Because the operations of the Company and Mutual are integrated with one another pursuant to the terms of the 2000 Management Agreement, the Company and Mutual share their operating facilities. See Item 1, "Management Agreement" in the "Narrative Description of Business." The Company's and Mutual's corporate headquarters are located in Columbus, Ohio in buildings owned by Mutual that contain
(1) Adjusted for a July 1998 2-for-1 common stock split as well as a July 1996 3-for-2 common stock split effected in the form of a stock dividend. (2) The earnings per share amounts prior to 1997 have been restated as required to comply with SFAS No. 128. (3) Preliminary industry information for 2000 from A.M. Best.
Through State Auto P&C, the Company provides management and operations services under the Midwest Management Agreement (as defined below), the Farmers Casualty Management Agreement (as defined below) and the Mutual Management Agreement (as defined below) each effective as of January 1, 2000 (collectively the "2000 Management Agreement"), for insurance and noninsurance affiliates. As of January 1, 2000, all individuals providing services to any of the State Auto Companies who were not already employees of State Auto P&C became employees of State Auto P&C. Under the 2000 Management Agreement, State Auto P&C through its employees, is responsible for performing all organizational, operational, and management functions for each of the managed companies. For its performance of these services, State Auto P&C is paid quarterly a management and operations services fee based on formulas outlined in the 2000 Management Agreement. This fee from a managed company may be deferred or withheld if a managed company's performance does not meet performance criteria set forth in the 2000 Management Agreement. The Ohio Department of Insurance (the "Department") has requested that State Automobile Mutual Insurance Company ("Mutual") file an analysis on a quarterly basis, starting with the quarter beginning January 1, 2001, with the Department that justifies the apportionment of the service fee paid by Mutual to State Auto P&C under the 2000 Management Agreement under the accounting guidance outlined in Statement of Statutory Accounting Principles No. 70 - Allocation of Expenses ("SSAP No. 70"). The Company believes its accounting for such service fee is consistent with all statutory accounting principles. However, there can be no assurance that all or any part of the service fee paid by Mutual will be justified to the Department's satisfaction, which may affect the amount of such fee recognized as revenue by the Company. See Item 7 - Forward-Looking Statements; Certain Factors Affecting Future Results. Pursuant to the 2000 Management Agreement, the Company received cash of $28.1 million equal to the net plan benefit liabilities assumed relating to the above described transfer of those individuals who were employees of Mutual as of January 1, 2000. Prior to January 1, 2000, State Auto P&C provided only executive management services to all insurance affiliates. The Midwest Management Agreement is a management agreement under which State Auto P&C provides management and operations services to Midwest Security Insurance Company, a Wisconsin domiciled, wholly owned subsidiary of Mutual ("Midwest Security"). The Farmers Casualty Management Agreement is a management agreement under which State Auto P&C provides management and operations services to Farmers Casualty and Mid-Plains. The Mutual Management Agreement is a management agreement under which State Auto P&C provides management and operations services to Mutual, Milbank, National and SAIC, and other non-insurance affiliates.
On July 7, 1998, State Auto Financial acquired all of the outstanding shares of Milbank from Mutual pursuant to the Option Agreement dated August 1993. The purchase price of Milbank was approximately $81.9 million. The transaction was effected through an exchange with Mutual of
Through Strategic Insurance Software, Inc. (S.I.S.), a wholly owned subsidiary, the Company develops and sells software for the processing of insurance transactions, database management systems for insurance agents and electronic interfacing of information between insurance companies and agents. S.I.S. sells its services and products to affiliated companies and their agents and markets similar services and products to nonaffiliated insurers and their agencies.
518 Property and Management and Leasing, LLC (518 PML), an Ohio limited liability company, is engaged in the business of owning and leasing real and personal property to affiliated companies. The members of 518 PML are State Auto P&C and Stateco.
the "Pooled Subsidiaries", while the Pooled Subsidiaries, Mutual and Midwest are collectively referred to below as the "Pooled Companies."
