UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
Form 10-Q
(X) Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the quarterly period ended March 31, 2002
-------------------------------------------------
( ) Transition report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the Transition period from _____________________ to _______________________
State Auto Financial Corporation
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Ohio 31-1324304
- ----------------------------------------- --------------------------------------
(State or other (I.R.S. Employer Identification No.)
jurisdiction of incorporation)
518 East Broad Street, Columbus, Ohio 43215-3976
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(Address of principal executive offices) (zip code)
(614) 464-5000
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Registrant's telephone number, including area code
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or 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.
[X] Yes [ ] No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Common shares, without par value 43,118,782
- --------------------------------- ------------------------
(CLASS) (OUTSTANDING ON 05/06/02)
INDEX
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed consolidated balance sheets - March 31, 2002 and
December 31, 2001
Condensed consolidated statements of income - Three months
ended March 31, 2002 and 2001
Condensed consolidated statements of cash flows - Three
months ended March 31, 2002 and 2001
Notes to condensed consolidated financial statements -
March 31, 2002
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 3. Quantitative and Qualitative Disclosure of Market Risk
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)
March 31 December 31
ASSETS 2002 2001
----------- -----------
(unaudited) (see note 1)
Fixed maturities:
Held to maturity, at amortized cost
(fair value $27,058 and $28,672 respectively) $ 25,847 $ 27,406
Available for sale, at fair value
(amortized cost $1,068,246 and $1,042,539, respectively) 1,071,633 1,051,405
Equity securities, available for sale at fair value
(cost $55,289 and $50,361 respectively) 66,077 59,845
Other invested assets 1,549 -
Total investments 1,165,106 1,138,656
----------- -----------
Cash and cash equivalents 21,092 30,016
Deferred policy acquisition costs 69,686 67,087
Accrued investment income and other assets 42,493 38,908
Due from affiliate 18,770 -
Net prepaid pension expense 45,087 43,344
Reinsurance recoverable on losses and loss expenses payable 7,995 13,919
Prepaid reinsurance premiums 6,072 4,955
Current federal income taxes - 1,549
Deferred federal income taxes 17,581 13,800
Property and equipment 13,116 13,250
Goodwill 2,012 2,012
----------- -----------
Total assets $ 1,409,010 $ 1,367,496
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Losses and loss expenses payable $ 537,572 $ 523,860
Unearned premiums 340,132 329,495
Note payable to affiliate 45,500 45,500
Postretirement benefit liabilities 63,154 57,237
Current federal income taxes 4,685 -
Other liabilities 7,543 5,059
Due to affiliates - 6,152
----------- -----------
Total liabilities 998,586 967,303
----------- -----------
STOCKHOLDERS' EQUITY
Common stock, without par value. Authorized 100,000,000 shares;
43,103,582 and 43,045,320 shares issued, respectively, at
stated value of $2.50 per share 107,759 107,613
Less 4,123,327 and 4,108,230 treasury shares, respectively, at cost (47,867) (47,613)
Additional paid-in capital 47,424 47,106
Accumulated other comprehensive income 9,299 12,030
Retained earnings 293,809 281,057
----------- -----------
Total stockholders' equity 410,424 400,193
----------- -----------
Total liabilities and stockholders' equity $ 1,409,010 $ 1,367,496
=========== ===========
See accompanying notes to condensed consolidated financial statements.
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
For the Three Months Ended March 31, 2002 and 2001
(dollars in thousands, except per share amounts)
(unaudited)
2002 2001
-------- --------
Earned premiums $212,836 $101,561
Net investment income 14,611 10,304
Management services income from affiliates 588 4,920
Net realized gains on investments 1,310 401
Other income (includes $134 and $414,
respectively, from affiliates) 614 815
-------- --------
Total revenues 229,959 118,001
-------- --------
Losses and loss expenses 147,240 65,783
Acquisition and operating expenses 62,437 30,599
Interest expense 540 569
Other expense, net 2,441 1,851
-------- --------
Total expenses 212,658 98,802
-------- --------
Income before federal income taxes 17,301 19,199
Federal income tax expense 4,136 4,659
-------- --------
Net income $ 13,165 $ 14,540
======== ========
Earnings per share:
- basic $ 0.34 $ 0.37
======== ========
- diluted $ 0.33 $ 0.36
======== ========
Dividends paid per common share $ 0.033 $ 0.030
======== ========
See accompanying notes to condensed consolidated financial statements.
