<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549
FORM 10-Q
[x] Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the quarter ended June 30, 1998
[ ] Transition Report Pursuant to Section 13 or 15 (d) of the Securities
Exchange Act of 1934
For the transition period from to
Commission File Number 0-5544
OHIO CASUALTY CORPORATION
(Exact name of registrant as specified in its charter)
OHIO
(State or other jurisdiction of incorporation or organization)
31-0783294
(I.R.S. Employer Identification No.)
136 North Third Street, Hamilton, Ohio
(Address of principal executive offices)
45025
(Zip Code)
(513) 867-3000
(Registrant's telephone number)
Securities registered pursuant to Section 12(g) of the Act:
Common Shares, Par Value $.125 Each
(Title of Class)
Common Share Purchase Rights
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days.
Yes X No
The aggregate market value as of August 3, 1998 of the voting stock held by
non-affiliates of the registrant was $1,248,357,909.
On August 3, 1998 there were 32,797,683 shares outstanding.
Page 1 of 13
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<TABLE>
PART I
ITEM 1. FINANCIAL STATEMENTS
OHIO CASUALTY CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEET
(In thousands)
(Unaudited)
<CAPTION>
June 30, December 31,
1998 1997
- ---------------------------------------------------------------------------
<S> <C> <C>
Assets
Investments:
Fixed maturities:
Available for sale, at fair value
(cost: $2,087,923 and $2,112,291) $2,195,854 $2,226,030
Equity securities, at fair value
(cost: $258,723 and $275,637) 943,842 859,475
Short-term investments at cost 62,273 65,849
----------- -----------
Total investments 3,201,969 3,151,354
Cash 47,806 54,206
Premiums and other receivables 227,041 193,615
Deferred policy acquisition costs 135,483 126,063
Property and equipment 54,206 50,699
Reinsurance recoverable 114,048 108,962
Other assets 105,194 93,883
- ---------------------------------------------------------------------------
Total assets $3,885,747 $3,778,782
===========================================================================
Liabilities
Insurance reserves:
Unearned premiums $ 517,056 $ 495,076
Losses 1,179,113 1,176,614
Loss adjustment expenses 297,098 307,193
Future policy benefits 31,011 34,148
Note payable 35,000 40,000
California Proposition 103 reserve 68,700 66,908
Deferred income taxes 130,395 95,389
Other liabilities 277,405 248,625
----------- -----------
Total liabilities 2,535,778 2,463,953
Shareholders' equity
Common stock, $.125 par value
Authorized: 150,000,000 shares
Issued: 46,803,872 5,850 5,850
Additional paid-in capital 4,185 3,923
Unrealized gain on investments, net of applicable
income taxes 516,299 454,241
Retained earnings 1,170,254 1,158,308
Treasury stock, at cost:
(Shares: 14,006,189; 13,182,240) (346,619) (307,493)
----------- -----------
Total shareholders' equity 1,349,969 1,314,829
- ---------------------------------------------------------------------------
Total liabilities and shareholders' equity $3,885,747 $3,778,782
===========================================================================
</TABLE>
Accompanying notes are integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on
pages 23-32 of the Corporation's 1997 Annual Report to Shareholders.
2
<PAGE> 3
<TABLE>
OHIO CASUALTY CORPORATION AND SUBSIDIARIES
STATEMENT OF CONSOLIDATED INCOME
(In thousands)
(Unaudited)
<CAPTION>
Three Months
Ended June 30,
1998 1997
- -----------------------------------------------------------------------------
<S> <C> <C>
Premiums and finance charges earned $311,663 $307,788
Investment income less expenses 41,300 45,153
Investment gains realized 8,151 8,498
--------- ---------
Total income 361,114 361,439
Losses and benefits for policyholders 216,551 183,254
Loss adjustment expenses 30,088 29,874
General operating expenses 29,826 27,836
California Proposition 103 reserve 896 1,053
Amortization of deferred policy acquisition costs 75,126 76,080
--------- ---------
Total expenses 352,487 318,097
Income before income taxes 8,627 43,342
Income taxes
Current (194) 7,423
Deferred (1,168) 2,957
--------- ---------
Total income taxes (1,362) 10,380
- ------------------------------------------------------------------------------
Income from continuing operations 9,989 32,962
Income from discontinued operations 345 1,143
- ------------------------------------------------------------------------------
Net income $ 10,334 $ 34,105
==============================================================================
Other comprehensive income, net of tax:
Net change in unrealized gains (losses),
net of income tax expense/(benefit) of
$(5,054) and $51,909, respectively (9,387) 92,059
Comprehensive income $ 947 $126,164
==============================================================================
Average shares outstanding - basic 33,426 34,222
Average shares outstanding - diluted 33,476 34,244
==============================================================================
Earnings per share (basic and diluted):
Income from continuing operations, per share $ 0.30 $ 0.96
Income from discontinued operations, per share 0.01 0.04
--------- ---------
Net income, per share $ 0.31 $ 1.00
Cash dividends, per share $ 0.44 $ 0.42
==============================================================================
</TABLE>
Accompanying notes are integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on
pages 23-32 of the Corporation's 1997 Annual Report to Shareholders.
