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| STFC > SEC Filings for STFC > Form 10-Q on 6-May-2009 | All Recent SEC Filings |
6-May-2009
Quarterly Report
The term "State Auto Financial" as used below refers only to State Auto Financial Corporation and the terms "our Company," "we," "us," and "our" as used below refer to State Auto Financial Corporation and its consolidated subsidiaries. The term "first quarter" as used below refers to the three months ended March 31 for the time period then ended. The term "SAP" as used below refers to Statutory Accounting Principles and the term "GAAP" as used below refers to U.S. Generally Accepted Accounting Principles.
The discussion and analysis presented below relates to the material changes in financial condition and results of operations for our consolidated balance sheets as of March 31, 2009 and December 31, 2008, and for the consolidated statements of income for the three-month periods ended March 31, 2009 and 2008. This discussion and analysis should be read together with "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for our year ended December 31, 2008 (the "2008 Form 10-K"), and in particular the discussions in those sections thereof entitled "Executive Summary" and "Critical Accounting Policies." Readers are encouraged to review the entire 2008 Form 10-K, as it includes information regarding our Company not discussed in this Form 10-Q. This information will assist in your understanding of the discussion of our current period financial results.
The discussion and analysis presented below includes forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements generally can be identified by the use of forward-looking terminology such as "may," "will," "expect," "intend," "estimate," "anticipate," "project," "believe" or "continue" or the negative thereof or variations thereon or similar terminology. Forward-looking statements speak only as of the date the statements were made. Although we believe that the expectations reflected in forward-looking statements have a reasonable basis, we can give no assurance that these expectations will prove to be correct. Forward-looking statements are subject to risks and uncertainties that could cause actual events or results to differ materially from those expressed in or implied by the statements. For a discussion of the most significant risks and uncertainties that could cause our actual results to differ materially from those projected, see "Risk Factors" in Item 1A of the 2008 Form 10-K, updated by Part II, Item 1A of this Form 10-Q. Except to the limited extent required by applicable law, we undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
We have three significant reportable segments - personal insurance, business insurance, and investment operations. The reportable insurance segments are business units managed separately because of the differences in the type of customers they serve or products they provide or services they offer. The insurance segments operate in 33 states and distribute their products through the independent insurance agency system. The personal insurance segment provides primarily personal auto (standard and nonstandard) and homeowners insurance to the personal insurance market. The business insurance segment provides primarily commercial auto, commercial multi-peril, fire and allied lines, other and product liability and workers' compensation insurance to small-to-medium sized businesses within the commercial insurance market. Our investable assets, the investment operations segment, are managed by our subsidiary Stateco Financial Services, Inc. ("Stateco"). Our investment portfolio is comprised primarily of publicly traded fixed income and equity securities. Financial information about our segments is set forth in Note 8 of our Condensed Consolidated Financial Statements included in Item 1 of this Form 10-Q.
A quota share reinsurance pooling arrangement (the "Pooling Arrangement") exists between State Auto Property & Casualty Insurance Company ("State Auto P&C"), Milbank Insurance Company ("Milbank"), Farmers Casualty Insurance Company ("Farmers"), and State Auto Insurance Company of Ohio ("SA Ohio") (collectively referred to as the "STFC Pooled Companies") and State Automobile Mutual Insurance Company ("State Auto Mutual") and its subsidiaries and affiliates, State Auto Insurance Company of Wisconsin ("SA Wisconsin"), State Auto Florida Insurance Company ("SA Florida"), Meridian Citizens Mutual Insurance Company ("Meridian Citizens Mutual"), Meridian Security Insurance Company ("Meridian Security"), Patrons Mutual Insurance Company of Connecticut ("Patrons Mutual"), and Litchfield Mutual Fire Insurance Company ("Litchfield") (collectively referred to as the "Patrons Insurance Group"), and Beacon National Insurance Company ("Beacon National") (collectively referred to as the "Mutual Pooled Companies"). Together, the STFC Pooled Companies and Mutual Pooled Companies are collectively referred to as the "Pooled Companies" or the "State Auto Pool." The State Auto Pool has an A.M. Best rating of A+ (Superior). See "Important Defined Terms Used" in the 2008 Form 10-K.
As of January 1, 2008, the Pooling Arrangement was amended, adding (the "Pooling Change") Beacon National, Patrons Mutual and Litchfield as participants and to add the middle market business of State Auto Mutual and Meridian Security to the Pooling Arrangement.
The Pooled Companies and State Auto National Insurance Company ("SA National") are collectively referred to herein as the "State Auto Group."
