-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, TK//1E8p5iCat/rAesjmoLlHMFYeJXZT+IXzH+qN9Amd74lHE2O450eN3JlzeWXr aQNuj92VWj/NBBWiYjoiZg== 0000073952-05-000057.txt : 20050726 0000073952-05-000057.hdr.sgml : 20050726 20050726160751 ACCESSION NUMBER: 0000073952-05-000057 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20050630 FILED AS OF DATE: 20050726 DATE AS OF CHANGE: 20050726 FILER: COMPANY DATA: COMPANY CONFORMED NAME: OHIO CASUALTY CORP CENTRAL INDEX KEY: 0000073952 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 310783294 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-05544 FILM NUMBER: 05974329 BUSINESS ADDRESS: STREET 1: 9450 SEWARD ROAD CITY: FAIRFIELD STATE: OH ZIP: 45014 BUSINESS PHONE: 5136032400 MAIL ADDRESS: STREET 1: 9450 SEWARD ROAD CITY: FAIRFIELD STATE: OH ZIP: 45014 10-Q 1 f10q605.txt OHIO CASUALTY CORP FORM 10-Q 06/30/05 ============================================================================== UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-Q [x] Quarterly Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 2005. ------------- [ ] Transition Report Pursuant to Section 13 or 15 (d) of the Securities Exchange Act of 1934 For the transition period from to ---------------- ------------- Commission File Number 0-05544 OHIO CASUALTY CORPORATION (Exact name of registrant as specified in its charter) OHIO 31-0783294 (State or other jurisdiction of) (I.R.S. Employer) incorporation or organization) Identification No.) 9450 Seward Road, Fairfield, Ohio 45014 (Address of principal executive offices) (Zip Code) (513) 603-2400 (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No On July 25, 2005, there were 64,487,792 shares of common stock outstanding. Page 1 of 33 ============================================================================== INDEX ----- Page ---- PART I FINANCIAL INFORMATION Item 1. Financial Statements 3 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 18 Item 3. Quantitative and Qualitative Disclosures about Market Risk 31 Item 4. Controls and Procedures 31 PART II OTHER INFORMATION Item 4. Submission of Matters to a Vote of Security Holders 32 Item 6. Exhibits 32 Signature 33 Exhibit 10 Ohio Casualty Corporation 2005 Incentive Plan Exhibit 31.1 Certification of Chief Executive Officer of Ohio Casualty Corporation in accordance with SEC Rule 13(a)-14(a) and Rule 15(d)-14(a) Exhibit 31.2 Certification of Chief Financial Officer of Ohio Casualty Corporation in accordance with SEC Rule 13(a)-14(a) and Rule 15(d)-14(a) Exhibit 32.1 Certification of Chief Executive Officer of Ohio Casualty Corporation in accordance with Section 1350 of the Sarbanes-Oxley Act of 2002 Exhibit 32.2 Certification of Chief Financial Officer of Ohio Casualty Corporation in accordance with Section 1350 of the Sarbanes-Oxley Act of 2002 2 PART I FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS Ohio Casualty Corporation & Subsidiaries CONSOLIDATED BALANCE SHEETS
June 30, December 31, (in millions, except share data) 2005 2004 =========================================================================================== Assets (Unaudited) Investments, at fair value: Fixed maturities: Available-for-sale, at fair value (amortized cost: $3,354.5 and $3,176.8) $ 3,521.7 $ 3,346.1 Held-to-maturity, at amortized cost (fair value: $287.1 and $303.1) 283.3 301.4 Equity securities, at fair value (cost: $102.2 and $98.9) 356.8 357.4 Short-term investments, at fair value 24.7 239.1 - ------------------------------------------------------------------------------------------- Total investments 4,186.5 4,244.0 Cash 10.0 13.5 Premiums and other receivables, net of allowance 334.2 350.8 Deferred policy acquisition costs 152.9 159.8 Property and equipment, net of accumulated depreciation 81.9 82.9 Reinsurance recoverable, net of allowance 703.8 666.5 Agent relationships, net of accumulated amortization 114.3 122.0 Interest and dividends due or accrued 52.2 49.9 Other assets 50.3 25.6 - ------------------------------------------------------------------------------------------- Total assets $ 5,686.1 $ 5,715.0 =========================================================================================== Liabilities Insurance reserves: Losses $ 2,357.2 $ 2,269.6 Loss adjustment expenses 501.4 486.8 Unearned premiums 706.6 715.5 Debt 200.6 383.3 Reinsuance treaty funds held 171.6 195.0 Deferred income taxes 28.1 21.9 Other liabilities 309.9 348.0 - ------------------------------------------------------------------------------------------- Total liabilities 4,275.4 4,420.1 Shareholders' Equity Common stock, $.125 par value Authorized: 150,000,000 Issued shares: 72,418,344; 72,418,344 9.0 9.0 Additional paid-in capital 15.2 - Accumulated other comprehensive income 254.5 259.1 Retained earnings 1,237.4 1,161.5 Treasury stock, at cost: (Shares: 7,963,160; 10,209,215) (105.4) (134.7) - ------------------------------------------------------------------------------------------- Total shareholders' equity 1,410.7 1,294.9 - ------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 5,686.1 $ 5,715.0 ===========================================================================================
Accompanying notes are an integral part of these consolidated financial statements. For complete disclosures see Notes to Consolidated Financial Statements on pages 54-71 of the Corporation's 2004 Form 10-K. 3 ITEM 1. Continued Ohio Casualty Corporation & Subsidiaries CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended June 30, (in millions, except share and per share data) (Unaudited) 2005 2004 - ------------------------------------------------------------------------------------------- Premiums and finance charges earned $ 365.5 $ 367.2 Investment income, less expenses 48.6 48.6 Investment gains realized, net 13.8 3.2 - ------------------------------------------------------------------------------------------- Total revenues 427.9 419.0 Losses and benefits for policyholders 191.7 203.1 Loss adjustment expenses 40.4 40.1 General operating expenses 120.4 125.8 Write-down and amortization of agent relationships 3.3 4.3 Amortization of deferred policy acquisition costs 84.7 91.9 Deferral of deferred policy acquisition costs (83.4) (96.5) Depreciation and amortization expense 2.8 3.3 Loss on retirement of convertible debt, including debt conversion expenses 8.3 - - ------------------------------------------------------------------------------------------- Total expenses 368.2 372.0 - ------------------------------------------------------------------------------------------- Income before income taxes 59.7 47.0 Income tax expense: Current 15.4 12.3 Deferred 2.2 2.0 - ------------------------------------------------------------------------------------------- Total income tax expense 17.6 14.3 - ------------------------------------------------------------------------------------------- Net income $ 42.1 $ 32.7 =========================================================================================== Average shares outstanding - basic 63,679,352 61,344,980 =========================================================================================== Earnings per share - basic: Net income, per share $ 0.66 $ 0.53 =========================================================================================== Average shares outstanding - diluted 66,997,317 71,371,586 =========================================================================================== Earnings per share - diluted: Net income, per share $ 0.63 $ 0.48 ===========================================================================================
Accompanying notes are an integral part of these consolidated financial statements. For complete disclosures see Notes to Consolidated Financial Statements on pages 54-71 of the Corporation's 2004 Form 10-K. 4 ITEM 1. Continued Ohio Casualty Corporation & Subsidiaries CONSOLIDATED STATEMENTS OF INCOME
Six Months Ended June 30, (in millions, except share and per share data) (Unaudited) 2005 2004 - ------------------------------------------------------------------------------------------- Premiums and finance charges earned $ 727.8 $ 728.3 Investment income, less expenses 97.0 99.1 Investment gains realized, net 13.8 6.9 - ------------------------------------------------------------------------------------------- Total revenues 838.6 834.3 Losses and benefits for policyholders 382.8 398.3 Loss adjustment expenses 83.3 78.4 General operating expenses 233.7 266.0 Write-down and amortization of agent relationships 7.7 11.5 Amortization of deferred policy acquisition costs 171.8 184.2 Deferral of deferred policy acquisition costs (164.8) (187.5) Depreciation and amortization expense 5.7 6.5 Loss on retirement of convertible debt, including debt conversion expenses 9.0 - - ------------------------------------------------------------------------------------------- Total expenses 729.2 757.4 - ------------------------------------------------------------------------------------------- Income before income taxes 109.4 76.9 Income tax expense (benefit): Current 21.0 23.6 Deferred 8.6 (0.2) - ------------------------------------------------------------------------------------------- Total income tax expense 29.6 23.4 - ------------------------------------------------------------------------------------------- Income before cumulative effect of an accounting change 79.8 53.5 Cumulative effect of an accounting change, net of tax - 1.6 - ------------------------------------------------------------------------------------------- Net income $ 79.8 $ 51.9 =========================================================================================== Average shares outstanding - basic 63,023,233 61,204,730 =========================================================================================== Earnings per share - basic: Net income, per share $ 1.27 $ 0.85 =========================================================================================== Average shares outstanding - diluted 69,327,993 71,204,439 =========================================================================================== Earnings per share - diluted: Net income, per share $ 1.18 $ 0.78 ===========================================================================================
Accompanying notes are an integral part of these consolidated financial statements. For complete disclosures see Notes to Consolidated Financial Statements on pages 54-71 of the Corporation's 2004 Form 10-K. 5 ITEM 1. Continued Ohio Casualty Corporation & Subsidiaries CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
Accumulated Additional other Total (in millions, except Common paid-in comprehensive Retained Treasury shareholders' share data) (Unaudited) Stock capital income earnings stock equity - ------------------------------------------------------------------------------------------------------------------- Balance January 1, 2004 $ 9.0 $ - $ 254.7 $1,033.4 $(151.3) $1,145.8 Net income 51.9 51.9 Change in unrealized gain, net of deferred income tax benefit of $21.3 (39.6) (39.6) Change in minimum pension liability, net of deferred income tax benefit of $8.9 16.4 16.4 --------- Other comprehensive income 28.7 Net issuance of restricted stock (59,284 shares) (0.4) 0.9 0.5 Net issuance of treasury stock (418,558 shares) (0.5) 5.5 5.0 - -------------------------------------------------------------------------------------------------------------------- Balance, June 30, 2004 $ 9.0 $ - $ 231.5 $1,084.4 $(144.9) $1,180.0 ==================================================================================================================== Balance January 1, 2005 $ 9.0 $ - $ 259.1 $1,161.5 $(134.7) $1,294.9 Net income 79.8 79.8 Change in unrealized gain, net of deferred income tax benefit of $2.4 (4.6) (4.6) --------- Other comprehensive income 75.2 Net issuance of restricted stock (13,664 shares) 0.2 0.2 Net issuance of treasury stock (926,806 shares) 4.0 (0.1) 11.8 15.7 Cash dividends paid ($0.06 per share) (3.8) (3.8) Issuance of common stock pursuant to Convertible Note transaction (See Note VII) 11.2 17.3 28.5 - -------------------------------------------------------------------------------------------------------------------- Balance, June 30, 2005 $ 9.0 $ 15.2 $ 254.5 $1,237.4 $(105.4) $1,410.7 ====================================================================================================================
Accompanying notes are an integral part of these consolidated financial statements. For complete disclosures see Notes to Consolidated Financial Statements on pages 54-71 of the Corporation's 2004 Form 10-K. 6 ITEM 1. Continued Ohio Casualty Corporation & Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS
Six Months Ended June 30, (in millions) (Unaudited) 2005 2004 - ------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities: Operating Activities Net income $ 79.8 $ 51.9 Adjustments to reconcile net income to cash from operations: Changes in: Insurance reserves 93.3 129.5 Reinsurance treaty funds held (23.4) 14.9 Income taxes (5.4) (9.9) Premiums and other receivables 16.6 (16.3) Deferred policy acquisition costs 6.9 (3.3) Reinsurance recoverable (37.3) (69.6) Other assets (5.7) (7.3) Other liabilities (48.9) (6.2) Loss on retirement of convertible debt, including debt conversion expenses 9.0 - Income tax benefit from stock option exercises 3.1 - Amortization and write-down of agent relationships 7.7 11.5 Depreciation and amortization 11.4 8.9 Investment gains realized, net (13.8) (6.9) - ------------------------------------------------------------------------------------------------- Net cash provided by operating activities 93.3 97.2 - ------------------------------------------------------------------------------------------------- Cash Flows from Investing Activities: Purchase of securities: Fixed maturity, available-for-sale (619.0) (627.5) Fixed maturity, held-to-maturity (0.4) (1.4) Equity (3.7) (7.2) Proceeds from sales of securities: Fixed maturity, available-for-sale 416.7 444.4 Equity 7.9 5.2 Proceeds from maturities and calls of securities: Fixed maturity, available-for-sale 29.6 65.6 Fixed maturity, held-to-maturity 17.4 27.3 Equity - 3.2 Property and equipment Purchases (4.9) (2.2) Sales 0.1 0.3 - ------------------------------------------------------------------------------------------------- Net cash used in investing activities (156.3) (92.3) - ------------------------------------------------------------------------------------------------- Cash Flows from Financing Activities: Debt: Repayments (160.0) (0.3) Proceeds from the issuance of senior notes - 199.3 Payment of issuance costs - (1.3) Loss on retirement of convertible debt, including conversion expense (3.6) - Proceeds from exercise of stock options 12.5 4.8 Dividends paid to shareholders (3.8) - - ------------------------------------------------------------------------------------------------- Net cash (used in) provided by financing activities (154.9) 202.5 - ------------------------------------------------------------------------------------------------- Net (decrease) increase in cash and cash equivalents (217.9) 207.4 Cash and cash equivalents, beginning of period 252.6 56.9 - ------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of period $ 34.7 $ 264.3 =================================================================================================
Accompanying notes are an integral part of these consolidated financial statements. For complete disclosures see Notes to Consolidated Financial Statements on pages 54-71 of the Corporation's 2004 Form 10-K. 7 Ohio Casualty Corporation & Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Ohio Casualty Corporation (the Corporation) is the holding company of The Ohio Casualty Insurance Company (the Company), which is one of six property- casualty insurance companies that make up the Ohio Casualty Group (the Group). All dollar amounts, except per share data, presented in the Notes to Consolidated Financial Statements are in millions unless otherwise noted. NOTE I - INTERIM ADJUSTMENTS We prepared the Consolidated Balance Sheet as of June 30, 2005 and the Consolidated Statements of Income, Shareholders' Equity and Cash Flows all for the three and six months ended June 30, 2005 and 2004, without an audit. In the opinion of management, all adjustments necessary to fairly present the financial position, results of operations and cash flows at June 30, 2005 and for all periods presented have been made. We prepared the accompanying unaudited Consolidated Financial Statements in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to the Quarterly Report on Form 10-Q and Article 10 of Regulation S-X. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been omitted. The unaudited Consolidated Financial Statements should be read together with the consolidated financial statements and notes thereto included in the Corporation's 2004 Annual Report on Form 10-K. The results of operation for the period ended June 30, 2005 are not necessarily indicative of the results of operation for the full year. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. The premiums receivable balance is presented net of bad debt allowances determined by management of $4.0 at June 30, 2005 and $4.3 at December 31, 2004. Property and equipment are carried at cost less accumulated depreciation of $171.9 and $167.4 at June 30, 2005 and December 31, 2004, respectively. Amounts recoverable from reinsurers are calculated in a manner consistent with the reinsurance contract and are reported net of allowance of $2.3 at June 30, 2005 and December 31, 2004. NOTE II - STOCK OPTIONS The Corporation accounts for stock options issued to employees and directors in accordance with Accounting Principles Board Opinion (APB) No. 25, "Accounting for Stock Issued to Employees." Under APB 25, the Corporation recognizes expense based on the intrinsic value of options. Had the Corporation adopted income statement recognition requirements of Financial Accounting Standards Board (FASB) 123 "Accounting for Stock Based Compensation," the Corporation's net income and earnings per share would have been reduced to the pro forma amounts disclosed below: 8
Three Months Ended Six Months Ended June 30 June 30 2005 2004 2005 2004 - ------------------------------------------------------------------------------- Net income As reported $42.1 $32.7 $79.8 $51.9 Add: Stock-based employee compensation reported in net income, net of related tax effect 0.2 0.1 0.3 0.1 Deduct: Total stock-based employee compensation, net of related tax effect 1.6 1.5 2.6 2.8 ----- ----- ----- ----- Pro forma $40.7 $31.3 $77.5 $49.2 Basic EPS As reported $0.66 $0.53 $1.27 $0.85 Pro Forma $0.64 $0.51 $1.23 $0.80 Diluted EPS* As reported $0.63 $0.48 $1.18 $0.78 Pro Forma $0.61 $0.46 $1.14 $0.74 ===============================================================================
*Diluted EPS has been adjusted for the effect of EITF Issue No. 04-8 for the three and six months ended June 30, 2005. Also see Note III. See Note X - Recently Issued Accounting Standards for additional information pertaining to FASB 123(R) - "Share-Based Payment." NOTE III - EARNINGS PER SHARE Basic and diluted earnings per share are summarized as follows:
Three Months Ended Six Months Ended June 30 June 30 2005 2004 2005 2004 - ------------------------------------------------------------------------------------- Net income $42.1 $32.7 $79.8 $ 51.9 Weighted average common shares outstanding - basic (thousands) 63,679 61,345 63,023 61,205 Income before cumulative effect of an accounting change $0.66 $0.53 $1.27 $ 0.88 Cumulative effect of an accounting change - - - $(0.03) Basic net income per weighted average share $0.66 $0.53 $1.27 $ 0.85 ===================================================================================== Net income $42.1 $32.7 $79.8 $ 51.9 Effect of EITF 04-8 on net income using "if-converted" method 0.2 1.7 1.8 3.3 Adjusted net income using "if-converted" method 42.3 34.4 81.6 55.2 Weighted average common shares outstanding (thousands) 63,679 61,345 63,023 61,205 Effect of dilutive securities (thousands) 1,199 1,130 1,273 1,102 Effect of EITF 04-8 (thousands) 2,119 8,897 5,032 8,897 - ------------------------------------------------------------------------------------ Weighted average common shares outstanding - diluted (thousands) 66,997 71,372 69,328 71,204 Income before cumulative effect of an accounting change $0.63 $0.48 $1.18 $ 0.80 Cumulative effect of an accounting change - - - $(0.02) Diluted net income per weighted average share $0.63 $0.48 $1.18 $ 0.78 =====================================================================================
