1
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 September 30, 1996
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( ) 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
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(Exact name of registrant as specified in its charter)
Ohio 31-1324304
________________________________ ________________________________________
(State or other jurisdiction of (I.R.S. Employer Identification No.)
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 18,086,712
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(CLASS) (OUTSTANDING ON 11/08/96)
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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
INDEX
Page Number
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PART I - Financial Information
Condensed Consolidated Balance Sheets -
September 30, 1996 and December 31, 1995 3
Condensed Consolidated Statements of Earnings -
For the three months ended September 30, 1996 and 1995 4
For the nine months ended September 30, 1996 and 1995 5
Condensed Consolidated Statements of Cash Flows -
For the nine months ended September 30, 1996 and 1995 6
Notes to Condensed Consolidated Financial Statements 7
Management's Discussion and Analysis of Results of Operations
and Financial Condition 8-10
PART II - Other Information 11-12
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3
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
September 30 December 31
ASSETS 1996 1995
------------ -----------
(unaudited) (Note 1)
Fixed maturities:
Held for investment, at amortized cost $ 91,782,988 $ 91,528,968
(fair value $91,572,549 and $93,939,778, respectively)
Available for sale, at fair value 279,942,482 278,318,510
(amortized cost $275,461,397 and $263,820,502, respectively)
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Total investments 371,725,470 369,847,478
Cash and cash equivalents 13,854,826 11,227,375
Deferred policy acquisition costs 16,515,138 15,866,092
Accrued investment income and other assets 13,384,317 13,167,739
Net prepaid pension expense 10,243,302 9,384,680
Reinsurance recoverable 9,014,222 9,277,494
Prepaid reinsurance premiums 3,394,139 3,169,925
Current federal income taxes 112,698 -
Deferred federal income taxes 1,087,586 -
Property and equipment, net 2,574,349 2,555,376
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Total assets $441,906,047 $434,496,159
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LIABILITIES AND STOCKHOLDERS' EQUITY
Losses and loss expenses payable $168,466,651 $170,575,325
Unearned premiums 93,654,803 90,107,566
Current federal income taxes - 565,431
Deferred federal income taxes - 2,334,170
Due to affiliates 2,303,133 795,696
Other liabilities 1,697,835 1,865,599
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Total liabilities 266,122,422 266,243,787
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STOCKHOLDERS' EQUITY
Common stock, without par value. Authorized 30,000,000
shares; 18,086,712 and 18,025,375 shares issued and outstanding,
respectively, at stated value of $5 per share 90,433,560 90,126,878
Additional paid-in capital 1,055,645 681,672
Net unrealized holding gains 3,386,053 9,964,824
Retained earnings 80,908,367 67,478,998
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Stockholders' equity 175,783,625 168,252,372
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Total liabilities and stockholders' equity $441,906,047 $434,496,159
============ ============
See accompanying notes to condensed consolidated financial statements.
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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
For the Three Months Ended September 30, 1996 and 1995
1996 1995
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(unaudited) (unaudited)
Earned premiums (net of ceded earned premiums of
$2,885,414 and $2,791,709 respectively) $60,239,698 $58,498,571
Net investment income 5,999,047 5,846,066
Management services income 1,997,413 1,908,928
Net realized gains on investments 255,031 176,422
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Total revenues 68,491,189 66,429,987
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Losses and loss expenses (net of ceded losses and loss
expenses of $1,365,509 and $515,967, respectively) 46,506,377 40,972,473
Acquisition and operating expenses 16,926,697 16,408,900
Other expense, net 528,080 760,073
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Total expenses 63,961,154 58,141,446
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Earnings before federal income taxes 4,530,035 8,288,541
Federal income tax expense:
Current 753,934 759,797
Deferred 116,113 1,069,574
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Total federal income taxes 870,047 1,829,371
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Net earnings $ 3,659,988 $ 6,459,170
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Weighted average common shares outstanding 18,086,725 17,976,395
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Net earnings per common share $ 0.20 $ 0.36
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Dividends paid per common share $ 0.040 $ 0.037
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See accompanying notes to condensed consolidated financial statements.
