<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D. C. 20549
Form 10-Q
(X) Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the quarterly period ended September 30, 2000
--------------------------------------------------
( ) Transition report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934.
For the Transition period from _______________________ to ______________________
State Auto Financial Corporation
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(Exact name of registrant as specified in its charter)
<TABLE>
<CAPTION>
<S> <C>
Ohio 31-1324304
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(State or other jurisdiction of incorporation) (I.R.S. Employer Identification No.)
518 East Broad Street, Columbus, Ohio 43215-3976
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(Address of principal executive offices) (zip code)
(614) 464-5000
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Registrant's telephone number, including area code
</TABLE>
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
(X) Yes ( ) No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date:
Common shares, without par value 38,464,416
-------------------------------- -------------------------
(CLASS) (OUTSTANDING ON 11/10/00)
<PAGE> 2
INDEX
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
<TABLE>
<CAPTION>
<S> <C>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed consolidated balance sheets - September 30 , 2000 and
December 31, 1999
Condensed consolidated statements of income - Three months
ended September 30, 2000 and 1999
Condensed consolidated statements of income - Nine months
ended September 30, 2000 and 1999
Condensed consolidated statements of cash flows - Nine months
ended September 30, 2000 and 1999
Notes to condensed consolidated financial statements -
September 30, 2000
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Item 3. Quantitative and Qualitative Disclosure of Market Risk
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
Item 2. Changes in Securities and Use of Proceeds
Item 3. Defaults upon Senior Securities
Item 4. Submission of Matters to a Vote of Security Holders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
</TABLE>
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except share data)
<TABLE>
<CAPTION>
September 30 December 31
ASSETS 2000 1999
---- ----
(unaudited) (see note 1)
<S> <C> <C>
Fixed maturities:
Held for investment, at amortized cost
(fair value $40,559 and $44,051 respectively) $ 40,096 $ 43,981
Available for sale, at fair value
(amortized cost $619,933 and $544,051, respectively) 616,977 527,806
Equity securities, at fair value (cost $44,397 and $39,303, respectively) 57,787 55,518
------------ ----------
Total investments 714,860 627,305
Cash and cash equivalents 17,744 24,560
Deferred policy acquisition costs 32,591 28,936
Accrued investment income and other assets 18,455 17,977
Due from affiliate 7,282 -
Net prepaid pension expense 36,862 18,931
Reinsurance receivable 9,100 10,807
Prepaid reinsurance premiums 11,769 15,784
Property and equipment, net 11,159 11,288
Deferred federal income taxes 5,071 1,828
Goodwill 2,335 2,529
------------ ----------
Total assets $867,228 $759,945
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Losses and loss expenses payable $246,753 $232,489
Unearned premiums 160,406 153,570
Note payable to affiliate 45,500 45,500
Current federal income taxes 193 1,322
Due to affiliates - 5,336
Postretirement health care benefits 54,494 2,498
Other liabilities 1,495 1,543
------------ ----------
Total liabilities 508,841 442,258
------------ ----------
STOCKHOLDERS' EQUITY
Common stock, without par value. Authorized 100,000,000 shares;
42,515,884 and 42,355,438 shares issued, respectively, at stated
value of $2.50 per share 106,290 105,888
Less treasury shares (4,046,939 and 4,034,342, respectively) at cost (46,954) (46,588)
Additional paid-in capital 43,271 42,562
Accumulated comprehensive income 6,935 156
Retained earnings 248,845 215,669
------------ ----------
Stockholders' equity 358,387 317,687
------------ ----------
Total liabilities and stockholders' equity $867,228 $759,945
============ ==========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
<PAGE> 4
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
For the Three Months Ended September 30, 2000 and 1999
(dollars in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
2000 1999
---- ----
<S> <C> <C>
Earned premiums $ 99,604 $ 98,229
Net investment income 9,743 8,566
Management services income 4,390 2,182
Net realized gains on investments 1,841 734
Other income (includes $395 and $480,
respectively, from affiliates) 750 749
------------ ------------
Total revenues 116,328 110,460
------------ ------------
Losses and loss expenses 76,500 68,978
Acquisition and operating expenses 28,671 28,957
Interest expense 682 351
Other expense 1,344 1,508
------------ ------------
Total expenses 107,197 99,794
------------ ------------
Income before federal income taxes 9,131 10,666
Federal income tax expense 1,125 2,134
------------ ------------
Net income $ 8,006 $ 8,532
============ ============
Earnings per share:
- basic $ 0.21 $ 0.22
============ ============
- diluted $ 0.20 $ 0.21
============ ============
Dividends paid per common share $ 0.030 $ 0.028
============ ============
</TABLE>
See accompanying notes to condensed consolidated financial statements.