Consolidated earned premiums increased 1.5% in 2000. 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 2.8%. The Company's nonstandard insurance segment's internal growth also decreased consolidated earned premiums by approximately 0.9%. Also negatively impacting the Company's consolidated earned premiums by approximately 0.3%, was 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 was mandated by the Insurance Department of that state. In 1994 and 1996, the North Carolina Rate Bureau ("NCRB") filed an auto rate increase which was challenged by the North Carolina Insurance Department. The parties agreed to a settlement of the dispute in late March 2000, which resulted in a rate reduction for the 1994 rate filing and the 1996 rate filing being approved as originally filed by the NCRB. Consequently, the Company was required to return approximately $1.1 million in disputed premiums, plus $530,000 in interest. The interest portion of the returned premium has been reflected in the miscellaneous expense line item.
Acquisition and operating expenses, as a percentage of earned premiums (the "expense ratio"), were 28.8% and 28.5% for the years 2000 and 1999, respectively. The increase in the expense ratio is impacted by the fixed costs such as salaries, depreciation and utilities which comprised a larger portion of earned premiums in 2000 than they did in 1999 as a result of the Company's less than anticipated premium writings in 2000.
Other expense increased $0.3 million to $6.9 million for the year ending December 31, 2000. Other expense for 2000 included the interest the Company paid on the North Carolina premium rate refunds, discussed above.
The effective federal tax rate was 22% and 25% for the years ended 2000 and 1999, respectively. During 2000, the Company continued to shift its fixed maturity portfolio from taxable to tax-exempt securities. As a result of this continued shift, tax exempt income comprised a larger proportion of income before federal income taxes in 2000 than in 1999. For additional clarification, see the reconciliation between actual federal income taxes and the amount computed at the statutory rate as detailed in footnote 7 in the notes to the Company's consolidated financial statements.
This same approach to underwriting also had an impact on the Company's nonstandard insurance segment, which experienced a decrease in its earned premiums in 1999. This was the continuing result of significant auto physical damage rate increases, the continuation of a more restrictive underwriting posture first implemented by the Company in this segment throughout most of its operating states in 1998 and increased competition in this market segment during 1999. While these actions have resulted in a decrease in the volume of business over the last several reporting periods, this segment's statutory loss experience continued to improve over comparative prior periods. The statutory loss ratio for the year ended December 31, 1999 decreased to 71.7% from 75.0% for the same period in 1998. Offsetting the decrease in earned premium was National's entry into three new states of operation during 1999: South Carolina in the first quarter; Maryland in the second quarter; and South Dakota in the fourth quarter.
Net investment income increased 5.4% in 1999. Contributing to the increase over the previous year was the transfer to the Company of approximately $11.4 million in conjunction with the change in the Pooling Arrangement, the addition of Farmers Casualty and Mid-Plains to the Company's operations and a general increase in investable assets over the previous 1998 period. Total cost of investable assets at December 31, 1999 and 1998, respectively was $651.9 million and $590.8 million.
The investment yields, based on fixed and equity securities at cost, were 5.4% and 5.7% for the annual periods ending 1999 and 1998, respectively. Contributing to the decrease in the 1999 yield was the continual shift in the composition of the fixed maturity portfolio from taxable to tax-exempt fixed maturities. At December 31, 1999 and 1998, respectively, tax exempt securities comprised approximately 76% and 71% of the fixed maturity portfolio. Additionally, in 1999, the Company continued to experience a number of calls on its higher yielding fixed maturities. Monies from these calls were reinvested at the then lower yielding rates. Another contributing factor was the Company continuing to build on its equity portfolio to enhance growth of statutory surplus over the long term, a program that began in late 1997. See further discussion regarding investments at the "Investments and Market Risk" sections included herein.
Stateco and State Auto P&C, respectively, increased $0.8 million in 1999. The executive management services provided by State Auto P&C primarily generated the increase.
