Adjusted for 1998 2-for-1 and 1996 3-for-2 common stock split effected in the form of a stock dividend.
State Auto Financial Corporation (“State Auto Financial” or “STFC”) and its 100% owned subsidiaries are collectively referred to as the “Company.” The Company is a member of the State Auto Group (defined below). The State Auto Group writes personal and commercial insurance through approximately 22,500 independent insurance agents associated with approximately 3,250 agencies in 26 states. The State Auto Group operates primarily in the central and eastern United States, excluding New York, New Jersey, and the New England states. State Auto Financial is a majority-owned subsidiary of State Automobile Mutual Insurance Company (“Mutual”), an Ohio domiciled property and casualty insurer and member of the State Auto Group. Mutual is one of only 15 companies in the United States that have received A.M. Best’s A+ or higher rating every year since 1954.
State Auto Financial provides personal and commercial insurance to the standard insurance market through the following 100% owned insurance subsidiaries, collectively referred to as the “STFC Pooled Companies”:
State Auto Financial also provides personal automobile insurance to the nonstandard insurance market through State Auto National Insurance Company (“SA National”), a 100% owned insurance subsidiary. State Auto Financial also provided nonstandard automobile insurance through Mid-Plains Insurance Company (“Mid-Plains”), a 100% owned subsidiary of Farmers. As of December 1, 2004, SA National and Mid-Plains entered into an assumption reinsurance agreement whereby SA National assumed all outstanding insurance claim liabilities of Mid-Plains on this date. Mid-Plains was dissolved on December 29, 2004.
The STFC Pooled Companies participate in a quota share reinsurance pooling arrangement (the “Pooling Arrangement”) with Mutual, SA Wisconsin and SA Florida (collectively the “Mutual Pooled Companies”). The Pooling Arrangement provides that the STFC Pooled Companies and the Mutual Pooled Companies cede to Mutual all of their insurance business and assume from Mutual an amount equal to their respective participation percentages as outlined in the Pooling Arrangement. The participation percentage for the STFC Pooled Companies has remained at 80% since October 1, 2001. The STFC Pooled Companies and Mutual Pooled Companies are collectively referred to as the “Pooled Companies.”
As of July 1, 2004, the Pooling Arrangement was amended to exclude certain middle market business written by Mutual.
Time period is for the year ended December 31, unless otherwise noted.
The following is a summary of significant transactions that occurred during 2002 through 2004 that will assist in the discussion of the Company’s current period financial results:
Losses and loss expenses payable are management’s best estimates at a given point in time of what the Company expects to pay claimants, based on known facts, circumstances and historical trends. Reserves for reported losses are established on either a case-by-case or formula basis depending on the type and circumstances of the loss. The case-by-case reserve amounts are determined by claims adjusters based on the Company’s reserving practices, which take into account the type of risk, the circumstances surrounding each claim and policy provisions relating to types of loss. The formula reserves are based on historical data for similar claims with provision for trend changes caused by inflation. Loss and loss expense reserves for incurred claims that have not yet been reported are estimated based on many variables including historical and statistical information, inflation, legal developments, storm loss estimates, and economic conditions. Case and formula basis loss reserves are reviewed on a regular basis, and as new data becomes available, estimates are updated resulting in adjustments to loss reserves. Generally, reported losses initially reserved on a formula basis and not settled after six months, are case reserved at that time. Although management uses many internal and external resources, as well as multiple established methodologies to calculate reserves, there is no method for determining the exact ultimate liability.
Acquisition costs, consisting of commissions, premium taxes, and certain underwriting expenses relating to the production of property and casualty business, are deferred and amortized ratably over the contract period. The method followed for computing the acquisition costs limits the amount of such deferred costs to their estimated realizable value. In determining estimated realizable value, the computation gives effect to the premium to be earned, losses and loss expenses expected to be incurred, and certain other costs expected to be incurred as premium is earned. These amounts are based on estimates, and accordingly, the actual realizable value may vary from the estimated realizable value.
Fixed maturity and equity security investments are classified as available for sale and carried at fair value. The unrealized holding gains or losses, net of applicable deferred taxes, are shown as a separate component of stockholders’ equity as “accumulated other comprehensive income,” and as such are not included in the determination of net income. Investment income is recognized when earned, and capital gains and losses are recognized when investments are sold.
The Company regularly monitors its investment portfolio for declines in value that are other than temporary, an assessment that requires significant management judgment. Among the factors management considers are the nature of the investment, severity and length of decline in fair value, events impacting the issuer, and overall market conditions. When a security in the Company’s investment portfolio has been determined to have a decline in fair value that is other than temporary, the Company adjusts the cost basis of the security to fair value. This results in a charge to earnings as a realized loss, which is not changed for subsequent recoveries in fair value. Future increases or decreases in fair value, if not other than temporary, are included in other comprehensive income.
See a discussion of other factors that may have an impact on management’s best estimates at “Impact of Significant External Factors” included in this Item 7.
The following table summarizes certain key performance indicators used to manage the operations of the Company for the years ended December 31, 2004, 2003, and 2002, respectively:
The Company’s reportable segments are State Auto standard insurance, State Auto nonstandard insurance, and investment management services. The profits of these segments are monitored by management on an unconsolidated basis and therefore do not reflect adjustments for transactions with other segments or realized gains or losses on sales of investments.
The following table reflects segment profits for the years ended December 31, 2004, 2003, and 2002, respectively:
A necessary discipline of a successful property and casualty insurance company is to produce an underwriting profit. When underwriting is not profitable, premiums are inadequate to pay for insurance losses and related acquisition and operating expenses. When an insurance company operates at an underwriting loss, net investment income may enable an insurance company to produce income. However, if an underwriting loss persists over an extended period of time, the insurance company puts itself at risk as a going concern. The Company has consistently focused on this underwriting objective and therefore views its underwriting results as a critical component of its overall performance.