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Three Months Ended March 31, 2002 and 2001
(in thousands)
(unaudited)
2002 2001
--------- ---------
Cash flows from operating activities:
Net income $ 13,164 $ 14,540
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization, net 1,258 687
Net realized gains on investments (1,310) (401)
Changes in operating assets and liabilities:
Deferred policy acquisition costs (2,598) (767)
Accrued investment income and other assets (3,680) (2,609)
Net prepaid pension expense (534) (1,250)
Postretirement health care benefits 1,077 (334)
Other liabilities and due to/from affiliate, net (22,438) 2,049
Reinsurance receivable and prepaid reinsurance premiums 4,806 (263)
Losses and loss expenses payable 13,712 (5,390)
Unearned premiums 10,637 3,896
Federal income taxes 4,136 2,158
Other, net (103) (8)
--------- ---------
18,127 12,308
Transfer of MIGI employee related net liabilities, effective 1/1/02 3,631 -
--------- ---------
Net cash provided by operating activities 21,758 12,308
--------- ---------
Cash flows from investing activities:
Purchase of fixed maturities - available for sale (104,303) (74,206)
Purchase of equity securities (9,291) (5,034)
Purchase of other invested assets (1,549) -
Maturities, calls and principal reductions of fixed maturities -
held to maturity 1,528 5,317
Maturities, calls and principal reductions of fixed maturities -
available for sale 6,777 10,939
Sale of fixed maturities - available for sale 72,185 42,007
Sale of equity securities 4,305 2,029
Net additions of property and equipment - (61)
--------- ---------
Net cash used in investing activities (30,348) (19,009)
--------- ---------
Cash flows from financing activities:
Net proceeds from the sale of common stock 79 630
Payment of dividends (413) (372)
--------- ---------
Net cash provided by (used in) financing activities (334) 258
--------- ---------
Net decrease in cash and cash equivalents (8,924) (6,443)
Cash and cash equivalents at beginning of period 30,016 21,305
--------- ---------
Cash and cash equivalents at end of period $ 21,092 $ 14,862
========= =========
Supplemental disclosures:
Federal income taxes paid - $ 2,500
========= =========
See accompanying notes to condensed consolidated financial statements.
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
March 31, 2002
(in thousands, except per share amounts)
(unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by accounting principles generally accepted in the U.S. for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three-month period ending March 31, 2002 are
not necessarily indicative of the results that may be expected for the year
ended December 31, 2002. The balance sheet at December 31, 2001 has been derived
from the audited financial statements at that date but does not include all of
the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements.
For further information, refer to the consolidated financial statements and
footnotes thereto included in the Registrant Company and Subsidiaries' annual
report on Form 10-K for the year ended December 31, 2001.
In June 2001, the Financial Accounting Standards Board issued Statements of
Financial Accounting Standards No. 141, Business Combinations, and No. 142,
Goodwill and Other Intangible Assets, effective for fiscal years beginning after
December 15, 2001. Under the new rules, goodwill is no longer amortized but is
subject to impairment tests in accordance with the statements. Other intangible
assets continue to be amortized over their useful lives. Effective January 1,
2002, the Company implemented the new rules in accordance with the statements
and their initial adoption did not impact the Company's financial position or
results of operations.
Effective January 1, 2002, employees of the Meridian Insurance Group, Inc., a
subsidiary of the former Meridian Mutual, became employees of State Auto P&C. In
conjunction with this transaction approximately $3.6 million in net plan benefit
liabilities was transferred from MIGI to the Company.
