Because the operations of the Company and Mutual are integrated with one another pursuant to the terms of the 2000 Management Agreement, the Company and Mutual share their operating facilities. See Item 1, "Management Agreement" in the "Narrative Description of Business." The Company's and Mutual's corporate headquarters are located in Columbus, Ohio in buildings owned by Mutual that contain approximately 270,000 square feet of office space. The Company and Mutual also have regional underwriting and claims office facilities, which they share through the Amended and Restated Management Agreement. These facilities include a 6,600 square foot branch office in Cleveland, Ohio owned by Mutual, and a 29,000 square foot branch office in Cincinnati, Ohio owned by Mutual. In May 1999, an office building constructed by 518 PML containing 38,000 square feet was completed and leased to Mutual as its Nashville Regional Office. Mutual also leases the regional office facility in Greer, South Carolina from 518 PML. Milbank owns an office facility in Milbank, South Dakota where Company employees provide services to Milbank agents and policyholders. Midwest Security leases an office facility in Onalaska, Wisconsin where Company employees service Midwest Security's agents and
State Auto P&C, in addition to its insurance operations, currently provides management and operations services under management agreements effective as of January 1, 2000, for all State Auto Insurance Companies, which include: Milbank; Farmers Casualty; SAIC; National; Mid-Plains; State Automobile Mutual Insurance Company (Mutual), a majority shareholder of State Auto Financial; and Mutual's wholly owned subsidiary, Midwest Security Insurance Company (Midwest Security); and, until June 30, 1997, State Auto Life Insurance Company (State Auto Life was sold by Mutual effective July 1997). Pursuant to this management and operations agreement, State Auto P&C received cash equal to the net plan benefit liabilities assumed relating to the transfer of all employees from Mutual, Stateco (as defined below) and S.I.S. (as defined below) to State Auto P&C, effective January 1, 2000. Prior to January 1, 2000, State Auto P&C provided executive management services to the foregoing entities.
In August 1998, State Auto Financial purchased $9.0 million of surplus notes from Farmers Casualty Company Mutual (FCCM), an Iowa domiciled property casualty insurer for the standard insurance market. In 1998, a plan to convert FCCM into a stock insurance company was approved by the board of FCCM, its policyholders and the Iowa Division of Insurance. The plan of conversion provided that State Auto Financial, in exchange for the redemption of the surplus notes, would acquire the newly issued shares of Farmers Casualty. Effective January 1, 1999, FCCM, renamed Farmers Casualty Insurance Company, became a wholly owned subsidiary of State Auto Financial. In addition, Farmers Casualty owns 100% of the outstanding shares of Mid-Plains, an Iowa domiciled property casualty insurer, which principally writes nonstandard auto insurance.
Stateco Financial Services, Inc. (Stateco), a wholly owned subsidiary of State Auto Financial, provides investment management services to affiliated companies and also provides insurance premium finance services to customers of State Auto P&C, Milbank and Mutual.
Net income for the Company increased 14.1% in 1999. The Company's statutory combined ratios for 1999 and 1998 were 96.9% and 97.8%, respectively. A decrease in the level of catastrophe losses for 1999 compared to 1998 positively impacted the Company's results.
This same approach to underwriting has also had an impact on the Company's nonstandard insurance segment, which experienced a decrease in its earned premiums in 1999. This was the continuing result of significant auto physical damage rate increases, the continuation of a more restrictive underwriting posture first implemented by the Company in this segment throughout most of its operating states in 1998 and increased competition in this market segment during 1999. While these actions have resulted in a decrease in the volume of business over the last several reporting periods, this segment's statutory loss experience continues to improve over comparative prior periods. The statutory loss ratio for the year ended December 31, 1999 decreased to 71.7% from 75.0% for the same period in 1998. Offsetting the decrease in earned premium was National's entry into three new states of operation during 1999: South Carolina in the first quarter; Maryland in the second quarter; and South Dakota in the fourth quarter.
