discontinued operations 0.11 0.00 0.00 0.00 Cumulative effect of accounting changes (0.04) 0.00 0.00 0.00 - ---------------------------------------------------------------------------------------------------------------------------- Net income 1.87 1.29 2.03 1.46 ============================================================================================================================ Average shares outstanding - BASIC* 61.1 65.8 68.5 70.4 Income after taxes per average share outstanding - DILUTED* Operating income 0.02 1.12 1.42 0.93 Realized investment gains (losses) 1.71 0.14 0.48 0.46 Discontinued operations 0.07 0.03 0.13 0.07 Gain on sale of discontinued operations 0.11 0.00 0.00 0.00 Cumulative effect of accounting changes (0.04) 0.00 0.00 0.00 - ---------------------------------------------------------------------------------------------------------------------------- Net income 1.87 1.29 2.03 1.46 ============================================================================================================================ Average shares outstanding -DILUTED* 61.1 65.9 68.5 70.5 Total assets 4,476.4 4,802.3 3,778.8 3,890.0 Shareholders' equity 1,151.0 1,321.0 1,314.8 1,175.1 Book value per share* 19.16 21.12 19.56 16.72 Dividends paid per share* 0.92 0.88 0.84 0.80 Percent increase over previous year 4.5% 4.8% 5.0% 5.3% PROPERTY AND CASUALTY OPERATIONS Net premiums written 1,586.9 1,299.6 1,207.6 1,209.0 Net premiums earned 1,554.1 1,267.8 1,204.3 1,223.4 GAAP underwriting gain (loss) before taxes (184.2) (74.1) (49.6) (112.2) Loss ratio 66.9% 63.7% 62.7% 66.5% Loss adjustment expense ratio 10.7% 9.1% 9.4% 9.7% Underwriting expense ratio 35.2% 34.4% 33.2% 33.3% Combined ratio 112.8% 107.2% 105.3% 109.5% Investment income before taxes 181.1 164.8 172.4 179.4 Per average share outstanding* 2.96 2.51 2.52 2.54 Property and casualty reserves Unearned premiums 725.2 668.4 494.9 491.4 Losses 1,545.0 1,569.5 1,174.5 1,215.8 Loss adjustment expense 363.5 376.3 307.2 331.8 Statutory policyholders' surplus 899.8 1,027.1 1,109.5 984.9 *Adjusted for 2 for 1 stock split effective July 22, 1999 (See Note 23) 27 28 ITEM 14. CONTINUED OHIO CASUALTY CORPORATION & SUBSIDIARIES TEN-YEAR SUMMARY OF OPERATIONS (IN MILLIONS, EXCEPT PER SHARE DATA) 1995 1994 1993 1992 ============================================================================================================= CONSOLIDATED OPERATIONS Income after taxes Operating income $ 91.4 $ 77.1 $ 51.5 $ 57.8 Realized investment gains (losses) 4.0 14.2 28.7 35.1 - ------------------------------------------------------------------------------------------------------------- Income from continuing operations 95.4 91.3 80.2 92.9 Discontinued operations 4.3 5.9 6.8 4.1 Gain on sale of discontinued operations 0.0 0.0 0.0 0.0 Cumulative effect of accounting changes 0.0 (0.3) 0.0 1.5 - ------------------------------------------------------------------------------------------------------------- Net income 99.7 96.9 87.0 98.5 ============================================================================================================= Income after taxes per average share outstanding - BASIC* Operating income 1.28 1.07 0.72 0.80 Realized investment gains (losses) 0.05 0.20 0.40 0.49 Discontinued operations 0.06 0.08 0.09 0.06 Gain on sale of discontinued operations 0.00 0.00 0.00 0.00 Cumulative effect of accounting changes 0.00 0.00 0.00 0.02 - ------------------------------------------------------------------------------------------------------------- Net income 1.39 1.35 1.21 1.37 ============================================================================================================= Average shares outstanding - BASIC* 71.5 72.0 72.0 72.0 Income after taxes per average share outstanding - DILUTED* Operating income 1.28 1.07 0.72 0.80 Realized investment gains (losses) 0.05 0.20 0.40 0.49 Discontinued operations 0.06 0.08 0.09 0.06 Gain on sale of discontinued operations 0.00 0.00 0.00 0.00 Cumulative effect of accounting changes 0.00 0.00 0.00 0.02 - ------------------------------------------------------------------------------------------------------------- Net income 1.39 1.35 1.21 1.37 ============================================================================================================= Average shares outstanding -DILUTED* 71.5 72.0 72.0 72.0 Total assets 3,980.1 3,739.0 3,816.8 3,760.7 Shareholders' equity 1,111.0 850.8 862.3 825.2 Book value per share* 15.69 11.82 11.97 11.72 Dividends paid per share* 0.76 0.73 0.71 0.67 Percent increase over previous year 4.1% 2.8% 6.0% 8.1% PROPERTY AND CASUALTY OPERATIONS Net premiums written 1,250.6 1,286.4 1,306.0 1,508.5 Net premiums earned 1,264.6 1,297.7 1,379.4 1,517.6 GAAP underwriting gain (loss) before taxes (68.8) (92.9) (147.3) (130.8) Loss ratio 61.2% 61.6% 64.9% 63.7% Loss adjustment expense ratio 10.2% 10.0% 11.8% 10.8% Underwriting expense ratio 32.6% 32.2% 33.6% 33.5% Combined ratio 104.0% 103.8% 110.3% 108.0% Investment income before taxes 184.6 183.8 190.4 194.6 Per average share outstanding* 2.58 2.55 2.64 2.70 Property and casualty reserves Unearned premiums 505.8 517.8 529.6 596.1 Losses 1,268.1 1,303.6 1,378.0 1,309.2 Loss adjustment expense 356.1 367.3 390.6 364.0 Statutory policyholders' surplus 876.9 660.0 713.6 674.2 10-Year Compound (IN MILLIONS, EXCEPT PER SHARE DATA) 1991 1990 Annual Growth ===================================================================================================== CONSOLIDATED OPERATIONS Income after taxes Operating income $ 99.1 $ 94.6 (35.3)% Realized investment gains (losses) 9.8 (8.7) 0.0% - ----------------------------------------------------------------------------------------------------- Income from continuing operations 108.9 85.9 0.7% Discontinued operations (1.0) (1.8) 4.8% Gain on sale of discontinued operations 0.0 0.0 0.0% Cumulative effect of accounting changes 0.0 0.0 0.0% - ----------------------------------------------------------------------------------------------------- Net income 107.9 84.1 1.2% ===================================================================================================== Income after taxes per average share outstanding - BASIC* Operating income 1.38 1.24 (34.0)% Realized investment gains (losses) 0.14 (0.11) 0.0% Discontinued operations (0.02) (0.03) 8.8% Gain on sale of discontinued operations 0.00 0.00 0.0% Cumulative effect of accounting changes 0.00 0.00 0.0% - ----------------------------------------------------------------------------------------------------- Net income 1.50 1.10 4.6% ===================================================================================================== Average shares outstanding - BASIC* 71.7 76.8 (3.3)% Income after taxes per average share outstanding - DILUTED* Operating income 1.38 1.24 (34.0)% Realized investment gains (losses) 0.14 (0.11) 0.0% Discontinued operations (0.02) (0.03) 8.8% Gain on sale of discontinued operations 0.00 0.00 0.0% Cumulative effect of accounting changes 0.00 0.00 0.0% - ----------------------------------------------------------------------------------------------------- Net income 1.50 1.10 4.6% ===================================================================================================== Average shares outstanding -DILUTED* 71.8 76.9 (3.3)% Total assets 3,531.3 3,252.9 3.6% Shareholders' equity 774.5 651.2 4.0% Book value per share* 10.79 9.10 7.6% Dividends paid per share* 0.62 0.58 5.9% Percent increase over previous year 6.9% 11.5% (8.2)% PROPERTY AND CASUALTY OPERATIONS Net premiums written 1,492.3 1,468.4 1.4% Net premiums earned 1,469.1 1,438.0 1.3% GAAP underwriting gain (loss) before taxes (74.5) (79.4) 11.4% Loss ratio 60.4% 61.4% Loss adjustment expense ratio 10.6% 10.9% Underwriting expense ratio 33.9% 33.0% Combined ratio 104.9% 105.3% Investment income before taxes 191.6 176.7 (0.4)% Per average share outstanding* 2.67 2.30 3.1% Property and casualty reserves Unearned premiums 605.2 582.0 2.8% Losses 1,216.1 1,148.9 3.8% Loss adjustment expense 350.0 335.1 1.7% Statutory policyholders' surplus 643.4 465.8 5.4% 28 29 ITEM 14. CONTINUED MANAGEMENT'S DISCUSSION & ANALYSIS Ohio Casualty Corporation (the Corporation) is the holding company of The Ohio Casualty Insurance Company, which is one of six property-casualty companies that make up the Ohio Casualty Group (the Group). RESULTS OF OPERATIONS Net income increased 34.4% for 1999 to $114.1 million or $1.87 per share. Contributing to 1999 net income were investment gains from a strategic reallocation of the Group's investment portfolio during the second quarter. Outstanding growth in the equity portfolio combined with share repurchases caused the relationship of asset classes to fall outside the Group's long-standing guidelines. These guidelines limit the fair market value of equity securities to 80% of statutory surplus. The Corporation responded by selling approximately $200.0 million in equity securities, resulting in the recognition of $145.0 million in previously unrealized gains. The 1999 combined ratio increased by 5.6 points to 112.8%. Losses were negatively impacted by catastrophes with $52.2 million of catastrophe losses in 1999 versus $44.6 million in 1998 and $21.4 million in 1997. Underwriting expenses, as a percentage of net premiums written, increased by .8% in 1999, compared with an increase of 1.2% in 1998 and a decrease of .1% for 1997. General operating expenses, a component of underwriting expenses, have increased over the period of 1997 to 1999. The increase in operating expense for 1999 is primarily due to restructuring expenses amounting to approximately $20.0 million or 1.2 points. The increase for 1998 pertained to greater emphasis on advertising as a part of the Corporation's efforts to increase name recognition of its property and casualty operations. Statutory net premiums written increased $287.3 million in 1999 to $1.6 billion. $262.2 million of this increase reflects a full twelve months of results from the acquisition of Great American Insurance Companies ("GAI") Commercial Lines Division versus one month of activity in 1998. Net premiums written from the GAI acquisition amounted to $293.8 million in 1999 and $31.6 million in 1998. In addition, the Group's premium growth continued to be led by our key agents with a 3.6% increase in written premiums for the year. The Group has established a successful Key Producer Program for agencies who are willing to set and achieve goals in production, loss ratio and retention. Excluding the GAI Commercial Division acquisition, the largest increase in net premiums written occurred in the personal auto line of business with a $21.9 million increase and the largest increase in net premiums written by individual state came in Kentucky with a $13.5 million increase. New Jersey is our largest state with 15.8% of total net premiums written during 1999. 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 Group 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 Group paid $3.4 million in 1999, $3.2 million in 1998 and $4.2 million in 1997. The Corporation anticipates future assessments will not materially affect the Corporation's results of operations, financial position or liquidity. The New Jersey State Senate passed an auto insurance reform bill effective March 22, 1999 that mandates a 15% rate reduction for personal auto policies based on a reduction in medical expense benefits, limitations on lawsuits and enhanced fraud prevention provisions. All new and renewal policies written on or after March 22, 1999 reflect the 15% rate reduction. The anticipated impact on the Group is a tradeoff of lower premium rates on personal auto policies for presumably lower losses but the degree of offset, if any, is uncertain at present. For 1999, the Group had personal auto net premiums written in New Jersey of $124.4 million. The estimated reduction in net premiums written stemming from this reform bill for 1999 is approximately $11.3 million. The projected impact in 2000 is a further reduction of approximately $5.7 million. 29 30 ITEM 14. CONTINUED The state of New Jersey has also begun to require insurance companies to write a portion of their premiums in Urban Enterprise Zones (UEZ). These zones are urban areas frequently having high loss ratios. The Group is assigned premiums if it does not write the required amount on its own. During 1999, the Group wrote $5.7 million in UEZ premiums, with $6.7 million in additional assigned premiums. The 1999 loss ratio on UEZ premiums is 132.1% and the loss ratio on the assigned business is 142.9%. Net cash used for operations was $137.7 million, compared with cash produced of $24.6 million in 1998 and $26.4 million in 1997. The decrease in 1999 primarily resulted from lower operating income. Investing activities produced net cash of $108.1 million in 1999, compared with $93.5 million in 1998 and $164.0 million in 1997. Total cash used for financing activities was $125.5 million in 1999, compared with total cash produced of $66.9 million in 1998 and total cash used of $131.9 million in 1997. The decrease in 1999 primarily resulted from decreased borrowing from notes payable. Dividend payments were $56.0 million in 1999, compared with $57.9 million in 1998 and $57.5 million in 1997. Overall, total cash used in 1999 was $155.0 million, compared with cash generated of $184.9 million in 1998 and $58.4 million in 1997. In order to evaluate corporate performance, the Corporation calculates a five-year average return on equity. Net income and unrealized gains and losses on investments are included in the calculation to derive a total return. A five-year average is used to correspond to our planning horizon and emphasize consistent long-term returns, not intermediate fluctuations. Our five-year average return on equity was 12.0%, 14.3% and 15.5% for 1999, 1998 and 1997, respectively. As described in more detail in Note 14, the Group purchased substantially all of the Commercial Lines Division of Great American Insurance Companies ("GAI") on December 1, 1998. The acquisition has been treated as a purchase for accounting purposes. The revenue and profit reported include the results of the division from the December 1, 1998 acquisition date forward. The Group's strategy in purchasing substantially all of the Commercial Lines Division of GAI includes broadening its product mix and adding approximately 1,400 agents to the Group's existing agency plant. From a geographic point of view, the Group increased its presence in areas where it already does business and added a presence in the Northeast, a region in which the Group had hoped to expand. Finally, the Group anticipates that it will achieve financial benefits through cross-selling of products, economies of scale and reductions in expenses through improved processes. Property and casualty operating income was $14.8 million, $.24 per share, in 1999, compared with $74.9 million, $1.14 per share, in 1998 and $97.4 million, $1.42 per share in 1997. Catastrophe losses in 1999 totaled $52.2 million, compared with $44.6 million in 1998 and $21.4 million in 1997. There were 27 separate catastrophes in 1999, compared with 37 catastrophes in 1998 and 25 in 1997. Catastrophe losses added 3.4 points to the combined ratio in 1999, compared with 3.6 points in 1998 and 1.8 points in 1997. 1999 catastrophes included tornadoes in the greater Cincinnati and Oklahoma City areas as well as damages from Hurricane Floyd. 1998 catastrophes include wind and hail-related losses in Kentucky, Minnesota and Iowa. HIGH/LOW MARKET PRICE PER SHARE (IN DOLLARS) High Low 1999 21 11/16 15 1/16 1998 25 9/16 17 1/16 1997 25 3/8 17 3/16 1996 19 5/8 15 3/16 1995 19 1/2 14 1/8 1994 16 7/8 13 1/4 1993 17 15/16 14 3/8 1992 16 5/8 12 1/4 1991 12 9/16 10 1990 12 11/16 6 11/16 PRIVATE PASSENGER AUTO - AGENCY As one of the Group's top emphasis products, net premiums written from our personal auto segment increased for the fourth consecutive year. Net premiums written increased $11.5 million or 2.2% to $526.9 30 31 ITEM 14. CONTINUED million in 1999, compared with $515.4 million in 1998 and $464.7 million in 1997. Factors increasing 1999 premium include $7.2 million of acquired business in the state of Kentucky; $10.4 million increase in premiums written for Urban Enterprise Zones in New Jersey; $16.5 million resulting from converting from six- to twelve-month policies in New Jersey. These increases are offset by lower retention rates and a state-mandated premium rate rollback in New Jersey amounting to approximately $11.3 million. The combined ratio increased to 106.2% in 1999 from 103.4% in 1998 and 105.4% in 1997. In 1999, we experienced increased frequency of losses accompanied with nonrecurring expenses associated with the restructuring of the Group's personal lines business centers and claims branch offices. PRIVATE PASSENGER AUTO - DIRECT The Group began direct marketing of personal auto coverage in January 1998. In 1998, premium was generated in three states. In 1999, premium was being generated in ten states. Net premiums written increased $10.4 million or 164.3% in 1999 to $16.8 million from $6.3 million in 1998. $3.2 million of 1999 new business premiums were generated from various internet partnerships. Combined ratios were 209.7% and 169.7% for 1999 and 1998, respectively. High ratios for a direct start-up business can be expected due to initial costs for equipment, advertising and other start-up expenditures. Additionally, the majority of premium written is from first year business. Based on industry averages, loss ratios on first year business run approximately 25.0 to 30.0 points higher than seasoned business. COMMERCIAL MULTI PERIL, FIRE & INLAND MARINE (CMP) Net premiums written from our CMP segment have increased for four consecutive years. Net premiums written increased $79.4 million or 35.2% to $305.2 million in 1999, compared to $225.7 million in 1998 and $206.1 million in 1997. Acquired business from GAI contributed $80.3 million to the 1999 increase. The increase in 1998 is largely attributable to production from our key agents, which increased approximately $7.3 million from 1997. Intense competition among property-liability insurers is fueling a sustained period of inadequate pricing levels in the commercial segment. Consequently, rates have remained flat while the combined ratio increased in 1999 to 126.0% from 113.5% in 1998 and 107.7% in 1997. For 1999, nonrecurring restructuring expenses accompanied with increased severity of losses adversely impacted the combined ratio. Catastrophe losses added 7.8 points in 1999, 4.9 points in 1998 and 2.5 points in 1997. GENERAL LIABILITY Net premiums written increased $6.1 million or 7.9% in 1999 to $82.5 million, compared with $76.4 million in 1998 and $78.7 million in 1997. The 1999 increase was generated from the GAI acquisition adding $4.5 million or 5.9% The combined ratio increased 1.6 points in 1999 to 115.6%, compared with 114.0% in 1998 and 113.0% in 1997. This line continues to be subject to inadequate pricing arising from intense competition. While profitable premium growth remains very difficult to achieve, the Group is focusing efforts on underwriting integrity. UMBRELLA Net premiums written increased $49.7 million or 265.4% in 1999 to $68.4 million, compared with $18.7 million in 1998 and $18.0 million in 1997. The 1999 increase was primarily generated from the GAI acquisition adding $48.7 million. With the GAI acquisition, this segment now includes excess coverages which are new to the Group. Additionally, the Group has increased its limits, broadened classes it will write and improved coverage forms. These enhancements offer promising revenue opportunities. The 1999 combined ratio was 47.3%, compared with 48.8% in 1998 and 58.4% in 1997. As a result of the Group's very good experience, this segment is one of the Group's top emphasis products. 