Other income includes revenue primarily from sales of software products to affiliates and third parties by the Company's insurance software subsidiary, S.I.S., as well as leasing revenue on real and personal property leased by 518 PML to affiliates. During 1999, other income increased 32.2%. Revenue generated from sales of software to third parties increased other income during 1999 by approximately 18.0%, while revenue generated through leasing transactions with affiliates increased other income by approximately 12.0%.
The Company continued in 1999 to make strides in the use of technology to streamline its personal and commercial operations as more agencies participated in electronic upload and download using the APT industry standard. Additionally, in 1999, the Company began the use of electronic funds transfer (EFT) between the Company and the insured in several operating states for personal automobile business.
2000 1999 1998 ---- ---- ---- (in thousands) Standard insurance $35,579 $41,146 $34,341 Nonstandard insurance (116) 1,647 1,313 Investment management services 5,354 5,191 4,908 Management and Operations services $17,552 $ 6,330 $ 5,290
The fluctuations in segment profit for the standard insurance segment, as discussed above, is due to a decline in its underwriting income due to an increase in the level of commercial losses, as discussed above. The improvement in segment profit in 1999 compared to 1998 was the result of a decrease in the level of catastrophe losses for this year. Prior to 1997, the nonstandard segment focused on improving its loss experience through implementation of a more restrictive underwriting posture and rate increases in several operating states. While this segment showed improvement as a result of these actions, 2000 experienced significant losses in several of its new states of operation. As discussed above, management continually monitors this segment's premium rate adequacy given the nature of the risks that are written through the nonstandard market. The investment management services segment profit increased slightly due to increasing market rates within the fixed maturity market. This segment's revenue is based on the average market value of the portfolio of the companies managed, which is largely comprised of fixed maturities. With the change in the interest rate environment throughout 2000, the average market value of the portfolio of the companies managed increased throughout 2000. The increase in the investment management services segment's profit from 1998 to 1999 was primarily the result of the acquisition of Farmers Casualty and Mid-Plains, effective January 1, 1999, at which time this segment began providing investment management services to these companies. Segment profits related to management and operations services has increased from that in previous years due to the change in the management and operations agreement as discussed in Note 1 (j) in the consolidated financial statements. For additional information on the Company's reportable segments, see footnote 14 on "Reportable Segments" in the Company's consolidated financial statements.
In 2000, net cash provided by operating activities increased to $87.7 million from $48.9 million in 1999. This increase was due to a cash transfer of $18.6 million to the Pooled Subsidiaries in connection with the 2000 amended Pooling Arrangement, as well as a cash transfer of $28.1 million to State Auto P&C relating to the net plan benefit liabilities assumed in connection with the 2000 Management Agreement. In 1999, net cash provided by operating activities decreased to $48.9 million from $56.7 million in 1998. The 1999 decrease was due to the cash transfer of $11.4 million to the Pooled Subsidiaries in connection with the 1999 amended Pooling Arrangement, as discussed above, whereas in
In 1996, the State Auto Insurance Companies negotiated a change in their catastrophe reinsurance program. In 1998, Midwest Security, 1999, Farmers Casualty and Mid-Plains, and 2000, SAIC, became parties to the catastrophe reinsurance program. The amount retained by the State Auto Insurance Companies is $40.0 million for each occurrence. For up to $80.0 million in losses, excess of $40.0 million, traditional reinsurance coverage is provided. Effective November 1999, State Auto P&C assumed catastrophe reinsurance from Mutual, Milbank, Midwest Security, Farmers Casualty, SAIC, National and Mid-Plains in the amount of $135 million excess of $120 million. Effective November 2000, the catastrophe reinsurance program was renegotiated whereby State Auto P&C now assumes $115 million excess of $120 million. This layer of $115 million in excess of $120 million has been excluded from the Pooling Arrangement. There have been no losses assumed under this agreement.
The primary investment objectives of the Company are to generate income, preserve capital and maintain adequate liquidity for the payment of claims. Fixed maturities that are purchased with the intention and ability of holding them until maturity are categorized as held to maturity and carried at amortized cost. Fixed maturities that may be sold due to changing investment strategies are categorized as available for sale and are carried at fair value. At December 31, 2000, the Company had no fixed maturity investments rated below investment grade, nor any mortgage loans.