In accordance with Emerging Issues Task Force (EITF) 04-8 "The Effect of Contingently Convertible Debt on Diluted Earnings Per Share," the earnings per share treatment of those securities that contain a contingent conversion feature require all of the shares underlying the convertible securities to be treated as outstanding using the "if-converted" method. As required by the EITF, all prior period earnings per share 9 amounts would need to be restated for periods presented subsequent to the March 2002 Convertible Notes issuance. The "if-converted" method gives effect to the add back to net income of interest expense and amortization of debt issuance costs, net of tax, associated with the convertible instruments. The adoption of EITF 04-8 reduced previously reported diluted earnings per share by $0.04 and $0.05 for the three and six months ended June 30, 2004, respectively. NOTE IV -- SEGMENT INFORMATION The Corporation has determined its reportable segments based upon its method of internal reporting, which is organized by product line. The property and casualty segments are Commercial, Specialty, and Personal Lines. These segments generate revenues by selling a wide variety of commercial, surety and personal insurance products. The Corporation also has an all other segment which derives its revenues from investment income. The other expenses included in this segment consist principally of costs related to the retirement of the convertible debt and interest expense in 2005. In 2004, the other expenses consist primarily of interest expense. Each segment of the Corporation is managed separately. The property and casualty segments are managed by assessing the performance and profitability of the segments through analysis of industry financial measurements determined on a GAAP basis, which includes loss, loss adjustment and underwriting expense ratios, combined ratio, premiums earned, underwriting gain/loss and statutory premiums written. The following tables present information by segment as it is reported internally to management. Asset information by reportable segment is not reported, since the Corporation does not produce such information internally. Three Months Ended June 30
Commercial Lines Segment 2005 2004 - --------------------------------------------------------------------------- Net premiums written $221.8 $220.3 % Change 0.7% 5.0% Net premiums earned 206.8 202.4 % Change 2.2% 5.8% Underwriting loss (before tax) (5.4) (4.3)
Specialty Lines Segment 2005 2004 - --------------------------------------------------------------------------- Net premiums written $39.7 $ 39.1 % Change 1.5% (9.4)% Net premiums earned 36.4 40.8 % Change (10.8)% 0.5% Underwriting gain (before tax) 1.7 2.0
Personal Lines Segment 2005 2004 - --------------------------------------------------------------------------- Net premiums written $123.4 $127.3 % Change (3.1)% 3.7% Net premiums earned 122.3 124.0 % Change (1.4)% 3.9% Underwriting gain (before tax) 19.8 5.3
Total Property & Casualty 2005 2004 - --------------------------------------------------------------------------- Net premiums written $384.9 $386.7 % Change (0.5)% 2.9% Net premiums earned 365.5 367.2 % Change (0.5)% 4.6% Underwriting gain (before tax) 16.1 3.0
All Other 2005 2004 - --------------------------------------------------------------------------- Revenues $ 9.0 $ 2.2 Write-down and amortization of agent relationships (3.3) (4.3) Other expenses (15.5) (3.5) - --------------------------------------------------------------------------- Net loss before income taxes $ (9.8) $(5.6)
10
Reconciliation of Revenues 2005 2004 - --------------------------------------------------------------------------- Net premiums earned for reportable segments $365.5 $367.2 Net investment income 44.9 47.6 Realized gains/(losses), net 9.0 (1.3) - --------------------------------------------------------------------------- Total property and casualty revenues (Statutory basis) 419.4 413.5 Property and casualty statutory to GAAP adjustment (0.5) 3.3 - --------------------------------------------------------------------------- Total revenues property and casualty (GAAP basis) 418.9 416.8 Other segment revenues 9.0 2.2 - --------------------------------------------------------------------------- Total revenues $427.9 $419.0 ===========================================================================
Reconciliation of Underwriting Gain (before tax) 2005 2004 - --------------------------------------------------------------------------- Property and casualty underwriting gain (before tax) (Statutory basis) $ 15.3 $ 0.1 Statutory to GAAP adjustment 0.8 2.9 - --------------------------------------------------------------------------- Property and casualty underwriting gain (before tax) (GAAP basis) 16.1 3.0 Net investment income 48.6 48.6 Realized gains, net 13.8 3.2 Write-down and amortization of agent relationships (3.3) (4.3) Other expenses (15.5) (3.5) - --------------------------------------------------------------------------- Income before income taxes and cumulative effect of an accounting change $ 59.7 $ 47.0 ===========================================================================
Six Months Ended June 30
Commercial Lines Segment 2005 2004 - --------------------------------------------------------------------------- Net premiums written $427.4 $432.5 % Change (1.2)% 4.2% Net premiums earned 412.4 400.2 % Change 3.0% 5.0% Underwriting loss (before tax) (18.3) (10.0)
Specialty Lines Segment 2005 2004 - --------------------------------------------------------------------------- Net premiums written $78.8 $73.9 % Change 6.6% (2.9)% Net premiums earned 71.5 82.5 % Change (13.3)% 4.4% Underwriting gain (before tax) 3.0 6.1
Personal Lines Segment 2005 2004 - --------------------------------------------------------------------------- Net premiums written $237.2 $244.3 % Change (2.9)% 3.1% Net premiums earned 243.9 245.6 % Change (0.7)% 2.2% Underwriting gain/(loss) (before tax) 47.5 (7.0)
Total Property & Casualty 2005 2004 - --------------------------------------------------------------------------- Net premiums written $743.4 $750.7 % Change (1.0)% 3.1% Net premiums earned 727.8 728.3 % Change (0.1)% 4.0% Underwriting gain/(loss) (before tax) 32.2 (10.9)
All Other 2005 2004 - --------------------------------------------------------------------------- Revenues $ 12.1 $ 3.7 Write-down and amortization of agent relationships (7.7) (11.5) Other expenses (25.9) (6.7) - --------------------------------------------------------------------------- Net loss before income taxes $(21.5) $(14.5)
11
Reconciliation of Revenues 2005 2004 - --------------------------------------------------------------------------- Net premiums earned for reportable segments $ 727.8 $728.3 Net investment income 89.1 97.2 Realized gains, net(a) 145.3 3.7 - --------------------------------------------------------------------------- Total property and casualty revenues (Statutory basis) 962.2 829.2 Property and casualty statutory to GAAP adjustment (135.7) 1.4 - --------------------------------------------------------------------------- Total revenues property and casualty (GAAP basis) 826.5 830.6 Other segment revenues 12.1 3.7 - --------------------------------------------------------------------------- Total revenues $ 838.6 $834.3 ===========================================================================
(a) The net realized gains reflected above on a statutory accounting basis are the result of inter-company transfers of equity securities within the Group, which for statutory purposes are recorded as if the securities were sold. For GAAP accounting, the statutory realized gains/losses on inter- company transfers of securities are not recognized until the security is disposed of outside of the Corporation.
Reconciliation of Underwriting Gain/(Loss) (before tax) 2005 2004 - --------------------------------------------------------------------------- Property and casualty underwriting gain/(loss) (before tax) (Statutory basis) $ 35.8 $ (3.8) Statutory to GAAP adjustment (3.6) (7.1) - --------------------------------------------------------------------------- Property and casualty underwriting gain/(loss) (before tax) (GAAP basis) 32.2 (10.9) Net investment income 97.0 99.1 Realized gains, net 13.8 6.9 Write-down and amortization of agent relationships (7.7) (11.5) Other expenses (25.9) (6.7) - --------------------------------------------------------------------------- Income before income taxes and cumulative effect of an accounting change $109.4 $ 76.9 ===========================================================================
NOTE V - AGENT RELATIONSHIPS The agent relationships asset is an identifiable intangible asset acquired in connection with the 1998 Great American Insurance Company (GAI) commercial lines acquisition. The Corporation follows the practice of allocating purchase price to specifically identifiable intangible assets based on their estimated values as determined by appropriate valuation methods. In the GAI acquisition, the purchase price was allocated to agent relationships and deferred policy acquisition costs. Agent relationships are evaluated quarterly as events or circumstances indicate a possible inability to recover their carrying amount. As a result of the evaluation, the agent relationship asset was written down before tax by $1.7 and $2.6 in the second quarter of 2005 and 2004, respectively. For the six months ended June 30, 2005 and 2004, the asset was written down before tax by $4.5 and $8.0, respectively. The write-downs are a result of agency cancellations and certain agents determined to be impaired based on updated estimated future undiscounted cash flows that were insufficient to recover the carrying amount of the asset for the agent. The remaining portion of the agent relationships asset will be amortized on a straight-line basis over the remaining useful period of approximately 19 years. For the three month and six month periods ended June 30, 2005, the Corporation recorded amortization expense of $1.6 and $3.2 which compares to $1.7 and $3.5 for the same periods of the prior year. At June 30, 2005 and December 31, 2004, the unamortized carrying value of the agent relationships asset was $114.3 and $122.0, respectively. The agent relationships asset is recorded net of accumulated amortization of $43.0 and $41.4 at June 30, 2005 and December 31, 2004, respectively. Future cancellation of agents included in the agent relationships intangible asset or a diminution of certain former Great American agents' estimated future revenues or profitability is likely to cause further impairment losses beyond the quarterly amortization of the remaining asset value over the remaining useful lives. NOTE VI - INTERNALLY DEVELOPED SOFTWARE In accordance with Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use," the Corporation capitalizes costs incurred during the application development stage for the development of internal-use software. These costs primarily relate to payroll and payroll-related costs for employees along with costs incurred for external consultants who are directly associated with the internal-use software project. Costs such as maintenance, training, data conversion, overhead and general and administrative are expensed as incurred. Management believes the expected future value of 12 the asset exceeds the carrying value. Management evaluates the asset on an annual basis for impairment. The costs associated with the software are amortized on a straight-line basis over an estimated useful life of 10 years commencing when the software is substantially complete and ready for its intended use. Capitalized software costs and accumulated amortization amounts included in the consolidated balance sheets were $56.4 and $13.7 at June 30, 2005 and $55.2 and $11.4 at December 31, 2004, respectively. NOTE VII - DEBT On March 19, 2002, the Corporation issued $201.3 aggregate principal amount of 5.00% Convertible Notes due March 19, 2022 (Old Notes). On March 22, 2005 the Corporation exchanged $65.6 of its Old Notes for $65.6 of new 5.00% Convertible Notes due March 19, 2022 (New Notes and collectively the Convertible Notes). The only change in the New Notes was the incorporation of a net share settlement feature. The Corporation paid a premium to the holders electing the exchange to the New Notes. Also on this date, the Corporation announced its intention to fully redeem before maturity the Convertible Notes at their regular redemption price of 102% of the principal amount plus accrued interest to, but excluding, the redemption date of May 2, 2005. In connection with this announced redemption, holders of the Convertible Notes could elect to convert their Convertible Notes into shares of the Corporation's common stock. Upon conversion of the Old Notes, the Corporation delivered 44.2112 of its common stock for each $1,000 principal amount of Old Notes surrendered for conversion. Upon conversion of the New Notes, the Corporation paid the principal amount in cash and any conversion consideration in excess of the principal amount in the Corporation's common stock. The above transactions impacted the Corporation's consolidated results of operations and consolidated balance sheet as follows:
2005 Loss on retirement of Convertible Debt, Impact on Old New including debt Shareholders' Notes Notes conversion expenses Equity ---------------------------------------------------------- Initial Issuance $201.3 $ - $ - $ - Repurchases in unsolicited negotiated transactions (a) (52.8) - (2.5) - Impact of exchange offer and related exchange premium (65.6) 65.6 (0.3) - Call Elections: Cash redemption (b) (53.9) (55.0) (5.7) - Equity conversion (c) (29.0) (10.6) (0.5) 28.5 - ------------------------------------------------------------------------------------------- June 30, 2005 $ - $ - $(9.0) $28.5 ===========================================================================================
(a) These repurchases were completed in the following periods: $35.8 in the second quarter of 2005, $4.5 in the first quarter of 2005 and $12.5 in the fourth quarter of 2004. As a result of these repurchases, the Corporation wrote off a proportionate amount of unamortized debt issuance costs of $1.2 in the second quarter of 2005, $0.1 in the first quarter of 2005 and $0.4 in the fourth quarter of 2004, which was included in the 2004 results of operations. In addition, the Corporation paid a premium on the repurchases of $0.8 in the second quarter of 2005, $0.4 in first quarter 2005 and $0.6 in the fourth quarter of 2004, which was also included in the 2004 results of operations. The loss on retirement of debt attributable to 2004 relating to the repurchase transactions are not included in the above table. (b) In connection with the cash redemption, the Corporation paid a call premium in the amount of $2.2 and wrote off the proportionate amount of unamortized debt issuance costs in the amount of $3.5 in the second quarter of 2005. (c) In connection with the equity conversion, the Corporation issued 1,282,123 shares of its common stock for conversion of the Old Notes, issued 23,462 shares of its common stock for conversion of the New Notes, recognized $0.5 in debt conversion expenses related to the New Notes, which represents the conversion price of $22.62 multiplied by 23,462 shares issued, and increased shareholders' equity by 13 $28.5 in the second quarter of 2005. The increase in shareholders' equity consists principally of the conversion of the principle amount of Old Notes ($29.0) and accrued interest through the date of conversion ($0.2) offset by the write-off of the proportionate amount of unamortized debt issuance cost ($1.4). On June 29, 2004, the Corporation issued $200.0 of 7.3% Senior Notes due June 15, 2014 (Senior Notes) and received net proceeds after related fees and discount of $198.0. The Corporation used part of the net proceeds to repurchase $52.8 of the Old Notes in unsolicited negotiated transactions, prior to the redemption discussed above. A substantial portion of the net proceeds was also used to redeem the Convertible Notes on May 2, 2005, as discussed above. Interest is payable on the Senior Notes on June 15 and December 15. The Senior Notes are reported on the consolidated balance sheet net of unamortized issuance-related costs and discount totaling $2.4 at June 30, 2005. The Convertible Notes and Senior Notes were reported on the consolidated balance sheet net of unamortized issuance-related costs and discount totaling $8.7 ($6.3 related to the Convertible Notes and $2.4 related to the Senior Notes) at December 31, 2004. The Corporation uses the effective interest rate method to record interest expense, amortization of issuance-related costs and amortization of the discount. The impact of the Convertible Notes on diluted earnings per share is based upon the "if-converted" method. In accordance with EITF 04-8, all diluted earnings per share amounts have been restated since the issuance of the Convertible Notes in March 2002. See Note III - Earnings Per Share of this Quarterly Report on Form 10-Q and Item 15, Notes to Consolidated Financial Statements, Footnote 10 on pages 66 and 67 of the Corporation's 2004 Annual Report on Form 10-K for further discussion. On July 31, 2002, the Corporation entered into a revolving credit agreement with an expiration date of March 15, 2005. In February 2005, the revolving credit agreement was renewed, under substantially the same terms and conditions, and will expire on March 15, 2006. Under the terms of the revolving credit agreement, the lenders agreed to make loans to the Corporation in an aggregate amount up to $80.0 for general corporate purposes. Interest is payable in arrears, and the interest rate on borrowings under the revolving credit agreement is based on a margin over LIBOR or the LaSalle Bank Prime Rate, at the option of the Corporation. The Corporation is obligated to pay agency fees and facility fees of up to $0.2 annually. These fees are expensed when incurred by the Corporation. The revolving credit agreement requires the Corporation to maintain minimum net worth of $800.0. The credit agreement also includes a minimum statutory surplus for the Company of $650.0. Additionally, other financial covenants and other customary provisions, as defined in the agreement, exist. At June 30, 2005, the Corporation was in compliance with all financial covenants and other provisions of this agreement. There were no amounts outstanding under this revolving credit agreement at either June 30, 2005 or December 31, 2004. In addition to the debt described above, the Corporation has a $6.5 loan with the State of Ohio that is secured by a mortgage on the Corporation's home office property. As of and for the three and six months ended June 30, 2005, the loan bears a fixed interest rate of 3%, compared to an interest rate of 2% as of and for the three and six months ended June 30, 2004. The loan requires annual principal payments of approximately $0.6 and expires in November 2009. The remaining balance at June 30, 2005 was $3.0, compared to $3.2 at December 31, 2004. Interest expense incurred for the six month period ending June 30, 2005 and 2004 was $10.4 and $5.2, respectively. Interest expense incurred for the three month period ending June 30, 2005 and 2004 was $4.4 and $2.6, respectively. The increase in interest expense incurred in the three and six month periods ending June 30, 2005 is related to the issuance of the Senior Notes on June 29, 2004. NOTE VIII - CONTINGENCIES In the fourth quarter of 2001, Ohio Casualty of New Jersey, Inc. (OCNJ) entered into an agreement to transfer its obligations to renew private passenger auto business in New Jersey to Proformance Insurance Company (Proformance). The contract stipulated that a premiums-to-surplus ratio of 2.5 to 1 must be maintained on the transferred business during the period March 2002 through December 2004. If this 14 criteria was not met, OCNJ would have to pay up to a maximum cumulative amount of $15.6 to Proformance to maintain this premiums-to-surplus ratio. Based on data provided by Proformance, the Group paid $6.8 in July 2004 to Proformance in settlement of this obligation through December 31, 2003. At December 31, 2004, based upon information provided by Proformance, the Group had accrued $8.8 to cover this estimated additional liability. Late in the first quarter of 2005, the Group, based on revised information provided by Proformance subsequent to the Corporation filing its 2004 Annual Report on Form 10-K, reduced its estimated liability and related accrual to $4.4 at March 31, 2005. In June 2005, the Group reached a settlement with Proformance for the final payment related to this obligation in the amount of $3.7 and in return received from Proformance a release of any and all future obligations related to this surplus guarantee. Accordingly, at June 30, 2005, no additional amounts are recorded on the Consolidated Balance Sheet pursuant to this surplus guarantee. The total amount paid by the Group pursuant to the surplus guarantee was $10.5, compared to the maximum cumulative exposure of $15.6. A proceeding entitled Carol Murray v. the Corporation, the Company, Avomark Insurance Co., Ohio Security Insurance Co. (Ohio Security), West American Insurance Co. (West American), American Fire and Casualty Insurance Co. (American Fire), and OCNJ was filed in the United States District Court for the District of Columbia on February 5, 2004. A motion to change venue was granted on May 25, 2004 with the proceeding assigned to the U.S. District Court for the Southern District of Ohio, Eastern Division, Columbus, Ohio. The plaintiff, a former automobile physical damage claim adjuster, originally sought to certify a nationwide collective action consisting of all current and former salaried employees since February 5, 2001 who are/were employed to process claims by policyholders and other persons for automobile property damage. The plaintiff has filed motions to expand the definition to include claim specialists, representative trainees, and representatives performing claims adjusting services. The complaint seeks overtime compensation for the plaintiff and the class of persons plaintiff seeks to represent. The defendants deny the allegations made in the complaint and are vigorously defending themselves. A proceeding entitled Carol Lazarus v. the Group was brought against West American in the Court of Common Pleas Cuyahoga County, Ohio on October 25, 1999. The Court ordered the case to proceed solely against West American on July 10, 2003. The complaint alleges West American improperly charged for uninsured motorists coverage following an October 1994 decision of the Supreme Court of Ohio in Martin v. Midwestern Insurance Company. The Martin decision was overruled legislatively in September 1997. West American filed a motion for summary judgment on December 16, 2003. Plaintiff filed a motion for class certification on February 23, 2004. West American has responded to the motion for class certification stating the motion is untimely (filed more than four years after the initial complaint) and that Carol Lazarus failed to provide sufficient evidence to satisfy the requirements for class certification. A proceeding entitled Douglas and Carla Scott v. the Company, West American, American Fire, and Ohio Security was filed in the District Court of Tulsa County, State of Oklahoma and served on January 3, 2005. The proceeding challenges the use of a certain vendor in valuing total loss automobiles. Plaintiff alleges that use of the database results in valuations to the detriment of the insureds. Plaintiff is seeking class status and alleges breach of contract, fraud and bad faith. The lawsuit is in its early stages and will be vigorously defended. The proceedings described above and various other legal and regulatory proceedings are currently pending that involve the Corporation and specific aspects of the conduct of its business. The outcome of these proceedings is currently unpredictable. However, at this time, based on their present status, it is the opinion of management that the ultimate liability, if any, in one or more of these proceedings in excess of amounts currently reserved is not expected to have a material adverse effect on the financial condition, liquidity or results of operation of the Corporation. 15 NOTE IX - EMPLOYEE BENEFITS The Corporation has a non-contributory defined benefit retirement plan and a contributory health care plan. The net periodic pension cost as of June 30 is determined as follows:
Three Months Ended Six Months Ended June 30 June 30 2005 2004 2005 2004 - ------------------------------------------------------------------------------------------ Service cost earned during the period $ 1.8 $ 1.9 $ 3.6 $ 4.0 Interest cost on projected benefit obligation 4.3 4.1 8.6 8.6 Expected return on plan assets (5.4) (5.4) (10.8) (10.7) Amortization of accumulated losses 0.9 0.7 1.8 1.4 Amortization of unrecognized prior service cost (0.5) (0.6) (1.1) (0.7) Curtailment cost - - - 0.1 - ------------------------------------------------------------------------------------------ Net periodic pension cost $ 1.1 $ 0.7 $ 2.1 $ 2.7 ==========================================================================================
The Corporation contributed approximately $1.9 and $3.8 in the three month and six month periods ended June 30, 2005, respectively, to the defined benefit retirement plan. The Corporation contributed approximately $7.5 in the first six months of 2004. The Corporation expects to contribute approximately $8.0 during the fiscal year 2005. In March 2004, the Corporation announced changes to the defined benefit retirement plan which were effective June 30, 2004, which freezes accrued benefits under the plan's current formula and incorporates a new benefit formula beginning July 2004. As a result of these changes and staff reductions announced in the first six months of 2004, the Corporation recognized a curtailment charge of $0.1 in 2004. The components of the Corporation's net periodic postretirement benefit cost as of June 30:
Three Months Ended Six Months Ended June 30 June 30 2005 2004 2005 2004 - ------------------------------------------------------------------------------------------ Service cost $ - $ 0.1 $ 0.1 $ 0.7 Interest cost 0.8 0.8 1.5 2.3 Amortization of accumulated losses - 0.1 - 0.2 Amortization of unrecognized prior service cost (1.5) (1.5) (3.0) (2.0) Curtailment cost - - - 0.1 - ------------------------------------------------------------------------------------------ Net periodic postretirement benefit cost $(0.7) $(0.5) $(1.4) $ 1.3 ==========================================================================================
In March 2004, the Corporation announced changes related to the postretirement health care plan effective July 1, 2004 that limits eligibility for subsidized retiree medical and dental coverage to then current retirees and employees with 25 or more years of service. Other employees are eligible for access to unsubsidized retiree dental coverage and medical coverage up to age 65. As a result of these changes and staff reductions, the Corporation recognized a curtailment charge of $0.1 in 2004. NOTE X - RECENTLY ISSUED ACCOUNTING STANDARDS In December 2004, the FASB finalized Statement 123(R), "Share-Based Payment." On April 14, 2005, the Securities and Exchange Commission (SEC) announced a phased-in implementation process that would allow the Corporation to defer the implementation of the statement no later than the beginning of the first fiscal year beginning after June 15, 2005. For the Corporation this would mean January 1, 2006. Statement 123(R) supersedes APB Opinion No. 25, "Accounting for Stock Issued to Employees," and amends FASB Statement No. 95, "Statement of Cash Flows." FASB 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized as compensation expense in the income statement at fair value. Pro forma disclosure is no longer an alternative. The Corporation currently intends to adopt the provisions of FASB 123(R) effective January 1, 2006. 16 FASB 123(R) permits public companies to adopt its requirements using one of two methods: (1) modified prospective or (2) modified retrospective. The Corporation currently intends to adopt using the modified prospective method in which compensation expense would be recognized beginning January 1, 2006 (a) based on the requirements of FASB 123(R) for all share-based payments granted after the January 1, 2006 and (b) based on the requirements of FASB 123 for all awards granted to employees prior to January 1, 2006 that remain unvested on that date. The adoption of FASB 123(R) fair value method is expected to increase the Corporation's compensation expense by approximately $3.0 to $4.0 in 2006. These estimated impacts could change materially from these estimates based upon the Corporation's use of equity-based awards granted in the future. Had the Corporation adopted FASB 123(R) in prior periods, the impact of that standard would have approximated the impact of FASB 123 as described in the disclosure of pro forma net income and earnings per share in Note II. FASB 123(R) also requires the benefits of tax deductions in excess of recognized compensation expense to be reported as a financing cash flow, rather than as an operating cash flow as required under current accounting literature. This requirement will reduce net operating cash flows and increase net financing cash flows in periods after the adoption. In March 2004, the FASB approved the consensus reached on the EITF Issue No. 03-1, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments." The objective of this consensus is to provide guidance for identifying impaired investments. EITF 03-1 also provides new disclosure requirements for investments that are deemed to be temporarily impaired. Originally, the accounting provisions of EITF 03-1 were effective for all reporting periods beginning after June 15, 2004, while the disclosure requirements are effective only for annual periods ending after June 15, 2004. In September 2004, the FASB issued two FASB Staff Positions (FSP), FSP EITF 03-1-a and FSP EITF 03-1-1, which delayed the measurement and recognition paragraphs of the consensus for further discussion. The disclosure requirements remain effective as originally issued under EITF 03-1 and have been adopted by the Corporation. In June 2005, the FASB issued a final FSP EITF 03-1-a (retitled FSP FAS 115-1, "The Meaning of Other-Than- Temporary Impairment and Its Application to Certain Investments") which will replace the guidance set forth in paragraphs 10-18 of Issue 03-1 and clarifies when an investor should recognize an impairment loss. The provisions of FSP FAS 115-1 are effective for other-than-temporary impairment analysis conducted in periods beginning after September 15, 2005. The Corporation has evaluated the provisions of FSP FAS 115-1 and believes the impact will be immaterial on the Corporation's overall results of operations or financial position. In May 2005, the FASB issued FASB Statement 154 "Accounting Changes and Error Corrections" which replaces APB Opinion No. 20 "Accounting Changes" and FASB Statement 3 "Reporting Accounting Changes in Interim Financial Statements." This statement changes the requirements for the accounting for and reporting of a change in accounting principle. This statement applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. This statement requires voluntary changes in accounting principles be recognized retrospectively to prior periods' financial statements, rather than recognition in the net income of the current period. Retrospective application requires restatements of prior period financial statements as if that accounting principle had always been used. This statement carries forward without change the guidance contained in Opinion 20 for reporting the correction of an error in previously issued financial statements and a change in accounting estimate. The provisions of FASB Statement 154 are effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. NOTE XI - SUBSEQUENT EVENT In May 2005, the Corporation's shareholders approved the 2005 Incentive Plan (the Plan). The Plan is a performance-based stock unit and cash award designed to foster and promote the long-term financial success of the Corporation and its subsidiaries and to align the interests of management and directors with that of the Corporation's shareholders. The 2005 Officer Long Term Incentive award under the Plan is tied to the long term strategic plan approved by the Board of Directors. The performance period will begin on 17 July 1, 2005 and will be based on the Corporation's achievement of its after- tax operating income targets for the 30 month period from July 1, 2005 to December 31, 2007. The award will be settled 50% in cash and 50% in shares of the Corporation's common stock. The Corporation will account for the award using APB 25 "Accounting for Stock Issued to Employees" and Financial Interpretation 44 "Accounting for Certain Transactions Involving Stock Compensation" for the period of July 1, 2005 through December 31, 2005. The Corporation will account for the award using FASB 123(R) upon adoption on January 1, 2006 as discussed in Note X, Recently Issued Accounting Standards. ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operation Ohio Casualty Corporation (the Corporation) is the holding company of The Ohio Casualty Insurance Company (the Company), which is one of six property- casualty insurance companies that make up the Ohio Casualty Group (the Group). All dollar amounts in this Management Discussion and Analysis (MD&A) are in millions unless otherwise noted. RESULTS OF OPERATIONS Net income The Corporation reported net income of $79.8, or $1.18 per share for the six months ending June 30, 2005, compared with $51.9, or $0.78 per share in the same period of 2004. For the second quarter of 2005, net income was $42.1, or $0.63 per share, compared with net income of $32.7, or $0.48 per share in the same quarter of 2004. Management of the Corporation believes the significant volatility of realized investment gains and losses limits the usefulness of net income as a measure of current operating performance. Therefore, management uses the non-GAAP financial measure of operating income to further evaluate current operating performance. Operating income is reconciled to net income in the table below:
Three Months Six Months Ended June 30 Ended June 30 2005 2004 2005 2004 - ----------------------------------------------------------------------------------- Operating income $33.2 $30.6 $70.9 $49.0 After-tax net realized gains 8.9 2.1 8.9 4.5 Cumulative effect of accounting change - - - (1.6) - ----------------------------------------------------------------------------------- Net income $42.1 $32.7 $79.8 $51.9 =================================================================================== Operating income per share - diluted $0.50 $0.45 $1.05 $0.74 After-tax net realized gains per share - diluted 0.13 0.03 0.13 0.06 Cumulative effect of accounting change per share - diluted - - - (0.02) - ----------------------------------------------------------------------------------- Net income per share - diluted $0.63 $0.48 $1.18 $0.78 ===================================================================================
Investment Results For the six months ended June 30, 2005 and 2004, consolidated before-tax net investment income was $97.0 ($70.6 after tax) and $99.1 ($66.4 after tax), respectively. The effective tax rate on investment income for the first six months of 2005 was 27.2%, compared with 33.0% for the same period of 2004. Second quarter 2005 and 2004 consolidated before-tax investment income was $48.6 ($35.2 after tax) and $48.6 ($32.5 after tax), respectively. The effective tax rate on investment income in the second quarter was 27.5%, compared with 33.2% for the same period of 2004. Before-tax investment income for the three month and six month periods ending June 30, 2005 was comparable to the same periods of the prior year, as the impact of lower before-tax investment yields in 2005 were offset by growth in our investment portfolio 18 as the insurance operations continue to generate positive cash flows. Before-tax and after-tax investment income comparisons are impacted by investments in tax exempt securities. As a result of the Corporation's return to profitability, management has invested more funds into tax exempt securities to maximize after-tax income. This investment strategy results in the Corporation's effective tax rate on investment income being lower in the current year when compared to prior periods. For the six months and three months ended June 30, 2005, net realized gains were $13.8, compared to $6.9 and $3.2, respectively, for the same periods of 2004. Included in the net realized gains for the three months ended June 30, 2005 is $7.0 attributable to the sale of 665,000 shares of National Atlantic Holding Corporation and subsidiaries ("NAHC"), the parent of Proformance, common stock. The Corporation acquired these shares in connection with the transaction discussed in Note VIII - Contingencies and continues to hold 202,955 NAHC shares. During the second quarter of 2005, the Group recorded realized losses of $1.2 on the disposal of several fixed maturity securities in the automotive industry, which had experienced market value declines during the second quarter resulting from negative financial news about the issuers. There were no material losses on the disposal of any securities in the second quarter of 2004. Invested assets comprise a majority of the consolidated assets. Consequently, accounting policies related to investments are critical. For further discussion of investment accounting policies, see the "Critical Accounting Policies" section on pages 31 and 32 of the Corporation's 2004 Annual Report on Form 10-K. Investments are continually evaluated based on current economic conditions, credit loss experience and other developments. The difference between the cost/amortized cost and estimated fair value of investments is continually evaluated to determine whether a decline in value is temporary or other than temporary in nature. This determination involves a degree of uncertainty. If a decline in the fair value of a security is determined to be temporary, the decline is recorded as an unrealized loss in shareholders' equity. If a decline in a security's fair value is considered to be other than temporary, the security is written down to the estimated fair value with a corresponding realized loss recognized in the current consolidated statement of income. The assessment of whether a decline in fair value is considered temporary or other than temporary includes management's judgement as to the financial position and future prospects of the entity issuing the security. It is not possible to accurately predict when it may be determined that a specific security will become impaired. Future impairment charges could be material to the results of operations. There were no impairment charges recorded during the six months ended June 30, 2005. The before-tax impairment charge recorded in the six months and three months ended June 30, 2004 was $5.2 and $1.4, respectively. Management believes that it will recover the cost basis in the securities held with unrealized losses as it has both the intent and ability to hold the securities until they mature or recover in value. Securities are sold to achieve management's investment goals, which include the diversification of credit risk, the maintenance of adequate portfolio liquidity, the generation of a competitive investment yield and the management of interest rate risk. In order to achieve these goals, sales of investments are based upon current market conditions, liquidity needs and estimates of the future market value of the individual securities. The following table summarizes, for all available-for-sale securities and held-to-maturity securities, the total gross unrealized losses, excluding gross unrealized gains, by investment category and length of time the securities have continuously been in an unrealized loss position as of June 30, 2005: 19
Available-for-sale with unrealized losses: Less than 12 months 12 months or longer Total ------------------- ------------------- ------------------- Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses ------------------- ------------------- ------------------- Fixed securities: States, municipalities and political subdivisions $ 69.6 $(0.4) $ 9.1 $ - $ 78.7 $(0.4) Corporate securities 77.3 (2.0) 26.5 (0.6) 103.8 (2.6) Mortgage-backed securities 43.4 (0.3) 8.0 (0.2) 51.4 (0.5) - ---------------------------------------------------------------------------------------------- Total fixed maturities 190.3 (2.7) 43.6 (0.8) 233.9 (3.5) Equity securities 30.2 (2.2) 0.6 (0.2) 30.8 (2.4) - ---------------------------------------------------------------------------------------------- Total temporarily impaired securities $220.5 $(4.9) $44.2 $(1.0) $264.7 $(5.9) ==============================================================================================
Held-to-maturity with unrealized losses: Less than 12 months 12 months or longer Total ------------------- ------------------- ------------------- Fair Unrealized Fair Unrealized Fair Unrealized Value Losses Value Losses Value Losses ------------------- ------------------- ------------------- Fixed securities: Corporate securities $12.9 $ - $52.1 $(0.6) $ 65.0 $(0.6) Mortgage-backed securities 19.9 (0.4) 17.0 (0.2) 36.9 (0.6) - ---------------------------------------------------------------------------------------------- Total temporarily impaired securities $32.8 $(0.4) $69.1 $(0.8) $101.9 $(1.2) ==============================================================================================
As part of the evaluation of the entire $7.1 aggregate unrealized loss on the investment portfolio, management performed a more intensive review of securities with a relatively higher degree of unrealized loss. Based on a review of each security, management believes that unrealized losses on these securities were temporary declines in value at June 30, 2005. In the tables above, there are approximately 120 securities represented. Of this total, 15 securities have unrealized loss positions greater than 5% of their book values at June 30, 2005, one of which is an equity security with an unrealized loss position exceeding 20% of its book value. This group represents $3.5, or 49.2% of the total unrealized loss position. Of this group, nine securities, representing approximately $3.0 in unrealized losses, have been in an unrealized loss position for less than twelve months. Of the remaining six securities, which have been in an unrealized loss position for longer than twelve months and total $0.5, management believes that it is probable that all contract terms of the security will be satisfied; the unrealized loss position is due to the changes in the interest rate environment; and that it has positive intent and the ability to hold the securities until they mature or recover in value. As noted above, one equity security had an unrealized loss position that exceeded 20% at June 30, 2005. This company operates in the pharmaceutical industry, which has experienced industry-wide product news that has negatively impacted the market values of the entire industry. Based on the company's strong financial position and strong product development pipelines, management believes that current decline in market value of the security does not represent an other than temporary decline in value. All securities are monitored by portfolio managers who consider many factors such as an issuer's degree of financial flexibility, management competence and industry fundamentals in evaluating whether the decline in fair value is temporary. In addition, management considers whether it is probable that all contract terms of the security will be satisfied and whether the unrealized loss position is due to changes in the interest rate environment. Should management subsequently conclude the decline in fair value is other than temporary, the book value of the security is written down to fair value with the realized loss being recognized in the then current consolidated statement of income. 20 The amortized cost and estimated fair value of available-for-sale and held- to-maturity fixed maturity securities in an unrealized loss position at June 30, 2005, by contractual maturity are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