3
<PAGE> 4
<TABLE>
OHIO CASUALTY CORPORATION AND SUBSIDIARIES
STATEMENT OF CONSOLIDATED INCOME
(In thousands)
(Unaudited)
<CAPTION>
Six Months
Ended June 30,
1998 1997
- ------------------------------------------------------------------------------
<S> <C> <C>
Premiums and finance charges earned $621,290 $610,267
Investment income less expenses 85,933 88,871
Investment gains (losses) realized 12,233 21,838
--------- ---------
Total income 719,456 720,976
Losses and benefits for policyholders 404,668 369,435
Loss adjustment expenses 56,468 60,129
General operating expenses 58,178 53,108
California Proposition 103 reserve 1,793 2,105
Amortization of deferred policy acquisition costs 148,857 151,781
--------- ---------
Total expenses 669,964 636,557
Income before income taxes 49,492 84,418
Income taxes
Current 7,263 19,091
Deferred 1,326 1,108
--------- ---------
Total income taxes 8,589 20,199
- ------------------------------------------------------------------------------
Income from continuing operations 40,903 64,219
Income from discontinued operations 625 2,601
- ------------------------------------------------------------------------------
Net income $ 41,528 $ 66,820
==============================================================================
Other comprehensive income, net of tax:
Net change in unrealized gains (losses), net
of income tax expense/(benefit) of $33,416
and $32,370, respectively 62,058 55,516
Comprehensive income $103,586 $122,336
==============================================================================
Average shares outstanding - basic 33,523 34,561
Average shares outstanding - diluted 33,568 34,580
==============================================================================
Earnings per share (basic and diluted)
Income from continuing operations, per share $ 1.22 $ 1.86
Income from discontinued operations, per share 0.02 0.07
--------- ---------
Net income, per share $ 1.24 $ 1.93
Cash dividends, per share $ 0.88 $ 0.84
==============================================================================
</TABLE>
Accompanying notes are integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on
pages 23-32 of the Corporation's 1997 Annual Report to Shareholders.
4
<PAGE> 5
<TABLE>
OHIO CASUALTY CORPORATION AND SUBSIDIARIES
STATEMENT OF CONSOLIDATED
SHAREHOLDERS' EQUITY
(In thousands)
(Unaudited)
<CAPTION>
Additional Unrealized Total
Common paid-in gain (loss) Retained Treasury shareholders'
Stock capital on investments earnings stock equity
- -------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C>
Balance,
January 1, 1997 $ 5,850 $ 3,603 $ 332,042 $1,076,545 $(242,940) $1,175,100
Unrealized gain 87,885 87,885
Deferred income tax on
net unrealized gain (32,370) (32,370)
Net issuance of treasury
stock under stock option
(20,288 shares) 273 173 220 666
Repurchase of treasury
stock (1,057,288 shares) (42,816) (42,816)
Net income 66,820 66,820
Cash dividends paid
($.84 per share) (29,050) (29,050)
- -------------------------------------------------------------------------------------------------------
Balance,
June 30, 1997 $ 5,850 $ 3,876 $ 387,557 $1,114,488 $(285,536) $1,226,235
=======================================================================================================
Balance
January 1, 1998 $ 5,850 $ 3,923 $ 454,241 $1,158,308 $(307,493) $1,314,829
Unrealized gain 95,474 95,474
Deferred income tax on
net unrealized gain (33,416) (33,416)
Net issuance of treasury
stock under stock option
plan and by charitable
donation (10,051 shares) 262 127 389
Repurchase of treasury
stock (834,000 shares) (39,253) (39,253)
Net income 41,528 41,528
Cash dividends paid
($.88 per share) (29,582) (29,582)
- -------------------------------------------------------------------------------------------------------
Balance,
June 30, 1998 $ 5,850 $ 4,185 $ 516,299 $1,170,254 $(346,619) $1,349,969
=======================================================================================================
</TABLE>
Accompanying notes are integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on
pages 23-32 of the Corporation's 1997 Annual Report to Shareholders.
