STATE AUTO FINANCIAL CORP, DEF 14A, 1998-04-23

STATE AUTO FINANCIAL CORP
DEF 14A, 1998-04-23
FIRE, MARINE & CASUALTY INSURANCE

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SCHEDULE 14A
(RULE 14a)
INFORMATION REQUIRED IN PROXY STATEMENT
SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(a) OF THE SECURITIES
EXCHANGE ACT OF 1934
(AMENDMENT NO. )

Filed by the Registrant [X]

Filed by a Party other than the Registrant [ ]

Check the appropriate box:

<TABLE>
<S> <C>
[ ] Preliminary Proxy Statement [ ] CONFIDENTIAL, FOR USE OF THE COMMISSION
ONLY (AS PERMITTED BY RULE 14a-6(e)(2))
[X] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to sec.240.14a-11(c) or sec.240.14a-12
</TABLE>

State Auto Financial Corporation
(NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

(NAME OF PERSON(S) FILING PROXY STATEMENT, IF OTHER THAN THE REGISTRANT)

Payment of Filing Fee (Check the appropriate box):
[X] No fee required.
[ ] Fee computed on table below per Exchange Act Rules 14a-6(i)(1) and 0-11.

(1) Title of each class of securities to which transaction applies: .......

(2) Aggregate number of securities to which transaction applies: ..........

(3) Per unit price or other underlying value of transaction computed
pursuant to Exchange Act Rule 0-11 (Set forth the amount on which the
filing fee is calculated and state how it was determined): ............

(4) Proposed maximum aggregate value of transaction: ......................

(5) Total fee paid: .......................................................

[ ] Fee paid previously with preliminary materials.

[ ] Check box if any part of the fee is offset as provided by Exchange Act Rule
0-11(a)(2) and identify the filing for which the offsetting fee was paid
previously. Identify the previous filing by registration statement number,
or the Form or Schedule and the date of its filing.

(1) Amount Previously Paid: ...............................................

(2) Form, Schedule or Registration Statement No.: .........................

(3) Filing Party: .........................................................

(4) Date Filed: ...........................................................

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[State Auto Financial Corporation Logo]

STATE AUTO FINANCIAL CORPORATION

NOTICE OF ANNUAL MEETING OF SHAREHOLDERS

To the Shareholders of
STATE AUTO FINANCIAL CORPORATION:

Notice is hereby given that the Annual Meeting of Shareholders of State
Auto Financial Corporation (the "Company") will be held at the Company's
principal executive offices located at 518 East Broad Street, Columbus, Ohio, on
Thursday, May 28, 1998, at 10:00 A.M., EDST, for the following purposes:

1. To elect three Class I directors, each to hold office for a three
year term and until a successor is elected and qualified;

2. To consider and vote upon an amendment to the Amended and Restated
Articles of Incorporation of the Company to authorize an additional
70,000,000 common shares, without par value;

3. To transact such other business as may properly come before the
meeting or any adjournment thereof.

The close of business on April 6, 1998, has been fixed as the record date
for the determination of shareholders entitled to notice of and to vote at the
meeting and any adjournment thereof.

In order that your shares may be represented at this meeting and to assure
a quorum, please sign and return the enclosed proxy promptly. A return addressed
envelope, which requires no postage, is enclosed. In the event you are able to
attend and wish to vote in person, at your request we will cancel your proxy.

By Order of the Board of Directors

JOHN R. LOWTHER
Secretary

Dated: April 22, 1998
<PAGE> 3

STATE AUTO FINANCIAL CORPORATION

PROXY STATEMENT

GENERAL

This Proxy Statement is furnished in connection with the solicitation of
proxies by the Board of Directors of State Auto Financial Corporation (the
"Company") to be used at its Annual Meeting of Shareholders to be held May 28,
1998. Shares represented by properly executed proxies will be voted at the
meeting in accordance with the choices indicated on the proxy. Any proxy may be
revoked at any time, insofar as it has not been exercised, by delivery to the
Company of a subsequently dated proxy or by giving notice of revocation to the
Company in writing or in open meeting. A shareholder's presence at the Annual
Meeting does not by itself revoke the proxy.

The mailing address of the principal executive offices of the Company is
518 East Broad Street, Columbus, Ohio 43215. The approximate date on which this
Proxy Statement and the form of proxy are first being sent or given to
shareholders is April 22, 1998.

The close of business on April 6, 1998, has been fixed as the record date
for the determination of shareholders entitled to notice of and to vote at the
meeting and any adjournment thereof. On the record date there were outstanding
and entitled to vote 18,350,632 of the Company's Common Shares, without par
value. Each Common Share is entitled to one vote.

ELECTION OF DIRECTORS

The number of directors currently is fixed at nine. The board of directors
is divided into three classes, Class I, Class II and Class III, with three
directors in each Class. The terms of office of directors in one Class expire
annually at each annual meeting of shareholders at such time as their successors
are elected and qualified. Directors in each Class are elected for three year
terms. The term of office of the Class I directors expires concurrently with the
holding of the Annual Meeting. The three nominees include two incumbent
directors in such Class who have been nominated for re-election and Mr. Robert
H. Moone, who would assume the seat currently held by Mr. Robert J. Murchake,
who is retiring from the Board as of the Annual Meeting.

At the Annual Meeting, it is the intention of the persons named in the
accompanying form of proxy, unless a contrary position is indicated on such
proxy, to vote the proxy for the election of the three nominees named in the
following table as Class I directors, each to hold office until the 2001 annual
meeting of shareholders and until a successor is elected and qualified. There is
no cumulative voting in the election of directors, and those nominees receiving
the highest number of votes will be elected. Abstentions and broker non-votes
will not be counted in determining the votes cast in the election of directors
and will not have a positive or negative effect on the election. In the event
that any nominee named in the table as a Class I director is unable to serve
(which is not anticipated), the persons named in the proxy may vote it for
another nominee of their choice.
<PAGE> 4

Set forth below is information about each of the Class I director nominees:

CLASS I DIRECTOR NOMINEES
(TERMS EXPIRING IN 2001)

<TABLE>
<CAPTION>
A COMMON
NAME OF DIRECTOR SHARES OWNED
NOMINEE/DIRECTOR PRINCIPAL OCCUPATION(S) OF THE BENEFICIALLY AS %
AND POSITION(S) DURING THE COMPANY OF APRIL 6, OF
WITH COMPANY AGE(1) PAST FIVE YEARS SINCE 1998(2)(3) CLASS
---------------- ------ ----------------------- -------- --------------- -----
<S> <C> <C> <C> <C> <C>
John R. Lowther(4).......... 47 Vice President, Secretary and General 1991 40,914 *
Vice President, Secretary Counsel of the Company, 5/91 to
and General Counsel present; Vice President, Secretary
and General Counsel of State Auto
Property and Casualty Insurance
Company, a wholly-owned subsidiary of
the Company, ("State Auto P&C") and
State Automobile Mutual Insurance
Company, the Company's parent and
owner of 65% of the common shares of
the Company, ("Mutual") 8/89 to
present.

Paul W. Huesman(5).......... 62 President, Huesman-Schmid Insurance 1991 24,307 *
Director Agency, Inc., an insurance agency,
for more than five years.

Robert H. Moone(6).......... 54 President and Chief Operating Officer 79,012 *
President and Chief of the Company, 5/96 to present;
Operating Officer Executive Vice President of the
Company, 11/93 to 5/96; Vice
President of the Company, 5/91 to
11/93; President and Chief Operating
Officer of State Auto P&C and Mutual,
5/96 to present; Executive Vice
President State Auto P&C and Mutual,
11/93 to 5/96; prior thereto Senior
Vice President of State Auto P&C and
Mutual.
</TABLE>

2
<PAGE> 5

Set forth below is information about the directors whose terms of office
continue after the Annual Meeting.