31 32 ITEM 14. CONTINUED COMMERCIAL AUTO Net premiums written increased $36.4 million or 26.2% in 1999 to $175.5 million, compared with $139.1 million in 1998 and $140.3 million in 1997. The 1999 increase was largely generated from the GAI acquisition adding $35.5 million or 25.5%. Excluding the acquisition, premiums were flat which is indicative of an exceptionally competitive market combined with selective underwriting. The 1999 combined ratio increased to 117.1%, compared with 105.4% in 1998 and 112.9% in 1997. 1999 was hindered by increased severity and large losses combined with higher overhead expenses associated with nonrecurring restructuring costs. WORKERS' COMPENSATION Net premiums written increased $91.5 million or 91.4% in 1999 to $191.7 million, compared with $100.2 million in 1998 and $97.2 million in 1997. The GAI acquisition contributed an additional $95.6 million or a 95.4% increase from 1998. Excluding the acquisition, net premiums written decreased $4.1 million or 4.7% in 1999 and decreased $9.7 million or 10.0% in 1998. These decreases are indicative of extremely competitive market conditions combined with increased emphasis on underwriting integrity. The combined ratio increased 7.9 points in 1999 to 117.5%, compared with 109.6% in 1998 and 93.0% in 1997. Fierce competition has resulted in flat rates while inflation, especially for medical costs, are driving losses upward. During 1999, the Group initiated various cost containment measures which are intended to mitigate this trend. For 1999, an increase in large losses as well as nonrecurring restructuring expenses hindered the combined ratio. HOMEOWNERS During 1999, the Group placed great emphasis on a homeowners Insurance-To-Value program. The program addresses underinsured homeowner properties and emphasizes adequate replacement cost values. Upon renewal, homeowners accounts are subject to a replacement cost valuation and appropriate premium increases are implemented. Also in 1999, homeowners products were offered as ancillary to our personal auto products. The Insurance-To-Value initiative and selective underwriting have resulted in a $1.2 million or .7% increase in 1999 net premiums written to $181.9 million in 1999, compared with $180.7 million in 1998 and $168.2 million in 1997. The combined ratio increased to 124.1% from 118.4% in 1998 and 111.2% in 1997. Combined ratios are heavily impacted by catastrophe losses which added 12.6 points in 1999, 15.2 points in 1998 and 8.1 points in 1997. FIDELITY & SURETY Net premiums written increased $1.1 million or 2.9% in 1999 to $38.1 million, compared with $37.0 million in 1998 and $34.4 million in 1997. Increases for the second consecutive year are primarily driven by commercial surety products and are fueled by a strong economy. The combined ratio decreased to 77.0% in 1999 from 81.4% in 1998 and 76.5% in 1997. The Group's combined ratio remains below the historical industry average of 86.2%. STATUTORY SURPLUS Statutory surplus, a traditional insurance industry measure of strength and underwriting capacity, was $899.8 million at December 31, 1999, compared with $1,027.1 million at December 31, 1998 and $1,109.5 million at December 31, 1997. The decrease in 1999 resulted from dividends, poor underwriting results and taxes on realized gains. The decrease in 1998 was due to the statutory treatment of agent relationships. The increase in 1997 was due primarily to unrealized gains in our investment portfolio and net income less dividends paid. The ratio of premiums written to statutory surplus is one of the measures used by insurance regulators to gauge the financial strength of an insurance company and indicates the ability of the Group to grow by writing additional business. Currently, the Group's ratio is 1.8 to 1. Ratios below 3 to 1 generally indicate additional capacity and financial strength. The National Association of Insurance Commissioners has developed a "Risk-Based Capital" formula for property and casualty insurers and life insurers. The formulas are 32 33 ITEM 14. CONTINUED intended to measure the adequacy of an insurer's capital given the asset structure and product mix of the company. Under the current formulas, all insurance companies in the Group comfortably exceed the necessary capital. NET PREMIUM WRITTEN DISTRIBUTION BY TOP STATES 1999 1998 1997 - ------------------------------------------------ New Jersey 15.8% 16.6% 17.9% Ohio 9.6% 11.3% 10.7% Kentucky 8.7% 9.1% 8.2% Pennsylvania 6.2% 7.4% 8.3% Illinois 5.1% 6.0% 5.2% - ------------------------------------------------ Premium distributions by state have shifted due to a full year of results from the GAI acquisition in 1999 versus one month in 1998. When excluding GAI, for comparison purposes, 1999 premiums increased $13.6 million in Kentucky, $9.2 million in New Jersey and $1.9 million in Ohio. Premiums decreased $9.5 million in Pennsylvania and $1.8 million in Illinois. Increased premiums in Kentucky result from a personal lines acquisition adding $9.3 million. The increase in New Jersey results from increased premiums written in Urban Enterprise Zones and converting from six- to twelve-month policies. These increases are offset by a state-mandated 15% rate rollback. The increase in Ohio is spread among homeowners, private and commercial auto and CMP. The decrease in Pennsylvania is driven by competitive pricing conditions in all lines. COMBINED RATIOS 1999 1998 1997 1996 1995 ===================================================================================================== Private Passenger Auto - Agency 106.2% 103.4% 105.4% 110.0% 100.3% Private Passenger Auto - Direct 209.7% 169.7% N/A N/A% N/A Commercial Multiple Peril, Fire and Inland Marine 126.0% 113.5% 107.7% 115.0% 105.7% General Liability 115.6% 114.0% 113.0% 89.1% 105.3% Umbrella 47.3% 48.8% 58.4% 35.9% 44.3% Commercial Auto 117.5% 109.6% 93.0% 94.3% 93.7% Workers' Compensation 117.1% 105.4% 112.9% 105.3% 115.3% Homeowners 124.1% 118.4% 111.2% 135.9% 113.7% Fidelity and Surety 77.0% 81.4% 76.5% 73.4% 84.5% - ----------------------------------------------------------------------------------------------------- Total 112.8% 107.2% 105.3% 109.5% 104.0% ===================================================================================================== RESTRUCTURING In December 1998, the Group initiated a restructuring and reorganization plan. Under the plan, the Group consolidated many of its branch locations for underwriting and claims throughout 1999. Personal lines business centers were reduced from five to three locations. Commercial underwriting branches were reduced from 17 to eight locations and claims branches were reduced from 38 to six locations. Workforce reductions have amounted to approximately 240 positions since the initial combination of personnel from the GAI acquisition. The plan is expected to generate approximately $14.0 million in annualized pre-tax savings upon full implementation. Restructuring charges recorded in 1998 were comprised of expenses associated with abandoned lease space totaling $10.0 million or $.15 per share before-tax and $6.5 million or $.10 per share after-tax. During 1999, the Group released $2.9 million of the liability due to payments under leases and $2.4 million for changes in assumptions used to establish the initial reserve. DISCONTINUED OPERATIONS During 1995, the Corporation's life operations were discontinued. In order to exit the life operations, The Ohio Casualty Insurance Company (the Company) executed an agreement in 1995 to reinsure the existing blocks of 33 34 ITEM 14. CONTINUED business through a 100% coinsurance arrangement. Since The Ohio Life Insurance Company was contractually replaced as the primary insurer, the Corporation recognized unamortized ceding commission of $1.1 million before tax in 1999, $1.1 million in 1998 and $10.7 million in 1997. On December 31, 1999, the Company sold 100% of The Ohio Life Insurance Company stock, thereby transferring all remaining assets and liabilities to the Buyer. The after-tax gain on this sale totaled $6.2 million, or $.11 per share. Net income from discontinued operations amounted to $4.3 million or $.07 per share in 1999, compared with $1.9 million or $.03 per share in 1998 and $8.7 million or $.13 per share in 1997. REINSURANCE In order to preserve capital and protect shareholder value, the Group purchases reinsurance against large or catastrophic losses. The Property Per Risk treaty covers the Group in the event that an insured sustains a property loss in excess of $1.0 million in a single insured event. Property reinsurance covers $29.0 million in excess of the retention. The Casualty Per Occurrence treaty covers the Group in the event an insured sustains a liability loss in excess of $1.0 million in a single insured event. Workers' compensation, umbrella and other casualty reinsurance covers $100.0 million, $50.0 million and $24.0 million, respectively, in excess of the retention. The catastrophe reinsurance treaty protects the Group against an accumulation of losses arising from one defined catastrophic occurrence or series of events. This treaty provides $150.0 million of coverage in excess of the Group's $25.0 million retention. In 1999, a portion of the catastrophe program was again renewed with a multi-year placement. The multi-year placements maintain rates, continuity and each reinsurer's overall share of the program. Over the last 20 years, there were two events that triggered coverage under our catastrophe reinsurance treaty. Losses and loss adjustment expenses from the Oakland Fires in 1991 and Hurricane Andrew in 1992 totaled $35.6 million and $29.8 million, respectively. Both of these losses exceeded our prior retention amount of $13.0 million. The Group recovered $33.9 million from reinsurers as a result of these events. Our reinsurance limits are designed to cover exposure to a catastrophic event expected to occur once every 300 years. The Aggregate Excess of Loss treaty covers the Group in the event that aggregate losses and allocated loss adjustment expenses exceed a 64% gross loss ratio subject to a $100 million aggregate limit. The Group also carries various treaties covering specialty lines of business brought about from the GAI transaction as well as facultative reinsurance contracts protecting certain individual risks. Reinsurance contracts do not relieve the Group of its obligation to policyholders. The collectibility of reinsurance is subject to the solvency of the reinsurers. Since the Group's reinsurance protection is an important component in our financial plan, we closely monitor the financial health and claims settlement performance of each of our reinsurers. Annually, financial statements are reviewed and various ratios calculated to identify reinsurers who have ceased to meet our standards of financial strength. If any reinsurers fail these tests, they are removed from the program at renewal. Currently, all of our domestic reinsurers have an A.M. Best rating of "A-" or better and the financial condition of all of our international reinsurers meet the Group's pre-established standards. Additionally, the Group utilizes a large base of reinsurers to mitigate its concentration risk. In 1999, 1998 and 1997 no reinsurer accounted for more than 10% of total ceded premiums. As a result of the Group's controls over reinsurance, uncollectible amounts have not been significant. CATASTROPHE LOSSES (IN MILLIONS) 1999 $52 1998 $45 1997 $21 1996 $62 1995 $27 34 35 ITEM 14. CONTINUED LOSS AND LOSS ADJUSTMENT EXPENSES The Group's largest liabilities are the reserves for losses and loss adjustment expenses. Loss and loss adjustment expense reserves are established for all incurred claims and are carried on an undiscounted basis before any credits for reinsurance recoverable. These reserves amounted to $1.9 billion at December 31, 1999, $2.0 billion at December 31, 1998 and $1.5 billion at December 31, 1997. In recent years, environmental liability claims have expanded greatly in the insurance industry. Fortunately, the Group has a substantially different mix of business than the industry. We have historically written small commercial accounts, and have not attracted significant manufacturing liability coverage. As a result, our environmental liability claims are substantially below the industry average. Our liability business reflected our current mix of approximately 66% contractors, 16% building/premises, 12% mercantile and only 6% manufacturers. Within the manufacturing category, we have concentrated on the light manufacturers, which further limits our exposure to environmental claims. Estimated asbestos and environmental reserves are composed of case reserves, incurred but not reported reserves and reserves for loss adjustment expense. For 1999, 1998 and 1997, respectively, those reserves were $41.1 million, $41.9 million and $40.1 million. Asbestos reserves were $9.6 million, $10.3 million and $7.0 million and environmental reserves were $31.5 million, $31.5 million and $33.2 million for those respective years. These loss estimates are based on currently available information. However, given the expansion of coverage and liability by the courts and legislatures, there is some uncertainty as to the ultimate liability. The Group changed its pollution exclusion policy language between 1985 and 1987 to effectively eliminate these coverages. CALIFORNIA WITHDRAWAL Due to a lack of profitability and a difficult regulatory environment, in 1992 the Group stopped writing business in California and in 1995 a withdrawal plan was approved by the California Department of Insurance. Under the terms of the plan, The Ohio Casualty Insurance Company, Ohio Security Insurance Company and West American Insurance Company withdrew from California, leaving American Fire and Casualty Company licensed to wind down the affairs of the Group. 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 have been less than would be considered "fair" by any reasonable standard. During the fourth quarter of 1994, the state of California assessed the Group $59.9 million for Proposition 103. In February 1995, California revised this billing to $47.3 million. 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 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. Thus far the Commissioner has not made a ruling. The asserted rollbacks to date have ranged from $24.4 million to $61.1 million. The Administrative Law Judge indicates clearly in her ruling that by her calculation the Group 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 Group's Constitutional argument that this rollback is confiscatory. The Group does not believe it is possible to pinpoint a specific rollback that may be required that is the most probable. The Group 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 $50.5 million at December 31, 1999. To date, the Group has paid $5.1 million in legal costs related to the withdrawal, Proposition 103 and Fair Plan assessments. 35 36 ITEM 14. CONTINUED INVESTMENTS Consolidated pre-tax investment income from continuing operations increased 9.0% to $184.3 million in 1999, compared with $169.0 million in 1998 and $177.7 million in 1997. After-tax investment income totaled $138.0 million in 1999, compared with $125.8 million in 1998 and $133.6 million in 1997. Pre-tax and after-tax investment income comparisons are impacted by investments in municipal bonds, which provide tax-free investment income. Cash flow from investment income has been impacted by our continued share repurchase program. During 1999, the Corporation purchased 2,478,000 shares of its common stock at a cost of $46.1 million, compared with 4,725,800 shares for $100.0 million in 1998 and 3,089,376 shares for $64.9 million in 1997. The Corporation is currently authorized to repurchase 1.6 million additional shares of its common stock to be held as treasury shares for stock options or other general corporate purposes. Since the beginning of 1987, we have repurchased 31.7 million shares at an average cost of $14.10 per share. In the future, we intend to continue repurchasing shares when doing so makes economic sense for the Corporation and its shareholders. At year end 1999, consolidated investments had a carrying value of $3.2 billion. The excess of market value over cost was $505.4 million, compared with $787.9 million at year-end 1998 and $697.6 million at year-end 1997. As mentioned in the Results of Operations section, the decrease in unrealized gains in 1999 was largely attributable to the Group's strategic reallocation of its investment portfolio. This resulted in $145.0 million of unrealized gains to be recognized. The after-tax proceeds have been invested in fixed income instruments which we anticipate will increase investment income in the future. The portfolio reallocation also impacted after-tax realized investment gains from continuing operations which amounted to $104.5 million in 1999, compared with $9.4 million in 1998 and $33.0 million in 1997. Tax exempt bonds decreased to 19.4% of the fixed income portfolio at year-end 1999 versus 34.8% and 39.4% for December 31, 1998 and 1997, respectively. The Corporation's financial position during the year did not require a large tax-exempt portfolio. As of December 31, 1999, the Corporation maintained $784.3 million in mortgage-backed securities, compared with $375.4 million and $347.1 million at December 31, 1998 and 1997, respectively. The 1999 increase is attributable to a redistribution of investments previously in tax exempt bonds and the strategic reallocation discussed above. The majority of mortgage-backed security holdings are less volatile planned amortization class, sequential structures and agency pass-through securities. Of this portfolio, $19.3 million, $9.6 million and $5.8 million were invested in more volatile bond classes (e.g. interest-only, super-floaters, inverses) in 1999, 1998 and 1997, respectively. The Group's fixed