<PAGE> 5
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
For the Nine Months Ended September 30, 2000 and 1999
(dollars in thousands, except per share amounts)
(unaudited)
<TABLE>
<CAPTION>
2000 1999
---- ----
<S> <C> <C>
Earned premiums $297,892 $295,558
Net investment income 28,741 25,374
Management services income 13,188 6,558
Net realized gains on investments 4,640 2,660
Other income (includes $1,166 and $1,195,
respectively, from affiliates) 2,281 2,427
------------ ----------
Total revenues 346,742 332,577
------------ ----------
Losses and loss expenses 206,904 203,442
Acquisition and operating expenses 88,378 84,991
Interest expense 2,047 418
Other expense, net 5,186 4,632
------------ ----------
Total expenses 302,515 293,483
------------ ----------
Income before federal income taxes 44,227 39,094
Federal income tax expense 10,044 9,313
------------ ----------
Net income $ 34,183 $ 29,781
============ ==========
Net earnings per share:
- basic $ 0.89 $ 0.72
============ ==========
- diluted $ 0.87 $ 0.71
============ ==========
Dividends paid per common share $ 0.085 $ 0.078
============ ==========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
<PAGE> 6
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months Ended September 30, 2000 and 1999
(in thousands)
(unaudited)
<TABLE>
<CAPTION>
2000 1999
---- ----
<S> <C> <C>
Cash flows from operating activities:
Net income $34,183 $29,781
Adjustments to reconcile net income to net cash provided by operating
activities:
Depreciation and amortization, net 2,252 2,157
Net realized gains on investments (4,640) (2,660)
Changes in operating assets and liabilities:
Deferred policy acquisition costs (1,888) (2,026)
Accrued investment income and other assets (945) 1,569
Net prepaid pension expense (17,932) (1,442)
Postretirement health care benefits 51,996 587
Other liabilities and due to/from affiliate, net (12,831) (2,718)
Reinsurance receivable and prepaid reinsurance premiums (2,127) (7,678)
Losses and loss expenses payable 1,730 3,507
Unearned premiums 6,836 8,223
Federal income taxes (7,927) (3,613)
---------- ----------
48,707 25,687
Cash provided from the change in the reinsurance pool
participation percentage 18,617 11,418
----------- ----------
Net cash provided by operating activities 67,324 37,105
----------- ----------
Cash flows from investing activities:
Purchase of fixed maturities - available for sale (143,473) (180,906)
Purchase of equity securities (14,864) (16,161)
Maturities, calls and principal reductions of fixed maturities -
held to maturity 3,830 10,595
Maturities, calls and principal reductions of fixed maturities -
available for sale 12,682 18,397
Sale of fixed maturities - available for sale 53,297 103,980
Sale of equity securities 14,745 12,435
Net cash acquired on acquisition of Farmers Casualty
Insurance Company and subsidiary - 11,568
Net additions of property and equipment (248) (3,443)
----------- ----------
Net cash used in investing activities (74,031) (43,535)
----------- ----------
Cash flows from financing activities:
Proceeds from issuance of debt - 30,000
Payments to acquire treasury stock (300) (29,995)
Net proceeds from sale of common stock 920 1,281
Payment of dividends (1,029) (985)
----------- ----------
Net cash (used in) provided by financing activities (109) 301
----------- ----------
Net decrease in cash and cash equivalents (6,816) (6,129)
Cash and cash equivalents at beginning of period 24,560 32,605
----------- ----------
Cash and cash equivalents at end of period $17,744 $26,476
=========== ==========
Supplemental disclosures:
Federal income taxes paid $11,111 $12,964
=========== ==========
</TABLE>
See accompanying notes to condensed consolidated financial statements.