2. COMPREHENSIVE INCOME
The components of comprehensive income, net of related tax, are as follows:
Three months ended
March 31
--------
2002 2001
-------- --------
Net income $ 13,165 $ 14,540
Unrealized holding gains (losses), net of tax (2,730) 285
-------- --------
Comprehensive income $ 10,435 $ 14,825
======== ========
The components of accumulated other comprehensive income, net of related tax,
included in stockholders' equity at March 31, 2002 and 2001 and December 31,
2001 include only unrealized holding gains (losses), net of tax.
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements - continued
March 31, 2002
(in thousands, except per share amounts)
(unaudited)
3. EARNINGS PER COMMON SHARE
The following table sets forth the computation of basic and diluted earnings per
common share:
Three months ended
March 31
--------
2002 2001
------- -------
Numerator:
Net income for basic and diluted
Earnings per share $13,165 $14,540
------- -------
Denominator:
Weighted average shares for
Basic earnings per share 38,966 38,619
Effect of dilutive stock options 802 989
Adjusted weighted average shares
For diluted earnings per share 39,768 39,608
------- -------
Basic earnings per share $ 0.34 $ 0.37
------- -------
Diluted earnings per share $ 0.33 $ 0.36
------- -------
4. REINSURANCE
The following provides the income statement transactions for ceded reinsurance
information for transactions with other insurers and reinsurers as well as the
ceded reinsurance transaction for the Pooling Arrangement between the Company's
Pooled Subsidiaries and Mutual:
Three months ended
March 31
--------
2002 2001
-------- --------
Premiums earned:
Other insurers and reinsurers $ 4,358 $ 2,935
Ceded under Pooling Arrangement
and Stop Loss 115,571 102,151
Losses and loss expenses incurred:
Other insurers and reinsurers $ 2,461 $ 912
Ceded under Pooling Arrangement 77,007 60,621
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements - continued
March 31, 2002
(in thousands, except per share amounts)
(unaudited)
5. SEGMENT INFORMATION
Effective October 1, 2001, the management agreement between State Auto P&C
and certain affiliate companies, including Mutual, was amended to eliminate
the management and operations service fee charged by State Auto P&C. As a
result of the loss of the management and operations services income under
this management agreement, substantially all of State Auto P&C's services
income has been eliminated. Consequently, beginning with the first quarter
2002, the management and operations services segment will be included in the
other category for segment reporting as the results of this segment no
longer meet the quantitative thresholds for separate presentation as a
reporting segment. The segment disclosures for the first quarter of 2001
have been restated to reflect this change.
Interim financial data by segment is as follows:
Three months ended
March 31
--------
2002 2001
----------- -----------
Revenues from external customers:
State Auto standard insurance $ 168,767 $ 103,851
State Auto nonstandard insurance 13,179 7,866
Meridian standard insurance 42,132 -
Meridian nonstandard insurance 3,276 -
Investment management services 672 825
All other 619 5,046
----------- -----------
Total revenues from external customers $ 228,645 $ 117,588
=========== ===========
Intersegment revenues:
State Auto standard insurance $ 23 $ 41
Investment management services 1,180 784
All other 584 1,614
----------- -----------
Total intersegment revenues $ 1,787 $ 2,439
=========== ===========
Segment profit (loss):
State Auto standard insurance $ 14,513 $ 12,121
State Auto nonstandard insurance 645 590
Meridian standard insurance (367) -
Meridian nonstandard insurance (96) -
Investment management services 1,603 1,360
All other 370 5,354
----------- -----------
Total segment profit 16,668 19,425
Reconciling items:
Corporate expenses (677) (627)
Net realized gains 1,310 401
----------- -----------
Total consolidated income before
federal income taxes $ 17,301 $ 19,199
=========== ===========
Segment assets:
Pooled subsidiaries $ 1,279,012 $ 866,746
State Auto nonstandard insurance 74,838 53,638
Investment management services 9,776 6,006
All other 15,993 15,626
----------- -----------
Total segment assets $ 1,379,619 $ 942,016
=========== ===========
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements - continued
March 31, 2002
(in thousands, except per share amounts)
(unaudited)
6. RECLASSIFICATIONS
Certain items in the 2001 condensed consolidated financial statements have been
reclassified to conform to the 2001 presentation.