5
<PAGE> 6
<TABLE>
OHIO CASUALTY CORPORATION AND SUBSIDIARIES
STATEMENT OF CONSOLIDATED CASH FLOWS
(In thousands)
(Unaudited)
<CAPTION>
Six Months
Ended June 30,
1998 1997
- ------------------------------------------------------------------------------
<S> <C> <C>
Cash flows from:
Operations
Net income $ 41,528 $ 66,820
Adjustments to reconcile net income to cash
from operations:
Changes in:
Insurance reserves 11,247 (26,774)
Income taxes (13,057) (9,751)
Premiums and other receivables (33,426) (25,382)
Deferred policy acquisition costs (9,420) (4,232)
Reinsurance recoverable (5,085) 8,913
Other assets (5,473) (7,357)
Other liabilities 13,384 (9,553)
Depreciation and amortization 7,541 11,134
Investment gains and losses (12,437) (22,562)
California Proposition 103 Reserve 1,793 2,105
---------- ----------
Net cash used by operations (3,405) (16,639)
Investments
Purchase of investments:
Fixed income securities - available for sale (115,809) (136,360)
Equity securities (8,368) (14,210)
Proceeds from sales:
Fixed income securities - available for sale 95,194 144,780
Equity securities 32,160 64,793
Proceeds from maturities and calls:
Fixed income securities - available for sale 66,289 27,740
Equity securities 4,601 2,784
Property and equipment:
Purchases (8,442) (6,324)
Sales 276 409
---------- ----------
Net cash generated from investments 65,901 83,612
Financing
Note payable (5,000) (5,000)
Proceeds from exercise of stock options 1 318
Purchase of treasury stock (37,891) (41,043)
Dividends paid to shareholders (29,582) (29,050)
---------- ----------
Net cash used in financing activity (72,472) (74,775)
Net change in cash and cash equivalents (9,976) (7,802)
Cash and cash equivalents, beginning of period 120,055 61,624
- ------------------------------------------------------------------------------
Cash and cash equivalents, end of period $ 110,079 $ 53,822
==============================================================================
</TABLE>
Accompanying notes are integral part of these financial statements. For
complete disclosures see Notes to Consolidated Financial Statements on
pages 23-32 of the Corporation's 1997 Annual Report to Shareholders.
6
<PAGE> 7
OHIO CASUALTY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
NOTE I - RECENTLY ISSUED ACCOUNTING STANDARDS
During 1997, the Corporation adopted Statement of Financial Accounting
Standard 128 "Earnings Per Share." Basic earnings per share is computed using
weighted average number of common shares outstanding. Diluted earnings per
share is computed similar to basic earnings per share except that the weighted
average number of shares outstanding is increased to include the number of
additional common shares that would have been issued if all dilutive
outstanding stock options would have been exercised. All prior periods were
recalculated under the new definition of basic and diluted earnings per share.
Basic and diluted earnings per share are summarized as follows:
<TABLE>
<CAPTION>
1998 1997
---- ----
<S> <C> <C>
Income from continuing operations $40,903 $64,219
Average common shares
outstanding - basic 33,523 34,561
Basic income from continuing
operations per average share $ 1.22 $ 1.86
====================================================================
Average common shares outstanding 33,523 34,561
Effect of dilutive securities 45 19
- --------------------------------------------------------------------
Average common shares
outstanding - diluted 33,568 34,580
Diluted income from continuing
operations - per average share $ 1.22 $ 1.86
====================================================================
</TABLE>
In 1997 the SEC issued Financial Reporting Release 48 "Disclosures about
Derivatives and Other Financial Instruments." This statement requires
enhanced accounting policy disclosures for derivative instruments as well as
quantitative and qualitative disclosures about market risk inherent in
derivative instruments and other financial instruments. The Corporation has
provided the accounting policy disclosures in Note III. The quantitative and
qualitative disclosure information regarding market risk will be included in
the Corporation's 1998 10-K filing.
