SCHEDULE 14A
(RULE 14a-101)
INFORMATION REQUIRED IN PROXY STATEMENT
SCHEDULE 14A INFORMATION
PROXY STATEMENT PURSUANT TO SECTION 14(a) OF THE SECURITIES
EXCHANGE ACT OF 1934
Filed by the Registrant [X]
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Check the appropriate box:
[ ] Preliminary Proxy Statement
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[X] Definitive Proxy Statement
[ ] Definitive Additional Materials
[ ] Soliciting Material Pursuant to Section 240.14a-11c or Section 240.14a-12
STATE AUTO FINANCIAL CORPORATION
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(Name of Registrant as Specified In Its Charter)
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(Name of Person(s) Filing Proxy Statement)
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pursuant to Exchange Act Rule 0-11 (set forth the amount on which the
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previously. Identify the previous filing by registration statement number,
or the Form or Schedule and the date of its filing.
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[State Auto Financial Corporation Logo]
STATE AUTO FINANCIAL CORPORATION
NOTICE OF ANNUAL MEETING OF SHAREHOLDERS
To the Shareholders of
STATE AUTO FINANCIAL CORPORATION:
Notice is hereby given that the Annual Meeting of Shareholders of State
Auto Financial Corporation (the "Company") will be held at the Company's
principal executive offices located at 518 East Broad Street, Columbus, Ohio, on
Friday, May 28, 2004, at 10:00 A.M., local time, for the following purposes:
1. To elect three Class I directors, each to hold office for a
three-year term and until a successor is elected and qualified;
2. To ratify the selection of Ernst and Young LLP as the Company's
independent public accountants for 2004; and
3. To transact such other business as may properly come before the
meeting or any adjournment thereof.
The close of business on April 5, 2004, has been fixed as the record date
for the determination of shareholders entitled to notice of and to vote at the
meeting and any adjournment thereof.
In order that your shares may be represented at this meeting and to assure
a quorum, please sign and return the enclosed proxy promptly. A return addressed
envelope, which requires no postage, is enclosed. In the event you are able to
attend and wish to vote in person, at your request we will cancel your proxy.
By Order of the Board of Directors
JOHN R. LOWTHER
Secretary
Dated: April 19, 2004
STATE AUTO FINANCIAL CORPORATION
PROXY STATEMENT
GENERAL
This Proxy Statement is furnished in connection with the solicitation of
proxies by the Board of Directors of State Auto Financial Corporation (the
"Company") to be used at its Annual Meeting of Shareholders to be held May 28,
2004 (the "Annual Meeting"). Shares represented by properly executed proxies
will be voted at the Annual Meeting in accordance with the choices indicated on
the proxy. A proxy may be revoked at any time, insofar as it has not been
exercised, by delivery to the Company of a subsequently dated proxy or by giving
notice of revocation to the Company in writing or in open meeting. A
shareholder's presence at the Annual Meeting does not by itself revoke the
proxy.
The mailing address of the principal executive offices of the Company is
518 East Broad Street, Columbus, Ohio 43215. The approximate date on which this
Proxy Statement and the form of proxy are first being sent or given to
shareholders is April 19, 2004.
PROXIES AND VOTING
The close of business on April 5, 2004, has been fixed as the record date
for the determination of shareholders entitled to notice of and to vote at the
Annual Meeting and any adjournment thereof. On the record date there were
outstanding and entitled to vote 39,719,413 of the Company's common shares,
without par value (the "Common Shares"). Each Common Share is entitled to one
vote.
Shareholders do not have the right to cumulate their votes in the election
of directors, and the nominees receiving the highest number of votes will be
elected as the Class I directors. The vote required for the ratification of the
selection of Ernst & Young LLP as the Company's independent public accountants
for 2004 is the favorable vote of a majority of the outstanding Common Shares
present in person or by proxy at the Annual Meeting.
All Common Shares represented by properly executed proxies will be voted at
the Annual Meeting in accordance with the choices indicated on the proxy. If no
choices are indicated on a proxy, the Common Shares represented by that proxy
will be voted in favor of the nominees listed in this Proxy Statement for
election as Class I directors and in favor of the ratification of the selection
of Ernst & Young LLP. Any proxy may be revoked at any time prior to its exercise
by delivering to the Company a subsequently dated proxy or by giving notice of
revocation to the Company in writing or in open meeting. A shareholder's
presence at the Annual Meeting does not by itself revoke the proxy.
Abstentions will be considered as Common Shares present and entitled to
vote at the Annual Meeting and will be counted for purposes of determining
whether a quorum is present. Abstentions will not be counted in determining the
votes cast for the election of directors and will not have a positive or
negative effect on the outcome of the election. Because the ratification of the
selection of Ernst & Young LLP requires the favorable vote of a majority of the
outstanding Common Shares present in person or by proxy at the Annual Meeting,
abstentions will have the same effect as a vote against this ratification.
If your Common Shares are held in street name, you will need to instruct
your broker regarding how to vote your Common Shares. If you do not provide
voting instructions to your broker, and if your broker does not have discretion
to vote your Common Shares without your instructions, a "broker non-vote" will
occur. Broker non-votes will not be counted in determining the votes cast for
the election of directors or with respect to the ratification of the selection
of Ernst & Young LLP and will not have a positive or negative effect on the
outcome of these matters.
PROPOSAL ONE: ELECTION OF DIRECTORS
The number of directors currently is fixed at nine. The Board of Directors
is divided into three classes, Class I, Class II and Class III, with three
directors in each Class. The term of office of directors in one Class expires
annually at each annual meeting of shareholders at such time as their successors
are elected and qualified. Directors in each Class are elected for three-year
terms. The term of office of the Class I directors expires concurrently with the
holding of the Annual Meeting. Messrs. Paul W. Huesman, John R. Lowther and
Robert H. Moone, the three persons recommended by the Nominating and Governance
Committee of the Company's Board of Directors, and each of whom is an incumbent
Class I director, have been nominated for re-election.
At the Annual Meeting, it is the intention of the persons named in the
accompanying form of proxy, unless a contrary position is indicated on such
proxy, to vote the proxy for the election of the three nominees named in the
following table as Class I directors, each to hold office until the 2007 annual
meeting of shareholders and until a successor is elected and qualified. Each of
the nominees has consented to being named in this Proxy Statement and to serve
if elected. In the event that any nominee named in the table as a Class I
director is unable to serve (which is not anticipated), the persons named in the
proxy may vote it for another nominee of their choice.
Proxies cannot be voted at the Annual Meeting for a greater number of
persons than the three nominees named in this Proxy Statement.
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Set forth below is information about each of the Class I director nominees:
CLASS I DIRECTOR NOMINEES
(TERMS EXPIRING IN 2007)
A COMMON
NAME OF DIRECTOR SHARES OWNED
DIRECTOR NOMINEE OF THE BENEFICIALLY AS %
AND POSITION(S) PRINCIPAL OCCUPATION(S) COMPANY OF APRIL 5, OF
WITH COMPANY AGE(1) DURING THE PAST FIVE YEARS SINCE 2004(2)(3) CLASS
---------------- ------ -------------------------- -------- --------------- -----
Paul W. Huesman(4) .... 68 Consultant to Huesman-Schmid 1991 77,564 *
Director Insurance Agency, Inc., an insurance
agency, 6/03 to present; Agent with
Huesman-Schmid Insurance Agency,
Inc., 01/03 to 6/03; Formerly
President of Huesman-Schmid
Insurance Agency, Inc., for more
than five years prior to 01/03.
John R. Lowther(5)..... 53 Senior Vice President of the 1991 117,127 *
Senior Vice President, Company, State Auto Property and
Secretary and General Casualty Insurance Company ("State
Counsel Auto P&C"), Milbank Insurance
Company ("Milbank"), State Auto
National Insurance Company
("National"), and Farmers Casualty
Insurance Company ("Farmers
Casualty"), each a wholly owned
subsidiary of the Company, and of
State Automobile Mutual Insurance
Company ("State Auto Mutual"), 3/01
to present; Secretary and General
Counsel of the Company, State Auto
P&C, Milbank, National, and State
Auto Mutual for more than five
years; Vice President of the
Company, State Auto P&C, Milbank,
National and State Auto Mutual for
more than five years prior to 3/01.
Robert H. Moone(6)..... 60 Chairman of the Board of the 1998 298,880 *
Chairman, President and Company, State Auto P&C, Milbank,
CEO National, Farmers Casualty and State
Auto Mutual, 1/01 to present;
President and CEO of the Company,
State Auto P&C, Milbank, National,
Farmers Casualty and State Auto
Mutual, 5/99 to present; President
and COO of the Company, State Auto
P&C, Milbank, National and State
Auto Mutual, 5/96 to 5/99.
3
Set forth below is information about the directors whose terms of office
continue after the Annual Meeting.