<PAGE> 7
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements
September 30, 2000
(in thousands, except per share amounts)
(unaudited)
1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation have been included.
Operating results for the three and nine month periods ending September 30, 2000
are not necessarily indicative of the results that may be expected for the year
ended December 31, 2000. The balance sheet at December 31, 1999 has been derived
from the audited financial statements at that date but does not include all of
the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements.
For further information, refer to the consolidated financial statements and
footnotes thereto included in the Registrant Company and Subsidiaries' annual
report on Form 10-K for the year ended December 31, 1999.
Effective January 1, 2000, the Pooling Arrangement was amended to make State
Auto Insurance Company ("SAIC"), a wholly owned standard insurance subsidiary of
State Auto Financial, a participant in the Pooling Arrangement and increase the
Pooled Subsidiaries (as defined below) aggregate participation to 53% (State
Auto Property and Casualty Insurance Company ("State Auto P&C") - 39%, Milbank
Insurance Company ("Milbank") - 10 %, Farmers Casualty Insurance Company
("Farmers Casualty") - 3% and SAIC - 1%) (collectively the "Pooled
Subsidiaries"). In conjunction with the change in pool participation, the Pooled
Subsidiaries received cash from Mutual of $18.6 million, which related to the
additional net insurance liabilities assumed by the Pooled Subsidiaries on
January 1, 2000. All parties that participate in the Pooling Arrangement have an
A.M. Best rating of A+ (Superior).
State Auto P&C, in addition to its insurance operations, effective January 1,
2000, provides management and operation services under new management agreements
for all insurance and non-insurance affiliates. Pursuant to the management and
operation services agreements, State Auto P&C received cash of approximately
$28.1 million equal to the net plan benefit liabilities assumed relating to the
transfer to State Auto P&C of all employees from Mutual, Stateco Financial
Services, Inc. ("Stateco"), and Strategic Insurance Software, Inc.("S.I.S."),
effective January 1, 2000. Stateco and S.I.S. are wholly owned subsidiaries of
the Company. Prior to January 1, 2000, State Auto P&C provided executive
management services to the Pooled Subsidiaries, State Automobile Mutual
Insurance Company ("Mutual"), Midwest Security Insurance Company ("Midwest
Security"), State Auto National Insurance Company ("National") and Mid-Plains
Insurance Company ("Mid-Plains"). As a result of the change in the nature of
services provided by State Auto P&C, the management fee charged to insurer
affiliates was amended and is based on a percentage of the three year adjusted
average surplus of each managed insurer, except for Midwest Security, Farmers
Casualty and Mid-Plains whose management fee continues to be based on a
percentage of quarterly direct premiums written.
2. COMPREHENSIVE INCOME
The components of comprehensive income, net of related tax, are as follows:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30 September 30
------------ ------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Net income $ 8,006 $ 8,532 $ 34,183 $ 29,781
Unrealized holding gains (losses), net of tax 3,123 (7,528) 6,779 (17,693)
---------- ---------- --------- ---------
Comprehensive income $ 11,129 $ 1,004 $ 40,962 $ 12,088
========== ========== ========= =========
</TABLE>
<PAGE> 8
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements - continued
September 30, 2000
(in thousands, except per share amounts)
(unaudited)
The components of accumulated other comprehensive income, net of related tax,
included in stockholders' equity at September 30, 2000 and December 31, 1999
include only unrealized holding gains (losses), net of tax.
