Our claims' handling has become more specialized with the addition of dedicated large and small property claim handlers and the formation of a catastrophe claim team, lessening our dependency on independent adjusters. We’re also continuing our efforts to change our geographic footprint.
In the business insurance segment, we completed the roll out of Business Insurance Evolution (“BIE”), which allows us to streamline the processing of policies, enabling us to shift our underwriting focus from smaller commercial accounts to larger accounts. The pricing and policy issuance efficiencies that have resulted from BIE, will help support our ability to achieve our price targets for standard business insurance in 2014.
more effectively and improve service levels. We are seeing improved loss ratios as a result of both price increases and improvements in our claims processing capabilities.
Over the next several years, we will replace all of our policy administration and billing systems for both personal and business insurance. The work will begin in 2014 with our billing systems and the upgrading of our agency portal. Work is also underway on a new specialty platform for our Excess & Surplus and Programs business units.
We also consider the following factors when assessing our fixed maturity investments for OTTI: (1) the financial condition of the issuer including receipt of scheduled principal and interest cash flows; (2) our intent to sell; and (3) if it is more likely than not that we will be required to sell the investments before recovery. When a fixed maturity has been determined to have an other-than-temporary impairment, the impairment charge is separated into an amount representing the credit loss, which is recognized in earnings as a realized loss, and the amount related to non-credit factors, which is recognized in other comprehensive income (loss). Future increases or decreases in fair value, if not other-than-temporary, are included in other comprehensive income (loss).
Expected Loss Ratio Method: The Expected Loss Ratio Method generates indicated IBNR by multiplying an expected loss ratio by earned premiums, then subtracting incurred-to-date losses. For slower reporting lines of business, new products, or data that is very immature, the actual claim data is often too limited or too volatile for other projection methods. With this method the premiums are used as a measure of loss exposure, and the loss ratios can be derived from pricing expectations.
Reserve ranges provide a quantification of the variability in the loss reserve projections. The primary determinant in estimating the loss reserve range boundaries are the variances measured within the historical reserving data for the various lines of business. MBE of loss reserves considers the expected variation to establish an appropriate position within a range. MBE loss and ALAE reserves for the STFC Pooled Companies’ share of the Pooled Companies’ reserves at December 31, 2013, was $960.1 million, within an estimated range of $820.0 million to $984.9 million (dollar amounts presented are on a direct basis, gross of salvage and subrogation recoverable, and before reinsurance, except for the STFC Pooled Companies’ participation in the inter-company Pooling Arrangement; therefore, these values cannot be compared to other loss and loss expenses payable tables included elsewhere within this Form 10-K.)
The potential impact of the loss reserve variability on net income can be illustrated using the range end points and carried reserve amounts listed above. For example, if ultimate losses reach a level corresponding to the high point of the range, $984.9 million, the reserve increase of $24.8 million corresponds to an after-tax decrease of $16.1 million in net income, assuming a tax rate of 35%. Likewise, should ultimate losses decline to a level corresponding to the low point of the range, $820.0 million, the $140.1 million reserve decrease would add $91.1 million of after-tax net income. The loss reserve range noted above represents a range of reasonably likely reserves, not a range of all possible reserves. Therefore, the ultimate losses could reach levels corresponding to reserve amounts outside the range provided.
An important assumption underlying the loss reserve estimation methods for the major casualty lines is that the loss cost trends implicitly built into the loss and ALAE patterns will continue into the future. To estimate the sensitivity of reserves to an unexpected change in inflation, projected calendar year payment patterns were applied to the December 31, 2013, other & product liability loss and ALAE reserve to generate estimated annual incremental loss and ALAE payments for each subsequent calendar year. Then, for purposes of sensitivity testing, an additional annual loss cost trend of 10% was added to the trend implicitly embedded in the estimated payment pattern, and revised incremental loss and ALAE payments were calculated. This type of inflationary increase could arise from a variety of sources including tort law changes, development of new medical procedures, social inflation, and other inflationary changes in costs beyond assumed levels.
The estimated cumulative impact that this additional, unexpected 10% increase in the loss cost trend would have on our results of operations over the lifetime of the underlying claims in other & product liability is an increase of $81.1 million on reserves, or a $52.7 million reduction to net income, assuming a tax rate of 35%. Inflation changes have much more impact on the longer tail commercial lines like other & product liability and workers’ compensation, and much less impact on the shorter tail personal lines’ reserves.
The following tables set forth the loss and loss expenses payable by major line of business at December 31, 2013 and 2012:
See discussion in “Results of Operations-Loss and LAE” section included in this Item 7.
To calculate the State Auto Group’s December 31, 2013 benefit obligation for each of the benefit plans, we used a discount rate of 4.85% based on an evaluation of the expected future benefit cash flows of our benefit plans used in conjunction with the Citigroup Pension Discount Curve at the measurement date. A lower discount rate results in, all else being equal, a higher present value of the benefit obligation. To calculate our benefit obligation at December 31, 2013 and net periodic benefit cost for the year ended December 31, 2014, a discount rate of 4.85% and an expected long-term rate of return on plan assets of 7.00% were used.
We selected an expected long-term rate of return on our plan assets by considering the mix of investments and stability of investment portfolio along with actual investment experience during the lifetime of the plans. Our assumptions regarding the discount rate and expected return on plan assets could have a significant effect on the amounts related to our benefit obligations and net periodic benefit cost depending on the degree of change between reporting periods.
The following table sets forth an illustration of variability with respect to the discount rate on our share of the State Auto Group’s December 31, 2013 benefit obligation and expected net periodic benefit cost for the year ending December 31, 2014, along with the variability of the expected return on plan assets to our expected net periodic benefit cost for the year ending December 31, 2014. Holding all other assumptions constant, sensitivity to changes in any one of our key assumptions are as follows:
The accumulated benefit obligation (“ABO”) of a defined benefit pension plan represents the actuarial present value of benefits attributed by the pension benefit formula to employee service rendered prior to the measurement date and based on current and past compensation levels, while the projected benefit obligation (“PBO”) is the ABO plus a factor for future compensation levels. The ABO, which considers current compensation levels only, provides information about the obligation an employer would have if the plan were discontinued at the measurement date. At December 31, 2013, our share of the State Auto Group’s ABO and PBO was $211.2 million and $230.5 million, respectively. At December 31, 2013, STFC’s share of the defined benefit pension plan’s fair value of the assets was $185.9 million, which resulted in an underfunded status within our balance sheet of $44.6 million. On a cash flow basis, we target an annual contribution level that meets at least the targeted normal cost plus any shortfall amortizations of the plan, as defined by ERISA. Currently, we expect to make a cash contribution to the pension plan up to $13.0 million in 2014.
The unfunded status on the pension plan and supplemental executive retirement plan decreased from $89.7 million at December 31, 2012, to $50.6 million at December 31, 2013. Primarily influencing this decrease are actuarial gains and losses arising from factors that include an increase in the discount rate and expected to actual demographic changes, such as retirement age, mortality, turnover, rate of compensation changes. In addition, we experienced greater returns on our plan assets.