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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
For the Nine Months Ended September 30, 1996 and 1995
1996 1995
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(unaudited) (unaudited)
Earned premiums (net of ceded earned premiums of
$8,366,487 and $8,373,180, respectively) $179,035,250 $ 173,733,760
Net investment income 17,866,113 16,859,475
Management services income 6,004,448 5,649,304
Net realized gains on investments 1,292,268 997,446
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Total revenues 204,198,079 197,239,985
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Losses and loss expenses (net of ceded losses and loss
expenses of $3,602,614 and $3,452,770, respectively) 133,475,120 118,822,510
Acquisition and operating expenses 49,853,520 50,200,308
Other expense, net 1,991,341 1,630,430
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Total expenses 185,319,981 170,653,248
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Earnings before federal income taxes 18,878,098 26,586,737
Federal income tax expense (benefit):
Current 4,639,650 7,058,443
Deferred 121,186 (56,115)
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Total federal income taxes 4,760,836 7,002,328
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Net earnings $ 14,117,262 $ 19,584,409
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Weighted average common shares outstanding 18,058,226 17,943,303
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Net earnings per common share $ 0.78 $ 1.09
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Dividends paid per common share $ 0.113 $ 0.103
============ =============
See accompanying notes to condensed consolidated financial statements.
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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 1996 and 1995
1996 1995
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(unaudited) (unaudited)
Cash flows from operating activities:
Net earnings $14,117,262 $19,584,409
Adjustments to reconcile net earnings to net cash
provided by operating activities:
Depreciation and amortization, net 565,676 412,963
Change in deferred policy acquisition costs (649,046) (529,604)
Change in accrued investment income and other assets (216,578) (3,437,313)
Change in net prepaid pension expense (858,622) (658,902)
Change in other liabilities and due to/from affiliate, net 1,340,653 1,015,365
Change in reinsurance recoverable and prepaid reinsurance premiums 39,058 343,569
Change in losses and loss expenses payable (2,108,674) 2,490,128
Change in unearned premiums 3,547,237 5,114,663
Change in federal income taxes (556,943) (1,541,487)
Net realized gains on investments (1,311,672) (997,446)
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13,908,351 21,796,345
Cash provided from the change in the reinsurance pool participation
percentages - 46,061,226
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Net cash provided by operating activities 13,908,351 67,857,571
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Cash flows from investing activities:
Purchase of fixed maturities - held to maturity (9,073,770) (12,397,245)
Purchase of fixed maturities - available for sale (100,746,601) (112,656,833)
Maturities, calls and principal reductions of fixed maturities -
held to maturity 8,612,448 2,974,988
Maturities, calls and principal reductions of fixed maturities -
available for sale 2,024,908 1,341,458
Sale of fixed maturities - available for sale 88,011,016 50,911,516
Net additions of property and equipment (101,663) (7,590)
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Net cash used in investing activities (11,273,662) (69,833,706)
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Cash flows from financing activities:
Net proceeds from sale of common stock 680,655 531,368
Payment of dividends (687,893) (615,595)
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Net cash used in financing activities (7,238) (84,227)
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Net increase (decrease) in cash and cash equivalents 2,627,451 (2,060,362)
Cash and cash equivalents at beginning of period 11,227,375 11,955,234
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Cash and cash equivalents at end of period $13,854,826 $9,894,872
=========== ============
Supplemental disclosures:
Federal income taxes paid $5,317,779 $8,543,815
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See accompanying notes to condensed consolidated financial statements.
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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 1996
(unaudited)
1. BASIS OF PRESENTATION
The financial statements for the interim periods included herein have been
prepared by the Company without audit; however, such information reflects all
adjustments (consisting of normal recurring adjustments) which are, in the
opinion of management, necessary for a fair presentation of the financial
position, results of operations and cash flows for the interim periods. Certain
information and footnote disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
condensed or omitted. These financial statements should be read in conjunction
with the financial statements and notes thereto for the year ended December 31,
1995 included in the Company's 1995 Annual Report filed with the Securities and
Exchange Commission on Form 10-K.
The results of operations for the interim periods presented are not necessarily
indicative of the operating results that may be expected for the full fiscal
year ending December 31, 1996.