The investment yields, based on fixed and equity securities at cost, were 5.4% and 5.7% for the annual periods ending 1999 and 1998, respectively. Contributing to the decrease in the 1999 yield was the continual shift in the composition of the fixed maturity portfolio from taxable to tax-exempt fixed maturities. At December 31, 1999 and 1998, respectively, tax exempt securities comprised approximately 76% and 71% of the fixed maturity portfolio. Additionally, in 1999, the Company continued to experience a number of calls on its higher yielding fixed maturities. Monies from these calls were reinvested at the then lower yielding rates. Another contributing factor was the Company continuing to build on its equity portfolio to enhance growth of statutory surplus over the long term, a program that began in late 1997. See further discussion regarding investments at the Investments and Market Risk sections included herein.
The Company continued in 1999 to make strides in the use of technology to streamline its personal and commercial operations as more agencies participated in electronic upload and download using the APT industry standard. Additionally, in 1999, the Company began the use of electronic funds transfer (EFT) between the Company and the insured in several operating states for personal automobile business. EFT is expected to be offered to insureds in additional states in 2000.
Interest expense relates to the line of credit agreement State Auto Financial entered into with Mutual during the second quarter of 1999 to assist in the funding of its repurchase program. See additional discussion in the Liquidity and Capital Resources section below.
Net income for the Company decreased 8.5% in 1998. The Company's statutory combined ratios for 1998 and 1997 were 97.8% and 94.1%, respectively. Impacting the Company's results for 1998 was an increase in the level of catastrophe losses compared to 1997. In fact, 1998 was the second worst catastrophe year in the Company's history.
Consolidated earned premiums increased 11.3% in 1998. This increase was principally the results of a change in the Pooled Subsidiaries aggregate pooled participation percentage (discussed above) which increased consolidated earned premiums by 7.1%. The standard insurance segment's internal growth, as written by the Pooled Companies (for 1998 includes State Auto P&C, Milbank, Mutual and Midwest Security), excluding the impact of the change in the Pooled Subsidiaries aggregate pooled participation percentages, increased consolidated earned premiums by 2.9%. The Company's nonstandard insurance segment's internal growth (i.e., National) increased consolidated earned premiums by 1.3% from the previous period.
State Auto P&C and Milbank, which represents State Auto Financial's standard insurance segment, achieved a 10.7% increase in the standard segment's earned premiums in both personal and commercial lines in 1998. Of the 10.7% increase, 7.6% was due to the change in the Pooling Arrangement and 3.1% was due to internal growth.
The nonstandard segment (National) increased its earned premiums in 1998 19.0%. This segment's growth has slowed compared to prior year levels due to aggressive underwriting action designed to improve profitability in Tennessee and Arkansas (National's two largest states), a more restrictive underwriting posture with several larger producers in its other states and rate increases implemented during 1997 in several operating states. While these actions have resulted in a decrease in growth over prior year levels, National's statutory loss experience has improved over comparative prior
periods. See discussion below. National began operations in four new states during 1998: Indiana, Pennsylvania, Utah and Wisconsin.
The Company has attempted to address the difficulties of securing growth by making selective acquisitions, which afford opportunities for increased writings in new, desirable states of operation. Within the last eight years, entry into new states, other than Oklahoma, has been by acquisition. In 1993, Mutual acquired Milbank which took the State Auto Insurance Companies into South and North Dakota, Minnesota and Utah. In 1997 Mutual acquired Midwest Security, thus entering Wisconsin. In 1999, State Auto Financial acquired Farmers Casualty and Mid-Plains taking the State Auto Insurance Companies into Iowa and Kansas. Though all of these acquisitions have been primarily personal lines companies, they have taken the Company into additional targeted states with an established independent agency force with an existing book of business on which to build. Management believes this reduces start up costs and permits faster growth in new states than has been the case with starting in a new state from scratch. With an established agency force, the Company has a "ready made" distribution force for offering an expanded product portfolio, including commercial lines and additional personal lines products.