CLASS II DIRECTORS
(TERMS EXPIRING IN 1999)

William J. Lhota............ 58 Executive Vice President, American 1994 11,000 *
Director Electric Power ("AEP"), an
investor-owned electric utility, and
President and Chief Operating
Officer, Appalachian Power Company,
Columbus Southern Power Company,
Indiana Michigan Power Company,
Kentucky Power Company, Kingsport
Power Company, Ohio Power Company and
Wheeling Power Company, all of which
are subsidiaries of AEP, 1/96 to
present; Executive Vice President,
American Electric Power Service
Corporation, 7/93 to 1/96; Executive
Vice President, Operations, American
Electric Power Service Corporation,
10/89 to 7/93. Mr. Lhota is also a
director of Huntington Bancshares,
Inc., a bank holding company, and AEP
Generating Company, Appalachian Power
Company, Columbus Southern Power
Company, Indiana Michigan Power
Company, Kentucky Power Company, and
Ohio Power Company.

David J. D'Antoni........... 53 Senior Vice President, Ashland, Inc.; 1995 16,500 *
Director President, Ashland Chemical Company,
a division of Ashland, Inc., 7/88 to
present, a chemical manufacturing and
a chemical and plastics distribution
business.
</TABLE>

3
<PAGE> 6

CLASS III DIRECTOR NOMINEES
(TERMS EXPIRING IN 2000)

<TABLE>
<CAPTION>
A COMMON
NAME OF DIRECTOR SHARES OWNED
DIRECTOR PRINCIPAL OCCUPATION(S) OF THE BENEFICIALLY AS %
AND POSITION(S) DURING THE COMPANY OF APRIL 6, OF
WITH COMPANY AGE PAST FIVE YEARS SINCE 1998(2)(3) CLASS
--------------- --- ----------------------- -------- --------------- -----
<S> <C> <C> <C> <C> <C>
Urlin G. Harris, Jr......... 61 Retired effective April 1, 1997 as an 1991 77,807 *
Director officer of the Company, State Auto
P&C, and Mutual; Executive Vice
President, Treasurer, and Chief
Financial Officer of the Company,
11/93 to March 31, 1997; Senior Vice
President, Treasurer, and Chief
Financial Officer of the Company,
5/91 to 11/93; Executive Vice
President, Treasurer and Chief
Financial Officer of State Auto P&C
and Mutual, 11/93 to 3/31/97; and
prior thereto, Senior Vice President,
Treasurer and Chief Financial Officer
of State Auto P&C and Mutual.
David L. Bickelhaupt........ 68 Retired Professor, The Ohio State 1991 11,560 *
Director University, Fisher College of
Business, where he taught for more
than five years. Principal of David
L. Bickelhaupt, Inc., a writing and
consulting business.

George R. Manser............ 67 Director of Corporate Finance 1991 33,775 *
Director Uniglobe Travel USA, 3/97 to present;
Chairman of the Board, Uniglobe
Travel (Capital Cities) Inc., a
travel agency franchisor, for more
than five years to present; Advisory
director to J.C. Bradford & Co., 8/94
to present; Mr. Manser is also a
director of Cardinal Health, Inc., a
wholesale pharmaceutical distributor,
AmeriLink Corporation, a
telecommunications business, Hallmark
Financial Services, Inc. a
nonstandard, Texas only, auto
insurer, and Checkfree Corporation, a
business facilitating electronic
commerce. Prior to 7/94, Mr. Manser
was also Chairman of North American
National Corporation.
</TABLE>

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* Less than one (1%) percent.

(1) Ages shown are as of the date of the annual meeting of shareholders.

(2) Except as indicated in the notes to this table, the persons named in the
table and/or their spouses have sole voting and investment power with
respect to all Common Shares shown as beneficially owned by the

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<PAGE> 7

named person. With respect to stock options, this table includes only stock
options for Common Shares which are currently exercisable or exercisable within
60 days of April 6, 1998. The Common Shares have been adjusted to reflect the
three-for-two stock split, effected in the form of a stock dividend,
effective July 8, 1996.

(3) The amount reported includes Common Shares attributable to options granted
under the 1991 Stock Option Plan for Messrs. Bailey (170,302), Moone
(27,645) and Lowther (16,375) and Common Shares attributable to options
granted under the 1991 Directors' Stock Option Plan for Messrs. Lhota
(4,000), D'Antoni (4,000), Bickelhaupt (9,600), Manser (10,000) and Huesman
(10,000). Mr. Harris' shares owned include 51,100 options granted under the
1991 Stock Option Plan to Mr. Harris while he was employed by the Company
and 1,000 shares granted under the 1991 Director's Stock Option Plan since
he retired from active service to the Company.

(4) Includes 13,375 Common Shares attributable to options granted to Mr. Lowther
under the 1991 Stock Option Plan which he assigned to his spouse pursuant to
the terms of the 1991 Stock Option Plan as to which shares he disclaims
beneficial ownership.

(5) Includes 5,574 Common Shares owned by the Huesman-Schmid Insurance Agency,
Inc.'s Profit Sharing Plan and 5,626 Common Shares owned by the
Huesman-Schmid Insurance Agency, Inc. Defined Benefit Pension Plan as to
which Mr. Huesman shares voting and investment power with the other trustee
of these plans.

(6) Includes 27,645 Common Shares attributable to options granted to Mr. Moone
under the 1991 Stock Option Plan which he assigned to the Anna Moone Living
Trust (Anna Moone and Robert H. Moone, co-trustees) pursuant to the terms of
the 1991 Stock Option Plan as to which shares he disclaims beneficial
ownership.

(7) Includes 28,750 Common Shares held by Bailey Enterprises, a family
partnership of which he is a member. Mr. Bailey exercises voting power and
investment power as to the Common Shares owned by Bailey Enterprises. This
also includes 20,680 Common Shares attributable to options granted to Mr.
Bailey under the 1991 Stock Option Plan, which he assigned to his spouse
pursuant to the terms of the 1991 Stock Option Plan, as to which shares he
disclaims beneficial ownership.

In addition to the Common Shares owned beneficially by Messrs. Bailey and
Moone, as set forth above, Michael F. Dodd, Steven J. Johnston and Cathy B.
Miley, the other named executive officers in the Summary Compensation Table set
forth below, owned beneficially 53,388 Common Shares, 23,438 Common Shares, and
66,504 Common Shares, respectively, of the Company as of April 6, 1998, each of
which represents less than 1% of the Company's outstanding Common Shares. These
amounts include Common Shares attributable to options which are currently
exercisable or exercisable within 60 days of April 6, 1998, granted under the
1991 Stock Option Plan in the amounts of 37,800, 17,850, and 33,600 for Messrs.
Dodd, and Johnston and Ms. Miley, respectively (17,250 of the foregoing 33,600
Common Shares attributable to Ms. Miley represent options granted to her
husband, Richard L. Miley, an officer of the Company, under the 1991 Stock
Option Plan). As of April 6, 1998, all directors and executive officers of the
Company as a group (20 persons) owned beneficially 851,481 (4.6%) Common Shares
of the Company, which included options for 543,642 Common Shares.

In addition to the Common Shares of the Company owned beneficially by
Messrs. Lowther, Harris, Bailey, Moone and Johnston, as described above, each of
these individuals beneficially owns and exercises sole

5
<PAGE> 8

voting and investment power as to the following number of shares of common stock
of Strategic Insurance Software, Inc., a majority-owned (86%) subsidiary of the
Company engaged in the software business:

<TABLE>
<CAPTION>
COMMON SHARES
BENEFICIALLY
OWNED AS OF
NAME OF BENEFICIAL OWNER APRIL 6, 1998 % OF CLASS
------------------------ ------------- ----------
<S> <C> <C>
Robert L. Bailey.......................................... 30,000 Shares 1.4%
Urlin G. Harris, Jr....................................... 30,000 Shares 1.4%
Robert H. Moone........................................... 22,500 Shares 1.0%
Steven J. Johnston........................................ 20,000 Shares *
John R. Lowther........................................... 15,000 Shares *
</TABLE>

- ---------------

* Less than one percent

As of April 6, 1998, all directors and executive officers of the Company,
as a group, owned 125,000 (5.6%) shares of common stock of Strategic Insurance
Software, Inc.