2. NET EARNINGS PER COMMON SHARE
Net earnings per common share is computed on the basis of the weighted average
number of common shares outstanding during each of the respective periods
presented. Additional shares arising from the assumed exercise of employee and
director stock options were not included in the computations as the dilutive
effect was not material.
3. STOCK SPLIT
On May 30, 1996, the Board of Directors of the Company authorized a
three-for-two stock split to be effected in the form of a stock dividend,
payable July 8, 1996 to shareholders of record on June 17, 1996. The stated
value for the additional shares issued was transferred from additional paid-in
capital and retained earnings to common stock and is reflected retroactively in
the accompanying condensed consolidated financial statements. Common shares
issued and outstanding, weighted average shares and per share data are restated
for periods presented in the accompanying condensed consolidated financial
statements.
4. REINSURANCE
Effective July 1, 1996, the State Auto Group (State Auto P&C, Mutual, Milbank
and National) negotiated a change in its catastrophe reinsurance program. In the
event the State Auto Group incurs catastrophe losses in excess of $120.0
million, the Company entered into a structured contingent financing transaction
with Chase Manhattan Bank ("Chase") to provide up to $100.0 million. Under this
arrangement, in the event of such a loss, the Company would sell redeemable
preferred shares to SAF Funding Corporation, a special purpose company ("SPC"),
which will borrow the money necessary for such purchase from Chase and a
syndicate of other lenders. The Company will contribute to State Auto P&C the
proceeds from the sale of its preferred shares. State Auto P&C has assumed
catastrophe reinsurance from Mutual, Milbank and National pursuant to a
catastrophe reinsurance agreement in the amount of $100.0 million excess of
$120.0 million. State Auto P&C will use the contributed capital to pay its
direct catastrophe losses and losses assumed under the catastrophe reinsurance
agreement. The Company is obligated to repay the SPC by redeeming the preferred
shares over a six year period. This layer of $100.0 million in excess of $120.0
has been excluded from the pooling agreement.
In addition, the Company's obligation to repay Chase has been secured by a Put
Agreement among the Company, Mutual and the Lenders, under which, in the event
of a default by the Company, as described in the Credit Agreement or in the Put
Agreement, Mutual would be obligated to put either the preferred shares or the
loan(s) outstanding.
5. RECLASSIFICATIONS
Certain items in the 1995 condensed consolidated financial statements have been
reclassified to conform with the 1996 presentation.
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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
Management's Discussion and Analysis of Results
of Operations and Financial Condition
Results of Operations
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Earnings before Federal income taxes decreased $3.8 million to $4.5 million for
the three months ended September 30, 1996 from the same 1995 period. Losses in
Raleigh, North Carolina from the effects of Hurricane Fran and additional loss
development from spring storms contributed to this decrease. For the nine months
ended September 30, 1996, earnings before Federal income taxes decreased $7.7
million to $18.9 million from the same 1995 period. Winter storm losses from the
first quarter combined with hailstorm losses in Kentucky in the second quarter
and the weather related losses in the third quarter contributed to the nine
month decrease. In spite of these catastrophe claims experienced during the
first nine months of 1996, the pricing and underwriting strategies of the
Company have done much to mitigate the impact of these storms. The GAAP combined
ratio, i.e., losses and loss expenses plus acquisition and operating expenses,
as a percentage of earned premiums, increased to 105.3% for the quarter ended
September 30, 1996 from 98.1% for the same period in 1995 and for the nine
months ended September 30, 1996, increased to 102.4% from 97.3% for the same
period in 1995.
Earned premiums increased $1.7 million to $60.2 million for the quarter ended
September 30, 1996 and $5.3 million to $179.0 million for the nine months ended
September 30, 1996, from the same 1995 periods. Direct written premiums for
commercial lines of business increased approximately 8.8% and 9.4% from the same
three month and nine month periods, respectively, in 1995. Personal lines of
business, except for State Auto National Insurance Company's ("National")
non-standard auto products, has been experiencing no growth. National's direct
written premiums increased approximately 37% for the quarter ended September 30,
1996 from the same 1995 period and 41% for the nine months ended September 30,
1996 from the same 1995 period. Without foregoing the current underwriting gains
achieved through past actions, management is continually reviewing current
strategies and developing new ones to enhance personal lines sales. During 1996,
State Automobile Mutual Insurance Company ("Mutual") and State Auto Property &
Casualty Insurance Company ("State Auto P&C") entered its 23rd state of
operation, Oklahoma, and intends to enter its 24th state, Wisconsin, in 1997
with the recent announcement by the Company's principal stockholder, Mutual, of
its intent to purchase Midwest Security Insurance Company, Onalaska, Wisconsin.