Available-for-sale: Amortized Estimated Unrealized Cost Fair Value Loss - ------------------------------------------------------------------------------------ Due in one year or less $ - $ - $ - Due after one year through five years 48.7 47.7 (1.0) Due after five years through ten years 100.1 98.6 (1.5) Due after ten years 36.7 36.2 (0.5) Mortgage-backed securities 51.9 51.4 (0.5) - ------------------------------------------------------------------------------------ Total $237.4 $233.9 $(3.5) ====================================================================================
Held-to-maturity: Amortized Estimated Unrealized Cost Fair Value Loss - ------------------------------------------------------------------------------------ Due in one year or less $ 2.0 $ 2.0 $ - Due after one year through five years 23.0 22.6 (0.4) Due after five years through ten years 37.4 37.2 (0.2) Due after ten years 3.2 3.2 - Mortgage-backed securities 37.5 36.9 (0.6) - ------------------------------------------------------------------------------------ Total $103.1 $101.9 $(1.2) ====================================================================================
For additional discussion relative to the Corporation's investment portfolio, see the "Investment Portfolio" section under "Liquidity and Capital Resources" on pages 26-28 of this MD&A. Agent Relationships The agent relationships asset is an identifiable intangible asset representing the excess of cost over fair value of net assets acquired in connection with the acquisition of the commercial lines business from Great American Insurance Company (GAI) in 1998. Generally Accepted Accounting Principles (GAAP) requires the Corporation to perform periodic reviews for possible impairment. These reviews consist of a comparison of estimated future cash flows to the carrying value of the intangible asset. If the estimated future cash flows are less than the carrying value for any individual agent included in the asset, that portion of the asset must be written down to its estimated fair value. The calculation of impairment follows accounting guidelines that do not permit increasing the intangible value for agents who are projected to generate more profit than was expected at the time of the initial assignment of the intangible value to each agent. The determination of impairment involves the use of management estimates and assumptions. Due to the inherent uncertainties and judgments involved in developing assumptions for each agent and the fact that the asset cannot be increased for any agent, further reductions in the valuation of the agent relationships asset are likely to occur in the future. These reductions could be significant if actual agent revenue production or profitability, or both, differ materially from current assumptions. Management has considered these and other factors in determining the remaining useful life of 19 years for this asset. Overall, the estimated future cash flows for the remaining acquired agents assigned an intangible value exceed the remaining asset book value of $114.3 recorded at June 30, 2005. For additional information regarding agent relationships asset, please refer to Note V in the Notes to the Consolidated Financial Statements on page 12 in the Quarterly Report on Form 10-Q. Operating Results Insurance industry regulators require the Group to report its financial condition and results of operations, among other things, using statutory accounting principles. Management uses industry standard financial measures determined on a statutory basis, as well as those determined on a GAAP basis to analyze the Group's property and casualty operations. These insurance industry financial measures include loss and loss adjustment expense (LAE) ratios, underwriting expense ratio, combined ratio, net premiums written 21 and net premiums earned. The combined ratio is a commonly used gauge of underwriting performance measuring the percentage of premium dollars used to pay insurance losses and related expenses. The combined ratio is the sum of the loss, LAE and underwriting expense ratios. All references to combined ratio or its components in this MD&A are calculated on a GAAP basis, unless otherwise indicated, and are calculated on a calendar year basis unless specified as calculated on an accident year basis. Insurance industry financial measures are included in the next several sections of this MD&A that discuss results of operations. A discussion of the differences between statutory accounting and generally accepted accounting principles in the United States is included in Item 15, page 69 of the Corporation's 2004 Annual Report on Form 10-K. At June 30, 2005 and December 31, 2004, statutory surplus, a financial measure that is required by insurance regulators and used to monitor financial strength, was $929.1 and $972.0, respectively. The ratio of twelve months ended net premiums written to statutory surplus as of June 30, 2005 was 1.6 to 1.0 compared to 1.5 to 1.0 at December 31, 2004. The decrease in statutory surplus during the first six months of 2005 is primarily a result of dividend declarations by the Company to the Corporation in the amount of $111.6 ($81.6 of which was paid in the first half of 2005 and the balance was paid on July 1, 2005). Premium Revenue Results Premium revenue reflects premiums earned by the Group. The Group's premiums are earned principally on a monthly pro rata basis over the term of the policy. Management analyzes premium revenues primarily by premiums written in the current period. Net premiums written differs from gross premiums written by premiums ceded to reinsurers. The table below summarizes property and casualty premium on a gross and net basis compared with the same period of the prior year:
Three months ended June 30, Six months ended June 30, 2005 2004 % Chg 2005 2004 % Chg ---- ---- ----- ---- ---- ----- Gross Premiums Written - ---------------------- Commercial Lines $223.9 $225.9 (0.9)% $435.1 $446.3 (2.5)% Specialty Lines 54.2 66.8 (18.9)% 107.4 128.6 (16.5)% Personal Lines 123.2 127.6 (3.4)% 238.1 246.5 (3.4)% ------ ------ ------ ------ All Lines $401.3 $420.3 (4.5)% $780.6 $821.4 (5.0)%
Three months ended June 30, Six months ended June 30, 2005 2004 % Chg 2005 2004 % Chg ---- ---- ----- ---- ---- ----- Net Premiums Written - -------------------- Commercial Lines $221.8 $220.3 0.7% $427.4 $432.5 (1.2)% Specialty Lines 39.7 39.1 1.5% 78.8 73.9 6.6% Personal Lines 123.4 127.3 (3.1)% 237.2 244.3 (2.9)% ------ ------ ------ ------ All Lines $384.9 $386.7 (0.5)% $743.4 $750.7 (1.0)%
Gross premiums written for the Commercial and Personal Lines segments declined for the three months and six months ended June 30, 2005, primarily as a result of a reduction in new business premium production for both segments and a decline in average renewal price increases. The Group is devoting more attention in 2005 to identifying opportunities to enhance premium growth through establishment of service centers, improved sales force effectiveness and facilitating agency management system interfaces. Specialty Lines gross premiums written declined as a result of lower new business production. The decline in net premiums written was partially offset by lower reinsurance costs due to increases in reinsurance retention in 2005 and $5.5 of return ceded premium on experience based reinsurance contracts in the second quarter of 2005, compared to $5.0 of return ceded premium in the second quarter of 2004. The experience rated reinsurance contracts are for a funded layer of casualty excess of loss reinsurance coverage. See the Corporation's 2004 Annual Report on Form 10-K Item 7, Reinsurance Programs on page 42 for greater detail. 22 Commercial Lines renewal price increases averaged 1.6% in the second quarter 2005 compared to 4.5% in the second quarter 2004. This decrease period over period is the result of a broad market trend of increased competitive pricing pressure. Renewal price increase means the average increase in premium for policies renewed by the Group. The average increase in premium for each renewed policy is calculated by comparing the total expiring premium for the policy with the total renewal premium for the same policy. Renewal price increases include, among other things, the effects of rate increases and changes in the underlying insured exposures of the policy. Only policies issued by the Group in the previous policy term with the same policy identification codes are included. Therefore, renewal price increases do not include changes in premiums for newly issued policies or business assumed through reinsurance agreements. Renewal price increases also do not reflect the cost of any reinsurance purchased on the policies issued. All Lines Discussion The following table provides key financial measures for All Lines:
Three Months Ended Six Months Ended June 30 June 30 2005 2004 2005 2004 ---- ---- ---- ---- All Lines - --------- Loss ratio 52.4% 55.3% 52.6% 54.7% Loss adjustment expense ratio 11.0% 10.1% 11.4% 10.8% Underwriting expense ratio 32.1% 33.8% 31.5% 36.0% ----- ----- ----- ------ Combined ratio 95.5% 99.2% 95.5% 101.5%
The All Lines combined ratio for the second quarter 2005 improved 3.7 points driven by a 2.9 point improvement in the loss ratio and a 1.7 point improvement in the underwriting expense ratio, partially offset by a 0.9 point deterioration of the loss adjustment expense ratio. The loss ratio improvement included lower catastrophe losses compared to the second quarter last year and includes favorable results from the Group's continued focus on underwriting quality and improved pricing levels, as reflected below. The underwriting ratio improvement is described below and includes the full impact of staff reductions related to the 2004 Cost Structure Efficiency (CSE) Initiative. The table below summarizes the impact of changes in provision for all prior accident year losses and LAE:
Three Months Six Months Ended June 30 Ended June 30 2005 2004 2005 2004 ---- ---- ---- ---- Statutory net liabilities, beginning of period $2,200.7 $2,141.9 $2,183.8 $2,128.9 Decrease in provision for prior accident year claims $(2.9) $(10.2) $(6.7) $(12.7) Decrease in provision for prior accident year claims as % of premiums earned (0.8)% (2.8)% (0.9)% (1.7)%
Catastrophe losses for the second quarter 2005 were $5.7 or 1.5 points compared to $11.7 or 3.2 points in the second quarter 2004, a decrease of 1.7 points. The effect of future catastrophes on the Corporation's results of operations cannot be accurately predicted. As such, severe weather patterns, acts of war or terrorist activities could have a material adverse impact on the Corporation's results of operations, reinsurance pricing and availability of reinsurance. During the second quarter of 2005, there were five catastrophes with the largest catastrophe generating $1.4 in incurred losses as compared with six catastrophes in the second quarter of 2004 with the largest catastrophe generating $3.8 in incurred losses. For additional disclosure of catastrophe losses, refer to Item 15, Losses and LAE Reserves in the Notes to the Consolidated Financial Statements on page 66 of the Corporation's 2004 Annual Report on Form 10-K. The deterioration in the loss adjustment expense ratio is related to adverse development on prior year reserves, primarily in the casualty lines, a change in the mix of premium, as commercial lines grows as a percent of the portfolio and bears a higher LAE ratio, and higher reinsurance retention and costs compared to last year. 23 The table below summarizes the variance in the underwriting expense ratio for the second quarter 2004 compared to the second quarter 2005: Underwriting expense ratio variance ----------------------------------- Underwriting expense ratio - second quarter 2004 33.8% Contingent liability to Proformance (0.2)% Decrease to professional fees (0.6)% 2004 Severance related expense due to work force reduction (0.8)% Impact of all other underwriting expense ratio items (0.1)% ------ Underwriting expense ratio - second quarter 2005 32.1% ===== The underwriting expense ratio for the second quarter of 2005 includes a $0.7 reduction to the surplus guarantee accrual recorded at March 31, 2005 related to final settlement with Proformance. The changes in the accrual for the surplus guarantee favorably impacted the results of operations for the first six months of 2005 by 0.7 points and increased last year's ratio 1.2 points. See Note VIII - Contingencies on pages 14 and 15 of this Quarterly Report on Form 10-Q. The remainder of the improvement in the underwriting expense ratio is related to the benefit of the CSE initiative. The largest portion of the CSE initiative's planned savings were implemented within the second quarter last year. The CSE initiative is ongoing and we continue to explore new cost savings and process improvement ideas. The employee count remained relatively flat when compared to December 31, 2004. As of June 30, 2005, the employee count was 2,170, compared with 2,190 at December 31, 2004 and approximately 2,200 at June 30, 2004. In both the second quarter 2005 and 2004, underwriting expenses included $0.8 of software amortization expense before tax, related to the rollout of P.A.R.I.S.(sm). On a GAAP accounting basis, the new application is being amortized over a ten-year period. This amortization expense is expected to be offset in part by reduced labor costs related to underwriting and policy processing. In 2001, the Group introduced into operation, P.A.R.I.S.(sm) for Commercial Lines. At the end of 2004, P.A.R.I.S.(sm) was deployed for the Specialty Lines commercial umbrella excess capacity product line. Further implementation for other Specialty and Personal Lines products is expected during 2005 and 2006. The P.A.R.I.S.(sm) system provides the policy administration environment used internally by the Group's associates. An extension of P.A.R.I.S.(sm) called P.A.R.I.S. Express(sm) leverages the P.A.R.I.S.(sm) system to provide underwriting, rating, inquiry and policy processing functionality to our agents. P.A.R.I.S. Express(sm) is a proprietary internet interface that uses the P.A.R.I.S.(sm) system to provide real-time functionality through a web browser to our agents. In addition, the Group is simultaneously introducing P.A.R.I.S. Connect(tm) which allows agents to transact with the Group directly from their agency management system without requiring re-entering of customer or agency information. For selected Commercial Lines agents, P.A.R.I.S. Express(sm) and P.A.R.I.S. Connect(tm) provides on-line quoting capability. In February of 2005, P.A.R.I.S. Express(sm) was extended to support issuance and endorsement processing for selected pilot agents; nationwide rollout is expected during 2005. Personal Lines currently offers on-line and real time quoting and issuance for new business and endorsements through existing (non- P.A.R.I.S.(sm)) systems. Agents want a cost effective, timely and simple system for issuing and maintaining insurance policies. P.A.R.I.S. Express(sm) and P.A.R.I.S. Connect(tm) are the cornerstone in the Group's strategy of focusing on superior agent service. The success of this strategic plan depends in part on the ability to provide agents with the technological advantages of these tools. If they do not work as expected, or fail to satisfy agents' needs, the Group may lose business to insurers with preferred technologies. 24 Segment Discussion The Corporation's organizational structure consists of three operating units: Commercial, Specialty and Personal Lines. The Corporation also has an all other segment, which derives its revenue from investment income. The following tables provide key financial measures for each of the property and casualty reportable segments: Commercial Lines Segment
Three Months Ended Six Months Ended June 30 June 30 Commercial Lines Segment 2005 2004 2005 2004 - -------------------------------------------------------------------------------- Net premiums written $221.8 $220.3 $427.4 $432.5 Net premiums earned 206.8 202.4 412.4 400.2 Loss ratio 55.7% 53.4% 56.5% 52.9% Loss adjustment expense ratio 12.9% 13.0% 14.0% 12.5% Underwriting expense ratio 34.0% 35.7% 33.9% 37.1% ------ ------ ------ ------ Combined ratio 102.6% 102.1% 104.4% 102.5%
The combined ratio for the three month period ended June 30, 2005 slightly deteriorated, compared to the same period last year, primarily due to adverse loss and LAE reserve development concentrated in the workers' compensation and general liability product lines, somewhat offset by favorable development in the commercial auto product line. The adverse prior year reserve development added 2.4 points to the second quarter 2005 loss and LAE ratios compared to favorable development of 1.0 points in the second quarter 2004. For the first six months of 2005, Commercial Lines loss and LAE reserves were adversely impacted by prior year development of 4.2 points compared to favorable development of 2.2 points in 2004. The adverse development on the workers' compensation product line for both periods is related to the ongoing review of lifetime claims and other severe cases. Also impacting the loss and LAE ratio for these periods were increased assessments for the National Workers' Compensation Pool, which added 2.8 points to the second quarter 2005 loss and LAE ratio, compared with 0.5 points for the comparable period of the prior year. The increased assessments this quarter were partially attributable to settlements between Kemper and the various Workers' Compensation Pools, in which the cash proceeds from the settlements as well as the net liabilities to the Pools of the Kemper Insurance Companies were reallocated and distributed to the remaining participating Pool companies. The Group continues to focus on improving profitability in the general liability and workers' compensation product lines. The Group has restricted writings in states where the workers' compensation product line has historically been unprofitable and is focused on growing this product line in profitable states. The first six months of 2005 Commercial Lines loss ratio included 1.0 points related to catastrophe losses compared to 0.8 points during the same period in 2004. The 3.2 point improvement in the underwriting expense ratio for the six months ended is the result of CSE initiatives. Specialty Lines Segment
Three Months Ended Six Months Ended June 30 June 30 Specialty Lines Segment 2005 2004 2005 2004 - -------------------------------------------------------------------------------- Net premiums written $39.7 $39.1 $78.8 $73.9 Net premiums earned 36.4 40.8 71.5 82.5 Loss ratio 41.6% 45.8% 42.3% 42.9% Loss adjustment expense ratio 9.8% 3.0% 8.9% 3.5% Underwriting expense ratio 43.9% 46.3% 44.6% 46.2% ----- ----- ----- ----- Combined ratio 95.3% 95.1% 95.8% 92.6%
The Specialty Lines combined ratio for the three months ended June 30, 2005 was comparable to the same period last year as favorable reserve development on bonds was offset by higher loss and LAE ratios related to increased retention on commercial umbrella risks. The Specialty Lines loss and LAE ratios were favorably impacted by prior year reserve development of 4.1 points in second quarter 2005 compared to 5.1 points in second quarter 2004. 25 Personal Lines Segment
Three Months Ended Six Months Ended June 30 June 30 Personal Lines Segment 2005 2004 2005 2004 - -------------------------------------------------------------------------------- Net premiums written $123.4 $127.3 $237.2 $244.3 Net premiums earned 122.3 124.0 243.9 245.6 Loss ratio 50.1% 61.6% 49.0% 61.6% Loss adjustment expense ratio 8.2% 7.8% 7.8% 10.4% Underwriting expense ratio 25.5% 26.4% 23.7% 30.9% ----- ----- ----- ------ Combined ratio 83.8% 95.8% 80.5% 102.9%
The combined ratio for the three months ended June 30, 2005 improved 12.0 points when compared to the same period of the prior year, primarily driven by improvements to both the loss and underwriting expense ratios, partially offset by an increase in the LAE ratio. The loss ratio for the second quarter 2005 improved 11.5 points when compared to second quarter 2004, while the LAE ratio deteriorated 0.4 points. The loss ratio improvement was driven by lower catastrophe losses, favorable development on prior years' reserves, increased pricing and favorable claims frequency trends. In the second quarter 2005, favorable development on prior year reserves lowered the loss and LAE ratio by 5.2 points compared to 4.8 points of favorable prior year reserve development in 2004. The second quarter 2005 Personal Lines loss ratio included 2.2 point of catastrophe losses, compared to 8.0 points in the second quarter of 2004. During the first six months of 2005, the Personal Lines loss ratio was impacted by 1.6 points related to catastrophe losses compared to 4.7 points during the same period in 2004. The second quarter 2005 underwriting expense ratio includes a 0.6 point reduction pertaining to the surplus guarantee related to the Proformance transaction compared to no impact in the same period last year. The first six months of 2005 underwriting expense ratio included a 2.1 point reduction related to the Proformance surplus guarantee, compared to a 3.7 point increase in the same period last year. The remainder of the improvement in the underwriting expense ratio is primarily related to the recognition of the full benefit of the CSE initiative staff reductions implemented in the first half of 2004.