Deferred income tax assets and liabilities represent the tax effect of the differences between the financial statement carrying value of existing assets and liabilities and their respective tax bases. In accordance with the Financial Accounting Standards Board’s Accounting Standards Codification 740, Income Taxes (ASC 740), we periodically evaluate our deferred tax assets, which requires significant judgment, to determine if they are realizable based upon weighing all available evidence, both positive and negative, including our historical and anticipated future taxable income. In making such judgments, significant weight is given to evidence that can be objectively verified.
During 2011, we experienced a net loss driven by the magnitude of record level catastrophe storm losses in the second quarter which significantly exceeded our projections. We considered both positive and negative evidence and concluded a valuation allowance should be established. At December 31, 2013 and 2012, we recorded a valuation allowance of $82.6 million and $100.5 million, respectively. The deferred income tax asset remaining after recognition of the valuation allowance represents a deferred tax asset on the gross unrealized fixed maturity losses where we have concluded this portion of the asset to be realizable due to our assertion that we have both the ability and intent to hold these securities through recovery or maturity.
The following table sets forth the components of our federal income tax expense for the years ended December 31, 2013 and 2012:
Based on ASC 740 intraperiod tax allocation guidelines, the following sets forth the change in valuation allowance attributable to continuing operations and other comprehensive income for the years ended December 31, 2013 and 2012:
Our 2013 net income was $60.8 million compared to net income of $10.7 million in 2012 and a net loss of $160.7 million in 2011. Our 2011 net loss included a non-cash charge of $103.3 million related to a valuation allowance against our net deferred tax asset.
Our 2013 revenues were $1,153.0 million compared to revenues of $1,150.1 million in 2012 and $1,553.7 million in 2011. Our 2013 expenses were $1,091.7 million compared to expenses of $1,139.5 million in 2012 and $1,665.8 million in 2011. The decline in revenues from 2011 to 2012 is attributed to the HO QS Arrangement (discussed below) and the 12.31.11 pool change (discussed above).
The following highlights significant factors that impacted 2013 results as compared to 2012 and 2011:
The 2013 results reflected a significant decrease in weather-related catastrophe losses when compared to the same 2012 and 2011 results. The 2013 catastrophe loss ratio was 3.4% compared to 6.4% and 16.2% for 2012 and 2011, respectively. The HO QS Arrangement benefited the catastrophe loss ratio by 1.4 points and 3.2 points, respectively, in 2013 and 2012 by ceding catastrophe losses to our reinsurance partners. The 2011 results of our personal and business insurance segments reflected a record level of weather-related catastrophe losses, which impacted 32 of our operating states, including Hurricane Irene and devastating tornadoes in Tuscaloosa, Alabama and Joplin, Missouri.
For the year ended December 31, 2012, the following table sets forth the reconciliation of as reported earned premiums to pro forma earned premiums that exclude the impact of the quota share reinsurance agreement covering our homeowners book of business. For the year ended December 31, 2011, the following table sets forth the reconciliation on a pro forma basis which assumes that the 12.31.11 pool change from 80% to 65% was in effect as of January 1, 2011.
the vesting period. See “Critical Accounting Policies - Pension and Postretirement Benefit Obligations section included in Item 7 of our 2012 Form 10-K.
In the following discussion of the results of our insurance segments, we sometimes refer to GAAP financial measures in the context of “as reported” and to non-GAAP financial measures in the context of “pro forma.” These pro forma, or non-GAAP financial measures, may (i) exclude the impact of the HO QS Arrangement cession for the years ended December 31, 2013 and 2012, (ii) exclude the impact of the unearned premium transfer associated with the termination of the umbrella quota share reinsurance agreement for the year ended December 31, 2012, (iii) exclude the one-time impact of the 1.1.11 pool change for the year ended December 31, 2011, (iv) assumes the 12.31.11 pool change from an 80% to 65% participation percentage had been in effect as of January 1, 2011, and (v) exclude the impact of program business written through our former RED unit, which is in run-off. We believe the use of these non-GAAP financial measures will enable investors to (a) better understand the impact of the reinsurance arrangement cession on our reported results for the years ended December 31, 2013 and 2012, and (b) perform a meaningful comparison of our results of operations for the years ended December 31, 2013, 2012 and 2011. We have also included Reconciliation Tables 1-9 and Tables 1-6 for readers to better understand the use and calculation of these non-GAAP financial measures.
See additional pro forma reconciliation tables for the HO QS Arrangement cession on our personal insurance segment’s SAP underwriting results at Reconciliation Table 5 and our homeowners’ line of business at Reconciliation Table 6.
The following table sets forth certain key performance indicators for our insurance segments for the years ended December 31, 2013, 2012 and 2011:
The following table sets forth the SAP loss and ALAE ratios by major product line of business for our personal insurance segment with the catastrophe and non-catastrophe impact shown separately for the years ended December 31, 2013, 2012 and 2011:
The as reported homeowners SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2013 was 37.4% compared to 38.9% in 2012 and 51.0% in 2011 (Table 2). The pro forma homeowners SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2013 improved 4.2 points when compared to the same 2012 period (Reconciliation Tables 6 and 7). The SAP non-catastrophe loss and ALAE ratio improved as a result of prior year rate actions emerging in earned premiums and the actions discussed below.
In addition to rate increases, we continue to utilize the following additional strategies to improve our homeowners results.
Insurance to value: We continue to focus on insurance to value so that our insureds maintain an amount of coverage sufficient to replace their home and contents in the case of a total loss. Proper insurance to value ensures that our premiums are commensurate with our loss exposure. During 2013, we integrated our insurance to value review with our underwriting workflow. We deployed a model that allows us to identify homeowner risks that have a high probability of having insurance to value gaps. This model allows us to optimize our insurance to value reports, which has led to additional cost savings.
The personal insurance segment's SAP catastrophe loss and ALAE ratio for 2013 was 3.0 loss ratio points compared to 5.7 loss ratio points and 22.3 loss ratio points for 2012 and 2011, respectively (Table 2). Cessions under the HO QS Arrangement reduced the homeowners catastrophe losses by $22.7 million and $49.5 million in 2013 and 2012, respectively (see Reconciliation Tables 6 and 7). In 2013, catastrophe losses without the HO QS cession were $29.5 million. The SAP catastrophe loss and ALAE ratio improved based on underwriting actions, rate increases and a return to better weather patterns when compared to 2012 and 2011, and as a result of the actions discussed above. In 2012, catastrophe losses without the HO QS cession were $58.0 million. The majority of the 2012 catastrophe losses were primarily related to a tornado, wind and hail activity in Louisville, Kentucky, and St. Louis, Missouri and wind activity from a storm in the Midwest and Mid-Atlantic states. In 2011, our catastrophe losses included losses arising from Hurricane Irene and the tornadoes in Tuscaloosa, Alabama and Joplin, Missouri, as well as other tornadoes and wind and hail storms. A majority of the losses generated from these catastrophes were concentrated in six states: Tennessee, Ohio, Missouri, Texas, North Carolina and Alabama. The severity of these storm losses was the highest in our history.