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
For information regarding the Company's significant accounting policies as well
as discussion regarding its critical accounting policies, refer to the
Management's Discussion and Analysis of Financial Condition and Results of
Operations as well as the consolidated financial statements and footnotes
thereto included in the Company and Subsidiaries annual report on Form 10-K for
the year ended December 31, 2001.
Results of Operations
- ---------------------
This discussion pertains to the following companies: State Auto Financial
Corporation (the "Company") and its wholly owned insurance subsidiaries State
Auto Property & Casualty Insurance Company ("State Auto P&C"), Milbank Insurance
Company ("Milbank"), Farmers Casualty Insurance Company ("Farmers Casualty") and
State Auto Insurance Company ("SAIC"); which engage in the State Auto standard
insurance segment of the Company's operations, as well as, beginning July 1,
2001, the Meridian standard and nonstandard insurance segments (defined below).
The Company's State Auto nonstandard segment of operations is conducted through
State Auto National Insurance Company ("State Auto National"), a wholly owned
subsidiary of the Company and Mid-Plains Insurance Company ("Mid-Plains") a
wholly owned subsidiary of Farmers Casualty. State Auto P&C, Milbank, Farmers
Casualty and SAIC are collectively referred to below as the "Pooled
Subsidiaries", while the Pooled Subsidiaries, State Automobile Mutual Insurance
Company ("Mutual") and its wholly owned subsidiary, Midwest Security Insurance
Company are collectively referred to below as the "Pooled Companies" or the
"State Auto Pool".
As more fully described in the Company's December 31, 2001 Form 10-K, following
is a summary of several transactions that occurred in the second half of 2001
that will assist in the discussion of the Company's current period financial
results:
- Effective June 1, 2001, Mutual entered into an agreement with
Meridian Mutual Insurance Company ("Meridian Mutual"),
pursuant to which Meridian Mutual would be merged with and
into Mutual, with Mutual continuing as the surviving
corporation. With the merging of Meridian Mutual into Mutual,
all insurance business that had been written by Meridian
Mutual became, legally, Mutual business. Effective July 1,
2001, the insurance business of the former Meridian Mutual
became part of the Pooling Arrangement and the Pooled
Subsidiaries assumed 53% of the Meridian Mutual business on
this same date. Concurrent with this transaction, the Pooled
Subsidiaries received cash of $6.4 million and fixed
maturities totaling $109.7 million, which related to the
additional net insurance liabilities assumed by the Pooled
Subsidiaries on July 1, 2001. This former Meridian Mutual
business assumed by the Pooled Subsidiaries comprises the
Company's "Meridian standard" and "Meridian nonstandard"
segments.
- On October 24, 2001, the board of directors of the Company and
Mutual and special independent committees thereof approved a
resolution of the disagreement between the Company and the
Ohio Department of Insurance ("ODI") regarding the service fee
paid by Mutual to State Auto P&C under the Mutual Management
Agreement (as defined in the Form 10-K). The disagreement with
ODI was resolved and ODI expressly did not take issue with
Mutual's payment of the service fee for the first three
quarters of 2001, nor with Mutual's accounting for the service
fee in each of those quarters. The ODI also approved
regulatory filings, effective October 1, 2001, which
implemented a revised Mutual Management Agreement, changed the
Pooled Subsidiaries pooling participation percentage and
implemented an inter-company stop loss reinsurance
arrangement. The following describes these changes, effective
October 1, 2001:
- The Mutual Management Agreement was amended to
eliminate the management and operations services fee
charged by State Auto P&C to participants to the
agreement, including Mutual. As a result of the loss
of the management and
operations services income under the Mutual
Management Agreement, substantially all of State Auto
P&C's services income has been eliminated, effective
October 1, 2001.