Statutory Earned Premium and Combined Ratios Combined Ratios Earned ----------------------------------------------------- Premium Calendar Year Accident Year Year to Date Year to Date Year to Date Calendar Accident June 30, June 30, June 30, Year Year (By operating segment) 2005 2005 2005(a) 2004 2004(a) - ------------------------------------------------------------------------------------------- Commercial Lines $412.4 103.3% 99.1% 99.3% 100.3% Specialty Lines 71.5 87.6% 93.7% 97.2% 102.9% Personal Lines 243.9 80.9% 89.0% 97.6% 95.5% - ------------------------------------------------------------------------------------------- Total All Lines $727.8 94.4% 95.4% 98.4% 98.7% ===========================================================================================
(a) The loss and LAE ratio component of the accident year combined ratio measures losses and LAE arising from insured events that occurred in the respective accident year. The current accident year excludes losses and LAE for insured events that occurred in prior accident years. The measurement date for accident year data is June 30, 2005. Partial and complete accident periods may not be comparable due to seasonality, claim reporting and development patterns, claim settlement rates and other factors. LIQUIDITY AND CAPITAL RESOURCES Investment Portfolio The following table sets forth the distribution and other data of investments at June 30, 2005 and December 31, 2004, respectively. 26
June 30, 2005 December 31, 2004 ------------- ----------------- Average Amortized Carrying % of Amortized Carrying % of Rating Cost Value Total Cost Value Total --------------------------------------------------------------------- U.S Government: Available-for-sale AAA $ 35.5 $ 36.8 0.9 $ 31.9 $ 33.4 0.8 States, municipalities, and political subdivisions: Investment grade: Available-for-sale AA+ 1,168.7 1,195.4 28.6 1,018.4 1,034.6 24.4 Corporate securities: Investment grade: Available-for-sale A 1,583.9 1,697.3 40.5 1,562.8 1,686.4 39.7 Held-to-maturity A+ 163.2 163.2 3.9 164.7 164.7 3.9 Below Investment grade: Available-for-sale BB 60.7 65.3 1.6 51.6 58.4 1.4 ------------------------------------------------------------- Total corporate securities 1,807.8 1,925.8 46.0 1,779.1 1,909.5 45.0 ------------------------------------------------------------- Mortgage-backed securities: Investment grade: Available-for-sale AAA 503.9 525.1 12.5 505.2 524.7 12.4 Held-to-maturity AAA 120.0 120.0 2.9 136.7 136.7 3.2 Below Investment grade: Available-for-sale B 1.9 1.9 - 6.9 8.6 0.2 ------------------------------------------------------------- Total mortgage-backed securities 625.8 647.0 15.4 648.8 670.0 15.8 ------------------------------------------------------------- Total fixed maturities 3,637.8 3,805.0 90.9 3,478.2 3,647.5 86.0 Equity securities 102.2 356.8 8.5 98.9 357.4 8.4 Short-term investments 24.7 24.7 0.6 239.9 239.1 5.6 ------------------------------------------------------------- Total investment portfolio $3,764.7 $4,186.5 100.0 $3,817.0 $4,244.0 100.0 =============================================================
The fixed maturity portfolio is allocated between investment grade and below investment grade as follows:
June 30, 2005 December 31, 2004 ------------- ----------------- Amortized Carrying % of Amortized Carrying % of Cost Value Fixed Cost Value Fixed ------------------------------------------------------------- Total investment grade $3,575.2 $3,737.8 98.2 $3,419.7 $3,580.5 98.2 Total below investment grade 62.6 67.2 1.8 58.5 67.0 1.8 The fixed maturity portfolio is allocated between available-for-sale and held-to-maturity as follows: Total available-for-sale fixed securities $3,354.5 $3,521.7 92.6 $3,176.8 $3,346.1 91.7 Total held-to-maturity fixed securities 283.3 283.3 7.4 301.4 301.4 8.3
The excess of carrying value over cost was $421.8 at June 30, 2005, compared with $427.0 at December 31, 2004. The decrease in 2005 was attributable to an increase in interest rates for fixed maturity securities and the decline in the market value of certain equity securities. This decline in the excess of carrying value over cost during the six months ended June 30, 2005 decreased the Corporation's book value by $0.06 per share, which was offset by the improved profitability of the Corporation. See page 30 for reconciliation of book value per share from December 31, 2004 to June 30, 2005. The consolidated fixed maturity portfolio, including short-term securities, has an intermediate duration and a laddered maturity structure. The duration of the fixed maturity portfolio was approximately 5.3 years at June 30, 2005 and 5.1 years at December 31, 2004. The increase in the duration is principally the result of the reduction in short term investments used to facilitate the redemption of the Convertible Notes. The Corporation and the Group remain fully invested and do not time markets. Fixed maturity securities are classified as investment grade or non- investment grade based upon the higher of the ratings provided by S&P and Moody's. When a security is not rated by either S&P or Moody's, the classification is based on other rating services, including the Securities Valuation Office of the National 27 Association of Insurance Commissioners. The market value of available-for- sale split-rated fixed maturity securities (i.e., those having an investment grade rating from one rating agency and a below investment grade rating from another rating agency) was $29.1 and $31.5 at June 30, 2005 and December 31, 2004, respectively. Investments in below investment grade securities have greater risks than investments in investment grade securities. The risk of default by borrowers that issue below investment grade securities is significantly greater because these borrowers are often highly leveraged and more sensitive to adverse economic conditions, including a recession or a sharp increase in interest rates. Following is a table displaying available-for-sale non-investment grade and non-rated securities in an unrealized loss position at June 30, 2005 and December 31, 2004:
Amortized Fair Unrealized Cost Value Loss - -------------------------------------------------------------------- June 30, 2005 $4.0 $4.0 $ - December 31, 2004 1.5 1.4 (0.1)
Equity securities are carried at fair market value on the consolidated balance sheets. As a result, shareholders' equity and statutory surplus fluctuate with changes in the value of the equity portfolio. As of June 30, 2005, the equity portfolio consisted of stocks in a total of 51 separate entities in nine different industries. Of this total, 32.6% were invested in five companies and the largest single position was 10.4% of the equity portfolio. At December 31, 2004, the equity portfolio consisted of stocks in 50 separate entities in nine different industries. Of this total, 31.2% were invested in five companies and the largest single position was 7.3% of the equity portfolio. In June 2004, the Corporation invested the proceeds of the Senior Note offering in short-term investments. Short-term investments are carried at fair market value on the consolidated balance sheets and produce a lower yield. In the second quarter of 2005, these investments were liquidated to fund the redemption of the Company's 5.00% Convertible Notes, see Liquidity and Capital Resources - Debt for additional information regarding this transaction. The investment portfolio also includes non-publicly traded securities such as private placements, non-exchange traded equities and limited partnerships which are carried at fair value. Fair values are based on valuations from pricing services, brokers and other methods as determined by management to provide the most accurate price. The carrying value of this portfolio at June 30, 2005, was $296.0 compared to $310.8 at December 31, 2004. The Corporation and Group use assumptions and estimates when valuing certain investments and related income. These assumptions include estimations of cash flows and interest rates. Although the Corporation and Group believe the values of its investments represent fair value, certain estimates could change and lead to changes in fair values due to the inherent uncertainties and judgements involved with accounting measurements. Losses and Loss Adjustment Expenses The Group's largest liabilities are reserves for losses and LAE. Loss and LAE reserves are established for all incurred claims without discounting for the time value of money and before credit for reinsurance recoverable. Loss and LAE reserves are adjusted upward or downward as new information is received. These reserves amounted to $2.9 billion at June 30, 2005 and $2.8 billion at December 31, 2004. As of June 30, 2005, the reserves by operating segment were as follows: $1.8 billion in Commercial Lines, $0.7 billion in Specialty Lines and $0.4 billion in Personal Lines. The Group's actuaries conduct a reserve study using generally accepted actuarial methods each quarter from which point estimates of ultimate losses and LAE by product line or coverage within product line are selected. In selecting the point estimates, thousands of data points are reviewed and the judgment of the 28 actuaries is applied broadly. Each quarter management records its best estimate of the liability for loss and LAE reserves by considering the actuaries' point estimates. Management's best estimate recognizes that there is uncertainty underlying the actuarial point estimates. Estimating the ultimate cost of claims is a complex process. This estimation process is based largely on the assumption that actuarial reserving methods, using historical loss experience applied by experienced reserving actuaries, produces reasonable estimates of future losses on prior insured events. Reserve estimates can change over time because of unexpected changes in the internal and/or external environment. Assumptions internal to company operations include: recording of premium and loss statistics in the appropriate detail is accurate and consistent; claims handling, including the recording of claims, payment and closure rates, and case reserving is consistent; the quality of business written and the mix of business (e.g. states, limits, coverages and deductibles) have been consistent; rate changes and changes in policy provisions have been measured accurately; reinsurance coverage has been consistent and reinsured losses are collectible. Assumptions related to the external environment include: tort law and the legal environment have been and remain consistent; coverage interpretation by the courts has been and remains consistent; regulations regarding coverage provisions have been consistent; and loss inflation is relatively stable. To the extent any of the above factors have changed over time, attempts are made to adjust for the changes. Changes to losses and LAE for prior accident years favorably impacted results of operations for the three months ended June 30, 2005 and 2004 by $2.9 and $10.2, respectively. For the six months ended June 30, 2005 and 2004, changes to losses and LAE for prior accident years favorably impacted the results of operations by $6.7 and $12.7, respectively. These amounts and those stated below are net of reinsurance, including the allowance for uncollectible reinsurance recoverables. The following table provides the before-tax amount of prior accident years' loss and LAE reserve development by reportable segment:
Three Months Ended Six Months Ended June 30 June 30 Year 2005 2004 2005 2004 2004 ------------------ ---------------- ---- (Favorable)/Unfavorable - ----------------------- Commercial Lines $ 5.0 $ (2.1) $ 17.2 $ (8.7) $(15.0) Specialty Lines (1.5) (2.1) (4.3) (5.2) (9.4) Personal Lines (6.4) (6.0) (19.6) 1.2 2.6 ------ ------- ------- ------- ------ All Lines Prior Accident Year Development $(2.9) $(10.2) $ (6.7) $(12.7) $(21.8) ====== ======= ======= ======= =======
For the six months ended June 30, 2005, the principal reason for favorable development is less severity than expected for automobile liability claims, both personal and commercial, spread across accident years 2000 through 2004. For Commercial Lines the favorable development in the commercial auto product line was more than offset by adverse development from the workers' compensation product line for accident years 2000 and prior. This adverse workers' compensation development is mostly attributable to a review of permanent cases to re-assess life expectancy and increased medical costs. A substantial increase in losses for prior accident years reported by the National Workers' Compensation Pool in the second quarter also contributed to the adverse development in this product line. The following table provides prior accident years' development for loss and LAE by accident year:
Three Months Ended Six Months Ended June 30 June 30 Year 2005 2004 2005 2004 2004 ------------------ ---------------- ---- (Favorable)/Unfavorable - ----------------------- Accident Year 2004 $(6.6) $ - $(15.9) $ - $ - Accident Year 2003 (6.5) (8.1) (17.3) (22.2) (36.9) Accident Year 2002 and Prior 10.2 (2.1) 26.5 9.5 15.1 ------ ------- ------- ------- ------- Total Prior Accident Years' Development $(2.9) $(10.2) $ (6.7) $(12.7) $(21.8) ====== ======= ======= ======= =======
29 In the opinion of management, the reserves recorded at June 30, 2005 represent the Group's best estimate of its ultimate liability for losses and LAE. However, due to the complexity of the estimation process and the potential variability of the assumptions used, final claim settlements may vary significantly from the amounts recorded. Furthermore, the timing, frequency and extent of adjustments to the estimated liabilities cannot be predicted since conditions and events which established loss and LAE reserve development and which serve as the basis for estimating ultimate claim costs may not occur in exactly the same manner in the future, if at all. Cash Flow Net cash generated from operations was $93.3 for the first six months of 2005, compared with $97.2 for the same period in 2004. Net cash used in investing was $156.3 in the first six months of 2005 compared with $92.3 during the first six months of 2004. The increase in net cash used for investing is primarily related to a decrease in net proceeds from sales and maturities of investments when compared to the same period in 2004. Cash used in financing operations was $154.9 in the first six months of 2005 compared with cash provided by financing operations of $202.5 in the first six months of 2004. Repurchases and the redemption of the convertible debt attributed to the decline in cash used in financing activities. Liquidity needs of the Group are expected to be met by net cash generated from operations, maturities of investments, interest and dividend receipts and current cash balances. For additional information regarding Liquidity of the Corporation, please see below. Debt For a discussion regarding Debt of the Corporation, please refer to Note VII in the Notes to the Consolidated Financial Statements on pages 13 and 14 of this Quarterly Report on Form 10-Q. At June 30, 2005, the Corporation had cash and marketable securities, totaling $249.6, which compared to $327.5 at December 31, 2004. In addition to investment income, the Corporation is dependent on dividend payments from the Company for additional liquidity. Insurance regulatory authorities impose various restrictions on the payment of dividends by insurance companies. During 2005, dividend payments from the Company to the Corporation are limited to approximately $138.3 without prior approval of the Ohio Insurance Department. During the first half of 2005, the Company declared dividends of $111.6 ($81.6 paid in the first half of 2005) to the Corporation resulting in a dividend payment limitation of $26.7 for the remainder of 2005. Book Value Per Share At June 30, 2005, the Corporation experienced an increase in book value of $1.07 per share from $20.82 per share to $21.89 per share when compared to book value at December 31, 2004. This increase is principally the result of improved profitability. Below is a table reconciling the changes in book value per share from December 31, 2004 to June 30, 2005.