The following table sets forth the net written premiums by major product line of business for our business insurance segment for the years ended December 31, 2013 and 2012 and on a pro forma basis for the year ended December 31, 2011 (see Reconciliation Table 5).
The following table sets forth the SAP loss and ALAE ratios by major product line of business for our business insurance segment with the catastrophe and non-catastrophe impact shown separately for the years ended December 31, 2013, 2012 and 2011:
As reported net written premiums for the business insurance segment for the years ended December 31, 2013 and 2012 increased 7.3% and 2.3%, respectively, compared to the same 2012 and 2011 periods (Reconciliation Table 5). As reported business insurance segment net written premiums for the year ended December 31, 2012 increased by 14.0% compared to pro forma net written premiums for the same 2011 period (Reconciliation Table 5). Net written premiums for the year ended December 31, 2012 reflected the impact of the termination of an umbrella quota share reinsurance agreement, effective July 1, 2012, and included $7.2 million related to the transfer of unearned premium remaining under the agreement. For the year ended December 31, 2011, $13.5 million was ceded under the umbrella treaty. Excluding the impact of the termination of this umbrella quota share reinsurance agreement, pro forma net written premiums increased 7.2%(2) and 9.3%(2), respectively, for the years ended December 31, 2013 and 2012. The increase in premiums was primarily due to (i) writing larger average premium new business accounts, (ii) achieving price increases in the high single digits, and (iii) experiencing more growth on existing polices due to improved economic conditions.
For the years ended December 31, 2013, 2012 and 2011 respectively, the following table sets forth the reconciliation of as reported net written premiums to pro forma net written premiums that exclude the impact of the ceded written premium and unearned premium associated with the termination of the umbrella quota share reinsurance agreement:
We believe our small business accounts are a foundational element of our premium writings and will continue as an important part of our future business plans. Improved efficiency and reduced processing expenses will be critical to our success in managing this portfolio. We believe Business Insurance Evolution ("BIE") is an important tool providing automated predictive price models and rules engines as part of our new business and policy renewal process on our smaller accounts. BIE will allow this process to move from being high touch processing (i.e. very manual), to low or in many instances no touch processing. We completed the roll out of BIE during the fourth quarter of 2013. Pricing and policy issuance efficiencies resulting from BIE have met our expectations and we believe that this will lead to further improvements in our combined ratio. In addition to the financial benefits, we believe the implementation of BIE will result in higher agent satisfaction.
During 2013, BIE allowed us to shift our underwriting focus from smaller commercial accounts to larger accounts with premiums in excess of $25,000. Through December 31, 2013 our efforts have resulted in increased policy counts in the $25,000-$100,000 premium range and we have seen renewal price increases in accounts with premiums in excess of $100,000.
The business insurance segment’s SAP non-catastrophe loss and ALAE ratio for the year ended December 31, 2013 was 50.0% compared to 50.7% and 58.1%, respectively for the same 2012 and 2011 periods (Table 4). The improvement has been primarily driven by prior period rate increases taken on all lines of business in this segment. The commercial auto and other & product liability SAP non-catastrophe loss and ALAE ratios improved 6.2 points and 4.5 points, respectively, compared to the same 2012 period (Table 4) primarily driven by an increase in earned premiums and greater favorable development of prior accident year losses. The improvement was partially offset by an increase in the fire & allied SAP non-catastrophe loss and ALAE ratio of 6.5 points, compared to the same 2012 period (Table 4) primarily driven by an increase in the severity of losses. The decrease from 2011 to 2012 was primarily due to fewer large losses in our fire and allied and other & product liability lines.
The business insurance segment’s SAP catastrophe loss and ALAE ratio for 2013 was 5.7% compared to 11.5% and 13.6%, respectively, for the same 2012 and 2011 periods (Table 4). The fire & allied lines catastrophe loss and ALAE ratio improved to 11.1% in 2013 compared to 31.9% and 28.5%, respectively, for the same 2012 and 2011 periods (Table 4). The decrease from 2012 to 2013 was primarily due to a decrease in the frequency and severity of storm activity.
The following table sets forth the SAP loss and LAE ratios for our specialty insurance segment with the catastrophe and non-catastrophe impact shown separately for the years ended December 31, 2013, 2012 and 2011:
Net written premiums for the Excess & Surplus property unit for the year ended December 31, 2013 increased 36.6%, compared to the same 2012 period (Table 5) due to increased new business growth, rate increases, premium from a rollover book of business through one of our distribution partners and a favorable property catastrophe reinsurance premium adjustment that occurred during the first quarter of 2013. As reported net written premiums for the year ended December 31, 2012 decreased 14.5% compared to as reported net written premiums for the same 2011 period (see Reconciliation Table 5) primarily due to the 12.31.11 Pool Change. Excluding the impact of the 12.31.11 Pool Change, net written premiums for the year ended December 31, 2012 increased 40.3% compared to pro forma net written premiums for the same 2011 period (Table 5) primarily due to new business and rate increases.
The Excess & Surplus property unit SAP non-catastrophe loss and ALAE ratio for 2013 was 12.5% compared to 4.8% and 15.1% for 2012 and 2011, respectively (see Table 6). The increase from 2012 to 2013 and the decrease from 2011 to 2012 was primarily due to favorable prior accident year development in 2012 that is affecting year over year comparisons.
Net written premiums for the Excess & Surplus casualty unit for the year ended December 31, 2013 increased 16.3%, compared to the same 2012 period (Table 5) primarily due to growth in our Umbrella and General Liability policies. As reported net written premiums for the year ended December 31, 2012 decreased 15.7%, compared to as reported net written premiums for the same 2011 period (Reconciliation Table 5) primarily due to the 12.31.11 Pool Change. Excluding the impact of the 12.31.11 Pool Change, as reported net written premiums for the year ended December 31, 2012 increased 24.5%, compared to pro forma net written premiums for the same 2011 period (Table 5) primarily due to a new professional liability product and growth in the general liability, environmental and umbrella product lines.
The Programs unit SAP non-catastrophe loss and ALAE ratio for 2013 was 100.2% compared to 109.9% and 74.2% for 2012 and 2011, respectively (Table 6). The overall improvement was due to changes in the mix of programs as RED runs off and as new programs are initiated. The pro forma SAP non-catastrophe loss and ALAE ratio for the Programs unit, excluding the former RED unit, for the year ended 2013 improved 12.5 points (Reconciliation Tables 8 and 9) compared to the same 2012 period, primarily due to changes in the mix of programs, as well as, underwriting actions and rate increases initiated in 2012 for the largest program. Included in the 2013 SAP non-catastrophe losses is $21.3 million of reserve strengthening related to business written through the former RED unit, which came from prior accident years. The increase from 2011 to 2012 was primarily due to $30.5 million of loss and loss expense reserve strengthening within the former RED unit, principally related to a large commercial trucking program and a sizable commercial restaurant program, both of which were canceled in 2012.