income strategy has been to maintain a portfolio with a laddered maturity structure and an intermediate duration. We believe that our portfolio composition and duration continue to be appropriate for our insurance business. Further, we do not try to time the financial markets. Instead, we believe it's prudent to remain fully invested at all times, subject only to our liquidity needs. Equity investments have decreased as a percentage of our consolidated portfolio from 27.3% in 1997 to 22.0% at year-end 1999. This decrease is again attributable to the strategic reallocation of the Group's investment portfolio mentioned earlier. The Corporation continues to have no exposure to futures, forwards, caps, floors, or similar derivative instruments as defined by Statement of Financial Accounting Standards No. 119. However, as noted in footnote number 17, the Corporation has an interest rate swap with Chase Manhattan Bank covering a portion of the outstanding balance of our line of credit. At year-end 1999, the amount covered by the swap was $10.0 million. This swap is not classified as an investment but rather as a hedge against a portion of the variable rate loan. Due to market conditions, the swap was eliminated in early 2000. MARKET RISK DISCLOSURES FOR FINANCIAL INSTRUMENTS Market risk is the risk of loss resulting from adverse changes in interest rates and market prices. In addition to market risk, the Corporation is exposed to other risks, including the credit risk related to its financial instruments 36 37 ITEM 14. CONTINUED and the underlying insurance risk relating to the Group's core business. The sensitivity analysis below summarizes only the exposure to market risk. The Corporation's investments are held for purposes other than trading with an objective of earning relative competitive returns by investing in a diverse portfolio of high-quality, liquid securities. As a result, the Corporation minimizes its credit risk. Interest Rate Risk - The Corporation has exposure to losses resulting from interest rate risk arising from potential volatility in interest rates. The Corporation attempts to mitigate its exposure to interest rate risk through active portfolio management including periodic reviews of our asset and liability positions. Estimates of cash flows, as well as the impact of interest rate fluctuations relating to the Corporation's investment portfolio and revolving line of credit are modeled and reviewed quarterly. Equity Price Risk - The Corporation's portfolio of marketable equity securities has exposure to losses resulting from equity price risk arising from potential volatility in equity market values. The Corporation attempts to mitigate its exposure to equity price risk by maintaining a portfolio of investments which are diversified across industries, and concentrations in any one company or industry are limited by parameters established by senior management. Market risk is actively managed by analysis of various portfolio characteristics on a routine basis. The following tables illustrate the hypothetical effect of an increase in interest rates of 100 basis points (1%) and a 10% decrease in equity values at December 31, 1999 and 1998, respectively. The changes in market rates selected reflect the Corporation's view of changes which are reasonably possible over a one-year period. These rates should not be considered a prediction by the Corporation of future events. This analysis is not intended to provide a precise forecast of the effect of changes in interest rates and equity prices on the Corporation's income, cash flow and shareholders' equity. In addition, the analysis does not take into account any actions the Corporation may take to reduce its exposure in response to market fluctuations. Estimated Adjusted Market Value December 31, 1999 Fair Value as indicated above - ------------------------------------------------------- Interest Rate Risk: Fixed maturities $2,377 $2,272 Short-term investments 104 104 Equity Price Risk: Equity securities 698 628 - ------------------------------------------------------- Totals $3,179 $3,004 ======================================================= Estimated Adjusted Market Value December 31, 1998 Fair Value as indicated above - ------------------------------------------------------- Interest Rate Risk: Fixed maturities $2,416 $2,312 Short-term investments 263 263 Equity Price Risk: Equity securities 925 832 - ------------------------------------------------------- Totals $3,604 $3,407 ======================================================= In addition to the above scheduled investments, the Corporation has a revolving line of credit. An increase in interest rates of one hundred basis points would result in additional annual interest expense of $2.3 million. Certain assumptions are inherent in the above analysis. The Corporation assumes an instantaneous shift in interest rates and equity prices at December 31, 1999 and 1998 and that the composition of its investment portfolio remains relatively constant. Also, the Corporation assumes a change in interest rates is reflected uniformly across all financial instruments even though interest rates on certain types of instruments may fluctuate or lag behind other instruments. The adjusted market values are estimated using discounted cash flow analysis and duration modeling. YEAR 2000 The Corporation successfully moved into the Year 2000 without impact or interruption to the business as a result of Year 2000 computer problems. Though no Year 2000 problems have occurred or are anticipated, the Corporation continues to monitor the situation. In 1999, the Corporation concluded its phased approach to convert its computer systems to be Year 2000 compliant. The four phases included in this approach were: awareness, planning, execution/ testing, and compliance. All phases were completed on schedule; however, we continued testing throughout 1999 to ensure utmost preparedness. 37 38 ITEM 14. CONTINUED 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 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 ensure that the conversion was completed on time. 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 included 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. In this environment, data was migrated forward and tested as the internal date in the computer was changed to critical dates in 1999 and 2000. This provided an excellent environment to test applications, system software and hardware. This involved individual and integrated compliance testing. The first step verified that the systems are compliant when they run independently. The second step verified compliance when they are integrated with all other systems with which they interface. Testing was performed throughout 1998 and 1999, 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 completed LPAR compliance testing. Following the completion of LPAR compliance testing, all systems underwent integrated testing of the production environment. This integrated testing, as was called for in our contingency plans, was repeated in the third and fourth quarters of 1999. 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 did not have to make an expensive effort to identify and remedy its Year 2000 issues and does not anticipate that it will be required to make further substantial expenditures to address any Year 2000 issues. As of December 31, 1999, the total amount spent for I/S related costs on the Year 2000 project is $2.8 million. These amounts do not include any costs associated with efforts made to contact third parties or related to contingency planning. During 1997, the Corporation began the compliance phase. The Year 2000 team identified all significant vendors, suppliers and agents of the Corporation and completed the initial contact to obtain written statements of their readiness and commitment to a date for their Year 2000 compliance. The Corporation monitored the Year 2000 status of these entities and developed contingency plans to reduce the possible disruption in business operations that may have resulted 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 had a system failure due to not being Year 2000 compliant, the Corporation believes this could have resulted in a delay in processing or reporting transactions of the Corporation, or a potential disruption in service to its customers, notwithstanding the Corporation's contingency plans to respond to these potential system failures by such third parties. The Corporation assessed 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 Companies ("GAI") on December 1, 1998. For a period of at least 24 months from the date of the acquisition, GAI is providing computer processing and communication services to the Group in connection with the acquired business pursuant to an Information Systems Agreement. Thus, the Corporation was 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 Group. The failure of GAI to have satisfactorily corrected a material Year 38 39 ITEM 14. CONTINUED 2000 problem in the computer processing systems being used to provide services to the Group in connection with the acquired business could have resulted in a material adverse effect on the ability of the Group to integrate the acquired business and to operate it on a profitable basis. The failure to correct a material Year 2000 problem could have resulted 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 have resulted in an interruption in the normal business operations. Due to the general uncertainty inherent in the Year 2000 problem, such failures could have materially and adversely affected 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 Group took various steps to manage this concern including providing educational information on Year 2000 to agents; adding clarification and exclusionary language to certain policies; and by evaluating underwriting practices. The Group believes that no coverage exists; however, minimal coverage may be interpreted to exist under some current liability and product policies. The Group has historically avoided manufacturing risks which produce computer or computer-dependent products. The Insurance Services Office (ISO) 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 Group addressed the Year 2000 issue by attaching the ISO exclusionary language, where approved by regulators, to general liability policies with a rating classification the Group believes could potentially have had Year 2000 losses. The ISO exclusionary language endorsement is included on all property policies where approved by regulators. These actions minimized the Group's potential exposure to Year 2000 underwriting 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 their company. The Group has written directors' and officers' (D&O) liability policies since 1995, with approximately $.6 million in premiums written in 1999. The Group managed its D&O Year 2000 exposure through underwriting guidelines which address Year 2000 issues in the application process. The Corporation had an effective program in place to resolve Year 2000 issues in a timely manner and has contingency plans to continue operations should an unforeseen situation arise. However, since it is not possible to anticipate all possible future outcomes, especially when third parties are involved, there could be scenarios in which the Corporation could experience interruptions in normal business operations. These scenarios include: disruption or delay in premium and claim processing; disruption in service to customers; litigation for Year 2000-related claims and adverse affects on the Group's ability to integrate the acquired business from GAI. The amount of potential liability and lost revenue cannot be reasonably estimated. NEW ACCOUNTING STANDARDS See discussion of new accounting standards in Note 21. FORWARD-LOOKING STATEMENTS The 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 report 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 uncertainties 39 40 ITEM 14. CONTINUED that may affect 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 of pricing 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 acquired from GAI and the ability of the Corporation to implement appropriate contingency plans to address Year 2000 problems which are not successfully remediated; ability of the Group to integrate the acquired business and to retain the acquired insurance business; and general economic and market conditions. 40 41 ITEM 14. CONTINUED OHIO CASUALTY CORPORATION & SUBSIDIARIES CONSOLIDATED BALANCE SHEET DECEMBER 31 (IN THOUSANDS, EXCEPT PER SHARE DATA) 1999 1998 1997 =========================================================================================================================== ASSETS Investments: Fixed maturities: Available-for-sale, at fair value $ 2,376,973 $ 2,415,904 $ 2,226,030 (Cost: $2,408,201; $2,307,734; $2,112,291) Equity securities, at fair value 698,129 924,906 859,475 (Cost: $161,498; $245,129; $275,637) Short-term investments, at fair value 104,398 262,863 65,849 (Cost: $104,446; $262,939; $65,849) - --------------------------------------------------------------------------------------------------------------------------- Total investments 3,179,500 3,603,673 3,151,354 Cash 45,559 42,139 54,206 Premiums and other receivables, net of allowance for bad debts of $9,338, $8,739 and $4,200, respectively 366,202 301,943 193,615 Deferred policy acquisition costs 177,745 176,606 126,063 Property and equipment, net of accumulated depreciation of $113,541, $97,991 and $87,232, respectively 94,670 80,065 50,699 Reinsurance recoverable 139,021 154,123 108,962 Agent relationships, net of accumulated amortization of $13,298, $1,031 and $0, respectively 293,565 308,206 0 Other assets 180,182 135,509 93,883 - --------------------------------------------------------------------------------------------------------------------------- Total assets $ 4,476,444 $ 4,802,264 $ 3,778,782 =========================================================================================================================== LIABILITIES Insurance reserves: Unearned premiums $ 725,399 $ 668,550 $ 495,076 Losses 1,544,967 1,580,599 1,176,614 Loss adjustment expenses 363,488 376,340 307,193 Future policy benefits 0 25,518 34,148 Notes payable 241,446 265,000 40,000 California Proposition 103 reserve 50,486 48,043 66,908 Deferred income taxes 62,843 140,730 95,389 Other liabilities 336,828 376,503 248,625 - --------------------------------------------------------------------------------------------------------------------------- Total liabilities (See Notes 1 and 8) 3,325,457 3,481,283 2,463,953 - --------------------------------------------------------------------------------------------------------------------------- SHAREHOLDERS' EQUITY Common stock, $.0625 par value 5,901 5,901 5,901 Authorized: 150,000 shares Issued shares: 94,418* Additional paid-in capital 4,286 4,135 3,872 Common stock purchase warrants 21,138 21,138 0 Accumulated other comprehensive income: Unrealized gain on investments, net of applicable income taxes 329,354 511,816 454,241 Retained earnings 1,243,463 1,185,349 1,158,308 Treasury stock, at cost (Shares: 34,335; 31,070; 26,364) * (453,155) (407,358) (307,493) - --------------------------------------------------------------------------------------------------------------------------- Total shareholders' equity 1,150,987 1,320,981 1,314,829 - --------------------------------------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 4,476,444 $ 4,802,264 $ 3,778,782 =========================================================================================================================== *Adjusted for 2 for 1 stock split effective July 22, 1999 (See Note 23) See notes to consolidated financial statements 41 42 ITEM 14. CONTINUED OHIO CASUALTY CORPORATION & SUBSIDIARIES STATEMENT OF CONSOLIDATED INCOME YEAR ENDED DECEMBER 31 (IN THOUSANDS, EXCEPT PER SHARE DATA) 1999 1998 1997 ======================================================================================================================== Premiums and finance charges earned $ 1,554,966 $ 1,268,824 $ 1,208,974 Investment income less expenses 184,287 169,024 177,700 Investment gains realized, net 160,827 14,411 50,749 - ------------------------------------------------------------------------------------------------------------------------ Total revenues 1,900,080 1,452,259 1,437,423 Losses and benefits for policyholders 1,008,668 805,020 751,207 Loss adjustment expenses 166,986 115,253 113,435 General operating expenses 173,212 120,304 103,299 Amortization of agent relationships 12,267 1,031 0 Amortization of deferred policy acquisition costs 401,993 316,516 303,494 Restructuring charge (2,378) 10,000 0 California Proposition 103 reserve, including interest 2,443 (18,865) (7,469) - ------------------------------------------------------------------------------------------------------------------------ Total expenses 1,763,191 1,349,259 1,263,966 - ------------------------------------------------------------------------------------------------------------------------ Income from continuing operations before income taxes 136,889 103,000 173,457 Income taxes: Current 11,067 6,258 44,263 Deferred 19,886 13,731 (1,198) - ------------------------------------------------------------------------------------------------------------------------ Total income taxes 30,953 19,989 43,065 - ------------------------------------------------------------------------------------------------------------------------ Income before discontinued operations 105,936 83,011 130,392 Income from discontinued operations, net of taxes of $78, $1,028 and $4,661, respectively (See Note 20) 4,270 1,916 8,655 Gain on sale of discontinued operations, net of taxes of $235, $0 and $0 (See Note 20) 6,190 0 0 Cumulative effect of accounting change, net of taxes (2,255) 0 0 - ------------------------------------------------------------------------------------------------------------------------ Net income $ 114,141 $ 84,927 $ 139,047 ======================================================================================================================== Other comprehensive income, net of taxes: Net change in unrealized gains (losses), net of income tax expense of $(98,249), $31,002 and $65,882, respectively (182,462) 57,575 122,199 - ------------------------------------------------------------------------------------------------------------------------ Comprehensive income (loss) (See Note 12) $ (68,321) $ 142,502 $ 261,246 ======================================================================================================================== Average shares outstanding - basic* 61,126 65,808 68,456 Average shares outstanding - diluted* 61,139 65,870 68,514 ======================================================================================================================== Earnings per