The purchase is targeted for closing in January 1997, subject to regulatory and
Board approval of a stock purchase agreement. Additionally, the pooled companies
(Mutual, State Auto P&C, and Milbank Insurance Company ("Milbank")) are
introducing several new products to its agents during the fourth quarter of 1996
and into 1997. Additionally, National currently operates in five states and is
about to enter three new states, Georgia, Arkansas and Minnesota.
Net investment income increased $0.2 million to $6.0 million for the quarter
ended September 30, 1996 and $1.0 million to $17.9 million for the nine months
ended September 30, 1996, from the same 1995 periods. An increase in invested
assets over the same 1995 periods contributed to these increases. Total
amortized cost of invested assets at September 30, 1996 was $367.2 million
compared to $347.4 million at September 30, 1995. The investment yield decreased
to 6.26% and 6.24% for the quarter and nine months ended September 30, 1996
compared to 6.55% and 6.48% for the same 1995 periods, respectively.
Management services income increased slightly to $2.0 million for the quarter
ended September 30, 1996 and $0.4 million to $6.0 million for the nine months
ended September 30, 1996 from the same 1995 periods. These increases are due to
increases in the fees generated from both investment and management services
from the same periods in 1995.
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Losses and loss expenses, as a percentage of earned premiums, increased to 77.2%
for the quarter ended September 30, 1996 from 70.0% for the same 1995 period and
for the nine months ended September 30, 1996, increased to 74.6% from 68.4% for
the same 1995 period. As previously discussed, the Company experienced property
damage claims in Raleigh, North Carolina resulting from Hurricane Fran as well
as additional loss development on second quarter spring storms. The losses
resulting from these catastrophe claims added 10.3 points to the current quarter
GAAP losses and loss expense ratio. For the nine months ended September 30,
1996, winter storm losses from the first quarter of 1996, combined with the
hailstorm activity of the second quarter and Hurricane Fran in the current
quarter added 7.4 points to the nine month GAAP losses and loss expense ratio.
Acquisition and operating expenses, as a percentage of earned premiums, for the
third quarter 1996 remained comparable to 1995 levels at 28.1% and for the nine
months ended September 30, 1996, decreased to 27.8% from 28.9% for the same 1995
period. The decrease in the ratios for 1996 is due primarily to the decrease in
the amount of Quality Performance Bonus earned by nearly all permanent employees
of the State Auto Group (Mutual, State Auto P&C, Milbank and National) in 1996
compared to the same periods in 1995.
Decrease in other expenses of $0.2 million to $0.5 million for the quarter ended
September 30, 1996 is primarily due to the State Auto Group changing the
catastrophe portion of its reinsurance treaty beginning July 1, 1996, that prior
to this period was accounted for as deposit reinsurance (See Liquidity and
Capital Resources). Expenses associated with the catastrophe portion of the
treaty accounted for as deposit reinsurance were included in miscellaneous
expense. Increase in other expenses of $0.4 million to $2.0 million for the nine
months ended September 30, 1996 from the same periods in 1995, is due to the
increased expense activity incurred by the Company's software subsidiary,
Strategic Insurance Software, Inc. (SIS). SIS operations began July 1, 1995.
Federal income taxes decreased $0.9 million to $0.9 million for the quarter
ended September 30, 1996 and $2.2 million to $4.8 million for the nine months
ended September 30, 1996 from the same periods in 1995. These decreases are due
to the decrease in taxable income as a result of the increased levels of
catastrophe losses in 1996 compared to the same periods in 1995.