MEETINGS OF THE BOARD OF DIRECTORS AND BOARD COMMITTEES

During the fiscal year ended December 31, 1997, the Company's Board of
Directors held four meetings. No incumbent director attended fewer than 75% of
the aggregate of the meetings of the Board and the meetings of all committees on
which he served.

The Board has an Audit Committee charged with several responsibilities,
including: 1) reviewing the Company's accounting functions, operations, and
management; 2) considering the adequacy and effectiveness of the internal
controls and internal auditing methods and procedures of the Company; 3) meeting
and consulting with the Company's independent auditors and with the Company's
financial and accounting personnel concerning the foregoing matters; 4)
reviewing with the Company's independent auditors the scope of their audit of
the Company and the results of their examination of its financial statements for
its then current fiscal year; and 5) considering the selection and recommending
to the Board of Directors a firm of certified public accountants to be appointed
as the independent auditors of the Company for its then current fiscal year.
Present members are Robert J. Murchake, George R. Manser and David L.
Bickelhaupt, although with Mr. Murchake retiring, one position will have to be
filled at the Annual Meeting of the Board of Directors on May 28, 1998. It is
currently anticipated that Mr. Urlin G. Harris, Jr. will be named to the Audit
Committee. The Audit Committee held two meetings during the Company's fiscal
year ended December 31, 1997.

The Board also has a 1991 Stock Option Plan Committee (the "Options
Committee") charged with the responsibility of administering the Company's 1991
Stock Option Plan. Present members of such committee, who also serve as the
Executive Compensation Committee, are George R. Manser, Robert J. Murchake and
William J. Lhota. Mr. Murchake's replacement on this committee, to be appointed
at the 1998 Annual Meeting of the Board of Directors, is expected to be Mr.
David J. D'Antoni. The Executive Compensation Committee and Options Committee
held two meetings during the Company's fiscal year ended December 31, 1997.

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<PAGE> 9

COMPENSATION OF DIRECTORS

Directors of the Company, who are not also officers of the Company, receive
from the Company an annual fee of $20,000 plus travel expenses incurred in
attending directors meetings and a fee of $500, plus travel expenses, for each
committee meeting attended. Directors may defer all or a portion of these fees
under the Company's deferred compensation plan for directors. In addition,
directors of the Company who are not full-time employees of the Company or its
parent or subsidiary corporations receive stock options pursuant to the 1991
Directors' Stock Option Plan. Under this plan, promptly following each annual
meeting of shareholders of the Company, each eligible director is granted a
non-qualified option to purchase 1,000 Common Shares of the Company at the fair
market value of such shares on the last trading day prior to the annual meeting
immediately preceding the date of grant. Options are immediately exercisable in
whole or in part and must be exercised within ten years of the date of grant.
The Director's compliance with the Stock Ownership Guidelines is a condition to
eligibility. (See "Executive Compensation Committee Report" below).

COMPENSATION OF EXECUTIVE OFFICERS

Pursuant to an Amended and Restated Management Agreement among Mutual, the
Company, State Auto P&C and State Auto National Insurance Company ("National"),
a wholly-owned subsidiary of the Company, and other affiliated companies, the
executive officers of the Company, State Auto P&C, and National are employees of
State Auto P&C and the Company rather than Mutual, while Mutual acts as the
common paymaster. The costs and expenses associated with these employees of
State Auto P&C and the Company are reimbursed to Mutual, as paymaster, in
accordance with the terms of the Amended and Restated Management Agreement. (See
"Certain Transactions" below).

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<PAGE> 10

SUMMARY OF CASH AND CERTAIN OTHER COMPENSATION

Set forth below is information concerning the compensation paid or accrued
by, or reimbursed to, Mutual for the Company's fiscal years ended December 31,
1997, 1996, and 1995, to each of the five most highly compensated executive
officers of the Company who received compensation in excess of $100,000:

SUMMARY COMPENSATION TABLE

<TABLE>
<CAPTION>
LONG TERM
COMPENSATION
AWARDS
------------
SECURITIES
ANNUAL COMPENSATION UNDERLYING
----------------------- OPTIONS ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY(1) BONUS(2) GRANTED(3)(4) COMPENSATION(5)
--------------------------- ---- --------- -------- ------------- ---------------
<S> <C> <C> <C> <C> <C>
Robert L. Bailey................... 1997 $396,815 $215,241 -0- $14,206
Chairman and 1996 $374,000 $193,688 25,000 $13,845
Chief Executive Officer 1995 $340,000 $245,013 22,700 $13,113

Robert H. Moone.................... 1997 $250,002 $119,600 -0- $ 9,579
President and 1996 $208,203 $ 45,338 13,440 $ 8,117
Chief Operating Officer 1995 $169,693 $ 49,816 9,700 $ 6,051

Michael F. Dodd.................... 1997 $153,309 $ 21,953 -0- $ 6,317
Senior Vice President 1996 $148,125 $ 2,769 4,500 $ 6,207
1995 $143,810 $ 32,984 4,500 $ 6,068

Steven J. Johnston................. 1997 $138,502 $ 60,821 -0- $ 5,223
Vice President, Treasurer and 1996 $115,619 $ 2,116 4,500 $ 4,283
Chief Financial Officer 1995 $108,556 $ 13,491 4,500 $ 4,036

Cathy B. Miley..................... 1997 $126,779 $ 40,843 -0- $ 5,239
Vice President 1996 $118,485 $ 19,890 4,500 $ 5,141
1995 $104,524 $ 12,326 4,500 $ 4,365
</TABLE>

- ---------------

(1) Includes amounts deferred pursuant to the State Auto Insurance Companies
Capital Accumulation Plan (the "CAP") and the Non-Qualified Incentive
Deferred Compensation Plan (the "Deferred Compensation Plan"). The CAP is a
defined contribution plan (within the meaning of the Employee Retirement
Income Security Act of 1974) ("ERISA") and is intended to be a qualified
plan under Sections 401(a) and 401(k) of the Internal Revenue Code of 1986,
as amended (the "Code"). Under the CAP, each participant is eligible to
enter into a written salary reduction agreement with his employer whereby
the participant's salary will be reduced by a whole percentage from 1% to
16%, as elected by the participant, in accordance with the rules governing
cash or deferred arrangements under Section 401(k) of the Code. The amount
deferred by a participant is contributed by his employer to the trust fund
for the CAP and invested in accordance with the election of the participant
from among investment funds established under the trust agreement. The
Deferred Compensation Plan is a non-qualified, unfunded deferred
compensation plan for eligible, key employees who are legally precluded from
contributing a full 6% of compensation to the CAP or who choose to defer a
portion of their salary beyond the amount matched by the CAP. Under the
Deferred Compensation Plan, such employees are eligible to enter into a
salary reduction agreement to defer payment of an additional portion of the
employee's salary as the employee prescribes on an election form executed
annually in advance of the year in which such compensation would be earned.
Deferred amounts, along with the Company matching amounts on that portion
deferred that is eligible for the match (see footnote (5), below), are
invested by Mutual in a variety of investment options made available to
participants in the Deferred Compensation Plan, pursuant to the terms of
such plan.
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<PAGE> 11

(2) The amounts appearing in this column represent bonuses paid pursuant to the
State Auto Quality Performance Bonus Plan (the "QPB") and as special
incentive bonuses pursuant to incentive bonus plans put into place by the
President for the benefit of Mr. Johnston and Ms. Miley to be earned in
1997, but which were paid in 1998. Mr. Bailey and Mr. Moone were also
subject to a special incentive bonus plan put into place for them by the
Executive Compensation Committee. (See "Report of Executive Compensation
Committee"). Under the QPB, quarterly bonuses are paid to employees who have
completed two full calendar quarters of service, if the direct statutory
combined ratio for such quarter was 101% or less for the insurers whose
results are pooled (see "Certain Transactions").