3. EARNINGS PER COMMON SHARE
The following table sets forth the computation of basic and diluted earnings per
common share:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30 September 30
------------ ------------
2000 1999 2000 1999
------- ------- ------- -------
<S> <C> <C> <C> <C>
Numerator:
Net income for basic and diluted
Earnings per share $ 8,006 $ 8,532 $34,183 $29,781
------- ------- ------- -------
Denominator:
Weighted average shares for
Basic earnings per share 38,460 40,342 38,406 41,340
Effect of dilutive stock options 784 756 629 773
Adjusted weighted average shares
For diluted earnings per share 39,244 41,098 39,035 42,113
------- ------- ------- -------
Basic earnings per share $ 0.21 $ 0.22 $ 0.89 $ 0.72
------- ------- ------- -------
Diluted earnings per share $ 0.20 $ 0.21 $ 0.87 $ 0.71
------- ------- ------- -------
</TABLE>
4. REINSURANCE
The following provides the income statement transactions for ceded reinsurance
information for transactions with other insurers and reinsurers as well as the
ceded reinsurance transaction for the Pooling Arrangement between the Company's
Pooled Subsidiaries and Mutual:
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30 September 30
------------ ------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Premiums earned:
Other insurers and reinsurers $ 4,732 $ 3,143 $ 10,355 $ 10,579
Ceded under Pooling Arrangement 100,411 101,709 297,858 295,423
Losses and loss expenses incurred:
Other insurers and reinsurers $ 1,103 $ 2,545 $ 1,572 $ 8,513
Ceded under Pooling Arrangement 78,682 73,849 211,090 206,147
</TABLE>
<PAGE> 9
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements - continued
September 30, 2000
(in thousands, except per share amounts)
(unaudited)
5. SEGMENT INFORMATION
<TABLE>
<CAPTION>
Three months ended Nine months ended
September 30 September 30
------------ ------------
2000 1999 2000 1999
---- ---- ---- ----
<S> <C> <C> <C> <C>
Revenues from external customers:
Standard insurance $ 101,866 $ 99,696 $ 304,066 $ 299,301
Nonstandard insurance 7,308 8,284 22,094 25,230
Investment management services 841 843 2,515 2,537
Management and operations services 3,662 -- 10,988 --
All other 801 814 2,417 2,646
--------- --------- --------- ---------
Total revenues from external customers 114,478 109,637 342,080 329,714
========= ========= ========= =========
Intersegment revenues:
Standard insurance $ 61 $ 30 $ 142 $ 90
Investment management services 1,078 640 3,230 1,930
Management and operations services 727 -- 2,126 --
All other 444 426 1,299 1,141
--------- --------- --------- ---------
Total intersegment revenues 2,310 1,096 6,797 3,161
========= ========= ========= =========
Segment profit (loss):
Standard insurance $ 1,732 $ 7,854 $ 23,029 $ 31,515
Nonstandard insurance (11) 999 367 811
Investment management services 1,336 1,291 3,975 3,926
Management and operations services 4,575 -- 13,724 --
All other 386 180 801 1,139
--------- --------- --------- ---------
Total segment profit 8,018 10,324 41,896 37,391
Reconciling items:
Corporate expenses (728) (432) (2,309) (947)
Net realized gains (losses) 1,841 734 4,640 2,660
Miscellaneous adjustments -- 40 -- (10)
--------- --------- --------- ---------
Total consolidated income before
federal income taxes $ 9,131 $ 10,666 $ 44,227 $ 39,094
========= ========= ========= =========
Segment assets:
Standard insurance $ 759,928 $ 702,049
Nonstandard insurance 46,990 45,568
Investment management services 6,791 6,028
Management and operations services 50,996 --
All other 14,473 14,636
--------- ---------
Total segment assets $ 879,178 $ 768,281
========= =========
</TABLE>
<PAGE> 10
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
Notes to Condensed Consolidated Financial Statements - continued
September 30, 2000
(in thousands, except per share amounts)
(unaudited)
The Company has four reportable segments: standard insurance, nonstandard
insurance, investment management services and effective January 1, 2000,
management and operations services. As noted in footnote 1 - Basis of
Presentation, the Company began providing management and operations services
through its wholly-owned subsidiary State Auto P&C.