As of December 31, 2000, the Company had fixed maturities with a fair value of $653.3 million designated as available for sale compared to $527.8 million at December 31, 1999. During 2000, the Company continued its program to increase its equity portfolio to enhance growth of statutory surplus over the long term. At December 31, 2000 and 1999, respectively, the equity portfolio totaled $58.3 and $55.5 million, respectively.
The fixed maturity portfolio is managed in a ladder-maturity style and considers business mix and liability payout patterns to ensure adequate cash flow to meet claims as they are presented. At December 31, 2000, the Company's fixed maturity portfolio had an average maturity of 12.5 years and a duration of 5.6 years. For the insurance subsidiaries, the maximum investment in any single note or bond is limited to 5.0% of statutory assets, other than obligations of the U.S. government or government agencies, for which there is no limit. The fixed maturity portfolio is very high in quality with all holdings either in Government obligations, municipal, or corporate obligations rated AA or better by the major bond rating agencies. The Company does not intend to change its investment policy on the quality of its fixed maturity investments. Investments in equity securities are selected based on their potential for appreciation as well as ability to continue paying dividends. Additional information regarding the composition of investments, along with maturity schedules regarding investments in fixed maturities, is included in footnote 2 of the consolidated financial statements.
The Company's primary market risk exposures are to changes in market prices for equity securities and changes in interest rates and credit ratings for fixed maturity securities. In 2000, market conditions were characterized by decreasing equity market prices and increasing fixed maturity market prices. The Company's equity portfolio increased from $55.5 million at December 31, 1999 to $58.3 million at December 31, 2000 as new monies were allocated during the year to acquire new equity positions. Though the Company continued to hold unrealized gains on this portfolio, equity securities held at year end experienced a $2.1 million decrease in unrealized holding gains from December 31, 1999. The market value of the available for sale fixed maturity portfolio was positively impacted during the year as a result of declining interest rates. In 2000, the fixed maturity security market experienced a significant decline in interest rates in response to the Federal Reserve Board's monetary policy and easing inflationary pressures. As a result of these market conditions, the Company experienced an increase of $33.2 million on the market value of its available for sale fixed maturity portfolio through December 31, 2000.
As previously discussed, in order to maximize investment income the Company manages its fixed maturity portfolio in a ladder-maturity style to ensure adequate cash flow to meet claims as they are presented for payment. It is not anticipated that fixed maturity investments would need to be sold in order to meet claim payments in the future. In fact, the Company has never had to sell assets to meet payment of its claims.
To provide the Company greater flexibility in order to manage its market risk exposures, the Company has segregated a portion of its fixed maturity portfolio, approximately 94% at December 31, 2000, in accordance with SFAS No. 115, as available for sale. Also, the Company does not maintain a trading portfolio.
o The Company's financial results are subject to the occurrence of weather-related and other types of catastrophic events, none of which are within the Company's control.
o The Company's operations are subject to changes occurring in the legislative, regulatory and judicial environment, including but not limited to changes related to the implementation of the Gramm Leach Bliley Act of 1999. Risks and uncertainties related to the legislative, regulatory, and judicial environment include, but are not limited to, legislative changes at both the state and federal level, state and federal regulatory rulemaking promulgations and adjudications that may affect the Company specifically, its affiliates or the industry generally, class action and other litigation involving the insurance industry and judicial decisions affecting claims, policy coverages and the general costs of doing business. Many of these changes are beyond the Company's control.