CLASS II DIRECTORS
(TERMS EXPIRING IN 2005)
A COMMON
NAME OF DIRECTOR SHARES OWNED
DIRECTOR AND OF THE BENEFICIALLY AS %
POSITION(S) PRINCIPAL OCCUPATION(S) COMPANY OF APRIL 5, OF
WITH COMPANY AGE(1) DURING THE PAST FIVE YEARS SINCE 2004(2)(3) CLASS
------------ ------ -------------------------- -------- --------------- -----
David J. D'Antoni(7)... 59 Senior Vice President and Group 1995 53,200 *
Director Operating Officer, Ashland, Inc.,
3/99 to present; President of APAC,
Inc., a subsidiary of Ashland, Inc.,
7/03 to 1/04; Senior Vice President
of Ashland, Inc. and President,
Ashland Chemical, a division of
Ashland, Inc., 7/88 to 3/99.
Ashland, Inc. is involved in oil
refining and marketing, highway
construction, automotive after
market products, specialty chemicals
and chemical and plastics
distribution. Mr. D'Antoni is also a
director of Omnova Solutions Inc., a
producer of decorative and
functional surfaces, coatings, and
specialty chemicals.
William J. Lhota....... 64 Principal, LHOTA SERVICES, a firm 1994 40,200 *
Director providing business and engineering
ethics consulting and
arbitration/mediation services, 1/02
to present; Retired President -
Energy Delivery, American Electric
Power, 6/00 to 12/01; Retired
Executive Vice President, American
Electric Power Service Corporation,
a management, technical, and
professional subsidiary of American
Electric Power, 11/89 to 6/00. Mr.
Lhota is also a director of
Huntington Bancshares, Inc., a bank
holding company.
S. Elaine Roberts...... 51 President and CEO of the Columbus 2002 4,200 *
Director Regional Airport Authority, 01/03 to
present; Executive Director of
Columbus Airport Authority, 12/00 to
01/03; Executive Director of Rhode
Island Airport Corporation, 12/94 to
12/00.
4
CLASS III DIRECTORS
(TERMS EXPIRING IN 2006)
A COMMON
NAME OF DIRECTOR SHARES OWNED
DIRECTOR AND OF THE BENEFICIALLY AS %
POSITION(S) PRINCIPAL OCCUPATION(S) COMPANY OF APRIL 5, OF
WITH COMPANY AGE(1) DURING THE PAST FIVE YEARS SINCE 2004(2)(3) CLASS
------------ ------ -------------------------- -------- --------------- -----
Urlin G. Harris, Jr.... 67 Secretary and Treasurer of Aspen Ski 1991 52,807 *
Director & Board Co., a ski equipment
retailer, 7/99 to present; retired
4/97 as an officer of the Company,
State Auto P&C, Milbank, National,
and State Auto Mutual; prior to his
retirement, Mr. Harris was an
executive officer of the Company
since its formation in 1991 and an
officer of State Auto Mutual since
before 1991.
Richard K. Smith(8).... 59 Retired 6/97 as Partner of KPMG, 1999 17,200 *
Director LLP, a public accounting firm;
Partner of KPMG, LLP, for more than
five years prior to 6/97.
Paul S. Williams....... 44 Executive Vice President, Chief 2003 0 *
Director Legal Officer and Secretary of
Cardinal Health, Inc. ("Cardinal"),
a provider of products and services
to healthcare providers and
manufacturers, 4/01 to present;
Senior Vice President of Cardinal,
1/01 to 4/01; Vice President of
Cardinal, 6/98 to 1/01; Deputy
General Counsel of Cardinal, 7/99 to
1/01; Assistant Secretary of
Cardinal, 6/98 to 4/01; Assistant
General Counsel of Cardinal, 6/98 to
7/99.
---------------
* Less than one (1%) percent.
(1) Ages shown are as of the date of the Annual Meeting.
(2) Except as indicated in the notes to this table, the persons named in the
table have sole voting and investment power with respect to all Common
Shares shown as beneficially owned by the named person. With respect to
stock options, this table includes only stock options for Common Shares
which are currently exercisable or exercisable within 60 days of April 5,
2004.
(3) The amount reported includes Common Shares attributable to options granted
under the Company's 1991 Stock Option Plan and the 2000 Stock Option Plan
for Messrs. Moone (186,013) and Lowther (60,333) and Common Shares
attributable to options granted under both the Company's 1991 Directors
Stock Option Plan and 2000 Directors Stock Option Plan for Messrs. Lhota
(19,200), D'Antoni (19,200), Huesman (22,200), Smith (9,200), Harris
(13,200) and Ms. Roberts (3,200).
(4) Includes 2,873 Common Shares owned by Mrs. Huesman, as to which Mr. Huesman
disclaims beneficial ownership, and 17,006 Common Shares owned by the
Huesman-Schmid Insurance Agency, Inc. Defined Benefit Pension Plan. Mr.
Huesman shares voting and investment power with the other trustee of this
plan with respect to these Common Shares.
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(5) Includes 6,500 Common Shares attributable to options granted to Mr. Lowther
under the Company's 1991 Stock Option Plan, which he assigned to his spouse
pursuant to the terms of the 1991 Stock Option Plan, and 2,000 Common Shares
attributable to options granted under the 1991 Stock Option Plan, which he
assigned pursuant to the 1991 Stock Option Plan to trusts maintained for the
benefit of his children and 14,244 Common Shares owned by Mrs. Lowther. Mr.
Lowther disclaims beneficial ownership of these Common Shares.
(6) Includes 38,190 Common Shares attributable to options granted to Mr. Moone
under the 1991 Stock Option Plan, which he assigned to the Anna Moone Living
Trust (Anna Moone and Robert H. Moone, co-trustees) pursuant to the terms of
the 1991 Stock Option Plan, and 11,400 Common Shares owned by Mrs. Moone.
Mr. Moone disclaims beneficial ownership of these Common Shares.
(7) Includes 12,000 Common Shares owned by Mrs. D'Antoni, as to which Mr.
D'Antoni disclaims beneficial ownership.
(8) Includes 5,000 Common Shares owned by Mrs. Smith, as to which Mr. Smith
disclaims beneficial ownership.
In addition to the Common Shares owned beneficially by Messrs. Lowther and
Moone, as set forth above, Mark A. Blackburn, Steven J. Johnston and Steven R.
Hazelbaker, the other named executive officers in the Summary Compensation Table
set forth below, owned beneficially 39,048, 106,728, and 7,707 Common Shares,
respectively, of the Company as of April 5, 2004, each of which represents less
than 1% of the Company's outstanding Common Shares. These amounts include Common
Shares attributable to options which are currently exercisable or exercisable
within 60 days of April 5, 2004, granted under the Company's 1991 Stock Option
Plan and the Company's 2000 Stock Option Plan in the amounts of 34,064, 73,464,
and 4,832 for Messrs. Blackburn, Johnston and Hazelbaker, respectively. These
persons and/or their spouses have sole voting and investment power with respect
to all Common Shares beneficially owned by them. As of April 5, 2004, all
directors and executive officers of the Company as a group (23 persons) owned
beneficially 1,375,729 (3.5%) Common Shares of the Company, which included
options for 785,812 Common Shares.
BOARD OF DIRECTORS AND BOARD COMMITTEES
The Company's Board of Directors (the "Board") has affirmatively determined
that six of the Company's nine directors, namely David J. D'Antoni, Urlin G.
Harris, Jr., William J. Lhota, S. Elaine Roberts, Richard K. Smith and Paul S.
Williams, are "independent" as defined by the NASDAQ Marketplace Rules
("NASDAQ"). During the fiscal year ended December 31, 2003, the Board held nine
meetings. No incumbent director attended fewer than 75% of the aggregate of the
meetings of the Board and the meetings of all committees on which he or she
served.
The Board has established an Audit Committee, a Compensation Committee, a
Nominating and Governance Committee (the "Nominating Committee"), an Investment
Committee, and a standing Independent Committee. All of the members of the
Audit, Compensation, Nominating and Independent Committees are "independent" as
defined by NASDAQ. In addition, all of the members of the Audit Committee are
independent as defined by the applicable rules of the Securities and Exchange
Commission (the "SEC"). The Board has adopted charters for each of the foregoing
Committees. Copies of the current charters for each of these Committees, along
with copies of the Company's current Corporate Governance Guidelines, Code of
Business Conduct, and Code of Ethics for Senior
6
Financial Officers, are available on the Company's website at www.stfc.com under
"Corporate Governance."
The Audit Committee is charged with several responsibilities, including: 1)
appointment, compensation, retention and oversight of the work performed by the
Company's independent auditors; 2) reviewing the Company's accounting functions,
operations, and management; 3) considering the adequacy and effectiveness of the
internal controls and internal auditing methods and procedures of the Company;
4) meeting and consulting with the Company's independent auditors and with the
Company's financial and accounting personnel concerning the foregoing matters;
5) reviewing with the Company's independent auditors the scope of their audit of
the Company and the results of their examination of its financial statements; 6)
participating in the process of administering the Company's Code of Business
Conduct; 7) establishing procedures for receipt, retention and treatment of
compliance regarding accounting, internal accounting controls or auditing
matters, including procedures for the confidential, anonymous submission by
employees of concerns regarding accounting or auditing matters; and 8) approving
in advance any other work performed by the Company's independent auditors that
they are permitted by law to perform for the Company. Present members are
Chairman Richard K. Smith, David J. D'Antoni and William J. Lhota. Based on a
recommendation of the Audit Committee, the Board has designated Richard K. Smith
as the "Audit Committee Financial Expert." The Audit Committee held eight
meetings during 2003. See also "Report of the Audit Committee" contained
elsewhere in this Proxy Statement.