share (basic and diluted):* Income from continuing operations, per share $ 1.73 $ 1.26 $ 1.90 Income from discontinued operations, per share 0.07 0.03 0.13 Gain on sale of discontinued operations, per share 0.11 0.00 0.00 Effect of change in accounting principle (net of taxes) (0.04) 0.00 0.00 - ------------------------------------------------------------------------------------------------------------------------ Net income, per share $ 1.87 $ 1.29 $ 2.03 ======================================================================================================================== *Adjusted for 2 for 1 stock split effective July 22, 1999 (See Note 23) 42 43 ITEM 14. CONTINUED OHIO CASUALTY CORPORATION & SUBSIDIARIES STATEMENT OF CONSOLIDATED SHAREHOLDERS' EQUITY COMMON ACCUMULATED ADDITIONAL STOCK OTHER TOTAL (in thousands, except per COMMON PAID-IN PURCHASE COMPREHENSIVE RETAINED TREASURY SHAREHOLDERS' share data) STOCK CAPITAL WARRANTS INCOME EARNINGS STOCK EQUITY ==================================================================================================================================== Balance, January 1, 1997 $ 5,901 $ 3,552 $ 0 $ 332,042 $ 1,076,545 $ (242,940) $1,175,100 Unrealized gain 188,081 188,081 Deferred income tax on net unrealized gain (65,882) (65,882) Net issuance of treasury stock under stock option plan (50 shares)* 320 172 305 797 Repurchase of treasury stock (3,089 shares)* (64,858) (64,858) Net income 139,047 139,047 Cash dividends paid ($.84 per share)* (57,456) (57,456) - ------------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 1997 $ 5,901 $ 3,872 $ 0 $ 454,241 $ 1,158,308 $ (307,493) $1,314,829 Unrealized gain 88,577 88,577 Deferred income tax on net unrealized gain (31,002) (31,002) Net issuance of treasury stock under stock option plan (20 shares)* 263 126 389 Repurchase of treasury stock (4,726 shares)* (99,991) (99,991) Issuance of warrants 21,138 21,138 Net income 84,927 84,927 Cash dividends paid ($.88 per share)* (57,886) (57,886) - ------------------------------------------------------------------------------------------------------------------------------------ Balance, December 31, 1998 $ 5,901 $ 4,135 $ 21,138 $ 511,816 $ 1,185,349 $ (407,358) $1,320,981 Unrealized gain (280,711) (280,711) Deferred income tax on net unrealized gain 98,249 98,249 Net issuance of treasury stock under stock option plan (24 shares) 151 290 441 Repurchase of treasury stock (2,478 shares) (46,087) (46,087) Net income 114,141 114,141 Cash dividends paid ($.92 per share) (56,027) (56,027) - ------------------------------------------------------------------------------------------------------------------------------------ BALANCE, DECEMBER 31, 1999 $ 5,901 $ 4,286 $ 21,138 $ 329,354 $ 1,243,463 $ (453,155) $1,150,987 ==================================================================================================================================== *Adjusted for 2 for 1 stock split effective July 22, 1999 (See Note 23) See notes to consolidated financial statements 43 44 ITEM 14. CONTINUED OHIO CASUALTY CORPORATION & SUBSIDIARIES STATEMENT OF CONSOLIDATED CASH FLOWS YEAR ENDED DECEMBER 31 (IN THOUSANDS) 1999 1998 1997 ========================================================================================================================== CASH FLOWS FROM: OPERATIONS Net income $ 114,141 $ 84,927 $ 139,047 Adjustments to reconcile net income to cash from operations: Changes in: Insurance reserves (17,153) (8,051) (315,255) Income taxes (5,510) (978) 10,691 Premiums and other receivables (64,259) 9,983 (6,939) Deferred policy acquisition costs (1,139) (13,171) (9,379) Reinsurance recoverable 15,101 (45,161) 253,720 Other assets (16,930) (39,156) (22,339) Other liabilities (38,806) 52,440 20,677 California Proposition 103 reserves 2,443 (18,865) (7,469) Amortization of agent relationships 12,267 1,031 0 Depreciation and amortization 28,769 15,902 16,035 Investment gains (162,698) (14,339) (52,382) Gain on sale of discontinued operations (See Note 20) (6,190) 0 0 Cumulative effect of an accounting change 2,255 0 0 - -------------------------------------------------------------------------------------------------------------------------- Net cash generated (used) from operating activities (137,709) 24,562 26,407 - -------------------------------------------------------------------------------------------------------------------------- INVESTING Purchase of securities: Fixed income securities - available-for-sale (1,572,645) (467,295) (351,393) Equity securities (26,696) (32,502) (66,433) Proceeds from sales: Fixed income securities - available-for-sale 1,287,982 425,355 342,193 Equity securities 302,355 51,217 144,688 Proceeds from maturities and calls: Fixed income securities - available-for-sale 133,269 136,066 103,165 Equity securities 3,000 21,848 10,013 Property and equipment: Purchases (31,425) (40,642) (18,968) Sales 1,270 517 702 Cash proceeds from sale of discontinued operations (See Note 20) 11,011 0 0 Cash paid in acquisition of business, net of cash acquired 0 (1,082) 0 - -------------------------------------------------------------------------------------------------------------------------- Net cash generated from investing activities 108,121 93,482 163,967 - -------------------------------------------------------------------------------------------------------------------------- FINANCING Notes payable: Borrowings 16,500 230,000 0 Repayments (40,054) (5,000) (10,000) Proceeds from exercise of stock options 211 1 371 Purchase of treasury stock (46,087) (100,212) (64,858) Dividends paid to shareholders (56,027) (57,886) (57,456) - -------------------------------------------------------------------------------------------------------------------------- Net cash generated (used) from financing activities (125,457) 66,903 (131,943) - -------------------------------------------------------------------------------------------------------------------------- Net change in cash and cash equivalents (155,045) 184,947 58,431 Cash and cash equivalents, beginning of year 305,002 120,055 61,624 - -------------------------------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of year $ 149,957 $ 305,002 $ 120,055 ========================================================================================================================== Additional disclosures: Interest paid $ 14,046 $ 3,547 $ 3,147 Income taxes paid 34,824 21,805 37,035 See notes to consolidated financial statements 44 45 ITEM 14. CONTINUED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (All dollar amounts in thousands, except share data, unless otherwise stated) NOTE 1 -- ACCOUNTING POLICIES A. NATURE OF BUSINESS Ohio Casualty Group includes six property and casualty insurers whose primary products consist of insurance for personal auto, commercial property, homeowners, workers' compensation and other miscellaneous lines. The Group operates through the independent agency system in over 40 states. Of 1999 net premium written, approximately 15.8% was generated in the state of New Jersey, 9.6% in Ohio and 8.7% in Kentucky. B. PRINCIPLES OF CONSOLIDATION The consolidated financial statements have been prepared on the basis of generally accepted accounting principles and include the accounts of Ohio Casualty Corporation and its subsidiaries. The results of operations of the acquisition of certain assets and liabilities of the Great American Insurance Company Commercial Lines Division ("GAI") have been included in the consolidated financial statements of the Corporation since the date of acquisition, December 1, 1998 (See Note 14). All significant inter-company transactions have been eliminated. C. INVESTMENTS Investment securities are classified upon acquisition into one of the following categories: (1) held to maturity securities (2) trading securities (3) available-for-sale securities Currently, the Corporation's investments are held as available-for-sale securities. Available-for-sale securities are those securities that would be available to be sold in the future in response to liquidity needs, changes in market interest rates, and asset-liability management strategies, among others. Available-for-sale securities are reported at fair value, with unrealized gains and losses excluded from earnings and reported as a separate component of shareholders' equity, net of deferred tax. Equity securities are carried at quoted market values and include nonredeemable preferred stocks and common stocks. Fair values of fixed maturities and equity securities are determined on the basis of dealer or market quotations or comparable securities on which quotations are available. Short-term investments include commercial paper and notes with original maturities of 90 days or less and are stated at fair value. Short-term investments are deemed to be cash equivalents. Realized gains or losses on disposition of investments are determined on the basis of specific cost of investments. D. PREMIUMS Property and casualty insurance premiums are earned principally on a monthly pro rata basis over the term of the policy; the premiums applicable to the unexpired terms of the policies are included in unearned premium reserve. E. DEFERRED POLICY ACQUISITION COSTS Acquisition costs incurred at policy issuance net of applicable ceding commissions are deferred and amortized over the term of the policy. Acquisition costs deferred consist of commissions, brokerage fees, salaries and benefits, and other underwriting expenses to include allocations for inspections, taxes, rent and other expenses which vary directly with the acquisition of insurance contracts. Periodically, we perform an analysis of the deferred policy acquisition costs in relation to the expected recognition of revenues including investment income to determine if any deficiency exists. No deficiencies have been indicated in the periods presented. F. PROPERTY AND EQUIPMENT Property and equipment are carried at cost less accumulated depreciation. Depreciation is computed principally on the straight-line method over the estimated lives of the assets. As of January 1, 1998, the Corporation adopted Statement of Position (SOP) 98-1 and began capitalizing costs incurred to internally develop software products used in the Corporation's operations. The Corporation amortizes these costs on a straight-line basis over the estimated useful life of the product, generally not to exceed five years. Unamortized software costs and accumulated amortization in the consolidated balance sheet were $17,960 and $368 at December 31, 1999, and $8,013 and $184 at December 31, 1998, respectively. G. AGENT RELATIONSHIPS The Corporation records an asset (agent relationships) for the excess of cost over the fair value of net assets acquired. Agent relationships are amortized on a straight-line basis over a twenty-five year period. Agent relationships are evaluated periodically as events or circumstances indicate a possible inability to recover their carrying amount. Such evaluation is based on various analyses, including cash flow and profitability projections that incorporate, as applicable, the impact on existing company businesses. The analyses necessarily involve significant management judgments to evaluate the capacity of an acquired business to perform within projections. If future undiscounted cash flows are insufficient to recover the carrying amount of the asset, an impairment loss will be recognized. H. LOSS RESERVES The reserves for unpaid losses and loss adjustment expenses are based on estimates of ultimate claim costs, including claims incurred but not reported, salvage and subrogation and inflation without discounting. The methods of making such estimates are continually reviewed and updated, and any resulting adjustments are reflected in earnings currently. I. DEFERRED INCOME TAXES The Corporation records deferred tax assets and liabilities based on temporary differences between the financial statement and tax bases of assets and liabilities using enacted tax rates in effect in the year in which the differences are expected to reverse. 45 46 ITEM 14. CONTINUED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (All dollar amounts in thousands, except share data, unless otherwise stated) J. STOCK OPTIONS The Corporation accounts for stock options issued to employees in accordance with Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees". Under APB 25, the Corporation recognizes expense based on the intrinsic value of options. K. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The insurance industry is subject to heavy regulation that differs by state. A dramatic change in regulation in a given state may have a material adverse impact on the Corporation. NOTE 2 -- INVESTMENTS Investment income is summarized as follows: 1999 1998 1997 - -------------------------------------------------------------- Investment income from: Fixed maturities $177,018 $155,153 $166,554 Equity securities 12,961 15,533 13,776 Short-term securities 5,942 5,332 3,477 - -------------------------------------------------------------- Total investment income 195,921 176,018 183,807 Investment expenses 11,634 6,994 6,107 --------- -------- -------- Net investment income $184,287 $169,024 $177,700 =============================================================== The proceeds, gross realized gains and gross realized losses from sales of available-for-sale securities were as follows: Gross Gross Net Realized Realized Realized December 31 Proceeds Gains Losses Gains - --------------------------------------------------------------- 1999 $1,590,337 $169,301 $8,474 $160,827 1998 476,572 22,531 8,120 14,411 1997 486,881 57,751 7,002 50,749 The increase in realized gains in 1999 was due to a strategic asset reallocation involving the sale of approximately $200 million in equity securities causing $145 million of realized gains during the year. The purpose of this reallocation was to bring the relationship of asset classes back in line with the Corporation's long standing portfolio guidelines. Proceeds from sales of securities increased in 1999 due to the selling of equity securities in the reallocation and an overall decrease of holdings in municipal securities as a result of our financial position during the year. Unrealized gains (losses) on investment in securities are summarized as follows: 1999 1998 1997 - ---------------------------------------------------------------- Unrealized gains (losses): Securities $(280,711) $ 88,577 $188,081 Deferred tax 98,249 (31,002) (65,882) - ---------------------------------------------------------------- Net unrealized gains $(182,462) $ 57,575 $122,199 (losses) ================================================================ The amortized cost and estimated market values of investments in debt and equity securities are as follows: GROSS GROSS ESTIMATED AMORTIZED UNREALIZED UNREALIZED FAIR 1999 COST GAINS LOSSES VALUE - ------------------------------------------------------------------- Securities available-for-sale: U.S. Government $ 65,214 $ 1,001 $ (1,108) $ 65,107 States, municipalities and political 456,959 9,724 (5,256) 461,427 subdivisions Corporate 1,082,975 17,344 (34,196) 1,066,123 securities Mortgage-backed securities: U.S. Government 47,865 30 (1,438) 46,457 Agency Other 755,188 5,093 (22,422) 737,859 - ------------------------------------------------------------------- Total fixed 2,408,201 33,192 (64,420) 2,376,973 maturities Equity securities 161,498 543,718 (7,087) 698,129 Short-term investments 104,446 29 (77) 104,398 - ------------------------------------------------------------------- Total securities, available-for-sale $2,674,145 $ 576,939 $ (71,584) $3,179,500 =================================================================== Gross Gross Estimated Amortized Unrealized Unrealized Fair 1998 Cost Gains Losses Value - --------------------------------------------------------------------- Securities available-for-sale: U.S. Government $ 74,534 $ 5,340 $ (20) $ 79,854 States, municipalities and political 800,945 38,668 (40) 839,573 subdivisions Debt securities issued by foreign 3,000 636 0 3,636 governments Corporate 1,062,165 62,275 (6,965) 1,117,475 securities Mortgage-backed securities: U.S. Government 6,130 145 0 6,275 Agency Other 360,960 9,226 (1,095) 369,091 - --------------------------------------------------------------------- Total fixed 2,307,734 116,290 (8,120) 2,415,904 maturities Equity securities 245,129 686,715 (6,938) 924,906 Short-term investments 262,939 5 (81) 262,863 - --------------------------------------------------------------------- Total securities, available-for-sale $2,815,802 $ 803,010 $(15,139) $3,603,673 ====================================================================== 46 47 ITEM 14. CONTINUED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (All dollar amounts in thousands, except share data, unless otherwise stated) Gross Gross Estimated Amortized Unrealized Unrealized Fair 1997 Cost Gains Losses Value - ---------------------------------------------------------------------- Securities available-for-sale: U.S. Government $ 66,244 $ 3,601 $ (1) $69,844 States, municipalities and political 835,355 40,405 (19) 875,741 subdivisions Debt securities issued by foreign 3,000 458 0 3,458 governments Corporate securities 872,904 58,046 (1,026) 929,924 Mortgage-backed securities: U.S. Government 16,876 678 (1) 17,553 Agency Other 317,912 12,838 (1,240) 329,510 - ---------------------------------------------------------------------- Total fixed 2,112,291 116,026 (2,287) 2,226,030 maturities Equity securities 275,637 597,803 (13,965) 859,475 Short-term investments 65,849 0 0 65,849 - ---------------------------------------------------------------------- Total securities, available-for- $2,453,777 $713,829 $(16,252) $3,151,354 sale ====================================================================== The amortized cost and estimated fair value of debt securities at December 31, 1999, by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Estimated Amortized Fair Cost Value - ----------------------------------------------------------------- Due in one year or less $ 43,062 $ 43,111 Due after one year through five 443,870 442,678 years Due after five years through ten 629,490 625,715 years Due after ten years 488,726 481,153 Mortgage-backed securities: U.S. Government Agency 47,865 46,457 Other 755,188 737,859 - ---------------------------------------------------------------- Total fixed maturities $ 2,408,201 $ 2,376,973 ================================================================ Certain securities were determined to have other than temporary declines in book value and were written down through realized investment losses. Total write-downs were $14,850, $12,709 and $14,433 during 1999, 1998 and 1997, respectively, representing a reduction in value of $6,967, $4,469 and $0 on fixed maturities and $7,883, $8,240 and $14,433 on equity securities. Proceeds from maturities and sales of investments in debt securities during 1999, 1998 and 1997 were $1,421,251, $561,421 and $445,358, respectively. Gross gains of $13,677, $23,108 and $12,665 and gross losses of $37,126, $6,778 and $4,311 were realized on those maturities and sales in 1999, 1998 and 1997, respectively. NOTE 3 -- FAIR VALUE OF FINANCIAL INSTRUMENTS The following table presents the carrying amounts and fair values of the Corporation's financial instruments: CARRYING FAIR 1999 AMOUNT VALUE - ------------------------------------------------------------ Assets Cash and short-term investments $ 149,957 $ 149,957 Securities - available-for- 3,075,102 3,075,102 sale Liabilities Long-term debt $ 241,446 $ 241,446 Carrying Fair 1998 Amount Value - ------------------------------------------------------------ Assets Cash and short-term investments $ 305,002 $ 305,002 Securities - available-for- sale 3,340,810 3,340,810 Liabilities Future policy benefits $ 25,518 $ 25,518 Long-term debt 265,000 265,000 Carrying Fair 1997 Amount Value - ------------------------------------------------------------ Assets Cash and short-term investments $ 120,055 $ 120,055 Securities - available-for- sale 3,085,505 3,085,505 Liabilities Future policy benefits $ 34,148 $ 34,148 Long-term debt 40,000 40,000 The Corporation believes that the fair value of long-term debt is approximately equal to its carrying value due to the market-based variable interest rates associated with the debt. NOTE 4 -- DEFERRED POLICY ACQUISITION COSTS Changes in deferred policy acquisition costs are summarized as follows: 47 48 ITEM 14. CONTINUED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (All dollar amounts in thousands, except share data, unless otherwise stated) 1999 1998 1997 - --------------------------------------------------------------- Deferred, January 1 $176,606 $126,063 $116,684 - --------------------------------------------------------------- Additions: Addition due to acquisition 0 37,371 0 Commissions and brokerage 250,390 207,747 190,029 Salaries and employee 70,823 50,194 46,241 benefits Other 80,826 70,654 67,301 - --------------------------------------------------------------- Deferral of expense 402,039 365,966 303,571 - --------------------------------------------------------------- Amortization to expense Discontinued operations (1,093) (1,093) (9,302) Continuing operations 401,993 316,516 303,494 - --------------------------------------------------------------- Deferred, December 31 $177,745 $176,606 $126,063 =============================================================== The above schedule includes deferred policy acquisition costs (net of unamortized ceding commission) for discontinued life insurance operations of $0, $(1,093) and $(2,186) as of 1999, 1998 and 1997, respectively. NOTE 5 -- INCOME TAX The effective income tax rate is less than the statutory corporate tax rate of 35% for 1999, 1998 and 1997 for the following reasons: 1999 1998 1997 - --------------------------------------------------------------- Tax at statutory rate $ 45,626 $ 36,050 $ 60,710 Tax exempt interest (12,543) (16,433) (16,522) Dividends received deduction (DRD) (3,483) (3,247) (3,239) Proration of DRD and tax exempt interest 2,124 2,826 2,796 Miscellaneous (771) 793 (679) - --------------------------------------------------------------- Actual tax $ 30,953 $ 19,989 $ 43,065 =============================================================== Tax years 1993 through 1995 are being examined by the Internal Revenue Service. Management believes there will not be a significant impact on the financial position or results of operations of the Corporation as a result of this audit. The components of the net deferred tax asset (liability) were as follows: 1999 1998 1997 - -------------------------------------------------------------- Unearned premium proration $ $ $ 34,065 38,574 35,209 Accrued expenses 34,595 48,549 52,520 Postretirement benefits 31,766 29,768 28,522 Discounted loss and loss expense reserves 69,955 70,663 78,217 - -------------------------------------------------------------- Total deferred tax assets 174,890 184,189 183,968 - -------------------------------------------------------------- Deferred policy (60,811) (49,765) (44,122) acquisition costs Unrealized gains on (176,922) (275,154) (244,591) investments - -------------------------------------------------------------- Total deferred tax (237,733) (324,919) (279,357) liabilities - -------------------------------------------------------------- Net deferred tax liability $ (62,843) $(140,730)$ (95,389) ============================================================== NOTE 6 -- EMPLOYEE BENEFITS The Corporation has a non-contributory defined benefit retirement plan, a contributory health care, life and disability insurance plan and a savings plan covering substantially all employees. Benefit expenses are as follows: 1999 1998 1997 - ---------------------------------------------------------- Employee benefit costs: Pension plan $ 1,858 $(1,610) $ (252) Health care 16,180 13,215 12,555 Life and disability insurance 743 502 463 Savings plan 2,948 2,404 2,321 - ---------------------------------------------------------- $21,729 $14,511 $15,087 ========================================================== The pension benefit is determined as follows: 1999 1998 1997 - ----------------------------------------------------------- Service cost (benefit) earned during the year $ 8,545 $ 6,011 $ 6,354 Interest cost on projected benefit obligation 15,729 15,068 15,003 Expected return on plan (19,598) (19,871) (18,650) assets Amortization of unrecognized net (3,017) (3,017) (3,017) obligation (asset) Amortization of unrecognized prior 199 199 58 service cost - ----------------------------------------------------------- Net pension benefit $ 1,858 $ (1,610)$ (252) =========================================================== Changes in the benefit obligation during the year: 1999 1998 1997 - ----------------------------------------------------------- Benefit obligation at beginning of year $239,293 $213,720 $197,538 - ----------------------------------------------------------- Service cost 8,545 6,011 6,354 Interest cost 15,729 15,068 15,003 Amendments 0 0 2,000 Actuarial loss (gain) (24,141) 17,132 4,142 Benefits paid (14,956) (12,638) (11,317) Curtailments 1,115 0 0 Special termination 3,509 0 0 benefits - ----------------------------------------------------------- Benefit obligation at end of year $229,094 $239,293 $213,720 =========================================================== Changes in pension plan assets during the year: 1999 1998 1997 - ------------------------------------------------------------- Fair value of plan assets at beginning of year $252,224 $276,477 $225,681 - ------------------------------------------------------------- Actual return on plan 40,279 (12,038) 62,113 assets Benefits paid (14,915) (12,215) (11,317) - ------------------------------------------------------------- Fair value of plan assets at end of year $277,588 $252,224 $276,477 ============================================================= Pension plan funding at December 31: 48 49 ITEM 14. CONTINUED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (All dollar amounts in thousands, except share data, unless otherwise stated) 1999 1998 1997 - -------------------------------------------------------------- Funded status $48,495 $12,931 $62,757 Unrecognized net gain 37,293 (6,697) 42,443 (loss) Unrecognized net assets 8,837 12,068 15,085 Unrecognized prior service cost (2,093) (2,308) (2,508) - -------------------------------------------------------------- Accrued pension liability $ 4,458 $ 9,868 $ 7,737 ============================================================== Expected long-term return on plan assets 8.75% 7.75% 8.25% Discount rate on plan benefit obligations 7.75% 6.75% 7.25% Expected future rate of salary increases 5.25% 5.25% 5.25% Pension benefits are based on service years and average compensation using the five highest consecutive years of earnings in the last decade of employment. The pension plan measurement date is October 1, 1999, 1998 and 1997. The maximum pension expense deductible for income tax purposes has been funded. Plan assets at December 31, 1999 include $27,057 of the Corporation's common stock at market value compared to $34,637 and $37,585 at December 31, 1998 and 1997, respectively. Postretirement benefit cost at December 31: 1999 1998 1997 - ------------------------------------------------------------- Service cost $ 3,141 $ 2,061 $ 1,739 Interest cost 6,448 5,753 5,588 Amortization of unrecognized 535 0 0 prior service costs - ------------------------------------------------------------- Net periodic postretirement benefit $10,124 $ 7,814 $ 7,327 cost ============================================================= Changes in the postretirement benefit obligation during the year: 1999 1998 1997 - -------------------------------------------------------------- Benefit obligation at beginning of year $98,347 $81,694 $71,797 - -------------------------------------------------------------- Service cost 3,141 2,061 1,739 Interest cost 6,448 5,753 5,588 Plan participants' contributions (4,652) (4,676) (3,912) Increase due to actuarial loss (gain), change in discount rate, or other assumptions (11,045) 7,099 6,326 Prior service cost unrecognized at year end 0 6,416 0 - -------------------------------------------------------------- Benefit obligation at end of year $92,239 $98,347 $81,694 ============================================================== Accrued postretirement benefit liability at December 31: 1999 1998 1997 - -------------------------------------------------------------- Accumulated postretirement benefit obligation $92,239 $98,347 $81,694 Unrecognized net gain (loss) 4,404 (6,642) (203) Unrecognized prior service cost (5,882) (6,416) 0 - ------------------------------------------------------------- Accrued postretirement benefit liability $90,761 $85,289 $81,491 ============================================================= Postretirement benefit weighted average rate assumptions at October 1: 1999 1998 1997 - -------------------------------------------------------- Medical trend rate 8% 7% 8% - -------------------------------------------------------- Dental trend rate 5% 5% 6% Ultimate health care trend rate 5% 5% 5% Discount rate 7.75% 6.75% 8.00% The above medical trend rates assumed for 1999, 1998 and 1997 were assumed to decrease .5%, 1% and 1% per year to the ultimate rate of 5% in 6, 2 and 3 years, respectively. The postretirement plan measurement date is October 1 for 1999, 1998 and 1997. Increasing the assumed health care cost trend by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1999 by approximately $15,681 and increase the postretirement benefit cost for 1999 by $2,227. Likewise, decreasing the assumed health care cost trend by one percentage point in each year would decrease the accumulated postretirement benefit obligation as of December 31, 1999 by approximately $12,913 and decrease the postretirement benefit cost for 1999 by $1,822. The Corporation's health care plan is a predominately managed care plan. Retired employees continue to be eligible to participate in the health care and life insurance plans. Employee contributions to the health care plan have been established as a flat dollar amount with periodic adjustments as determined by the Corporation. The health care plan is unfunded. Benefit costs are accrued based on actuarial projections of future payments. There are currently 3,582 active employees and 1,505 retired employees covered by these plans. Employees may contribute a percentage of their compensation to a savings plan. A portion of employee contributions is matched by the Corporation and invested in Corporation stock purchased on the open market by trustees of the plan. NOTE 7 - STOCK OPTIONS The Corporation is authorized under provisions of the 1993 Stock Incentive Programs to grant options to 49 50 ITEM 14. CONTINUED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (All dollar amounts in thousands, except share data, unless otherwise stated) purchase 2,587,000 shares of the Corporation's common stock to key executive employees, directors and other full time salaried employees at a price not less than the fair market value of the shares on dates the options are granted. The options granted may be either "Incentive Stock Options" or "Nonqualified Stock Options" as defined by the Internal Revenue Code; the difference in the option plans affects treatment of the options for income tax purposes by the individual employee and the Corporation. The options are non-transferable and exercisable at any time after the vesting requirements are met. Option expiration dates are ten years from the grant date. Options vest either at 100% six months from the grant date or at 33% per year for three consecutive years from the date of the grant. At December 31, 1999, 1,125,852 remaining options may be granted. In addition, the 1993 Stock Incentive Program provides for the grant of Stock Appreciation Rights in tandem with the stock options. Stock Appreciation Rights provide the recipient with the right to receive payment in cash or stock equal to appreciation in value of the optioned stock from the date of grant in lieu of exercise of the stock options held. At December 31, 1999, there were no outstanding stock appreciation rights. Restricted stock awards are occasionally granted by the Corporation. The common shares covered by a restricted stock award may be sold or otherwise disposed of only after a minimum of three years from the grant date of the award. The difference between issue price and the fair market value on the date of issuance is recorded as compensation expense. The amount of compensation expense recognized related to restricted stock awards was $231 in 1999, $387 in 1998 and $345 in 1997 before tax, respectively. Currently there are 37,852 shares of restricted stock outstanding. The Corporation also issues, at its discretion, dividend payment rights in connection with the grant of stock options. These rights entitle the holder to receive, for each dividend payment right, an amount in cash equal to the aggregate amount of dividends that the Corporation has paid on each common share from the date on which such right becomes effective through the payout date. One third of these rights becomes vested on each anniversary after the grant. Dividends accrue and payments are made when the rights are fully vested by the rightholder. The Corporation recognizes compensation expense accordingly. The amount of compensation expense related to dividend payment rights recognized in 1999 was $52 with $551 in 1998 and $517 in 1997 before tax. As of December 31, 1999, 1,003,000 dividend payment rights were outstanding. The Corporation continues to elect APB 25 for recognition of stock-based compensation expense. Under APB 25, expense is recognized based on the intrinsic value of the options. However, under the provision of FAS 123 the Corporation is required to estimate on the date of grant the fair value of each option using an option-pricing model. Accordingly, the Black-Scholes option pricing model is used with the following weighted-average assumptions: dividend yield of 4.5% for 1999, 1998 and 1997, expected volatility of 28.5% for 1999, 26.7% for 1998 and 26.1% for 1997, risk free interest rate of 5.25% for 1999, 5.63% for 1998 and 6.87% for 1997, and expected life of eight years. The following table summarizes information about the stock-based compensation plan as of December 31, 1999, 1998 and 1997, and changes that occurred during the year: 1999 1998 1997 - ---------------------------------------------------------------- Weighted- Weighted- Weighted- Avg Avg Avg Shares Exercise Shares Exercise Shares Exercise (000) Price (000) Price (000) Price ---------------- --------------- ---------------- Outstanding beginning 759 $20.26 525 $18.69 347 $16.92 of year Granted 723 20.31 246 23.49 240 20.72 Exercised (16) 17.50 (12) 12.50 (54) 16.67 Canceled (140) 20.67 0 (8) 16.19 ----- ---- --- Outstanding end of year 1,326 $20.28 759 $20.26 525 $18.69 ====== ==== === Options exercisable 527 320 162 at year end Weighted-Avg fair value of options $4.70 $5.30 $5.09 granted during the year Adjusted for July 22, 1999 2 for 1 stock split (See Note 23). At year end 1999, 1,326,262 options were outstanding with an average remaining contractual life of 7.97 years and weighted exercise price of $20.28. The outstanding options had an exercisable price ranging from $14.00 to $23.63. Of the amount outstanding, 527,259 were exercisable with a weighted average exercise price of $19.38. At year end 1998, 759,368 options were outstanding with an average remaining contractual life of 7.94 years and a weighted exercise price of $20.27. Of the amount outstanding, 319,362 were exercisable with a weighted average exercise price of $18.45. At year end 1997, 524,988 options were outstanding with an average remaining contractual life of 8.35 years and a weighted exercise price of $18.69. Of the amount outstanding, 162,986 were exercisable with a weighted average exercise price of $17.03. Had the Corporation adopted FAS 123, the amount of compensation expense that would have been recognized in 1999, 1998 and 1997 respectively, would be $1,831, $1,164 and $755. The Corporation's net income and earnings per share would have been reduced to the pro forma amounts disclosed below: 50 51 ITEM 14. CONTINUED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (All dollar amounts in thousands, except share data, unless otherwise stated) 1999 1998 1997 - ---------------------------------------------------- ----------- -------- ----------- Net Income As Reported: $114,141 $84,927 $139,047 Pro Forma: $112,491 $83,994 $138,411 Basic and diluted earnings per share As Reported: $1.87 $1.29 $2.03 Pro Forma: $1.84 $1.28 $2.02 NOTE 8 -- REINSURANCE AND OTHER CONTINGENCIES In the normal course of business, the Group seeks to reduce the loss that may arise from catastrophes or other events that cause unfavorable underwriting results by reinsuring certain levels of risk with other insurers or reinsurers. In the event that such reinsuring companies might be unable at some future date to meet their obligations under the reinsurance agreements in force, the Group would continue to have primary liability to policyholders for losses incurred. The Group evaluates the financial condition of its reinsurers and monitors concentrations of credit risk to minimize its exposure to significant losses from reinsurer insolvencies. The following amounts are reflected in the financial statements as a result of reinsurance ceded: 1999 1998 1997 - --------------------------------------------------------------- Ceded premiums earned, presented net $72,297 $35,334 $32,169 