o The laws of the various states establish insurance departments with broad regulatory powers relative to approving intercompany arrangements, such as management, pooling, and investment management agreements, granting and revoking licenses to transact business, regulating trade practices, licensing agents, approving policy forms, setting reserve requirements, determining the form and content of required statutory financial statements, prescribing the types and amount of investments permitted and requiring minimum levels of statutory capital and surplus. The Ohio Department of Insurance (the "Department") has requested that, beginning in 2001, Mutual file an analysis on a quarterly basis with the Department that justifies the apportionment of the service fee paid by Mutual to State Auto P&C under the 2000 Management Agreement under statutory accounting guidance outlined in SSAP No. 70. The Company believes that its accounting for such service fee is consistent with all statutory accounting principles. However, there can be no assurance that all or any part of the service fee paid by Mutual will be justified to the Department's satisfaction, which may affect the amount of such fee recognized as revenue by Company. In addition, although premium rate regulation varies among states and lines of insurance, such regulations generally require approval of the regulatory authority prior to any changes in rates. Furthermore, all of the states in which the State Auto Group transacts business have enacted laws which restrict these companies' underwriting discretion. Examples of these laws include restrictions on agency terminations and laws requiring companies to accept any applicant for automobile insurance. These laws may adversely affect the ability of the insurers in the State Auto Group to earn a profit on their underwriting operations.
We have audited the accompanying consolidated balance sheets of State Auto Financial Corporation and subsidiaries as of December 31, 2000 and 1999 and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of State Auto Financial Corporation and subsidiaries as of December 31, 2000 and 1999, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States.
SAIC was formed in 1999 to engage in the business of providing standard personal insurance to its policyholders through the use of leading edge technology within the independent agency system. Effective January 1, 2000, SAIC was chartered and licensed as a property and casualty insurer in the state of Ohio and began operations at that time.
Through Stateco, the Company provides investment management services to affiliated companies and also provides insurance premium finance services
518 PML, an Ohio limited liability company, was formed to engage in the business of owning and leasing real and personal property to affiliated companies. As of January 1, 1998, State Auto P&C and Stateco became initial members of 518 PML.
The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States, which vary in certain respects from statutory accounting practices followed by State Auto P&C, Milbank, Farmers Casualty, SAIC, National and Mid-Plains that are prescribed or permitted by the Departments.
In August 1998, State Auto Financial purchased $9.0 million of surplus notes from Farmers Casualty Company Mutual (FCCM), an Iowa domiciled standard property casualty insurer. In 1998, a plan to convert FCCM into a stock insurance company was approved by the board of FCCM, its policyholders and the Iowa Division of Insurance. The plan of conversion contemplated that State Auto Financial, in exchange for the redemption of the surplus notes, would acquire the newly issued shares of Farmers Casualty. Effective January 1, 1999, FCCM, renamed Farmers Casualty Insurance Company, became a wholly owned subsidiary of State Auto Financial.
(g) GOODWILL Goodwill represents the excess of cost of acquisition over the fair value of the net assets acquired and is being amortized using the straight-line method over 15 years. Accumulated amortization is $1,605,000 and $1,347,000 at December 31, 2000 and 1999, respectively.
(h) LOSSES AND LOSS EXPENSES PAYABLE Losses and loss expenses payable are based on formula and case-basis estimates for reported claims, and on estimates, based on experience and perceived trends, for unreported claims and loss expenses. The liability for unpaid losses and loss expenses, net of estimated salvage and subrogation recoverable of $13,403,000 and $13,505,000 at December 31, 2000 and 1999, respectively, has been established to cover the estimated ultimate cost of insured losses. The amounts are necessarily based on estimates of future rates of inflation and other factors, and accordingly there can be no assurance that the ultimate liability will not vary from such estimates. The estimates are continually reviewed and adjusted as necessary; such adjustments are included in current operations (see note 4). Salvage and subrogation recoverables are estimated using historical experience.
(i) PREMIUM REVENUES Premiums are recognized as earned using the monthly pro rata method over the contract period.
(l) FEDERAL INCOME TAXES The Company files a consolidated federal income tax return and pursuant to an agreement, each entity within the consolidated group pays its share of federal income taxes based on separate return calculations. Milbank filed a consolidated federal income tax return with the Company for periods subsequent to July 1, 1998. Prior to this time, Milbank was included in the consolidated federal income tax return of Mutual.