(3) In 1996 and 1995, the persons listed in the Summary Compensation Table were
granted options to purchase the number of Common Shares of the Company set
forth in this column pursuant to the 1991 Stock Option Plan, all of which
were non-qualified stock options except one-half of the options granted to
Mr. Moone, Mr. Johnston and Ms. Miley, which were incentive stock options.
No stock options were granted in 1997.

(4) Adjusted to reflect a three-for-two common stock split declared in May 1996
effected in the form of a stock dividend.

(5) The amounts appearing in this column represent the Company's contributions
and credits on behalf of each named person under the CAP or the Deferred
Compensation Plan. Each participant in the CAP is credited annually with his
allocable share of employer matching contributions made to the CAP from the
consolidated net accumulated or current earnings of Mutual and its
subsidiaries. A participant's share of the matching contribution equals 75%
of his salary reduction contributions up to 2% of compensation, plus 50% of
his salary reduction contributions from 3% to 6% of compensation. While a
participant is always vested in his own salary reduction contributions, the
rights of a participant to amounts credited to his account as matching
contributions vest as follows: (a) one-third of matching contributions
allocated for the plan year preceding the plan year in which termination of
employment occurs, two-thirds of matching contributions allocated for the
second plan year before the plan year in which termination of employment
occurs, and 100% of the matching contributions allocated for the third and
earlier plan years before the plan year in which termination of employment
occurs; and (b) notwithstanding the foregoing, after the participant has
five or more years of service with Mutual and its subsidiaries, all matching
contributions become vested. The following are the amounts of the Company
matching contributions under the CAP for 1997 for the officer indicated: Mr.
Dodd--$5,201; Mr. Johnston--$4,986; and Ms. Miley--$4,437. Each employee who
is eligible to participate in the Deferred Compensation Plan is credited
annually with his allocable share of Company matching contributions on the
same basis that contributions are matched under the CAP, provided that no
more than 6% of any employee's salary is subject to being matched under
either the CAP or the Deferred Compensation Plan. The following amounts
reflect the Company's contribution to the Deferred Compensation Plan for
1997: Mr. Bailey--$13,888 and Mr. Moone--$8,750. The amounts appearing in
this column also represent the premiums for policies of whole life insurance
purchased on behalf of the officers of the Company, including the executive
officers named above, from Investors Life Insurance Company of Indiana
("Investors Life"), the successor to State Auto Life Insurance Company
("State Auto Life"), then a wholly-owned subsidiary of Mutual, which was
merged with and into Investors Life in July 1997. The following amounts
represent the premiums paid for whole life insurance for 1997: Mr.
Bailey--$318; Mr. Moone--$829; Mr. Dodd--$1,116; Mr. Johnston--$237; and Ms.
Miley--$802.

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<PAGE> 12

AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR END OPTION VALUES

The following table shows the number of Common Shares represented by both
exercisable and non-exercisable stock options held by each of the named
executive officers as of December 31, 1997.

<TABLE>
<CAPTION>
NUMBER OF SECURITIES VALUE OF
UNDERLYING UNEXERCISED
UNEXERCISED IN-THE-MONEY
OPTIONS AT OPTIONS AT
SHARES FY-END(#) FY-END($)
ACQUIRED ON VALUE EXERCISABLE/ EXERCISABLE/
NAME EXERCISE(#) REALIZED($) UNEXERCISABLE(1)(2) UNEXERCISABLE(2)
---- ----------- ----------- -------------------- ----------------
<S> <C> <C> <C> <C>
Robert L. Bailey(3)............... 0 0 170,302/-0- $4,030,347
Robert H. Moone(4)................ 0 0 55,290/-0- $1,237,484
Michael F. Dodd................... 7,350 $171,806 37,800/-0- $878,021
Steven J. Johnston................ 0 0 17,850/-0- $377,254
Cathy B. Miley(5)................. 0 0 16,350/-0- $342,138
</TABLE>

- ---------------

(1) The number of securities underlying exercisable options was adjusted to
reflect a three-for-two common stock split declared in May 1996 effected in
the form of a stock dividend.

(2) The value of in-the-money options was determined by subtracting the exercise
price from the market value of the Company's Common Shares as of December
31, 1997 ($32.25), based on the closing price of the Company's Common shares
on the NASDAQ National Market System on that date, the last trading day of
1997. The exercise price for exercisable options was adjusted to reflect a
three-for-two common stock split declared in May 1996 effected in the form
of a stock dividend.

(3) 20,680 of these options have been assigned to Mr. Bailey's spouse pursuant
to the terms of the 1991 Stock Option Plan.

(4) In accordance with the terms of the 1991 Stock Option Plan, one-half of
these options have been assigned to the living trust of Mr. Moone's spouse
of which he is the co-trustee.

(5) Ms. Miley is also deemed to beneficially own options granted to Mr. Richard
L. Miley, her husband, also an officer of the Company, which amount to
17,250 options, as to all of which she disclaims beneficial ownership, which
have a value of $362,208.

EMPLOYEES' RETIREMENT PLAN

The executive officers referred to in the Summary Compensation Table, as
well as substantially all other employees of Mutual and its subsidiaries, are
eligible to participate in the State Auto Insurance Companies' Employee
Retirement Plan (the "Retirement Plan"). The Retirement Plan is a defined
benefit plan (within the meaning of ERISA) which is intended to be a qualified
plan under Section 401(a) of the Code, and is subject to the minimum funding
standards of Section 412 of the Code. Benefits payable under the Retirement Plan
are funded through employer contributions to a trust fund.

In addition, the executive officers identified in the Summary Compensation
table benefit from a non-qualified Amended and Restated Supplemental Executive
Retirement Plan (the "Supplemental Plan"). The Supplemental Plan is intended to
offset the impact of the Code's and ERISA's limitations on retirement benefits
available under the Retirement Plan by providing for a lump sum or deferred cash
payments in an actuarially determined amount upon retirement of officers whose
participation in the Supplemental Plan is approved by the Board of Directors of
Mutual.

10
<PAGE> 13

The table below shows estimated annual benefits payable under the
Retirement Plan and the Supplemental Plan to a participant upon retirement at
age 65 with indicated average annual compensation and period of service:

ESTIMATED ANNUAL RETIREMENT BENEFIT

<TABLE>
<CAPTION>
ANNUAL ANNUAL RETIREMENT BENEFIT BASED ON YEARS OF SERVICE
AVERAGE ----------------------------------------------------
COMPENSATION 15 YEARS 20 YEARS 25 YEARS 30 YEARS 35 YEARS
- ------------ -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
$125,000 $43,422 $ 57,387 $ 71,353 $ 85,319 $ 99,285
$150,000 $51,144 $ 68,086 $ 85,028 $101,970 $118,913
$175,000 $57,692 $ 77,611 $ 97,529 $117,448 $137,367
$200,000 $64,240 $ 87,135 $110,030 $132,925 $155,820
$225,000 $70,788 $ 96,660 $122,531 $148,403 $174,274
$250,000 $74,116 $101,501 $128,885 $156,269 $183,654
$300,000 $74,116 $111,727 $128,885 $156,269 $178,177
$400,000 $74,116 $139,909 $153,741 $169,109 $202,440
$450,000 $74,199 $154,000 $169,561 $186,905 $224,474
$500,000 $79,283 $168,090 $185,381 $204,702 $246,508
</TABLE>

Note: The annual average compensation applies to post-1988 salaries. Post-1988
salaries have been capped according to Internal Revenue Code.