The following tables set forth, on a SAP and pro forma basis, certain of our key performance indicators for the Programs unit before and after the impact of our former RED unit’s underwriting results for the years ended December 31, 2013 and 2012:
The Workers’ compensation strategy focuses on accounts under $25,000 and debit mod accounts over $100,000, which focuses on accounts with higher average losses driven mostly by injuries that impact soft tissue. Workers’ compensation unit net written premiums for the year ended December 31, 2013, increased slightly when compared to the same 2012 period (Table 5). As reported net written premiums for the year ended December 31, 2012 decreased 8.8% compared to as reported net written premiums for the same 2011 period (Reconciliation Table 5) primarily due to the 12.31.11 Pool Change. Excluding the impact of the 12.31.11 Pool Change, as reported net written premiums for the year ended December 31, 2012 increased 17.8% compared to pro forma net written premiums for the same 2011 period (Table 5). The 2011 to 2012 premium increase in our workers’ compensation unit was driven by increases in our debit mod business, due primarily to state expansion and a firming market place along with growth in our small account workers’ compensation product, written in conjunction with our standard business products.
As shown above, the 2013 loss and loss expenses attributable to prior years totaled a decrease of $21.2 million, or favorable development, in the estimated ultimate liability for prior years’ claims. The following table sets forth a tabular presentation of the favorable development by accident year for the year ended December 31, 2013:
We experienced favorable catastrophe loss development of $5.4 million in 2013 related to catastrophe losses primarily from 2012.
In the specialty insurance segment, the non-catastrophe loss and ALAE reserves accounted for $10.5 million of adverse development related to the last three accident years, which was driven by RED reserve strengthening (discussed above). Favorable development of prior accident year non-catastrophe loss and ALAE reserves, excluding the impact of RED, was $10.9 million in 2013, of which $12.3 million related to the workers' compensation unit. The favorable workers' compensation development was primarily attributable to better than anticipated severity emerging across all accident years, with approximately one third coming from accident year 2012. Adverse development of prior accident year RED reserves totaled $21.3 million, more than offsetting the favorable development reported by non-RED specialty insurance segment units.
As shown above, the 2012 loss and loss expenses attributable to prior years totaled a decrease of $16.9 million, or favorable development, in the estimated ultimate liability for prior years’ claims. The following table sets forth a tabular presentation of the favorable development by accident year for the year ended December 31, 2012:
In the specialty insurance segment, the non-catastrophe loss and ALAE reserves accounted for $27.8 million of adverse development related to the latest two accident years, which was driven by RED reserve strengthening (discussed above).
Favorable catastrophe loss development of $4.3 million was primarily within our fire & allied lines, other personal, personal auto and homeowners lines of business.
The following table sets forth loss and loss expenses payable by major line of business at December 31, 2013 and 2012:
Our GAAP expense ratio was 33.6% in 2013 compared to 33.2% and 33.9% in 2012 and 2011, respectively.
Our acquisition and operating expenses were $354.8 million in 2013 compared to $345.9 million and 485.0 million in 2012 and 2011, respectively. The change from 2012 to 2013 was primarily driven by increases in agent and employee incentive compensation. The 2011 to 2012 change was primarily driven by the 12.31.11 pool change and the HO QS arrangement, which account for $81.3 million and $48.2 million of the decrease, respectively.
Our investment portfolio and the investment portfolios of other members of the State Auto Group are managed by our subsidiary, Stateco. Stateco utilizes its own personnel to invest in fixed maturities and large-cap equities and outside investment managers to invest in small-cap equities and international funds. The Investment Committee (the “Committee”) of our Board of Directors establishes the investment policies to be followed by Stateco. Our primary investment objectives are to maintain adequate
liquidity and capital to meet our responsibilities to policyholders, grow long term economic surplus to increase our capital position, maintain a consistent level of income to support operations and manage investment risk. Our current investment strategy does not rely on the use of derivative financial instruments.
Our externally managed equity portfolios invest in U.S. small-cap equities and international funds. These managers are permitted to manage the portfolios according to their own respective portfolio objectives. In selecting our outside investment managers we confirm that their portfolio objectives, including risk tolerance, are acceptable to us; however, there may be slight differences in their objectives with respect to dividend payments and other constraints that we apply to our large-cap equity holdings.
At December 31, 2013, our investments in fixed maturities, equity securities and certain other invested assets were held as available-for-sale and carried at fair value. The unrealized holding gains or losses, net of applicable deferred taxes, are included as a separate component of stockholders’ equity as accumulated other comprehensive income (loss) and as such are not included in the determination of net income (loss).
The following table sets forth the composition of our investment portfolio at carrying value at December 31, 2013 and 2012:
There are no mortgage backed securities in our fixed maturity portfolio which may be labeled sub-prime mortgage backed securities. We invest only in conventional mortgage backed securities issued by a federal agency or that are U.S. Government guaranteed. Specifically, approximately $353.8 million or 19.3% of our fixed maturity available-for-sale investment portfolio as of December 31, 2013, were in either GNMA pools, which are guaranteed by the full faith and credit of the U.S. Government, or FNMA or Freddie Mac pools.
Our fixed maturity investment portfolio at December 31, 2013 included obligations of states and political subdivisions with a total carrying value of $774.2 million, with $238.8 million of these securities, or 30.8% of our municipal securities portfolio (“Muni Portfolio”), enhanced by third party monoline insurers (a “Credit Enhancement”) for the payment of principal and interest in the event of an issuer default. A Credit Enhancement is not a primary consideration to us when purchasing a municipal security, as we consider the underlying credit quality of the security as the primary rating factor in our evaluation process. Of the total $774.2 million of municipal securities in our investment portfolio at December 31, 2013, 86.1% were rated AA or better, without the benefit of a Credit Enhancement. We do not believe that a loss of a Credit Enhancement would have a material adverse impact on our results of operations, financial position or liquidity, due to the underlying strength of the issuers of the securities, as well as our ability and intent to hold the securities. In addition, as of December 31, 2013, we had no direct investment in any guarantor including any bond insurer.
The following table sets forth the credit ratings of our municipal securities, excluding Credit Enhancements, based on ratings by nationally recognized rating agencies at December 31, 2013:
Our investment operations revenue for the year ended December 31, 2013 was primarily impacted by the following factors.
Interest earned on our fixed maturity securities declined primarily due to lower levels of inflation in 2013 as compared to the same 2012 period. This directly impacts the income received on our Treasury Inflation-Protected Securities ("TIPS"), which decreases as inflation declines and increases as inflation rises. In addition, interest earned also declined due to lower yields. As our higher yielding bonds mature or are called by the issuers, the proceeds are being reinvested at a lower interest rate.
Equity sales were executed for various reasons in 2013, 2012 and 2011, including: (i) the achievement of our price target, (ii) in response to changes in business conditions, which in our opinion diminished the future business prospects on these securities, (iii) to manage our equity holdings consistent with our investment objectives and (iv) in 2012 and 2011, to accumulate cash for settlement of the transfers related to the 12.31.11 pool change with the Mutual Pooled Companies in early 2012.
The following table sets forth realized gains (losses) and the proceeds received on sale for our investment portfolio for the years ended December 31, 2013, 2012 and 2011:
As of December 31, 2013, Level 3 assets as a percentage of total assets were 0.4%, which we have determined to be insignificant.