The Company monitors the profitability of its insurance segments by utilizing certain components of segment profit that are characteristic within the property and casualty insurance industry, namely underwriting profit and combined ratio. Underwriting profit under Statutory Accounting Principles (“SAP”) is determined by subtracting from earned premiums, losses and loss expenses and net underwriting expenses incurred. SAP requires
During each of 2004 and 2003, the Company’s insurance segments attained then record level net underwriting profit while also incurring then record level catastrophe losses. The GAAP Combined Ratio improvements are the direct result of the Company obtaining adequate cost based rates, re-underwriting the former Meridian Mutual business applying State Auto underwriting guidelines along with terminating unprofitable Meridian programs. Management of the Company continues to focus on growing premiums without compromising profitability. The Company’s investment yield has
Net income before federal income taxes for the Company increased $68.3 million (82.0%) to $151.6 million in 2004 from 2003. The most significant factors contributing to this increase were an improvement in the Company’s loss experience from 2003 along with growth in earned premium. The Company’s GAAP loss and LAE ratio reflected a 6.3 point improvement in 2004 from 2003, despite 2004 being the largest catastrophe (in dollars) loss year in the Company’s history. As discussed in more detail below, the Company’s challenge is to grow premiums without compromising profitability as industry-wide price competition appears to be increasing.
The following table summarizes the consolidated earned premiums by segment, by line of business, for the years ended December 31, 2004 and 2003:
As reflected in the table above, earned premiums increased from year to year across almost all lines of business, with the exception of nonstandard auto, commercial multi-peril and workers’ compensation. Overall the composition of the Company’s book of business did not change significantly from year to year, with the standard auto - personal line continuing to be the Company’s most significant line of business.
Net investment income increased $7.2 million (11.1%) to $71.8 million in 2004 from 2003. This growth was the result of an increase in invested assets generated by cash flow provided by operations and financing activities, partly offset by a decline in the investment yield. Between April 1, 2003 and December 31, 2003, the Company issued debt, net of repayments, of $85.5 million. Total cost of invested assets at December 31, 2004 and 2003 was $1,682.8 million and $1,530.1 million, respectively. Invested assets are comprised of total investments and cash equivalents. Reflecting a decline in the interest rate environment, the annualized investment yields based on average invested assets at cost decreased to 4.5% in 2004 from 4.6% in 2003. The Company manages its investment portfolio to maximize after tax profits. With the Company’s improving loss experience throughout 2003, management began allocating a higher proportion of new monies and reinvestments to municipal bonds in the fourth quarter of 2003 which continued throughout 2004. This reallocation is expected to result in lower pre-tax investment yields but higher after tax investment income than if the Company continued with the portfolio allocation of 2003. See further discussion regarding investments at the “Liquidity and Capital Resources,” “Investments” and “Market Risk” sections, included in this Item 7.
Consolidated losses and loss expenses, as a percentage of earned premiums (the “GAAP loss and LAE ratio”), were 61.5% and 67.8% for the years 2004 and 2003, respectively. Losses and loss expenses for a calendar year represents the combined estimated ultimate liability for claims occurring in the current calendar year along with development of claims occurring in prior years. The following table presents the provision for losses and loss expenses for those claims occurring in the current calendar year and prior years, along with the respective impact on the current calendar year GAAP loss and LAE ratio for the years 2004 and 2003, respectively:
The development in the respective calendar year for claims occurring in prior years is well within normal expectations for reserve development and claim settlement uncertainty. See additional discussion in “Other Disclosures”, “Losses and Loss Expenses Payable”, included in this Item 7.
For the years 2004 and 2003, catastrophe claims contributed 7.0 and 6.8 points, respectively, to the consolidated GAAP loss and LAE ratio. During 2004, hurricanes Charley, Frances, Jeanne and Ivan contributed a total of $39.6 million in catastrophe losses, or 3.9 GAAP loss and LAE ratio points. In 2003, high winds, tornadoes, hail, lightning and resulting fires from one numbered catastrophe loss caused damage in 17 of the Company’s 26 operating states (“CAT 88”). Claims resulting from CAT 88 totaled $39.6 million or 4.1 GAAP loss and LAE points for the year 2003. In terms of dollars, CAT 88 remains the largest single catastrophe loss event in State Auto history. As discussed below, each of the Company’s insurance operating segments was impacted by these catastrophe losses. Catastrophe losses discussed herein are as designated by Insurance Services Office’s Property Claim Services (“PCS”) unit, a nationally recognized industry service. PCS defines catastrophes as events resulting in $25.0 million or more in insured losses industry wide and affecting significant numbers of insureds and insurers.
The State Auto standard segment’s GAAP loss and LAE ratio improved 6.3 points in 2004 from 2003, despite being impacted by the record level catastrophe losses described above. For the years 2004 and 2003, catastrophe losses represent 7.5 and 7.3 points of this segment’s GAAP loss and LAE ratios, respectively. Hurricanes Charley, Frances, Jeanne and Ivan accounted for 4.2 points of the 2004 total segment catastrophe loss points and CAT 88 accounted for 4.4 points of the 2003 total catastrophe points. Absent the impact of catastrophe losses in each year, this segment’s GAAP loss and LAE ratio improved 6.4 points in 2004 from 2003.
The QPA obligates the Company to share a portion of the underwriting profit generated by the independent agency’s State Auto book of business. The QPA is paid annually in the year after it is earned. While there is a provision in the QPA that causes the percentage of the profit sharing to vary based on overall written premium, there is no bonus earned in the absence of underwriting profit. Based on improvement in the Company’s underwriting results in 2004 as compared to 2003, the Company increased its expected 2004 QPA accrual as compared to 2003. For the years ended December 31, 2004 and 2003, QPA accounted for 1.9 and 1.6 GAAP expense ratio points, respectively.