Benefits shown above are computed as a straight single life annuity
beginning at age 65. Such amounts are not subject to offset for Social Security
benefits or other amounts payable to participants in the Retirement Plan. As of
December 31, 1997, the years of credited service to the nearest whole year and
annual average compensation for each of the individuals named in the Summary
Compensation Table actively participating in the Retirement Plan on such date
were as follows:

<TABLE>
<CAPTION>
NAME OF YEARS OF CURRENT ANNUAL AVERAGE COMPENSATION
INDIVIDUAL CREDITED SERVICE FOR PURPOSES OF RETIREMENT PLAN
---------- ---------------- -------------------------------
<S> <C> <C>
Robert L. Bailey...................... 26 $160,000
Robert H. Moone....................... 27 $160,000
Michael F. Dodd....................... 36 $153,309
Steven J. Johnston.................... 12 $122,602
Cathy B. Miley........................ 20 $126,779
</TABLE>

EMPLOYMENT CONTRACT

In November 1995, the Company's Board of Directors approved an employment
agreement with Robert L. Bailey, Chairman and CEO of the Company, State Auto
P&C, and Mutual and the Company's other principal operating affiliates and
subsidiaries. Pursuant to this Agreement, the Company agreed to employ Mr.
Bailey until December 31, 2000, with an optional two year renewal with mutual
consent, at such compensation as may be determined by the Executive Compensation
Committee. Under the contract, Mr. Bailey shall be entitled to fringe benefits
available to other officers of State Auto, including, as applicable, those made
available to employees age 65 or older. Under the contract, Mr. Bailey is
entitled to receive a special supplemental retirement benefit equal to 60% of
his highest salary during the term of the agreement less sums payable to Mr.
Bailey as of his retirement date under the State Auto Insurance Companies'

11
<PAGE> 14

retirement plan calculated on the basis of a straight life annuity, provided
that the special supplemental retirement benefit shall not be less than $100,000
annually for the remainder of his life following his retirement.

No other employee of the Company works pursuant to an employment agreement.

COMPENSATION COMMITTEE
INTERLOCKS AND INSIDER PARTICIPATION

The Executive Compensation Committee currently consists of the following
three members of the Company's Board of Directors: George R. Manser, Robert J.
Murchake and William J. Lhota, who also make up the Options Committee. None of
the members of the Executive Compensation Committee is, or was, an officer or
employee of the Company, any of its subsidiaries, or of Mutual. Also, no
executive officer of the Company served during 1997 as a member of a
compensation committee or as a director of any entity of which any of the
Company's Executive Compensation Committee members served as an executive
officer with the exception of James E. Duemey, Vice President--Chief Investment
Officer, who served as a director of Uniglobe Travel (Capital Cities), Inc., for
which Mr. Manser served as chairman of the board in 1997.

EXECUTIVE COMPENSATION COMMITTEE AND OPTIONS COMMITTEE REPORT

The following is the report of the Executive Compensation Committee and the
Options Committee, whose members are identified below, with respect to
compensation reported for 1997 as reflected in the compensation tables above.

Pursuant to the Amended and Restated Management Agreement, the Chief
Executive Officer and the other named executive officers are employees of State
Auto P&C. When the 1997 salaries noted in the compensation tables above were
set, the Company's Executive Compensation Committee determined the compensation
of the Chairman and Chief Executive Officer and the President and Chief
Operating Officer. Mr. Robert Moone, as President of the Company, State Auto P&C
and Mutual is responsible for administering the base salary component of the
cash compensation paid to the other named executive officers, all of whom
reported to him in 1997 and he makes recommendations to the Chairman and Chief
Executive Officer with respect to incentive bonuses for certain of the named
executive officers.

The Executive Compensation Committee's policies as to base salary of the
Chief Executive Officer, which the President utilized in determining the
salaries of the named executive officers, and the Options Committee's policies
as to stock options are as follows:

The compensation policies applied by the President in setting base salaries
earned by the named executive officers in 1997 mirror those applied in the
Company at large. This compensation system is intended to reward individuals
based on their performance, to encourage a focus on underwriting profit, to
provide for competitive levels of compensation necessary to attract and retain
executive officers, and to create an understanding of the importance of
achieving company-wide goals over the long term. The Options Committee grants
options on a periodic basis as an additional, long-term inducement to the
executive officers to improve the Company's performance and enhance the value of
the Company's Common Shares.

For 1997, compensation for the named executive officers, other than the
Chief Executive Officer, had two components as to which discretion is exercised:
annual base salary and incentive bonus arrangements. The President reviews the
named executive officers' base salary approximately every 12 months. Merit
raises granted each year reflect the President's assessment of the individual
officer's performance in achieving
12
<PAGE> 15

division-wide goals set at the beginning of the year. The overall performance of
the Company's operating units is also considered. In individual cases, raises
may also reflect a named executive officer's assumption of additional duties and
responsibilities. Annual salary reviews also reflect the fact that the named
executive officers had an opportunity to earn an additional incentive bonus for
superior performance.

The Executive Compensation Committee and Options Committee believe that
stock options and individual stock purchases by executive officers create a
mutuality of interest between the shareholders and management. This is believed
to be desirable and in the best interests of the shareholders as it focuses
management's attention on the importance of long term appreciation in the price
of the Company's common stock. In that regard, as of December 31, 1996, the
Options Committee imposed stock ownership guidelines on the Chief Executive
Officer, the President, the other named executive officers, and all other option
recipients under the 1991 Stock Option Plan and the 1991 Directors Stock Option
Plan. Compliance with these guidelines, which require optionees under the 1991
Stock Option Plan to own Common Shares of the Company equal to percentages of
base salary depending on the person's position within the Company, and optionees
under the 1991 Director's Stock Option Plan to own Common Shares with a value
equal to at least three times their annual director's fee. These guidelines are
intended to be a condition precedent to receipt of future option grants. All
optionees have five years to reach their required level of ownership, but each
year, optionees who are not currently in compliance are expected to make
proportional progress toward their respective goal. Every named executive
officer met the stock ownership requirements imposed by the Stock Ownership
Guidelines for 1997 and, thus, no named executive was ineligible for any stock
options which were granted in February 1998.

No options were awarded in 1997 by the Options Committee. However, the
Committee did grant options effective February 13, 1998 to several officers and
key employees, including the named executive officers.

There are two forms of cash bonus available to certain of the named
executive officers. The Company's QPB is intended to provide a more short term
incentive to the employees to generate underwriting profits on a quarterly
basis. Under the QPB, quarterly bonuses are paid to all employees who have
completed two full calendar quarters of service, if the pooled companies' direct
statutory combined ratio for such quarter was 101% or less (see "Certain
Transactions").

In addition, with the concurrence of the Chairman and Chief Executive
Officer, Mr. Moone developed individualized incentive compensation plans for Mr.
Johnston and Ms. Miley, while Mr. Moone and the Chief Executive Officer had
their incentive bonus program for 1997 determined by the Executive Compensation
Committee. Each plan applicable to such named executive officer provided for a
set of objective measures of performance, which measures were designed by the
President, to focus the attention and effort of these individuals on the success
and profitability of the Company. One half of such incentive bonus available
depended upon the named executive officer meeting particularized objectives and
targets applicable to such person's area of responsibility within the Company.
The other half was driven by the same objective measures set forth in Mr.
Bailey's incentive plan described below.

There are four components to the Company's compensation arrangements with
the Chief Executive Officer-base salary, incentive compensation arrangements,
QPB, and stock options.

For 1997, the Chief Executive Officer received a cash raise equal to
$22,815 or 6%. The salary for 1997 was set in the fall of 1996. Comparison
salary data that was available to the Committee was dated August 1996.