Net cash used in investing was $23.0 million in 2013, compared to net cash provided by investing activities of $9.3 million and $246.2 million for 2012 and 2011, respectively. The following factors significantly contributed to the fluctuations between those years:
The change in 2013 can generally be attributed to less sales proceeds from available for sale securities when compared to 2012, as well as, a lower level of call activity during 2013 compared to the same 2012 period.
In 2011, we sold equity securities and certain fixed maturity securities in order to accumulate cash to be in a position to settle the transfers related to the 12.31.11 pool change with the Mutual Pooled Companies in early 2012.
Prior to July 26, 2013, State Auto Financial had a $100.0 million unsecured revolving credit facility with a syndicate of lenders which was to mature in September 2016 (the “STFC Credit Facility”). The STFC Credit Facility was terminated on July 26, 2013, and replaced with the SPC Credit Facility, as described above. The STFC Credit Facility was available for general corporate purposes and provided for interest-only payments during its term. Principal and interest was to be due in full at maturity. Interest was based on LIBOR or a base rate plus a calculated margin amount. The STFC Credit Facility included certain covenants, including financial covenants that required us to maintain a minimum net worth and not exceed a certain debt to capitalization ratio.
On July 11, 2013, State Auto P&C obtained a loan (the “FHLB Loan”) from the Federal Home Loan Bank of Cincinnati (the “FHLB”). State Auto P&C became a member of the FHLB during the first quarter of 2013. The FHLB Loan is a 20-year term loan, callable after three years with no prepayment penalty thereafter, in the principal amount of $85.0 million. The FHLB Loan provides for interest-only payments during its term, with principal due in full at maturity. The interest rate is fixed over the term of the loan at 5.03%. The FHLB Loan is fully secured by a pledge of specific investment securities of State Auto P&C. Proceeds from the FHLB Loan, along with cash on hand, were used by State Auto Financial to redeem all of its outstanding Senior Notes, as further described below.
On July 15, 2013, State Auto Financial completed the redemption of all of its outstanding $100.0 million 6.25% Senior Notes due November 2013. The total redemption price paid by State Auto Financial was $103.0 million, which included interest through the redemption date and a make-whole amount due to the Senior Notes being redeemed prior to their November 15, 2013 maturity date. The redemption price was funded by proceeds from the FHLB Loan and cash on hand.
State Auto Financial’s Delaware business trust subsidiary (the “Capital Trust”) has outstanding $15.0 million liquidation amount of capital securities, due 2033. In connection with the Capital Trust’s issuance of the capital securities and the related purchase by State Auto Financial of all of the Capital Trust’s common securities (liquidation amount of $0.5 million), State Auto Financial has issued to the Capital Trust $15.5 million aggregate principal amount of unsecured Floating Rate Junior Subordinated Debt Securities due 2033 (the “Subordinated Debentures”). The sole assets of the Capital Trust are the Subordinated Debentures and any interest accrued thereon. Interest on the Capital Trust’s capital and common securities is payable quarterly at a rate equal to the three-month LIBOR rate plus 4.20%, adjusted quarterly. The applicable interest rates for December 31, 2013 and 2012 were 4.44% and 4.51%, respectively.
The following table sets forth our notes payable at December 31, 2013:
Related to our notes payable, our primary market risk exposure is to the change in interest rates and our credit rating. For a discussion regarding our credit ratings see “Credit and Financial Strength Ratings” included in this Item 7. Based upon the notes payable carrying value at December 31, 2013, we had $15.5 million notes payable with variable interest and $85.3 million notes payable with interest fixed at 5.03%, which equated to approximately 15.4% variable interest debt and 84.6% fixed interest debt. Our 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) our currently existing notes payable fixed and variable interest rate position. See our contractual obligations table included in “Contractual Obligations” included in this Item 7.
Under the HO QS Arrangement, the reinsurers have agreed to accept 75% of the State Auto Group’s subject homeowners net liability. The liability of the reinsurers will not exceed any of the following: $3.0 million as to any one risk with respect to property losses; $2.0 million as to any one insured with respect to liability losses; $55.0 million as to all losses arising from any one loss occurrence; 50% of the ceded net earned premium for the first contract year with respect to all losses arising from all catastrophe loss occurrences commencing during the first contact year, subject to an amount not to exceed $181.0 million for the first contract year; 40% of the ceded net earned premium for the second contract year with respect to all losses arising from all catastrophe loss occurrences commencing during the second contact year, subject to an amount not to exceed $150.0 million for the second contract year; 30% of the ceded net earned premium for the third contract year with respect to all losses arising from all catastrophe loss occurrences commencing during the third contract year, subject to an amount not to exceed $117.0 million for the third contract year; or 34% of the ceded net earned premium for the term of the agreement with respect to all losses arising from all catastrophe loss occurrences commencing during the term of the agreement, subject to an amount not to exceed $380.0 million for the term of the contract. A “catastrophe loss occurrence” is defined as any one loss occurrence which has been assigned a catastrophe number by the ISO PCS. We believe this reinsurance arrangement reduces risk and volatility in the homeowners line of business and to our overall book of business while providing us with additional catastrophe protection.
Members of the State Auto Group maintain a property catastrophe excess of loss reinsurance agreement, covering property catastrophe related events affecting at least two risks. As of June 1, 2013, this property catastrophe reinsurance agreement was revised to increase the treaty limit. Under this agreement, the State Auto Group retains the first $55.0 million of catastrophe loss, each occurrence, with a 5.0% co-participation on the next $265.0 million (previously $245.0 million) of covered loss, each occurrence. The reinsurers are responsible for 95% of the excess over $55.0 million up to $320.0 million (previously $300.0 million) of covered losses, each occurrence. Under this agreement, our companies are responsible for losses above $320.0 million (previously $300.0 million).
At June 1, 2013, the State Auto Group renewed the July 1, 2012 property per risk excess of loss reinsurance agreement, aligning its effective date with that of our property catastrophe treaty. This reinsurance agreement provides that the State Auto Group is responsible for the first $1.0 million of each covered loss for Excess & Surplus property and Programs units, and the first $3.0 million of each covered loss for other property business. The State Auto Group is also responsible for an additional $2.0 million in aggregate retention per treaty year for losses exceeding $3.0 million. The reinsurers are responsible for 100.0% of the loss in excess of $1.0 million for the Excess and Surplus property and Programs units and $3.0 million for other property business up to $20.0 million of covered loss. The rates for this reinsurance are negotiated annually.
For Excess & Surplus casualty and Programs unit risks, the State Auto Group has a combined casualty treaty whereby under Section A, we retain the first $1.0 million of covered loss and the reinsurers are responsible for 90.0% (previously 87.0%) of loss in excess of $1.0 million up to $10.0 million for all primary business and excess business written directly above a primary policy. Under Section B, as respects excess policies over another carrier's primary policy, we have a $10.0 million proportional agreement where we retain $1.0 million of each risk and the reinsurers are responsible for 90.0% (previously 87.0%) of loss for each risk based on the percentage the $1.0 million we retain bears to the total policy limit. The rates for this reinsurance are negotiated annually.
