-----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, ADibEWI2mF5PyrxorJpqUGcASwJ6OX985/ftzxBJu/tzvNlwznL/TeB2yzHRw6C/ 0Zg3M5y+C4eEMaaiPacKKQ== 0000073952-06-000056.txt : 20061101 0000073952-06-000056.hdr.sgml : 20061101 20061101160844 ACCESSION NUMBER: 0000073952-06-000056 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20060930 FILED AS OF DATE: 20061101 DATE AS OF CHANGE: 20061101 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: 061178983 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 f10q3q.txt OHIO CASUALTY CORP - FORM 10-Q - SEPTEMBER 30, 2006 ============================================================================== 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 September 30, 2006. [ ] 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 (I.R.S. Employer of 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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. Large accelerated filer X Accelerated filer Non-accelerated filer ----- Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes No X ----- On October 31, 2006, there were 60,992,517 shares of common stock outstanding. Page 1 of 34 ============================================================================== 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 19 Item 3. Quantitative and Qualitative Disclosures about Market Risk 33 Item 4. Controls and Procedures 33 PART II OTHER INFORMATION Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 33 Item 6. Exhibits 34 Signature 34 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
September 30, December 31, (in millions, except share data) (Unaudited) 2006 2005 - ------------------------------------------------------------------------------------------- Assets Investments, at fair value: Fixed maturities: Available-for-sale, at fair value (amortized cost: $3,483.9 and $3,453.5) $ 3,553.2 $ 3,527.7 Held-to-maturity, at amortized cost (fair value: $245.7 and $260.5) 250.7 264.4 Equity securities, at fair value (cost: $188.6 and $144.2) 404.4 375.1 - ------------------------------------------------------------------------------------------- Total investments 4,208.3 4,167.2 Cash and cash equivalents 18.6 54.5 Premiums and other receivables, net of allowance 338.5 309.2 Deferred policy acquisition costs 155.4 153.7 Property and equipment, net of accumulated depreciation 79.3 80.1 Reinsurance recoverable, net of allowance 703.7 741.8 Agent relationships, net of accumulated amortization 100.7 109.7 Interest and dividends due or accrued 47.4 55.0 Deferred tax asset, net 14.2 14.8 Other assets 125.5 77.1 - ------------------------------------------------------------------------------------------- Total assets $ 5,791.6 $ 5,763.1 =========================================================================================== Liabilities Insurance reserves: Losses $ 2,459.1 $ 2,435.0 Loss adjustment expenses 519.6 511.8 Unearned premiums 693.1 679.6 Debt 199.7 200.4 Reinsuance treaty funds held 121.9 150.4 Other liabilities 320.5 359.5 - ------------------------------------------------------------------------------------------- Total liabilities 4,313.9 4,336.7 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 22.6 18.8 Accumulated other comprehensive income 162.8 178.0 Retained earnings 1,489.4 1,360.6 Treasury stock, at cost: (Shares: 11,214,271; 9,137,208) (206.1) (140.0) - ------------------------------------------------------------------------------------------- Total shareholders' equity 1,477.7 1,426.4 - ------------------------------------------------------------------------------------------- Total liabilities and shareholders' equity $ 5,791.6 $ 5,763.1 ===========================================================================================
Accompanying notes are an integral part of these consolidated financial statements. For complete disclosures see Notes to Consolidated Financial Statements on pages 67-84 of the Corporation's 2005 Form 10-K. 3 ITEM 1. Continued Ohio Casualty Corporation & Subsidiaries CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended September 30, (in millions, except share and per share data) (Unaudited) 2006 2005 - ------------------------------------------------------------------------------------------- Premiums and finance charges earned $ 356.3 $ 362.5 Investment income, less expenses 51.3 51.4 Investment gains realized, net 11.4 22.4 - ------------------------------------------------------------------------------------------- Total revenues 419.0 436.3 Losses and benefits for policyholders 188.8 204.5 Loss adjustment expenses 35.8 42.5 General operating expenses 115.4 121.6 Write-down and amortization of agent relationships 1.6 2.4 Amortization of deferred policy acquisition costs 82.1 83.3 Deferral of policy acquisition costs (83.7) (87.4) Depreciation and amortization expense 2.9 3.0 - ------------------------------------------------------------------------------------------- Total expenses 342.9 369.9 - ------------------------------------------------------------------------------------------- Income before income taxes 76.1 66.4 Income tax expense (benefit): Current 22.8 11.2 Deferred (2.0) (0.3) - ------------------------------------------------------------------------------------------- Total income tax expense 20.8 10.9 - ------------------------------------------------------------------------------------------- Net income $ 55.3 $ 55.5 =========================================================================================== Weighted average shares outstanding - basic 61,151,087 64,400,341 =========================================================================================== Earnings per share - basic: Net income, per share $ 0.90 $ 0.86 =========================================================================================== Weighted average shares outstanding - diluted 62,441,227 65,656,774 =========================================================================================== Earnings per share - diluted: Net income, per share $ 0.89 $ 0.85 ===========================================================================================
Accompanying notes are an integral part of these consolidated financial statements. For complete disclosures see Notes to Consolidated Financial Statements on pages 67-84 of the Corporation's 2005 Form 10-K. 4 ITEM 1. Continued Ohio Casualty Corporation & Subsidiaries CONSOLIDATED STATEMENTS OF INCOME
Nine Months Ended September 30, (in millions, except share and per share data) (Unaudited) 2006 2005 - ------------------------------------------------------------------------------------------- Premiums and finance charges earned $ 1,069.5 $ 1,090.3 Investment income, less expenses 154.1 148.4 Investment gains realized, net 30.9 36.2 - ------------------------------------------------------------------------------------------- Total revenues 1,254.5 1,274.9 Losses and benefits for policyholders 577.1 587.3 Loss adjustment expenses 115.2 125.8 General operating expenses 348.8 355.3 Write-down and amortization of agent relationships 9.0 10.1 Amortization of deferred policy acquisition costs 247.7 255.1 Deferral of policy acquisition costs (249.4) (252.2) Depreciation and amortization expense 8.0 8.7 Loss on retirement of convertible debt, including debt conversion expenses - 9.0 - ------------------------------------------------------------------------------------------- Total expenses 1,056.4 1,099.1 - ------------------------------------------------------------------------------------------- Income before income taxes 198.1 175.8 Income tax expense: Current 45.9 32.2 Deferred 9.4 8.2 - ------------------------------------------------------------------------------------------- Total income tax expense 55.3 40.4 - ------------------------------------------------------------------------------------------- Net income $ 142.8 $ 135.4 =========================================================================================== Average shares outstanding - basic 62,393,244 63,487,313 =========================================================================================== Earnings per share - basic: Net income, per share $ 2.29 $ 2.13 =========================================================================================== Average shares outstanding - diluted 63,868,978 68,012,120 =========================================================================================== Earnings per share - diluted: Net income, per share $ 2.24 $ 2.02 ===========================================================================================
Accompanying notes are an integral part of these consolidated financial statements. For complete disclosures see Notes to Consolidated Financial Statements on pages 67-84 of the Corporation's 2005 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, 2005 $ 9.0 $ - $ 259.1 $1,161.5 $(134.7) $1,294.9 Net income 135.4 135.4 Change in unrealized gain, net of deferred income tax benefit of $34.2 (63.1) (63.1) --------- Comprehensive income 72.3 Net issuance of restricted stock (26,828 shares) 0.2 0.4 0.6 Net issuance of treasury stock (1,066,438 shares) 5.2 (0.2) 13.7 18.7 Repurchase of treasury stock (570,115 shares) (14.6) (14.6) Cash dividends paid ($0.06 per share) (7.7) (7.7) Issuance of common stock pursuant to Convertible Note transaction (See Note VII) 11.2 17.3 28.5 - -------------------------------------------------------------------------------------------------------- Balance, September 30, 2005 $ 9.0 $ 16.6 $ 196.0 $1,289.0 $(117.9) $1,392.7 ======================================================================================================== Balance January 1, 2006 $ 9.0 $ 18.8 $ 178.0 $1,360.6 $(140.0) $1,426.4 Net income 142.8 142.8 Change in unrealized gain, net of deferred income tax benefit of $8.8 (15.2) (15.2) --------- Comprehensive income 127.6 Net issuance of restricted stock (18,638 shares) 0.7 0.3 1.0 Unearned stock compensation (2.9) 2.9 - Stock based compensation, including income tax benefit of $1.8 5.9 5.9 Net issuance of treasury stock (388,194 shares) 0.1 5.8 5.9 Repurchase of treasury stock (2,483,895 shares) (72.2) (72.2) Cash dividends paid ($0.27 per share) (16.9) (16.9) - -------------------------------------------------------------------------------------------------------- Balance, September 30, 2006 $ 9.0 $ 22.6 $ 162.8 $1,489.4 $(206.1) $1,477.7 ========================================================================================================
Accompanying notes are an integral part of these consolidated financial statements. For complete disclosures see Notes to Consolidated Financial Statements on pages 67-84 of the Corporation's 2005 Form 10-K. 6 ITEM 1. Continued Ohio Casualty Corporation & Subsidiaries CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30, (in millions) (Unaudited) 2006 2005 - ------------------------------------------------------------------------------------------------- Cash Flows from Operating Activities: Net income $ 142.8 $ 135.4 Adjustments to reconcile net income to cash from operations: Changes in: Insurance reserves 45.4 153.1 Reinsurance treaty funds held (28.5) (32.0) Income taxes 7.4 (0.2) Premiums and other receivables (29.3) 25.8 Deferred policy acquisition costs (1.7) 2.9 Reinsurance recoverable 38.1 (39.8) Other assets (60.1) (9.0) Other liabilities (19.9) (26.8) Loss on retirement of convertible debt, including debt conversion expenses - 9.0 Stock-based compensation expense 5.4 1.3 Income tax benefit from stock option exercises - 3.6 Write-down and amortization of agent relationships 9.0 10.1 Depreciation and amortization 8.0 8.7 Investment gains realized, net (30.9) (36.2) - ------------------------------------------------------------------------------------------------- Net cash provided by operating activities 85.7 205.9 - ------------------------------------------------------------------------------------------------- Cash Flows from Investing Activities: Purchase of securities: Fixed income, available-for-sale (685.7) (1,073.1) Fixed income, held-to-maturity (0.5) (0.7) Equity (72.8) (18.5) Proceeds from sales of securities: Fixed income, available-for-sale 543.4 745.3 Equity 70.7 34.2 Proceeds from maturities and calls of securities: Fixed income, available-for-sale 100.7 58.7 Fixed income, held-to-maturity 13.0 26.6 Property and equipment Purchases (7.5) (7.4) Sales 0.3 1.2 - ------------------------------------------------------------------------------------------------- Net cash used in investing activities (38.4) (233.7) - ------------------------------------------------------------------------------------------------- Cash Flows from Financing Activities: Debt: Repayments (0.5) (160.2) Payments for deferred financing costs (0.5) - Loss on retirement of convertible debt, including conversion expense - (3.6) Proceeds from exercise of stock options 4.6 14.2 Repurchase of treasury stock (72.2) (13.3) Income tax benefit from stock option exercises 2.3 - Dividends paid to shareholders (16.9) (7.7) - ------------------------------------------------------------------------------------------------- Net cash used in financing activities (83.2) (170.6) - ------------------------------------------------------------------------------------------------- Net decrease in cash and cash equivalents (35.9) (198.4) Cash and cash equivalents, beginning of period 54.5 252.6 - ------------------------------------------------------------------------------------------------- Cash and cash equivalents, end of period $ 18.6 $ 54.2 =================================================================================================
Accompanying notes are an integral part of these consolidated financial statements. For complete disclosures see Notes to Consolidated Financial Statements on pages 67-84 of the Corporation's 2005 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), collectively the "Consolidated Corporation". 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 September 30, 2006 and the Consolidated Statements of Income, Shareholders' Equity and Cash Flows for the three and nine months ended September 30, 2006 and 2005, without an audit. In the opinion of management, all adjustments necessary to fairly present the financial position, results of operations and cash flows at September 30, 2006 and for each period 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 2005 Annual Report on Form 10-K. The results of operations for the period ended September 30, 2006 are not necessarily indicative of the results of operations 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 $1.8 at September 30, 2006 and $4.2 at December 31, 2005. Property and equipment are carried at cost less accumulated depreciation of $184.1 and $177.2 at September 30, 2006 and December 31, 2005, respectively. Amounts recoverable from reinsurers are calculated in a manner consistent with the reinsurance contract and are reported net of allowance of $3.7 at September 30, 2006 and December 31, 2005. 8 NOTE II - EARNINGS PER SHARE Basic and diluted earnings per share are summarized as follows:
Three Months Ended Nine Months Ended September 30, September 30, 2006 2005 2006 2005 - --------------------------------------------------------------------------------------------- Net income $55.3 $55.5 $142.8 $135.4 Weighted average common shares outstanding - basic (thousands) 61,151 64,400 62,393 63,487 Basic net income per weighted average share $0.90 $0.86 $2.29 $2.13 ============================================================================================= Net income $55.3 $55.5 $142.8 $135.4 Effect of EITF 04-8 on net income using "if-converted" method - - - 1.8 Adjusted net income using "if-converted" method 55.3 55.5 142.8 137.2 Weighted average common shares outstanding - basic (thousands) 61,151 64,400 62,393 63,487 Effect of dilutive securities from stock compensation plans (thousands) 1,290 1,257 1,476 1,259 Effect of EITF 04-8 (thousands) - - - 3,266 - --------------------------------------------------------------------------------------------- Weighted average common shares outstanding - diluted (thousands) 62,441 65,657 63,869 68,012 Diluted net income per weighted average share $0.89 $0.85 $2.24 $2.02 =============================================================================================
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. 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. As a result of this EITF, the Consolidated Corporation has included 3.3 million shares into its diluted earnings per share calculation using the "if-converted" method for the nine months ended September 30, 2005. See Note VII for more information regarding the convertible securities. NOTE III - SEGMENT INFORMATION The Consolidated 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 Consolidated Corporation also has an All Other segment which derives its revenues from investment income of the Corporation. The other expenses included in this segment consist primarily of interest expense. Each of the segments of the Consolidated 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 Consolidated Corporation does not produce such information internally. 9 Three Months Ended September 30,
Commercial Lines Segment 2006 2005 - -------------------------------------------------------------------- Net premiums written $207.4 $207.1 % Change 0.1% 1.9% Net premiums earned 209.2 206.1 % Change 1.5% 2.2% Underwriting gain/(loss) (before tax) 4.9 (23.1)
Specialty Lines Segment 2006 2005 - -------------------------------------------------------------------- Net premiums written $ 37.6 $ 38.0 % Change (1.1)% 32.4% Net premiums earned 36.1 36.3 % Change (0.6)% 13.4% Underwriting gain (before tax) 7.5 1.8
Personal Lines Segment 2006 2005 - -------------------------------------------------------------------- Net premiums written $114.5 $123.9 % Change (7.6)% (3.7)% Net premiums earned 111.0 120.1 % Change (7.6)% (2.2)% Underwriting gain (before tax) 9.1 23.1
Total Property & Casualty 2006 2005 - -------------------------------------------------------------------- Net premiums written $359.5 $369.0 % Change (2.6)% 2.3% Net premiums earned 356.3 362.5 % Change (1.7)% 1.7% Underwriting gain (before tax) 21.5 1.8
All Other Segment 2006 2005 - -------------------------------------------------------------------- Revenues $ 4.0 $ 5.9 Write-down and amortization of agent relationships (1.6) (2.4) Other expenses (6.5) (6.8) - -------------------------------------------------------------------- Loss before income tax $(4.1) $(3.3)
Reconciliation of Revenues 2006 2005 - -------------------------------------------------------------------- Net premiums earned for reportable segments $356.3 $362.5 Net investment income 47.5 47.6 Realized gains, net 11.2 20.3 - -------------------------------------------------------------------- Total property and casualty revenues 415.0 430.4 All other segment revenues 4.0 5.9 - -------------------------------------------------------------------- Total revenues $419.0 $436.3 ====================================================================
Reconciliation of Underwriting Gain (before tax) 2006 2005 - -------------------------------------------------------------------- Property and casualty underwriting gain (before tax) $21.5 $ 1.8 Net investment income 51.3 51.4 Realized gains, net 11.4 22.4 Write-down and amortization of agent relationships (1.6) (2.4) Other expenses (6.5) (6.8) - -------------------------------------------------------------------- Income before income tax 76.1 66.4 Income tax expense 20.8 10.9 - -------------------------------------------------------------------- Net income $55.3 $55.5 ====================================================================
10 Nine Months Ended September 30,
Commercial Lines Segment 2006 2005 - -------------------------------------------------------------------- Net premiums written $643.7 $634.5 % Change 1.4% (0.2)% Net premiums earned 620.3 618.4 % Change 0.3% 2.7% Underwriting loss (before tax) (3.6) (41.4)
Specialty Lines Segment 2006 2005 - -------------------------------------------------------------------- Net premiums written $110.7 $116.8 % Change (5.2)% 13.8% Net premiums earned 109.3 107.8 % Change 1.4% (5.8)% Underwriting gain (before tax) 16.1 4.8
Personal Lines Segment 2006 2005 - -------------------------------------------------------------------- Net premiums written $332.0 $361.1 % Change (8.1)% (3.2)% Net premiums earned 339.9 364.1 % Change (6.6)% (1.2)% Underwriting gain (before tax) 30.0 70.6
Total Property & Casualty 2006 2005 - -------------------------------------------------------------------- Net premiums written $1,086.4 $1,112.4 % Change (2.3)% 0.1% Net premiums earned 1,069.5 1,090.3 % Change (1.9)% 0.5% Underwriting gain (before tax) 42.5 34.0
All Other Segment 2006 2005 - -------------------------------------------------------------------- Revenues $ 11.3 $ 18.0 Write-down and amortization of agent relationships (9.0) (10.1) Other expenses (20.4) (32.7) - -------------------------------------------------------------------- Loss before income tax $(18.1) $(24.8)
Reconciliation of Revenues 2006 2005 - -------------------------------------------------------------------- Net premiums earned for reportable segments $1,069.5 $1,090.3 Net investment income 142.2 137.4 Realized gains, net 31.5 29.2 - -------------------------------------------------------------------- Total property and casualty revenues 1,243.2 1,256.9 All other segment revenues 11.3 18.0 - -------------------------------------------------------------------- Total revenues $1,254.5 $1,274.9 ====================================================================
Reconciliation of Underwriting Gain (before tax) 2006 2005 - -------------------------------------------------------------------- Property and casualty underwriting gain (before tax) $ 42.5 $ 34.0 Net investment income 154.1 148.4 Realized gains, net 30.9 36.2 Write-down and amortization of agent relationships (9.0) (10.1) Other expenses (20.4) (32.7) - -------------------------------------------------------------------- Income before income tax 198.1 175.8 Income tax expense 55.3 40.4 - -------------------------------------------------------------------- Net income $142.8 $135.4 ====================================================================
Management of the Consolidated Corporation believes the significant volatility of realized investment gains and losses limits the usefulness of net income as a measure of current operating performance. Accordingly, 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: 11
Three Months Ended Nine Months Ended September 30, September 30, 2006 2005 2006 2005 - ------------------------------------------------------------------------------------ Net income $55.3 $55.5 $142.8 $135.4 After-tax net realized gains 7.5 22.8 20.1 31.8 - ------------------------------------------------------------------------------------ Operating income $47.8 $32.7 $122.7 $103.6 ====================================================================================
NOTE IV - STOCK BASED COMPENSATION The Consolidated Corporation has several stock based incentive programs that are utilized to facilitate the Consolidated Corporation's long-term financial success. Effective January 1, 2006, the Consolidated Corporation began accounting for stock based incentive programs under Statement of Financial Accounting Standard (SFAS) 123(R), "Share-Based Payment." SFAS 123(R) superseded Accounting Principles Board (APB) Opinion No. 25, "Accounting for Stock Issued to Employees," and amends SFAS No. 95, "Statement of Cash Flows." SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, be recognized as compensation expense in the income statement at fair value. Pro forma disclosure is no longer an alternative. The Consolidated Corporation adopted the provisions of SFAS 123(R) using the modified prospective method in which compensation expense is recognized (a) based on the requirements of SFAS 123(R) for all share-based payments granted after January 1, 2006 and (b) based on the requirements of SFAS 123 for all awards granted to employees prior to January 1, 2006 that remained unvested on January 1, 2006. The adoption of SFAS 123(R) decreased the Consolidated Corporation's net income by $0.6 and $1.4 for the three and nine months ended September 30, 2006. Basic and diluted earnings per share were reduced by $0.01 and $0.02 for the three and nine months ended September 30, 2006, by the adoption of SFAS 123(R). The Consolidated Corporation uses the straight- line method of recording compensation expense relative to share-based payments. SFAS 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 SFAS 95 prior to its amendment. This requirement reduced net operating cash flows and increased net financing cash flows by $2.3 during the first nine months of 2006. The Consolidated Corporation has several share-based incentive programs which are briefly described below. For a more detailed discussion of each of these share-based incentive programs, see Note 5 in the Notes to the Consolidated Financial Statements in the Annual Report on Form 10-K for the year ended December 31, 2005. 2005 Incentive Plan On May 18, 2005, the shareholders of the Corporation approved the Consolidated Corporation's 2005 Incentive Plan (2005 Plan) which provides for stock based compensation to employees and non-employee directors. Approval of the 2005 Plan resulted in the termination of the then existing stock incentive plans of the Consolidated Corporation. At September 30, 2006, there were 1,865,965 shares available for issuance under the 2005 Plan. Equity-based awards that may be granted under the 2005 Plan include stock options (incentive and non-qualified), restricted stock, restricted stock units, stock appreciation rights and shares of the Corporation's common stock as defined in the 2005 Plan document. In addition to equity-based compensation, the 2005 Plan also authorizes grants of performance based awards in the form of restricted stock, restricted stock units, stock units and cash awards. The 2005 Plan limits the number of shares of stock with respect to which awards may be issued to any participant in a calendar year to 400,000. Options granted under the 2005 Plan may be exercised at any time after the vesting requirements are met, which ranges from immediate vesting to three years. During the third quarter of 2006, there were no stock options granted from the 2005 Plan. Total options outstanding, excluding forfeitures, were 103,750 at September 30, 2006. The 2005 Plan also provides for the grant of freestanding and/or tandem stock appreciation rights (SARs) and restricted stock. At September 30, 2006, there were 350,000 outstanding freestanding SARs, none of which were granted during the third quarter of 2006. There were no issued and outstanding tandem SARs. The requisite service period for outstanding SARs is three years. 12 During the nine months ended September 30, 2006 and 2005, there were 19,750 and 33,500 restricted shares issued, excluding forfeitures, under either the 2005 Plan or a predecessor plan. At September 30, 2006, there are 128,000 restricted shares which are under the restriction period. SFAS 123(R) eliminated the presentation of the contra-equity account, unearned compensation, on the face of the consolidated balance sheets. As a result, $2.9 was reclassified to additional paid-in capital during the first quarter of 2006 when SFAS 123(R) was implemented. Long-term Incentive Plan In July 2005, the Consolidated Corporation adopted a Long-Term Incentive Plan (LTIP) award to better align officer interests with shareholders for performance that promotes the long-term success of the Consolidated Corporation. The 2005 LTIP award is a performance based award covering a thirty-month period beginning July 1, 2005 and ending December 31, 2007 (the "performance period"). The 2006 LTIP award is a performance based award with the final payout modified based upon achievement of a market condition, comprised of total shareholder returns generated by the Consolidated Corporation over the performance period relative to total shareholder returns generated by a selected peer group over this same performance period. The performance period began on January 1, 2006 and will end on December 31, 2008. At the end of both performance periods, payout, if any, will be made 50% in the form of Corporation common shares and 50% in cash. There is no provision to pay the share portion of the payout in cash. Employee Stock Purchase Plan The Consolidated Corporation has an employee stock purchase plan that is available to eligible employees as defined in the plan. Under the plan, shares of the Corporation's common stock may be purchased at a discount of up to 10% of the lesser of the closing price of the Corporation's common stock on the first trading day or the last trading day of the offering period. The offering period (currently three months) and the offering price are subject to change. Participants may purchase no more than twenty- five thousand dollars, prior to the stated discount, of the Corporation's common stock in a calendar year. During the nine months ended September 30, 2006, there were 78,115 shares purchased under the plan compared to 81,106 shares purchased under the plan in the same period of 2005. At September 30, 2006, there were 1,741,799 shares available for future issuance under the plan. Following is a summary of stock based compensation expense recognized by the Consolidated Corporation:
Three Months Ended Nine Months Ended September 30, September 30, 2006 2005 2006 2005 - ------------------------------------------------------------------------------------ 2005 Incentive Plan Stock Options $0.6 $ - $2.0 $ - Stock Appreciation Rights 0.3 - 0.9 - Restricted Stock 0.4 0.2 1.1 0.5 Long Term Incentive Plan 0.7 0.8 1.1 0.8 Employee Stock Purchase Plan - - 0.3 - - ------------------------------------------------------------------------------------ Total Stock-Based Compensation $2.0 $1.0 $5.4 $1.3 ====================================================================================
The following table summarizes information about the stock-based compensation plans (options and SARs) as of September 30, 2006:
Weighted- Weighted- Aggregate Avg Avg Intrinsic Shares Exercise Remaining Value (000) Price Contract Life ($ in 000) -------------------------------------------------- Outstanding at January 1, 2006 3,958 $15.68 Granted 135 $31.05 Exercised (338) $14.31 Forfeited (7) $21.54 ------ Outstanding at September 30, 2006 3,748 $16.41 6.0 $37,138 Exercisable at September 30, 2006 3,048 $14.31 5.5 $35,247
13 The total intrinsic value of stock options exercised was $0.2 and $1.7 during the three months ended September 30, 2006 and 2005, respectively, and $5.4 and $10.9 for the nine months ended September 30, 2006 and 2005, respectively. The total fair value of shares vested for restricted stock was less than $0.1 and $1.1 during the three and nine months ended September 30, 2006, respectively. During the same periods in 2005, the total fair value of shares vested for restricted stock was less than $0.1. The following table summarizes information about the restricted stock activity as of September 30, 2006:
Weighted- Avg Shares Grant Date (000) Fair Value ------------------------- Restricted stock awards at January 1, 2006 148 $25.49 Granted 20 30.32 Released (39) 19.35 Forfeited (1) 19.13 ----- Restricted stock awards at September 30, 2006 128 $28.16 =====
The per share weighted-average fair value of options and awards granted by the Consolidated Corporation is as follows:
Three Months Ended Nine Months Ended September 30, September 30, 2006 2005 2006 2005 - ------------------------------------------------------------------------------------ Stock options N/A $ 9.31 $ 9.45 $ 9.18 Restricted stock N/A $25.12 $30.32 $24.64 SARs N/A N/A $ 9.80 N/A Employee Stock Purchase Plan $4.80 $ 7.62 $ 7.54 $ 5.67
Under the provisions of SFAS 123(R), the Consolidated Corporation is required to estimate on the date of grant the fair value of each option and freestanding SAR using an option-pricing model. Accordingly, the Black- Scholes option pricing model is used with the following weighted-average assumptions:
September 30, 2006 2005 - ------------------------------------------------------------------------ Dividend yield 1.0% 1.8% Expected volatility 32.0% 42.9% Risk-free interest rate 4.6% 4.2% Expected term 4.5 years 5.0 years
The dividend yield is determined by using the expected per share dividend during 2006. In 2005, the dividend yield was based upon the average of selected peer companies. The expected volatility is based on the Corporation's stock price over a historical period which approximates the expected term. The risk free interest rate is the implied yield currently available on U.S. Treasury issues with a remaining term approximating the expected term. The expected term is calculated as the historic weighted average life of similar awards. As of September 30, 2006, there was $6.5 of total unrecognized compensation cost ($4.1 relating to options and freestanding SARs and $2.4 relating to restricted stock) related to non-vested share-based compensation arrangements granted under the Consolidated Corporation's share-based payment plans. That cost is expected to be recognized over a weighted- average period of 0.9 years for options and freestanding SARs and 2.9 years for restricted stock. In 2005, the Consolidated Corporation accounted for stock based compensation issued to employees in accordance with APB 25, as was permitted by SFAS 123. Under APB 25, the Consolidated Corporation recognized compensation expense based on the intrinsic value of stock based compensation. Had the Consolidated Corporation adopted the income statement recognition requirements of SFAS 123 "Accounting for Stock Based Compensation," the Consolidated Corporation's net income and earnings per share would have been reduced to the pro forma amounts disclosed below: 14
Three Months Ended Nine Months Ended September 30, 2005 September 30, 2005 - ------------------------------------------------------------------------------- Net income As reported $55.5 $135.4 Add: Stock-based employee compensation reported in net income, net of related tax effect 0.6 0.9 Deduct: Total stock-based employee compensation, net of related tax effect 1.6 4.2 - ------------------------------------------------------------------------------- Pro forma $54.5 $132.1 =============================================================================== Basic EPS As reported $0.86 $2.13 Pro Forma $0.85 $2.08 Diluted EPS* As reported $0.85 $2.02 Pro Forma $0.83 $1.97 ===============================================================================
*Diluted EPS has been adjusted for the effect of EITF Issue No. 04-8 for the nine months ending 2005. The three month period ended September 30, 2005 was not impacted due to the redemption/repurchase of the Convertible Notes in the second quarter of 2005. Also See Note II. 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 Consolidated 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 $0.2 and $0.8 in the third quarter of 2006 and 2005, respectively. For the nine months ended September 30, 2006 and 2005, the asset was written down before tax by $4.5 and $5.3, 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 18 years. For the three and nine month period ended September 30, 2006, the Consolidated Corporation recorded amortization expense of $1.4 and $4.5 which compares to $1.6 and $4.8 for the same periods of the prior year. At September 30, 2006 and December 31, 2005, the unamortized carrying value of the agent relationships asset was $100.7 and $109.7, respectively. The agent relationships asset is recorded net of accumulated amortization of $48.1 and $45.5 at September 30, 2006 and December 31, 2005, respectively. Future cancellation of agents included in the agent relationships intangible asset or a diminution of certain former GAI agents' estimated future revenues or profitability is reasonably possible 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 Consolidated 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 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 not exceeding 10 years commencing when the software is substantially complete and ready for its intended use. 15 Capitalized software costs and accumulated amortization amounts included in the consolidated balance sheets within Property and Equipment were $62.0 and $19.2 at September 30, 2006 and $58.5 and $15.9 at December 31, 2005, respectively. NOTE VII - DEBT The following table represents outstanding debt and deferred financing costs of the Consolidated Corporation at September 30, 2006 and December 31, 2005:
September 30, December 31, 2006 2005 - ----------------------------------------------------------------------------- Senior Debt (net of discount and issuance costs of $2.1 and $2.3, respectively) $197.9 $197.7 Ohio Loan 2.2 2.7 Deferred Financing Costs (0.4) - - ----------------------------------------------------------------------------- Total Debt $199.7 $200.4 =============================================================================
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 a substantial majority of the net proceeds to repurchase and redeem the Convertible Notes (see reference to Note 15 below). As a result of the repurchase and redemption of the Convertible Notes, the Corporation recorded a loss on retirement of $9.0 for the nine month period ended September 30, 2005, principally comprised of the write-off of unamortized debt issuance cost and premium paid on repurchases of the Convertible Notes during these periods and issued 1,305,585 shares of its common stock. See Note 15 included in the Notes to Consolidated Financial Statements in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2005 for a detailed discussion regarding the repurchase and redemption of the Convertible Notes. Interest is payable on the Senior Notes on June 15 and December 15. The Senior Notes are reported on the Consolidated Balance Sheets net of unamortized issuance-related costs and discount totaling $2.1 at September 30, 2006 and $2.3 at December 31, 2005. The Corporation uses the effective interest rate method to record interest expense, amortization of issuance- related costs and amortization of the discount. On February 16, 2006, the Corporation entered into a new revolving credit agreement with an expiration date of March 16, 2011 and simultaneously terminated its prior $80.0 revolving credit agreement. Under the terms of the new revolving credit agreement, the lenders agreed to make loans to the Corporation in an aggregate amount up to $125.0 for general corporate purposes. Additionally, the new revolving credit agreement contains a $50.0 "accordion feature" and provision for the issuance of letters of credit up to the amount of the total facility. The accordion feature permits the Corporation to increase the facility commitment from $125.0 to $175.0 subject to a successful syndication of the requested increase. Please refer to Note 15 included in the Notes to the Consolidated Financial Statements in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2005 for a detailed discussion regarding the terms and provisions of the new revolving credit agreement. At September 30, 2006, the Corporation was in compliance with all financial covenants and other provisions of this agreement. There were no borrowings outstanding under the revolving line of credit at either September 30, 2006 or December 31, 2005. Interest expense incurred for the nine month periods ended September 30, 2006 and 2005 was $11.0 and $14.1, respectively. Interest expense incurred for both the three month periods ended September 30, 2006 and 2005 was $3.7. 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). Please refer to Note 7 in the Notes to the Consolidated Financial Statements in the Corporation's Annual Report on Form 10-K for the year ended December 31, 2005 for a detailed discussion regarding this agreement. Late in the first quarter of 2005, OCNJ, based on revised information provided by Proformance subsequent to the Consolidated Corporation filing its 2004 Annual Report on Form 10-K, reduced its estimated liability by $4.4 which left a remaining liability of $4.4 at March 31, 2005. 16 In June 2005, OCNJ 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 from any and all future obligations related to this surplus guarantee. The total amount paid by OCNJ 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 Company (Avomark), Ohio Security Insurance Company (Ohio Security), West American Insurance Company (West American), American Fire and Casualty Insurance Company (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 also filed motions to expand the definition to include claim specialists, representative trainees, and representatives performing claims adjusting services. The complaint sought overtime compensation for the plaintiff and the class of persons plaintiff sought to represent. The U.S. District Court dismissed the complaint against Avomark, Ohio Security, West American, American Fire, and OCNJ on September 27, 2005. The U.S. District Court also granted the motion for summary judgment of the Corporation and the Company on September 27, 2005. The proceeding was ordered closed with judgment in favor of the defendants. The decision has been appealed by plaintiff to the U.S. Sixth Circuit Court of Appeals. 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. The Court on April 13, 2006 granted a motion for class certification requested by Carol Lazarus and denied West American's motion for summary judgment. The decision regarding class certification has been appealed by West American. 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. By 2001, the Company, American Fire, West American, Ohio Security and OCNJ had sought refunds for retaliatory taxes paid to New Jersey in prior years on the basis that New Jersey's calculation of premium and retaliatory taxes deprived the Company, American Fire, West American, Ohio Security and OCNJ of some or all of the benefit of New Jersey's premium tax cap. After the refund requests were denied in a final determination issued by the New Jersey Division of Taxation in July 2001, American Fire appealed to the New Jersey Tax Court and in December 2003, the court affirmed the determination. American Fire appealed to the Superior Court of New Jersey; in March 2005, the court reversed the Tax Court, and the Director of the Division of Taxation was ordered to recalculate the retaliatory tax as proposed by American Fire. The New Jersey Division of Taxation appealed the Superior Court decision to the New Jersey Supreme Court and the case was argued in November 2005. In October 2006, the Supreme Court affirmed the judgment of the Superior Court of New Jersey on statutory grounds and instructed the Director of the Division of Taxation to recalculate refunds due the Company, American Fire, West American, Ohio Security and OCNJ. No amounts have been recorded in the Consolidated Financial Statements as of September 30, 2006 or December 31, 2005. The Company, American Fire, West American, Ohio Security and OCNJ will recognize the benefit of such refunds upon receipt or settlement. The proceedings described above and various other legal and regulatory proceedings are currently pending that involve the Consolidated 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 Consolidated Corporation. 17 NOTE IX - EMPLOYEE BENEFITS The Company has a non-contributory defined benefit retirement plan and a contributory health care plan. The net periodic pension cost for the periods ended September 30 is determined as follows:
Three Months Ended Nine Months Ended September 30, September 30, 2006 2005 2006 2005 - ------------------------------------------------------------------------------- Service cost earned during the period $ 2.1 $ 1.8 $ 6.3 $ 5.4 Interest cost on projected benefit obligation 4.4 4.3 13.0 12.9 Expected return on plan assets (6.5) (5.5) (19.5) (16.3) Amortization of accumulated losses 1.1 1.0 3.1 2.7 Amortization of unrecognized prior service cost (0.6) (0.5) (1.7) (1.7) Settlement - - 1.0 - - ------------------------------------------------------------------------------- Net periodic pension cost $ 0.5 $ 1.1 $ 2.2 $ 3.0 ===============================================================================
During the second quarter of 2006, the Company's former CEO made a lump sum benefit plan payment election, pursuant to the terms of the Benefit Equalization Plan, which resulted in an increase to net periodic pension cost of $1.0. This lump sum benefit plan payment is accounted for as a "settlement" pursuant to the provisions of SFAS 88, "Employers' Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and Termination Benefits." The components of the Company's net periodic postretirement benefit cost for the periods ended September 30:
Three Months Ended Nine Months Ended September 30, September 30, 2006 2005 2006 2005 - ------------------------------------------------------------------------------- Service cost $ - $ - $ 0.2 $ 0.2 Interest cost 0.7 0.7 2.0 2.2 Amortization of accumulated losses - 0.1 - 0.1 Amortization of unrecognized prior service cost (1.5) (1.5) (4.5) (4.5) - ------------------------------------------------------------------------------- Net periodic postretirement benefit cost $(0.8) $(0.7) $(2.3) $(2.0) ===============================================================================
NOTE X - INCOME TAX At December 31, 2004, the Consolidated Corporation disclosed it had been examined by the Internal Revenue Service (IRS) for tax years 1997 to 2001 and was then in the process of finalizing a settlement. On August 25, 2005, the IRS issued notification to the Consolidated Corporation that a settlement agreement concerning its examination of these tax years was approved. This settlement resulted in a $2.7 net tax benefit related to realized capital gains, and interest income, before tax, of $0.9. In conjunction with the IRS settlement, the Consolidated Corporation reduced its book tax reserves by $9.1 ($8.0 related to realized capital gains and $1.1 related to operations). Additionally, on September 28, 2005, the IRS advised the Consolidated Corporation that it accepted a protective claim for refund for the 1996 tax year related to adjustments resulting from the 2003 settlement of the IRS examination of the 1995 tax year. The acceptance of this protective refund claim resulted in a $3.4 net tax benefit related to operations, and interest income, before tax, of $1.6 million. In the aggregate, when considering all of the above referenced items, net income for the three and nine months ended September 30, 2005, was favorably impacted by $16.8, comprised of a $15.2 net tax benefit ($4.5 related to operations and $10.7 related to capital gains) and $1.6 after- tax interest income. This net tax benefit had the effect of lowering the Consolidated Corporation's effective income tax rate for the nine months ended September 30, 2005 by 6.6%. The results of operations for both the three and nine month periods ended September 30, 2006, do not include any similar type settlement adjustments with the IRS. 18 NOTE XI - SHARE REPURCHASES During the third quarter of 2006, the Corporation repurchased 249,186 shares of its common stock at an average cost of $25.87. These repurchases completed the share repurchase program authorized by the Corporation's Board of Directors in the third quarter of 2005. Under this program, four million shares were repurchased at an average cost of $27.94. In September 2006, the Board of Directors approved another share repurchase program with authorization to repurchase up to $100.0 of the Corporation's common stock. Purchases may be made in the open market or in privately negotiated transactions. Through October 31, 2006, the Corporation has repurchased 227,200 shares under the newly authorized share repurchase program at an average cost of $27.19. NOTE XII - RECENTLY ISSUED ACCOUNTING STANDARDS In September 2006, the Financial Accounting Standards Board (FASB) issued SFAS 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans an amendment of FASB Statements No. 87, 88, 106, and 132(R)." This Statement requires recognition of the overfunded or underfunded status of a defined benefit postretirement plan as an asset or liability on the balance sheet and to recognize changes in that funding status in the year in which the changes occur through other comprehensive income. This requirement is the first phase of implementing the standard and is effective for the fiscal year ending after December 15, 2006. The implementation of the first phase of this standard is expected to increase Shareholders' Equity in the range of $2.0 to $6.0. As of December 31, 2006, the Corportion expects total Shareholders' Equity to increase in the range of $25.0 to $35.0, a result of favorable asset performance, contributions to the plan and the effect of the adoption of SFAS 158. This impact could change materially from this estimate based upon the completion of the Consolidated Corporation's actuarial valuations as of the measurement date for 2006. The second phase of implementation of SFAS 158 requires the measurement date of the funded status of a plan to coincide with the year end date of the company, with limited exceptions. The effective date for implementing this phase of SFAS 158 is for fiscal years ending after December 15, 2008. Currently the Consolidated Corporation utilizes a measurement date of September 30th. The Consolidated Corporation is currently evaluating the impact this phase of the Standard will have on its consolidated financial statements. In July 2006, the FASB released FASB Interpretation No. (FIN) 48, `Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109.' This Interpretation clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS 109, `Accounting for Income Taxes.' This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting for interim periods, disclosure and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Consolidated Corporation currently is evaluating the impact of this Interpretation. 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), collectively the "Consolidated Corporation." All dollar amounts in this Management Discussion and Analysis (MD&A) are in millions unless otherwise noted. RESULTS OF OPERATIONS Net Income The Consolidated Corporation reported net income of $55.3, or $0.89 per share and $55.5, or $0.85 per share for the three months ended September 30, 2006 and 2005, respectively, which included after-tax realized investment gains of $7.5 ($0.12 per share) and $22.8 ($0.35 per share) for the three months ended September 30, 2006 and 2005, respectively. For the nine months ended September 30, 2006 and 2005, 19 net income was $142.8, or $2.24 per share and $135.4 or $2.02 per share, respectively, which included after-tax realized investment gains of $20.1 ($0.32 per share) and $31.8 ($0.47 per share) for the nine months ended September 30, 2006 and 2005, respectively. During the third quarter 2005, the Consolidated Corporation favorably concluded settlements with the Internal Revenue Service (IRS) for tax years 1996 through 2001. As a result of the IRS settlement, net income was favorably impacted for the three and nine months ended September 30, 2005 by $16.8 ($0.26 per share for the three months and $0.25 per share for the nine months). For additional information regarding this IRS settlement in 2005, see Note X in the Notes to the Consolidated Financial Statements on page 18 of this Quarterly Report on Form 10-Q. The Consolidated Corporation adopted the provisions of SFAS 123(R) as of January 1, 2006. For further information on the impact of the adoption of SFAS 123(R) in 2006, see Note IV to the unaudited interim consolidated financial statements included in Item 1. "Financial Statements" of this 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 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 82 of the Corporation's 2005 Annual Report on Form 10-K. At September 30, 2006 and December 31, 2005, statutory surplus, a financial measure that is required by insurance regulators and used to monitor financial strength, was $1,030.5 and $1,004.5, respectively. The ratio of twelve months ended net premiums written to statutory surplus as of both September 30, 2006 and December 31, 2005, was 1.4 to 1.0. Premium Revenue Results Gross premium written differs from net premiums written by the amount of premiums ceded to reinsurers. Management analyzes premium revenues primarily by premiums written in the current period, which is a better indicator of current production levels. Net premiums written are recognized into revenue on a monthly pro rata basis over the coverage term of the policy which is reflected in the consolidated income statements as earned premium. The table below summarizes property and casualty premium on a gross and net basis compared with the same periods of the prior year:
Three Months Ended Nine Months Ended September 30, September 30, 2006 2005 % Chg 2006 2005 % Chg ---- ---- ----- ---- ---- ----- Gross Premiums Written - ---------------------- Commercial Lines $212.7 $212.5 0.1% $ 660.7 $ 647.7 2.0% Specialty Lines 49.9 53.0 (5.8)% 148.5 160.4 (7.4)% Personal Lines 116.1 125.3 (7.3)% 336.3 363.4 (7.5)% ------ ------ -------- -------- All Lines $378.7 $390.8 (3.1)% $1,145.5 $1,171.5 (2.2)% ====== ====== ======== ========
20
Three Months Ended Nine Months Ended September 30, September 30, 2006 2005 % Chg 2006 2005 % Chg ---- ---- ----- ---- ---- ----- Net Premiums Written - -------------------- Commercial Lines $207.4 $207.1 0.1% $ 643.7 $ 634.5 1.4% Specialty Lines 37.6 38.0 (1.1)% 110.7 116.8 (5.2)% Personal Lines 114.5 123.9 (7.6)% 332.0 361.1 (8.1)% ------ ------ -------- -------- All Lines $359.5 $369.0 (2.6)% $1,086.4 $1,112.4 (2.3)% ====== ====== ======== ========
All Lines gross premiums written declined for the three and nine months periods ended September 30, 2006 when compared with the same periods of the prior year, due primarily to lower in-force policy counts and rate reductions. This decline was partially offset by an increase in new business premium production and improving policy renewal rates in all three segments. Net premiums written for the nine months ended September 30, 2005 were favorably impacted by $5.5 return of ceded premium on experience based reinsurance contracts. The return of ceded premium benefited all three operating segments in 2005. There was not a comparable return of ceded premium during the periods presented in 2006. For Commercial Lines, the increase in gross premiums written for both the three and nine month periods ended September 30, 2006 is the result of an increase in new business premium of 6.4% and 12.7%, respectively, coupled with a slight improvement in policy renewal rates for these same periods. These improvements were offset by involuntary assumed workers' compensation premium adjustments due to various reapportionments, which had the effect of reducing gross and net premiums written by $1.9 compared to the third quarter of 2005. For Specialty Lines, the decline in gross premiums written for both the three and nine month periods ended September 30, 2006 is primarily the result of declines in the commercial umbrella product line of 13.7% and 14.9% respectively, as both in-force policies and new business premium production are lower than the same periods of the prior year. This decline is primarily in the unsupported lead umbrella and excess capacity products, the result of our efforts to improve the overall profitability of the commercial umbrella product line. This decline is partially offset by strong growth of 9.8% and 12.2% in our fidelity and surety bond product line for the three and nine month periods ended September 30, 2006, respectively, as we continue to leverage our market knowledge and strong producer base. For Personal Lines, the decline in gross premiums written for both the three and nine month periods ended September 30, 2006 is the result of rate reductions previously taken in a number of states in both the personal auto and homeowners product lines and lower in-force policy counts when compared to the same periods of the prior year. However, the rate of decline in policy count has lessened throughout 2006. This decline is partially offset by an increase in new business premium production of 10.1% and 5.9% for the three and nine month periods ended September 30, 2006 and slightly improved policy renewal rates for the same respective periods. Commercial Lines average renewal prices have been essentially flat throughout 2006, compared to increases of 1.5% and 2.3% in the third quarter and year-to-date periods ended September 30, 2005. For the commercial umbrella product line, we have seen average renewal price increase of 1.9% and 1.2% compared to 2.9% and 5.0% for the three and nine month periods ended September, 30, 2006 and 2005, respectively. This decrease, period over period, in both Commercial Lines and the commercial umbrella product line 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 any effects of reinsurance. 21 All Lines Discussion The following table provides key financial measures for All Lines:
Three Months Ended Nine Months Ended September 30, September 30, 2006 2005 2006 2005 ---- ---- ---- ---- All Lines - --------- Loss ratio 53.0% 56.4% 54.0% 53.9% Loss adjustment expense ratio 10.0% 11.7% 10.8% 11.5% Underwriting expense ratio 30.9% 31.4% 31.3% 31.5% ----- ----- ----- ----- Combined ratio 93.9% 99.5% 96.1% 96.9%
The improvement in the All Lines combined ratio for the third quarter is primarily the result of a decrease of $10.6 (2.8 points) in catastrophe losses, an increase of $16.8 (4.7 points) in favorable prior year reserve development, as reflected in the table below and continued favorable claim frequency trends. These improvements were partially offset by an increase in current accident year large loss activity (losses over $250 thousand) for the quarter, which increased the loss ratio by 1.9 points, as presented in the table below. Large loss activity can be volatile from year to year as indicated by the Group's experience over the last four years. The current accident year large loss impact on the loss ratio in each of these years, evaluated at September 30 for each of the respective years, is as follows: 2005 3.7% 2004 3.6% 2003 5.0% 2002 3.3% All Lines Loss Ratio Analysis We monitor incurred losses by operating segment, product line, risk classification, geographic region and agency addressing loss ratio issues or trends as part of our ongoing business operations. We also track current accident year large losses, as defined, to monitor severity trends. We do not believe the increases for the three and nine months ended September 30, 2006 are indicative of a new trend. The following table provides a reconciliation of significant changes to the All Lines loss ratio for the three and nine month periods ended September 30, 2006 and 2005, respectively.
Three Months Ended Nine Months Ended September 30, September 30, 2006 2005 Pt Chg 2006 2005 Pt Chg ---- ---- ------ ---- ---- ------ Ratios as a % of premiums earned - ------------------------- Current accident year large losses, as defined 6.3% 4.4% 1.9 5.0% 3.7% 1.3 Catastrophe losses - calendar year basis 2.1% 4.9% (2.8) 2.5% 2.4% 0.1 Loss development from prior accident years -2.9% 0.8% (3.7) -3.0% -0.2% (2.8) All other losses 47.5% 46.3% 1.2 49.5% 48.0% 1.5 ----- ----- ----- ----- Total losses 53.0% 56.4% (3.4) 54.0% 53.9% 0.1 ===== ===== ===== =====
An effect of a continuing soft Commercial and Personal Lines market is the upward pressure placed upon the combined ratio, as reflected in "All other losses" in the table above, which is the result of loss cost trends increasing at a rate faster than increases in premium rates (both new and renewal). 22 The following table summarizes reserve development, net of reinsurance, by operating segment:
Three Months Ended Nine Months Ended September 30, September 30, (Favorable)/Unfavorable 2006 2005 2006 2005 Operating Segment ---- ---- ---- ---- - ------------------------ Commercial Lines $ (2.8) $12.7 $ (4.6) $ 29.9 Specialty Lines (9.3) (3.0) (20.5) (7.3) Personal Lines (1.6) (6.6) (12.3) (26.2) ------- ------ ------- ------- Total Prior Accident Years' Development $(13.7) $ 3.1 $(37.4) $ (3.6) ======= ====== ======= =======
The loss and LAE ratio components of the accident year combined ratio measure 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 table below summarizes the impact of changes in provision for all prior accident year losses and LAE:
Three Months Ended Nine Months Ended September 30, September 30, 2006 2005 2006 2005 ---- ---- ---- ---- Statutory net liabilities, beginning of period $2,305.8 $2,228.2 $2,258.5 $2,183.8 (Decrease)/increase in provision for prior accident year claims $(13.7) $3.1 $(37.4) $(3.6) (Decrease)/increase in provision for prior accident year claims as % of premiums earned (3.8)% 0.9% (3.5)% (0.3)%
The underwriting expense ratio improved 0.5 points for the three month period ended September 30, 2006, primarily the result of decreased incentive accruals, the recovery and recognition of premium tax credits and ongoing expense management initiatives offset partially by a decrease in net premiums earned, which puts upward pressure on the ratio. For the nine month period ended September 30, 2006, the underwriting expense ratio improved slightly, a result of decreased incentive accruals, the recovery and recognition of premium tax credits and a reduction in the allowance for bad debt of premium receivables, offset partially by the pension settlement charge discussed in Note IX in the Notes to the Consolidated Financial Statements on page 18 of this Quarterly Report on Form 10-Q. In addition, the 2005 nine month underwriting expense ratio was favorably impacted by a $5.1 reduction to the surplus guarantee accrual, which reduced the 2005 underwriting expense ratio by 0.5 points. Catastrophe losses for the third quarter 2006 were $7.3 compared to $17.9 in the third quarter 2005. For the nine months ended September 30, 2006, catastrophe losses were $27.0 compared to $26.0 in the same period of the prior year. The effect of future catastrophes on the Group'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 Group's results of operations, future reinsurance pricing and availability of reinsurance. For additional disclosure of catastrophe losses, please refer to Item 15, Losses and LAE Reserves in the Notes to the Consolidated Financial Statements on page 79 of the Corporation's 2005 Annual Report on Form 10-K. The table below summarizes the catastrophe loss ratios by operating segment.
Three Months Ended Nine Months Ended September 30, September 30, 2006 2005 2006 2005 ---- ---- ---- ---- Commercial Lines 1.2% 8.2% 1.9% 3.4% Specialty Lines 0.1% 0.0% 0.0% 0.0% Personal Lines 4.4% 0.8% 4.5% 1.3% Total All Lines 2.1% 4.9% 2.5% 2.4%
Segment Discussion The Consolidated Corporation's organizational structure consists of three reportable segments: Commercial, Specialty and Personal Lines. These reportable segments represent the Consolidated Corporation's operating segments. The Consolidated Corporation also has an all other segment, which 23 derives its revenue from investment income of the Corporation. The following tables provide key financial measures for each of the property and casualty reportable segments: Commercial Lines Segment
Three Months Ended Nine Months Ended September 30, September 30, Commercial Lines Segment 2006 2005 2006 2005 - ---------------------------------------------------------------------------- Net premiums earned $209.2 $206.1 $620.3 $618.4 Loss ratio 54.8% 63.5% 56.1% 58.8% Loss adjustment expense ratio 11.1% 15.3% 12.2% 14.5% Underwriting expense ratio 31.7% 32.4% 32.3% 33.4% ----- ------ ------ ------ Combined ratio 97.6% 111.2% 100.6% 106.7%
The Commercial Lines combined ratio improved for both the three and nine month periods ended September 30, 2006, a result of a significant decline in catastrophe losses and favorable prior year reserve development, as reflected in the tables above. These improvements were partially offset by increased current accident year large loss activity which added 2.3 points to the loss ratio for the quarter and 1.6 points year to date compared to the same period last year as presented in the table below. Commercial Lines Loss Ratio Analysis We monitor incurred losses by product line, risk classification, geographic region and agency addressing loss ratio issues or trends as part of our ongoing business operations. We also track current accident year large losses, as defined, to monitor severity trends. We do not believe the increases for the three and nine months ended September 30, 2006 are indicative of a new trend. The following table provides a reconciliation of significant changes to the All Lines loss ratio for the three and nine month periods ended September 30, 2006 and 2005, respectively.
Three Months Ended Nine Months Ended September 30, September 30, 2006 2005 Pt Chg 2006 2005 Pt Chg ---- ---- ------ ---- ---- ------ Ratios as a % of premiums earned - ------------------------- Current accident year large losses, as defined 7.0% 4.7% 2.3 5.9% 4.3% 1.6 Catastrophe losses - calendar year basis 1.2% 8.2% (7.0) 1.9% 3.4% (1.5) Loss development from prior accident years -0.3% 4.7% (5.0) -0.3% 3.8% (4.1) All other losses 46.9% 45.9% 1.0 48.6% 47.3% 1.3 ----- ----- ----- ----- Total losses 54.8% 63.5% (8.7) 56.1% 58.8% (2.7) ===== ===== ===== =====
As indicated in the All Lines section, current accident year large loss activity can be volatile from year to year. The current accident year large loss impact on the Commercial Lines loss ratio, evaluated at September 30 for each of the respective years, has been as follows: 2005 4.3% 2004 5.0% 2003 7.1% 2002 3.6% The 2006 favorable reserve development described above was primarily concentrated in the commercial auto and commercial multiple peril (CMP) product lines offset by adverse development in the workers' compensation product line. In 2005, the adverse development was primarily concentrated in the workers' compensation and CMP product lines. The underwriting expense ratio improvement is due to the same reasons outlined in the All Lines sections on pages 22 and 23 of this MD&A. The nine month period in 2005 also included a $2.8 return of ceded premium on experienced based reinsurance contracts, which favorably impacted all of the above ratios for that period. 24 Specialty Lines Segment
Three Months Ended Nine Months Ended September 30, September 30, Specialty Lines Segment 2006 2005 2006 2005 - ---------------------------------------------------------------------------- Net premiums earned $36.1 $36.3 $109.3 $107.8 Loss ratio 33.2% 49.1% 37.8% 44.6% Loss adjustment expense ratio 7.4% 5.4% 8.2% 7.7% Underwriting expense ratio 38.6% 40.7% 39.2% 43.3% ----- ----- ----- ----- Combined ratio 79.2% 95.2% 85.2% 95.6%
The Specialty Lines combined ratio improved due to favorable prior year reserve development of $9.3 (25.6 points) primarily concentrated in the commercial umbrella product line, partially offset by two newly reported large losses. The same period in 2005 included favorable development of $3.0 (8.2 points). For the nine month period ended September 30, 2006, the combined ratio improved 10.4 points primarily driven by $20.5 (18.8 points) of favorable prior year reserve development partially offset by an increase in large loss activity. The same period in 2005 experienced $7.3 (6.8 points) of favorable prior year reserve development. The nine month period of 2005 included a $1.3 return of ceded premium on experience based reinsurance contracts which favorably impacted all of the above ratios. Underwriting expenses continue to be favorably impacted by increased ceding commissions on reinsurance contracts and lower incentive accruals for both the three and nine month periods of 2006 when compared to the same periods in 2005. Personal Lines Segment
Three Months Ended Nine Months Ended September 30, September 30, Personal Lines Segment 2006 2005 2006 2005 - ---------------------------------------------------------------------------- Net premiums earned $111.0 $120.1 $339.9 $364.1 Loss ratio 56.0% 46.4% 55.3% 48.2% Loss adjustment expense ratio 8.8% 7.5% 9.1% 7.7% Underwriting expense ratio 27.0% 26.9% 26.9% 24.7% ----- ----- ----- ----- Combined ratio 91.8% 80.8% 91.3% 80.6%
The Personal Lines combined ratios increased for the three and nine month periods ended September 30, 2006, primarily as a result of increased catastrophe losses and favorable prior year reserve development that was lower than in the same periods of the prior year as reflected in the tables above. Decreases in net premiums earned for the quarter and year to date when compared to the same periods in 2005, which relate to rate reductions taken in the last half of 2005 and first half of 2006, have also put upward pressure on the combined ratio. The nine month period in 2005 was favorably impacted by a return of ceded premium on experience based reinsurance contracts of $1.4. The underwriting expense ratio increased by 2.2 points for the nine month period ended September 30, 2006, due primarily to the favorable Proformance surplus guarantee adjustments which reduced the 2005 underwriting expense ratio by 1.4 points. The table below presents the calendar year and accident year combined ratios calculated on a statutory basis. The loss and LAE ratio components of the accident year combined ratio measure 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. Earned Premium and Statutory Combined Ratios
Combined Ratios --------------------------------------------------- Earned Premium Calendar Year Accident Year Year to Date Year to Date Year to Date Calendar Accident September 30, September 30, September 30, Year Year (By operating segment) 2006 2006 2006(a) 2005 2005(a) - ------------------------------------------------------------------------------------------- Commercial Lines $ 620.3 100.9% 101.7% 102.3% 98.5% Specialty Lines 109.3 85.7% 104.2% 89.9% 99.5% Personal Lines 339.9 91.8% 95.3% 81.2% 87.3% - ------------------------------------------------------------------------------------------- Total All Lines $1,069.5 96.6% 100.0% 94.2% 94.9% ===========================================================================================
(a) The measurement date for accident year data is September 30, 2006. Partial and complete accident periods may not be comparable due to seasonality, claim reporting and development patterns, claim settlement rates and other factors. Investment Results For the three and nine month periods ended September 30, 2006 and 2005, consolidated pre-tax investment income was $51.3 and $154.1 and $51.4 and $148.4, respectively. However, included in 2005's third quarter and year to date pre-tax investment income is $2.5 of interest income on favorable tax settlements with the IRS. See Note X in the Notes to the Consolidated Financial Statements on page 18 of 25 this Quarterly Report on Form 10-Q for additional information. After giving consideration in both of these periods for this amount, pre-tax investment income increased in the current year periods by 4.9% and 5.6%, respectively, over the prior year. This increase is the result of reduced investment related expenses, positive operating cash flows and a modest improvement in reinvestment yields resulting from the recent upward movement in interest rates when compared with the prior year. For the three and nine month periods ended September 30, 2006, net realized gains were $11.4 and $30.9 versus $22.4 and $36.2 for the comparable periods in 2005. The Consolidated Corporation realized $13.8 and $49.3 in gross gains and $2.4 and $18.4 in gross losses for the three and nine month periods ended September 30, 2006, respectively. During both the three and nine month periods ending September 30, 2005, the Consolidated Corporation realized $25.5 and $44.6 in gross gains and $3.1 and $8.4 in gross losses, respectively. Included in these realized losses are write downs of securities for other than temporary decline in market value of $2.2 and $11.8 for the three and nine month periods ended September 30, 2006 and $0.9 for both periods of 2005. 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 page 41 of the Corporation's 2005 Annual Report on Form 10-K. Investments are continually evaluated based on current economic conditions (including the interest rate environment), market value changes and developments specific to each issuer. 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. All securities are monitored by portfolio managers who consider many factors such as an issuer's financial and operating performance, degree of financial flexibility and industry fundamentals in evaluating whether the decline in fair value is temporary. On November 3, 2005, the FASB released FASB Staff Position (FSP) SFAS 115-1 and SFAS 124-1 replacing Emerging Issues Task Force (EITF) 03-1. The final language on FSP SFAS 115-1 / SFAS 124-1 requires investors to recognize an impairment loss when the impairment is deemed other-than-temporary and when the investor no longer has the positive intent and ability to hold the security until recovery in value, even if a decision to sell the security has not been made. The FSP applies to reporting periods beginning after December 15, 2005. 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 September 30, 2006. Available-for-sale securities 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 income securities: U.S. government $ 17.6 $ (0.3) $ - $ - $ 17.6 $ (0.3) States, municipalities and political subdivisions 38.7 (0.1) 100.9 (0.8) 139.6 (0.9) Corporate securities 189.3 (2.1) 89.0 (2.8) 278.3 (4.9) Mortgage-backed securities Other 188.9 (1.1) 99.2 (1.5) 288.1 (2.6) - -------------------------------------------------------------------------------------------- Total fixed income securities 434.5 (3.6) 289.1 (5.1) 723.6 (8.7) Equity securities 22.6 (1.3) 8.8 (0.3) 31.4 (1.6) - -------------------------------------------------------------------------------------------- Total temporarily impaired securities $457.1 $(4.9) $297.9 $(5.4) $755.0 $(10.3) ============================================================================================
26 Held-to-maturity securities 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 income securities: Corporate securities $11.0 $(0.3) $117.6 $(4.3) $128.6 $(4.6) Mortgage-backed securities 9.4 (0.2) 64.8 (1.8) 74.2 (2.0) - -------------------------------------------------------------------------------------------- Total temporarily impaired securities $20.4 $(0.5) $182.4 $(6.1) $202.8 $(6.6) ============================================================================================
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. As part of the evaluation of the entire $16.9 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 September 30, 2006. In the tables above, there are approximately 295 securities represented. Of this total, 18 securities have unrealized loss positions greater than 5% of their book values at September 30, 2006, with two exceeding 15%. This group represents $3.7, or 21.8% of the total unrealized loss position. Of this group, 10 securities, representing approximately $1.8 in unrealized losses, have been in an unrealized loss position for less than twelve months. The remaining eight securities have been in an unrealized loss position for longer than twelve months and total $1.9 in unrealized losses. 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. The amortized cost and estimated fair value of available-for-sale and held- to-maturity fixed income securities in an unrealized loss position at September 30, 2006, 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 $ 18.5 $ 18.4 $(0.1) Due after one year through five years 107.5 106.4 (1.1) Due after five years through ten years 201.4 198.6 (2.8) Due after ten years 114.2 112.1 (2.1) Mortgage-backed securities 290.7 288.1 (2.6) - ------------------------------------------------------------------------------- Total $732.3 $723.6 $(8.7) ===============================================================================
Held to maturity: Amortized Estimated Unrealized Cost Fair Value Loss - ------------------------------------------------------------------------------- Due in one year or less $ 2.4 $ 2.4 $ - Due after one year through five years 36.0 35.0 (1.0) Due after five years through ten years 91.7 88.2 (3.5) Due after ten years 3.1 3.0 (0.1) Mortgage-backed securities 76.2 74.2 (2.0) - ------------------------------------------------------------------------------- Total $209.4 $202.8 $(6.6) ===============================================================================
For additional discussion relative to the Consolidated Corporation's investment portfolio, see the "Investment Portfolio" section under "Liquidity and Capital Resources" on pages 28 and 29 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. For information regarding agent relationships asset, please 27 refer to Note V in the Notes to the Consolidated Financial Statements on page 15 in this Quarterly Report on Form 10-Q and the Corporation's Annual Report on Form 10-K for the year ended December 31, 2005 - Critical Accounting Policies. LIQUIDITY AND CAPITAL RESOURCES Investment Portfolio The following table sets forth the distribution and other data of investments at September 30, 2006 and December 31, 2005, respectively.
September 30, 2006 December 31, 2005 ------------------ ----------------- Average Amortized Carrying % of Amortized Carrying % of Rating Cost Value Total Cost Value Total ---------------------------------------------------------------------- U.S. Government: Available-for-sale AAA $ 27.3 $ 27.2 0.6 $ 25.8 $ 25.9 0.6 States, municipalities, and political subdivisions: Investment grade: Available-for-sale AA+ 1,402.2 1,423.3 33.7 1,269.7 1,277.4 30.2 Corporate securities: Investment grade: Available-for-sale A 1,422.1 1,467.3 34.7 1,489.0 1,552.4 36.8 Held-to-maturity A+ 158.6 158.6 3.8 160.1 160.1 3.8 Below Investment grade: Available-for-sale BB 79.2 81.8 1.9 65.5 68.5 1.6 ----------------------------------------------------------- Total corporate securities 1,659.9 1,707.7 40.4 1,714.6 1,781.0 42.2 ----------------------------------------------------------- Mortgage-backed securities: Investment grade: Available-for-sale AAA 553.1 553.6 13.1 601.6 601.6 14.3 Held-to-maturity AAA 92.1 92.1 2.2 104.3 104.3 2.5 Below Investment grade: Available-for-sale 1.9 1.9 ----------------------------------------------------------- Total mortgage-backed securities 645.2 645.7 15.3 707.8 707.8 16.8 ----------------------------------------------------------- Total fixed income securities 3,734.6 3,803.0 90.0 3,717.9 3,792.1 89.8 Equity securities* 188.6 404.4 9.6 144.2 375.1 8.9 Cash and cash equivalents 18.6 18.6 0.4 54.5 54.5 1.3 ----------------------------------------------------------- Total investment securities, cash and cash equivalents $3,941.8 $4,226.9 100.0 $3,916.6 $4,221.7 100.0 ===========================================================
* Included in equity securities as of September 30, 2006 are common stock with a cost of $126.7 and carrying value of $341.7 and preferred stock with a cost of $61.9 and carrying value of $62.7. Included in equity securities as of December 31, 2005 are common stock with a cost of $97.3 and carrying value of $327.9 and preferred stock with a cost of $46.9 and carrying value of $47.2. The fixed income portfolio is allocated between investment grade and below investment grade securities as follows:
September 30, 2006 December 31, 2005 ------------------ ----------------- Amortized Carrying % of Amortized Carrying % of Cost Value Fixed Cost Value Fixed ------------------------------------------------------------- Total investment grade $3,655.4 $3,722.1 97.9 $3,650.5 $3,721.7 98.1 Total below investment grade 79.2 81.8 2.1 67.4 70.4 1.9 The fixed income portfolio is allocated between available-for-sale and held-to-maturity securities as follows: Total available-for-sale fixed incme securities $3,483.9 $3,553.2 93.4 $3,453.5 $3,527.7 93.0 Total held-to-maturity fixed income securities 250.7 250.7 6.6 264.4 264.4 7.0
The excess of carrying value over cost was $285.1 at September 30, 2006 compared with $305.1 at December 31, 2005. The decrease in unrealized gains in 2006 was attributable to declining market values of fixed income securities as a result of an increase in interest rates and the sale of certain highly appreciated equity securities. 28 The consolidated fixed income portfolio, including short-term securities, has an intermediate duration and a laddered maturity structure. The duration of the fixed maturity portfolio was approximately 5.0 and 5.2 years at September 30, 2006 and December 31, 2005, respectively. The Consolidated Corporation remains fully invested and does not time markets. Fixed income securities are classified as investment grade or non- investment grade based upon the higher of the ratings provided by Standard and Poor's (S&P) and Moody's Investor Service (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 Association of Insurance Commissioners. The market value of available-for- sale split-rated fixed income securities (i.e., those having an investment grade rating from one rating agency and a below investment grade rating from another rating agency) was $14.2 and $35.2 at September 30, 2006 and December 31, 2005, respectively. Following is a table displaying available-for-sale non-investment grade and non-rated securities in an unrealized loss position at September 30, 2006 and December 31, 2005:
Amortized Fair Unrealized Cost Value Loss - -------------------------------------------------------------------- September 30, 2006 $20.2 $19.7 $(0.5) December 31, 2005 13.6 13.2 (0.4)
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 September 30, 2006, the equity portfolio consisted of stocks in a total of 78 separate entities covering all ten major S&P industry sectors. Of this total, 20.0% was invested in five companies and the largest single position was 4.4% of the equity portfolio. At December 31, 2005, the equity portfolio consisted of stocks in 60 separate entities in ten different industries. Of this total, 24.2% were invested in five companies and the largest single position was 5.4% of the equity portfolio. The investment portfolio also includes securities that do not have a readily available market price 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 September 30, 2006 was $259.3 compared to $285.3 at December 31, 2005. Losses and Loss Adjustment Expenses The Group's largest liabilities are reserves for losses and LAE. Loss and LAE reserves (collectively "loss reserves") are established for all incurred claims without discounting for the time value of money. Before credit for reinsurance recoverables, these reserves amounted to $3.0 billion and $2.9 billion at September 30, 2006 and December 31, 2005, respectively. As of September 30, 2006, the loss reserves by operating segment were as follows: $1,882.6 Commercial Lines, $717.6 Specialty Lines and $378.5 Personal Lines. The Group purchases reinsurance to mitigate the impact of large losses and catastrophic events. Loss reserves ceded to reinsurers amounted to $649.7 and $684.6 at September 30, 2006 and December 31, 2005, respectively. The Group conducts a quarterly review of loss reserves using the methods described in its Annual Report on Form 10-K for the year ended December 31, 2005 and records its best estimate each quarter based on that review. In the opinion of management, the reserves recorded at September 30, 2006 represent the Group's best estimate of its ultimate liability for losses and LAE. However, due to the inherent 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 with certainty since conditions and events which established historical loss reserve development and which serve as the basis for estimating ultimate claim costs may not occur in exactly the same manner, if at all. Loss reserves are an estimate of ultimate unpaid costs of losses and LAE for claims that have been reported and claims that have been incurred but not yet reported. Loss reserves do not represent an exact calculation of liability, but instead represent estimates, generally utilizing actuarial expertise and reserving methods, at a given accounting date. These loss reserve estimates are expectations of what the ultimate 29 settlement and administration of claims will cost upon final resolution in the future, based on the Group's assessment of facts and circumstances then known. In establishing reserves, the Group also takes into account estimated recoveries for reinsurance, salvage and subrogation. The process of estimating loss reserves involves a high degree of judgment and is subject to a number of risk factors. These risk factors can be related to both internal and external events, such as changes in claims handling procedures, economic inflation, legal trends and legislative changes, among others. Please refer to the Corporation's Annual Report on Form 10-K for the year ended December 31, 2005, for a detailed discussion of these risk factors. The impact of these items on ultimate costs for loss and LAE is difficult to estimate. Loss reserve estimation differs by product line due to differences in claim complexity, the volume of claims, the potential severity of individual claims, the determination of occurrence date for a claim and reporting lags (the time between the occurrence of the policyholder loss event and when it is actually reported to the insurer). Informed judgment is applied throughout the process. The Group continually refines its loss reserve estimates in a regular ongoing process as historical loss experience develops and additional claims are reported and settled. The Group considers all significant facts and circumstances known at the time loss reserves are established. Due to the inherent uncertainty underlying loss reserve estimates, final resolution of the estimated liability will be different from that anticipated at the reporting date. Therefore, actual paid losses in the future may yield a materially different amount than currently reserved--favorable or unfavorable. The Group reflects adjustments to loss reserves in the results of operations in the period the estimates are changed. The following table displays case, IBNR and LAE reserves by product line gross of reinsurance recoverables. Case reserves represent amounts determined for each claim based on the known facts regarding the claim and the parameters of the coverage that our policy provides. The IBNR reserves include provisions for incurred but not reported claims, provisions for losses in excess of the case reserves on previously reported claims, claims to be reopened and a provision for uncertainty in recognition of the variability and risk factors described below. The IBNR provision also includes an offset for anticipated salvage and subrogation recoveries. LAE reserves are an estimate of the expenses related to resolving and settling claims. Reserves ceded to reinsurers and reserves net of reinsurance are also shown. Loss and LAE Reserves as of September 30, 2006 and December 31, 2005:
September 30, 2006 - ------------------ Gross Total Total Operating Segment Case IBNR LAE Total Ceded Net - ------------------------------------------------------------------------------------ Commercial Lines $ 743.1 $ 778.7 $360.8 $1,882.6 $173.6 $1,709.0 Workers' compensation 410.1 346.0 70.8 826.9 141.0 685.9 Commercial auto 111.2 107.6 44.0 262.8 7.2 255.6 General liability 64.8 120.2 94.4 279.4 4.9 274.5 CMP, fire & inland marine 157.0 204.9 151.6 513.5 20.5 493.0 Specialty Lines 133.4 489.0 95.2 717.6 408.1 309.5 Commercial umbrella 121.8 488.5 89.5 699.8 402.2 297.6 Fidelity & surety 11.6 0.5 5.7 17.8 5.9 11.9 Personal Lines 195.8 119.1 63.6 378.5 68.0 310.5 Personal auto & umbrella 165.3 83.3 47.0 295.6 67.3 228.3 Personal property 30.5 35.8 16.6 82.9 0.7 82.2 Total All Lines $1,072.3 $1,386.8 $519.6 $2,978.7 $649.7 $2,329.0 - ------------------------------------------------------------------------------------
30
December 30, 2006 - ------------------ Gross Total Total Operating Segment Case IBNR LAE Total Ceded Net - ------------------------------------------------------------------------------------ Commercial Lines $ 700.9 $ 762.2 $351.5 $1,814.6 $165.4 $1,649.2 Workers' compensation 387.1 344.0 69.2 800.3 131.4 668.9 Commercial auto 103.2 109.7 44.6 257.5 6.0 251.5 General liability 59.4 117.3 92.6 269.3 5.2 264.1 CMP, fire & inland marine 151.2 191.2 145.1 487.5 22.8 464.7 Specialty Lines 134.8 516.2 92.9 743.9 454.1 289.8 Commercial umbrella 116.4 516.1 85.9 718.4 442.4 276.0 Fidelity & surety 18.4 0.1 7.0 25.5 11.7 13.8 Personal Lines 194.8 126.1 67.4 388.3 65.1 332.2 Personal auto & umbrella 164.1 91.3 50.6 306.0 64.1 241.9 Personal property 30.7 34.8 16.8 82.3 1.0 81.3 Total All Lines $1,030.5 $1,404.5 $511.8 $2,946.8 $684.6 $2,262.2 - ------------------------------------------------------------------------------------