- The Pooling Arrangement (as defined in the Form 10K)
was amended such that the Pooled Subsidiaries
aggregate participation was increased from 53% to
80%. In conjunction with this change in pool
participation, the Pooled Subsidiaries received cash
of $2.2 million and fixed maturities totaling $236.3
million from Mutual, which related to the additional
net insurance liabilities assumed by the Pooled
Subsidiaries on October 1, 2001.
- For the period October 1, 2001 through December 31,
2003, Mutual entered into a stop loss reinsurance
arrangement (the "Stop Loss") with the Pooled
Subsidiaries. Under the Stop Loss, Mutual has agreed
to participate in the Pooling Arrangement's quarterly
underwriting losses and gains in the manner
described. If the Pooling Arrangement's quarterly
statutory loss and loss adjustment expense ratio (the
"Pool loss and LAE ratio") is between 70.75% and
80.00% (after the application of all available
reinsurance), Mutual will reinsure the Pooled
Subsidiaries 27% of the Pooling Arrangement's losses
in excess of a Pool loss and LAE ratio of 70.75% up
to 80.00%. The Pooled Subsidiaries would be
responsible for their share of the Pooling
Arrangement's losses over the 80.00% threshold. Also,
Mutual will have the right to participate in the
profits of the Pooling Arrangement. Mutual will
assume 27% of the Pooling Arrangement's underwriting
profits attributable to Pool loss and LAE ratios less
than 69.25%, but more than 59.99%.
Effective January 1, 2002, employees of the Meridian Insurance Group, Inc., a
subsidiary of the former Meridian Mutual, became employees of State Auto P&C. In
conjunction with this transaction approximately $3.6 million in net plan benefit
liabilities was transferred from MIGI to the Company.
Income before federal income taxes decreased $1.9 million to $17.3 million for
the quarter ended March 31, 2002. Largely contributing to this decline were the
loss results on the former Meridian Mutual business, assumed by the Pooled
Subsidiaries beginning in July 2001.
Consolidated earned premiums increased for the three-month period ended March
31, 2002, by 109.6%, from the same 2001 time period. This increase was
principally the result of the addition of the former Meridian Mutual business to
the Pooling Arrangement, effective July 1, 2001, and a change in the Pooled
Subsidiaries' aggregate pooling participation percentage from 53% to 80%,
effective October 1, 2001. These actions increased consolidated earned premiums
92.8% from the same 2001 time period. Reducing consolidated earned premiums in
the current quarter by $425,000 (0.4%) was a cession to Mutual under the Stop
Loss (see discussion below). The internal growth of the Company's State Auto
standard segment's earned premiums increased consolidated earned premiums 15.5%.
While this segment continued to experience an increase in production levels in
its commercial lines of business, beginning in late 2001, this segment began
experiencing increased sales in its personal lines of business, largely due to
changes in the market place and to the expansion of the new personal lines sales
specialist position. Production levels within the Company's State Auto
nonstandard segment, due to a combination of rate changes as well as increased
policy counts, continued to increase. This segment's earned premiums increased
consolidated earned premiums 5.2%.
The internal growth of the Meridian standard and nonstandard segments decreased
consolidated earned premiums 2.7% and 0.8%, respectively. These decreases are
not unexpected, given the corrective actions taken in both these segments. One
of the more significant actions within Meridian's standard segment was with the
Group Advantage(R) Program. Group Advantage(R) was a program where Meridian made
its personal lines products available to Sam's Club members through Sam's Club
retail outlets. While this program generated significant growth, it consistently
failed to meet profitability objectives. As a result, in late 2000, the former
Meridian Mutual stopped writing new Group Advantage(R) business and began to
terminate existing business as permitted by law. At the end of 2000, there were
approximately 15,000 Group Advantage(R) policies in force. At the end of 2001,
there were approximately 800 such policies in force. At the end of March 31,
2002, there are approximately 130 such policies in force. Regarding the Meridian
nonstandard segment, there is currently an integration plan in place to write
all new nonstandard auto business produced by the former Meridian agents through
the State Auto
nonstandard segment, specifically through National on the National system
platform. Most notably, the National system utilizes credit scoring and
"point-of-sale" underwriting tools. The order of integration has been
prioritized such that the states with most need for profit improvement are
migrating to National first. Additionally, as discussed below, within both
Meridian segments, management is continuing to take appropriate rate increases
in almost every line of business.