6. RECLASSIFICATIONS
Certain items in the 1999 condensed consolidated financial statements have been
reclassified to conform to the 2000 presentation.
<PAGE> 11
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Results of Operations
---------------------
This discussion pertains to the following companies: State Auto Financial
Corporation (the "Company") and its wholly owned insurance subsidiaries State
Auto Property & Casualty Insurance Company ("State Auto P&C"), Milbank Insurance
Company ("Milbank"), Farmers Casualty Insurance Company ("Farmers Casualty"),
State Auto Insurance Company ("SAIC"); State Automobile Mutual Insurance Company
("Mutual") and its wholly owned subsidiary, Midwest Security Insurance Company
("Midwest"), all of the foregoing of which engage in the standard insurance
segment of the Company's operations. The Company's nonstandard segment of
operations is conducted through State Auto National Insurance Company ("State
Auto National"), a wholly owned subsidiary of the Company and Mid-Plains
Insurance Company ("Mid-Plains") a wholly owned subsidiary of Farmers Casualty.
State Auto P&C, Milbank, Farmers Casualty and SAIC are collectively referred to
below as the "Pooled Subsidiaries", while the Pooled Subsidiaries, Mutual and
Midwest are collectively referred to below as the "Pooled Companies".
Income before federal income taxes decreased $1.5 million to $9.1 million for
the three months ended September 30, 2000 from the same 1999 period.
Contributing to this decrease was a relatively small number of severe commercial
losses and Midwest storm loss damage. For the nine months ended September 30,
2000, income before federal income taxes increased $5.1 million to $44.2 million
from the same 1999 period. Contributing to the nine-month results was a decrease
in the level of catastrophe losses compared to the same period in 1999. Also
contributing to the current year quarter and year to date operations was an
amendment to the Company's Pooling Arrangement and a change in the management
services provided by State Auto P&C, both of which were effective as of January
1, 2000. These changes were described in the Management's Discussion and
Analysis included with the 10Q for the period ending June 30, 2000, (the "June
30, 2000 MD&A") which is incorporated herein by this reference. Briefly stated,
the Pooling Arrangement was changed to give the Pooled Subsidiaries 53% of the
premiums and losses written by the Pooled Companies, while under a new
Management and Operations Agreement, State Auto P&C employees began to provide
management and operations services to all its affiliates under a revised fee
structure.
Consolidated earned premiums during the quarter ended September 30, 2000,
increased $1.4 million (1.4%) to $99.6 million from the same 1999 period. This
increase was principally the result of the change in the Pooled Subsidiaries'
aggregate pooled participation percentage from 50% to 53% (referred to above).
This action increased consolidated earned premiums 5.5%. The standard insurance
segment's internal growth, as written by the Pooled Companies, excluding the
impact of the change in the Pooling Arrangement, decreased consolidated earned
premiums by 3.1%. The Company's nonstandard insurance segment's internal growth
also decreased consolidated earned premiums by approximately 1.0%.
Consolidated earned premiums for the nine months ended September 30, 2000,
increased $2.3 million (0.8%) to $297.9 million from the same 1999 period.
Increasing consolidated earned premiums by 5.5% was the change in the Pooled
Subsidiaries' aggregate pooled participation percentage (discussed above).
Offsetting this increase, was a decrease in the internal growth of the standard
insurance segment of 3.2% and of the nonstandard insurance segment of 1.1%. Also
negatively impacting the Company's consolidated earned premiums by approximately
0.4%, is a return of premiums to the policyholders in the state of North
Carolina as a result of a rate reduction dating back to 1994 that has been
mandated by the Insurance Department of this state, which was previously
described in the June 30, 2000 MD&A incorporated herein.