The Compensation Committee is charged with several responsibilities,
including: 1) administering the Company's 2000 Stock Option Plan and 1991 Stock
Option Plan; 2) evaluating and approving the compensation, fringe benefits and
perquisites provided to the Company's executive officers and adopting
compensation policies applicable to the Company's officers; and 3) evaluating
the compensation provided to the members of the Board and its committees.
Present members of such committee are Chairman William J. Lhota, David J.
D'Antoni, and Richard K. Smith. See also "Compensation Committee Report"
contained elsewhere in this Proxy Statement. The Compensation Committee held
four meetings during 2003.
The Nominating Committee is charged with several responsibilities,
including: 1) selecting nominees for election as directors; 2) reviewing the
performance of the Board; and 3) annually reviewing and recommending to the
Board changes to the Company's Corporate Governance Guidelines. The members of
the Nominating Committee are Chairperson S. Elaine Roberts, William J. Lhota,
and Paul S. Williams. This Committee met seven times in 2003.
The Nominating Committee will set the minimum qualifications for persons
whom it would recommend for nomination for election or re-election (election and
re-election are hereafter collectively referred to as "election") as a director
of the Company, which minimum qualifications are described in the Nominating
Committee's charter. The following matters will be considered in the Nominating
Committee's selection of a person to recommend for nomination as a director of
the Company: such person's status as independent (based on the then current
NASDAQ rules); business or professional skills and experience; temperament;
integrity; educational background; and judgment. The objective of the Nominating
Committee in this regard is to nominate for election as directors persons who
share the values of the Company and possess the following minimum
qualifications: high personal and professional integrity; the ability to
exercise sound business judgment; an inquiring mind; professional demeanor, and
the time available to devote to Board activities and the willingness to do so.
The Nominating Committee will consider these criteria in the context of an
assessment of
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the perceived needs of the Board as a whole and will seek to achieve diversity
of occupational and personal backgrounds. Ultimately, the Nominating Committee's
intention is to select nominees for election to the Board whom the Nominating
Committee believes will be effective, in conjunction with the other members of
the Board, in collectively serving the long-term interests of the shareholders.
In the context of recommending an incumbent director to be nominated for
election to the Board, the Nominating Committee will focus its assessment on the
contributions of such person during his or her Board tenure and such person's
independence at that time.
Based on the criteria described above, the Nominating Committee will
recommend to the Board nominees for election to the Board at each annual
shareholders meeting and at any other shareholders meeting held for the election
of one or more directors.
In addition to incumbent directors who will be evaluated for re-nomination
as described above, the Nominating Committee may maintain a list of other
potential candidates whom the Nominating Committee may evaluate pursuant to the
criteria set forth above for consideration as Board members. By following the
procedures set forth below, shareholders may recommend potential candidates to
be included on this list. As a matter of policy, the Nominating Committee will
consider and evaluate such candidates recommended by shareholders in the same
manner as all other candidates for nomination to the Board who are not incumbent
directors.
In the absence of extraordinary circumstances, when a director vacancy
arises for any reason, the Nominating Committee will use the following process
to identify the person(s) whom the Nominating Committee will recommend to the
Board for election as a director to fill such vacancy(ies). The Nominating
Committee will first look to the list of names of potential nominees, as
described above, and make a preliminary evaluation of such person(s) based on
the criteria set forth above. If there are no names on the list or if all of the
names on this list are eliminated following such evaluation process, the
Nominating Committee may solicit other potential nominees' names from other
directors of the Company, directors of the Company's parent, the Chairman or
other persons whom the Nominating Committee reasonably believes would have the
opportunity to possess first hand knowledge of a suitable candidate based on the
criteria described above. The Nominating Committee may also hire a director
search firm, as contemplated below.
Once the Nominating Committee has preliminarily concluded that a person(s)
may meet the criteria described above, the Nominating Committee will, at a
minimum, obtain from such person(s) a completed Prospective Director
Questionnaire which shall solicit information regarding the person's business
experience, educational background, personal information, and information
relating to the person's business, personal or family relationships with the
Company and other directors, among other matters. Following a review of such
completed Prospective Director Questionnaire by the Nominating Committee, the
Chairman and counsel for the Company, the Nominating Committee will conduct at
least one interview with a person(s) whose candidacy it desires to pursue. Based
on all information secured from the prospective nominee, which will include a
background check and a criminal record check, the Nominating Committee will meet
and decide whether or not to recommend such person(s) for nomination for
election as a director of the Company. Any decision by the Committee in this
regard will reflect its considered judgment of the person(s) being able to
fulfill the objectives outlined above.
The Company has adopted procedures by which shareholders may recommend
individuals for membership to the Board. As described in its charter, it is the
policy of the Nominating Committee to
8
consider and evaluate candidates recommended by shareholders for membership on
the Board in the same manner as all other candidates for nomination to the Board
who are not incumbent directors. If a shareholder desires to recommend an
individual for Board membership, then that shareholder must provide a written
notice to the Secretary of the Company at 518 East Broad Street, Columbus, Ohio
43215 (the "Recommendation Notice"). For a recommendation to be considered by
the Nominating Committee, the Recommendation Notice must contain, at a minimum,
the following: the name and address, as they appear on the Company's books, and
telephone number of the shareholder making the recommendation, including
information on the number of shares owned; and if such person is not a
shareholder of record or if such shares are owned by an entity, reasonable
evidence of such person's ownership of such shares or such person's authority to
act on behalf of such entity; the full legal name, address and telephone number
of the individual being recommended, together with a reasonably detailed
description of the background, experience and qualifications of that individual;
a written acknowledgement by the individual being recommended that he or she has
consented to that recommendation and consents to the Company's undertaking of an
investigation into that individual's background, experience and qualifications
in the event that the Nominating Committee desires to do so; the disclosure of
any relationship of the individual being recommended with the Company or any of
its subsidiaries or affiliates, whether direct or indirect; and, if known to the
shareholder, any material interest of such shareholder or individual being
recommended in any proposals or other business to be presented at the Company's
next annual meeting of shareholders (or a statement to the effect that no
material interest is known to such shareholder).
As of April 12, 2004, the Company had not received any such recommendations
from shareholders for nominees for the Board.
The Investment Committee oversees the investment functions of the Company
and its insurance subsidiaries. The members of the Investment Committee are
Chairman Urlin G. Harris, Jr., Paul W. Huesman, S. Elaine Roberts, and Richard
K. Smith. This Committee met four times in 2003.
The standing Independent Committee principally serves to review
inter-company transactions between or among the Company and its subsidiaries and
State Auto Mutual and its subsidiaries. This Committee also helps determine
which entity, the Company or State Auto Mutual, is best suited to take advantage
of transactional opportunities presented by a third party. The members of the
standing Independent Committee are Chairman David J. D'Antoni, Paul S. Williams,
and S. Elaine Roberts. This Committee only meets as needed, which was one time
in 2003.
As further described in the Company's Corporate Governance Guidelines, the
Company provides a process by which security holders may send communications to
the Board. Any security holder who desires to communicate with a director of the
Company may send such communication to any or all directors through the
Secretary of the Company, John Lowther, by e-mail to Mr. Lowther at
John.Lowther@stateauto.com or in writing to Mr. Lowther at the home office, 518
East Broad Street, Columbus, Ohio 43215. Security holders should designate
whether such communication should be sent to a specific director or to all
directors. Mr. Lowther is responsible for forwarding such communication to the
director or directors so designated by the security holder.
The Company's Corporate Governance Guidelines also provide that directors
are expected to attend the Company's annual meetings of shareholders. All of the
directors of the Company who were directors last year attended last year's
annual meeting of shareholders.
9
Since 2002, the Board has met in executive session, without management
present, prior to each regular quarterly Board meeting. During 2003, there were
four such executive sessions. The Board's policy in regard to the role of chair
for each of these sessions is that it would rotate among the various committee
chairs. The persons who led these meetings during 2003 were Mr. Lhota, Mr.
D'Antoni, Ms. Roberts and Mr. Harris. In 2004, the Company's Corporate
Governance Guidelines and the NASDAQ Marketplace Rules changed, requiring at
least two executive sessions of the Board annually, at which only independent
directors are present. The Board intends to comply with these new rules in 2004.