Reserve variability and uncertainty - ----------------------------------- There is a great deal of uncertainty in the loss reserve estimates and unforeseen events can have unfavorable impacts on the loss reserve estimates. Reinsurance is purchased to mitigate the impact of large losses and catastrophic events. To illustrate the uncertainty by operating segment, the table presented in the All Lines discussion of this MD&A on page 22 provides the before-tax amount of prior accident years' loss reserve development by operating segment on a net of reinsurance basis for the three-months ended September 30, 2006 and 2005, and year ended December 31, 2005. This table illustrates the variability of reserves between operating segments, and from period to period. Within each operating segment, development can also be favorable or adverse by product line within the same period. For example, for the Commercial Lines operating segment in the nine months ended September 30, 2006, the workers' compensation product line had adverse development of $16.8 while the commercial auto product line had favorable development of $16.6. Reserve estimates are also uncertain by accident period. To illustrate this, the following table provides the before-tax amount of prior accident years' loss and LAE reserve development by accident year on a net of reinsurance basis for all lines combined:
Three Months Ended Nine Months Ended September 30, September 30, Year 2006 2005 2006 2005 2005 ---- ---- ---- ---- ---- (Favorable)/Unfavorable - ----------------------- Accident Year 2005 $ (5.3) $ - $ (9.8) $ - $ - Accident Year 2004 (2.3) (3.2) (15.4) (19.1) (30.8) Accident Year 2003 and Prior (6.1) 6.3 (12.2) 15.5 10.7 ------- ------ ------- ------- ------- Total Prior Accident Years' Development $(13.7) $ 3.1 $(37.4) $ (3.6) $(20.1) ======= ====== ======= ======= =======
Please refer to the Corporation's Annual Report on Form 10-K for the year ended December 31, 2005, for a broader discussion of reserve variability and uncertainty. The Group does not prepare loss reserve ranges, nor does it project future variability, when determining its best estimate, although the above examples of actual historical changes in loss reserve estimates provide a measure of the uncertainty underlying the current loss reserve estimates. The Loss Reserve process takes all risk factors into account, but no one risk factor has been bifurcated to perform a sensitivity or variability analysis because the risk factors were considered in the aggregate. As a result, the Group is not in a position to quantify the impact of reasonably likely changes to significant assumptions at this time. Nevertheless, the Group is undertaking an assessment to evaluate the sensitivity or variability of changes in significant assumptions related to the Group's estimate of loss reserves in the aggregate and/or by product line, to the extent material. Upon completion of such sensitivity or variability assessment, and to the extent that management believes the information to be reasonably accurate and credible and would be beneficial, in the opinion of management, 31 to the understanding of the Group's financial statements, the Corporation will include the outcome of this sensitivity/variability analysis either in the aggregate or by product line, as appropriate, in the first practicable periodic filing of the Corporation that follows the completion of this assessment and continuing thereafter. Cash Flow Net cash provided by operations was $85.7 for the first nine months of 2006, compared with $205.9 for the same period in 2005. The decline in cash provided by operations is primarily the result of increased income tax payments, incentive plan payments, contributions to the Company's retirement plan and the purchase of company owned life insurance to help offset the increase in future benefit costs. The decline in net cash used in investing of $38.4, compared with $233.7 during the first nine months of 2005 primarily relates to a reduction in the cash generated by operations, as discussed above. Cash used by financing operations was $83.2 in the first nine months of 2006, compared with $170.6 in the first nine months of 2005. The reinstatement of the shareholder dividend and the repurchase of the Corporation's common stock contributed to the cash used in financing activities during 2006. See Part II, Item 2, for additional information regarding the share repurchase program. For the same period in 2005, cash used in financing activities was attributed to the repurchase and redemption of the Corporation's Convertible Notes. 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 page 16 of this Quarterly Report on Form 10-Q. At September 30, 2006, the Corporation had cash and marketable securities, totaling $297.0, which compared to $253.2 at December 31, 2005. 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 2006, dividend payments from the Company to the Corporation are limited to approximately $415.0 without prior approval from the Ohio Department of Insurance. During the first nine months of 2006, the Company paid dividends of $125.0 to the Corporation resulting in a dividend payment limitation of $290.0 for the remainder of 2006. Book Value Per Share At September 30, 2006, the book value per share of the Consolidated Corporation increased $1.60 per share from $22.54 per share to $24.14 per share when compared to book value at December 31, 2005. This increase is principally the result of improved profitability offset by declines in unrealized gains and the affects of the share repurchase and dividend programs. At September 30, 2006 and December 31, 2005 there were 61,204,073 and 63,281,136 actual shares outstanding, respectively. Below is a table reconciling the changes in book value per share from December 31, 2005 to September 30, 2006.
December 31, 2005 $22.54 Activity year-to-date September 2006: Net income 2.26 Change in unrealized gains (0.21) Impact of share repurchase program (0.20) Dividend to shareholders (0.27) Other 0.02 ------- September 30, 2006 $24.14 =======
Rating Agencies Regularly the financial condition of the Consolidated 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. On September 18, 2006, Fitch announced that it upgraded the senior unsecured debt rating of Ohio Casualty to 32 BBB and the insurance financial strength rating of its operating subsidiaries to A. At this time, the rating outlook was changed from positive to stable. Following are the Consolidated Corporation's current ratings and rating outlooks.
A.M. Best Fitch Moody's S&P --------- ----- ------- --- Financial strength rating (Group) A- A A3 A- Senior unsecured debt rating (Corporation) bbb- BBB Baa3 BBB- Rating outlook Positive Stable Positive Stable
For more information on the rating agency actions, please refer to Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations in the Corporation's 2005 Annual Report on Form 10-K for the year ended December 31, 2005. 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 Consolidated 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 Consolidated 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 2005 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. PART II Other Information ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds During the third quarter of 2006, the Corporation completed the share repurchase program which was authorized by the Corporation's Board of Directors in the third quarter of 2005. In September 2006, the Board of Directors approved another share purchase program with authorization to repurchase up to $100.0 of the Corporation's common stock. The repurchases may be made in the open market or in privately 33 negotiated transactions from time to time and are funded from available working capital. As of October 31, 2006, the Corporation has repurchased 227,200 shares under the new program at an average cost of $27.19. The table below summarizes the status of share repurchases during the third quarter ended September 30, 2006 under the previously authorized program.
ISSUER PURCHASES OF EQUITY SECURITIES - ------------------------------------------------------------------------------- (c) Total (d) Maximum Number Number of of Shares Shares that Purchased as May Yet Be (a) Total Part of Publicly Purchased Number of (b) Average Announced Under the Shares Price Paid Plans or Plans or Period Purchased per Share Programs Programs - ------------------------------------------------------------------------------- July 1 - 31, 2006 78,000 $25.96 78,000 171,186 August 1 - 31, 2006 171,186 25.83 171,186 - September 1 - 30, 2006 - - - - ------- ------- Total 249,186 $25.87 249,186 -
ITEM 6. Exhibits Exhibits: 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 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) November 1, 2006 /s/Michael A. Winner ----------------------------------- Michael A. Winner, Executive Vice President and Chief Financial Officer 34 EX-31 2 exh31-1.txt CEO CERTIFICATION TO FORM 10-Q 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: October 30, 2006 /s/Dan R. Carmichael ------------------------------------- Dan R. Carmichael President and Chief Executive Officer EX-31 3 exh31-2.txt CFO CERTIFICATION TO FORM 10-Q 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: October 30, 2006 /s/Michael A. Winner ------------------------------------- Michael A. Winner Executive Vice President and Chief Financial Officer EX-32 4 exh32-1.txt CEO 906 CERTIFICATION TO FORM 10-Q Exhibit 32.1 CERTIFICATION I, Dan R. Carmichael, President and Chief Executive Officer of Ohio Casualty Corporation (the "Company"), certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that: 1. The Quarterly Report on Form 10-Q of the Company for the period ended September 30, 2006 (the "Report") fully complies with the requirements of Section 13(a) of the Securities; Exchange Act of 1934 (15 U.S.C. 78m); and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. Dated: October 30, 2006 /s/Dan R. Carmichael --------------------------------------------- Name: Dan R. Carmichael Title: President and Chief Executive Officer A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. EX-32 5 exh32-2.txt CFO 906 CERTIFICATION TO FORM 10-Q Exhibit 32.2 CERTIFICATION I, Michael A. Winner, Executive Vice President and Chief Financial Officer of Ohio Casualty Corporation (the "Company"), certify, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, 18 U.S.C. Section 1350, that: 1. The Quarterly Report on Form 10-Q of the Company for the period ended September 30, 2006 (the "Report") fully complies with the requirements of Section 13(a) of the Securities; Exchange Act of 1934 (15 U.S.C. 78m); and 2. The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company. Dated: October 30, 2006 /s/Michael A. Winner ---------------------------------------- Name: Michael A. Winner Title: Executive Vice President and Chief Financial Officer A signed original of this written statement required by Section 906 has been provided to the Company and will be retained by the Company and furnished to the Securities and Exchange Commission or its staff upon request. -----END PRIVACY-ENHANCED MESSAGE-----