As previously reported, commercial lines growth prospects seem to be improving
generally. Published reports from competitors and our own experience tends to
indicate that commercial lines pricing is firming. During third quarter 2000,
the Pooled Companies experienced 11.0% growth in its commercial lines direct
written premiums. On the other hand, while the personal lines business continues
to be very price competitive the Company's rate of decline in internal growth in
these lines has slowed somewhat. Some of our competitors seem to be trying to
hold the line on personal lines pricing, based on published reports. The
Company's steadfastness in its underwriting and pricing postures has been a key
factor in the
<PAGE> 12
Company's underwriting results year to date, particularly as compared to other
property casualty insurers. The Company intends to continue its strategy of
taking modest price increases on a regularly scheduled basis and to preserve its
underwriting diligence regarding risk selection, through underwriting audits and
other measures. The Company also continues to develop new products to enhance
its product portfolio; to appoint new agents in its operating territories; and
to regularly review rates in each line and each state to refine its pricing
levels for the markets it believes offer the most profit potential.
Net investment income increased $1.2 million (13.7%) to $9.7 million and $3.4
million (13.3%) to $28.7 million for the three month and nine month periods
ending September 30, 2000, respectively, from the same 1999 periods.
Contributing to these increases was the cash transfers to the Company in
conjunction with the change in the Pooling Arrangement and transfer of employees
to State Auto P&C referred to above. The investment yield, based on fixed and
equity securities at cost, increased to 5.45% for both the three month and nine
month periods ending September 30, 2000, from 5.4% for same 1999 comparable
periods.
Management services income increased $2.2 million to $4.4 million and $6.6
million to $13.2 million for the three month and nine month periods ending
September 30, 2000, respectively, from the same 1999 period. These increases are
largely attributable to the change in the nature of the management services
provided by State Auto P&C as addressed in the June 30, 2000 MD&A, previously
incorporated herein.
Losses and loss expenses, as a percentage of earned premiums (the "loss ratio"),
increased to 76.8% for the three months ended September 30, 2000 from 70.2% for
the same 1999 period and for the nine months ended September 30, 2000, increased
to 69.5% from 68.8% for the same 1999 period. The increase in the three and nine
month loss ratios was largely the result of the Company experiencing a
relatively small number of large unusual commercial claims. Management noted
that these large commercial losses did not impact any one line of business or
geographic region and does not believe the nature of these claims indicates
deterioration in core underwriting operations. See discussion above regarding
management's response to its perception of the current underwriting environment.
Acquisition and operating expenses, as a percentage of earned premiums (the
"expense ratio"), decreased to 28.8% for the quarter ended September 30, 2000
from 29.5% for the same 1999 period and for the nine months ended September 30,
2000, increased to 29.7% from 28.8% for the same 1999 period. The decrease in
the three month ratio is attributable to an improvement in a number of expense
items of the Company and not any one specific item. The increase in the expense
ratio for the nine month period can be attributed to an increase in the amount
of Quality Performance Bonus earned by employees compared to that earned during
the same respective time periods in 1999.
Interest expense relates to the line of credit agreement the Company entered
into with Mutual during the second quarter of 1999 to assist in the funding of
its stock repurchase program.
Other expense decreased $0.2 million to $1.3 million and increased $0.6 million
to $5.2 million for the three month and nine month periods ending September 30,
2000, respectively, from the same 1999 periods. Increasing the nine month
results was the estimated amount of interest the Company must pay on the North
Carolina premium rate refunds as discussed above.
The effective Federal tax rate was 12.3% and 22.7% for the three month and nine
month periods ending September 30, 2000, respectively, compared to 20.0% and
23.8% for the same 1999 periods, respectively. Through 1999, the Company
continued its shift of its fixed maturity portfolio into tax exempt securities
from 71% at December 31, 1998 to approximately 74% through September 30, 1999.
Through September 30, 2000, approximately 78% of the Company's fixed maturity
portfolio was invested in tax exempt fixed maturities. The decreases in the
three and nine month effective Federal tax rates are primarily a result of tax
exempt income comprising a larger proportion of income before federal income
taxes in 2000 versus 1999.