COMPENSATION OF DIRECTORS
Directors of the Company who are not also officers of the Company receive
from the Company an annual fee of $20,000, plus travel expenses incurred in
attending directors meetings, and a fee of $500, plus travel expenses, for each
committee meeting attended. In addition to the foregoing, each committee chair
receives an additional $5,000 annual retainer (up to a maximum of $5,000 even if
a director chairs more than one committee). The Company pays $500, plus travel
expenses, for attending a special board meeting. In addition, there has been a
Special Independent Committee in place to address issues created by the
attempted takeover of the Company by Gregory M. Shepard. The chair of the
Special Independent Committee receives $1,000 per meeting. Directors may defer
all or a portion of these fees under the Company's deferred compensation plan
for directors. In addition, directors of the Company who are not full-time
employees of the Company or its parent or subsidiary corporations receive stock
options pursuant to the 2000 Directors Stock Option Plan. Under this plan,
promptly following each annual meeting of shareholders of the Company, each
eligible director is granted a non-qualified option to purchase 4,200 Common
Shares of the Company at the fair market value of such shares on the last
trading day prior to the annual meeting. Options are immediately exercisable in
whole or in part and must be exercised within ten years of the date of grant. A
director's compliance with the Stock Ownership Guidelines is a condition to his
or her eligibility for receipt of options under this plan.
COMPENSATION OF EXECUTIVE OFFICERS
Pursuant to the 2000 Management Agreement (see "Certain Transactions" on
page 26), the executive officers of the Company, State Auto P&C, Milbank, and
National, as well as every other person providing services to these companies,
are employees of State Auto P&C rather than State Auto Mutual, while State Auto
Mutual acts as the common paymaster and common agent. The costs and expenses
associated with these employees of State Auto P&C are reimbursed to State Auto
Mutual, as paymaster, in accordance with the terms of the 2000 Management
Agreement. See "Certain Transactions" below.
10
SUMMARY OF CASH AND CERTAIN OTHER COMPENSATION
Set forth below is information concerning the compensation paid or accrued
by, or reimbursed to, State Auto Mutual for the Company's fiscal years ended
December 31, 2003, 2002, and 2001, to the Company's chief executive officer and
its four most highly compensated executive officers, other than the chief
executive officer:
SUMMARY COMPENSATION TABLE
LONG TERM
COMPENSATION
AWARDS
------------
SECURITIES
ANNUAL COMPENSATION UNDERLYING
-------------------- OPTIONS ALL OTHER
NAME AND PRINCIPAL POSITION YEAR SALARY(1) BONUS(2) GRANTED(3) COMPENSATION(4)
--------------------------- ---- --------- -------- ------------ ---------------
Robert H. Moone............. 2003 $484,000 $ 29,111 48,000 $17,770
Chairman, President and 2002 $440,000 $287,445 27,500 $16,230
Chief Executive Officer 2001 $400,000 $256,298 24,100 $14,830
Mark A. Blackburn........... 2003 $231,231 $ 14,070 14,500 $ 906
Senior Vice President 2002 $220,220 $ 85,012 10,400 $ 906
2001 $197,892 $ 50,314 9,100 $ 906
Steven J. Johnston.......... 2003 $264,507 $ 16,018 14,500 $ 9,069
Senior Vice President, 2002 $235,155 $ 94,806 11,600 $ 6,803
Treasurer and 2001 $189,860 $ 44,345 9,200 $ 6,063
Chief Financial Officer
John R. Lowther............. 2003 $226,893 $ 13,773 14,500 $ 7,960
Senior Vice President, 2002 $214,049 $ 82,282 10,200 $ 7,236
Secretary and General 2001 $174,036 $ 69,721 7,900 $ 6,639
Counsel
Steven R. Hazelbaker........ 2003 $225,000 $ 13,863 4,500 $ 7,858
Vice President 2002 $225,000 $ 2,388 5,000 $ 6,663
2001 $ 131,250 -- -- $ 4,933
---------------
(1) Includes amounts deferred pursuant to the State Auto Insurance Companies
Capital Accumulation Plan (the "CAP") and the Non-Qualified Incentive
Deferred Compensation Plan (the "Deferred Compensation Plan"). The CAP is a
defined contribution plan (within the meaning of the Employee Retirement
Income Security Act of 1974) ("ERISA") and is intended to be a qualified
plan under Sections 401(a) and 401(k) of the Internal Revenue Code of 1986,
as amended (the "Code"). Under the CAP, each participant is eligible to
enter into a written salary reduction agreement with the participant's
employer whereby the participant's salary will be reduced by a whole
percentage from 1% to 50%, as elected by the participant, in accordance with
the rules governing cash or deferred arrangements under Section 401(k) of
the Code. The amount deferred by a participant is contributed by his or her
employer to the trust fund for the CAP and invested in accordance with the
election of the participant from among investment funds established under
the trust agreement, including the Common Shares. The Deferred Compensation
Plan is a non-qualified, unfunded deferred compensation plan for eligible
key employees who are legally precluded from contributing a full 6% of
compensation to the CAP or who
11
choose to defer a portion of their salary beyond the amount matched by the
CAP. Under the Deferred Compensation Plan, such employees are eligible to
enter into a salary reduction agreement to defer payment of an additional
portion of the employee's salary as the employee prescribes on an election
form executed annually in advance of the year in which such compensation
would be earned. The total amount of salary deferred under the CAP and the
Deferred Compensation Plan cannot exceed in the aggregate 50% of salary.
Deferred amounts, along with the Company matching amounts on that portion
deferred that is eligible for the match (see footnote (4), below), are
invested by State Auto P&C in a variety of investment options made available
to participants in the Deferred Compensation Plan pursuant to the terms of
such plan.
(2) The amounts appearing in this column represent bonuses paid pursuant to the
State Auto Quality Performance Bonus Plan (the "QPB"). Under the QPB for
2003, quarterly bonuses were paid to employees who had completed two full
calendar quarters of service if the direct statutory combined ratio for such
quarter was 100% or less for all combined affiliated insurers.
Also included in this column are special incentive bonuses earned in 2002
and 2001 under special incentive bonus plans recommended by the Chief
Executive Officer and approved by the Compensation Committee for Mr.
Johnston, Mr. Blackburn, and Mr. Lowther. While similar plans were in place
for 2003, the amounts of those bonuses were not determined as of the date
this Proxy Statement was printed. The Compensation Committee also had in
place special incentive bonus plans for Mr. Moone in 2003, 2002 and 2001.
The bonus shown for Mr. Moone for 2002 and 2001 includes the special bonus
earned in each such year. The 2003 incentive bonus for Mr. Moone has not
been determined as of the date this Proxy Statement was printed (see
"Compensation Committee Report").
(3) In each year noted, the persons listed in the Summary Compensation Table
were granted options to purchase the number of Common Shares of the Company
set forth in this column pursuant to the Company's 2000 Stock Option Plan.
(4) The amounts appearing in this column represent the Company's contributions
and credits on behalf of each named person under the CAP or the Deferred
Compensation Plan. Each participant in the CAP is credited annually with his
or her allocable share of employer matching contributions made to the CAP
from the consolidated net accumulated or current earnings of State Auto P&C
and its affiliates. A participant's share of the matching contribution
equals 75% of his or her salary reduction contributions up to 2% of
compensation, plus 50% of his or her salary reduction contributions from 3%
to 6% of compensation. While a participant is always vested in his or her
own salary reduction contributions, the rights of a participant to amounts
credited to his or her account as matching contributions vest as follows:
(a) one-third of matching contributions allocated for the plan year
preceding the plan year in which termination of employment occurs,
two-thirds of matching contributions allocated for the second plan year
before the plan year in which termination of employment occurs, and 100% of
the matching contributions allocated for the third and earlier plan years
before the plan year in which termination of employment occurs; and (b)
notwithstanding the foregoing, after the participant has completed three or
more years of service with State Auto P&C and its affiliates, all matching
contributions become vested. The following are the amounts of the Company
matching contributions under the CAP for 2003 for the officer indicated: Mr.
Moone -- $7,000; Mr. Johnston -- $7,000; Mr. Lowther -- $7,000; and Mr.
Hazelbaker -- $7,000. Each employee who is eligible to participate in the
Deferred Compensation Plan is credited annually with his or her allocable
share of Company matching contributions on the same basis that contributions
are
12
matched under the CAP, provided that no more than 6% of any employee's
salary is subject to being matched under either the CAP or the Deferred
Compensation Plan. The following amounts reflect the Company's contribution
to the Deferred Compensation Plan for 2003: Mr. Moone -- $9,940; Mr.
Johnston -- $1,416; and Mr. Lowther -- $288. The amounts appearing in this
column also represent the premiums for policies of whole life insurance
purchased on behalf of the officers of the Company, including the executive
officers named above. The following amounts represent the premiums paid for
whole life insurance for 2003: Mr. Moone -- $830; Mr. Johnston -- $653; Mr.
Blackburn -- $906; Mr. Lowther -- $672; and Mr. Hazelbaker -- $858.
OPTION GRANTS IN LAST FISCAL YEAR
The following table shows the number of options granted in 2003 to the
individuals named in the Summary Compensation Table and estimates the potential
realizable value of these option grants.