The Committee evaluated his performance and his compensation level based on
both objective and subjective measures. The Chief Executive Officer's salary
ranked 10th out of 19 companies of similar size
13
<PAGE> 16

included in an annual salary survey conducted by the National Association of
Independent Insurers ("NAII"), which is Mutual's and State Auto P&C's national
trade association. These survey participants are not necessarily reflected in
the group of companies included in the NASDAQ insurance stocks index reflected
on the performance graph below. Of nineteen companies in this NAII salary
survey, Mr. Bailey's salary for 1996 was approximately 92% of the mean base
salary for Chief Executive Officers of companies in the same size category as
the Company and Mutual. The Executive Compensation Committee believed a 6% raise
was appropriate in part to keep Mr. Bailey's salary moderately competitive in
the marketplace based on this NAII salary survey.

In setting Mr. Bailey's salary for 1997, it also considered the volume of
premium written by the Company, the asset size of the Company, the Company's
position in the markets where it's active as compared to its competition and the
Company's underwriting performance in light of the significant amount of
catastrophe losses in 1996. The Committee also recognized that the Chief
Executive Officer had effectively addressed issues surrounding Mr. Moone's
assumption of additional responsibilities in becoming President of the Company.
The general absence of perquisites within the Company was also a factor.

In addition, the cash Incentive Compensation Plan created by the Executive
Compensation Committee in 1995 continued in place for 1997. This plan
contemplates a cash bonus, the amount of which depends solely on how the
Company's performance compared to a group of five peer companies in two areas:
combined ratio and total shareholder return as averaged over three years. Each
of the peer companies and State Auto is ranked from 6 to 1 (6 being the best)
for each of these criteria and the rank equates to a point level. Thus, the
highest point total attainable is 12, the lowest 2. The CEO's total bonus will
depend in part on the points State Auto earns based on the following:

<TABLE>
<CAPTION>
TOTAL POINTS EARNED PERCENT OF BONUS EARNED
- ------------------- -----------------------
<S> <C>
12-10 100%
9-8 80%
7-6 60%
5-4 20%
2-0 0%
</TABLE>

Mr. Bailey's targeted bonus available equals 40% of his annual salary. In
addition, the Committee reserved the discretion to award Mr. Bailey a bonus
equal to up to 150% of the bonus target or 60% of his annual salary based on a
subjective evaluation of his performance in addition to the objective criteria
noted above. Based on the Company's performance in 1996, in 1997, the Committee
awarded Mr. Bailey a bonus equal to 50% of his base salary or $187,000. This is
the result of the Company's performance achieving ten (10) points under the
formula described (first in the total shareholder return criteria and third in
the combined ratio criteria) and an additional 10% bonus based on the
committee's subjective judgment of his and the Company's performance during
1996. For 1997, the Committee will award a minimum bonus of $158,726, based on
the fact that the Company's combined ratio and total shareholder return earned
Mr. Bailey twelve points, since, the Company was first among the peer companies
in both the total shareholder return and combined ratio criteria. As of the date
hereof, the Committee has not met to consider the discretionary element to his
bonus calculation for 1997.

EXECUTIVE COMPENSATION COMMITTEE/STOCK OPTIONS COMMITTEE

Robert J. Murchake
George R. Manser
William J. Lhota

14
<PAGE> 17

PERFORMANCE GRAPH

The line graph below compares the total return on $100 invested on December
31, 1992, in the Company's shares, the CRSP Total Return Index for the NASDAQ
Stock Market ("NASDAQ Index"), and the CRSP Total Return Index for NASDAQ
insurance stocks ("NASDAQ Ins. Index"), with dividends reinvested.

COMPARISON OF CUMULATIVE TOTAL RETURN

<TABLE>
<CAPTION>
12/31/92 12/31/93 12/31/94 12/31/95 12/31/96 12/31/97
-------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
STFC 100.000 119.243 129.989 239.599 251.222 453.490
NASDAQ Index 100.000 114.796 112.214 158.699 195.196 239.527
NASDAQ Ins. Index 100.000 106.956 100.679 143.014 163.034 239.181
</TABLE>

PRINCIPAL HOLDERS OF VOTING SECURITIES

The following table sets forth certain information as of April 6, 1998,
with respect to the only shareholder known by the Company to be the beneficial
owner of more than 5% of any class of the Company's outstanding Common Shares:

<TABLE>
<CAPTION>
AMOUNT AND NATURE
NAME AND ADDRESS OF BENEFICIAL PERCENT
OF BENEFICIAL OWNER OWNERSHIP(1) OF CLASS
------------------- ------------ --------
<S> <C> <C>
State Automobile Mutual Insurance Company................. 11,976,376 65%
518 East Broad Street
Columbus, OH 43215
</TABLE>

- ---------------

(1) Mutual exercises sole voting and investment power with respect to such
shares.

15
<PAGE> 18

CERTAIN TRANSACTIONS

The Company and its subsidiaries, State Auto P&C and National, operate and
manage their businesses in conjunction with Mutual under a Management Agreement
(the "Management Agreement"). Effective April 1, 1994, the Management Agreement
was amended and restated (the "Amended and Restated Management Agreement"). The
Amended and Restated Management Agreement effected a restructuring of executive
management. Previously, all employees were employees of Mutual. As of April 1,
1994, several members of executive management became employees of State Auto
P&C. These individuals include the named executive officers, Messrs. Bailey,
Moone, Johnston, Dodd, and Ms. Miley, among others. Under the Amended and
Restated Management Agreement and the Midwest Management Agreement (as defined
below), State Auto P&C has the responsibility to oversee its own operations and
all operations of National and Mutual and its insurance subsidiaries, Milbank
Insurance Company ("Milbank") and Midwest Security Insurance Company. It is
believed that this arrangement better positions the Company for future growth
and development of its business. In addition, some of the same individuals
became employees of the Company and are responsible for managing its affairs. At
the same time, Mutual continues to provide facilities, services and
non-executive employees to all companies in the group for which Mutual is
reimbursed by the company for whose benefit the expense of the facilities,
services and employees was incurred in a manner similar to the way they were
shared under the management agreement prior to amendment. In addition, at a
closing on March 11, 1997, Mutual acquired 100% of the outstanding common shares
of Midwest Security Insurance Company ("Midwest"), a Wisconsin domiciled
property casualty insurer effective as of January 1, 1997. In conjunction with
this transaction, State Auto P&C and Mutual entered into a Management Agreement
with Midwest (the "Midwest Management Agreement") in which State Auto P&C
provides executive management services to Midwest akin to those described under
the Amended and Restated Management Agreement. For these services, State Auto
P&C receives a management fee of 0.75% of Midwest's direct written premium,
subject to Midwest's performance meeting the performance standard set forth in
the agreement.

In return for the executive management services it provides under the
Amended and Restated Management Agreement, except as set forth above, State Auto
P&C receives an annual fee equal to 2% of the five year average annual statutory
surplus of each insurance company managed (less statement valuations for managed
subsidiaries). However, the management fee from a managed insurer can be
withheld if that company does not meet the standards of performance described or
incorporated in the Amended and Restated Management Agreement, as approved by
the boards of directors of the insurers that are a party to it. During 1997, the
following companies incurred the following executive management fees to State
Auto P&C under the Amended and Restated Management Agreement and the Midwest
Management Agreement: Mutual--$4,340,000; Milbank--$830,000; National--$186,000;
and Midwest Security--$162,000. Based on a review by the Company of other
similar arrangements, the Company believes the amount of the management fee
charged to each company is similar to what would be charged by an independent
third party performing the same service.

The Amended and Restated Management Agreement also addresses procedures for
potential conflicts of interest. Generally, business opportunities presented to
the common officers of the companies, other than business opportunities that
meet certain criteria, must be presented to the Coordinating Committee. This
committee reviews and evaluates the business opportunity using such factors as
it considers relevant. Based upon such review and evaluation, this committee
then makes recommendations to each respective board of directors as to whether
or not such business opportunities should be pursued and, if so, by which
company. The boards of directors of Mutual or any of its subsidiaries and of the
Company or any of its subsidiaries must then act on the recommendation of the
committee after considering all other factors deemed relevant to them.