The investment yields, based on fixed and equity securities at cost, were 5.7% and 6.0% for the annual periods ending 1998 and 1997, respectively. Contributing to the decrease in the investment yields over these periods has been a decline in the overall market fixed maturity interest rate environment from the previous comparable periods as well as a gradual shift in the composition of the fixed maturity portfolio from taxable to tax-exempt fixed maturities. At December 31, 1998 and 1997, respectively, tax exempt securities comprised approximately 71% and 59% of the fixed maturity portfolio. Despite these lower yielding rates, the Company has no intention of compromising the quality of its portfolio for higher yielding, more risky investments. Additionally, the Company began a program in late 1997 to build on the equity portfolio to enhance growth of statutory surplus over the long term, which continued in 1998. See further discussion regarding investments at the Investments and Market Risk sections included herein.
Losses and loss expenses, as a percentage of earned premiums, were 68.0% and 65.1% for years 1998 and 1997, respectively. As previously discussed, the Company experienced increased levels in storm-related catastrophe losses in 1998, primarily in the standard insurance segment. The second
quarter 1998 was impacted by storm-related catastrophe losses occurring in nearly all operating states and the third quarter was adversely affected by several Midwestern wind and hail storms. The impact of the 1998 catastrophe losses amounted to 8.1 GAAP loss ratio points whereas catastrophe losses in 1997 totaled 2.4 GAAP loss ratio points. Despite the higher level of catastrophe losses as compared to 1997, the Company did not experience any significant loss activity from hurricanes Bonnie, Earl and Georges. The relatively low level of hurricane losses within the last three years validates the Company's strategy of closely monitoring concentration of risks subject to coastal losses. Absent the increased level of catastrophes, the Company's underlying book remained strong and in fact, reflects improvement from prior years, validating the Company's philosophy of responsible underwriting versus emphasis on premium growth achieved through irresponsible pricing or risk selection.
Net cash provided by or used in financing activities consists of proceeds from issuance of common stock and payment of dividends to shareholders. Mutual, whose ownership in State Auto Financial is approximately 70%, has waived its right to receipt of the dividends declared by State Auto Financial in an effort to enhance the statutory surplus of the insurance subsidiaries of State Auto Financial for use in support of underwriting operations. Prior to the declaration of each dividend by State Auto Financial, Mutual's directors review the facts and circumstances then present in deciding whether to waive such dividend.
In 1996, the State Auto Insurance Companies negotiated a change in their catastrophe reinsurance program. In 1998, Midwest Security and 1999, Farmers Casualty and Mid-Plains, became parties to the catastrophe reinsurance program. The amount retained by the State Auto Insurance Companies is $40.0 million for each occurrence, an increase of $20.0 million over the prior program. For up to $80.0 million in losses, excess of $40.0 million, traditional reinsurance coverage is provided. State Auto P&C assumed catastrophe reinsurance from Mutual, Milbank, Midwest Security, Farmers Casualty, National and Mid-Plains in the amount of $100 million excess of $120 million. Effective November 1999, the catastrophe reinsurance program was renegotiated whereby State Auto P&C assumes $135 million excess of $120 million. This layer of $135 million in excess of $120 million has been excluded from the Pooling Arrangement. There have been no losses assumed under this agreement.