Farmers Casualty and Mid-Plains file a consolidated federal income tax return with the Company for periods subsequent to January 1, 1999. Prior to this time, Farmers Casualty and Mid-Plains filed their own consolidated return.
and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse.
(m) CASH EQUIVALENTS The Company considers all highly liquid debt instruments with a maturity of three months or less to be cash equivalents.
Separate presentation of the accumulated balance of other comprehensive income within the equity section of the statement of financial position is also required. The Company has presented the required displays of total comprehensive income and its components, within the "Consolidated Statements of Stockholders' Equity." See additional disclosures at note 13.
Deferred federal income taxes on the net unrealized holding gain for available for sale investments was $10,940,000 and $84,000 at December 31, 2000 and 1999, respectively.
The amortized cost and fair value of fixed maturities segregated by held to maturity and available for sale, at December 31, 2000, by contractual maturity, are summarized as follows:
Cash and cash equivalents:The carrying amounts reported in the balance sheets for these instruments approximate their fair value.
In the ordinary course of business, the Company assumes and cedes reinsurance with other insurers and reinsurers and are members in various pools and associations. See Note 6(a) for discussion of reinsurance with affiliates. The voluntary arrangements provide greater diversification of business and limit the maximum net loss potential arising from large risks and catastrophes. Most of the ceded reinsurance is effected under reinsurance contracts known as treaties; some is by negotiation on individual risks. Although the ceding of reinsurance does not discharge the original insurer from its primary liability to its policyholder, the insurance company that assumes the coverage assumes the related liability.
Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured business. The recoverability of these assets depends on the reinsurers' ability to perform under the reinsurance agreements. The Company evaluates and monitors the financial condition and concentrations of credit risk associated with its reinsurers under voluntary reinsurance arrangements to minimize its exposure to significant losses from reinsurer insolvencies. The Company has reported ceded losses and loss expenses payable and prepaid reinsurance premiums with other insurers and reinsurers as assets. All reinsurance contracts provide indemnification against loss or liability relating to insurance risk and have been accounted for as reinsurance. Prior to the reinsurance transaction with Mutual under the pooling arrangement, as discussed in note 6(a), the effect of the Company's reinsurance on its balance sheets and income statements, is as follows:
(a) REINSURANCE State Auto P&C, Milbank, Farmers Casualty and SAIC (the Pooled Subsidiaries) participate in a quota share reinsurance pooling arrangement (the Pooling Arrangement) with Mutual whereby the Pooled Subsidiaries cede to Mutual all of their insurance business and assume from Mutual an amount equal to their respective participation percentages in the Pooling Arrangement. All premiums, losses and loss expenses and underwriting expenses are allocated among the participants on the basis of each company's participation percentage in the Pooling Arrangement. The Pooling Arrangement provides indemnification against loss or liability relating to insurance risk and has been accounted for as reinsurance.
Pursuant to the Pooling Arrangement, Mutual is responsible for the collection of premiums and payment of losses, loss expenses and underwriting expenses of the Pooled Subsidiaries. Unpaid balances are reflected in due to or due from affiliates in the accompanying consolidated balance sheets. Settlements of the intercompany account are made quarterly. No interest is paid on this account. All premium balance receivables and reinsurance recoverable on paid losses from unaffiliated reinsurers are carried by Mutual. The Company had off-balance-sheet credit risk of approximately $60 million and $47 million related to premium balances due to Mutual from agents and insureds at December 31, 2000 and 1999, respectively.
(e) OTHER TRANSACTIONS S.I.S. provides insurance software products and services to Mutual and its affiliate. Revenue relating to these services amount to $900,000, $1,109,000 and $1,048,000 in 2000, 1999 and 1998, respectively, and is included in other income. Effective January 1, 1998, 518 PML began leasing assets to Mutual and its affiliate. Revenue relating to these services amount to $646,000, $567,000 and $268,000 in 2000, 1999 and 1998, respectively and is included in other income.