Liquidity and Capital Resources
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Net cash provided by operating activities decreased to $13.9 million for the
nine months ended September 30, 1996 from $67.9 million for the same 1995
period. This decrease is primarily due to the fact that on January 1, 1995,
$46.0 million was transferred to State Auto P&C, in connection with the amended
pooling arrangement. Net cash used in investing activities decreased to $11.3
million for the nine months ended September 30, 1996 from $69.8 million for the
same 1995 period. This change is due to the investing of the $46.0 million
associated with the pooling change. As of September 30, 1996, funds consisting
of cash and cash equivalents available for general operations were $13.9 million
compared to $9.9 million at September 30, 1995. No long-term fixed maturities
were required to be sold to meet financial obligations during the first nine
months of 1996.
Effective July 1, 1996, the State Auto Group negotiated a change in its
catastrophe reinsurance program. The amount retained by the State Auto Group is
$40.0 million for each occurrence, an increase of $20.0 million over the prior
program. For up to $80.0 million in losses, excess of $40.0 million, traditional
reinsurance coverage is provided. In the event the State Auto Group incurs
catastrophe losses in excess of $120.0 million, State Auto Financial Corp.
("STFC") entered into a structured contingent financing transaction with Chase
Manhattan Bank ("Chase") to provide up to $100.0 million. Under this
arrangement, in the event of such a loss, STFC would sell redeemable preferred
shares to SAF Funding Corporation, a special purpose company ("SPC"), which will
borrow the money necessary for such purchase from Chase and a syndicate of other
lenders. STFC will contribute to State Auto P&C the
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proceeds from the sale of its preferred shares. State Auto P&C has assumed
catastrophe reinsurance from Mutual, Milbank and National pursuant to a
catastrophe reinsurance agreement in the amount of $100.0 million excess of
$120.0 million. State Auto P&C will use the contributed capital to pay its
direct catastrophe losses and losses assumed under the catastrophe reinsurance
agreement. STFC is obligated to repay the SPC (which will repay the lenders) by
redeeming the preferred shares over a six year period. This layer of $100.0
million in excess of $120.0 has been excluded from the pooling agreement as well
by virtue of an Amended and Restated Reinsurance Pooling Agreement.
In addition, STFC's obligation to repay Chase has been secured by a Put
Agreement among STFC, Mutual and the Lenders, under which, in the event of a
default by STFC as described in the Credit Agreement or in the Put Agreement,
Mutual would be obligated to put either the preferred shares or the loan(s)
outstanding.
The Board of Directors declared a quarterly cash dividend of $0.04 per common
share payable on September 30, 1996, to shareholders of record on September 13,
1996. Additionally, at its May 30, 1996, Annual Meeting, the Board of Directors
declared a three-for-two stock split, effected in the form of a stock dividend,
payable July 8, 1996, to shareholders of record on June 17, 1996. All per share
figures have been adjusted to reflect the stock split.
The Company had no material commitments for capital expenditures as of September
30, 1996.
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STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
PART II. OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Changes in Securities - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Securities Holders - None
Item 5. Other Information - None
INDEX TO EXHIBITS
Item 6. a. Exhibits
Exhibit No. Description of Exhibits Page No.
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10(Y) Amended and Restated Reinsurance
Pooling Agreement between State
Automobile Mutual Insurance
Company, State Auto Property and
Casualty Insurance Company and
Milbank Insurance Company effective
July 1, 1996
10(Z) Property Catastrophe Overlying
Excess of Loss Reinsurance Contract
between State Automobile Mutual
Insurance Company, Milbank
Insurance Company, State Auto
National Insurance Company and
State Auto Property and Casualty
Insurance Company dated July 1, 1996
10(AA) Credit Agreement between SAF
Funding Corporation and The Chase
Manhattan Bank dated August 16, 1996
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Exhibit No. Description of Exhibits Page No.
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10(BB) Put Agreement between State
Automobile Mutual Insurance
Company, State Auto Financial
Corporation and The Chase Manhattan
Bank dated August 16, 1996
10(CC) Standby Purchase Agreement between
State Auto Financial Corporation
and SAF Funding Corporation dated
August 16, 1996
27 Financial data schedules
b. Reports on Form 8-K - None
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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: NOVEMBER 12, 1996 /s/ Urlin G. Harris, Jr.
------------------------------------
Urlin G. Harris, Jr.
Treasurer and Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)