To provide funding if the State Auto Insurance Companies were to incur catastrophe losses in excess of $120.0 million, State Auto Financial entered into a structured contingent financing transaction with a financial institution and a syndicate of other lenders (the Lenders) to provide up to $135.0 million for reinsurance purposes. In the event of such a loss, this arrangement provides that State Auto Financial would sell redeemable preferred shares to SAF Funding Corporation, a special purpose company (SPC), which would borrow the money necessary for such purchase from the Lenders. State Auto Financial would then contribute to State Auto P&C the funds received from the sale of its preferred shares. State Auto P&C would use the contributed capital to pay its direct catastrophe losses and losses assumed under the catastrophe reinsurance agreement. State Auto Financial is obligated to repay SPC (which would repay the Lenders) by redeeming the preferred shares over a six-year period. In the event of a default by State Auto Financial, the obligation to repay SPC has been secured by a Put Agreement
The primary investment objectives of the Company are to generate income, preserve capital and maintain adequate liquidity for the payment of claims. Fixed maturities that are purchased with the intention and ability of holding them until maturity are categorized as held to maturity and carried at amortized cost. Fixed maturities that may be sold due to changing investment strategies are categorized as available for sale and are carried at fair value. At December 31, 1999, the Company had no fixed maturity investments rated below investment grade, nor any mortgage loans.
The Company has minimal exposure to foreign currency exchange rate risk and it does not own any derivative financial instruments. To provide the Company greater flexibility in order to manage its market risk exposures, the Company has segregated a portion of its fixed maturity investments, in accordance with SFAS No. 115, as available for sale. Also, the Company does not maintain a trading portfolio.
In prior years, the Company discussed the nature and progress of its plans to become Year 2000 ready. In late 1999, the Company completed its remediation and testing of systems. As a result of those planning and implementation efforts, the Company experienced no significant disruptions in mission critical information technology, agent management systems, upload/download software and non-information technology systems and believes those systems successfully responded to the Year 2000 date change. The Company expensed approximately $0.5 million during 1999 in connection with remediating its systems. The Company is not presently aware of any material problems resulting from year 2000 issues, whether with its products, its internal systems, or the products and services of third parties. The Company will continue to monitor its mission critical computer applications and those of its suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly.
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 limitations imposed for competitive pricing. Inflation has been modest over the last several years thereby allowing pricing of premiums to keep pace with inflation on certain lines of business.
weather-related events, other types of catastrophic events, fluctuations of securities markets, economic conditions, technological difficulties and advancements, availability of labor and materials in storm hit areas, late reported claims, previously undisclosed damage, utilities and financial institution disruptions, shortages of programmers, other types of technical and professional employees, and regulatory or governmental systems breakdowns, and other risks indicated in the Company's filing with the Securities and Exchange Commission, including the Company's Management's Discussion and Analysis for its year ended December 31, 1999.
We have audited the accompanying consolidated balance sheets of State Auto Financial Corporation and subsidiaries as of December 31, 1999 and 1998 and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of State Auto Financial Corporation and subsidiaries as of December 31, 1999 and 1998, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States.
- State Auto Property and Casualty Insurance Company (State Auto P&C), a South Carolina corporation - Milbank Insurance Company (Milbank), a South Dakota corporation - Farmers Casualty Insurance Company (Farmers Casualty), an Iowa corporation - State Auto National Insurance Company (National), an Ohio corporation - State Auto Insurance Company (SAIC), an Ohio corporation - Stateco Financial Services, Inc. (Stateco), an Ohio corporation - Strategic Insurance Software, Inc. (S.I.S.), an Ohio corporation, and majority-owned subsidiary
The following provides financial information for Milbank included in the accompanying financial statements for the year ended December 31, 1997:
SAIC was formed in 1999 to engage in the business of providing standard personal insurance to its policyholders through the use of leading edge technology within the independent agency system. Effective January 1, 2000, SAIC is chartered and licensed as a property and casualty insurer in the state of Ohio.
518 PML, an Ohio limited liability company, was formed in December 1997 to engage in the business of owning and leasing real and personal property to affiliated companies. As of January 1, 1998, State Auto P&C and Stateco became initial members of 518 PML. State Auto P&C contributed real property, while Stateco contributed $7.0 million in cash and real property.