The Corporation adopted Statement of Financial Accounting Standard 130
"Reporting Comprehensive Income" during the first quarter of 1998.
Comprehensive income is defined as changes in equity of a business enterprise
during a period from transactions and other events from non-owner sources.
The Corporation has displayed comprehensive income on its Statement of
Consolidated Income on pages 3 and 4 of this Form 10-Q.
In June 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard 131 "Disclosures about Segments of an Enterprise
and Related Information." This statement requires selected information to be
reported on the Corporation's operating segments. Operating segments are
determined by the way management structures the segments in making operating
decisions and assessing performance. The Corporation is currently reviewing
what changes, if any, this will require on the presentation of the financial
statements for fiscal periods beginning after December 31, 1997.
In December 1997, the American Institute of Certified Public Accountants
issued Statement of Position 97-3 "Accounting by Insurance and Other
Enterprises for Insurance-Related Assessments." This statement provides
guidance on accounting for insurance related assessments and required
disclosure information. This statement is effective for fiscal years
beginning after December 15, 1998. The Corporation does not believe that this
statement will materially affect the Corporation's financial statements or
disclosures.
The Corporation adopted Statement of Position 98-1 "Accounting for the Costs
of Computer Software Developed or Obtained for Internal Use." This statement
provides guidance on accounting for the costs of computer software developed
or obtained for internal use and allows for certain costs associated with
7
<PAGE> 8
developing/obtaining software for internal use to be capitalized. Pursuant to
this, the Corporation capitalized $1.4 million during the second quarter of
1998 and has capitalized $2.5 million year to date. Prior to this Statement
of Position, this amount would have been expensed as incurred.
In February 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard 132 "Employers' Disclosures about Pensions and
Other Postretirement Benefits." The purpose of this statement is to
standardize the disclosure requirements for pensions and other postretirement
benefits. The only impact to the Corporation will be the modification of its
footnote disclosure. The Corporation will make these modifications beginning
with the Annual Report to Shareholders for the year ended December 31, 1998.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standard 133 "Accounting for Derivative Instruments and
Hedging Activities." This statement standardizes the accounting for
derivative instruments by requiring those items to be recognized as assets or
liabilities with changes in fair value reported in earnings or other
comprehensive income in the current period. The Corporation expects the
adoption of FAS 133 to have an immaterial impact on the financial results due
to its limited use of derivative instruments. This statement is effective for
fiscal quarters of fiscal years beginning after June 15, 1999 (January 1, 2000
for the Corporation).
NOTE II - INTERIM ADJUSTMENTS
It is believed that all material adjustments necessary to present a fair
statement of the results of the interim period covered are reflected in this
report. The operating results for the interim periods are not necessarily
indicative of the results to be expected for the full year. These statements
should be read in conjunction with the financial statements and notes thereto
in the Corporation's Annual Report to Shareholders.
NOTE III - ACCOUNTING POLICY ON DERIVATIVES
The Corporation has outstanding an interest rate swap on its revolving line of
credit. The effect of the swap agreement is to establish a hedge against
future interest rate changes. Net proceeds or payments from the swap are
charged to interest expense in the current period.
Covered call options are written on stocks and bonds held in the investment
portfolio. Changes in the values of the covered call options are recognized
in shareholders equity as unrealized appreciation or depreciation.
8
<PAGE> 9
ITEM 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations
-----------------------------------------------------------------
Property and casualty pre-tax underwriting losses for the six months ended
June 30, 1998 were $45.7 million, $1.36 per share, compared with $23.9
million, $0.69 per share for the same period in 1997. Gross premiums for the
first six months of 1998 increased 3.3%. Commercial lines decreased 3.9% and
personal lines increased 9.2% for the first six months of 1998.
Property and casualty net premium written increased 3.5% for the second
quarter of 1998 and 2.4% year to date. Premium from key agents grew 11.0% for
the quarter and increased 8.1% year to date. Key agents work closely with the
Corporation to establish goals to increase profitability, growth, and
retention. Non-key active agents grew 2.7% during the second quarter with
year to date growth of 1.5% over 1997. This brings total active agent premium
growth to 8.9% for the second quarter and 6.5% year to date.