The following table sets forth our significant contractual obligations at December 31, 2013:
The following table sets forth the statutory leverage ratios for our insurance subsidiaries at December 31, 2013, 2012 and 2011:
State Auto P&C, Milbank and SA Ohio are subject to regulations and restrictions under which payment of dividends from statutory surplus can be made to State Auto Financial during the year without prior approval of regulatory authorities. Under the insurance regulations of Iowa and Ohio (the states of domicile), the maximum amount of dividends that the Company may pay out of earned surplus to shareholders within a twelve month period without prior approval of the Department is limited to the greater of 10% of the most recent year-end policyholders' surplus or net income for the twelve month period ending the 31st day of December of the previous year-end. Pursuant to these rules, $75.3 million is available for payment to State Auto Financial from its insurance subsidiaries in 2014 without prior approval. State Auto Financial received dividends from its insurance subsidiaries in the amount of $10.0 million, $20.0 million and $0 million in 2013, 2012 and 2011, respectively.
We are reviewed regularly by the independent rating agencies, including those rating agencies listed in the table above. We believe that these ratings provide a meaningful way for policyholders, agents, creditors, shareholders and others to compare us to our competitors. Our ratings are influenced by many factors, including operating and financial performance, asset quality, liquidity, financial leverage, exposure to catastrophe risks and operating leverage.
Generally, credit ratings affect the cost, type and availability of debt financing. Higher rated securities receive more favorable pricing and terms relative to lower rated securities at the time of issue.
The financial strength ratings set forth above relate to the State Auto Group and express the opinion of the rating agency as to the ability of the State Auto Group to meet its ongoing obligations to policyholders. The A.M. Best financial strength rating influences our ability to write insurance business as agents and policyholders generally prefer higher rated companies. Lower rated companies may be required to compete for agents and policyholders by offering higher commissions or lower premiums and expanded coverage, or a combination thereof.
The amendments in this guidance result in additional disclosure requirements under GAAP and do not change the current requirements for reporting net income or other comprehensive income in financial statements. The new guidance requires an entity to present, either in a single note, or, parenthetically on the face of the statement where net income is presented, the effects of significant amounts reclassified from each component of accumulated other comprehensive income by the respective line items of net income, only, if the amount reclassified is required under GAAP to be reclassified to net income in its entirety in the same reporting period. If a component is not required to be reclassified to net income in its entirety, the entity would, instead, cross-reference it to the related disclosure required under GAAP. This guidance is effective prospectively for fiscal years and interim periods beginning after December 15, 2012. We adopted this guidance at January 1, 2013, and it did not have a material impact on the condensed consolidated financial statements.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of State Auto Financial Corporation and subsidiaries at December 31, 2013 and 2012, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of State Auto Financial Corporation and subsidiaries as of December 31, 2013 and 2012, and the related consolidated statements of income (loss), comprehensive income (loss), stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2013, and our report dated March 6, 2014, expressed an unqualified opinion thereon.
The consolidated financial statements have been prepared in conformity with U.S. generally accepted accounting principles (“GAAP”), which vary in certain respects from statutory accounting practices (“SAP”) followed by State Auto P&C, Milbank and SA Ohio that are prescribed or permitted by the Departments.
Material estimates that are particularly susceptible to significant change in the near term relate to the determination of losses and loss expenses payable and the realization of deferred tax assets. In connection with the determination of losses and loss expenses payable, management uses historical data, current business conditions and assumptions about future conditions to formulate estimates of the ultimate cost to settle claims. Deferred tax assets are evaluated periodically by management to determine if they are realizable, requiring management to make certain judgments and assumptions. In evaluating the ability to recover deferred tax assets, management considers all available evidence, including loss carryback potential, past operating results, existence of cumulative losses in the most recent years, projected performance of the business, future taxable income, including the ability to generate capital gains, and prudent and feasible tax planning strategies. If, based on available information, it is more likely than not that the deferred income tax asset will not be realized, then a valuation allowance must be established with a corresponding charge to net income and/or other comprehensive income. These estimates by their nature are subject to uncertainties for various reasons.
The Company regularly monitors its investments that have fair values less than cost or amortized cost for signs of other-than-temporary impairment, an assessment that 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. Among the factors that management considers for fixed maturity securities are the financial condition of the issuer including receipt of scheduled principal and interest cash flows, and intent to sell including if it is more likely than not that the Company will be required to sell the investments before recovery. When a fixed maturity security has been determined to have an other-than-temporary impairment, the impairment charge is separated into an amount representing the credit loss, which is recognized in earnings as a realized loss, and the amount related to non-credit factors, which is recognized in other comprehensive income (loss). Future increases or decreases in fair value, if not other-than-temporary, are included in other comprehensive income (loss).
Acquisition costs, consisting of commissions, premium taxes and certain underwriting expenses related to the successful acquisition or renewal of property and casualty business, are deferred and amortized over the same period in which the related premiums are earned. 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. Future changes in estimates, the most significant of which is expected losses and loss adjustment expenses, that indicate a reduction in
expected future profitability may result in unrecoverable deferred acquisition costs. Anticipated investment income is considered in determining whether a premium deficiency exists.
The Company files a consolidated federal income tax return. Pursuant to a written tax sharing agreement, each entity within the consolidated group pays or receives its share of federal income taxes based on separate return calculations.
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 $24.7 million and $25.7 million at December 31, 2013 and 2012, respectively, has been established to cover the estimated ultimate cost to settle insured losses. The amounts are 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 materially from such estimates. The estimates are continually reviewed and adjusted as necessary; such adjustments are included in current operations (see Note 4). Anticipated salvage and subrogation is 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.
The following tables set forth the cost or amortized cost and fair value of available-for-sale securities by lot at December 31, 2013 and 2012:
The following tables set forth the Company’s gross unrealized losses and fair value on its investments by lot, aggregated by investment category and length of time for individual securities that have been in a continuous unrealized loss position at December 31, 2013 and 2012:
The following table sets forth the realized losses related to other-than-temporary impairments on the Company’s investment portfolio recognized for the years ended December 31, 2013, 2012 and 2011:
Fixed maturities with fair values of approximately $8.7 million and $10.0 million were on deposit with insurance regulators as required by law at December 31, 2013 and 2012, respectively.
The following table sets forth the realized and unrealized holding gains (losses) on the Company’s investment portfolio for the years ended December 31, 2013, 2012 and 2011:
Below is the fair value hierarchy that categorizes into three levels the inputs to valuation techniques that are used to measure fair value.
Transfers between levels may occur due to changes in the availability of market observable inputs. Transfers in and out of levels are reported as having occurred at the beginning of the quarter in which the transfer occurred. There were no transfers between levels during the years ended December 31, 2013 and 2012.
The following tables set forth the Company’s available-for-sale investments within the fair value hierarchy at December 31, 2013 and 2012:
Included in other invested assets are the FHLB membership common stock ("FHLB common stock"), purchased when State Auto P&C joined the FHLB in 2013, and the Trust Securities (as defined in Note 6b). The Trust Securities and FHLB common stock are carried at cost, which approximates fair value. The fair value of the FHLB common stock at December 31, 2013 was $4.5 million and the fair value of the Trust Securities were $0.5 million. Both investments have been placed in Level 3 of the fair value hierarchy.