16
<PAGE> 19

The Amended and Restated Management Agreement and the Midwest Management
Agreement each has a ten-year term and automatically renews for an additional
ten-year term, provided that any party to the agreement can terminate its own
participation at the end of the term then in effect by giving at least two
years' advance written notice of nonrenewal to the other parties, with the
exception that Milbank may terminate its participation on 120 days notice. Any
party may also terminate its participation upon events constituting a change of
control or potential change of control (as defined in the Amended and Restated
Management Agreement and the Midwest Management Agreement) of the Company, or
upon agreement of the parties. The agreement is automatically terminated with
respect to a party (and only that party) if such party is subject to insolvency
proceedings.

Since January 1987, State Auto P&C and Mutual have participated in an
intercompany pooling arrangement, which has been amended from time to time
including amendments adding participants to the pooling arrangement and
adjusting pooling percentages. Under the terms of the pooling arrangement, State
Auto P&C and the other pool participants cede all of their insurance business to
Mutual. All of Mutual's property and casualty insurance business is also
included in the pooled business. Mutual then cedes a percentage of the pooled
business to State Auto P&C and the other pool participants and retains the
balance. While Milbank was added January 1, 1995, the parties intend, subject to
regulatory approval, to amend the pooling arrangement pursuant to an Amended and
Restated Reinsurance Pooling Agreement effective as of January 1, 1998, to add
Midwest as a party to the arrangement and to allocate the pooling percentages as
follows: Mutual--52%; State Auto P&C--37%; Milbank--10%, and Midwest
Security--1%.

Stateco Financial Services, Inc. ("Stateco") provides insurance premium
finance services to certain policyholders of Mutual, State Auto P&C, and
Milbank. Premiums for property and casualty insurance are typically payable at
the time a policy is placed in force or renewed. On certain large commercial
policies, the premium cost may be difficult for a policyholder to pay in one
sum. Stateco makes loans to policyholders for the term of an insurance policy to
enable them to pay the insurance premium in installments over the term of the
policy, and retains a contractual right to cancel the insurance policy if the
loan installment is not paid on a timely basis.

In 1993, Stateco expanded its business activities to include a broader
range of financial services. It now undertakes on behalf of Mutual, State Auto
P&C, Milbank, National and Midwest the responsibility of managing those
companies' investable assets. In consideration of this service, Stateco charges
such companies an annual fee, paid quarterly, based on a percentage of the
average investable assets of each company. The percentage currently set is .4%
for bonds and .5% for equities, with a .1% bonus available if the stock
portfolio return exceeds that of the S&P 500 for the same period. During 1997,
the following companies incurred the following fees to Stateco:
Mutual--$2,675,000; State Auto P&C--$1,520,000; Milbank--$508,000;
National--$79,000; and Midwest--$90,000. The Company believes the fees charged
are comparable to those charged by independent investment managers.

The Company's majority-owned subsidiary, Strategic Insurance Software, Inc.
("SIS"), develops and sells software for use by insurance companies and
insurance agencies. SIS sells its software and software support services to its
affiliated insurers and to nonaffiliated entities. In 1997, these affiliates
paid $1,617,000 to SIS for its services and products.

Mutual has guaranteed the adequacy of State Auto P&C's loss and loss
expense reserves as of December 31, 1990. Pursuant to the guarantee, Mutual has
agreed to reimburse State Auto P&C for any losses and loss expenses in excess of
State Auto P&C's December 31, 1990 reserves ($65,463,732) that may develop from
claims that have occurred on or prior to that date. This guarantee ensures that
any deficiency in

17
<PAGE> 20

the reserves of State Auto P&C as of December 31, 1990, under the pooling
arrangement percentages effective on December 31, 1990, will be reimbursed by
Mutual.

Paul W. Huesman, a director of the Company, is the president and a majority
owner of The Huesman-Schmid Insurance Agency, an independent insurance agency
licensed to sell insurance products for State Auto P&C, Mutual and National.
During 1997, State Auto P&C, National and Mutual paid such insurance agency and
its affiliated agencies commissions in the amount of $325,938. Such commissions
were determined in the same manner as commissions are determined for other
agencies of State Auto P&C, Mutual and National.

Effective July 1, 1996, the Company and Mutual negotiated a change in their
catastrophe reinsurance program and, as part of this change, State Auto P&C has
become the catastrophe reinsurer for itself, Mutual, Milbank and National as
described below. The amount retained by State Auto P&C, Mutual, Milbank and
National (collectively 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, STFC entered into a structured contingent financing
transaction with Chase Manhattan Bank ("Chase") to provide up to an additional
$100.0 million to be used to cover catastrophe losses. 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 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 Assumption 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 Assumption Agreement. State Auto Financial 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 million
has been excluded from the pooling agreement as well by virtue of the Amended
and Restated Reinsurance Pooling Agreement effective as of January 1, 1998. In
addition, State Auto Financial's obligation to repay Chase has been secured by a
Put Agreement among State Auto Financial, 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.

In December 1997, the Company formed 518 Property Management and Leasing,
LLC ("518 PML"), an Ohio limited liability company. 518 PML is currently
developing real estate it owns near Nashville, Tennessee on which it will
construct an office building which it plans to lease to Mutual on completion.
Mutual's current office space in Nashville is leased from a third party;
however, that lease expires in June 1999. 518 PML plans to charge Mutual rent
that is generally reflective of market rents for similar office space in the
area for the space it will be occupying. In addition, State Auto P&C has
contributed to 518 PML the office building it owned in Greer, South Carolina
which 518 PML leases to Mutual for its Southern Regional Office facility at a
market-based rent. No sums were paid on this lease in 1997.

In addition, in March 1998, the Company's Board of Directors authorized the
officers of the Company to take such steps as are necessary to effect the
exercise of the option it holds to acquire 100% of the outstanding stock of
Milbank from Mutual, pursuant to an option agreement dated August 20, 1993 (the
"Option Agreement") between the Company and Mutual. The transaction cannot close
until the Company and Mutual complete certain procedural requirements
contemplated by the Option Agreement, as adopted by the Directors of State Auto
Financial and Mutual and it secures necessary regulatory approvals. The price
the Company will pay for Milbank as set by the Option Agreement's formula is not
yet determined as it depends

18
<PAGE> 21

on the GAAP book value of Milbank as of the month end immediately prior to the
closing date set forth in a definitive stock purchase agreement to be prepared
by the parties to the transaction.

PROPOSED AUTHORIZATION OF ADDITIONAL COMMON SHARES

GENERAL

The following discussion is a summary of the material features of the
proposal to authorize an additional 70,000,000 Common Shares. The additional
Common Shares will be authorized pursuant to an amendment to the Company's
Amended and Restated Articles of Incorporation. The following discussion is
qualified in its entirety by reference to the proposed amendment, a copy of
which is attached hereto as Exhibit A.

PURPOSE AND EFFECT OF THE AUTHORIZATION OF ADDITIONAL COMMON SHARES

The Company's Amended and Restated Articles of Incorporation provide that
the Company has the authority to issue 30,000,000 Common Shares, without par
value, of which 18,350,632 shares are issued and outstanding as of April 6,
1998. The Company has 1,800,000 Common Shares reserved for issuance under the
1991 Stock Option Plan, 150,000 Common Shares reserved for issuance under the
1991 Directors' Stock Option Plan, and 1,200,000 Common Shares reserved for
issuance under the 1991 Employee Stock Purchase and Dividend Reinvestment Plan.
The total remaining number of Common Shares available for issuance is 8,499,368.