INDIVIDUAL GRANTS POTENTIAL POTENTIAL
------------------------------------------------ REALIZABLE VALUE REALIZABLE VALUE
% OF TOTAL AT ASSUMED AT ASSUMED
NUMBER OF OPTIONS ANNUAL RATES OF ANNUAL RATES OF
SECURITIES GRANTED TO EXERCISE STOCK PRICE STOCK PRICE
UNDERLYING EMPLOYEES OR BASE APPRECIATION FOR APPRECIATION FOR
OPTIONS IN FISCAL PRICE EXPIRATION OPTION TERM OPTION TERM
NAME GRANTED(1) YEAR ($/SH)(2) DATE 5%($)(3) 10%($)(3)
---- ---------- ---------- --------- ---------- ---------------- ----------------
Robert H. Moone...... 48,000 11.79% $18.74 05/21/2013 $565,703 $1,433,603
Mark A. Blackburn.... 14,500 3.56% $18.74 05/21/2013 $170,890 $ 433,068
Steven J. Johnston... 14,500 3.56% $18.74 05/21/2013 $170,890 $ 433,068
John R. Lowther...... 14,500 3.56% $18.74 05/21/2013 $170,890 $ 433,068
Steven R.
Hazelbaker......... 4,500 1.11% $18.74 05/21/2013 $ 53,035 $ 134,400
---------------
(1) Options were granted on May 22, 2003. The options are fully exercisable in
1/3 increments over a three-year vesting period, so long as employment with
the Company or its subsidiaries or its parent continues. There are no stock
appreciation rights, performance units, or other instruments granted in
tandem with these options, nor are there any reload provisions, tax
reimbursement features or performance-based conditions to exercisability.
(2) The option exercise price is the closing price of the Company's shares on
the NASDAQ National Market System on the day of the grant.
(3) The dollar amounts under these columns are the result of calculations at the
5% and 10% rates dictated by the Securities and Exchange Commission when the
"Potential Realizable Value" alternative is used and are not intended to be
a forecast of the Company's stock price.
AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR
AND FISCAL YEAR END OPTION VALUES
The following table sets forth stock option exercises during 2003 by the
executive officers named in the Summary Compensation Table and shows the number
of Common Shares represented by both exercisable and non-exercisable stock
options and the value of in-the-money stock options
13
(exercisable and non-exercisable) held by each of the named executive officers
as of December 31, 2003.
NUMBER OF SECURITIES VALUE OF UNEXERCISED
UNDERLYING IN-THE-MONEY
UNEXERCISED OPTIONS OPTIONS AT
AT FY-END(#) FY-END($)
SHARES ACQUIRED VALUE EXERCISABLE/ EXERCISABLE/
NAME ON EXERCISE(#) REALIZED($)(1) UNEXERCISABLE UNEXERCISABLE(2)
---- --------------- -------------- -------------------- --------------------
Robert H. Moone(3)..... -0- -0- 152,812/74,368 $1,916,909/410,565
Mark A. Blackburn...... -0- -0- 22,732/24,468 $ 228,127/138,439
Steven J. Johnston..... 2,800 $ 32,116 61,698/25,302 $ 779,419/144,545
John R. Lowther(4)..... 13,500 $161,258 57,966/23,934 $ 757,183/134,708
Steven R. Hazelbaker... -0- -0- 1,666/7,834 $ 12,228/45,172
---------------
(1) Aggregate market value of the Common Shares covered by the option less the
aggregate price paid by the executive officer.
(2) The value of in-the-money options was determined by subtracting the exercise
price from the market value of the Company's Common Shares as of December
31, 2003 ($23.34), based on the closing price of the Company's Common Shares
on the NASDAQ National Market System on that date, the last trading day of
2003.
(3) 38,190 of the options indicated as exercisable at fiscal year end have been
assigned to the living trust of Mr. Moone's spouse of which he is the
co-trustee.
(4) 6,500 of the options indicated as exercisable at fiscal year end have been
assigned to Mr. Lowther's spouse and 2,000 of such options have been
assigned to trusts maintained for the benefit of Mr. Lowther's children.
EMPLOYEES' RETIREMENT PLAN
During 2003, the executive officers named in the Summary Compensation
Table, as well as substantially all employees of State Auto P&C, were eligible
to participate in the State Auto Insurance Companies' Employee Retirement Plan
(the "Retirement Plan"). The Retirement Plan is a defined benefit plan (within
the meaning of ERISA) which is intended to be a qualified plan under Section
401(a) of the Code, and is subject to the minimum funding standards of Section
412 of the Code. Benefits payable under the Retirement Plan are funded through
employer contributions to a trust fund.
In addition, the executive officers named in the Summary Compensation Table
benefited in 2003 from a non-qualified Amended and Restated Supplemental
Executive Retirement Plan (the "Supplemental Plan"). The Supplemental Plan is
intended to offset the impact of the Code's and ERISA's limitations on
retirement benefits available under the Retirement Plan by providing for a lump
sum or deferred cash payments in an actuarially determined amount upon
retirement of officers whose participation in the Supplemental Plan is approved
by the Board of Directors of State Auto Mutual.
14
The table below shows estimated annual benefits payable under the
Retirement Plan and the Supplemental Plan to a participant upon retirement at
age 65 with indicated average annual compensation and period of service:
ESTIMATED ANNUAL RETIREMENT BENEFIT
ANNUAL ANNUAL RETIREMENT BENEFIT BASED ON YEARS OF SERVICE
AVERAGE ----------------------------------------------------
COMPENSATION 15 YEARS 20 YEARS 25 YEARS 30 YEARS 35 YEARS
------------ -------- -------- -------- -------- --------
$125,000 $42,197 $53,629 $ 65,062 $ 76,494 $ 87,876
$150,000 $50,431 $64,399 $ 78,368 $ 92,336 $106,242
$175,000 $53,965 $70,470 $ 86,974 $103,479 $119,917
$200,000 $56,544 $75,584 $ 94,625 $113,665 $136,639
$225,000 $59,122 $80,699 $102,275 $123,852 $145,360
$250,000 $61,700 $85,813 $109,925 $134,038 $158,082
$300,000 $64,690 $91,742 $118,795 $145,848 $172,831
$400,000 $64,690 $91,742 $118,795 $145,848 $172,831
$450,000 $64,690 $91,742 $118,795 $145,848 $172,831
$500,000 $64,690 $91,742 $118,795 $145,848 $172,831
Note: The annual average compensation applies to post-1988 salaries. Post-1988
salaries have been capped according to the Internal Revenue Code. Benefit
amounts are based on the straight life annuity and are not subject to offset by
Social Security.
Benefits shown above are computed as a straight single life annuity
beginning at age 65. Such amounts are not subject to offset for Social Security
benefits or other amounts payable to participants in the Retirement Plan. As of
December 31, 2003, the years of credited service to the nearest whole year and
annual average compensation for each of the named executive officers in the
Summary Compensation Table actively participating in the Retirement Plan on such
date were as follows:
NAME OF YEARS OF CURRENT ANNUAL AVERAGE COMPENSATION
INDIVIDUAL CREDITED SERVICE FOR PURPOSES OF RETIREMENT PLAN
---------- ---------------- -----------------------------------
Robert H. Moone............... 33 $200,000
Mark A. Blackburn............. 4 $200,000
Steven J. Johnston............ 18 $200,000
John R. Lowther............... 17 $200,000
Steven R. Hazelbaker.......... 9 $200,000
EMPLOYMENT CONTRACTS AND CHANGE-IN-CONTROL ARRANGEMENTS
EMPLOYMENT AGREEMENT WITH MR. MOONE
Robert H. Moone, the Company's Chairman, President, and Chief Executive
Officer, has entered into an Employment Agreement with the Company, with the
current term continuing through December 31, 2005, or until his earlier death or
disability, or upon earlier termination by either Mr. Moone or the Company as
permitted by the agreement. The Employment Agreement may be renewed at the end
of the current term for one additional two-year term with the mutual consent of
15
the parties. If Mr. Moone does not desire to renew the agreement in December
2005, while State Auto does, then that shall be a voluntary termination of Mr.
Moone's employment. On the other hand, if Mr. Moone desires to renew the
agreement in December 2005, but State Auto does not, then that shall be an
involuntary termination of Mr. Moone's employment. Mr. Moone's Employment
Agreement provides that his annual rate of compensation will not be less than
his base salary at the time the agreement was entered into by the parties, plus
such increases in base compensation as may be authorized by the Compensation
Committee. The Employment Agreement also provides for Mr. Moone's continued
participation in the Company's QPB and his incentive bonus arrangement
(collectively "Incentive Compensation Plans").
In the event Mr. Moone is terminated for cause, he will be entitled to
receive salary payments for twelve bi-weekly pay periods following the date of
termination plus any compensation to which he is entitled under the Incentive
Compensation Plans. In the event Mr. Moone is terminated without cause (other
than for death, disability, or retirement), he will be entitled to the
following: payment of his base salary and receipt of benefits under his
Employment Agreement, both for a 24-month period; payment of the average of the
prior two years' aggregate QPB payments; and payment of the average of the two
prior years' incentive bonus arrangement. Mr. Moone and his spouse shall also be
entitled to participate in the Company's health insurance plan until he becomes
eligible for Medicare. In the event Mr. Moone becomes disabled, which disability
continues for more than six consecutive months during a twelve-month period, the
Company may terminate Mr. Moone's Employment Agreement, and he will be entitled
to receive his base salary and payments under the Incentive Compensation Plans
to the date of termination. Thereafter, Mr. Moone will be entitled to receive
20% of his base salary, in addition to disability benefits received from any of
the Company's long-term disability benefit plans, throughout the period of his
disability or until he attains age 65, whichever first occurs. In the event of
Mr. Moone's death, his beneficiaries will receive payment of his base annual
salary for twelve months plus a pro-rata share of Incentive Compensation Plan
payments "earned" as of the date of death.
EXECUTIVE AGREEMENTS (CHANGE-IN-CONTROL ARRANGEMENTS)
The Company has entered into Executive Agreements with Mr. Moone and three
of the persons named in the Summary Compensation Table, which provide for the
payment of certain benefits in the event of a change in control of the Company
or State Auto Mutual. These Executive Agreements were entered into as part of
the Company's corporate strategy to provide protection for, and thus retain, its
well-qualified senior executive officers notwithstanding any actual or
threatened change in control of the Company or of its parent, State Auto Mutual.
These also serve the shareholders' interest by ensuring that any potential
acquisition of the Company will be viewed objectively by the executives since
the executive's potential loss of employment is not personally an adverse event.
A "Change in Control" of the Company generally includes:
- The acquisition by any person of beneficial ownership of 25% or more of
the Company's outstanding voting securities;
- A change in the composition of the board of directors of the Company if a
majority of the new directors were not appointed or nominated by the
directors currently sitting on the board of directors or their subsequent
nominees;
16
- A merger involving the Company where the Company's shareholders
immediately prior to the merger own less than 51% of the combined voting
power of the surviving entity immediately after the merger;
- The dissolution of the Company; or
- A disposition of assets, reorganization, or other corporate event
involving the Company which would have the same effect as any of the
above-described events.
As respects State Auto Mutual, a Change in Control includes:
- A person who has not been a director or an officer of State Auto Mutual
for at least the previous 12 months becomes empowered to vote the proxy
of the members of State Auto Mutual;
- State Auto Mutual affiliates with or merges with a third party where a
majority of the current board of State Auto Mutual does not continue in
office;
- State Auto Mutual is subject to an order of rehabilitation or liquidation
issued by the Ohio Department of Insurance; or
- State Auto Mutual converts to a stock corporation and a majority of the
board of directors of State Auto Mutual does not continue to serve on the
board of directors of the converted company.
Under each Executive Agreement, the Company or its successor must provide
severance benefits to the executive officer if his employment is terminated
(other than on account of the officer's death or disability or termination for
cause):
- By the Company, at any time within 36 months after a Change in Control;
- By the Company, at any time prior to a Change in Control but after
commencement of any discussions with a third party relating to a possible
Change in Control involving such third party ("Change in Control
Discussion") if the officer's termination is in contemplation of such
possible Change in Control and such Change in Control is actually
consummated within 12 months after the date of such officer's
termination;
- By the executive officer voluntarily with Good Reason at any time within
36 months after a Change in Control of the Company; and
- By the executive officer voluntarily with Good Reason at any time after
commencement of Change in Control Discussions if such Change in Control
is actually consummated within 12 months after the date of such officer's
termination.
"Good Reason" generally means the assignment to the executive officer of
duties which are materially and adversely different from or inconsistent with
the duties, responsibility or status of the executive officer's position during
the twelve months prior to the Change in Control, a reduction in such officer's
salary, benefits or incentive bonus or a demand to relocate to more than 35
miles from the executive officer's current location, made by the Company or its
successor. An executive officer's determination of Good Reason will be
conclusive and binding upon the parties if made in good faith, except that, if
the executive officer is serving as Chief Executive Officer of the Company
immediately
17
prior to a Change in Control, the occurrence of a Change in Control will be
conclusively deemed to constitute Good Reason.
In addition to accrued compensation, bonuses, and vested benefits and stock
options, the executive officer's severance benefits payable under the Executive
Agreements include:
- A lump-sum cash payment equal to three times the officer's annual base
salary;
- A lump-sum cash payment equal to three times the highest annual incentive
compensation to which the officer would be entitled;
- Thirty-six months of continued insurance benefits;
- Thirty-six months of additional service credited for purposes of
retirement benefits; and
- Out-placement benefits in an amount equal to 15% of the officer's annual
base salary.
Each Executive Agreement also provides that the Company will pay the
executive officer such amounts as would be necessary to compensate such officer
for any excise tax paid or incurred due to any severance payment or other
benefit provided under the Executive Agreement. However, in the event the
executive officer's contractual severance payments and benefits were subject to
any excise tax, but otherwise would not be subject to such tax if the total of
such payments and benefits were reduced by 10% or less, then such payments and
benefits will be reduced by the minimum amount necessary (not to exceed 10% of
such payments and benefits) so that the Company will not have to pay an excess
severance payment and the executive officer will not be subject to an excise
tax.
The Executive Agreements provide that, for a period of five years after any
termination of the executive's employment, the Company will provide the
executive with coverage under a standard directors' and officers' liability
insurance policy at its expense, and will indemnify, hold harmless, and defend
the executive to the fullest extent permitted under Ohio law against all
expenses and liabilities reasonably incurred by the executive in connection with
or arising out of any action, suit, or proceeding in which he may be involved by
reason of having been a director or officer of the Company or any subsidiary.
The Company must pay the cost of counsel (legal and accounting) for an
executive officer in the event such officer is required to take any action to
enforce any of the rights granted under his Executive Agreement. In addition,
the executive officer is entitled to prejudgment interest on any amounts found
to be due to him in connection with any action taken to enforce such officer's
rights under the Executive Agreement at a rate equal to the prime commercial
rate of the Company's principal bank or its successor in effect from time to
time plus 4%.
The Executive Agreements have a three-year term (except Mr. Moone's, which
has a two-year renewable term to coincide with his Employment Agreement),
subject to automatic renewals and to an extension for thirty-six months after
any month in which a Change in Control occurs. An Executive Agreement will
terminate if the employment of the executive officer terminates other than under
circumstances which trigger the severance benefits. The Executive Agreement also
imposes a post termination confidentiality covenant and a non-competition
covenant on the executive officer. The confidentiality covenant has a one-year
term, while the non-compete has a six-month term and includes a company size
factor and a geographic factor as respects the scope of the non-compete.
18
No other named executive officer of the Company has an employment agreement
with the Company.
COMPENSATION COMMITTEE
INTERLOCKS AND INSIDER PARTICIPATION
The Compensation Committee currently consists of the following three
members of the Company's Board of Directors: Chairman William J. Lhota, David J.
D'Antoni, and Richard K. Smith. None of the members of the Compensation
Committee is, or was, an officer or employee of the Company, any of its
subsidiaries, or of State Auto Mutual. Also, no executive officer of the Company
served during 2003 as a member of a compensation committee or as a director of
any entity of which any of the Company's Compensation Committee members served
as an executive officer.
COMPENSATION COMMITTEE REPORT
The Compensation Committee consists of the following independent directors:
William J. Lhota, Chair; David J. D'Antoni; and Richard K. Smith. This is their
report on executive compensation.
One of the Compensation Committee's responsibilities is to determine the
compensation paid to the Chief Executive Officer ("CEO") and all other officers
who have reporting obligations under Section 16 of the Securities Exchange Act
of 1934 ("Section 16 Officers") (collectively, the CEO and the Section 16
Officers are hereafter referred to as "Executive Officers"). The Compensation
Committee's decision making with regard to compensation seeks to implement a
compensation system that:
(1) Provides competitive compensation that is necessary to attract and
retain executive talent;
(2) Rewards individuals appropriately for performance;
(3) Offers incentives that encourage a focus on underwriting profit while
achieving sales goals;
(4) Fosters the attainment of company-wide goals over the long term; and
(5) Drives behaviors that are reasonably expected to build shareholder
value over the long term.
The Compensation Committee believes that these underlying principles are
reflected in its decision making regarding the compensation earned by the
Executive Officers. Total compensation of the Executive Officers includes annual
base salary, annual incentive bonus, and stock options.
The base salaries of the CEO and the Section 16 Officers reflect the
Compensation Committee's -- and in the case of an individual Section 16 Officer,
such person's immediate superior's -- evaluation of the person's performance of
his or her job responsibilities as measured by an analysis of company-wide and
division-wide metrics. In individual cases, salaries may also be adjusted to
reflect competitive imbalances among peer companies, as gauged by a compensation
consultant retained by the Compensation Committee. It is the Compensation
Committee's objective to have annual base compensation at the 50th percentile of
the peer group over the long term. This peer group of fourteen insurers (the
"Pay Peer Group") was selected by the consultant and it does not include each of
the insurers identified below utilized in the peer comparisons for Executive
Bonus Plan (as defined below) bonuses.
19
Bonus compensation may take two forms. First, virtually every employee of
the Company, including every Executive Officer, earns a bonus if the Company's
direct loss ratio falls below a stipulated target, measured on a quarterly
basis. This is the Company's quarterly Quality Performance Bonus ("QPB"). This
short term incentive, which is paid as a percentage of quarterly pay, is
intended to motivate all employees to produce an underwriting profit for the
Company. In order to encourage employees in field offices to take appropriate,
but sometimes difficult action, 70% of the bonus for each field office employee
is tied to their individual office results. All corporate employees, including
Executive Officers, receive the same average percentage based on company-wide
results.
Second, the Compensation Committee has also created individual incentive
bonus plans for the CEO and certain Section 16 Officers (each an "Executive
Bonus Plan"). Executive Bonus Plans reward these officers based on their
attaining specific division-wide goals and on the performance of the Company
overall, relative to its peers. These bonus plans include underwriting
performance and total shareholder return as measures of performance. Certain of
these Section 16 Officers' incentive plans also include a sales factor, as the
Compensation Committee believes it is important to reinforce the significance of
top line growth to the Company's overall success. These officers' bonuses are
purely formula driven. One half of the bonus is based on the attainment of
measurable division-wide goals while the other half considers a peer comparison
based on two or three specific performance criteria. These peer comparison
performance measures are three-year average total shareholder return, the
combined ratio of the entire State Auto Group, which includes the results of the
insurance affiliates of the Company, including State Auto Mutual and the
Meridian Group (collectively "State Auto") and for certain Section 16 Officers'
plans, State Auto's net written premium growth. These performance measures are
compared with those same results for a set of nine peer companies which are as
follows: Alfa Insurance Group, Allstate, Chubb, Cincinnati Insurance Companies,
Harleysville Group, EMC Insurance Group, Inc., Ohio Casualty Group, Safeco and
Selective Insurance Group (the "Executive Bonus Peer Group"). The consultant
advised that size parity is more important in assessing base salary
competitiveness than comparisons of stock based performance measures. Therefore,
the Compensation Committee believes that it is appropriate for the Executive
Bonus Peer Group to be different from the Pay Peer Group because of the
performance measures contemplated by the Executive Bonus Plans.
The remaining aspect of the compensation awarded to the CEO and Section 16
Officers is stock options. Stock options are granted to persons at the operating
managerial level and above as well as to certain key technical personnel.
Options are believed to be a long-term incentive which properly focuses the
employee's attention on attainment of business goals that will enhance long term
shareholder value. Realistically, options have value only when the market price
of the Company's stock appreciates, which the Compensation Committee believes is
primarily driven by the performance of the Company.
The Compensation Committee has conditioned the grant of stock options on
compliance with stock ownership guidelines (the "Ownership Guidelines"). They
require each optionee under the 2000 Stock Option Plan to own a sufficient
number of the Company's Common Shares such that the value of those shares equals
a specified percentage of such optionee's salary. For purposes of determining
compliance with the Ownership Guidelines, the salary and stock value are
measured as of the end of each calendar year.
Most Section 16 Officers were awarded options based on a formula developed
by the Compensation Committee's independent consultant, who had completed a
competitive study of the
20
Company's compensation program. This formula utilized the Black-Scholes option
pricing model, a targeted grant value and the trading range of STFC shares over
a multi-day time period. It is anticipated that the number of shares granted in
2003 will remain relatively stable for 2004 and possibly 2005.
With respect to the compensation paid to the CEO, Mr. Moone, the
Compensation Committee met in May 2003 to consider and determine Mr. Moone's
Executive Bonus Plan bonus earned for 2002. There is a significant delay in
calculating this aspect of the bonus because of the delay in securing peer
company financial results.
Mr. Moone's 2002 non-discretionary bonus under his Executive Bonus Plan was
driven by the Company's performance with respect to the following three factors,
as compared to the Executive Bonus Plan Peer Group: three-year average total
shareholder return ("TSR"), combined ratio ("CR") and net written premium growth
("NWP"). Mr. Moone's bonus target percentage in the non-discretionary bonus
element was 50% of his salary.
Based on the peer comparisons, Mr. Moone earned seven points for CR ( 8th
place), eight points for NWP ( 3rd place), and nine points for TSR ( 2nd place).
The 24 total points earned Mr. Moone a bonus of 80% of target or $176,000.
In deciding on Mr. Moone's discretionary bonus for 2002, where he could
earn up to 25% of base salary, the Compensation Committee considered the
following factors: his management of the issues surrounding the shareholder
proposal included in the 2003 Proxy Statement, which first presented itself in
late 2002, the revenue growth attained by STFC in 2002, the improvement in the
Meridian combined ratio, his management of the surplus of STFC and his oversight
of the development of governance guidelines and other corporate governance
measures for STFC. The Compensation Committee did not assign a particular weight
to any of the foregoing considerations.
Considering all those issues, the Compensation Committee agreed to grant
him a discretionary bonus of $100,000 or 22.7% of his 2002 salary. In the
aggregate, Mr. Moone's total Executive Bonus Plan bonus earned in 2002 (but paid
in 2003) was $276,000, and this number is included in the Bonus Column in the
Summary Compensation Table for the year 2002.
For 2003, there were four components to the Company's compensation
arrangements with the Chief Executive Officer: base salary; incentive
compensation arrangements; QPB; and stock options. The QPB and stock option
elements are discussed above.
In November 2002, the Compensation Committee evaluated Mr. Moone's
performance and his compensation level based on both objective and subjective
measures. The Compensation Committee's objective is to maintain Mr. Moone's
total salary at a level that is competitive with the salary of the person
holding comparable position(s) at one or more sets of peer companies. The
Compensation Committee reviewed the salary component of compensation of chief
executive officers of companies of similar size included in an annual salary
survey conducted by the Property Casualty Insurers Association of America
("PCI") (formerly known as the NAII), which is State Auto Mutual's and State
Auto P&C's national trade association. In addition, the Compensation Committee
utilized a compensation consultant that compared chief executive officer
compensation at State Auto to the Pay Peer Group. Besides the salary comparison
data, the Compensation Committee considered several factors, including the
overall operations of the State Auto Group, as reflected in the combined ratio
and quarterly earnings reports, the substantial increase in the size of the
Company and the
21
improvement seen in the results of the Meridian book of business. As a result of
these considerations the Compensation Committee awarded Mr. Moone a raise in
base salary of $44,000 or 10% to be effective for the calendar year 2003. With
this raise, Mr. Moone's salary remains below the 25th percentile of the Pay Peer
Group.
In addition, the cash Executive Bonus Plan continued in place for 2003 for
Mr. Moone. His Executive Bonus Plan utilized three parameters for peer
comparison: three-year average total shareholder return, statutory combined
ratio, and direct written premium growth. Thus, the total number of points
available continued to be 30, as reflected in the table below.
As noted above, the Executive Bonus Plan Peer Group to which the
performance of the Company is compared is as follows: Alfa Insurance Group,
Allstate, Chubb, Cincinnati Insurance Companies, Harleysville Group, EMC
Insurance Group, Inc., Ohio Casualty Group, Safeco, and Selective Insurance
Group. The points system is as follows:
TOTAL POINTS EARNED PERCENT OF TARGET
------------------- -----------------
30-27 100%
26-23 80%
22-19 60%
18-15 40%
14-11 20%
10 or less 0%
The performance of State Auto as respects combined ratio, three-year
average total shareholders' return, and direct written premium growth are ranked
from ten to one, with ten being the best in each criteria. The rank equates to a
point total. The highest point total attainable is thirty, the lowest is three.
The Executive Bonus Plan Peer Group is not necessarily the same group of
insurers in the NASDAQ Insurance Index or in the PCI Salary Survey referred to
above.
For 2003, Mr. Moone's targeted bonus available equals 75% of his 2003
annual salary. In addition, the plan contemplates that the Compensation
Committee may award an additional bonus of up to 25% of base salary based on a
subjective evaluation of his performance by the Committee. As respects the bonus
to be earned for 2003, the Committee will determine the number of points the
Company earned when the statutory combined ratio and premium revenue growth
numbers for each of the members of the Executive Bonus Plan Peer Group become
available. In addition, the Compensation Committee must determine the amount, if
any, of bonus payable due to its evaluation of Mr. Moone's performance as
Chairman, President and Chief Executive Officer under the discretionary
component of the Executive Bonus Plan for Mr. Moone. Hence, Mr. Moone's bonus
earned in the 2003 calendar year remains undetermined.
COMPENSATION COMMITTEE
David J. D'Antoni
Richard K. Smith
William J. Lhota, Chairman
22
REPORT OF THE AUDIT COMMITTEE
The Audit Committee provides assistance to the directors in fulfilling
their responsibility to the shareholders relating to corporate accounting,
reporting practices of the Company, and the quality and integrity of financial
reports of the Company. In so doing, the Audit Committee maintains free and open
communication between the directors, the independent auditors, the internal
auditors, and the senior management of the Company. Notwithstanding the
foregoing, it is not the duty of the Audit Committee to plan or conduct audits
or to determine that the Company's financial statements and disclosures are
complete, accurate, and in accordance with generally accepted accounting
principles and applicable rules and regulations. These are the responsibilities
of management and the independent auditors.