Book Value ----- December 31, 2004 $20.82 Activity for the six months ended June 30, 2005: Net income 1.28 Change in unrealized gains (0.06) Impact of convertible notes and other APIC transactions 0.24 Dividend to shareholders (0.06) Impact of increase in actual shares outstanding (0.33) ------- June 30, 2005 $21.89 ======
30 Rating Agencies Regularly the financial condition of the Corporation and the Group is reviewed by four independent rating agencies, A. M. Best Company (A.M. Best), Fitch, Inc. (Fitch), Moody's and S&P. These agencies assign ratings and rating outlooks reflecting the agencies' opinions of the Group's financial strength and the ability of the Corporation to meet its financial obligations to its debt security holders. Following are the Corporation's current ratings and rating outlooks.
A.M. Best Fitch Moody's S&P --------- ----- ------- --- Financial strength rating A- A- A3 BBB Senior unsecured debt rating bbb- BBB- Baa3 BB Rating outlook Stable Stable Stable Positive
For more information on the most recent rating agency actions, please refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in the Corporation's 2004 Annual Report on Form 10-K for the year ended December 31, 2004. Forward Looking Statements Ohio Casualty Corporation publishes forward-looking statements relating to such matters as anticipated financial performance, business prospects and plans, regulatory developments and similar matters. The statements contained in this Management's Discussion and Analysis that are not historical information, are forward-looking statements within the meaning of The Private Securities Litigation Reform Act of 1995. The operations, performance and development of the Corporation's business are subject to risks and uncertainties which may cause actual results to differ materially from those contained in or supported by the forward looking statements. The risks and uncertainties that may affect the operations, performance, development and results of the Corporation's business include the following: changes in property and casualty reserves; catastrophe losses; premium and investment growth; product pricing environment; availability of credit; changes in government regulation; performance of financial markets; fluctuations in interest rates; availability and pricing of reinsurance; litigation and administrative proceedings; rating agency actions; acts of war and terrorist activities; ability to achieve targeted expense savings; ability to appoint and retain agents; ability to achieve premium targets and profitability goals; and general economic and market conditions. ITEM 3. Quantitative and Qualitative Disclosures about Market Risk There have been no material changes in the information about market risk set forth in the Corporation's 2004 Annual Report on Form 10-K. ITEM 4. Controls and Procedures (a) The Corporation's Chief Executive Officer and Chief Financial Officer evaluated the disclosure controls and procedures (as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934, as amended) as of the end of the period covered by this report. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that the Corporation's disclosure controls and procedures are effective. (b) There were no significant changes in the Corporation's internal control over financial reporting identified in connection with the foregoing evaluation that occurred during the Corporation's last fiscal quarter that have affected, or are reasonably likely to materially affect, the Corporation's internal control over financial reporting. 31 PART II Other Information ITEM 4. Submission of Matters to a Vote of Security Holders At the Annual Meeting of Shareholders (the Annual Meeting) held on May 18, 2005, shareholders voted on the re-election of four members of the Board of Directors for terms expiring in 2008 as follows. Dan R. Carmichael For 51,888,760; Withheld 5,025,828 Catherine E. Dolan For 49,958,687; Withheld 6,955,901 Philip G. Heasley For 51,054,689; Withheld 5,859,899 Michael L. Wright For 52,484,554; Withheld 4,430,034 Other directors whose term of office continued after the meeting were: Terrence J. Baehr, Jack E. Brown, Ralph S. Michael III, Robert A. Oakley, Stanley N. Pontius and Jan H. Suwinski. Ralph S. Michael III resigned from the Board of Directors effective July 25, 2005. Also, at the Annual Meeting, shareholders approved a proposal for The Ohio Casualty Corporation 2005 Incentive Plan. The proposal was approved with a final vote of: For 43,096,208; Against 8,760,493; Abstain 246,349; Broker Non-Vote 4,811,538 ITEM 6. Exhibits Exhibits: 10 Ohio Casualty Corporation 2005 Incentive Plan 31.1 Certification of Chief Executive Officer of Ohio Casualty Corporation in accordance with SEC Rule 13(a) and Rule 15(d) 31.2 Certification of Chief Financial Officer of Ohio Casualty Corporation in accordance with SEC Rule 13(a) and Rule 15(d) 32.1 Certification of Chief Executive Officer of Ohio Casualty Corporation in accordance with Section 1350 of the Sarbanes-Oxley Act of 2002 32.2 Certification of Chief Financial Officer of Ohio Casualty Corporation in accordance with Section 1350 of the Sarbanes-Oxley Act of 2002 32 SIGNATURE Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. OHIO CASUALTY CORPORATION ------------------------- (Registrant) July 26, 2005 /s/Michael A. Winner ------------------------------- Michael A. Winner, Executive Vice President and Chief Financial Officer 33 EX-10 2 exh10.txt OHIO CASUALTY CORP 2005 INCENTIVE PLAN Exhibit 10 OHIO CASUALTY CORPORATION 2005 INCENTIVE PLAN 1.00 PURPOSE This Plan is intended to foster and promote the long-term financial success of the Company and its Subsidiaries; to reward performance and to increase shareholder value by providing Participants appropriate incentives and rewards; to enable the Company to attract and retain the services of outstanding individuals upon whose judgment, interest and dedication the successful conduct of the Company's and its Subsidiary's business is largely dependent; to encourage Participants' ownership interest in the Company; and to align the interests of management and directors with that of the Company's shareholders. 2.00 DEFINITIONS When used in this Plan, the following terms will have the meanings given to them in this section unless another meaning is expressly provided elsewhere in this document or clearly required by the context. When applying these definitions and any other word, term or phrase used in this document, the form of any word, term or phrase will include any and all of its other forms. Act. The Securities Exchange Act of 1934, as amended. Annual Meeting. The annual meeting of the Company's shareholders. Award. Any Incentive Stock Option, Nonqualified Stock Option, Restricted Stock, Restricted Stock Unit, Stock Appreciation Right, shares of Stock, Stock Units and Cash Awards. Grants of Restricted Stock, Restricted Stock Units, Stock Units and Cash Awards may, as determined by the Committee in its sole discretion, constitute Performance-Based Awards, as described in Section 11.00. Award Agreement. The written or electronic agreement between the Company and each Participant that describes the terms and conditions of each Award and the manner in which it will be settled if earned. If there is any conflict between the terms of this Plan and the terms of the Award Agreement, the terms of the Plan will prevail. Beneficiary. The individual a Participant designates to receive (or to exercise) any Plan benefits (or rights) that are unpaid (or unexercised) when the Participant dies. A Beneficiary may be designated only by following the procedures described in Section 15.02; neither the Company nor the Committee is required or permitted to infer a Beneficiary from any other source. Board. The Company's board of directors. Business Combination. A transaction of the type described in Section 13.01. Business Criteria. One or more of the criteria listed in Section 11.02. Cash Award. Any Award that is granted to a Participant under Section 10.00 and which the Award Agreement specifies will be paid in cash. Cause. For purposes of this Plan and unless otherwise specified in the Award Agreement, with respect to any Participant who is an Employee: [1] Any act of fraud, intentional misrepresentation, embezzlement, misappropriation or conversion of any Company or Subsidiary asset or business opportunity; [2] Conviction of, or entering into a plea of nolo contendere to, a felony; [3] Intentional, repeated or continuing violation of any of the Company's policies or procedures that occurs or continues after notice to the Participant that he or she has violated a Company policy or procedure; or [4] Any breach of a written covenant or agreement with the Company or any Subsidiary, including the terms of this Plan. Code. The Internal Revenue Code of 1986, as in effect on the Effective Date or as amended or superseded after the Effective Date, and any applicable regulations and rulings issued under the Code. Committee. [1] In the case of Awards to Directors, the entire Board; or [2] In the case of all other Awards, the Board's compensation committee which also is a "compensation committee" within the meaning of Section 1.162-27(c)(4) of U. S. Treasury Regulations. The Committee will be comprised of at least three individuals [a] each of whom must be [i] an outside director, as defined in Section 1.162-27(e)(3)(i) of U. S. Treasury Regulations and [ii] a "non-employee director" within the meaning of Rule 16b-3 under the Act and [b] none of whom may receive remuneration from the Company or any Subsidiary in any capacity other than as a director, except as permitted under Section 1.162-27(e)(3) of U. S. Treasury Regulations. Company. Ohio Casualty Corporation, a corporation organized under the laws of Ohio, and all successors to it. Director. Each member of the Board or of the board of directors of any Subsidiary who is not an Employee. Disability. A disability as defined in Code Section 22(e)(3). Dividend Equivalent Right. A right to receive the amount of any dividend paid on a Share of Stock underlying a Stock Unit, as provided in Section 9.03. Effective Date. The earlier of [1] the date this Plan is approved by the Board or [2] the date this Plan is approved by the Company's shareholders. Employee. Any individual who is a common law employee of the Company or of any Subsidiary. A worker who is classified as other than a common law employee but who is subsequently reclassified as a common law employee of an Employer for any reason and on any basis will be treated as a common law employee only from the date of that reclassification and will not retroactively be reclassified as an Employee for any purpose of this Plan. Exercise Price. The price, if any, at which a Participant may exercise an Award. Fair Market Value. The value of one share of Stock on any relevant date, determined as follows: [1] If the shares are traded on an exchange (including the NASDAQ National Market System), the reported "closing price" on the relevant date, if it is a trading day; otherwise on the next trading day; [2] If the shares are traded over-the-counter with no reported closing price, the mean between the lowest bid and the highest asked prices on that quotation system on the relevant date if it is a trading day; otherwise on the next trading day; or [3] If neither subsection [1] nor [2] of this definition applies, the fair market value as determined by the Committee in good faith and, with respect to Incentive Stock Options, consistent with rules prescribed under Code Section 422. Freestanding SAR. A Stock Appreciation Right that is not associated with an Option and is granted under Section 7.00. Grant Date. The later of [1] the date the Committee establishes the terms of an Award or [2] the date specified in the Award Agreement. Incentive Stock Option. Any Option granted under Section 5.00 that, on the Grant Date, meets the conditions imposed under Code Section 422(b) and is not subsequently modified in a manner inconsistent with Code Section 422. Nonqualified Stock Option. Any Option granted under Section 5.00 that is not an Incentive Stock Option. Option. The right granted under Section 5.00 to purchase a share of Stock at a stated price for a specified period of time. An Option may be either [1] an Incentive Stock Option or [2] a Nonqualified Stock Option. Participant. Any Employee or Director to whom the Committee grants an Award. Designation of a Participant in any year will not require the Committee to designate that person to receive an Award in any other year or, once designated, to receive the same type or amount of Award granted to the Participant in any other year. The Committee will consider the factors it deems pertinent to selecting Participants and in determining the type and amount of their respective Awards. Performance-Based Award. An Award granted subject to Section 11.00. Performance Period. The period over which the Committee will determine if a Participant has met conditions imposed on a Performance-Based Award. Plan. Ohio Casualty Corporation 2005 Incentive Plan. Plan Year. The Company's fiscal year. Prior Plan. The Ohio Casualty Corporation 2002 Stock Incentive Plan. Restricted Stock: An Award granted under Section 6.01. Restricted Stock Unit: An Award granted under Section 6.02. Restriction Period. The period over which the Committee will determine if a Participant has met conditions placed on Restricted Stock or Restricted Stock Units. Retirement or Retire. In the case of: [1] An Employee, Termination of Service after meeting the definition of normal or early retirement under the Company's tax- qualified defined benefit pension plan (or if no plan of this type is then in effect, as defined in the tax-qualified defined benefit pension plan that the Company most recently maintained), whether or not the Employee is then accruing (or ever has accrued) a benefit under that plan; and [2] In the case of Directors, their departure from the Board for any reason other than Disability or death. Stock. Common shares of the Company. Stock Appreciation Right (or "SAR"). An Award granted under Section 7.00 that is either a Tandem SAR or a Freestanding SAR. Stock Unit. An Award granted under Section 9.00. Subsidiary. Any corporation, partnership or other form of unincorporated entity of which the Company owns, directly or indirectly, 50 percent or more of the total combined voting power of all classes of stock, if the entity is a corporation; or of the capital or profits interest, if the entity is a partnership or another form of unincorporated entity. Tandem SAR. An SAR that is associated with an Option and which expires when that Option expires or is exercised, as described in Section 7.00. Termination of Service (or references to a Participant's Service being Terminated). As applicable, [1] termination of the employee-employer relationship between a Participant and the Company and all Subsidiaries for any reason, [2] with respect to an Employee of a Subsidiary, a severance or diminution of the ownership relationship between the Company and that entity after which that entity is no longer a Subsidiary and after which that person is not an Employee of the Company or any entity that then is a Subsidiary or [3] cessation of a Director's service on the Board (and the boards of directors of all Subsidiaries) for any reason. However, (with respect to any Award that is not an Incentive Stock Option) and unless the Committee specifies otherwise either in the Award Agreement or subsequently, a Termination of Service will not have occurred solely because an Employee becomes a consultant to the Company or any Subsidiary but only if that consultant is providing bona fide services to the Company or any Subsidiary. Also, with respect to any Award (including an Incentive Stock Option), a Termination of Service will not have occurred while the Employee is absent from active employment for a period of not more than three months (or, if longer, the period during which reemployment rights are protected by law, contact or written agreement, including the Award Agreement, between the Participant and the Company) due to illness, military service or other leave of absence approved by the Company. 3.00 ADMINISTRATION 3.01 Committee Duties. [1] The Committee is granted all powers appropriate and necessary to administer the Plan. Consistent with the Plan's purpose, the Committee may adopt, amend and rescind rules and regulations relating to the Plan, to the extent appropriate to protect the Company's interests, and has complete discretion to make all other decisions necessary or advisable for the administration and interpretation of the Plan. Any action by the Committee will be final, binding and conclusive for all purposes and upon all Participants. [2] The Committee (or the Board, as appropriate) also may amend the Plan and Award Agreements without any additional consideration to affected Participants to the extent necessary to avoid penalties arising under Code Section 409A, even if those amendments reduce, restrict or eliminate rights granted under the Plan or Award Agreement (or both) before those amendments. 3.02 Delegation of Duties. In its sole discretion, the Committee may delegate to any individual or entity (including Employees) that it deems appropriate any of its duties other than those described in Section 3.03[1] and [2]. 3.03 Participation. [1] Consistent with the terms of the Plan, the Committee will: [a] Decide which Employees and Directors may become Participants; [b] Decide which Participants will be granted Awards; [c] Identify the type of Awards to be granted to each Participant; [d] Specify the terms and conditions imposed on any Awards granted; [e] Develop the procedures through which an Award may be exercised; [f] Specify the circumstances under which the Company may cancel an Award or reacquire any Award or shares of Stock acquired through the Plan; [g] Impose any other terms and conditions the Committee believes are appropriate and necessary to implement the purpose of this Plan; and [h] Discharge the duties described in Section 11.00 with respect to Performance Based Awards. [2] The Committee may establish different terms and conditions: [a] For each type of Award; [b] For Participants receiving the same type of Award; and [c] For the same Participant for each Award the Participant receives, whether or not those Awards are granted at different times. [3] The Committee (or its delegate) will prepare and deliver an Award Agreement to each affected Participant with respect to each Award. The Award Agreement will describe: [a] The type of Award and when and how it may be exercised; [b] The effect of exercising an Award; [c] Any Exercise Price associated with the Award; [d] Any conditions that must be met before the Award may be exercised; [e] Any performance objectives imposed on Performance-Based Awards as described in Section 11.00; [f] When and how the Award may be exercised; and [g] Any other applicable terms and conditions affecting the Award. 3.04 Conditions of Participation. By accepting an Award, each Participant agrees: [1] To be bound by the terms of the Award Agreement and the Plan; and [2] That the Committee (or the Board) may amend the Plan and the Award Agreements without any additional consideration to the extent necessary to avoid penalties arising under Code Section 409A, even if those amendments reduce, restrict or eliminate rights granted under the Plan or Award Agreement (or both) before those amendments. 4.00 STOCK SUBJECT TO PLAN 4.01 Number of Shares. [1] Subject to Section 4.03, the number of shares of Stock subject to Awards under the Plan is the sum of: [a] 988,000; plus [b] The number of shares of Stock that were authorized to be awarded under the Prior Plan but were not awarded under the Prior Plan; plus [c] The number of shares of Stock that were awarded under the Prior Plan but which are subsequently forfeited under the terms of the Prior Plan. The terms of the Prior Plan will continue to apply to all awards issued under the Prior Plan while those awards are outstanding under the Prior Plan. However, the terms of this Plan will apply to Awards issued with respect to all shares of Stock described in Section 4.01[1][a], [b] and [c]. [2] The shares of Stock to be delivered under the Plan may consist, in whole or in part, of treasury Stock or authorized but unissued Stock not reserved for any other purpose. 4.02 Unfulfilled Awards. Any Stock subject to an Award that, for any reason, is forfeited, cancelled, terminated, relinquished, exchanged or otherwise settled without the issuance of Stock or without payment of cash equal to the difference between the Award's Fair Market Value and its Exercise Price may again be granted under the Plan and, in the discretion of the Committee, may be subject to a subsequent Award. 