Ceded losses incurred, presented net 19,346 41,477 13,387 Reserve for unearned premiums 36,603 12,290 8,242 Reserve for losses 75,882 82,589 54,209 Reserve for future policy benefits 0 25,518 34,148 Reserve for loss adjustment expenses 9,770 8,707 7,794 Annuities are purchased from other insurers to pay certain claim settlements. These payments are made directly to the claimants; should such insurers be unable to meet their obligations under the annuity contracts, the Group would be liable to claimants for the remaining amount of annuities. The claim reserves are presented net of the related annuities on the Corporation's balance sheet. The total amount of unpaid annuities was $23,267, $24,155 and $25,123 at December 31, 1999, 1998 and 1997, respectively. On October 2, 1995, as part of the transaction involving the reinsurance of the Ohio Life business to Employers' Reassurance Corporation, The Ohio Casualty Insurance Company agreed to manage a $163,615 fixed income portfolio for Employers' Reassurance. The term of the agreement is seven years, terminating on October 2, 2002. There is no separate fee for this investment management service. The assets of the fixed income portfolio are not carried on the Corporation's balance sheet as these are assets of Employers' Reassurance Corporation. The agreement requires that the Corporation pay an annual rate of 7.25% interest to Employers' Reassurance and maintain the market value of the account at $163,615. As the market value fluctuates from this amount, the Corporation is required to make up the deficiency and is entitled to receive any excess. Accordingly, the Corporation accrues any deficiency or excess in market value over the guaranteed amount of $163,615. This results in either investment income or loss and is recorded in earnings of the current period. At December 31, 1999, the market value of the account was below the $163,615 required balance by $2,384, compared with excesses of $1,356 in 1998 and $2,080 in 1997. The deficit in 1999 was related to an overall drop in the market value due to rising interest rates. NOTE 9 -- LOSSES AND LOSS RESERVES The following table presents a reconciliation of liabilities for losses and loss adjustment expenses: 1999 1998 1997 - ------------------------------------------------------------- Balance as of January 1, net of reinsurance recoverables of $91,296, $62,003 and $70,048 $1,865,643 $1,421,804 $1,486,622 Addition related to acquisition 0 483,938 0 Incurred related to: Current year 1,176,072 989,114 922,065 Prior years (418) (66,119) (53,615) - ------------------------------------------------------------- 1,175,654 922,995 868,450 Paid related to: Current year 600,942 513,292 448,402 Prior years 617,026 449,802 484,866 - ------------------------------------------------------------- Total paid 1,217,968 963,094 933,268 Balance as of December 31, net of reinsurance recoverables of $85,126, $91,296 and $62,003 $1,823,329 $1,865,643 $1,421,804 ============================================================= The following table presents catastrophe losses incurred and the respective impact on the loss ratio: 1999 1998 1997 - ------------------------------------------------------------ Incurred losses $52,208 $44,595 $21,389 Loss ratio effect 3.4% 3.6% 1.8% In 1999, 1998 and 1997 there were 27, 37 and 25 catastrophes respectively. The largest catastrophe in each year was $17,900, $7,300 and $4,600 in incurred losses. Additional catastrophes with over $1,000 in incurred losses numbered 7, 14 and 3 in 1999, 1998 and 1997. The effect of catastrophes on the Corporation's results cannot be accurately predicted. As such, severe weather patterns could have a material adverse impact on the Corporation's results. Inflation has historically affected operating costs, premium revenues and investment yields as business expenses have increased over time. The long term effects of inflation are considered when estimating the ultimate 51 52 ITEM 14. CONTINUED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (All dollar amounts in thousands, except share data, unless otherwise stated) liability for losses and loss adjustment expenses. The liability is based on historical loss development trends which are adjusted for anticipated changes in underwriting standards, policy provisions and general economic trends. It is not adjusted to reflect the effect of discounting. Reserves for asbestos-related illnesses and toxic waste cleanup claims cannot be estimated with traditional loss reserving techniques. In establishing liabilities for claims for asbestos-related illnesses and for toxic waste cleanup claims, management considers facts currently known and the current state of the law and coverage litigation. However, given the expansion of coverage and liability by the courts and the legislatures in the past and the possibilities of similar interpretations in the future, there is uncertainty regarding the extent of remediation. Accordingly, additional liability could develop. Estimated asbestos and environmental reserves are composed of case reserves, incurred but not reported reserves and reserves for loss adjustment expense. For 1999, 1998 and 1997, respectively, total case, incurred but not reported and loss adjustment expense reserves were $41,098, $41,898 and $40,121. Asbestos reserves were $9,564, $10,364 and $6,966 and environmental reserves were $31,534, $31,534 and $33,155 for those respective years. NOTE 10 -- EARNINGS PER SHARE Basic and diluted earnings per share are summarized as follows: 1999 1998 1997 - --------------------------------------------------------------- Income from continuing operations $105,936 $83,011 $130,392 Average common shares outstanding - basic (000's) 61,126 65,808 68,456 Basic income from continuing operations per average share $1.73 $1.26 $1.90 =============================================================== Average common shares outstanding 61,126 65,808 68,456 Effect of dilutive securities 13 62 58 - --------------------------------------------------------------- Average common shares outstanding - diluted 61,139 68,870 68,514 Diluted income from continuing operations per average share $1.73 $1.26 $1.90 =============================================================== Adjusted for July 22, 1999 2 for 1 stock split (See Note 23). At December 31, 1999, 6,000,000 purchase warrants and 1,074,469 stock options were not included in earnings per share calculations for 1999 as they were antidilutive. NOTE 11 -- QUARTERLY FINANCIAL INFORMATION (UNAUDITED) 1999 FIRST SECOND THIRD FOURTH - -------------------------------------------------------------- Premiums and finance charges earned $384,545 $374,309 $384,274 $411,838 Net investment income 41,809 41,013 49,679 51,786 Investment gains (losses) realized 903 167,340 (2,269) (5,147) Income (loss) from continuing operations 11,717 96,673 (6,982) 4,528 Income from discontinued operations 1,795 104 117 2,254 Gain on sale of discontinued operations 0 0 0 6,190 Cumulative effect of accounting change, net of taxes (2,255) 0 0 0 Net income (loss) 11,257 96,777 (6,865) 12,972 Basic and diluted net income (loss) per share 0.18 1.58 (0.11) 0.22 1998 First Second Third Fourth - -------------------------------------------------------------- Premiums and finance charges earned $309,627 $311,663 $314,956 $332,406 Net investment income 44,634 41,299 42,231 40,860 Investment gains (losses) realized 4,082 8,151 3,537 (1,359) Income from continuing operations 30,914 9,989 22,903 19,205 Income from discontinued operations 280 345 278 1,013 Net income 31,194 10,334 23,181 20,218 Basic and diluted net income per 0.46 0.15 0.35 0.32 share The second quarter of 1999 investment gains realized included approximately $145,000 related to the strategic asset reallocation that was completed during the quarter. The fourth quarter adjustments for 1998 included income of $12,262 after tax for the reduction in Proposition 103 liability and an expense of $6,500 after tax for a restructuring charge. NOTE 12 -- COMPREHENSIVE INCOME Changes in accumulated other comprehensive income related to changes in unrealized gains (losses) on securities were as follows: 52 53 ITEM 14. CONTINUED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (All dollar amounts in thousands, except share data, unless otherwise stated) 1999 1998 1997 - -------------------------------------------------------------- Unrealized holding gains (losses) arising during the period, net of taxes $ (56,994) $71,207 $143,794 Less: Reclassification adjustment for gains included in net income, net of taxes 125,468 13,632 21,595 - --------------------------------------------------------------- Net unrealized gains (losses) on securities, net of taxes $(182,462) $57,575 $122,199 =============================================================== NOTE 13 -- SEGMENT INFORMATION 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 private passenger auto - agency, private passenger auto - direct, CMP, fire, inland marine, general liability, umbrella, workers' compensation, commercial auto, homeowners, fidelity and surety. 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. 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 it is reported internally to management. In 1999, the Group began managing the private passenger auto - direct segment separately from private passenger auto - agency and umbrella segment separately from general liability. As a result, prior year results for general liability and private passenger auto - agency have been restated to reflect this change. Asset information by reportable segment is not reported, since the Corporation does not produce such information internally. Private Passenger Auto - Agency 1999 1998 1997 - -------------------------------------------------------------- Net premiums written $526,884 $515,447 $464,693 % Increase 2.2% 10.9% 1.8% Net premiums earned 513,045 498,783 460,029 % Increase 2.9% 8.4% 0.6% Underwriting loss (before tax) (35,326) (20,732) (25,926) Loss ratio 69.3% 68.7% 72.0% Loss expense ratio 11.9% 10.3% 9.6% Underwriting expense ratio 25.0% 24.4% 23.8% Combined ratio 106.2% 103.4% 105.4% Impact of catastrophe losses on combined ratio 0.8% 1.2% 0.5% Private Passenger Auto - Direct 1999 1998 1997 - -------------------------------------------------------------- Net premiums written $ 16,776 $6,347 $ 0 % Increase 164.3% N/A N/A Net premiums earned 13,096 2,002 0 % Increase 554.1% N/A N/A Underwriting loss (before tax) (16,738) (3,488) 0 Loss ratio 129.1% 105.6% N/A Loss expense ratio 16.3% 15.9% N/A Underwriting expense ratio 64.3% 48.2% N/A Combined ratio 209.7% 169.7% N/A Impact of catastrophe losses on combined ratio 0.3% N/A N/A CMP, Fire, Inland Marine 1999 1998 1997 - ------------------------------------------------------------- Net premiums written $305,181 $225,749 $206,133 % Increase 35.2% 9.5% 5.6% Net premiums earned 298,766 217,236 200,330 % Increase 37.5% 8.4% 2.5% Underwriting loss (before tax) (80,245) (33,008) (17,812) Loss ratio 71.9% 64.5% 58.7% Loss expense ratio 11.1% 6.2% 7.0% Underwriting expense ratio 43.0% 42.8% 42.0% Combined ratio 126.0% 113.5% 107.7% Impact of catastrophe losses on combined ratio 7.8% 4.9% 2.5% General Liability 1999 1998 1997 - ------------------------------------------------------------- Net premiums written $82,489 $ 76,427 $ 78,653 % Increase (decrease) 7.9% (2.8%) (6.4%) Net premiums earned 71,562 78,061 80,947 % Decrease (8.3%) (3.6%) (6.1%) Underwriting loss (before tax) (17,063) (10,000) (9,379) Loss ratio 46.4% 41.7% 39.9% Loss expense ratio 15.2% 17.3% 23.3% Underwriting expense ratio 54.0% 55.0% 49.8% Combined ratio 115.6% 114.0% 113.0% Umbrella 1999 1998 1997 - ------------------------------------------------------------- Net premiums written $68,392 $18,717 $18,045 % Increase 265.4% 3.7% 0.4% Net premiums earned 70,453 18,474 18,023 % Increase (decrease) 281.4% 2.5% (0.9%) Underwriting gain (before tax) 37,826 9,181 7,487 Loss ratio 17.7% 11.3% 21.9% Loss expense ratio (2.8%) (2.0%) 1.5% Underwriting expense ratio 32.4% 39.5% 35.0% Combined ratio 47.3% 48.8% 58.4% 53 54 ITEM 14. CONTINUED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (All dollar amounts in thousands, except share data, unless otherwise stated) Workers' Compensation 1999 1998 1997 - ------------------------------------------------------------- Net premiums written $191,688 $100,150 $ 97,176 % Increase (decrease) 91.4% 3.1% (15.8%) Net premiums earned 195,773 100,336 103,484 % Increase (decrease) 95.1% (3.0%) (16.7%) Underwriting gain (loss) (before tax) (32,849) (9,606) 9,130 Loss ratio 71.9% 69.1% 57.2% Loss expense ratio 11.8% 8.2% 6.4% Underwriting expense ratio 33.8% 32.3% 29.4% Combined ratio 117.5% 109.6% 93.0% Commercial Auto 1999 1998 1997 - ------------------------------------------------------------- Net premiums written $175,482 $139,087 $140,295 % Increase (decrease) 26.2% (0.9%) 0.6% Net premiums earned 171,676 139,114 139,933 % Increase (decrease) 23.4% (0.5%) (1.8%) Underwriting loss (before tax) (30,803) (7,453) (18,146) Loss ratio 69.3% 61.2% 69.3% Loss expense ratio 11.4% 8.6% 10.2% Underwriting expense ratio 36.4% 35.6% 33.3% Combined ratio 117.1% 105.4% 112.9% Impact of catastrophe losses on combined ratio 1.0% 0.7% 0.3% Homeowners 1999 1998 1997 - ------------------------------------------------------------- Net premiums written $181,905 $180,697 $168,168 % Increase 0.7% 7.5% 1.0% Net premiums earned 183,047 177,419 166,474 % Increase 3.2% 6.6% 0.5% Underwriting loss (before tax) (43,667) (33,824) (19,254) Loss ratio 79.2% 73.8% 66.5% Loss expense ratio 9.3% 8.2% 8.7% Underwriting expense ratio 35.6% 36.4% 36.0% Combined ratio 124.1% 118.4% 111.2% Impact of catastrophe losses on combined ratio 12.6% 15.2% 8.1% Fidelity & Surety 1999 1998 1997 - ------------------------------------------------------------- Net premiums written $38,100 $37,022 $34,418 % Increase (decrease) 2.9% 7.6% (0.2%) Net premiums earned 36,890 36,403 35,045 % Increase 1.3% 3.9% 2.7% Underwriting gain (before tax) 7,722 6,351 8,663 Loss ratio 7.2% 10.3% 7.9% Loss expense ratio 5.9% 5.2% 2.8% Underwriting expense ratio 63.9% 65.9% 65.8% Combined ratio 77.0% 81.4% 76.5% Total Property & Casualty 1999 1998 1997 - ------------------------------------------------------------- Net premiums written $1,586,897 $1,299,643 $1,207,581 % Increase (decrease) 22.1% 7.6% (0.1%) Net premiums earned 1,554,308 1,267,828 1,204,265 % Increase (decrease) 22.6% 5.3% (1.6%) Underwriting loss (before tax) (211,143) (102,579) (65,237) Loss ratio 66.9% 63.7% 62.7% Loss expense ratio 10.7% 9.1% 9.4% Underwriting expense ratio 35.2% 34.4% 33.2% Combined ratio 112.8% 107.2% 105.3% Impact of catastrophe losses on combined ratio 3.4% 3.6% 1.8% All other 1999 1998 1997 - ------------------------------------------------------------- Revenues $13,707 $ 5,391 $ 6,833 Expenses 20,814 6,663 6,880 - ------------------------------------------------------------- Net income $ (7,107) $(1,272) $ (47) Reconciliation of Revenues 1999 1998 1997 - ------------------------------------------------------------- Net premiums earned for reportable segments $1,554,308 $1,267,828 $1,204,265 Investment income 181,078 164,812 172,372 Realized gains 144,754 26,516 58,912 Miscellaneous income (2,426) 162 453 - ------------------------------------------------------------- Total property and casualty revenues 1,877,714 1,459,318 1,436,002 (Statutory basis) Property and casualty statutory to GAAP adjustment 8,658 (12,450) (5,412) - ------------------------------------------------------------- Total revenues property and casualty 1,886,372 1,446,868 1,430,590 (GAAP basis) Other segment revenues 13,708 5,391 6,833 - ------------------------------------------------------------- Total revenues $1,900,080 $1,452,259 $1,437,423 ============================================================= Reconciliation of Underwriting gain (loss) (before tax) 1999 1998 1997 - ------------------------------------------------------------- Property and casualty under- writing loss (before $(211,143) $(102,579) $ (65,237) tax) (Statutory basis) Statutory to GAAP adjustment 26,905 28,528 15,597 - ------------------------------------------------------------- Property and casualty under- writing loss (before tax) (GAAP basis) (184,238) (74,051) (49,640) Net investment income 184,287 169,024 177,700 Realized gains 160,827 14,411 50,749 Other income (23,987) (6,384) (5,352) - ------------------------------------------------------------- Income from continuing operations before income $136,889 $103,000 $173,457 taxes ============================================================= NOTE 14 -- ACQUISITION OF COMMERCIAL LINES BUSINESS On December 1, 1998, the Group 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 Group 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, general liability and commercial auto. Four commercial 54 55 ITEM 14. CONTINUED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (All dollar amounts in thousands, except share data, unless otherwise stated) operations as well as substantially all California business and all pre-1987 environmental claims were excluded from the transaction. Under the asset purchase agreement, the Group assumed $645,813 of commercial lines insurance liabilities, $62,639 in other liabilities and acquired $287,900 of investments, $1,500 in cash and $119,052 in other assets. This resulted in an assumption by the Group of a net statutory-basis liability of $300,000 plus warrants to purchase 6 million shares of Ohio Casualty Corporation common stock at a price of $22.505. In addition, if the annualized production from the transferred agents at the end of eighteen months equals or exceeds the production in the twelve months prior to closing, GAI will receive an additional $40,000. This bonus payment grades down ratably where if eighteen-month annualized production equals 71% or less of previous production, no bonus payment is required. The bonus payment will be accrued as additional agent relationships when minimum contingency is achieved. The transaction was accounted for using the purchase method of accounting. The Corporation has recorded agent relationships of $308,550 relating to this transaction, consisting of $284,674 of net liabilities assumed, $21,138 in warrants given and $2,738 in acquisition expenses. Deferred policy acquisition costs of $37,371 were also recorded as a result of the transaction. The Corporation follows the practice of allocating purchase price to specifically identifiable intangible assets based on their estimated values as determined by appropriate valuation methods. In the GAI acquisition, allocation of the purchase price was made to agent relationships and deferred policy acquisition costs as the Corporation believes it did not acquire any other significant specifically identifiable intangible assets. The warrants which were issued in connection with the transaction provide for the purchase of the Corporation's common stock at $22.505 per share and expire in December 2003. The warrants may be settled through physical or net share settlement and thus have been recorded as equity in the financial statements at their estimated fair value. Estimated fair value was determined based on a third party appraisal of the warrants. The following table presents the unaudited proforma results of operations for 1998 and 1997 had the acquisition occurred at the beginning of each year. (Unaudited) 1998 1997 - ---------------------------- ------------- ------------- Revenues $1,750,528 $1,775,556 Net income 58,866 130,206 Diluted earnings per share 0.89 1.90 NOTE 15 -- RESTRUCTURE CHARGE During December 1998, the Group adopted a plan to restructure its branch operations. To continue in the Corporation's efforts to reduce expenses, personal lines business centers were reduced in 1999 from five to three locations. Underwriting branch locations were reduced from seventeen to eight locations and claims branches were reduced from thirty-eight to six locations in 1999. The Corporation recognized $10,000 in expense in its 1998 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. During 1999, the Corporation reduced $5,336 of liability. Of the total $5,336 reduced, $2,958 was due to payments under leases and $2,378 was for changes in assumptions used to establish the initial reserve. The activities under the plan were completed in 1999, but due to leases still in effect, the balance in the restructuring reserve, $4,664 at December 31, 1999, will continue to remain as leases expire in 2000. NOTE 16 -- STATUTORY ACCOUNTING INFORMATION The following information has been prepared on the basis of statutory accounting principles which differ from generally accepted accounting principles. The principal differences relate to deferred acquisition costs, required statutory reserves, assets not admitted for statutory reporting, California Proposition 103 reserve, agent relationships and deferred federal income taxes. 