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 recoverability of deferred policy acquisition costs. In connection with the determination of these items, management uses historical data and current business conditions to formulate estimates including assumptions related to the ultimate cost to settle claims. These estimates by their nature are subject to uncertainties for various reasons. The Company's results of operations and financial condition could be impacted in the future should the ultimate payments required to settle claims vary from the liability currently provided.
not included in the determination of net income. Gains and losses on the sale of equity securities are computed using the first-in, first-out method.
(f) SURPLUS NOTE RECEIVABLE In August 1998, State Auto Financial purchased $9.0 million of surplus notes from Farmers Casualty Company Mutual (FCCM), an Iowa domiciled standard property casualty insurer. In 1998, a plan to convert FCCM into a stock insurance company was approved by the board of FCCM, its policyholders and the Iowa Division of Insurance. The plan of conversion contemplated that State Auto Financial, in exchange for the redemption of the surplus notes, would acquire the newly issued shares of Farmers Casualty. Effective January 1, 1999, FCCM, renamed Farmers Casualty Insurance Company, became a wholly owned subsidiary of State Auto Financial.
(k) SOFTWARE REVENUE RECOGNITION S.I.S. recognizes revenue from license fees when the product is delivered and service revenue when services are performed. Costs of developing and testing new or enhanced software products are capitalized and are amortized on a product-by-product basis utilizing the straight-line method over a period not to exceed three years. Unamortized software development costs of $1,248,000 and $1,567,000 are included in accrued investment income and other assets at December 31, 1999 and 1998, respectively. Software amortization, included in other expenses, was $614,000, $673,000 and $489,000 in 1999, 1998 and 1997, respectively.
(l) FEDERAL INCOME TAXES The Company files a consolidated federal income tax return and pursuant to an agreement, each entity within the consolidated group pays its share of federal income taxes based on separate return calculations. Milbank filed a consolidated federal income tax return with the Company for periods subsequent to July 1, 1998. Prior to this time, Milbank was included in the consolidated federal income tax return of Mutual and its subsidiaries.
(m) CASH EQUIVALENTS For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments with a maturity of three months or less to be cash equivalents.
(n) OTHER COMPREHENSIVE INCOME 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 and excludes any impact of changes in minority interest of subsidiaries. Other comprehensive income includes all other non-owner related changes to equity and includes net unrealized gains and losses on available-for-sale fixed maturities and equity securities.
(o) NEW ACCOUNTING STANDARD In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133), which was required to be adopted in years beginning after June 15, 2000. SFAS No. 133 requires companies to recognize all derivatives on the balance sheet at fair value. Management believes SFAS No. 133 will not have a material impact on the Company upon adoption.
Nine STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company)
The Company's investments in held to maturity securities and available for sale securities are summarized as follows:
Deferred federal income taxes on the net unrealized holding gain for available for sale investments was $84,000 and $10,919,000 at December 31, 1999 and 1998, respectively.
The amortized cost and fair value of fixed maturities segregated by held to maturity and available for sale, at December 31, 1999, by contractual maturity, are summarized as follows:
Fixed maturities with carrying values of approximately $20,473,000 and $17,666,000 were on deposit as required by law or specific escrow agreement at December 31, 1999 and 1998, respectively.
YEAR ENDED DECEMBER 31 ---------------------- 1999 1998 1997 ---- ---- ---- (dollars in thousands)
Investment expenses .............. 219 296 259 ------------------------------------- Net investment income ............ $34,262 32,506 31,107 -------------------------------------
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.
CASH AND CASH EQUIVALENTS AND SURPLUS NOTE RECEIVABLE: The carrying amounts reported in the balance sheet for these instruments approximate their fair value.
The liability for losses and loss expenses decreased by $6,878,000 in 1999, $13,591,000 in 1998 and $17,432,000 in 1997, for claims that had occurred in prior years. These decreases have resulted primarily from moderating trends in the frequency and severity of losses and loss expenses due to medical cost containment, tort reform and lower inflation. This along with fundamental improvements primarily in the auto liability and workers' compensation lines of business resulted in incurred losses and loss expenses developing favorably. Because of the nature of the business written over the years, the Company's management believes that the Company has limited exposure to environmental claim liabilities.