4.03 Adjustment in Capitalization. If, after the Effective Date, there is a Stock dividend or Stock split, recapitalization (including payment of an extraordinary dividend), merger, consolidation, combination, spin-off, distribution of assets to shareholders, exchange of shares, or other similar corporate change affecting Stock, the Committee will appropriately adjust the number of Awards that may or will be granted to Participant in any Plan Year, the aggregate number of shares of Stock available for Awards under Section 4.01 or subject to outstanding Awards (as well as any share-based limits imposed under this Plan) the respective Exercise Prices and/or limitations applicable to outstanding or subsequently granted Awards and any other affected factor, limit or term applying to Awards. Any decision of the Committee under this section will be final and binding on all Participants and Beneficiaries. 4.04 Limitations on Number of Shares Issuable to a Participant. The aggregate number of shares of Stock with respect to which Awards may be issued under this Plan to any Participant in any calendar year will not exceed 400,000 (adjusted as provided in Section 4.03), including Awards that are cancelled or deemed to have been cancelled under Section 162-27(e)(2)(vi)(B) of U. S. Treasury Regulations during the Plan Year granted. 5.00 OPTIONS 5.01 Grant of Options. [1] The Committee may grant Options to Participants who are Employees at any time during the term of this Plan. Options granted to Employees may be either [a] Incentive Stock Options or [b] Nonqualified Stock Options. [2] The Committee may grant Nonqualified Stock Options to each Director at any time, subject to any terms and conditions imposed by the Committee on the Grant Date. 5.02 Option Price. Except as provided in Section 5.04[2], each Option will bear an Exercise Price that is not less than the Fair Market Value of a share of Stock on the Grant Date. 5.03 Exercise of Options. Options awarded to a Participant under Section 5.01 may be exercised at the times and subject to the restrictions and conditions (including a vesting schedule) that the Committee specifies in the Award Agreement and to the terms of the Plan. However: [1] An Option may not be exercised for a fraction of a share, (instead, fractional shares will be settled in cash); [2] The Committee may prohibit a Participant from exercising Options for fewer than the minimum number of shares specified by the Committee in the Award Agreement but only if this prohibition does not prevent a Participant from acquiring the full number of shares of Stock for which Options are then exercisable; and [3] Unless the Committee specifies otherwise in the Award Agreement, no Option may be exercised more than 10 years after its Grant Date. 5.04 Incentive Stock Options. Notwithstanding anything in the Plan to the contrary: [1] The aggregate Fair Market Value of the Stock (determined as of the Grant Date) with respect to which Incentive Stock Options are exercisable for the first time by any Participant during any calendar year (under all option plans of the Company and all Subsidiaries) will not exceed $100,000 [or the amount specified in Code Section 422(d)], determined under rules issued under Code Section 422; [2] Each Incentive Stock Option granted to a Participant who owns [as defined in Code Section 424(d)] Stock possessing more than 10 percent of the total combined voting power of all classes of Stock or the combined voting power of any Subsidiary, determined under rules issued under Code Section 422, will bear an Exercise Price that is at least 110 percent of the Fair Market Value of a share of Stock on the Grant Date; [3] No Incentive Stock Option may be granted to any individual who is not an Employee on the Grant Date; [4] No Incentive Stock Option may be exercised more than 10 years after it is granted (five years if the Participant owns [as defined in Code Section 424(d)] Stock possessing more than 10 percent of the total combined voting power of all classes of Stock or the combined voting power of any Subsidiary), determined under rules issued under Code Section 422; and [5] The maximum number of shares of Stock that may be granted through Incentive Stock Options during the term of the Plan will not be larger than 2,000,000. 5.05 Payment for Options. The Committee will develop procedures through which a Participant may pay an Option's Exercise Price, including a cashless exercise or tendering shares of Stock the Participant already has owned for at least six months, either by actual delivery of the previously owned shares of Stock or by attestation, valued at their Fair Market Value on the exercise date, as partial or full payment of the Exercise Price. 5.06 Restrictions on Transferability. The Committee may impose restrictions on any shares of Stock acquired through an Option, including restrictions related to applicable federal securities laws, the requirements of any national securities exchange or system on which Stock is then listed or traded, or any applicable blue sky or state securities laws. 5.07 Restrictions on Reload/Repricing. Regardless of any other provision of this Plan: [1] Neither the Company nor the Committee may "reprice" (as defined under rules issued by the exchange on which the Stock then is traded or, if the Stock is not then traded on an exchange, as defined under rules issued by the New York Stock Exchange) any Award without the prior approval of the shareholders; and [2] No Participant will be entitled (and no Committee discretion may be exercised to extend to any Participant) to an automatic grant of additional Options in connection with any exercise of an Option. 6.00 RESTRICTED STOCK AND RESTRICTED STOCK UNITS 6.01 Restricted Stock. Subject to the terms of this Plan, the Committee may grant Restricted Stock to Participants at any time during the term of this Plan under terms and conditions that the Committee specifies in the Award Agreement and to the terms of the Plan. [1] Restricted Stock may not be sold, transferred, pledged, assigned or otherwise alienated or hypothecated until the end of the applicable Restriction Period. At the Committee's sole discretion, all shares of Restricted Stock will: [a] Be held by the Company as escrow agent during the Restriction Period; or [b] Be issued to the Participant in the form of certificates bearing a legend describing the restrictions imposed on the shares. [2] Restricted Stock will be: [a] Forfeited (or if shares were issued to the Participant for a cash payment, those shares will be resold to the Company for the amount paid), if all restrictions have not been met at the end of the Restriction Period, and again become available under the Plan; or [b] Released from escrow and distributed (or any restrictions described in the certificate removed) as soon as practicable after the last day of the Restriction Period, if all restrictions have then been met. [3] During the Restriction Period, and unless the Award Agreement provides otherwise, each Participant to whom Restricted Stock has been issued as described in Section 6.01[1][b]: [a] May exercise full voting rights associated with that Restricted Stock; and [b] Will be entitled to receive all dividends and other distributions paid with respect to that Restricted Stock; provided, however, that if any dividends or other distributions are paid in shares of Stock, those shares will be subject to the same restrictions on transferability and forfeitability as the shares of Restricted Stock with respect to which they were issued. 6.02 Restricted Stock Units. Subject to the terms of this Plan, the Committee may grant Restricted Stock Units to Participants at any time during the term of this Plan under terms and conditions that the Committee specifies in the Award Agreement and to the terms of the Plan. [1] Restricted Stock Units may not be sold, transferred, pledged, assigned or otherwise alienated or hypothecated. [2] Restricted Stock Units will be: [a] Forfeited, if all restrictions have not been met at the end of the Restriction Period, and again become available under the Plan; or [b] As soon as practicable after all restrictions have then been met, will be settled in the form specified in the Award Agreement. If the Award Agreement specifies that SARs will be settled [i] in shares of Stock, the number of shares issued will equal the number of Restricted Stock Units to be settled, [ii] for cash equal, the amount distributed will equal the number of Restricted Stock Units to be settled multiplied by the Fair Market Value of a share of Stock on the settlement date or [iii] in a combination of shares of Stock or cash, as computed under subsection 6.02[2][b][i] and [ii]. [3] During the Restriction Period, Participants may not exercise any voting rights associated with the shares of Stock underlying his or her Restricted Stock Units or to receive any dividends or other distributions otherwise payable with respect to the shares of Stock underlying his or her Restricted Stock Units. 7.00 STOCK APPRECIATION RIGHTS The Committee may grant Freestanding SARs and Tandem SARs (or a combination of each) to Participants at any time during the term of this Plan. [1] The Exercise Price specified in the Award Agreement will: [a] In the case of a Freestanding SAR, never be less than 100 percent of the Fair Market Value of a share of Stock on the Grant Date; and [b] In the case of a Tandem SAR, never be less than the Exercise Price of the related Option. [2] Tandem SARs may be exercised with respect to all or part of the shares of Stock subject to the related Option by surrendering the right to exercise the equivalent portion of the related Option. However: [a] A Tandem SAR may be exercised only with respect to the shares of Stock for which its related Option is then exercisable; [b] A Tandem SAR will expire no later than the date the related Option expires; [c] The value of the payout with respect to a Tandem SAR related to an Incentive Stock Option will not be more than 100 percent of the difference between the Exercise Price of the related Option and the Fair Market Value of the shares of Stock subject to the related Option at the time the Tandem SAR is exercised; and [d] A Tandem SAR related to an Incentive Stock Option may be exercised only if the Fair Market Value of the shares of Stock subject to the related Option is greater than the Option's Exercise Price. [3] Freestanding SARs will be exercisable subject to the terms the Committee specifies in the Award Agreement and to the terms of the Plan. [4] A Participant exercising an SAR will receive an amount equal to: [a] The difference between the Fair Market Value of a share of Stock on the exercise date and the Exercise Price; multiplied by [b] The number of shares of Stock with respect to which the SAR is exercised. Unless otherwise specified in the Award Agreement, all SARs will be settled in shares of Stock. 8.00 OTHER STOCK AWARDS TO PARTICIPANTS The Committee may grant Awards of shares of Stock to any Participant as an incentive, bonus or in lieu of any retainer due to a Director as it determines to be in the best interests of the Company and subject to such other terms and conditions as it deems appropriate. 9.00 STOCK UNITS 9.01 Stock Unit Awards. The Committee may, in its discretion, grant Stock Units to Participants. Stock Units will be subject to any terms and conditions, including vesting that the Committee specifies in the Award Agreement and to the terms of the Plan. Stock Units may constitute Performance-Based Awards, as described in Section 11.00. The Award Agreement will state the form in which the Stock Unit is to be settled and when the Stock Unit will be settled. Shares of Stock issued through a Stock Unit Award may be issued with or without payment by the Participant as required by applicable law or any other consideration specified by the Committee. The Award Agreement will specify if the Participant granted a Stock Unit also will be entitled to a Dividend Equivalent Right. 9.02 Settling of Stock Units. One share of Stock will be issued for each Stock Unit to be settled in shares of Stock unless the Award Agreement provides for settlement in cash or partially in cash and partially in shares of Stock. If all or part of any Stock Unit Award is to be settled in cash, the amount distributed will be the Fair Market Value of the number of shares of Stock that otherwise would have been distributed to settle the Stock Unit. 9.03 Disposition of Dividend Equivalent Rights. The right to receive the amount of any Dividend Equivalent Right will be forfeited or paid in cash or in the form of additional Stock Units (as provided in the Award Agreement) when the associated Stock Unit is forfeited or settled. 10.00 CASH AWARDS The Committee may, in its discretion, grant Cash Awards. Cash Awards [1] will be subject to the terms and conditions, including vesting, that the Committee specifies in the Award Agreement and to the terms of the Plan and [2] may constitute Performance-Based Awards under Section 11.00. The maximum annual Cash Award that may be paid to any Participant in any single Plan Year is not more than $5,000,000. 11.00 PERFORMANCE-BASED AWARDS 11.01 Generally. Any Restricted Stock, Restricted Stock Units, Stock Units or Cash Awards granted under the Plan may be granted in a manner that qualifies as "performance-based compensation" under Code Section 162(m). As determined by the Committee in its sole discretion, either the granting or vesting of Performance-Based Awards will be based on achieving performance objectives derived from one or more of the Business Criteria over the Performance Period established by the Committee. 11.02 Business Criteria. [1] The Business Criteria imposed on Performance-Based Awards will be one of more of the following and may be applied solely with reference to the Company (or Subsidiary) or relatively between the Company (or Subsidiary) and one or more unrelated entities: [a] Operating income (pre- or post-tax); [b] Total return to shareholders; [c] Return on equity; [d] Premiums; [e] Share price; [f] Book Value; [g] Surplus; [h] Underwriting profit, underwriting ratio; [i] Expense or expense ratio; [j] Combined ratio; [k] Income, net income (pre- or post-tax); and [l] Performance relative to peer companies. [2] Different Business Criteria may be applied to individual Participants or to groups of Participants and, as specified by the Committee, may be based on the results achieved [a] separately by Company or any Subsidiary, [b] any combination of the Company and Subsidiaries or [c] any combination of segments, products or divisions of the Company and Subsidiaries. 11.03 Establishment of Performance Goals. With respect to Performance- Based Awards, the Committee will establish in writing [1] the performance objectives to be applied and the Performance Period over which their achievement will be measured, [2] the method for computing the Cash Award or other Award that will be granted or earned if (and to the extent that) those performance objectives are met and [3] the Participants or class of Participants to which the performance objectives apply. Performance objectives will be established in writing no later than 90 days after the beginning of the applicable Performance Period (but in no event after 25 percent of the Performance Period has elapsed). 11.04 Certification of Performance. No Performance-Based Award will be paid to any Participant for any Performance Period until the Committee certifies in writing that the associated objective performance objectives (and all other material conditions) imposed as a condition of receiving that Award have been met. 11.05 Modification of Performance-Based Awards. Once established, the Committee may not revise any performance objectives associated with a Performance-Based Award or increase the amount of the Cash Award or other Award that may be paid or earned if those performance objectives are met. However, the Committee may reduce or eliminate the Cash Award or other Award that may be paid or earned if those performance objectives are met. 12.00 TERMINATION OF SERVICE/LIMITS ON EXERCISABILITY/BUYOUTS 12.01 Effect of Termination of Service on Awards Other than Performance- Based Awards. Unless otherwise specified in the Award Agreement and subject to Sections 12.03 and 12.04, all Awards (other than Performance-Based Awards) will be exercisable or forfeited upon a Termination of Service as provided in this section: [1] Death. If a Participant's Service Terminates because of death, [a] all outstanding Restricted Stock, Restricted Stock Units, Freestanding SARs, Stock, Stock Units or Cash Awards (whether or not then vested) will be settled as provided in the Plan and the Award Agreement and [b] all Options and Tandem SARs (whether or not then exercisable) may be exercised by the Participant's Beneficiary anytime before the earlier of the expiration date specified in the Award Agreement or 15 months after the Participant's death. However, if the Award Agreement under which an Incentive Stock Option was granted to the deceased Participant specifies an expiration date that is more than 12 months after the Participant's death and that Incentive Stock Option is not exercised within 12 months after the Participant's death, the Option will be treated as a Nonqualified Stock Option for the balance of the period described in the preceding sentence. [2] Disability. If a Participant's Service Terminates because of Disability, [a] all outstanding Restricted Stock, Restricted Stock Units, Freestanding SARs, Stock, Stock Units or Cash Awards (whether or not then vested) will be settled as provided in the Plan and the Award Agreement and [b] all Options and Tandem SARs (whether or not then exercisable) may be exercised by the Participant (or his or her Beneficiary) anytime before the earlier of the expiration date specified in the Award Agreement or 15 months after the Participant Terminates. However, if the Award Agreement under which an Incentive Stock Option was granted to the Disabled Participant specifies an expiration date that is more than 12 months after the Participant's Termination because of Disability and that Incentive Stock Option is not exercised within 12 months after the Participant's Termination because of Disability, the Option will be treated as a Nonqualified Stock Option for the balance of the period described in the preceding sentence. [3] Retirement. If a Participant's Service Terminates because of Retirement, [a] all outstanding Restricted Stock, Restricted Stock Units, Freestanding SARs, Stock, Stock Units or Cash Awards (whether or not then vested) will be settled as provided in the Plan and the Award Agreement and [b] all Options and Tandem SARs (whether or not then exercisable) may be exercised by the Participant (or the Participant's Beneficiary) anytime before the earlier of the expiration date specified in the Award Agreement or 15 months after the Participant Retires. However, if the Award Agreement under which an Incentive Stock Option was granted to the Retired Participant specifies an expiration date that is more than three months after the Participant's Retirement and that Incentive Stock Option is not exercised within three months after the Participant's Retirement, the Option will be treated as a Nonqualified Stock Option for the balance of the period described in the preceding sentence. [4] Voluntary Termination of Service By Participant. If a Participant who is an Employee voluntarily Terminates Service, [a] all vested Restricted Stock, Restricted Stock Units, Freestanding SARs, Stock, Stock Units or Cash Awards will be settled as provided in the Plan and the Award Agreement, [b] all exercisable Options and Tandem SARs may be exercised by the Participant (or the Participant's Beneficiary) anytime before the earlier of the expiration date specified in the Award Agreement or three months after the Participant's voluntary Termination of Service and [c] all Awards that are not vested or exercisable on the date the Participant voluntarily Terminates Service will be forfeited. [5] Involuntary Termination of Service Without Cause. If the Service of a Participant who is an Employee is Terminated involuntarily without Cause, [a] all vested Restricted Stock, Restricted Stock Units, Freestanding SARs, Stock, Stock Units or Cash Awards will be settled as provided in the Plan and the Award Agreement, [b] all exercisable Options and Tandem SARs may be exercised by the Participant (or the Participant's Beneficiary) anytime before the earlier of the expiration date specified in the Award Agreement or three months after the Participant's Service is involuntarily Terminated without Cause and [c] all Awards that are not vested or excisable on the date the Participant's Service is involuntarily Terminated without Cause will be forfeited. [6] Involuntary Termination of Service With Cause. If the Service of a Participant who is an Employee is Terminated involuntarily for Cause, all outstanding Awards (whether or not then exercisable) will be forfeited as of the date the Participant's Service is Terminated for Cause. 