If the shareholders approve the amendment, the Board of Directors would
have the authority to issue an additional 70,000,000 Common Shares. On March 6,
1998, the Board of Directors declared a two-for-one stock split to be
distributed on July 8, 1998, to shareholders of record on June 18, 1998. The
stock split is contingent upon the shareholders approving the authorization of
the Additional Shares. If the authorization of the Additional Shares is
approved, a total of 18,350,632 of the additional Common Shares will be issued
in connection with the stock split based on shares outstanding as of the record
date for this meeting. In addition to providing Common Shares for the stock
split, the Board of Directors foresees that the additional authorized but
unissued Common Shares would give the Company flexibility to issue additional
Common Shares for a variety of purposes The additional Common Shares may be
issued to provide additional funds for working capital and capital expenditures
or for other purposes, such as in connection with employee benefit plans or
acquisitions. The Board of Directors believes that it is necessary for the
Company to have an adequate reserve of authorized but unissued Common Shares so
that the Company has the flexibility to meet changing circumstances.

The additional Common Shares, if authorized, would be issued on such terms
as the Board of Directors deems appropriate. Shareholders of the Company will
have no preemptive rights to subscribe for or purchase such shares.

The additional Common Shares could also be used by the Board of Directors
to defeat or delay a hostile takeover which the Board of Directors believes is
not in the best interests of the Company. Faced with an actual or proposed
hostile takeover, the Board of Directors could issue to a friendly party or
existing shareholders, in a private transaction, additional Common Shares such
that the Company would become a less attractive acquisition for a hostile party.
Such action would tend to insulate incumbent management from removal and prevent
the shareholders from being able to sell their shares to a potential acquirer.
The Board of Directors is not aware of any current proposals by any party to
acquire control of the Company. Further, Mutual's ownership of more than 65% of
the Company's shares makes such a circumstance unlikely to occur in the
foreseeable future.

19
<PAGE> 22

To the extent that the additional Common Shares are issued, the issuance
thereof may result in dilution of a shareholder's ownership interest in the
Company and in the per share equity of the Common Shares in the earnings and
assets of the Company.

Approval of the additional Common Shares will require the affirmative vote
of the holders of a majority of the outstanding Common Shares. Abstentions and
broker non-votes will have the same effect as votes cast against the approval of
the Additional Shares. Mutual, which beneficially owns 65% of the outstanding
Common Shares, has indicated its intention to vote in favor of approval for the
authorization of the Additional Shares.

THE BOARD OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT SHAREHOLDERS VOTE "FOR"
THE AUTHORIZATION OF THE ADDITIONAL COMMON SHARES.

INDEPENDENT PUBLIC ACCOUNTANTS

Ernst & Young LLP served as the independent public accountants for the
Company for its fiscal year ended December 31, 1997, which was the first year of
a new three year commitment entered into between the Company and Ernst & Young
LLP. Ernst & Young LLP has been retained by the Company as its independent
public accountants for the fiscal year ending December 31, 1998. It is expected
that a representative of Ernst & Young LLP will be present at the shareholders'
meeting and will be given an opportunity to make a statement, if such
representative desires, and to respond to appropriate questions.

SHAREHOLDER PROPOSALS

Proposals of shareholders intended to be presented at the Annual Meeting of
Shareholders to be held in May 1999 must be received by the Company for
inclusion in the Proxy Statement and form of Proxy on or prior to December 22,
1998.

SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
the Company's officers, directors and persons who own more than 10% of a
registered class of the Company's equity securities to file statements of
beneficial ownership of the Company's Common Shares. Based solely on a review of
copies of the forms filed under Section 16(a) and furnished to the Company, the
Company believes that all applicable Section 16(a) filing requirements were
complied with during 1997 with the following exception: Mutual, a greater than
10% shareholder filed an amended Form 4 in February 1998 relating back to
December 1995 which involved 10,065 shares Mutual delivered to its employees as
Christmas gifts in the amount of five shares for each employee.

OTHER MATTERS

Management does not know of any other matters which may come before the
meeting. However, if any other matters properly come before the meeting, it is
the intention of the persons named in the accompanying form of proxy to vote the
proxy in accordance with their judgment on such matters.

The Company will bear the cost of solicitation of proxies. In addition to
the use of the mails, proxies may be solicited by officers, directors, and
regular employees, personally or by telephone or telegraph, and the Company will
reimburse banks, brokers, and nominees for their out-of-pocket expenses incurred
in sending proxy material to the beneficial owners of shares held by them. If
there are follow-up requests for proxies, the Company may employ other persons
for such purpose.
JOHN R. LOWTHER
Secretary
20
<PAGE> 23

EXHIBIT A
STATE AUTO FINANCIAL CORPORATION

RESOLVED, that the Amended and Restated Articles of Incorporation of State
Auto Financial Corporation are further amended by deleting the first sentence of
the Article Fourth and replacing it with the following:

FOURTH: The maximum number of shares which the Corporation shall be
authorized to have outstanding is One Hundred and Five Million
(105,000,000) which shall be divided into three classes consisting of One
Hundred Million (100,000,000) common shares, without par value (the "Common
Shares"), Two Million, Five Hundred Thousand (2,500,000) Class A preferred
shares, without par value (the "Class A Preferred Shares"), and Two
Million, Five Hundred Thousand (2,500,000) Class B preferred shares,
without par value (the "Class B Preferred Shares").

21
<PAGE> 24

DETACH CARD
- --------------------------------------------------------------------------------

STATE AUTO FINANCIAL CORPORATION ANNUAL MEETING OF SHAREHOLDERS
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS OF THE COMPANY

The undersigned hereby appoints Robert L. Bailey, and in the event he is unable
to so act, Robert H. Moone and any one or more of them, Proxies, with full power
of substitution, to represent and vote all common shares, without par value, of
State Auto Financial Corporation (the "Company") which the undersigned would be
entitled to vote if personally present at the Annual Meeting of Shareholders to
be held at the Company's principal executive offices located at 518 East Broad
Street, Columbus, Ohio on Thursday, May 28, 1998, at 10:00 A.M., EDST, and at
any and all adjournments thereof, as specified on the reverse of this Proxy.

<TABLE>
<S> <C>
1. ELECTION OF THE FOLLOWING WITHHOLD [ ]
NOMINEES AS CLASS I DIRECTORS: for all Nominees
FOR all Nominees [ ]
(except as marked to the contrary)
</TABLE>

John R. Lowther, Paul W. Huesman, and Robert H. Moone

TO WITHHOLD AUTHORITY TO VOTE FOR ANY INDIVIDUAL NOMINEE(S) PRINT THE NAMES
IN THE SPACE BELOW

-----------------------------------------------------------------------------

2. Approval of an amendment to the Amended and Restated Articles of
Incorporation of the Company, approving 70,000,000 additional authorized
common shares, without par value.

For [ ] Opposed [ ] Abstain [ ]

3. In the discretion of the named proxies, to vote on all other matters that
may properly come before the meeting or any adjournment thereof.

(CONTINUED, AND TO BE SIGNED ON OTHER SIDE)
<PAGE> 25

DETACH CARD
- --------------------------------------------------------------------------------

State Auto Financial Corporation

(Continued from the other side)

The shares represented by this Proxy will be voted as directed by the
shareholder. IF NO DIRECTION IS GIVEN WHEN THE DULY EXECUTED PROXY IS RETURNED,
SUCH SHARES WILL BE VOTED "FOR ALL NOMINEES" IN ITEM 1 AND FOR APPROVAL OF THE
AMENDMENT TO THE AMENDED AND RESTATED ARTICLES OF INCORPORATION APPROVING
70,000,000 ADDITIONAL AUTHORIZED COMMON SHARES, WITHOUT PAR VALUE.
[ ] I PLAN TO ATTEND MEETING

Date........................, 1998

..................................
Signature

..................................
Title

Please mark, date and sign as your
name appears above and return in
the enclosed envelope. If acting
as executor, administrator,
trustee, guardian, etc., you
should so indicate when signing.
If the signer is a corporation,
please sign the full corporate
name by a duly authorized officer.
If shares are held jointly, each
stockholder named should sign.