Net income before federal income taxes for the Company increased $45.5 million (120.0%) to $83.3 million in 2003 from 2002. The most significant factors contributing to this increase were an improvement in the Company’s loss experience from 2002 along with growth in earned premium. The Company’s GAAP loss and LAE ratio reflected a 5.1 point improvement in 2003 from 2002, despite the largest catastrophe loss event in Company history occurring in May 2003.
Consolidated earned premiums increased $64.0 million (7.1%) to $960.6 million in 2003 from 2002. This increase was primarily the result of premium rate increases across all lines of business (see earned premium table below). The State Auto standard segment contributed a 6.7% increase to consolidated earned premiums in 2003 from 2002, while the State Auto nonstandard segment contributed a 1.2% increase to consolidated earned premiums in the same period. These increases in earned premiums were partly offset by two factors: re-underwriting the Meridian policies migrating on renewal to the State Auto systems platform, as well as the non-renewal of policies due to significant rate increases, execution of underwriting action that the Company believed was necessary to improve the underwriting performance of the Meridian book of business and an increase in premiums ceded to Mutual under the Stop Loss. The Meridian integration also included the migration of Indiana business to affiliate companies outside the Pooled Companies. During the years 2003 and 2002, the STFC Pooled Companies ceded a total of $12.8 million and $1.4 million, respectively, in earned premiums to Mutual in accordance with the Stop Loss arrangement. The effect of the increased premiums ceded reduced consolidated earned premium by 1.2% in 2003 from 2002 (premiums ceded were 1.4% and 0.2% of consolidated earned premium for the years 2003 and 2002, respectively). The Stop Loss ended on December 31, 2003 and was not renewed. See the Stop Loss discussion below regarding loss and loss adjustment expense cession.
the Company continued with the portfolio allocation of 2003. See further discussion regarding investments at the “Liquidity and Capital Resources,” “Investments” and “Market Risk” sections, included in this Item 7.
The following table summarizes the consolidated GAAP loss and LAE ratio by segment, by line of business for the years ended December 31, 2003 and 2002, respectively:
As noted in the above table, all lines of business contributed to the 5.1 point GAAP loss and LAE improvement in 2003 from 2002, except for workers’ compensation and fire and allied lines which combined represent 10% of total earned premiums in 2003. The Company monitors all lines of business paying particular attention to auto - personal, homeowners and workers’ compensation due to the significance these lines have on the profitability of the Company. The auto - personal line continues to be the most significant line of business and therefore has the greatest influence on net income. The homeowners line of business is the Company’s second largest (see earned premium table above). The loss experience in this line was adversely affected in the last two years by the apparent increased severity of storms; however, due to management’s efforts, its GAAP loss and LAE ratio improved by 10.1 points in 2003 from 2002. Workers’ compensation continues to be the Company’s most volatile line of business due to the risks insured.
The effective tax expense rates for the years 2003 and 2002 were 23.6% and 2.1%, respectively. Improvement in the Company’s 2003 underwriting results along with an increase in net realized gains on investments and the gradual shift in increasing the fixed maturity portfolio from tax-exempt to taxable securities from 2002 contributed to the tax expense rate increase.
and cash contributions to the Companies defined benefit pension plan (the “Pension Plan”). Over the last three years, operating cash flows have been sufficient to meet the operating needs of the Company while providing increased opportunities for investment. The Company utilizes reinsurance agreements to limit its loss exposure and contribute to its liquidity and capital resources. See the discussion of Reinsurance Arrangements included in Item 1 of this Form 10-K.
During 2004 and 2003, as permitted by regulations of the Internal Revenue Service, the Company contributed $5.0 million and $4.6 million, respectively, to the Company’s Pension Plan on behalf of its employees. There were no contributions to the Pension Plan in 2002. The contribution to the Pension Plan in 2003 was the first year since 1997 that the Company was permitted to make a tax deductible contribution to the Pension Plan under applicable rules. The actuarially determined funding amount to the pension plan ranges from the minimum amount the Company would be required to contribute to the maximum amount that would be deductible for tax purposes. Contributed amounts in excess of the minimum amounts are deemed voluntary. Amounts in excess of the maximum amount would be subject to an excise tax and may not be deductible for tax purposes. The actuarially determined funding amount to the Pension Plan is generally not determined until the second quarter with respect to the contribution year. The Company expects to contribute approximately $7.5 million during 2005 to the Pension Plan, depending on the actuarially determined funding requirements of the Pension Plan.
Net cash used in investing activities was $130.4 million, $280.2 million and $85.6 million for the 2004, 2003 and 2002 years, respectively. The decreased net investing activities during 2004 was the result of the Company having a smaller amount of cash and cash equivalents available to invest at the beginning of 2004 versus 2003 ($40.0 million in 2004 compared to $96.0 million in 2003), along with a decrease in cash provided by financing activities, as compared to 2003. The 2003 cash used in investing activities reflects the increase in cash flow provided by financing activities discussed below.
In conjunction with a plan approved by State Auto Financial’s Board of Directors in 1999 to repurchase shares of its common stock, State Auto Financial entered into a line of credit agreement with Mutual for $45.5 million. The interest rate is adjustable annually on each January 1 to reflect adjustments in the then current prime lending rate less 1.75 points, as well as State Auto Financial’s current financial position. The interest rate was 2.25%, 2.50% and 3.00% for 2004, 2003, and 2002, respectively. Beginning January 1, 2005, the interest rate on this credit agreement is 3.50%. Principal is due upon demand, with final payment to be received on or prior to December 31, 2005. At December 31, 2004, State Auto Financial had approximately $38.5 million in cash and invested assets to meet its current operating and debt related obligations that include interest expense and principal repayments. While the Company is considering its options with regard to its outstanding debt to Mutual, if it chooses repayment, the funding is anticipated to be derived from State Auto Financial’s current cash and invested assets as well as cash dividend payments in 2005 from its insurance subsidiaries.