1999 1998 1997 - ----------------------------------------------------------- Property and Casualty Insurance Statutory net income $109,172 $ 82,044 $ 142,457 Statutory policyholders' surplus 899,759 1,027,105 1,109,517 The Ohio Casualty Insurance Company (the Company), domiciled in Ohio, prepares its statutory financial statements in accordance with the accounting practices prescribed or permitted by the Ohio Insurance Department. Prescribed statutory accounting practices include a variety of publications of the National Association of Insurance Commissioners (NAIC), as well as state laws, regulations and general administrative rules. Permitted statutory accounting practices encompass all accounting practices not so prescribed. The Company received written approval from the Ohio Insurance Department to have the California Proposition 103 liability reported as a direct charge to surplus and not included as a charge in the 1995 statutory statement of operations. Following this same treatment, during 1997 and 1998 the principal reduction in the Proposition 103 liability was taken as an increase to 55 56 ITEM 14. CONTINUED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (All dollar amounts in thousands, except share data, unless otherwise stated) statutory surplus and not included in the 1997 or 1998 statutory statements of operations. For statutory purposes, agent relationships related to the GAI acquisition were taken as a direct charge to surplus. The Corporation is dependent on dividend payments from its insurance subsidiaries in order to meet operating expenses and to pay dividends. Insurance regulatory authorities impose various restrictions and prior approval requirements on the payment of dividends by insurance companies and holding companies. At December 31, 1999, approximately $98,269 of retained earnings are not subject to restriction or prior dividend approval requirements. In 1998, the NAIC adopted the Codification of Statutory Accounting Principles guidance, which will replace the current Accounting Practices and Procedures manual as the NAIC's primary guidance on statutory accounting. The Codification provides guidance for areas where statutory accounting has been silent and changes current statutory accounting in some areas, e.g. deferred income taxes are recorded. The Ohio Insurance Department has adopted the Codification guidance, effective January 1, 2001. The Company has not estimated the potential effect of the Codification guidance. NOTE 17 -- BANK NOTE PAYABLE During 1997, the Corporation signed a credit facility that makes available a $300,000 revolving line of credit. This line of credit was accessed in 1997 to refinance the outstanding term loan balance the Corporation had at that time. In 1998, the line of credit was used for capital infusion of $200,000 into the property and casualty subsidiaries due to the acquisition. The line of credit was again accessed during 1998 for the purchase of a building and to purchase treasury shares. The credit agreement contains financial covenants and provisions customary for such arrangements. The agreement expires in October 2002, with any outstanding loan balance due at that time. The revolving line of credit maintains an interest rate swap that existed on the previous term loan. The effect of the swap agreement was to establish a fixed rate of 6.34% on the outstanding balance converted to the revolving line of credit. As of December 31, 1999, $10,000 was outstanding on the converted balance. The remaining balance and any additional borrowings under the line of credit bear interest at a periodically adjustable rate (6.67% at December 31, 1999). The interest rate is determined on various bases including prime rates, certificate of deposit rates and the London Interbank Offered Rate. Interest incurred on borrowings amounted to $14,055, $3,547 and $3,147 in 1999, 1998 and 1997, respectively. Under the loan agreement, the maximum permissible consolidated funded debt cannot exceed 30% of consolidated tangible net worth. NOTE 18 -- CALIFORNIA PROPOSITION 103 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 have been less than what would be considered "fair" by any reasonable standard. During the fourth quarter of 1994, the state of California assessed the Group $59,867 for Proposition 103. In February 1995, California revised this billing to $47,278. The assessment was revised again in August 1995 to $42,100 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 $35,900 or $39,900 plus interest. In 1998, the Administrative Law Judge finally issued a proposed ruling with a rollback liability of $24,428 plus interest. Her ruling was sent to the California Commissioner of Insurance to be accepted, rejected or modified. The Group expected the commissioner to rule sometime after the election in November 1998, but he has so far failed to do so. The asserted rollbacks to date have ranged from $24,428 to $61,197. The Administrative Law Judge indicates clearly in her ruling that by her calculation the Corporation would have lost approximately $1,000 on 1989 operations if a rollback of $24,428 were imposed. Given that conclusion, it is clear that any assessment greater than $24,428 would strengthen the Group's Constitutional argument that this rollback is confiscatory. The Group does not believe it is possible to pinpoint a specific rollback that may be required that is the most probable. The Group has established a contingent liability for Proposition 103 rollback at $24,428 plus simple interest at 10% from May 8, 1989. This brings the total reserve to $50,486 at December 31, 1999. To date, the Group has paid $5,147 in legal costs related to the withdrawal, Proposition 103, and Fair Plan assessments. NOTE 19 -- SHAREHOLDER RIGHTS PLAN In December 1989, the Board of Directors adopted the Shareholders Rights Agreement (the Agreement). The Agreement is designed to deter coercive or unfair takeover tactics and to prevent a person(s) from gaining control of the Corporation without offering a fair price to all shareholders. Under the terms of the Agreement, each outstanding common share is associated with one half of one common share purchase right, expiring in 2009. Currently, each whole right, when exercisable, entitles the registered 56 57 ITEM 14. CONTINUED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (All dollar amounts in thousands, except share data, unless otherwise stated) holder to purchase one common share of the Corporation at a purchase price of $125 per share. The rights become exerciseable for a 60 day period commencing 11 business days after a public announcement that a person or group has acquired shares representing 20 percent or more of the outstanding shares of common stock, without the prior approval of the board of directors; or 11 business days following commencement of a tender or exchange of 20 percent or more of such outstanding shares of common stock. If after the rights become exercisable, the Corporation is involved in a merger, other business consolidation or 50 percent or more of the assets or earning power of the Corporation is sold, the rights will then entitle the rightholders, upon exercise of the rights, to receive shares of common stock of the acquiring company with a market value equal to twice the exercise price of each right. The Corporation can redeem the rights for $0.01 per right at any time prior to becoming exercisable. NOTE 20 -- DISCONTINUED OPERATIONS (LIFE INSURANCE) Discontinued operations include the operations of Ohio Life, a subsidiary of The Ohio Casualty Insurance Company. On October 2, 1995, the Company transferred its life insurance and related businesses through a 100% coinsurance arrangement to Employers' Reassurance Corporation and entered into an administrative and marketing agreement with Great Southern Life Insurance Company ("Great Southern"). In connection with the reinsurance agreement, $144,469 in cash and $161,401 of securities were transferred to Employers' Reassurance to cover the liabilities of $348,479. Ohio Life received an adjusted ceding commission of $37,641 as payment. After deduction of deferred acquisition costs, the net ceding commission from the transaction was $17,284. During the fourth quarter of 1997, Great Southern legally replaced Ohio Life as the primary insurer for approximately 76% of the life insurance policies subject to the 1995 agreement. As a result of this assumption, fourth quarter of 1997 net income was positively impacted by a partial recognition of unamortized ceding commission. The after-tax impact was an increase to net income of $5,300. 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 $1,093 before tax during the fourth quarter 1998. In 1999, the Corporation recognized the remaining $1,093 of unamortized ceding commission. During 1999, Great Southern Life Insurance Company replaced Employers' Reassurance Corporation on the 100% coinsurance treaty. On December 31, 1999, the Company completed the sale of the Ohio Life shell, thereby transferring all remaining assets and liabilities, as well as reinsurance treaty obligations, to the Buyer. The after-tax gain on this sale totaled $6,200 million, or $.11 per share. Results of the discontinued life insurance operations for the years ended December 31 were as follows: 1999 1998 1997 - ------------------------------------------------------------- Gross premiums written $ 0 $ 0 $ 1,267 Net premiums earned 1,765 3,708 23,865 Net investment income 827 2,288 3,954 Realized investment gains (losses) 1,200 (72) 1,633 - ------------------------------------------------------------- Total income 3,792 5,924 29,452 Income before income taxes 4,349 2,944 13,316 - ------------------------------------------------------------- Provision for income taxes 79 1,029 4,661 - ------------------------------------------------------------- Net income $ 4,270 $ 1,916 $ 8,655 ============================================================= Gain on sale of discontinued operations - after tax $ 6,190 $ 0 $ 0 ============================================================= Assets and liabilities of the discontinued life insurance operations as of the years ended December 31 were as follows: 1999 1998 1997 - -------------------------------------------------------------- Cash $ 0 $ 24 $ 9,214 Investments 0 13,917 21,320 Deferred policy acquisition costs, net of unamortized ceding commission 0 (1,093) (2,185) Reinsurance receivable 0 36,599 36,198 Other assets 0 3,191 4,219 - -------------------------------------------------------------- Total assets $ 0 $52,638 $68,766 ============================================================== Future policy benefits $ 0 $25,518 $34,148 Deferred income tax 0 (1,215) (1,357) Other liabilities 0 46,822 35,512 - -------------------------------------------------------------- Total liabilities $ 0 $71,125 $68,303 ============================================================== NOTE 21 -- NEW ACCOUNTING STANDARDS 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, 2000 (January 1, 2001 for the Corporation). 57 58 ITEM 14. CONTINUED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (All dollar amounts in thousands, except share data, unless otherwise stated) NOTE 22 -- CHANGE IN ACCOUNTING METHOD During the first quarter of 1999, 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 has accrued a total liability for insurance assessments of $2,300 million net of taxes, as of January 1, 1999. This was recorded as a change in accounting method. NOTE 23 -- STOCK SPLIT On May 27, 1999, the Board of Directors declared a 2 for 1 stock split of the outstanding common shares of record on July 1, 1999. The split was effective in the form of a 100% stock dividend payable on July 22, 1999. The number of common shares outstanding and earnings per share information for prior years have been adjusted to reflect the stock split. 58 59 ITEM 14. CONTINUED (b) REPORTS ON FORM 8-K OR 8-K/A SINCE OCTOBER 1, 1999. On November 19, 1999, the Corporation filed Form 8-K announcing that Thomas A. Hayes, Executive Vice President and Chief Operating Officer of Ohio Casualty Corporation is no longer associated with the Corporation. On February 24, 2000, the Corporation filed Form 8-K announcing the resignation of Lauren N. Patch as President and Chief Executive Officer and from the Corporation's Board of Directors. The Corporation also named William L. Woodall President and Chief Executive Officer effective February 17, 2000, and successor to Joseph L. Marcum as Chairman of the Board effective April 26, 2000. (c) EXHIBITS. (SEE INDEX TO EXHIBITS ATTACHED HERETO.) 59 60 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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) March 13, 2000 By: /S/ WILLIAM L. WOODALL ---------------------- William L. Woodall President Chief Executive Officer Vice Chairman of the Board Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. March 13, 2000 /S/ JOSEPH L. MARCUM ---------------------------------------------------------------------------------- Joseph L. Marcum, Chairman of the Board March 13, 2000 /S/ WILLIAM L. WOODALL ---------------------------------------------------------------------------------- William L. Woodall, President, Chief Executive Officer, Vice Chairman of the Board March 13, 2000 /S/ TERRENCE J. BAEHR ---------------------------------------------------------------------------------- Terrence J. Baehr, Director March 13, 2000 /S/ ARTHUR J. BENNERT ---------------------------------------------------------------------------------- Arthur J. Bennert, Director March 13, 2000 /S/ JACK E. BROWN ---------------------------------------------------------------------------------- Jack E. Brown, Director March 13, 2000 /S/ CATHERINE E. DOLAN ---------------------------------------------------------------------------------- Catherine E. Dolan, Director March 13, 2000 /S/ WAYNE R. EMBRY ---------------------------------------------------------------------------------- Wayne R. Embry, Director March 13, 2000 /S/ VADEN FITTON ---------------------------------------------------------------------------------- Vaden Fitton, Director March 13, 2000 /S/ STEPHEN S. MARCUM ---------------------------------------------------------------------------------- Stephen S. Marcum, Director March 13, 2000 /S/ STANLEY N. PONTIUS ---------------------------------------------------------------------------------- Stanley N. Pontius, Director March 13, 2000 /S/ HOWARD L. SLONEKER III ---------------------------------------------------------------------------------- Howard L. Sloneker III, Director 60 61 FORM 10-K, ITEM 14 INDEX TO FINANCIAL STATEMENTS AND SCHEDULES OHIO CASUALTY CORPORATION The following statements are included herein as Item 14: Page Number in This Report -------------- Consolidated Balance Sheet at December 31, 1999, 1998, 1997 41 Statement of Consolidated Income for the years ended December 31, 1999, 1998 and 1997 42 Statement of Consolidated Shareholders' Equity for the years ended December 31, 1999, 1998 and 1997 43 Statement of Consolidated Cash Flow for the years ended December 31, 1999, 1998 and 1997 44 Notes to Consolidated Financial Statements 45-58 Report of Independent Accountants 62 Page Number in This Report -------------- The following financial statement schedules are included herein: Schedule I - Consolidated Summary of Investments Other Than Investments in Related Parties at December 31, 1999 63 Schedule II - Condensed Financial Information of Registrant for the years ended December 31, 1999, 1998 and 1997 64 Schedule III - Consolidated Supplementary Insurance Information for the years ended December 31, 1999, 1998 and 1997 65-67 Schedule IV - Consolidated Reinsurance for the years ended December 31, 1999, 1998 and 1997 68 Schedule V - Valuation and Qualifying Accounts for the years ended December 31, 1999, 1998 and 1997 69 Schedule VI - Consolidated Supplemental Information Concerning Property and Casualty Insurance Operations for the years ended December 31, 1999, 1998 and 1997 70 61 62 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Shareholders of Ohio Casualty Corporation: In our opinion, the consolidated financial statements listed in the index appearing under Item 14(a) on page 61 present fairly, in all material respects, the financial position of Ohio Casualty Corporation and its subsidiaries at December 31, 1999, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1999 in conformity with accounting principles generally accepted in the United States. In addition, in our opinion, the financial statement schedules listed in the index appearing under Item 14(a) on page 61 present fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedules are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedules based on our audits. We conducted our audits of these statements in accordance with auditing standards