With the acquisition of the Rockhill Insurance Group and the build out of RED, in 2010, management focused on assessing and positioning a realignment of our internal organization, including people, processes and compensation reward programs, to be more strategic in the personal, business and specialty insurance markets. Considering these internal changes, and with the inclusion of the Rockhill Insurers into the Pooling Arrangement as of January 1, 2011, our reportable insurance segments will change from personal and business insurance to personal insurance, business insurance and specialty insurance, aligning how these insurance segments report to our principal operating decision makers.
Underwriting profitably requires more than sensible pricing, coverage enhancements and discerning risk evaluation. By reducing the per policy costs of operating our business, we increase the profit margin. In early 2009, we began a restructuring of our field and claims operations. We are seeing productivity and expense ratio improvements. The restructuring meant a reduction in both the personal and commercial lines staffs and an increase in our information technology and claims personnel. While difficult for us, these reductions were necessary, and we believe we handled the reductions with sensitivity, including providing severance packages and retirement incentives to those associates affected.
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 accumulated other comprehensive income (loss). Future increases or decreases in fair value, if not other-than-temporary, are included in accumulated other comprehensive income (loss).
In November 2009, we announced to our employees a one-time election to select between two retirement benefit options: to either continue participation in the existing defined benefit pension plan with no changes; or to choose a new defined contribution plan in which we automatically contribute a percentage of the employee’s annual income resulting in a freeze to the employee’s existing accrued defined pension benefit. On May 31, 2010, employees’ elections were finalized which resulted in a $2.4 million curtailment gain on this date.
Charges related to the restructuring of our field and claims operations, as well as those recorded due to the North Carolina Beach Plan write-off in 2009, contributed to the difference between our GAAP expense ratio and our SAP expense ratio. The restructuring differences relate mainly to the timing of the recognition of employee
Standard personal auto net written premiums for the year ended December 31, 2010 increased 6.8% compared to the same 2009 period. Rate increases contributed to approximately half of this premium growth, while the State Auto Group’s expansion of its operations within four of our newer states, Texas, Colorado, Arizona and Connecticut, contributed to the balance. Net written premiums for the year ended December 31, 2009 increased 15.4% compared to the same 2008 period. The expansion into Texas, Colorado, Arizona and Connecticut contributed to approximately 5 points of this growth in 2009, and rate increases also contributed to this growth. While growth continues to be strong, we are experiencing a slowdown in new business and a lower issue-to-quote ratio which we attribute to the impact of our rate increases.
We continue to invest in products, processes and systems that we believe will increase our business insurance writings. We have implemented a pricing process that we believe will help us price property, liability, auto and workers’ compensation risks at appropriate levels. In addition, we have broadened our property, liability, auto and workers’ compensation pricing ranges to improve our ability to recognize the spectrum of risks within our markets.
The favorable development in 2008 came primarily from accident year 2007. The more notable items contributing to the 2008 favorable development were:
At December 31, 2010, 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 amount of interest earned on our fixed maturity securities declined due to a shift in this portfolio to holding higher levels of taxable bonds with shorter durations and lower rates of return and fewer long duration tax exempt bonds earning higher rates of return. Also contributing to the decrease in net investment income was an increase in the call activity on our higher yielding bonds when compared to 2009 and 2008.
Our insurance subsidiaries must have adequate liquidity to ensure that their cash obligations are met. However, because the STFC Pooled Companies participate in the Pooling Arrangement, they do not have the daily liquidity concerns normally associated with an insurance company. This is because under the terms of the Pooling Arrangement, State Auto Mutual receives all premiums and pays all losses and expenses associated with the insurance business produced by the pool participants and then settles the intercompany balances generated by these transactions with the participating companies within 45 days following each quarter end.
At the beginning of 2009, we held higher levels of cash as a result of our conservative approach to investing as markets weakened in the last half of 2008 and because of our need to pay claims associated with the higher level of catastrophes occurring during the second half of 2008. During 2009, as markets improved and claim activity returned to more normal levels, we began reinvesting as opportunities arose, including loaning State Auto Mutual $70.0 million.
The leverage ratios increased in 2010. While premiums grew 9.3%, surplus declined 1.7%. Of the total $13.7 million decline in surplus, $40.8 million was related to the dividends and sale of SA National. At December 31, 2009, SA National had $61.8 million in surplus, and of the dividends paid to STFC during 2010, $21.0 million was contributed from STFC to State Auto P&C. Offsetting the SA National decline was the 2010 unrealized holding gains on investments and net income on the remaining insurance subsidiaries.
The published financial strength ratings on the insurance company subsidiaries of State Auto Financial are opinions as to the ability of those companies to meet their ongoing obligations to their policyholders. The A.M. Best financial strength ratings influence 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. State Auto Mutual has received A.M. Best’s A+ or higher rating every year since 1954. The STFC Pooled Companies and the Mutual Pooled Companies are collectively assigned a pool rating by A.M. Best.
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,
The following table sets forth net deferred acquisition costs for the years ended December 31, 2010, 2009 and 2008:
Level 2 includes observable inputs for assets or liabilities other than quoted prices included in Level 1, and it includes valuation techniques which use prices for similar assets and liabilities.
The following table sets forth the status of the Company’s non-vested and vested restricted shares and changes for the years ended December 31, 2010, 2009 and 2008:
Aggregate intrinsic value for total options outstanding at December 31, 2010 is $3.1 million. Aggregate intrinsic value for total options exercisable at December 31, 2010 is $0.8 million.
As of January 1, 2011, the Pooling Arrangement was amended to add Rockhill Insurance Company, Plaza Insurance Company, American Compensation Insurance Company and Bloomington Compensation Insurance Company, each of which are subsidiaries of State Auto Mutual (collectively, the “Rockhill Insurers”), to the pool, each with a participation percentage of 0.0%.