On October 1, 2003 State Auto Financial entered into an interest rate swap contract for a notional amount of $25.0 million as a hedge on the ten year treasury rate in connection with the forecasted issuance of the Senior Notes. The swap contract was designated as a cash flow hedge and settled on November 6, 2003, the pricing date of the Senior Notes, with the Company receiving $0.8 million in cash. The gain has been recorded in accumulated other comprehensive income and is being amortized into interest expense as the underlying interest expense is recognized for the Senior Notes.
On March 11, 2004, State Auto Financial terminated its interest rate swap contract entered into on November 6, 2003 and received proceeds of $2.9 million. Of the $2.9 million received, $2.3 million settled future net swap payments and was deferred in notes payable and will be amortized as
an offset to interest expense over the life of the Senior Notes. The remaining $0.6 million related to net swap payments from inception to termination and was recorded as an offset to interest expense.
On May 6, 2004, State Auto Financial entered into an interest rate swap contract for a notional amount of $50.0 million, receiving semiannual payments at a fixed rate of 6.25% and making semiannual payments at a variable rate equal to the six month LIBOR plus 0.94% with LIBOR to be determined the last day of each interest reset period. The swap contract was designated as a fair value hedge to protect against changes in fair value of the Senior Notes. During August 2004, State Auto Financial terminated the interest rate swap contract entered into on May 6, 2004 and received proceeds of $1.8 million. Of the $1.8 million received, $1.5 million settled future net swap payments and was deferred in notes payable and will be amortized as an offset to interest expense over the life of the Senior Notes. The remaining $0.3 million related to net swap payments from inception to termination was recorded as an offset to interest expense.
The statutory leverage ratios for the Company at December 31, 2004, 2003 and 2002 are as follows:
These improvements over the three year periods are due to a combination of the capital contributions made by State Auto Financial (State Auto P&C $39.0 million and SA National $30.0 million) from proceeds of the debt securities issued in 2003, improvement in the results of underwriting operations in 2004 and 2003 as well as effective January 1, 2003, the reserving process for statutory reporting began anticipating salvage and subrogation recoverable for each company. Under GAAP, the reserving process has historically anticipated salvage and subrogation recoverable. The Company believes these leverage ratios at December 31, 2004 indicate the financial strength of the Company and its position to support future premium growth.
On March 4, 2005, the Board of Directors of State Auto Financial declared a quarterly cash dividend of $0.045 per common share, payable on March 31, 2005, to shareholders of record on March 19, 2005. This is the 55th consecutive cash dividend declared by State Auto Financial’s Board since State Auto Financial had its initial public offering of common stock on June 28, 1991. State Auto Financial has increased cash dividends to shareholders for twelve consecutive years.
otherwise payable by State Auto Financial on its common shares, provided that any such revocation shall be effected prior to the declaration of a quarterly dividend by State Auto Financial.
As discussed above, as of January 1, 2005, the Pooling Arrangement was amended to make the Meridian Insurers participants. The pooling participation percentage of the STFC Pooled Companies remained at 80%. In conjunction with this amendment, the STFC Pooled Companies received $54.0 million in cash from the Meridian Insurers which related to the additional net insurance liabilities assumed on January 1, 2005. The following table presents the impact on the Company’s balance sheet on January 1, 2005 relating to the additional net insurance liabilities assumed on this date:
Stateco performs investment management services, which comprises the investment management services segment, on behalf of the Company and Mutual and its subsidiaries. The Investment Committee of each insurer’s Board of Directors sets investment policies to be followed by Stateco.
The primary investment objectives of the Company are to generate income, preserve capital and maintain adequate liquidity for the payment of claims. Fixed maturity securities are categorized as available for sale and are carried at fair value. The Company’s Investment Policy and Guidelines permit investment in debt issues rated A or better by two major rating services. The Company’s fixed maturities portfolio is composed of high quality, investment grade issues, comprised almost entirely of debt issues rated AAA or AA. At December 31, 2004, the Company had no fixed maturity investments rated below investment grade, nor any mortgage loans.
The Company regularly monitors its investment portfolio for declines in value that are other than temporary, an assessment which requires significant management judgment regarding the evidence known. Such judgments could change in the future as more information becomes known which could negatively impact the amounts reported herein. Among the factors that management considers are the nature of the investment, severity
The following table provides detailed information on the Company’s investment portfolio for its gross unrealized gains and losses, adjusted for investments with other than temporary impairment at December 31, 2004:
Expected maturities may differ from contractual maturities as the issuers may have the right to call or prepay the obligations with or without call or prepayment penalties.
Realized gains and losses for the year ended December 31, 2004, are summarized as follows:
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. Related to the Company’s investment portfolio, the Company has no exposure to foreign currency exchange rate risk nor does it rely on the use of derivative financial instruments. To provide the Company greater flexibility in order to manage its market risk exposures, the Company categorizes its fixed maturities as available for sale. The Company does not maintain a trading portfolio.
At December 31, 2004, the Company’s notes payable are summarized as follows:
Related to the Company’s notes payable, the Company’s primary market risk exposure is to the change in interest rates and its credit rating. Based upon the notes payable carrying value at December 31, 2004, the Company has $61.0 million notes payable with variable interest and $103.5 million notes payable with interest fixed at 6.25%, which equates to approximately 37.1% variable interest debt and 62.9% fixed interest debt. The Company’s decision to obtain fixed versus variable interest rate debt is influenced primarily by the following factors: (a) current market interest rates, (b) anticipated future market interest rates, (c) availability of fixed versus variable interest instruments, and (d) its currently existing notes payable fixed and variable interest rate position. As noted above, the Company’s notes payable mature staggered over the next 30 years with $45.5 million due in 2005, $103.5 million in 2013 and $15.5 million in 2033.
The Company’s internal actuarial staff conducts quarterly reviews of projected loss development information to assist management in making estimates of reserves for ultimate losses and loss expenses payable. Several factors are considered in estimating ultimate liabilities including consistency in relative case reserve adequacy, consistency in claims settlement practices, recent legal developments, historical data, actuarial projections, accounting projections, exposure growth, current business conditions, catastrophe developments, and late reported claims. In addition, reasonableness tests are performed on measures of claim severity, loss ratio, and trend factors, all of which are implicit to the liability estimates.