RESULTS OF OPERATIONS
We recognized net losses of $14.0 million and $12.5 million for the three-month periods ended March 31, 2009 and 2008, respectively. The first quarter 2009 pretax loss totaled $30.9 million while 2008 first quarter pretax loss was $15.0 million. First quarter 2009 results were negatively impacted by an increased level of realized investment losses, and a decline in investment income in our investment segment, as well as an increased level of catastrophe losses in our insurance segments. Our GAAP loss and loss expense ratios for the first quarters 2009 and 2008 were 78.6% and 76.8%, respectively.
The following table summarizes certain key performance metrics for first quarters 2009 and 2008 that we use to monitor our financial performance:
($ millions, except per share amounts) Three months ended
March 31
GAAP Basis: 2009 2008
Total revenue $ 294.0 301.0
Net loss $ (14.0 ) (12.5 )
Stockholders' equity $ 760.7 882.4
Book value per share $ 19.21 22.18
Debt to capital ratio 13.4 11.8
Loss and LAE ratio(1) 78.6 % 76.8
Expense ratio(1) 33.4 % 34.5
Combined ratio(1) 112.0 % 111.3
Catastrophe loss and LAE points 15.3 12.5
Premium written growth(2) 5.7 % 31.4
Premium earned growth 2.4 % 10.8
Investment yield 3.5 % 4.2
Three months ended
March 31
SAP Basis: 2009 2008
Loss and LAE ratio(3) 78.1 % 76.4
Expense ratio(3) 32.5 % 32.4
Combined ratio(3) 110.6 % 108.8
Net premiums written to surplus(4) 1.6 1.2
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(1) Defined below.
(2) 21.6 points of the percentage increase for 2008 related to the one-time $53.6 million transfer of unearned premium to us on January 1, 2008, in conjunction with the Pooling Change.
(3) SAP loss and LAE ratio is losses and loss expenses as a percentage of net earned premium. SAP expense ratio is statutory underwriting expenses and miscellaneous expenses offset by miscellaneous income ("underwriting expenses") as a percentage of net written premiums. SAP combined ratio is the sum of the SAP loss and LAE ratio and the SAP expense ratio.
(4) We use the statutory net premiums written to surplus ratio as there is no comparable GAAP measure. This is a twelve-month rolling ratio, also called the leverage ratio, which measures a company's statutory surplus available to absorb losses.
Insurance Segments
Insurance industry regulators require our insurance subsidiaries to report their financial condition and results of operations using SAP. We use SAP financial results, along with industry standard financial measures determined on a SAP basis and certain measures determined on a GAAP basis, to internally monitor the performance of our insurance segments. The more common financial measures used are loss and LAE ratios, underwriting expense ratio, combined ratio, net premiums written and net premiums earned. The combined ratio is the sum of the loss and LAE ratio and the underwriting expense ratio. When the combined ratio is less than 100%, the insurer is operating at an underwriting gain and when it is greater than 100%, the insurer is operating at an underwriting loss. Underwriting gain (loss) is determined by subtracting from net earned premiums, losses and loss expenses and underwriting expenses.
One of the more significant differences between GAAP and SAP is that SAP requires all underwriting expenses to be expensed immediately and not deferred over the same period that the premium is earned. In converting SAP underwriting results to GAAP underwriting results, acquisition costs are deferred and amortized over the periods the related written premiums are earned. For a discussion of deferred policy acquisition costs see "Critical Accounting Policies - Deferred Acquisition Costs" included in Item 7 of our 2008 Form 10-K. The "GAAP combined ratio" is defined as the sum of the "GAAP loss and LAE ratio" (loss and loss expenses as a percentage of earned premiums) plus "GAAP expense ratio" (acquisition and operating expenses as a percentage of earned premiums).
All references to financial measures or components thereof in this discussion are calculated on a GAAP basis, unless otherwise noted.
The following tables provide a summary of our insurance segments' SAP underwriting gain or loss and SAP combined ratio for the first quarters of 2009 and 2008:
($ millions) Quarter ended
March 31, 2009
% % %
Personal Ratio Business Ratio Total Ratio
Net written premiums $ 174.0 $ 113.1 $ 287.1
Net earned premiums 173.8 112.2 286.0
Losses and loss expenses 149.7 86.1 73.6 65.6 223.3 78.1
Underwriting expenses 51.2 29.4 42.1 37.2 93.3 32.5
SAP underwriting loss and SAP combined ratio $ (27.1 ) 115.5 $ (3.5 ) 102.8 $ (30.6 ) 110.6
($ millions) Quarter ended
March 31, 2008
% % %
Personal Ratio Business Ratio Total Ratio
Net written premiums(1) $ 182.2 $ 143.0 $ 325.2
Net earned premiums 165.2 114.0 279.2
Losses and loss expenses 130.8 79.2 82.5 72.4 213.3 76.4
Underwriting expenses 51.8 28.4 53.5 37.4 105.3 32.4
SAP underwriting loss and SAP combined ratio $ (17.4 ) 107.6 $ (22.0 ) 109.8 $ (39.4 ) 108.8
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(1) Includes the one-time transfer of $53.6 million of unearned premiums to us on January 1, 2008, in conjunction with the Pooling Change ($24.8 million for our personal insurance segment and $28.8 million for our business insurance segment).