The Corporation participates in an experience rated First Casualty Excess of
Loss Treaty. In accordance with FASB 113 (Accounting and Reporting for
Reinsurance of Short-Duration and Long-Duration Contracts), anticipated
profits from this agreement are recorded as returned premium and therefore
increase net premium written for the period. As of June 30, 1998, the
actuarial projections of estimated profit from this agreement was $7.5
million. Of this amount, $1.0 million was recognized as return premium in the
first quarter and $6.5 million in the second quarter. In the comparable
period last year, $3.0 million was recognized in the first quarter as return
premium and $7.3 million was recognized in the second quarter.
New Jersey is our largest state with 16.7% of total premiums written during
the year. Legislation passed in 1992 requires automobile insurers operating
in the state to accept all risks that meet underwriting guidelines regardless
of risk concentration. This leads to a greater risk concentration in the
state than the Corporation would otherwise accept. New Jersey also requires
assessments to be paid for the New Jersey Unsatisfied Claim and Judgment Fund
(UCJF). The assessment for 1998 is approximately $3.2 million compared with
$4.2 million in 1997. Recently, the New Jersey State Senate passed an auto
insurance reform bill that mandates a 15% rate reduction for personal auto
policies for drivers who agree not to sue for "pain and suffering" unless they
suffer permanent injury in an accident. The bill was passed by the Assembly
and signed by the governor. It is currently uncertain what effective date the
state will use to implement the rollback. The anticipated impact on the
corporation is a tradeoff of lower premium rates on personal auto policies for
presumably lower losses on these policies. As of June 30, 1998 the
Corporation had personal auto net premium written of $55.1 million or 51.5% of
total premium that the Corporation writes in New Jersey. The maximum impact
of this reform bill on the Corporation would have been a decrease of $8.3
million for the year in premium if all policyholders made this election on
their policies.
The combined ratio for the first six months increased 4.7 points to 108.3%
from 103.6% from the same period last year. The six month combined ratio for
homeowners increased 13 points to 127.8% from 114.8% in the same period last
year. The results for homeowners was largely impacted by the severe storm
losses that occurred throughout the country during the second quarter.
Personal automobile, the Corporation's largest line, recorded a 1998 six month
combined ratio of 102.3%, down .7 points from 103.0% in 1997. Workers'
compensation combined ratio for the first six months of 1998 increased 32
points to 116.5% from 84.5% during the same period last year. This
deterioration is the result of reserve increases resulting from additional
development of pre-existing claims.
The general liability combined ratio for the second quarter increased 3.8
points to 106.8% from 103.0% in 1997. The six month combined ratio decreased
2 points to 98.9% from 100.9% in the same period of 1997. The six month
combined ratio for CMP, fire and inland marine increased 1.8 points to 107.9%
from 106.1% in 1997 due primarily to weather related losses.
Second quarter catastrophe losses were $23.8 million and accounted for 7.6
points on the combined ratio. This compares with $4.6 million and 1.5 points
for the same period in 1997. Year to date catastrophe losses increased $16.9
million from $9.9 million in 1997 to $26.8 million in 1998. This increase is
a direct result of severe storm losses during the second quarter.
9
<PAGE> 10
Estimated asbestos and environmental reserves are composed of case reserves,
incurred but not reported reserves and reserves for loss adjustment expense.
The total asbestos and environmental reserves as of June 30, 1998 were $40.1
million compared with $41.0 million at June 30, 1997.
For the quarter, property and casualty before tax investment income was $40.0
million, $1.20 per share, decreasing from $44.1 million, $1.29 per share, for
the same period last year. This decline comes as the result of additional
stock repurchases made during the second quarter and holding over $55.0
million more in cash and cash equivalents at June 30, 1998 versus the same
period in 1997. Also 1997 net investment income was increased by $1.7 million
as a result of an agreement where Ohio Casualty had agreed to manage an
investment portfolio for Americo and guarantee a 7.25% return. Any return
above this amount was recorded as income to Ohio Casualty. During the fourth
quarter of 1997, this portfolio was transferred out of the property and
casualty business and into the holding company, and therefore is no longer
included in property and casualty investment income. The effective tax rate
on investment income for the second quarter of 1998 was 24.8% compared with
24.1% for the comparable period in 1997. Additional discussion of the
Corporation's investment taxation is included in the 1997 Annual Report to
Shareholders.
Net cash used by operations was $3.4 million for the first six months of the
year compared with net cash used of $16.6 million from operations for the same
period in 1997. Net cash used by operations differs from net income of $41.5
million mainly due to $12.4 million of realized investment gains for the year
and an increase in premium receivables of $33.4 million over December 31,
1997. Shareholder dividend payments were $29.6 million in the first six
months of 1998 compared with $29.0 million for the same period of 1997.