Since 1995, State Auto P&C and Milbank have participated in the Pooling Arrangement with Mutual. During 1997 the aggregate pooling participation percentage of the Pooled Subsidiaries was 45%. Effective January 1, 1998, the Pooled Subsidiaries aggregate participation in the Pooling Arrangement increased from 45% to 47% and Midwest Security Insurance Company (Midwest), a wholly-owned subsidiary of Mutual, became a participant in the Pooling Arrangement. On January 1, 1999, Farmers Casualty was acquired by State Auto Financial and became a participant in the Pooling Arrangement on that same date, at which time the Pooled Subsidiaries' aggregate participation increased to 50%. In conjunction with these changes in pool participation, the Pooled Subsidiaries received cash from Mutual of $11.4 million and $19.7 million, which related to the additional net insurance liabilities assumed by the Pooled Subsidiaries on January 1, 1999 and 1998, respectively. Effective January 1, 2000, the Pooling Arrangement was amended to make SAIC a participant in the Pooling Arrangement and the Pooled Subsidiaries aggregate participation increased to 53%. In conjuction with this change in pool participation, the Pooled Subsidiaries, which effective January 1, 2000 includes SAIC, received cash from Mutual of $18.6 million, which related to the additional net insurance liabilities assumed by the Pooled Subsidiaries on January 1, 2000. All parties that participate in the Pooling Arrangement have an A. M. Best rating of A+ (Superior).
Earned premiums: Ceded .............................. $(395,698) (356,638) (342,309) Assumed ............................ 358,700 328,144 296,046
Losses and loss expenses incurred: Ceded .............................. $(268,536) (252,795) (236,456) Assumed ............................ 242,935 223,641 191,436
During 1996, Mutual, State Auto P&C, Milbank and National negotiated a change in their catastrophe reinsurance program. In 1998, Midwest Security and 1999, Farmers Casualty and Mid-Plains, became parties to the catastrophe reinsurance program. Collectively, these participants in the catastrophe reinsurance program are referred to as the "State Auto Insurance Companies." State Auto P&C assumed catastrophe reinsurance from Mutual, Milbank, Midwest Security, Farmers Casualty, National and Mid-Plains in the amount of $100 million excess of $120 million. Effective November 1999, the catastrophe reinsurance program was renegotiated whereby State Auto P&C assumes $135 million excess of $120 million. Under this agreement, the Company has assumed from Mutual and its affiliate premiums written and earned of $2,355,000, $2,475,000 and $2,505,000 for 1999, 1998 and 1997, respectively. There have been no losses assumed under this agreement. This layer of $135 million in excess of $120 million has been excluded from the Pooling Arrangement.
(b) INTERCOMPANY BALANCES Pursuant to the Pooling Arrangement, Mutual is responsible for the collection of premiums and payment of losses, loss expenses and underwriting expenses of the Pooled Subsidiaries. Unpaid balances are reflected in due to or due from affiliates in the accompanying consolidated balance sheets. Settlements of the intercompany account are made quarterly. No interest is paid on this account. All premium balance receivables and reinsurance recoverable on paid losses from unaffiliated reinsurers are carried by Mutual. The Company had off-balance-sheet credit risk of approximately $47 million and $40 million related to premium balances due to Mutual from agents and insureds at December 31, 1999 and 1998, respectively.
(c) NOTE PAYABLE State Auto Financial entered into a line of credit agreement with Mutual for $45.5 million in conjunction with its stock repurchase program, at an interest rate of 6.0%. See related footnote at note 9 (b). Principal payment is due on demand after December 31, 2000, with final payment to be received on or prior to December 31, 2005. The interest rate is adjustable annually after the year 2000 to reflect adjustments in the then current prime lending rate as well as State Auto Financial's current financial position. Interest expense on the loan from Mutual was $955,000 in 1999.