Liquidity and Capital Resources
-------------------------------
Through the nine months ended September 30, 2000, net cash provided by operating
activities increased to $67.3 million from $37.1 million during the same time
period in 1999. This increase is due to the cash transfers in conjunction with
the change in the Pooling Arrangement and transfer of employees to State
<PAGE> 13
Auto P&C as noted above. Additionally, there was a general increase in cash
flows that resulted from the change in pool percentages from previous periods.
Overall, net cash used in investing activities was $74.0 million up from $43.5
million in 1999. This increase in cash used in investing activities was the
result of the investment of the cash transferred to the Company from the January
1, 2000 Pooling Arrangement amendment and transfer of employees to State Auto
P&C.
Net cash used in financing activities for the nine months ended September 30,
2000 did not change significantly between the two time periods.
As of September 30, 2000, funds consisting of cash and cash equivalents were
$17.7 million versus $26.5 million at September 30, 1999.
During the second quarter 2000, the Company's Board of Directors approved a plan
to repurchase up to 1.0 million shares of its common stock from the public over
a one year period ending December 31, 2001. To date, State Auto Financial has
repurchased 25,122 shares.
Market Risk
-----------
With respect to Market Risk, see the discussion regarding this subject in the
Company's December 31, 1999 Management's Discussion and Analysis of Financial
Condition and Results of Operations, included in the December 31, 1999 Form
10-K. There have been no material changes from the information reported
regarding Market Risk in the 1999 Form 10-K.
SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995
Statements contained herein expressing the beliefs of management and the other
statements, which are not historical facts contained in this report, are forward
looking statements within the meaning of the Private Securities Litigation
Reform Act of 1995. Such forward-looking statements are subject to certain risks
and uncertainties that could cause the Company's actual results to differ
materially from those projected. Such statements include, without limitation,
those pertaining to the weather related catastrophes impacting the Company's
losses, product offerings, statements relating to the new insurer, State Auto
Insurance Company, the state of competition, the Company's agent appointment
efforts, rate reviews, sales forecasts, loss forecasts, and other companies
actions in response to their adverse underwriting results. These risks and
uncertainties include, but are not limited to, legislative changes at both the
state and federal level, state and federal regulatory rule making
promulgation's, class action litigation involving the insurance industry and
judicial decisions affecting claims, policy coverages and the general costs of
doing business, the impact of competitive products and pricing, product
development, geographic spread of risk, weather and weather-related events,
other types of catastrophic events, fluctuations of securities markets, economic
conditions, technological difficulties and advancements, availability of labor
and materials in storm hit areas, late reported claims, previously undisclosed
damage, utilities and financial institution disruptions, shortages of
programmers, other types of technical and professional employees, and regulatory
or governmental systems breakdowns, and other risks indicated in the Company's
filings with the Securities and Exchange Commission, including, without
limitation, the Company's Form 10-K and 10Q reports and the exhibits included
therein.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE OF MARKET RISK
---------------------------------------------------------------
The information called for by this item is provided under the caption "Market
Risk" under Item 2 - Management's Discussion and Analysis of Financial
Condition.
<PAGE> 14
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES
PART II. OTHER INFORMATION
Item 1. Legal Proceedings - None
Item 2. Changes in Securities and Use of Proceeds - None
Item 3. Defaults Upon Senior Securities - None
Item 4. Submission of Matters to a Vote of Security Holders - None
Item 5. Other Information - None
INDEX TO EXHIBITS
Item 6. a. Exhibits
Exhibit No. Description of Exhibits
----------- -----------------------
27 Financial data schedules
b. Reports on Form 8-K:
Form 8-K filed on September 28, 2000 incorporating a Press
Release dated September 28, 2000 advising the public of losses during the third
quarter which would be expected to adversely affect earnings for the quarter.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
STATE AUTO FINANCIAL CORPORATION
Date: NOVEMBER 13, 2000 /s/ Steven J. Johnston
----------------- -------------------------------------
Steven J. Johnston
Treasurer and Chief Financial Officer
(Duly Authorized Officer and
Principal Financial Officer)