The Company recorded favorable development related to prior years' loss and loss expense reserves in 2013, 2012 and 2011 of $21.2 million, $16.9 million and $33.3 million, respectively. Favorable development of unallocated loss adjustment expenses contributed approximately $8.0 million of the 2013 development, while $5.4 million was attributable to favorable development on catastrophe reserves, which is lower than 2012, but, in line with the Company's historical favorable development. The personal and business insurance segments non-catastrophe loss and ALAE reserves accounted for $18.3 million of favorable development driven by the other & product liability, commercial auto and homeowners lines with $8.3 million, $8.0 million and $2.9 million of favorable development, respectively. The favorable development in these lines was driven by the emergence of lower than anticipated claim severity. Somewhat offsetting the favorable development was adverse development in the personal auto line, specifically the no-fault coverage. The specialty insurance segment non-catastrophe loss and ALAE reserves accounted for $10.5 million of adverse development, driven by RED reserve strengthening of $21.3 million related to a large restaurant program and a commercial auto trucking program. Somewhat offsetting the unfavorable development was favorable development of workers' compensation reserves of $12.3 million driven by better than anticipated severity emerging across all accident years, with approximately one third coming from accident year 2012.
Favorable development of unallocated loss adjustment expenses contributed approximately $6.3 million of the 2012 development, while $10.4 million was attributable to favorable development on catastrophe reserves from accident year 2011. The personal and business insurance segments' non-catastrophe loss and ALAE reserves accounted for $28.0 million of favorable development related to the latest three accident years, primarily in the personal auto liability, other & product liability, and fire & allied lines with $10.5 million, $9.4 million and $5.1 million of favorable development, respectively. The favorable development in these lines was driven by emergence of lower than anticipated claim severity. The specialty insurance segment non-catastrophe loss and ALAE reserves accounted for $27.8 million of adverse development related to the latest two accident years, which was driven by RED reserve strengthening.
Favorable development on prior years loss adjustment expense reserves contributed approximately $7.6 million of the 2011 development, while $4.3 million was attributable to favorable development on catastrophe reserves. The personal and business insurance segments' non-catastrophe loss and ALAE reserves accounted for $28.1 million of favorable development in 2011, primarily in the homeowners, commercial multi-peril and fire & allied lines with $14.2 million, $6.1 million and $4.9 million of favorable development, respectively. The favorable development in these lines was driven by emergence of lower than anticipated claim severity, primarily from accident years 2010 and 2009 as well as, to a lesser extent, the past five accident years in the commercial multi-peril line of business. The specialty insurance segment non-catastrophe loss and ALAE reserves accounted for $6.7 million of adverse development in 2011, which was driven by greater than anticipated large losses in the commercial auto line of business and reserve increases on certain life time disability claims in the workers’ compensation line of business.
On December 31, 2011, the State Auto Group entered into the Homeowners Quota Share Arrangement, which is a three-year quota share agreement covering its homeowners book of business. Under this arrangement, the State Auto Group cedes to reinsurers 75% of its homeowners business under policies in force at the effective date and new and renewal policies thereafter issued during the term of the agreement. The arrangement remains in place until December 31, 2014. A reinsurer may terminate its participation in the arrangement upon the occurrence of certain events, including, without limitation, the following: the policyholders’ surplus of the State Auto Group has been reduced by more than 25% from the amount of its surplus as of September 30, 2011; or the State Auto Group has been assigned an A.M. Best’s rating below A-. As of December 31, 2013, the State Auto Group was in compliance with the terms of the arrangement. Under the arrangement, the State Auto Group receives a 29.0% commission on all premiums ceded to the reinsurers during the term of the agreement. Subject to the terms and conditions of the arrangement, the State Auto Group may receive a profit commission. On December 31, 2011, the Company transferred $106.3 million of unearned premium related to this arrangement. The amount of ceding commission earned is limited to the amount of deferred acquisition costs that would have been deferred if not for entering in the arrangement. The Company has recorded $8.6 million and $8.4 million of excess ceding commission as a deferred liability on the consolidated balance sheet at December 31, 2013 and 2012, respectively.
The following table sets forth the effect of the Company’s external reinsurance on its balance sheets at December 31, 2013 and 2012, prior to the reinsurance transaction with State Auto Mutual under the Pooling Arrangement, as discussed in Note 6a:
The following table sets forth the effect of the Company’s external reinsurance on its income statements for the years ended December 31, 2013, 2012 and 2011, prior to the reinsurance transaction with State Auto Mutual under the Pooling Arrangement, as discussed in Note 6a:
The insurance subsidiaries of State Auto Financial participate in a quota share reinsurance pooling arrangement (“the Pooling Arrangement”) with State Auto Mutual and its subsidiaries and affiliates, State Auto Insurance Company of Wisconsin (“SA Wisconsin”), Meridian Citizens Mutual Insurance Company (“Meridian Citizens Mutual”), Meridian Security Insurance Company (“Meridian Security”) which includes State Auto Florida Insurance Company and Beacon National Insurance Company as these companies were merged with Meridian Security at the close of business on December 31, 2012 and Patrons Mutual Insurance Company of Connecticut (“Patrons Mutual”) which includes Litchfield Mutual Fire Insurance Company as it was merged with Patrons Mutual at the close of business March 31, 2013. State Auto P&C, Milbank and SA Ohio are referred to as the “STFC Pooled Companies,” and State Auto Mutual, SA Wisconsin, Meridian Citizens Mutual, Meridian Security and Patrons Mutual are referred to as the “Mutual Pooled Companies.” The STFC Pooled Companies, the Mutual Pooled Companies, including the Rockhill Insurers (defined below), are collectively referred to as the “State Auto Group.”
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 State Auto 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
State Auto Mutual as assets only in situations when net amounts ceded to State Auto Mutual exceed net amounts assumed. All parties that participate in the Pooling Arrangement have an A.M. Best rating of A (Excellent).
The following table sets forth the reinsurance transactions on the Company’s balance sheets for the Pooling Arrangement between the STFC Pooled Companies and State Auto Mutual at December 31, 2013 and 2012:
Under these agreements, the Company earned interest of $4.9 million for each of the three years ended December 31, 2013, 2012 and 2011, respectively. See Note 3 for the notes receivable fair value discussion.
Stateco provides State Auto Mutual and its affiliates investment management services. Investment management income is recognized quarterly based on a percentage of the average fair value of investable assets and the equity portfolio performance of each company managed. Revenue related to these services amounted to $1.6 million, $2.9 million and $1.9 million in 2013, 2012 and 2011, respectively, and is included in other income (affiliates) on the consolidated statements of income.