Losses and loss expenses payable is management’s best estimate (“MBE”) at a given point in time of what the Company expects to pay claimants, based on known facts, circumstances and historical trends. Reserves for reported losses are established by the Company’s claim division on either a case-by-case or formula basis depending on the type and circumstances of the loss. The case-by-case reserve amounts are determined based on the Company’s reserving practices, which take into account the type of risk, the circumstances surrounding each claim and policy provisions relating to types of loss. The objective of the claims division is to establish ultimate case reserves that are sufficient, but not excessive. The formula reserves are based on historical data for similar claims with provision for trend changes caused by inflation. Loss and loss expense reserves for incurred claims that have not yet been reported (“IBNR”) are estimated based on many variables including historical and statistical information, inflation, legal developments, storm loss estimates, and economic conditions. Case and formula basis loss reserves are reviewed on a regular basis, and as new data becomes available, estimates are updated resulting in adjustments to loss reserves. Generally, reported losses initially reserved on a formula basis and not settled after six months are case reserved at that time. Although management uses many resources to calculate reserves, there is no method for determining the exact ultimate liability.
The potential impact of loss reserve variability on net income is quantifiable using the range end points and carried reserve amounts listed above. For example, if ultimate losses reach the high point of $703.0 million, the reserve increase of $20.9 million is an after-tax decrease of $13.6 million on net income. Likewise, should losses decline to the low end of $618.0 million, the $64.1 million reserve decrease would add $41.7 million of after-tax net income.
The estimated cumulative impact that this additional, unexpected two percent increase in the loss cost trend would have on our results of operations over the lifetime of the underlying claims in other liability is an increase of $8.2 million on reserves, or a $5.3 million after-tax
The property and casualty industry has had significant loss experience from claims related to asbestos, environmental remediation, product liability, mold and other mass torts. Asbestos reserves are $4.5 million, and environmental reserves are $5.1 million, for a total of $9.6 million, or 1.5% of net reserves. Because the Company has insured primarily product retailers and distributors, not manufacturers, incurred losses have not been significant from asbestos and environmental claims activity.
Included in the table are the estimated payments to be made with respect to the Company’s notes payable and in the settlement of direct loss and ALAE reserves:
(1) The Company’s actuarial department derived expected payment patterns separately for the direct loss and ALAE reserves. These patterns were applied to the December 31, 2004, loss and ALAE payable to generate estimated annual incremental loss and ALAE payments for each subsequent calendar year. These amounts are based on historical payment patterns and do no represent actual contractual obligations. The actual payment amounts and the related timing of those payments could differ significantly from these estimates.
On December 16, 2004, the FASB issued FASB Statement No. 123 (revised 2004), Share-Based Payment, which is a revision of FASB Statement No. 123, Accounting for Stock-Based Compensation. Statement 123(R) supersedes APB Opinion No. 25, Accounting for Stock Issued to Employees, and amends FASB Statement No. 95, Statement of Cash Flows. Generally, the approach in Statement 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro-forma disclosure only will no longer be an alternative. The Statement provides two alternative methods of adoption: the modified prospective transition or the modified retrospective transition. Under the modified prospective method, unvested stock based awards, that were granted prior to adoption, will continue to be accounted for in accordance with Statement 123 except the compensation cost attributable to the unvested portion of the awards must be recognized in the income statement. Awards that are vested will not be recognized in the income statement. Under the modified retrospective method, prior periods are restated by recognizing compensation cost in the amounts previously reported in the pro-forma footnote disclosures under Statement 123. The Company has not elected a transition method. Statement 123(R) must be adopted no later than July 1, 2005.
Inflation can have a significant impact on property and casualty insurers because premium rates are established before the amount of losses and loss expenses are known. When establishing rates, the Company attempts to anticipate increases from inflation subject to the limitations of modeling economic variables. General inflation, as measured by the CPI, has been relatively modest over the last several years; however, price inflation on the goods and services purchased by insurance companies in settling claims has been steadily increasing. In particular, repair costs for homes, autos, and commercial buildings, and medical care costs, have risen disproportionately over the last few years. Costs for building materials typically rise dramatically following substantial natural catastrophes such as the industry experienced in Florida and adjacent states in 2004. The Company continues to adjust its pricing projections as loss cost trends change in order to ensure premiums keep pace with inflation in all lines of business.
The Terrorism Risk Insurance Act of 2002 (the “Terrorism Act”) established a temporary federal program that provides for a system of shared public and private compensation for insured losses resulting from acts of terrorism committed by or on behalf of a foreign interest. In order for a loss to be covered under the Terrorism Act, it must be the result of an event that is certified as an act of terrorism by the U.S. Secretary of Treasury (“subject losses”). In the case of a war declared by Congress, only workers’ compensation losses are covered by the Terrorism Act. The Terrorism Insurance Program (the “Program”) generally requires that all commercial property casualty insurers licensed in the U.S. participate in the Program. The amount of compensation paid to participating insurers under the Program is 90% of subject losses, after an insurer deductible, subject to an annual cap that limits the amount of subject losses to $100 billion aggregate per program year. The Company’s deductible under this federal Program is approximately $63.9 million for 2005, subject to final rules to be established by the U.S. Treasury. Under the Terrorism Act, commercial property and casualty insurers
Company management monitors the changing product distribution channels, along with its changing relationships with agencies and consolidation occurring within the agency distribution system itself. The Company remains committed to cultivating strong relationships with its agencies and to selling insurance products through the independent agency system.
In at least two of the states where the Company does business, the law permits a plaintiff/claimant to bring an action directly against the Company, as opposed to its insured, for “third party bad faith.” This right creates a certain amount of negotiating leverage for plaintiffs in those states that might not otherwise exist and presents an exposure to loss to the Company.