State Auto P&C's December 31, 1990 liability for losses and loss expenses of $65,464,000 has been guaranteed by Mutual. Pursuant to the guaranty agreement, all ultimate adverse development of the December 31, 1990 liability, if any, is to be reimbursed by Mutual to State Auto P&C in conformance with pooling percentages in place at that time. As of December 31, 2000, there has been no adverse development of the liability.
Effective January 1, 2000, all employees of Mutual, Stateco and S.I.S., became employees of State Auto P&C, under new management agreements effective on that same date. See related discussion at Note (1)(b). Pursuant to the new management agreements, the Company paid cash of approximately $14.6 million to Mutual, equal to the net prepaid pension asset received.
The Company maintains a defined contribution plan that covers substantially all employees of the Company. Contributions to the plan are based on employee contributions and the level of Company match. The Company's share of the expense under the plan totaled $890,000, $852,000 and $782,000 for the years 2000, 1999 and 1998, respectively.
Prior to 2000, State Auto P&C, Stateco and S.I.S., pursuant to an intercompany agreement, were participants, together with Mutual, in a postretirement medical and life insurance benefit plan. The postretirement benefit obligation was immaterial to the consolidated balance sheet prior to 2000.
Plan assets are primarily composed of mutual funds and government securities.
The following table presents the funded status for the Company's postretirement benefit obligation and the amounts recognized in the consolidated balance sheet as of December 31, 2000 (in thousands):
The assumed rate of future increases in per capita cost of health care benefits was 10% for the first year and grading down 1% per year to an ultimate rate of 5%. The health care cost trend rate assumption affects the amounts reported. For example, increasing the assumed health care cost trend rate by one percentage point would increase the accumulated postretirement benefit obligation by approximately $6,100,000 and would increase the medical service and interest cost by approximately $800,000.
(a) STOCK SPLIT On June 2, 1998, State Auto Financial's authorized capital was increased to 100,000,000 shares of common stock and State Auto Financial's Board of Directors declared a two-for-one common stock split. The financial statements, notes and other references to share information and per share data have been given retroactive effect to reflect the stock split for all periods presented.
In May 2000, State Auto Financial's Board of Directors approved a plan to repurchase up to 1.0 million shares of its common stock from the public over a period ending December 31, 2001. Through December 31, 2000, State Auto Financial has repurchased 25,122 shares from the public. Repurchases during 2000 were funded through dividends from subidiaries.
Pro forma net earnings per common share Basic .................................... $ 1.19 1.02 0.85 Diluted .................................. $ 1.17 1.00 0.83
The fair value of options granted in 2000, 1999 and 1998 were estimated at the date of grant using the Black-Scholes option-pricing model. The weighted average fair values and related assumptions for options granted were as follows:
2000 1999 1998 ---- ---- ---- Fair value .............................. $4.66 $4.49 $6.10 Dividend yield .......................... .90% .90% .75% Risk free interest rate ................. 6.51% 5.77% 5.31% Expected volatility factor .............. .34 .32 .31 Expected life (years) ................... 7.2 5.7 6.6
The Company has a stock option incentive plan for certain designated independent insurance agencies that represent the Company and its affiliates. The Company has reserved 400,000 shares of common stock under this plan. The plan provides that the options become exercisable on the first day of the calendar year following the agency's achievement of specific production and profitability requirements over a period not greater than two calendar years from date of grant or a portion thereof in the first calendar year in which an agency commences participation under the plan. Options granted and vested under this plan have a 10-year term. The Company has accounted for the plan in its accompanying financial statements at fair value. The fair value of options granted was estimated at the reporting date or vesting date using the Black-Scholes option-pricing model. The weighted average fair value and related assumptions for 2000 and 1999, respectively, were as follows: fair value of $10.91 and $4.02; dividend yield of .90% for both years; expected volatility factor of .32 and .30; risk-free interest rate of 5.19% and 6.80%; and expected life of the option of 9.0 and 9.7 years. Expense of $493,000 and $105,000 associated with this plan was recognized in 2000 and 1999, respectively.