During the first six months of 1998, Ohio Casualty continued its share
repurchase program. The total number of shares acquired during the period was
834,000, or 2.5% of outstanding shares, at an average price of $47.07 per
share for a total cash outflow of $37.7 million. The Company has remaining
authorization to repurchase 1,192,812 additional shares.
In 1995 the Corporation reinsured substantially all of its life insurance and
related businesses to Great Southern Life Insurance Company. During the
fourth quarter of 1997, Great Southern Life Insurance Company legally replaced
Ohio Life as the primary insurer for approximately 76% of the life insurance
policies subject to the 1995 agreement. As a result, 76% of the unamortized
ceding commission was recognized during the 4th quarter of 1997. There
remains approximately $2.1 million in unamortized ceding commission. This
will continue to be amortized over the remaining life of the underlying
policies.
Investments in below investment grade securities (Standard and Poor's rating
below BBB-) and unrated securities are summarized as follows:
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
- ----------------------------------------------------------------------
<S> <C> <C>
Below investment grade securities:
Carrying value $177.5 $141.4
Amortized cost 162.0 135.6
Unrated securities:
Carrying value $256.5 $242.8
Amortized cost 241.2 228.6
</TABLE>
Utilizing ratings provided by other agencies, such as the NAIC, categorizes
additional unrated securities into below investment grade ratings. The
following summarizes the additional unrated securities that are rated in the
below investment grade category by other rating agencies:
<TABLE>
<CAPTION>
June 30, December 31,
1998 1997
- ----------------------------------------------------------------------
<S> <C> <C>
Below investment grade securities at
carrying value $177.5 $141.4
Other rating agencies categorizing unrated
securities as below investment grade 8.0 8.1
------ ------
Below investment grade securities at
carrying value $185.5 $149.5
</TABLE>
10
<PAGE> 11
All of the Corporation's below investment grade securities are performing in
accordance with contractual terms and are making principal and interest
payments as required. The securities in the Corporation's below investment
grade portfolio have been issued by 55 corporate borrowers in approximately 33
industries.
For further discussion of the Corporation's investments, see Item 1 of the
Corporation's Form 10-K for the year ended December 31, 1997.
In 1994, the National Association of Insurance Commissioners developed a risk-
based capital model to establish standards which will compare insurance
company statutory surplus to required minimum capital based on risks of
operations and assist regulators in determining solvency requirements. The
model is based on four risk factors in two categories: asset risk consisting
of investment risk and credit risk; and underwriting risk composed of loss
reserve and premiums written risks. Based on current calculations, all of the
Ohio Casualty Group companies have at least twice the necessary capital to
conform with the risk-based capital model.
Proposition 103 was passed by the State of California in 1988 in an attempt
to legislate premium rates for that state. That statute included a provision
requiring the rollback of premium rates for 1989. The Corporation is
currently involved in hearings with the California Department of Insurance
to determine the Corporation's rate rollback liability under Proposition 103.
In 1997, the Administrative Law Judge presiding over the hearings requested
a submission from the Department showing revised rollback calculations. The
Department filed two revised rollback calculations in December 1997. These
alternatives, based on its concession of certain issues were $35.9 million
plus interest, and $39.9 million plus interest. After consultation with
outside counsel, the Corporation determined that $35.9 million plus interest
was the more reasonable of the two Department calculations should the
Department prevail. As a result the Corporation's reserve for this alleged
liability (including interest) is $68.7 million.
In June 1998, the Administrative Law Judge issued a proposed decision that
the Corporation's rollback liability is $24.4 million plus interest. The
Commissioner of Insurance may affirm, modify or reject the proposed decision
in whole or in part, and his determination will be subject to independent
judgment review by a California superior court. The Corporation will
continue to challenge the validity of any rollback, and asserts that the
proposed $24.4 million rollback, if adopted, would be confiscatory.
The proceedings concerning the Corporation's potential rollback liability
remain ongoing, and it is uncertain when this matter will ultimately be
resolved. The Corporation anticipates further negotiations with the
Department. For further discussion of the Corporation's withdrawal from
California, see footnote 15 in the Corporation's Annual Report to Shareholders.