State Auto P&C provides Mutual and its insurance affiliate executive management services to oversee the insurance operations of these companies. Revenue relating to these services amount to $5,628,000, $4,908,000 and $4,563,000 in 1999, 1998 and 1997, respectively. Stateco provides Mutual and its affiliate investment management services. Revenue related to these services amount to $3,099,000, $3,037,000 and $2,804,000 in 1999, 1998 and 1997, respectively.
State Auto P&C's December 31, 1990 liability for losses and loss expenses of $65,464,000 has been guaranteed by Mutual. Pursuant to the guaranty agreement, all ultimate adverse development of the December 31, 1990 liability, if any, is to reimbursed by Mutual to State Auto P&C in conformance with pooling percentages in place at that time. As of December 31, 1999, there has been no adverse development of the liability.
Federal income taxes paid during 1999, 1998 and 1997 were $12,621,000, $11,768,000 and $14,254,000, respectively.
COMPONENTS OF NET PERIODIC BENEFIT Service cost ........................... $ 2,047 1,686 1,548 Interest cost .......................... 3,278 2,977 2,760 Expected return on plan assets ......... (6,125) (5,430) (4,742) Amortization of prior service cost ..... 114 114 114 Amortization of transition asset ....... (124) (121) (121) Amortization of net gain ............... 7 (8) (3) --------------------------------- Net periodic benefit ................... $ (803) (782) (444) ---------------------------------
YEAR ENDED DECEMBER 31 ---------------------- 1999 1998 1997 ---- ---- ----
State Auto P&C, Stateco and S.I.S. are also participants with Mutual in a defined contribution plan that covers substantially all employees of Mutual and the Company. Contributions to the plan are based on employee contributions and the level of Company match. The Company's share of the expense under the plan totaled $852,000, $782,000 and $726,000 for the years 1999, 1998 and 1997, respectively.
On June 2, 1998, State Auto Financial's authorized capital was increased to 100,000,000 shares of common stock and State Auto Financial's Board of Directors declared a two-for-one common stock split. The financial statements, notes and other references to share information and per share data have been given retroactive effect to reflect the stock splits for all periods presented.
(10) PREFERRED STOCK State Auto Financial has authorized two classes of preferred stock. For both classes, upon issuance, the Board of Directors has authority to fix and determine the significant features of the shares issued, including, among other things, the dividend rate, redemption price, redemption rights, conversion features and liquidation price payable in the event of any liquidation, dissolution, or winding up of the affairs of State Auto Financial. See note 6 (a) regarding State Auto Financial's obligation to issue redeemable preferred shares to SPC in connection with its catastrophic reinsurance arrangements with a financial institution.
Pro forma net earnings per common share Basic ........................................ $ 1.02 0.85 0.96 Diluted ...................................... $ 1.00 0.83 0.94
The Company has stock option plans for certain directors and key employees of Mutual, State Auto P&C, Stateco and S.I.S. The nonemployee directors' plan provides each nonemployee director an option to purchase 1,000 shares of common stock following each annual meeting of the shareholders at an option price equal to the fair market value at the last business day prior to the annual meeting. The Company has reserved 300,000 shares of common stock under this plan. These options are exercisable at issuance to 10 years from date of grant. The key employee's plan provides that qualified stock options may be granted at an option price not less than fair market value at date of grant and that nonqualified stock options may be granted at any price determined by the options committee of the Board of Directors. The Company has reserved 3,600,000 shares of common stock under this plan. These options are exercisable at such time or times as may be determined by a committee of the Company's Board of Directors. Normally, for certain employees these options are exercisable from 1 to 10 years from date of grant and 3 to 10 years for remaining employees.
The Company evaluates performance and allocates resources based on profit or loss from operations, excluding net realized gains on investments on the Company's investment portfolio, before federal income taxes. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies.