State Auto Financial ( STFC)

Q3 2011 Earnings Call

November 8, 2011 10:00 AM ET

Executives

Steve English – VP and CFO

Robert Restrepo – President, Chairman and CEO

Analysts

Matt Rohrmann – Keefe, Bruyette & Woods

Paul Newsome – Sandler O’Neill & Partners

Ryan Burns

Larry Greenberg – Langen McAlenney

Presentation

Operator

Good morning, and thank you for standing by. I would like to remind all parties that your lines have been placed on listen-only until the question-and-answer portion of today’s conference. (Operator Instructions) Today’s conference is being recorded. If you should have any objection, you may disconnect at this time.

It is now my pleasure to introduce your speakers for today, Mr. Bob Restrepo, Chairman and Chief Executive Officer; and Mr. Steve English, Chief Financial Officer. Thank you, gentlemen. You may begin.

Steve English

Thank you, Emily. Good morning, and welcome to our third quarter 2011 earnings conference call. Today, I’m joined by several members of STFC’s senior management team, our Chairman, President and CEO, Bob Restrepo; Chief Investment Officer, Jim Duemey; Chief Actuarial Officer, Matt Mrozek and our Chief Accounting Officer and Treasurer, Cindy Powell.

Today’s call will include prepared remarks by our CEO, Bob Restrepo and me, after which, we will open the lines for questions. Please note our comments today may include forward-looking statements, which by their nature, involve a number of risk factors and uncertainties which may affect future financial performance. Such risk factors may cause actual results to differ materially from those contained in our projections or forward-looking statements. These types of factors are discussed at the end of our press release as well as in our annual and quarterly filings with the Securities and Exchange Commission to which I refer you.

A financial packet containing reconciliations of certain non-GAAP measures, along with supplemental financial information was distributed to registered participants prior to this call and made available to all interested parties on our website www.stateauto.com under the investor section as an attachment to the press release.

Now, I’ll turn the call over to STFC’s Chairman, President and CEO, Bob Restrepo.

Robert Restrepo

Thank you, Steve and good morning everyone. State Auto posted a second consecutive quarterly loss in the third quarter. On October 17th, we announced the estimated pre-tax impact of the third quarter catastrophe losses to be between $60 million and $63 million. The reported number is $61 million and the breakdown is $25 million of prior period development from second quarter 2011 catastrophes, $16 million from Hurricane Irene and $20 million from other third quarter catastrophe events. As a reminder, these numbers far exceeds State Auto Financial Corporation’s historic five-year average catastrophe losses for the quarter of approximately $25 million. Our third quarter catastrophe loss ratio of 17 points is nearly double our five year average of 8.8%.

Year-to-date, STFC has $232.9 million of catastrophe losses, which is the highest in our company’s history and well over the third quarter five-year average loss ratio of 11.5%. In addition to unprecedented catastrophe events, we strengthened workers compensation reserves on prior accident year lifetime disability cases and our legacy State Auto book. All in, the result is a net loss of $58.7 million or $1.46 of diluted share. The loss from operations per diluted share for the quarter was $1.62 versus a net loss last year in the same period of $0.04.

Our GAAP combined ratio for the quarter was 122.4% versus 105.9% for the same quarter last year. Year-to-date, STFC recorded a net loss of $247.4 million or $6.15 per diluted share and the GAAP combined ratio for the first nine months of the year was 124.2% compared to 106.9% for the same period in 2010.

Combined with a net deferred tax valuation allowance, we initially booked last quarter, our capital levels have dropped approximately by a third since the beginning of the year. As a result, we’ve taken a series of actions to reduce volatility, improve earnings and strengthen our long-term capital position. These include revising the reinsurance pooling arrangement between STFC and State Auto Mutual to 65% from 80%.

Pursuing a quota share reinsurance treaty covering as much as 65% of our homeowners business and discontinuing retiree medical coverage for most of our active employee base in certain retirees. Over the next few minutes, I’ll comment on operating results including actions we have underway to improve earnings. Following that, Steve will comment on the actions we’ve undertaken to improve our short-term capital position and enable the completion of our property insurance remediation and specialty insurance diversification plans.

In personal lines, our personal auto business remains profitable. The loss ratio deteriorated a bit because of increased frequency of bodily injury large losses. Frequency of large losses has increased while severity remains unchanged. We see no indications of adverse selection but are taking additional pricing actions to improve results.

Uninsured and underinsured motorist activity, claim activity is up a bit relative to past trends but stable. Industry wide miles driven remains fairly flat and our risk profile remains unchanged. Results will improve with price increases. Our written premium is down 7.9%, driven by the run-off in the non-standard automobile business which we sold. Policy count is also down in our core states of Ohio, Indiana, Kentucky, and Tennessee due to our aggressive homeowners underwriting and pricing actions.

Year-to-date, written premiums declined 6.6%, while prices are up 2.5%. In homeowners, the story is still cats. Large losses are up relative to third quarter of 2010, but are comparable to historical trends. The real story continues to be the weather. Our catastrophe loss ratio in the homeowners line was 58% in the quarter, up significantly from our five year average of 34% in the third quarter. Results were driven by development from second quarter losses and losses incurred from Hurricane Irene.

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