The Corporation continues to work on converting our computer systems to be
year 2000 compliant by year end 1998. Changes are nearing completion and
compliance testing is well under way. Compliance testing is being conducted
in an environment that simulates conditions in late 1999 and early 2000. The
compliance testing phase was added during 1997 to our year 2000 criteria.
This involves individual system compliance testing and integrated system
compliance testing. The first step verifies that the systems are compliant
when they run independently. The second step verifies compliance when they
are integrated with all other systems with which they interface. Testing is
scheduled throughout 1998 focusing initially on systems critical to the daily
business operation and followed by all others. To date, the Corporation has
spent approximately $1.2 million and expects to spend an additional $.9
million to complete our efforts.
The Corporation continues to contact vendors who provide products and/or
services requesting verification that they either are or will be year 2000
compliant. Most have responded, second requests have been mailed to those not
responding to the first request and follow ups are scheduled for those
indicating they will be compliant at a future date.
The year 2000 issue is also a concern from an underwriting standpoint as well
regarding the extent of liability for coverage under various general
liability, property and directors and officers liability and product policies.
<PAGE> 12 11
The Corporation believes that minimal coverage could exist under some current
liability and product policies. This exposure would be minimal as our
commercial lines business has historically excluded any manufacturing risks
which produce computer or computer dependent products.
The Insurance Services Office (ISO) recently developed policy language that
clarifies that there is no coverage for certain year 2000 occurrences. The
liability exclusion has been accepted in over 40 states and a companion filing
for property has been accepted in at least 20 states at this time. Several
states have not adopted or approved the property exclusion form citing
specifically that there is no coverage under the current property contracts
and therefore, there is no reason to accept a clarifying endorsement. The
Corporation is currently addressing the year 2000 issue by attaching the ISO
exclusionary language to all general liability policies with a rating
classification the Corporation believes could potentially have year 2000
losses. The ISO exclusionary language endorsement is included on all property
policies. These actions will minimize the Corporation's exposure to year 2000
losses.
Directors and officers could be held liable if a company in their control
failed to take necessary actions to fix any year 2000 problems and that
failure results in a material financial loss to the Company. The Corporation
has written directors' and officers' liability policies since 1995, with
approximately $.9 million in premiums written in 1997. The Corporation is
managing its D&O year 2000 exposure through a combination of underwriting
guidelines which address year 2000 issues in the application process and
reinsurance policies which provide coverage for any loss in excess of $.3
million.
During the first quarter of 1998, the Corporation was in violation of one of
its loan covenants for its revolving line of credit. The covenant states that
no more than 30% of the Corporation's investment portfolio at market value may
be invested in equity securities. At March 31, 1998 the actual percentage of
equity securities to consolidated investments was 30.2% at market value. This
violation occurred solely because of appreciation in the Corporation's equity
portfolio. The Corporation has not allocated any new funds to the equity
portfolio in the last three years. The syndicate of banks under the credit
agreement have all signed waivers of default for this occurrence.
From time to time, the Company may publish forward looking statements relating
to such matters as anticipated financial performance, business prospects and
plans, regulatory developments and similar matters. The statements contained
in this Management's Discussion and Analysis of Financial Condition and
Results of Operations that are not historical information, are forward looking
statements. The Private Securities Litigation Reform Act of 1995 provides a
safe harbor under The Securities Act of 1933 and The Securities Exchange Act
of 1934 for forward-looking statements. In order to comply with the terms of
the safe harbor, the Company notes that a variety of factors could cause the
Company's actual results and experience to differ materially from the
anticipated results or other expectations expressed in the Company's forward-
looking statements. The risks and uncertainties that may affect the
operations, performance, development and results of the Company's business
include the following: changes in property and casualty reserves; catastrophe
losses; premium and investment growth; product pricing environment;
availability of credit; changes in government regulation; performance of
financial markets; fluctuations in interest rates; availability and pricing of
reinsurance; litigation and administrative proceedings; year 2000 issues and
general economic and market conditions.
12
<PAGE> 13
PART II
Item 1. Legal Proceedings - None
Item 2. Changes in Securities - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information - None
Item 6. Exhibits and reports on Form 8-K - None
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
OHIO CASUALTY CORPORATION
-------------------------
(Registrant)
August 12, 1998 /s/ Barry S. Porter
-------------------------------
Barry S. Porter, CFO/Treasurer
(on behalf of Registrant and as
Principal Accounting Officer)
13
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