Net investment income during the quarter ended March 31, 2002 increased $4.3
million (41.8%) to $14.6 million from the same 2001 period. Contributing to the
increase over the previous 2001 time period was an increase in investable assets
due to the transfer of cash and fixed maturity securities from Mutual totaling
$354.6 million to the Pooled Subsidiaries in conjunction with the Pooled
Subsidiaries assuming 53% of the former Meridian Mutual business on July 1, 2001
and the change in the Pooled Subsidiaries aggregate pooling participation,
effective October 1, 2001, from 53% to 80%. The investment yield, based on fixed
maturity and equity securities at cost, decreased to 5.0% for the three month
period from 5.5% for the same 2001 comparable period.
The management services income, including investment management fees, decreased
$4.3 million to $0.6 million for the three months ended March 31, 2002. This
decrease, as discussed above, is largely the result of the resolution of the
disagreement between the Company and ODI regarding the service fee paid by
Mutual to State Auto P&C. The service fee under the 2000 Mutual Management
Agreement paid by Mutual for the three-month period ending March 31, 2001 was
approximately $4.2 million.
Losses and loss expenses, as a percentage of earned premiums (the "loss and LAE
ratio"), were 69.2% and 64.8% for the three months ended March 31, 2002 and
2001, respectively. During the first quarter of 2002, the Pooled Companies
produced a statutory loss and LAE ratio under the Stop Loss (described above)
that was less than 69.25%, but more than 59.99%, thereby ceding to Mutual, under
the Stop Loss, $425,000 in earned premiums. Absent the impact of the Stop Loss,
the loss and LAE ratio for the current three-month period was 69.0%. For
discussion purposes, the following table provides comparative statutory loss and
loss adjustment expense ratios (the "Statutory Loss and LAE Ratio"), net of the
Stop Loss, for the Company's insurance operating segments for the three months
ended March 31, 2002 and 2001, respectively:
- -------------------------------------------- ------- --------
2002 2001
---- ----
- -------------------------------------------- ------- --------
State Auto standard segment 65.9 64.5
- -------------------------------------------- ------- --------
State Auto nonstandard segment 81.2 71.2
- -------------------------------------------- ------- --------
Meridian standard segment 77.5 -
- -------------------------------------------- ------- --------
Meridian nonstandard segment 86.3 -
---- ----
- -------------------------------------------- ------- --------
Total Statutory Loss and LAE Ratio 69.3 65.0
==== ====
- -------------------------------------------- ------- --------
The Company's State Auto standard segment reflected an increase of 1.4 points in
its Statutory Loss and LAE Ratio in 2002 compared to the same time period in
2001. 0.6 points of this increase is due to an increase in the level of
catastrophe losses over the same 2001 time period. Also contributing to the
current period increase, was an increase in the loss and LAE ratio on this
segment's largest line of business, automobile, which was partially offset by an
improvement in its second largest line of business, homeowners. Management
recognizes the significance of private passenger auto insurance to the
profitability of the Company and it is vigilant in its efforts to preserve this.
It regularly performs underwriting audits, monitors rate adequacy, and endeavors
to exploit all available underwriting tools. The Company's State Auto
nonstandard segment's Statutory Loss and LAE Ratio reflected an increase of 10.0
points in its Statutory Loss and LAE Ratio in 2002 from the same time period in
2001. Given the nature of the risks written through this segment, this segment
tends to be more volatile on a quarterly basis than those risks written through
the standard segment. Contributing largely to this Statutory Loss and LAE Ratio
increase were several unusually large losses experienced by this segment in the
current quarter as compared to the same time period in 2001.