A summary of information pertaining to options outstanding and exercisable as of December 31, 2000 follows:
Numerator: Net earnings for basic and diluted earnings per common share .................................. $47,714 42,816 37,497 ----------------------- Denominator: Weighted average shares for basic net earnings per common share .................................. 38,427 40,780 41,887 Effect of dilutive stock options .................... 693 746 1,014 ----------------------- Adjusted weighted average shares for diluted net earnings per common share ............. 39,120 41,526 42,901 ======================= Basic net earnings per common share ................... $ 1.24 1.05 0.89 ======================= Diluted net earnings per common share ................. $ 1.21 1.03 0.87 =======================
YEAR ENDED DECEMBER 31, 2000 ---------------------------- BEFORE-TAX TAX (EXPENSE) NET-OF-TAX AMOUNT OR BENEFIT AMOUNT ------ ---------- ------ (in thousands)
Net unrealized holding gains on securities: Unrealized holding gains arising during 2000 ........................... $36,272 (12,695) 23,577 Reclassification adjustments for gains realized in net income ................ (5,255) 1,839 (3,416) --------------------------------- Net unrealized holding gains ............ 31,017 (10,856) 20,161 --------------------------------- Other comprehensive income ................ $31,017 (10,856) 20,161 =================================
YEAR ENDED DECEMBER 31, 1999 ---------------------------- BEFORE-TAX TAX (EXPENSE) NET-OF-TAX AMOUNT OR BENEFIT AMOUNT ------ ---------- ------ (in thousands)
Revenue from segments in the other category is attributable to three other operating segments of the Company; an insurance software development and resale segment, a premium finance segment and a property management and leasing segment. These segments have never met the quantitative thresholds for individual presentation as reportable segments.
Intersegment revenues: Standard insurance ...................... 162 120 90 Investment management services .......... 2,884 2,575 2,363 Management and operations services ...... 4,303 1,451 1,060 All other ............................... 1,744 1,676 1,167 -------------------------------- Total intersegment revenues ............... 9,093 5,822 4,680 -------------------------------- Total revenue ............................. 466,531 441,578 403,488 --------------------------------
Reconciling items: Intersegment revenues ................... (9,093) (5,822) (4,680) Corporate revenues ...................... 81 250 326 Net realized gains on investment ........ 5,255 2,555 2,925 -------------------------------- Total consolidated revenues ............... $462,774 440,871 402,059 ================================
Reconciling items: Corporate expenses ......................... (3,085) (1,122) (495) Net realized gains on investment ........... 5,255 2,555 2,925 ------------------------------ Total consolidated income before federal income taxes ............................... $ 61,444 56,985 49,605 ==============================
Reconciling items: Corporate net investment income ............ 81 249 326 Reclassification adjustments in consolidation ............................ 2,895 2,574 2,363 ------------------------------ Total consolidated net investment income ..... $ 38,915 34,262 32,506 ==============================
SEGMENT ASSETS: Standard insurance ......................... $850,080 708,384 641,195 Nonstandard insurance ...................... 48,811 44,670 37,997 Investment management services ............. 6,879 6,367 7,449 All other .................................. 15,543 14,940 15,741 -------- ------- ------- Total segment assets ....................... 921,313 774,361 702,382
Reconciling items: Corporate assets ........................... 1,150 1,223 10,979 Reclassification adjustments in consolidation ............................ (24,357) (15,639) (3,583) -------- ------- ------- Total consolidated assets .................... $898,106 759,945 709,778 ======== ======= ======= STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company)
Revenues from external customers are derived entirely within the United States. Also, all long-lived assets are located within the United States.
(16) CONTINGENCIES The Company's insurance subsidiaries are involved in litigation and may become involved in potential litigation arising in the ordinary course of business. Additionally, the insurance subsidiaries may be impacted by adverse court decisions where insurance coverages are expanded beyond the scope originally contemplated in the policy(ies). In the opinion of management, the effects, if any, of such litigation and published court decisions are not expected to be material to the consolidated financial statements.