12.02 Effect of Termination of Service on Performance-Based Awards. Unless the Committee provides otherwise in the Award Agreement or subsequently, a Participant will forfeit all Performance-Based Awards if, before the end of a Performance Period: [1] His or her Service is Terminated involuntarily for Cause; or [2] He or she Terminates Service voluntarily. However, if, before the end of a Performance Period, a Participant dies, becomes Disabled, Retires or his or her Service is involuntarily Terminated without Cause and the Committee determines (under Section 11.04) that the performance objectives established for that period are met, such Participant or the Beneficiary of such Participant will receive a partial award equal to: [3] The Cash Award and/or other Award that would have been paid to that Participant at the end of the Performance Period during which the Participant dies, becomes Disabled, Retired or was involuntarily Terminated without Cause; multiplied by [4] The number of whole months between the beginning of the Performance Period and the date the Participant dies, became Disabled, Retired or was involuntarily Terminated without Cause; and divided by [5] The number of whole months included in the Performance Period. 12.03 Other Limits on Exercisability. Regardless of any other provision of the Plan, all unexercised Awards granted to a Participant will be forfeited if that Participant, before his or her Termination of Service or after Termination of Service but while any Award remains exercisable: [1] Without the Committee's written consent, which may be withheld for any reason or for no reason, serves (or agrees to serve) as an officer, director or employee of any proprietorship, partnership or corporation or becomes the owner of a business or a member of a partnership that competes with any portion of the Company's (or a Subsidiary's) business or renders any service (including business consulting) to entities that compete with any portion of the Company's (or a Subsidiary's) business; [2] Refuses or fails to consult with, supply information to, or otherwise cooperate with, the Company after having been requested to do so; or [3] Deliberately engages in any action that the Committee concludes harms the Company or any Subsidiary. 12.04 Buy Out of Section 12.00 Awards. At any time, the Committee, in its sole discretion and without the consent of the Participant, may cancel any or all outstanding Options, SARs, Restricted Stock, Restricted Stock Units and Stock Units (collectively, "Section 12.00 Awards") held by that Participant by providing to that Participant written notice ("Buy Out Notice") of its intention to exercise the rights reserved in this section. If a Buy Out Notice is given, the Company also will pay to each affected Participant the difference between [1] the Fair Market Value of each (or portion of each) Section 12.00 Awards to be cancelled and [2] the Exercise Price associated with each cancelled Section 12.00 Award. However, unless otherwise specified in the Award Agreement, no payment will be made with respect to any Section 12.00 Award that is not exercisable (or, in the case of Restricted Stock or Restricted Stock Units, still is subject to a restriction and not vested) when cancelled under this section. The Company will complete any buy out made under this section as soon as administratively possible after the date of the Buy Out Notice. At the Committee's option, payment of the buy out amount may be made in cash, in whole shares of Stock or partly in cash and partly in shares of Stock. The number of whole shares of Stock, if any, included in the buy out amount will be determined by dividing the amount of the payment to be made in shares of Stock by the Fair Market Value as of the date of the Buy Out Notice. 13.00 MERGER, CONSOLIDATION OR SIMILAR EVENT 13.01 Definition of Business Combination. [1] Any event that is defined as a "change in control" (or analogous term) under any other written agreement with the Company or any Subsidiary, but only to the extent specified in that other agreement; or [2] Any transaction (or series of related transactions) that results in the merger or consolidation of the Company or the exchange of Stock for the securities of another entity (other than a Subsidiary) that has acquired the Company's assets or which is in control [as defined in Code Section 368(c)] of an entity that has acquired the Company's assets but only if [a] immediately after the transaction (or the end of a series of related transitions) the persons who owned a majority of the voting power of the Company immediately before the transaction (or the beginning of a series of related transactions) own less than a majority of the voting power of the Company and [b] the terms of the transaction (or series of related transactions) are binding on all holders of Stock (except to the extent that dissenting shareholders are entitled to relief under applicable law). 13.02 Effect of Business Combination on Options, SAR, Restricted Stock and Restricted Stock Units. If the Company undergoes a Business Combination, [1] all Options and SARs that are then outstanding will become fully exercisable for the remainder of their term (whether or not otherwise exercisable by the terms of the Award Agreement and whether or not any associated performance objectives have then been met) and [2] all remaining restrictions on outstanding Restricted Stock and Restricted Stock Units will lapse as of the date of the Business Combination. 13.03 Effect of Business Combination on Stock Units, Cash or Performance- Based Awards. If the Company undergoes a Business Combination, all restrictions and conditions imposed on Stock Units and Cash Awards will lapse and all performance objectives imposed on Performance-Based Awards will be deemed to have been met. The amount paid under this section will be [1] the value of affected Stock Units or the amount of affected Cash Awards or, in the case of Performance-Based Awards, the target award or, if higher, the award level actually achieved immediately before the effective date of the Business Combination, multiplied [2] by the number of whole months between the beginning of the period over which time-based restrictions on Stock Units and Cash Awards otherwise would have been measured or, in the case of Performance- Based Awards, the beginning of the period over which Performance Goals were to be measured and the date of the Business Combination and divided by [3] the period (expressed in whole months) over which time-based restrictions on Stock Units and Cash Awards otherwise would have been measured or, in the case of Performance-Based Awards, the period (expressed in whole months) over which Performance Goals were to have been measured. 13.04 Application of Code Section 280G. Except as otherwise provided in the Award Agreement or any other written agreement between the Participant and the Company or any Subsidiary then in effect, if the sum (or value) due under Sections 13.02 and 13.03 that are characterizable as parachute payments, when combined with other parachute payments attributable to the same event (whether or not that event is a Business Combination), constitute "excess parachute payments" as defined in Code Section 280G(b)(1), the entity responsible for making those payments or its successor or successors (collectively, "Payor") will reduce the Participant's benefits under this Plan by the smaller of [1] the value of the sum or the value of the payments due under Sections 13.02 and 13.03 or [2] the amount necessary to ensure that the Participant's total "parachute payment" as defined in Code Section 280G(b)(2)(A) under this and all other agreements will be $1.00 less than the amount that otherwise would generate an excise tax under Code Section 4999. If the reduction described in the preceding sentence applies, within 10 business days of the effective date of the event generating the payments, the Payor will apprise the Participant of the amount of the reduction ("Notice of Reduction"). Within 10 business days of receiving that information, the Participant may specify how (and against which benefit or payment source, including benefits and payment sources other than this Plan) the reduction is to be applied ("Notice of Allocation"). The Payor will be required to implement these directions within 10 business days of receiving the Notice of Allocation. If the Payor has not received a Notice of Allocation from the Participant within 10 business days of the date of the Notice of Reduction or if the allocation provided in the Notice of Allocation is not sufficient to fully implement the reduction described in this section, the Payor will apply the reduction described in this section proportionately based on the amounts otherwise payable under Sections 13.02 and 13.03 or, if a Notice of Allocation has been returned that does not sufficiently implement the reduction described in this section, on the basis of the reductions specified in the Notice of Allocation. 14.00 AMENDMENT, MODIFICATION AND TERMINATION OF PLAN The Board or the Committee may terminate, suspend or amend the Plan at any time without shareholder approval except to the extent that shareholder approval is required to satisfy applicable requirements imposed by [1] Rule 16b-3 under the Act, or any successor rule or regulation, [2] applicable requirements of the Code or [3] any securities exchange, market or other quotation system on or through which the Company's securities are listed or traded. Also, no Plan amendment may [4] result in the loss of a Committee member's status as a "non-employee director" as defined in Rule 16b-3 under the Act, or any successor rule or regulation, with respect to any employee benefit plan of the Company, [5] cause the Plan to fail to meet requirements imposed by Rule 16b-3 or [6] without the consent of the affected Participant, (except as specifically provided otherwise in the Plan or the Award Agreement), adversely affect any Award granted before the amendment, modification or termination. However, nothing in this section, the Plan or any Award Agreement will restrict the Committee's right to exercise the discretion retained in Section 12.04 or the Committee's or the Board's right to amend the Plan and any Award Agreements without any additional consideration to affected Employees to the extent necessary to avoid penalties arising under Code Section 409A, even if those amendments reduce, restrict or eliminate rights granted under the Plan or Award Agreement (or both) before those amendments. 15.00 MISCELLANEOUS 15.01 Assignability. Except as provided in this section, an Award may not be transferred except by will or applicable laws of descent and distribution and, during the Participant's lifetime, may be exercised only by the Participant or the Participant's guardian or legal representative. However, with the Committee's written consent (which may be withheld for any reason or for no reason), a Participant or a specified group of Participants may transfer Awards (other than Incentive Stock Options) to a revocable inter vivos trust, of which the Participant is the settlor, or may transfer Awards (other than Incentive Stock Options) to any member of the Participant's immediate family, any trust, whether revocable or irrevocable, established solely for the benefit of the Participant's immediate family, or any partnership or limited liability company whose only partners or members are members of the Participant's immediate family ("Permissible Transferees"). Any Award transferred to a Permissible Transferee will continue to be subject to all of the terms and conditions that applied to the Award before the transfer and to any other rules prescribed by the Committee. A Permissible Transferee may subsequently transfer an Award but only to another Permissible Transferee and only after complying with the terms of this section as if the Permissible Transferee was a Participant. 15.02 Beneficiary Designation. Each Participant may name a Beneficiary or Beneficiaries (who may be named contingently or successively) to receive or to exercise any vested Award that is unpaid or unexercised at the Participant's death. Each designation made will revoke all earlier designations made by the same Participant, must be made on a form prescribed by the Committee and will be effective only when filed in writing with the Committee. If a Participant has not made an effective Beneficiary designation, the deceased Participant's Beneficiary will be his or her surviving spouse or, if there is no surviving spouse, the deceased Participant's estate. 15.03 No Guarantee of Continuing Service. Nothing in the Plan may be construed as: [1] Interfering with or limiting the right of the Company or any Subsidiary to Terminate any Participant's employment at any time; [2] Conferring on any Participant any right to continue as an Employee or Director; [3] Guaranteeing that any Employee will be selected to be a Participant; or [4] Guaranteeing that any Participant will receive any future Awards. 15.04 Tax Withholding. The Company will withhold from other amounts owed to a Participant, or require the Participant to remit to the Company, an amount sufficient to satisfy federal, state and local withholding tax requirements on any Award, exercise or cancellation of an Award or purchase of shares of Stock. If these amounts are not to be withheld from other payments due to the Participant (or if there are no other payments due to the Participant), the Company will defer payment of cash or issuance of shares of Stock until the earlier of: [1] Thirty days after the settlement date; or [2] The date the Participant remits the required amount. If the Participant has not remitted the required amount within 30 days of the settlement date, the Company will permanently withhold from the value of the Awards to be distributed the minimum amount required to be withheld to comply with applicable federal, state and local income, wage and employment taxes and distribute the balance to the Participant. In its discretion, the Committee may allow a Participant to elect, subject to conditions the Committee establishes, to reimburse the Company for this withholding obligation through one or more of the following methods: [3] By having shares of Stock otherwise issuable under the Plan withheld by the Company (but only to the extent of the minimum amount that must be withheld to comply with applicable state, federal and local income, employment and wage tax laws); [4] By delivering, including by attestation, to the Company previously acquired shares of Stock that the Participant has owned for at least six months; [5] By remitting cash to the Company; or [6] By remitting a personal check immediately payable to the Company. 15.05 Indemnification. Each individual who is or was a member of the Committee or of the Board will be indemnified and held harmless by the Company against and from any loss, cost, liability or expense that may be imposed upon or reasonably incurred by him or her in connection with or resulting from any claim, action, suit or proceeding to which he or she may be made a party or in which he or she may be involved by reason of any action taken or not taken under the Plan as a Committee or Board member and against and from any and all amounts paid, with the Company's approval, by him or her in settlement of any matter related to or arising from the Plan as a Committee or Board member; or paid by him or her in satisfaction of any judgment in any action, suit or proceeding relating to or arising from the Plan against him or her as a Committee or Board member, but only if he or she gives the Company an opportunity, at its own expense, to handle and defend the matter before he or she undertakes to handle and defend it in his or her own behalf. The right of indemnification described in this section is not exclusive and is independent of any other rights of indemnification to which the individual may be entitled under the Company's organizational documents, by contract, as a matter of law, or otherwise. 15.06 No Limitation on Compensation. Nothing in the Plan is to be construed to limit the right of the Company to establish other plans or to pay compensation to its employees or Directors in cash or property, in a manner not expressly authorized by the Plan. 15.07 Requirements of Law. The grant of Awards and the issuance of shares of Stock will be subject to all applicable laws, rules and regulations and to all required approvals of any governmental agencies or national securities exchange, market or other quotation system. Also, no shares of Stock will be issued under the Plan unless the Company is satisfied that the issuance of those shares of Stock will comply with applicable federal and state securities laws. Certificates for shares of Stock delivered under the Plan may be subject to any stock transfer orders and other restrictions that the Committee believes to be advisable under the rules, regulations and other requirements of the Securities and Exchange Commission, any stock exchange or other recognized market or quotation system upon which the Stock is then listed or traded, or any other applicable federal or state securities law. The Committee may cause a legend or legends to be placed on any certificates issued under the Plan to make appropriate reference to restrictions within the scope of this section. 15.08 Term of Plan. Subject to Section 14.00, the Plan will continue until the tenth anniversary of the date it is adopted by the Board or approved by the Company's shareholders, whichever is earliest. 15.09 Governing Law. The Plan and all related agreements will be construed in accordance with and governed by the laws (other than laws governing conflicts of laws) of the United States and of the State of Ohio. 15.10 No Impact on Benefits. Plan Awards are incentives designed to promote the objectives described in Section 1.00. Also, Awards are not compensation for purposes of calculating a Participant's rights under any employee benefit plan or other agreement that does not specifically require the inclusion of Awards in calculating benefits. EX-31 3 exh31-1.txt CEO CERTIFICATION Exhibit 31.1 CERTIFICATION I, Dan R. Carmichael, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Ohio Casualty Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in exchange Act Rules 13a-15(f) and 15d-15(f)) for the Registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation, of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: July 26, 2005 /s/Dan R. Carmichael ------------------------- Dan R. Carmichael President and Chief Executive Officer EX-31 4 exh31-2.txt CFO CERTIFICATION Exhibit 31.2 CERTIFICATION I, Michael A. Winner, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Ohio Casualty Corporation; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in exchange Act Rules 13a-15(f) and 15d-15(f)) for the Registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation, of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: July 26, 2005 /s/Michael A. Winner ------------------------- Michael A. Winner Executive Vice President and Chief Financial Officer EX-32 5 exh32-1.txt CEO CERTIFICATION 906 Exhibit 32.1 CERTIFICATION PURSUANT TO TITLE 18, UNITED STATES CODE, SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Ohio Casualty Corporation (the "Company") on Form 10-Q for the fiscal period ended June 30, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Dan R. Carmichael, Chief Executive Officer of the Company, certify, pursuant to Title 18, United States Code, Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. It is not intended that this statement be deemed to be filed for purposes of the Securities Exchange Act of 1934. /s/Dan R. Carmichael ----------------------------- Dan R. Carmichael President and Chief Executive Officer July 26, 2005 EX-32 6 exh32-2.txt CFO CERTIFICATION 906 Exhibit 32.2 CERTIFICATION PURSUANT TO TITLE 18, UNITED STATES CODE, SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Ohio Casualty Corporation (the "Company") on Form 10-Q for the fiscal period ended June 30, 2005 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Michael A. Winner, Chief Financial Officer of the Company, certify, pursuant to Title 18, United States Code, Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. It is not intended that this statement be deemed to be filed for purposes of the Securities Exchange Act of 1934. /s/Michael A. Winner ----------------------------- Michael A. Winner Executve Vice President and Chief Financial Officer July 26, 2005 -----END PRIVACY-ENHANCED MESSAGE-----