Revenue
We measure our top-line growth for our insurance segments based on net written premiums, which represent the premiums on the policies we have issued for a period, net of reinsurance. Net written premiums provide us with an indication of how well we are doing in terms of revenue growth before it is actually earned. Our policies provide a fixed amount of coverage for a stated period of time, often referred to as "the policy term." As such, our written premiums are recognized as earned ratably over the policy term. The unearned portion of written premiums, called unearned premiums, is reflected on our balance sheet as a liability and represents our obligation to provide coverage for the unexpired terms of the policy.
The following table shows the one-time impact on net written premiums of the unearned premiums transferred to us on January 1, 2008, in conjunction with the Pooling Change for the three months ended March 31, 2008.
Net Written Premiums
Reconciliation Table
($ millions) Including Pooling Excluding
Pooling Change Pooling
Change Impact Change
Personal insurance segment:
Standard auto $ 101.4 $ 7.9 $ 93.5
Nonstandard auto 12.3 - 12.3
Homeowners 59.1 14.4 44.7
Other personal 9.4 2.5 6.9
Total personal 182.2 24.8 157.4
Business insurance segment:
Commercial auto 36.6 10.0 26.6
Commercial multi-peril 31.0 6.1 24.9
Fire & allied lines 28.1 5.7 22.4
Product & other liability 24.7 3.9 20.8
Workers' compensation 13.3 2.0 11.3
Other business 9.3 1.1 8.2
Total business 143.0 28.8 114.2
Total personal & business $ 325.2 $ 53.6 $ 271.6
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Personal Insurance Segment Revenue
Our personal insurance segment consists primarily of auto (standard and nonstandard) and homeowners products, with personal auto representing 41.1% of our total consolidated net written premiums. The following tables provide a summary of written and earned premiums, net of reinsurance, by major product line of business for our personal insurance segment for the first quarters of 2009 and 2008. The one-time impact of the Pooling Change has been excluded for 2008 to present net written premiums on a comparative basis (see Net Written Premium Reconciliation Table above):
($ millions) Net Written Premiums
%
2009 2008 Change
Personal insurance segment:
Standard auto $ 106.8 93.5 14.2
Nonstandard auto 11.2 12.3 (8.9 )
Homeowners 48.5 44.7 8.5
Other personal 7.5 6.9 8.7
Total Personal $ 174.0 157.4 10.5
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($ millions) Net Earned Premiums
%
2009 2008 Change
Personal insurance segment:
Standard auto $ 101.5 93.5 8.6
Nonstandard auto 10.0 10.8 (7.4 )
Homeowners 54.8 53.9 1.7
Other personal 7.5 7.0 7.1
Total Personal $ 173.8 165.2 5.2
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Standard auto net written premium grew 14.2% in the first quarter of 2009 from the same 2008 period. Our new products and advanced technology have strengthened our position with our independent agencies and allowed us to take advantage of consumers looking for greater value in their insurance products. Consequently, the number of our new business quotes on personal lines increased significantly in the first quarter of 2009 in comparison to the same 2008 period. While the number of new business quotes is higher, our issue to quote ratio has remained relatively consistent with prior years. Growth was also driven by the State Auto Group's entry into and development of new states by expansion and acquisition. Two of our relatively new states, Texas and Arizona, have contributed a significant portion of this growth.
Nonstandard auto net written premium decreased 8.9% in the first quarter of 2009 from the same 2008 period. In 2008, we began increasing rates and tightening underwriting controls, and beginning in 2009 terminating certain agencies that failed to consistently perform to our expectations. In the first quarter 2009, we implemented rate increases in 10 of our operating states, resulting in an average increase of 3.0% in these states. These actions have slowed new business writings for the nonstandard auto line of business.
Homeowners net written premiums increased 8.5% in first quarter of 2009 from the same 2008 period. New business in Texas and Arizona contributed to this growth as well as rate changes taken in several of our states. We continue to aggressively address our rate needs in this line of business, with substantially higher rate changes filed and planned to be effective in the second and third quarters of this year.