• The Company maintains loss reserves to cover its estimated ultimate unpaid liability for losses and loss expenses with respect to reported and unreported claims incurred as of the end of each accounting period. Reserves do not represent an exact calculation of liability, but instead represent estimates, generally using actuarial projection techniques at a given accounting date. The Company refines reserve estimates in a regular ongoing process as historical loss experience develops and additional claims are reported and settled. The Company records adjustments to reserves in the results of operations for the periods in which the estimates are changed. Because establishing reserves is an inherently uncertain process involving estimates, currently established reserves may not be adequate. If the Company concludes that estimates are incorrect and reserves are inadequate, the Company is obligated to increase its reserves. An increase in reserves results in an increase in losses and a reduction in the Company’s net income for the period in which the deficiency in reserves is identified. Accordingly, an increase in reserves could have a material adverse effect on the Company’s results of operations, liquidity, and financial condition.
• Mutual and the Company have acquired other insurance companies, and it is anticipated that Mutual and the Company will continue to pursue acquisitions of other insurance companies in the future. Acquisitions involve numerous risks and uncertainties, including the following: obtaining necessary regulatory approvals of the acquisition may prove to be more difficult than anticipated; integrating the acquired business may prove to be more costly or difficult than anticipated; integrating the acquired business without material disruption to existing operations may prove to be more difficult than anticipated; anticipated cost savings may not be fully realized (or not realized within the anticipated time frame) or additional or unexpected costs may be incurred; loss results of the Company acquired may be worse than expected; and retaining key employees of the acquired business may prove to be more difficult than anticipated. In addition, other companies in the insurance industry have similar acquisition strategies. There can be no assurance that any future acquisitions will be successfully integrated into the Company’s operations, that competition for acquisitions will not intensify or that the Company will be able to complete such acquisitions on acceptable terms and conditions. In addition, the costs of unsuccessful acquisition efforts may adversely affect the Company’s financial performance.
• The Company’s operations are subject to changes occurring in the legislative, regulatory and judicial environment. 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 Company, its affiliates, or the insurance industry generally; and judicial decisions affecting claims, policy coverages and the general costs of doing business. Many of these changes are beyond the Company’s control.
• The Company is subject to numerous other factors which affect its operations, including, without limitation, the development of new insurance products, geographic spread of risk, 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, and shortages of technical and professional employees and unexpected challenges to the control of the Company by Mutual.
We have audited the accompanying consolidated balance sheets of State Auto Financial Corporation and subsidiaries as of December 31, 2004 and 2003, and the related consolidated statements of income, changes in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2004. Our audits also included the financial statement schedules listed in the Index at Item 15(a)(2). These financial statements and schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedules based on our audits.
In our opinion, management’s assessment that State Auto Financial Corporation maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, State Auto Financial Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on the COSO criteria.
• State Auto Property and Casualty Insurance Company (State Auto P&C), a South Carolina corporation
• State Auto National Insurance Company (SA National), an Ohio corporation
Mid-Plains Insurance Company (Mid-Plains), an Iowa corporation, a wholly-owned subsidiary of Farmers, was dissolved effective December 29, 2004. Its results of operations are included in these consolidated financial statements up through the date of dissolution and through December 31, 2004, by virtue of an assumption reinsurance agreement with SA National.
The Company, through State Auto P&C, Milbank, Farmers and SA Ohio, provides standard personal and commercial insurance to its policyholders. The Company’s principal lines of business include personal and commercial automobile, homeowners, commercial multi-peril, workers’ compensation, general liability and fire insurance. SA National provides nonstandard automobile insurance. State Auto P&C, Milbank, Farmers, SA Ohio, and SA National operate primarily in the central and eastern United States, excluding New York, New Jersey, and the New England states, through an independent insurance agency system. State Auto P&C, Milbank, Farmers, SA Ohio, and SA National are chartered and licensed as property and casualty insurers in the states of South Carolina, South Dakota, Iowa, and Ohio (SA Ohio and SA National), respectively, and are licensed in various other states. As such, they are subject to the regulations of the applicable Departments of Insurance of their respective states of domicile (the Departments) and the regulations of each state in which they operate. These property and casualty insurance companies undergo periodic financial examination by the Departments and insurance regulatory agencies of the states that choose to participate. A large portion of the Company’s revenues are derived from a reinsurance pooling agreement with Mutual. The nature of the underlying policies and geographical distribution of underwriting activity is similar to the Company.
518 PML, an Ohio limited liability company, was formed to engage in the business of owning and leasing real and personal property to the Company’s affiliates.
Material estimates that are particularly susceptible to significant change in the near term relate to the determination of losses and loss expenses payable. In connection with the determination of this estimate, management uses historical data and current business conditions and assumptions about future conditions to formulate estimates of the ultimate cost to settle claims. These estimates by their nature are subject to
Certain items in the prior period consolidated financial statements have been reclassified to conform to the 2004 presentation.
At December 31, 2004 and 2003, all investments in fixed maturity and equity securities were classified as available for sale and therefore are carried at fair value. Other invested assets are comprised of limited liability partnership and other investments that are carried at fair value. The unrealized holding gains or losses, net of applicable deferred taxes, are shown as a separate component of stockholders’ equity as “accumulated other comprehensive income” and as such are not included in the determination of net income. Gains and losses on the sale of investments are computed using the first-in, first-out method.
The Company regularly monitors its investments that have fair value less than the carrying amount for signs of other than temporary impairment. Among the factors that management considers are market conditions, the amount, timing and length of decline in fair value, and events impacting the issuer. When other than temporary impairment is recognized, the investment cost is written down to fair value of the date the determination is made and a realized loss is recorded. The cost is not adjusted for any subsequent recovery in fair value.
