State Auto Financial Corporation

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State Auto Financial Corporation

518 East Broad Street
Columbus, Ohio 43215
U.S.A.
Telephone: (614) 464-5000
Toll Free: (800) 444-9950
Fax: (614) 464-5325
Web site: http://www.stateauto.com

Public Company
Incorporated: 1991
Employees: 2,029Total Assets: $2.02 billion (2004)
Stock Exchanges: NASDAQ
Ticker Symbol: STFC
NAIC: 524126 Direct Property and Casualty Insurance Carriers; 551112 Offices of Other Holding Companies

State Auto Financial Corporation is an insurance holding company for five regional insurance subsidiaries: State Auto Property and Casualty Insurance Company, Milbank Insurance Company, Farmers Casualty Insurance Company, State Auto Insurance Company of Ohio, and State Auto National Insurance Company. Through its insurance subsidiaries, State Auto Financial writes personal and commercial automobile, homeowners, commercial multi-peril, fire, and general liability insurance, serving customers in 26 states through 22,500 independent insurance agents. The company's insurance operations are supported through ten regional and branch offices. State Auto Financial also controls three non-insurance subsidiaries: Stateco Financial Services, Inc., which provides investment management services to all of the holding company's subsidiaries; Strategic Insurance Software, Inc., a developer of software that is marketed in the insurance agency management system market; and 518 Property Management and Leasing, LLC, a subsidiary that owns and leases real and personal property to other State Auto Financial subsidiaries. Policyholder-owned State Auto Mutual Insurance Company controls 67 percent of State Auto Financial.

ORIGINS

The company at the center of a billion-dollar tug-of-war in the early 21st century began operating nearly a century earlier, formed with modest resources that hardly suggested the birth of one of the country's largest insurance companies. In 1921, Robert S. Pein borrowed $30,000 and started the State Automobile Insurance Company, the first home-office casualty company in Columbus, Ohio. Pein, motivated by his displeasure at the exorbitant rates charged by other insurers and their inept settlement of claims, promised to give Columbus residents a better alternative for their insurance needs, but it was doubtful he could have foreseen the expansion of his business into a billion-dollar corporation with operations covering more than half of the United States.

Pein's start-up capital was enough to hire three employees and rent a room in downtown Columbus. The company's trappings could not have been more humble, but Pein registered almost immediate success, enabling him and his small staff to occupy larger quarters within a short time. State Automobile Insurance, which wrote auto insurance during its first years in business, moved its headquarters twice by 1925, the year it began writing non-assessable policies, under which policyholders could not be assessed additional fees if the losses became too great. Perhaps the most notable aspect of the company's first years in business was Pein's decision to use only independent insurance agents to distribute his company's insurance products. It was a decision that became the company's policy, one that was strictly adhered to years after Pein's death, representing one of the defining characteristics of the State Auto Financial group of companies in the 21st century.

The 1930s presented a formidable challenge to virtually every type of business in the United States, presenting an exacting, determinative test of a company's durability. For State Automobile Insurance, the crucible arrived early in the company's development, making its chances at survival all that more tenuous, but the company responded to the harsh economic conditions of the Great Depression with remarkable resilience. Pein's company, it could be easily argued, thrived during the disastrous decade. As if setting the tone for the robustness the company would demonstrate during the 1930s, a new, larger headquarters building was occupied at the decade's start, the company's third move to grander quarters in nine years. Pein began expanding operations the following year, entering Kentucky, West Virginia, and Tennessee, giving State Automobile Insurance a four-state operating territory that relied on more than 700 agents.

Midway through the decade, as the Great Depression reached its trough, State Automobile Insurance exhibited even greater strength, expanding its product portfolio and its operating territory. The company was aided somewhat by the passage of two laws in Ohio, the first of which, promulgated in 1935, was a statute assigning financial responsibility to drivers. The following year, the state passed the Driver's License Law, making driving a privilege rather than a right. Because of the two laws, the number of drivers buying liability insurance increased markedly, but Ohio was not the only source of growth for Pein's enterprise. On the heels of the expansion achieved early in the decade, the company entered Maryland, South Carolina, and Michigan midway through the decade. State Automobile Insurance's growing customer base had more products to choose from as well, as the company began offering an early version of homeowners insurance and general liability coverage.

In some ways, the 1940s presented a bigger challenge than the Great Depression to State Auto Insurance, but again the company persevered, ensuring that it was well positioned to share in the explosive growth of the national economy following World War II. Several months after the United States entered the conflict, every automobile manufacturer in the country halted production of civilian passenger cars to direct their efforts fully toward the prosecution of the war. For insurers such as State Automobile Insurance who were heavily reliant on writing automobile insurance, the nation's new priorities cut off the supply of new business that would have come from the purchase of new automobiles. State Automobile Insurance withstood the shock to its operations and, by the end of the 1940s, when new automobile production soared to a near record level, the company reigned as a formidable regional force. State Automobile Insurance had $20.4 million in assets by the 1940s, issuing more than 250,000 policies and recording gross premium writings of $14.5 million during the final year of the decade.

COMPANY PERSPECTIVES

With a commitment to responsible cost-based pricing, conservative investments and sound underwriting practices, State Auto Financial Corporation has maintained a healthy financial record since becoming a public company in 1991. Combined with its focus on providing outstanding service to policyholders and agents, State Auto has earned the reputation as one of the strongest and best managed regional insurance groups in the industry. The State Auto Pool has consistently received A.M. Best Company's A+ (Superior) rating.

POST-WORLD WAR II EXPANSION

State Automobile Insurance's postwar growth was highlighted by the expansion of the company's selection of insurance offerings, vigorous geographic expansion, numerous acquisitions, and, for the first time in its history, changes in leadership. Pein began to cede control of his company in 1954, when Paul Gingher, who joined State Automobile Insurance in 1931, was named executive vice-president. Gingher was named president two years later by Pein, who assumed the role of chairman, but he occupied his new post for only a matter of months, passing away before the end of 1956. During this transition in leadership, the company added fire insurance and inland marine coverage in Ohio and certain other states in its operating territory. Once State Automobile Insurance was firmly under Gingher's control, the company began capitalizing on a new, expedient means of rounding out its product portfolio and expanding geographically by acquiring other insurers. In 1958, the company purchased two companies based in Greer, South Carolina, Dixie Fire and Casualty Co. and the Southern Home Insurance Co. The acquisitions paved the company's entry into Alabama, Georgia, Mississippi, North Carolina, South Carolina, and Virginia.

State Automobile Insurance's actions during the 1950s set the tone for the company's development in succeeding decades. The emphasis was on expansion, which often was achieved via acquisition. In 1962, the year the company began offering health insurance, its product selection was broadened further with the purchase of Columbus Mutual Life Insurance Co. The following year, the company formed a non-insurance subsidiary, Stateco, Inc., which facilitated the financing of insurance premiums. By the time State Automobile Insurance celebrated its 50th anniversary, its stature as an insurer had been elevated substantially by postwar economic growth. The $20 million in assets supporting the company at the end of the 1940s had swelled to $370 million by 1971. The company's volume of business as measured by the amount of premiums written in a year had increased exponentially as well, jumping from $14.5 million in 1949 to $127.7 million in 1971. The figure increased to $185 million by the end of the decade, when State Automobile Insurance maintained operations in 14 states.

In contrast to the expansionist mindset directing the company's movements during the 1960s and 1970s, the 1980s were characterized by streamlining efforts undertaken by the executive staff in Columbus. In 1983, Robert L. Bailey, who was named director of product services and distribution four years earlier, was named president of State Automobile Insurance, the third change in leadership after Gingher's tenure. Bailey would lead the company for the next two decades, and under his stewardship, cost-cutting measures were effected and underwriting efforts were strengthened. Bailey also emphasized a more balanced business mix, seeking to increase the company's involvement in the commercial sector. In 1984, the company derived 80 percent of its revenue from personal business, relying on commercial work for the other 20 percent. Bailey set a goal of increasing the company's commercial business to 40 percent of revenues. A decade later, he reorganized the company to achieve an even split between personal and commercial business.

KEY DATES

1921:: Robert Pein opens an insurance office in Columbus, Ohio.
1931:: State Automobile Insurance expands beyond Ohio's borders for the first time.
1949:: The company's assets exceed $20 million.
1958:: State Automobile Insurance completes its first acquisitions.
1971:: Assets reach $370 million during the company's 50th anniversary.
1991:: State Auto Financial is created to facilitate an initial public offering of stock.
1993:: Milbank Insurance Co. is acquired.
1998:: Farmers Casualty Co. is acquired.
2001:: State Auto Financial completes the largest acquisition in its history, purchasing Meridian Insurance Group.
2003:: Gregory Shepard launches a takeover attempt of State Auto Financial.
2004:: Takeover specialist Carl Icahn purchases half of Shepard's State Auto Financial stock.

PUBLIC DEBUT IN THE 1990S AND UNCERTAINTY IN THE 21ST CENTURY

Although each decade brought some sort of change to the company, the 1990s stood out from the rest. Expansion resumed in earnest, touched off by a move into Mississippi in 1989, but the decade's most profound event was the public debut of the enterprise Pein had created 70 years earlier. In 1991, the company completed its initial public offering (IPO) of stock, a corporate maneuver that required the formation of State Auto Financial Corporation as a holding company for all companies either formed internally or acquired during the previous decades. Policyholder-owned State Auto Mutual Insurance Co., in turn, was given a 67 percent stake in State Auto Financial. To this new structure, new assets were added throughout the decade, joining subsidiaries such as the 1958 acquisition of Southern Home, which changed its name to State Auto Property & Casualty Co., and Stateco, Inc., which lengthened its name to Stateco Financial Services, Inc. One year after the IPO, the State Auto group of companies began to grow. State Auto National was launched in Ohio to compete in the non-standard automobile market, a new venture that registered quick success, expanding into seven other states within its first four years of operation. In 1993, the group gained another member when State Auto Financial acquired Milbank Insurance Co., a Milbank, South Dakota-based insurer that provided the company with entry into markets in North Dakota, South Dakota, Minnesota, and Utah. In 1997, the acquisition of Midwest Security Insurance Co., an insurer based in Onalaska, Wisconsin, established State Auto Financial's presence in its 24th state, a purchase that was followed one year later by the addition of Des Moines, Iowa-based Farmers Casualty Co., which added two more states, Kansas and Iowa, to State Auto Financial's geographic coverage. By the end of the decade, the string of acquisitions lifted the company's annual revenues to $440 million.

In retrospect, the series of acquisitions completed during the 1990s represented a mere prelude to what would be both Bailey's masterstroke and his swan song. In October 2000, two months before Bailey's retirement, State Auto Financial announced it was acquiring Meridian Insurance Group, one of Indiana's largest insurers with $302 million in revenue. State Auto Financial's announcement ended a hostile takeover, a "bitter battle" as described by the October 26, 2000 edition of the Indianapolis Star, led by Gregory Shepard, who owned an Illinois-based insurer named American Union Insurance Co. and ranked as Meridian Insurance's largest shareholder. Shepard, who had launched his bid in August, was beaten to the punch by State Auto Financial, withdrawing his offer in December. State Auto Financial completed the transaction in June 2001, a deal that made it the 48th largest property/casualty insurer in the United States with more than $1 billion in written premiums and $2 billion in assets. The acquisition of Meridian Insurance and its largest insurance arm, Meridian Security Insurance Co., which operated in 18 states, provided an enormous boost to State Auto Financial's stature, increasing the group's penetration in a number of important Midwest states. "In virtually every respect the fit is perfect in terms of marketing systems, products, people, and philosophy," Bailey said in an October 26, 2000 interview with the Indianapolis Star. "We intend to utilize fully the skills and experience of the entire Meridian staff."

As State Auto Financial prepared for the future, a cloud of uncertainty hung over the company, representing virtually the only wrinkle in an otherwise stalwart organization. Shepard, evidently, was not as enthusiastic as Bailey about the Meridian Insurance deal. In 2003, Shepard launched a bid to acquire State Auto Financial, proposing a $256 million deal that reportedly would use State Auto Financial's existing assets as the means to finance the transaction. State Auto Financial firmly opposed the offer and urged shareholders to reject Shepard's advances, describing the takeover attempt as a "scheme" that "makes no economic sense," according to Robert Moone, Bailey's replacement, in the September 3, 2003 issue of A.M. Best Newswire. Shepard was not to be deterred, however, responding to the company's rejection by extending his bid five more times. The battle between Shepard and State Auto Financial carried on until mid-2004, when the saga gained a new protagonist. Carl Icahn, whose personal fortune eclipsed $7 billion, entered the fray, acquiring half of Shepard's two million shares for $13 per share at a time when State Auto Financial's stock was trading at $27 per share. Icahn was a well-known takeover specialist who earned his reputation during the 1980s when he spearheaded takeovers of Texaco, TWA, and USX. His intervention did little to resolve questions concerning State Auto Financial's future ownership, nor did it end speculation about Shepard's involvement in a hostile takeover attempt. "I don't know what game Shepard is playing," an analyst remarked in a May 17, 2004 interview with Mergers & Acquisitions Report, "but I know he is playing a game. The fact that one million shares in this stock are exchanging hands at $13 is so absurd I don't think anyone knows what to do with it. I just don't understand the sale."

As State Auto Financial plotted its course for the second half of the decade, industry observers continued to ponder the implications of Icahn's stock purchase.

PRINCIPAL SUBSIDIARIES

State Auto Property and Casualty Insurance Company; Stateco Financial Services, Inc.; Milbank Insurance Company; Farmers Casualty Insurance Company; State Auto Insurance Company of Ohio; State Auto National Insurance Company; Strategic Insurance Software, Inc.; 518 Property Management and Leasing, LLC; State Automobile Mutual Insurance Company; State Auto Insurance Company of Wisconsin; State Auto Florida Insurance Company; BroadStreet Capital Partners, Inc.; Meridian Citizens Mutual Insurance Company; Meridian Insurance Group, Inc.; Meridian Security Insurance Company.