generally accepted in the United States, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. As discussed in Note 22 to the financial statements, the Company changed its method of accounting for insurance-related assessments. /s/ PricewaterhouseCoopers LLP PricewaterhouseCoopers LLP Cincinnati, Ohio February 3, 2000 62 63 Schedule I Ohio Casualty Corporation and Subsidiaries Consolidated Summary of Investments Other than Investments in Related Parties (In thousands) December 31, 1999 Amount shown Type of investment Cost Value in balance sheet - ------------------ ---- ----- ---------------- Fixed maturities Bonds: United States govt. and govt. agencies with auth $ 65,214 $ 65,107 $ 65,107 States, municipalities and political subdivisions 456,959 461,427 461,427 Corporate securities 1,082,975 1,066,123 1,066,123 Mortgage-backed securities: U.S. government guaranteed 47,865 46,457 46,457 Other 755,188 737,859 737,859 ---------- ---------- ---------- Total fixed maturities 2,408,201 2,376,973 2,376,973 Equity securities: Common stocks: Banks, trust and insurance companies 39,032 213,275 213,275 Industrial, miscellaneous and all other 122,378 484,718 484,718 Preferred stocks: Non-redeemable 88 136 136 Convertible 0 0 0 ---------- ---------- ---------- Total equity securities 161,498 698,129 698,129 Short-term investments 104,446 104,398 104,398 ---------- ---------- ---------- Total investments $2,674,145 $3,179,500 $3,179,500 ========== ========== ========== 63 64 Schedule II Ohio Casualty Corporation Condensed Financial Information of Registrant (In thousands) 1999 1998 1997 ---- ---- ---- Condensed Balance Sheet: Investment in wholly-owned subsidiaries, at equity $ 1,314,399 $ 1,482,064 $ 1,258,432 Investment in bonds/stocks 52,581 76,687 85,742 Cash and other assets 32,145 31,066 13,000 ----------- ----------- ----------- Total assets 1,399,125 1,589,817 1,357,174 Notes payable 241,446 265,000 40,000 Other liabilities 6,692 3,836 2,345 ----------- ----------- ----------- Total liabilities 248,138 268,836 42,345 Shareholders' equity $ 1,150,987 $ 1,320,981 $ 1,314,829 =========== =========== =========== Condensed Statement of Income: Dividends from subsidiaries $ 112,122 $ 119,988 $ 169,988 Equity in subsidiaries 8,955 (33,929) (30,867) Operating (expenses) (6,936) (1,132) (74) ----------- ----------- ----------- Net income $ 114,141 $ 84,927 $ 139,047 =========== =========== =========== Condensed Statement of Cash Flows: Cash flows from operations Net distributed income $ 105,186 $ 118,856 $ 169,914 Other (8,609) (2,562) (805) ----------- ----------- ----------- Net cash from operations 96,577 116,294 169,109 Investing Purchase of bonds/stocks (11,987) (200,740) (57,031) Sales of bonds/stocks 42,148 14,440 28,147 ----------- ----------- ----------- Net cash from investing 30,161 (186,300) (28,884) Financing Notes payable: Borrowings 16,500 230,000 (10,000) Repayments (40,054) (5,000) 0 Exercise of stock options 211 1 371 Purchase of treasury stock (46,087) (100,212) (64,858) Dividends paid to shareholders (56,027) (57,886) (57,456) ----------- ----------- ----------- Net cash from financing (125,457) 66,903 (131,943) Net change in cash 1,281 (3,103) 8,282 Cash, beginning of year 8,554 11,657 3,375 ----------- ----------- ----------- Cash, end of year $ 9,835 $ 8,554 $ 11,657 =========== =========== =========== 64 65 Schedule III Ohio Casualty Corporation and Subsidiaries Consolidated Supplementary Insurance Information (In thousands) December 31, 1999 Deferred Future policy Benefits, policy benefits Net losses and acquisition losses and Unearned Premium investment loss costs loss expenses premiums revenue income expenses ------------ -------------- ------------- ------------- ------------- ------------- Segment - ------- Property and casualty insurance: Underwriting Commercial auto $ 12,672 $ 186,221 $ 88,559 $ 171,676 $ $ 136,792 Private Passenger Auto - Agency 35,934 399,860 153,282 512,731 403,643 Private Passenger Auto - Direct 2,063 10,108 8,383 13,096 19,073 Workers' compensation 16,459 609,438 99,603 195,773 156,273 Gen. liability, A&H 14,745 214,921 42,816 71,562 53,321 Umbrella 6,732 67,668 39,229 70,453 460 Homeowners 28,213 64,193 98,221 183,047 160,311 CMP, fire and allied lines, inland marine 49,568 343,676 166,833 298,766 242,806 Fidelity, surety, burglary 11,359 12,370 28,319 36,890 2,975 Miscellaneous Income 69 Addition due to acquisition Investment 181,131 ------------ -------------- ------------- ------------- ------------- ------------- Total property and casualty insurance 177,745 1,908,455 725,245 1,554,063 181,131 1,175,654 Life ins.(discontinued operations) 1,765 827 Premium finance 154 903 113 Corporation 3,043 ------------ -------------- ------------- ------------- ------------- ------------- Total $177,745 $ 1,908,455 $725,399 $ 1,556,731 $185,114 $1,175,654 ============ ============== ============= ============= ============= ============= Amortization of deferred General acquisition operating Premiums costs expenses written ------------ ------------ -------------- Segment - ------- Property and casualty insurance: Underwriting Commercial auto $ 37,224 $ 13,893 $ 175,482 Private Passenger Auto - Agency 108,539 35,280 526,653 Private Passenger Auto - Direct 3,072 7,716 16,776 Workers' compensation 29,261 26,629 191,688 Gen. liability, A&H 29,066 6,213 82,489 Umbrella 12,840 12,074 68,392 Homeowners 47,470 17,503 181,905 CMP, fire and allied lines, inland marine 84,283 35,868 305,181 Fidelity, surety, burglary 18,836 5,477 38,100 Miscellaneous Income Addition due to acquisition 31,402 Investment ------------ ------------ -------------- Total property and casualty insurance 401,993 160,653 1,586,666 Life ins.(discontinued operations) (731) 174 Premium finance 1,277 804 Corporation 23,614 ------------ ------------ -------------- Total $401,262 $185,718 $1,587,470 ============ ============ ============== 1. Net investment income has been allocated to principal business segments on the basis of separately identifiable assets. 2. The principal portion of general operating expenses has been directly attributed to business segment classifications incurring such expenses with the remainder allocated based on policy counts. 65 66 Schedule III Ohio Casualty Corporation and Subsidiaries Consolidated Supplementary Insurance Information (In thousands) December 31, 1998 Deferred Future policy Benefits, policy benefits Net losses and acquisition losses and Unearned Premium investment loss costs loss expenses premiums revenue income expenses ------------ -------------- ------------- ------------- ------------ ------------- Segment - ------- Property and casualty insurance: Underwriting Commercial auto $ 9,890 $ 189,817 $ 83,448 $ 139,114 $ $ 97,077 Private Passenger Auto - Agency 34,700 417,316 139,195 498,225 393,879 Private Passenger Auto - Direct 862 1,254 4,348 2,002 2,433 Workers' compensation 7,627 591,527 95,839 100,336 77,632 Gen. liability, A&H 12,008 259,017 52,984 78,061 46,013 Umbrella 2,946 61,152 12,509 18,474 1,895 Homeowners 28,379 63,230 98,807 177,419 145,500 CMP, fire and allied lines, inland marine 38,542 348,013 154,233 217,236 153,575 Fidelity, surety, burglary 11,342 14,532 27,019 36,403 5,662 Miscellaneous Income 334 Investment 164,812 Addition due to acquisiton 31,402 Retro reinsurance assumed from acquisition ------------ -------------- ------------- ------------- ------------ ------------- Total property and casualty insurance 177,698 1,945,858 668,382 1,267,604 164,812 923,666 Life ins. (discontinued operations) (1,092) 36,599 3,709 2,288 (1) Premium finance 168 1,219 94 Corporation 4,118 ------------ -------------- ------------- ------------- ------------ ------------- Total $176,606 $ 1,982,457 $ 668,550 $ 1,272,532 $ 171,312 $923,665 ============ ============== ============= ============= ============ ============= Amortization of deferred General acquisition operating Premiums costs expenses written ------------ ------------ ------------- Segment - ------- Property and casualty insurance: Underwriting Commercial auto $ 26,833 $ 18,309 $ 139,087 Private Passenger Auto - Agency 100,122 11,684 514,915 Private Passenger Auto - Direct 439 146 6,347 Workers' compensation 18,060 11,912 100,150 Gen. liability, A&H 27,202 11,766 76,427 Umbrella 6,673 2,887 18,717 Homeowners 46,448 17,497 180,697 CMP, fire and allied lines, inland marine 67,125 24,541 225,749 Fidelity, surety, burglary 17,646 6,124 37,021 Miscellaneous Income Investment Addition due to acquisiton 5,968 Retro reinsurance assumed from acquisition 137,636 ------------ ------------ ------------- Total property and casualty insurance 316,516 104,866 1,436,746 Life ins. (discontinued operations) 2,524 456 Premium finance 1,529 1,170 Corporation 6,075 ------------ ------------ ------------- Total $ 319,040 $ 112,926 $1,437,916 ============ ============ ============= 1. Net investment income has been allocated to principal business segments on the basis of separately identifiable assets. 2. The principal portion of general operating expenses has been directly attributed to business segment classifications incurring such expenses with the remainder allocated based on premium volume. 66 67 Schedule III Ohio Casualty Corporation and Subsidiaries Consolidated Supplementary Insurance Information (In thousands) December 31, 1997 Deferred Future policy Benefits, policy benefits Net losses and acquisition losses and Unearned Premium investment loss costs loss expenses premiums revenue income expenses ------------ -------------- ------------- ------------- ------------- ------------ Segment - ------- Property and casualty insurance: Underwriting Commercial auto $ 8,835 $ 167,558 $ 64,350 $ 139,932 $ $107,740 Private Passenger Auto - Agency 29,247 421,276 122,536 459,180 375,431 Workers' compensation 5,290 367,802 40,705 103,484 65,762 Gen. liability, A&H 11,411 207,902 35,199 80,947 51,104 Umbrella 2,625 46,257 7,831 18,024 4,227 Homeowners 26,582 64,681 94,752 166,474 125,136 CMP, fire and allied lines, inland marine 33,537 193,885 103,751 200,330 131,499 Fidelity, surety, burglary 10,721 12,296 25,759 35,045 3,743 Miscellaneous Income 3,925 Investment 172,372 ------------ -------------- ------------- ------------- ------------- ------------ Total property and casualty insurance 128,248 1,481,657 494,883 1,207,341 172,372 864,642 Life ins.(discontinued operations) (2,185) 36,298 23,865 3,954 268 Premium finance 193 1,632 65 Corporation 5,264 ------------ -------------- ------------- ------------- ------------- ------------ Total $126,063 $ 1,517,955 $495,076 $ 1,232,838 $181,655 $864,910 ============ ============== ============= ============= ============= ============ Amortization of deferred General acquisition operating Premiums costs expenses written ------------ ------------ ------------- Segment - ------- Property and casualty insurance: Underwriting Commercial auto $ 28,242 $ 15,886 $ 140,295 Private Passenger Auto - Agency 93,488 9,047 463,933 Workers' compensation 21,313 9,979 97,176 Gen. liability, A&H 27,423 9,428 78,653 Umbrella 6,308 2,169 18,045 Homeowners 44,666 15,897 168,168 CMP, fire and allied lines, inland marine 64,520 21,220 206,133 Fidelity, surety, burglary 17,534 5,220 34,418 Miscellaneous Income Investment ------------ ------------ ------------- Total property and casualty insurance 303,494 88,846 1,206,821 Life ins.(discontinued operations) 15,049 819 6 Premium finance 1,655 1,511 Corporation 5,329 ------------ ------------ ------------- Total $318,543 $ 96,649 $1,208,338 ============ ============ ============= 1. Net investment income has been allocated to principal business segments on the basis of separately identifiable assets. 2. The principal portion of general operating expenses has been directly attributed to business segment classifications incurring such expenses with the remainder allocated based on policy counts. 67 68 Schedule IV Ohio Casualty Corporation and Subsidiaries Consolidated Reinsurance (In thousands) December, 1999, 1998 and 1997 Percent of amount Ceded to Assumed assumed Gross other from other Net to net amount companies companies amount amount ------------ ------------ ------------ ------------ ------------ Year Ended December 31, 1999 Life insurance in force $ 279 $ 279 $ 0 $ 0 0.0% Premiums Property and casualty insurance $ 1,325,243 $ 106,852 $ 368,275 $ 1,586,666 23.2% Life insurance (Discontinued operations) 1,694 1,694 0 0 0.0% Accident and health insurance 198 198 0 0 0.0% ------------ ------------ ------------ ------------ Total premiums 1,327,135 108,744 368,275 1,586,666 23.2% Premium finance charges 804 Life insurance - FAS 97 adjustment 0 ------------ Total premiums and finance charges written 1,587,470 Change in unearned premiums and finance charges (29,911) Retro reinsurance assumed from acquisition - ------------ Total premiums and finance charges earned 1,557,559 Miscellaneous income (2,593) Discontinued operations - life insurance 0 ------------ Total premiums & finance charges earned - continuing operations $ 1,554,966 ============ Year Ended December 31, 1998 Life insurance in force $ 329 $ 329 $ 0 $ 0 0.0% Premiums Property and casualty insurance $ 1,289,837 $ 79,268 $ 226,177 $ 1,436,746 15.7% Life insurance (Discontinued operations) 3,187 3,187 0 0 0.0% Accident and health insurance 567 567 0 0 0.0% ------------ ------------ ------------ ------------ Total premiums 1,293,591 83,022 226,177 1,436,746 15.7% Premium finance charges 1,170 Life insurance - FAS 97 adjustment 0 ------------ Total premiums and finance charges written 1,437,916 Change in unearned premiums and finance charges (31,790) Retro reinsurance assumed from acquisition (137,636) ------------ Total premiums and finance charges earned 1,268,490 Miscellaneous income 334 Discontinued operations - life insurance 0 ------------ Total premiums & finance charges earned - continuing operations $ 1,268,824 ============ Year Ended December 31, 1997 Life insurance in force $ 547 $ 547 $ 0 $ 0 0.0% ============ ============ ============ ============ Premiums Property and casualty insurance $ 1,225,813 $ 31,298 $ 12,306 $ 1,206,821 1.0% Life insurance (Discontinued operations) 18,359 18,359 0 0 0.0% Accident and health insurance 1,392 1,575 189 6 3150.0% ------------ ------------ ------------ ------------ Total premiums 1,245,564 51,232 12,495 1,206,827 1.0% Premium finance charges 1,511 Life insurance - FAS 97 adjustment 0 ------------ Total premiums and finance charges written 1,208,338 Change in unearned premiums and finance charges (3,283) ------------ Total premiums and finance charges earned 1,205,055 Miscellaneous income 3,925 Discontinued operations - life insurance (6) ------------ Total premiums & finance charges earned - continuing operations $ 1,208,974 ============ 68 69 Schedule V Ohio Casualty Corporation and Subsidiaries Valuation and Qualifying Accounts (In thousands) Balance at Addition Balance at beginning Charged to due to end of of period expenses Acquisition Deductions period Year ended December 31, 1999 Reserve for bad debt 8,739 600 0 0 9,339 Year ended December 31, 1998 Reserve for bad debt 4,200 100 4,439 0 8,739 Year ended December 31, 1997 Reserve for bad debt 3,700 500 0 0 4,200 69 70 Schedule VI Ohio Casualty Corporation and Subsidiaries Consolidated Supplemental Information Concerning Property and Casualty Insurance Operations (In thousands) Claims and claim Reserves for adjustment expenses Deferred unpaid claims incurred related to policy and claim Discount Net ----------------------- Affiliation with acquisition adjustment of Unearned Earned investment Current Prior registrant costs expenses reserves premiums premiums income year years ----------- ------------ --------- ---------- ----------- ---------- ----------- ----------- Property and casualty subsidiaries Year ended December 31, 1999 $ 177,745 $ 1,908,455 $ 0 $ 725,245 $1,554,063 $ 181,131 $1,176,072 $ (418) =========== ============ ========= ========== =========== ========== =========== ========== Year ended December 31, 1998 $ 177,698 $ 1,945,858 $ 0 $ 668,382 $1,267,604 $ 164,812 $ 989,115 $ (66,119) =========== ============ ========= ========== =========== ========== =========== ========== Year ended December 31, 1997 $ 128,248 $ 1,481,657 $ 0 $ 494,883 $1,207,341 $ 172,372 $ 921,818 $ (53,615) =========== ============ ========= ========== =========== ========== =========== ========== Amortization Paid of deferred claims policy and claim Affiliation with acquisition adjustment Premiums registrant costs expenses written ----------- ------------ ------------ Property and casualty subsidiaries Year ended December 31, 1999 $ 401,993 $1,217,948 $ 1,586,666 =========== ============ ============ Year ended December 31, 1998 $ 316,516 $ 963,094 $ 1,436,746 =========== ============ ============ Year ended December 31, 1997 $ 303,494 $ 929,399 $ 1,206,821 =========== ============ ============ 70 71 FORM 10-K OHIO CASUALTY CORPORATION INDEX TO EXHIBITS Page Number ------ Exhibit 21 Subsidiaries of Registrant 72 Exhibit 23 Consent of Independent Accountants to incorporation of their opinion by reference in Registration Statement on Form S-3 and Form S-8 73 Exhibit 27 Financial Data Schedule 74 Exhibit 28 Information from Reports Furnished to State Insurance Regulation Authorities 75-88 Exhibits incorporated by reference: Exhibit 2 Asset Purchase Agreement between Ohio Casualty Corporation and Great American Insurance Company filed with Form 10Q on November 13, 1998 Exhibit 3 Amended Articles of Incorporation and Code of Regulations filed with Form 8-K on January 15, 1987 Exhibit 3a Amendment to Amended Articles of Incorporation authorizing a new class of 2,000,000 shares of preferred stock, dated April 15, 1992 filed with Form 10-Q dated August 12, 1992 Exhibit 3b Amendment to Amended Articles of Incorporation increasing authorized number of shares to 150,000,000 common shares and authorized 2,000,000 preferred shares, dated April 17, 1996 filed with Form 10-K dated March 27, 1997 Exhibit 4 Amended and Restated Rights Agreement dated as of February 19, 1998 between Ohio Casualty Corporation and First Chicago Trust Company of New York, as Rights Agent filed with Form 10-Q dated May 14 1998 Exhibit 10a Ohio Casualty Corporation 1993 Stock Incentive Program filed with Form 10-Q as Exhibit 10d on May 31, 1993 Exhibit 10a1 Ohio Casualty Corporation amended 1993 Stock Incentive Program filed with Form 10-Q dated May 14, 1997 Exhibit 10b Coinsurance Life, Annuity and Disability Income Reinsurance Agreement between Employer's Reassurance Corporation and The Ohio Life Insurance Company dated as of October 2, 1995 filed with Form 10-K dated March 26, 1996 Exhibit 10c Credit Agreement dated October 27, 1997 with Chase Manhattan Bank, N.A. as agent, filed with Form 10-Q on November 13, 1997 Exhibit 22 Definitive Proxy Statement of the Corporation for the Annual Meeting of Shareholders for 2000 71