Acquisition costs, consisting of commissions, premium taxes, and certain underwriting expenses that relate to and vary with the production of property and casualty business, are deferred and amortized ratably over the contract period. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value. In determining estimated realizable value, the computation gives effect to the premium to be earned, losses and loss expenses to be incurred, and certain other costs expected to be incurred as premium is earned, without credit for anticipated investment income. These amounts are based on estimates and accordingly, the actual realizable value may vary from the estimated realizable value. Net deferred policy acquisition costs for the year ended December 31, are:
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 $27.2 million and $26.8 million at December 31, 2004 and 2003, 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. As such, losses and loss expenses payable represent management’s best estimate of the ultimate liability related to reported and unreported claims.
At the time a derivative contract is entered into, the Company formally documents and designates the derivative as either a hedge of the fair value of a recognized asset or liability (fair value hedge) or a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge). The Company does not have any derivative contracts hedging foreign currencies or derivative contracts held for speculative purposes. The Company formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives used for hedging transactions are highly effective in offsetting changes in fair values or cash flows of hedged items. When it is determined that a derivative is not highly effective as a hedge or that it has ceased to be a highly effective hedge, the Company discontinues hedge accounting prospectively.
Changes in fair value of derivatives designated as cash flow hedges, to the extent effective, are recorded in net unrealized gains/losses on derivatives, a separate component of accumulated other comprehensive income. Amounts are reclassified to earnings from accumulated other comprehensive income when the underlying hedged item impacts earnings. Changes in fair value of derivatives designated as fair value hedges are recorded currently in earnings to the extent the derivative was effective in offsetting changes in fair value of the hedged item. The Company classifies in the statement of cash flows amounts received from derivative contracts that are accounted for as hedges of identifiable transactions in the same category as the cash flows from the items being hedged.
Comprehensive income is defined as all changes in an enterprise’s equity during a period other than those resulting from investments by owners and distributions to owners. Comprehensive income includes net income and other comprehensive income. Other comprehensive income includes all other non-owner related changes to equity and represents net unrealized gains and losses on available for sale fixed maturities, equity securities, other invested assets, and derivative instruments.
The Company follows Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) and related Interpretations in accounting for its employee stock incentive plans using the intrinsic value method to account for stock-based compensation. Had compensation cost for the Company’s plans been determined based on the fair values at the grant dates consistent with the method of SFAS No. 123, Accounting for Stock-Based Compensation (“SFAS No. 123”), the Company’s pro-forma net earnings and net earnings per share information would have been as follows:
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
The cost or amortized cost and fair value of the Company’s investments are summarized as follows:
At December 31, 2004 and 2003, there were no investments reflected in the tables below with an unrealized holding loss that had a fair value significantly below cost continually for more than one year. There are no individually material securities with an unrealized holding loss at December 31, 2004 and 2003. The following tables show the Company’s investments gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at December 31, 2004 and 2003:
Fixed maturities with fair values of approximately $52.3 million and $49.4 million were on deposit with regulators as required by law or specific escrow agreement at December 31, 2004 and 2003, respectively.
fees. Based on terms of the agreement, the Company does not have the right to sell or re-pledge the collateral, unless there is an event of default by the borrower. At December 31, 2004 and 2003, the amount of collateral held was approximately, $144.7 million and $193.2 million, respectively.
Investment securities: Fair values for investments in fixed maturities are based on quoted market prices, where available. For fixed maturities not actively traded, fair values are estimated using values obtained from independent pricing services. The fair values for equity securities are based on quoted market prices. The fair value of other invested assets is based on equity or cash flow, as applicable. The investment securities fair value adjustments are recorded in the consolidated financial statements.
Activity in the liability for losses and loss expenses for the year ended December 31, are summarized as follows:
The decrease of $22.2 million and $1.8 million in 2004 and 2003, respectively, and the increase of $12.4 million in 2002, for claims occurring in prior years are well within normal expectations for reserve development and claim settlement uncertainty.
In the ordinary course of business, the Company assumes and cedes reinsurance with other insurers and reinsurers and is a member in various pools and associations. See Note 6a 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 6a, the effect of the Company’s external reinsurance on its balance sheets and income statements, are summarized as follows:
The Pooling Arrangement does not relieve each individual pooled subsidiary of its primary liability as the originating insurer; consequently, there is a concentration of credit risk arising from business ceded to Mutual. As the Pooling Arrangement provides for the right of offset, the Company has reported losses and loss expenses payable and prepaid reinsurance premiums to Mutual as assets only in situations when net amounts ceded to Mutual exceed that assumed. The STFC Pooled Companies’ participation percentage was 80% for the years 2004, 2003, and 2002. All parties that participate in the Pooling Arrangement have an A.M. Best rating of A+ (Superior).
Effective January 1, 2005, the Pooling Arrangement was amended to add as participants Meridian Security Insurance Company (Meridian Security) and Meridian Citizens Mutual Insurance Company (Meridian Citizens), Indiana domiciled property and casualty insurers together, referred to as the “Meridian Insurers”. Meridian Security is a wholly-owned subsidiary of Meridian Insurance Group, Inc. (“MIGI”), which is wholly-owned by Mutual. MIGI is party to an affiliation agreement with Meridian Citizens. The STFC Pooled Companies pooling participation percentage remains at 80%. In conjunction with the Pooling Arrangement Amendment, the STFC Pooled Companies received $54.0 million in cash in 2005 from the Meridian Insurers which related to the additional net insurance liabilities assumed on January 1, 2005.
State Auto P&C assumes catastrophe reinsurance from the State Auto Group in the amount of $100.0 million excess of $120.0 million in exchange for a premium paid by each reinsured company. Under this agreement, the Company has assumed from Mutual and its affiliates premiums written and earned of $2.7 million, $2.8 million, and $2.9 million for 2004, 2003, and 2002, respectively. There have been no losses assumed under this agreement. The catastrophe reinsurance program with State Auto P&C has been excluded from the Pooling Arrangement.