On July 26, 2013, State Auto Financial terminated its then-current credit agreement with a syndicate of lenders, as further described below. Concurrent with the termination of this credit agreement, State Auto P&C entered into a new credit facility (the “SPC Credit Facility”) with a syndicate of lenders. The SPC Credit Facility provides State Auto P&C with a $100.0 million five-year revolving credit facility maturing in July 2018. During the term of the SPC Credit Facility, State Auto P&C has the right to increase the total facility to a maximum amount of $150.0 million, provided that no event of default has occurred and is continuing. The SPC Credit Facility is available for general corporate purposes and provides for interest-only payments during its term, with principal and interest due in full at maturity. Interest is based on the London Interbank Offered Rate ("LIBOR") or a base rate plus a calculated margin amount. All advances under the SPC Credit Facility are to be fully secured by a pledge of specific investment securities of State Auto P&C. The SPC Credit Facility includes certain requirements, including financial requirements that State Auto Financial maintain a minimum net worth and a certain debt to capitalization ratio.
As of December 31, 2013, State Auto P&C had not made any borrowings and both State Auto P&C and State Auto Financial were in compliance with all covenants and requirements of the SPC Credit Facility.
During 2011, the Company determined that a valuation allowance should be established due to the magnitude of the catastrophe losses from unprecedented storms experienced industry wide. At December 31, 2013 and 2012, the Company recorded a valuation allowance of $82.6 million and $100.5 million, respectively. The deferred income tax asset remaining after recognition of the valuation allowance represents a deferred tax asset on the gross unrealized fixed maturity losses where management determined this portion of the asset to be realizable due to management’s assertion that it has both the ability and intent to hold these securities through recovery or maturity.
At December 31, 2013, the Company carried no balance for uncertain tax positions. The Company had no accrual for the payment of interest and penalties at December 31, 2013 or 2012.
The Company provides a defined benefit pension plan for its eligible employees. Substantially all Company employees hired prior to January 1, 2010 become eligible to participate the year after becoming 20 years of age and vest with 5 years of credited service or attaining age 65. The Company’s policy is to fund pension costs in accordance with the requirements of the Employee Retirement Income Security Act of 1974. Benefits are determined by applying factors specified in the plan to a participant’s defined average annual compensation.
The following table sets forth the weighted average assumptions used to determine the benefit plans’ obligations at December 31, 2013 and 2012:
The following table sets forth the weighted average assumptions used to determine the benefit plans’ net periodic cost for the years ended December 31, 2013, 2012 and 2011:
The pension plan's investment policy objective is to preserve the investment principal while generating income and appreciation in fair value to meet the pension plan's obligations. The pension plan's investment strategy and risk tolerance is balanced between meeting cash obligation requirements and a long-term relatively high risk tolerance takes into account the predictable cash requirements, nature of the plan’s liabilities and the plan’s long term time horizon. Since the nature and timing of the benefit plans’ liabilities and cash requirements are predictable, the liquidity requirements are somewhat moderate. One of
The following tables set forth the Company’s share of the postretirement plan’s available-for-sale securities within the fair value hierarchy at December 31, 2013 and 2012:
The following tables set forth the changes in the Company’s accumulated other comprehensive income component (AOCI), net of tax, for the years ended December 31, 2013, 2012 and 2011:
The Equity Plan provides for the award of qualified and nonqualified stock options, restricted shares, performance shares, performance units and other stock-based awards. The Company has reserved 3.0 million common shares under the Equity Plan. As of December 31, 2013, a total of 1.1 million common shares are available for issuance under the Equity Plan. The Equity Plan provides that (i) no more than 33% of the common shares authorized for issuance under the Equity Plan may be granted in the form of awards other than stock options, (ii) the maximum number of common shares subject to awards of stock options, restricted shares and performance shares that may be granted in any calendar year is equal to 1.5% of the total number of common shares of the Company outstanding as of December 31 of the prior year, and (iii) the maximum number of common shares subject to awards of stock options, restricted shares and performance shares that may be granted in any calendar year to any one individual is 250,000 shares. The Equity Plan automatically terminates on May 8, 2019.
As of December 31, 2013, there was $0.1 million of total unrecognized compensation cost related to non-vested restricted share compensation arrangements. The remaining cost is expected to be recognized over a period of 1.25 years.
The fair value of share-based awards granted to employees was estimated at the date of grant using the Black-Scholes option-pricing model. The following table sets forth the weighted average fair values and related assumptions for options granted for the years ended December 31, 2013, 2012 and 2011:
Aggregate intrinsic value for total options outstanding at December 31, 2013 was $14.0 million. Aggregate intrinsic value for total options exercisable at December 31, 2013 was $5.3 million.
The following table sets forth the compilation of basic and diluted net (loss) earnings per common share for the years ended December 31, 2013, 2012 and 2011:
The following table sets forth the options to purchase shares of common stock and the restricted share units ("RSU award") provided to each outside director of the Company, that were not included in the computation of diluted earnings per common share because the exercise price of the options, or awards, was greater than the average market price or their inclusion would have been antidilutive for the years ended December 31, 2013, 2012 and 2011:
As of January 1, 2013 our units within the specialty insurance segment changed from RED, Rockhill and Workers’ Compensation to Excess & Surplus Property, Excess & Surplus Casualty, Programs and Workers’ Compensation. This change did not have any impact on segment reporting.
The following table sets forth financial information regarding the Company’s reportable segments for the years ended December 31, 2013, 2012 and 2011:
The following table sets forth financial information regarding the Company’s reportable segments at December 31, 2013 and 2012:
Assets attributed to the investment operations segment include the total investments and cash and cash equivalent categories from the balance sheet. All other assets are corporate assets and are not assigned to a segment.
In accordance with the Contingencies Topic of the FASB's ASC, the Company accrues for a litigation-related liability when it is probable that such a liability has been incurred and the amount can be reasonably estimated. The Company reviews all litigation on an ongoing basis when making accrual and disclosure decisions. For certain legal proceedings, the Company cannot reasonably estimate losses or a range of loss, if any, particularly for proceedings that are in their early stages of development or where the plaintiffs seek indeterminate damages. Various factors, including, but not limited to, the outcome of potentially lengthy discovery and the resolution of important factual questions, may need to be determined before probability can be established or before a loss or range of loss can be reasonably estimated. If the loss contingency in question is not both probable and reasonably estimable, the Company does not establish an accrual and the matter will continue to be monitored for any developments that would make the loss contingency both probable and reasonably estimable. Based on currently available information known to the Company, it believes that its reserves for litigation-related liabilities are reasonable. However, in the event that a legal proceeding results in a substantial judgment against, or settlement by, the Company, there can be no assurance that any resulting liability or financial commitment would not have a material adverse effect on the financial condition, results of operations or cash flows of the consolidated financial statements of State Auto Financial Corporation.
The following describes a pending class action legal proceeding in which the Company is a party:
The Company is also involved in other lawsuits arising in the ordinary course of its business, some of which arise out of, or are related to, our insurance policies and may allege extra contractual damages. These lawsuits are in various stages of development. The Company generally contests these matters vigorously, but may pursue settlement if appropriate. Based on current available information, the Company does not believe it is reasonably possible that any such lawsuit, or related lawsuits, will be material to its results of operations or have a material adverse effect on its consolidated financial or cash flow positions.