Our strategy to grow our personal lines business includes introducing our products, enhanced systems and easier technologies into new states. During the first quarter 2009, we began introducing our personal lines products and technologies into Connecticut through the independent agent distribution channel as a result of State Auto Mutual's affiliation with the Patrons Insurance Group.
Business Insurance Segment Revenue
We focus our business insurance sales on small-to-medium sized businesses within the commercial insurance market and offer a broad range of both property and liability coverages such as commercial auto, commercial multi-peril, fire and allied lines, other and products liability and workers' compensation.
The following table provides a summary of written and earned premiums, net of reinsurance, by major product line for our business insurance segment for the first quarters of 2009 and 2008. The one-time impact of the Pooling Change has been excluded for 2008 to present net written premiums on a comparative basis (see Net Written Premium Reconciliation Table above):
($ millions) Net Written Premiums
%
2009 2008 Change
Business insurance segment:
Commercial auto $ 26.0 26.6 (2.3 )
Commercial multi-peril 24.2 24.9 (2.8 )
Fire & allied lines 24.5 22.4 9.4
Other & product liability 19.3 20.8 (7.2 )
Workers' compensation 12.6 11.3 11.5
Other commercial 6.5 8.2 20.7
Total business $ 113.1 114.2 (1.0 )
($ millions) Net Earned Premiums
%
2009 2008 Change
Business insurance segment:
Commercial auto $ 27.2 27.8 (2.2 )
Commercial multi-peril 24.0 24.8 (3.2 )
Fire & allied lines 23.8 23.6 0.8
Other & product liability 19.4 20.5 (5.4 )
Workers' compensation 10.9 10.3 5.8
Other commercial 6.9 7.0 (1.4 )
Total business $ 112.2 114.0 (1.6 )
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The business insurance segment net written premiums for first quarter 2009 decreased 1.0% from the same 2008 period. Business insurance continues to be impacted by rate competition as well as ease of doing business issues. It will be difficult to generate measurable growth given the impact of the economy on premium bases such as payrolls, sales, and number of vehicles. However, we are seeking to balance our traditional underwriting discipline with new products and pricing tools that support the production of profitable new business.
We continue to invest in products, processes and systems that we believe will increase our business insurance writings. We have expanded our marketability by introducing new products and enhancing existing products. For our property and liability business, we have implemented a more granular pricing process that we believe will help us price risks more accurately and improve account retention; we are pursuing the same for our commercial auto and workers compensation lines of business. In addition, we have broadened our property, liability, auto and workers compensation pricing ranges to recognize better the spectrum of risks within our markets.
We also continue to enhance our back office systems, such as enhancements to our insurance policy administration system, to make it easier for our agents to quote and submit business insurance policies to us. Our system now allows transactions to be processed throughout the day using real-time and straight-through processing rather than in large batch cycles at night. Besides the efficiency gains we have achieved for employees, we have leveraged this real-time and straight-through processing functionality with bizXpressSM., our web-based quote system that gives agents the ability to quote business owners and commercial auto risks on-line.
We are working to expand the scope of bizXpress to add new products and lines of business, including workers' compensation. We believe this technology investment should better position us for revenue growth opportunities in the future and start to drive efficiencies into our business model much like we have seen in personal insurance. The majority of all transactions in business insurance utilize the straight-through processing technology. This has resulted in faster delivery of policies to our agents and their insureds for new business and endorsements.
Similar to our personal lines segment, we are leveraging our relationship with the agency distribution channel as a result of State Auto Mutual's affiliation with the Patrons Insurance Group. We introduced our commercial package, auto and workers' compensation products in Connecticut in the first quarter of 2009.
Loss and LAE
Our GAAP loss and LAE ratio was 78.6% and 76.8% for the first quarter of 2009 and 2008, respectively. The increase in the loss ratio was primarily due to an increase in catastrophe storm losses. Catastrophe losses include losses that have been designated as such by ISO's Property Claim Services ("PCS") unit, a nationally recognized industry service. PCS defines catastrophes as events resulting in $25.0 million or more in insured losses industry wide and affecting significant numbers of insureds and insurers. Our catastrophe losses for the first quarter 2009 totaled $43.8 million (15.3 loss ratio points) compared to $35.0 million (12.5 loss ratio points) in the first quarter 2008. During the first quarter 2009, there were six PCS catastrophes, two of which were the primary contributors to our results. A January ice storm which affected large parts of Indiana and Kentucky and a windstorm in February which swept through the Midwest and Mid-Atlantic States accounted for the vast majority of our catastrophe losses in the quarter.
As of January 1, 2009, members of the State Auto Group entered into a property . . .
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