The Subordinated Debentures are unsecured and subordinated to all of the Company’s existing and future senior indebtedness. As sponsor of the Capital Trust, State Auto Financial incurred security issuance costs related to the Trust Preferred Capital Securities and Subordinated Debentures of $0.5 million, which is recorded in other assets and is being amortized into interest expense ($18,000 and $13,000 for 2004 and 2003, respectively) as the underlying interest expense is recognized on the Trust Securities.
State Auto P&C provides management and operation services to certain of Mutual’s insurance affiliates for a fee. Revenue relating to these services amounted to $1.0 million, $1.1 million, and $0.6 million in 2004, 2003, and 2002, respectively, and is included in other income (affiliates).
State Auto P&C’s December 31, 1990 liability for losses and loss expenses of $65.5 million 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, 2004, there has been no adverse development of the liability.
On October 1, 2003, State Auto Financial entered into an interest rate swap contract for a notional amount of $25.0 million as a hedge on the ten year treasury rate in connection with the forecasted issuance of the Senior Notes. The swap contract was designated as a cash flow hedge and settled on November 6, 2003, the pricing date of the Senior Notes, with the Company receiving $0.8 million. The gain has been recorded in accumulated other comprehensive income and is being amortized as an offset to interest expense ($62,000 and $7,000 in 2004 and 2003, respectively) as the underlying interest expense is recognized for the Senior Notes.
On December 21, 2003, State Auto Financial repaid the $15.0 million term loan note to the bank that it entered into on December 21, 2002. Interest adjusted quarterly and accrued at LIBOR plus 0.75 points (2.15% at December 31, 2002) and was payable quarterly. This note agreement had various covenants including financial ratio covenants.
Federal income taxes paid during 2004, 2003, and 2002 were $37.2 million, $15.9 million, and $6.0 million, respectively.
On December 8, 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”) was signed into law. The Act expanded Medicare to include, for the first time, coverage for prescription drugs. In May of 2004, the FASB issued FASB Staff Position 106-2 (“FSP 106-2”), Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003. FSP 106-2 provides guidance on accounting for the effects of the Act for employers that sponsor postretirement health care plans that provide drug benefits. The accrued postretirement benefit obligation or net periodic postretirement costs do not reflect any amount associated with the subsidy at December 31, 2004, as the Company has not concluded whether the benefits provided by its plan are “actuarially equivalent” to Medicare Part D under the Act.
The Company had no additional minimum liability included in other comprehensive income for the pension and postretirement plans for 2004, 2003 and 2002.
The Plan’s investment policy objective is to preserve the investment principal while generating income and appreciation in fair value to meet the Plans’ obligations. The Plans’ investment strategy and risk tolerance is balanced between meeting cash obligation requirements and a long term relatively high risk tolerance. Since the nature and timing of the Plans’ liabilities and cash requirements are predictable, the liquidity requirements are somewhat moderate. Therefore at least 75% of the Plans’ assets should be in public marketable securities. Bond investments will normally range from 10 to 20 years in maturity. Debt instruments, convertible debt and preferred stock are rated “A” or better by two major rating services. The equity portfolio is comprised primarily of large capitalization, high quality stocks with a strong earnings growth and dividends payment history. Total holding of a specific stock cannot exceed 2% of the outstanding stock. No one equity holding can be greater than 5% of the total equity portfolio. Total holdings of bonds and stocks of any one corporation cannot exceed 5% of admitted assets.
The following table summarizes the Plans’ permitted asset allocation exposure range as a percent of total assets’ fair market value:
Also, the Company has a supplemental executive retirement plan (“SERP”) for which the accrued obligation at December 31, 2004 and 2003 was $4.1 million, for both years, that is included in the balance sheet postretirement benefit liabilities amount.
The Company maintains a defined contribution plan that covers substantially all employees of the Company. The Company matches the first 2% of contributions of participants’ salary at the rate of 75 cents for each dollar contributed. Participant contributions of 3% to 6% are matched at a rate of 50 cents for each dollar contributed. The Company’s share of the expense under the plan totaled $2.2 million, $2.1 million, and $2.0 million for the years 2004, 2003, and 2002, respectively.
State Auto P&C, Milbank, Farmers, SA Ohio and SA National are subject to regulations and restrictions under which payment of dividends from statutory earned surplus can be made to State Auto Financial during the year without prior approval of regulatory authorities. Pursuant to these rules, approximately $94.6 million is available for payment to State Auto Financial in 2005 without prior approval.
The Company has an employee stock purchase plan with a dividend reinvestment feature, under which employees of the Company may choose at two different specified time intervals each year to have up to 6% of their annual base earnings withheld to purchase the Company’s common stock. The purchase price of the stock is 85% of the lower of its beginning-of-interval or end-of-interval market price. The Company has reserved 2.4 million shares of common stock under this plan. At December 31, 2004 and 2003, 2.1 million and 2.0 million shares, respectively, have been purchased under this plan.
A summary of information pertaining to the total options outstanding and exercisable as of December 31, 2004 follows:
At December 31, 2004, the Company has three reportable segments: State Auto standard insurance, State Auto nonstandard insurance, and investment management services. The reportable segments are business units managed separately because of the differences in products or service they offer, type of customer they serve or because of management considerations. The State Auto standard and State Auto nonstandard segments operate primarily in the central and eastern United States, excluding New York, New Jersey, and the New England states, distributing products through the independent insurance agency system.
The investment management services segment manages the investment portfolios of affiliated insurance companies.
Revenue from segments in the other category is attributable to three other operating segments of the Company, which individually are not material: management and operations services segment, an insurance software development and resale segment, and a property management and leasing segment.
Effective January 1, 2005, the pooling arrangement was amended to make the Meridian Insurers participants. The STFC Pooled Companies’ pooling participation percentages remain at 80%. In conjunction with this amendment, the STFC Pooled Companies received $54.0 million in cash from the Meridian Insurers, which related to the additional net insurance liabilities assumed on January 1, 2005. The following table presents the impact on the Company’s balance sheet relating to the additional net insurance liabilities assumed on this date.