While the former Meridian Mutual ("Meridian") business continues to produce
worse loss results than the State Auto book, the first quarter of 2002 produced
tangible evidence of the impact of management's integration efforts, not only
through an improvement in the Statutory Loss and LAE Ratios from third and
fourth quarter of 2001, but also a strong improvement in the Meridian rate per
exposure. The Company continues to seek adequate cost-based rates on the
Meridian book and is re-underwriting much of it to be certain risks written fall
within State Auto guidelines.
Acquisition and operating expenses, as a percentage of earned premiums (the
"expense ratio"), were 29.3% and 30.1% for the three months ended March 31, 2002
and 2001, respectively. The decrease in the expense ratio in the current quarter
is impacted by fixed costs, such as salaries, depreciation, utilities, which
comprise a lesser portion of earned premiums in 2002 than 2001 as a result of
the Company's growth in premium writings that began in early 2001.
Interest expense relates to the line of credit agreement the Company entered
into with Mutual during 1999 to assist in the funding of its stock repurchase
program. Based on terms of the agreement, the interest rate adjusts annually. In
2002, the interest rate is 4.75% compared to 5.0% in 2001.
The effective Federal tax rate was 23.9% and 24.3% for the three month ending
March 31, 2002 and 2001, respectively.
Liquidity and Capital Resources
- -------------------------------
Net cash provided by operating activities increased to $21.8 million from $12.3
million in 2001. The increase in cash flow from operations in 2002 is largely
attributable to an increase in the Company's pool participation percentage, as
described above, as well as an increase in net investment income over the same
2001 time period. Overall, net cash used in investing activities increased to
$30.3 million from $19.0 million in 2001. This increase is due to the Company
investing unallocated cash in 2002 to long-term investments.
On March 1, 2002, the Board of Directors of State Auto Financial approved a plan
to repurchase up to 1.0 million shares of its common stock from the public over
a period extending to and through December 31, 2003. Through April 10, 2002, no
shares have been repurchased under this plan.
As of March 31, 2002, funds consisting of cash and cash equivalents were $21.1
million versus $14.9 million at March 31, 2001.
New Accounting Standards
- ------------------------
In June 2001, the Financial Accounting Standards Board issued statements of
Financial Accounting Standards No. 141, Business Combinations, and No. 142,
Goodwill and Other Intangible Assets, effective for fiscal years beginning after
December 15, 2001. Under the new rules, goodwill will no longer be amortized but
will be subject to annual impairment tests in accordance with the Statements.
Other intangible assets will continue to be amortized over their useful lives.
Effective January 1, 2002, the Company implemented the new rules in accordance
with the statements and their initial adoption did not impact the Company's
financial position or results of operations.
Market Risk
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With respect to Market Risk, see the discussion regarding this subject in the
Company's December 31, 2001 Management's Discussion and Analysis of Financial
Condition and Results of Operations, included in the December 31, 2001 Form
10-K. There have been no material changes from the information reported
regarding Market Risk in the 2001 Form 10-K.
FORWARD-LOOKING STATEMENTS; CERTAIN FACTORS AFFECTING FUTURE RESULTS
Statements contained in this Form 10-Q or any other reports or documents
prepared by the Company or made by management may be "forward-looking" within
the meaning of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements are subject to certain risks and uncertainties that
could cause the Company's actual results to differ materially from those
projected. Forward-looking statements may be identified, preceded by, followed
by, or otherwise include, without limitation, words such as "plans," "believes,"
"expects," "anticipates," "intends," "estimates," or similar expressions. The
following factors, among others, in some cases have affected and in the future
could affect the Company's actual financial performance.
In addition to the acquisition of the Meridian Insurers and Mutual's merger with
Meridian Mutual as discussed above, during the past several years, Mutual and
the Company have acquired other insurance
companies, such as Milbank, Farmers Casualty, and Midwest Security, and it is
anticipated that Mutual and the Company will continue to pursue acquisitions of
other insurance companies in the future. Acquisitions involve numerous risks and
uncertainties, including the following: obtaining necessary regulatory approvals
of the acquisition may prove to be more difficult than anticipated; integrating
the acquired business may prove to be more costly or difficult than anticipated;
integrating the acquired business without material disruption to existing
operations may prove to be more difficult than anticipated; anticipated cost
savings may not be fully realized (or not realized within the anticipated time
frame) or additional or unexpected costs may be incurred; loss results of the
Company acquired may be worse than expected; and retaining key employees of the
acquired business may prove to be more difficult than anticipated. In addition,
other companies in the insurance industry have similar acquisition strategies.
There can be no assurance that any future acquisitions will be successfully
integrated into the Company's operations, that competition for acquisitions will
not intensify or that the Company will be able to complete such acquisitions on
acceptable terms and conditions. In addition, the costs of unsuccessful
acquisition efforts may adversely affect the Company's financial performance.
Other risk factors include, without limitation, the following:
- The Company's financial results are subject to the occurrence
of weather-related and other types of catastrophic events,
none of which are within the Company's control.
- The Company's operations are subject to changes occurring in
the legislative, regulatory and judicial environment. Risks
and uncertainties related to the legislative, regulatory, and
judicial environment include, but are not limited to,
legislative changes at both the state and federal level, state
and federal regulatory rulemaking promulgations and
adjudications that may affect the Company specifically, its
affiliates or the industry generally, class action and other
litigation involving the Company, its affiliates, or the
insurance industry generally and judicial decisions affecting
claims, policy coverages and the general costs of doing
business. Many of these changes are beyond the Company's
control.
- The laws of the various states establish insurance departments
with broad regulatory powers relative to approving
intercompany arrangements, such as management, pooling, and
investment management agreements, granting and revoking
licenses to transact business, regulating trade practices,
licensing agents, approving policy forms, setting reserve
requirements, determining the form and content of required
statutory financial statements, prescribing the types and
amount of investments permitted and requiring minimum levels
of statutory capital and surplus. In addition, although
premium rate regulation varies among states and lines of
insurance, such regulations generally require approval of the
regulatory authority prior to any changes in rates.
Furthermore, all of the states in which the State Auto Group
transacts business have enacted laws which restrict these
companies' underwriting discretion. Examples of these laws
include restrictions on agency terminations and laws requiring
companies to accept any applicant for automobile insurance and
laws regulating underwriting "tools". These laws may adversely
affect the ability of the insurers in the State Auto Group to
earn a profit on their underwriting operations.
- The property and casualty insurance industry is highly
competitive. While prices have generally increased in some
lines, price competition continues to be intense. The Company
competes with numerous insurance companies, many of which are
substantially larger and have considerably greater financial
resources. In addition, because the Company's products are
marketed exclusively through independent insurance agencies,
most of which represent more than one company, the Company
faces competition within each agency. The Company competes
through underwriting criteria, appropriate pricing, and
quality service to the policyholder and the agent and through
a fully developed agency relations program. See "Marketing" in
the "Narrative Description of Business" in Item 1 of the
Company's December 31, 2001 Form 10-K.
- The Company is subject to numerous other factors which affect
its operations, including, without limitation, the development
of new insurance products, geographic spread of risk,
fluctuations of securities markets, economic conditions,
technological difficulties and advancements, availability of
labor and materials in storm hit areas, late reported claims,
previously undisclosed damage, utilities and financial
institution disruptions, and shortages of technical and
professional employees.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
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The information called for by this item is provided under the caption "Market
Risk" under Item 2 - Management's Discussion and Analysis of Financial
Condition.
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
PART II. OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Changes in Securities and Use of Proceeds - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information - None
INDEX TO EXHIBITS
Item 6. a. Exhibits
Exhibit No. Description of Exhibits
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10(LL) Amendment No. 3 to the Management and
Operations Agreement effective January 1, 2002
b. Reports on Form 8-K: A Form 8-K dated January 28, 2002, was
filed, providing information regarding State Auto Financial
Corporation's fourth quarter 2001 loss reserve adjustments on
the former Meridian Mutual business assumed through the State
Auto Pooling Arrangement.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
STATE AUTO FINANCIAL CORPORATION
Date: MAY 10, 2002 /s/ Steven J. Johnston
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Steven J. Johnston
Treasurer and Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)