In the course of fulfilling its responsibilities, the Audit Committee
reviewed the audited financial statements in the Annual Report on Form 10-K for
the Company's 2003 fiscal year with management, including a discussion of the
quality, not just the acceptability, of the accounting principles, the
reasonableness of significant judgments, and the clarity of disclosures in the
financial statements. The Audit Committee also reviewed with the independent
auditors, who are responsible for expressing an opinion on the conformity of
those audited financial statements with generally accepted accounting
principles, their judgments as to the quality, not just the acceptability, of
the Company's accounting principles and such other matters as are required to be
discussed with the Audit Committee under auditing standards generally accepted
in the United States, including those matters required to be discussed by SAS 61
(Codification of Statements on Auditing Standards, AU Section 380). In addition,
the Audit Committee discussed with the independent auditors the auditors'
independence from management and the Company, including the matters in the
written disclosures required by the Independence Standards Board and considered
the compatibility of any permitted and pre-approved non-audit services with the
auditors' independence.
The Audit Committee discussed with the Company's internal and independent
auditors the overall scope and plans for their respective audits. The Audit
Committee meets with the internal and independent auditors, with and without
management present, to discuss the results of their examinations, their
evaluations of the Company's internal controls, and the overall quality of the
Company's financial reporting. The Committee held a total of eight meetings in
2003, four in person and four telephone conference calls, and each member of the
Audit Committee attended at least 75% of the meetings.
In reliance on the reviews and discussions referred to above, the Audit
Committee recommended to the Board of Directors (and the Board has approved)
that the audited financial statements be included in the Annual Report on Form
10-K for the 2003 fiscal year for filing with the SEC.
The full responsibilities of the Audit Committee are set forth in its
charter, which is reviewed periodically by the Board and, if deemed necessary
following such review, amended. In addition to the foregoing, these
responsibilities include sole authority for selecting the independent auditor,
reviewing with management the adequacy of reserves, sole authority to retain
independent advisors, receipt and retention of matters relating to allegations
of accounting or other improprieties, reviewing matters relating to the Code of
Business Conduct and participating in disclosure control procedures and
functioning as the qualified legal compliance committee.
As discussed above, the Audit Committee is responsible to monitor and
review the Company's financial reporting process on behalf of the Board of
Directors. However, it is not the duty or
23
responsibility of the Audit Committee to conduct auditing or accounting reviews
or procedures. Members of the Audit Committee are not employees of the Company,
and some members are not accountants or auditors by profession or experts in the
fields of accounting or auditing. Therefore, the Audit Committee has relied,
without independent verification, on management's representation that the
financial statements have been prepared with integrity and objectivity and in
conformity with accounting principles generally accepted in the United States
and on the representations of the independent auditor included in its report on
the Company's financial statements. The Audit Committee's review does not
provide the Audit Committee with an independent basis to determine that
management has maintained appropriate accounting and financial reporting
principles or policies, or appropriate internal controls and procedures designed
to assure compliance with accounting standards and applicable laws and
regulations. Furthermore, the Audit Committee's considerations and discussions
with management and the independent auditors do not assure that the Company's
financial statements are presented in accordance with generally accepted
accounting principles, that the audit of the Company's financial statements has
been carried out in accordance with generally accepted auditing standards, or
that the Company's independent accountants are in fact "independent."
All of the members of the Audit Committee are independent directors as
defined by the rules and regulations of NASDAQ and the provisions of the
Sarbanes Oxley Act of 2002, as implemented by the rules of the SEC. The Board of
Directors has confirmed and determined that Richard K. Smith, the Chair of the
Committee, is an "audit committee financial expert" as defined by the rules of
the SEC. Mr. Smith is a retired partner of the "Big Four" firm, KPMG, LLP, and
while at that firm he had experience auditing property casualty insurance
companies, some of which presented a size and level of complexity from a
financial statement perspective at least equal to that presented by the Company.
The Audit Committee will receive regular reports from the Company's
compliance officer with respect to matters coming within the scope of the Code
of Business Conduct. The Chief Executive Officer and the principal financial
officers have each agreed to be bound by the Code of Business Conduct and the
Sarbanes Oxley mandated Code of Ethics for Senior Financial Officers as a
Special Supplement to the Code of Business Conduct. The Company has also
implemented and applied the Amended and Restated Code of Business Conduct
throughout the Company. It also has in place procedures for the receipt of
complaints concerning the Company's accounting, internal accounting controls, or
auditing matters, including the confidential, anonymous submission by employees
of the Company of concerns regarding questionable accounting or auditing
matters.
AUDIT COMMITTEE
David J. D'Antoni
William J. Lhota
Richard K. Smith, Chairman
24
PERFORMANCE GRAPH
The line graph below compares the total return on $100 invested on December
31, 1998, in the Company's shares, the CRSP Total Return Index for the NASDAQ
Stock Market ("NASDAQ Index"), and the CRSP Total Return Index for NASDAQ
insurance stocks ("NASDAQ Ins. Index"), with dividends reinvested.
COMPARISON OF CUMULATIVE TOTAL RETURN
[PERFORMANCE GRAPH]
STFC NASDAQ INDEX NASDAQ INS. INDEX
---- ------------ -----------------
12/31/98 100.000 100.000 100.000
12/31/99 74.467 185.428 77.561
12/31/00 147.219 111.832 97.400
12/31/01 134.860 88.765 104.386
12/31/02 129.848 61.369 105.208
12/31/03 196.844 91.753 130.027
PRINCIPAL HOLDERS OF VOTING SECURITIES
The following table sets forth certain information, as of April 5, 2004,
with respect to the only shareholders known to the Company to be the beneficial
owners of more than 5% of the Company's outstanding Common Shares:
AMOUNT AND NATURE
NAME AND ADDRESS OF BENEFICIAL PERCENT
OF BENEFICIAL OWNER OWNERSHIP OF CLASS
------------------- ----------------- --------
State Automobile Mutual Insurance Company(1)..... 26,253,151 66.1%
518 East Broad Street
Columbus, OH 43215
Gregory M. Shepard(2)............................ 2,000,000 5.1%
15 Country Club Place
Bloomington, Illinois 61701
---------------
(1) State Auto Mutual exercises sole voting and investment power with respect to
such Common Shares.
(2) Based solely on Schedule 13Ds filed with the SEC.
25
CERTAIN TRANSACTIONS
In 2003, the Company and its subsidiaries, State Auto P&C, Milbank,
National, State Auto Insurance Company of Ohio, formerly known as State Auto
Insurance Company ("SAOH"), Strategic Insurance Software, Inc. ("S.I.S."),
Stateco Financial Services, Inc. ("Stateco"), and 518 Property Management and
Leasing LLC ("518 PML"), operated and managed their businesses in conjunction
with State Auto Mutual under a Management and Operations Agreement dated January
1, 2000 (the "2000 Management Agreement"). During 2003, the 2000 Management
Agreement was a pure cost allocation agreement. Under the 2000 Management
Agreement, every executive, managerial, technical, professional, supervisory,
and clerical function for the above named companies is performed by an employee
of State Auto P&C. In addition to the 2000 Management Agreement, there is also a
Management and Operations Agreement dated January 1, 2000 (the "2000 Midwest
Management Agreement"), among State Auto P&C, State Auto Mutual and State Auto
Insurance Company of Wisconsin ("SAWI"), a wholly owned subsidiary of State Auto
Mutual, and a Management and Operations Agreement dated January 1, 2000 (the
"2000 Farmers Casualty Management Agreement"), among State Auto P&C, Farmers
Casualty, and Mid-Plains Insurance Company ("Mid-Plains"), a wholly owned
subsidiary of Farmers Casualty. In addition, effective July 2002, State Auto P&C
entered into a Management Service Agreement with Meridian Security Insurance
Company, Meridian Citizens Security Insurance Company, and Meridian Citizens
Mutual Insurance Company (collectively the "MIGI Insurers"), pursuant to which
State Auto P&C's employees provide management and operations services to the
MIGI Insurers in exchange for a reimbursement of its expenses plus an override
equal to 10% of the expenses attributable to such employee expenses (the "MIGI
Management Agreement").
During 2003, the following companies incurred the following management fees
to State Auto P&C under the 2000 Midwest Management Agreement, the 2000 Farmers
Casualty Management Agreement, and the MIGI Management Agreement:
SAWI -- $226,000; Farmers Casualty -- $194,000; Mid-Plains -- $11,000; Meridian
Security -- $684,000; Meridian Citizens Security -- $86,000; and Meridian
Citizens Mutual -- $86,000.
The 2000 Management Agreement also addresses procedures for potential
conflicts of interest. Generally, business opportunities presented to the common
officers of the companies, other than business opportunities that meet certain
criteria, must be presented to Independent Committees of State Auto Mutual's and
the Company's boards of directors. These committees review and evaluate the
business opportunity using such factors as each considers relevant. Based upon
such review and evaluation, these committees then make recommendations to each
respective board of directors as to whether or not such business opportunities
should be pursued and, if so, by which company. The boards of directors of State
Auto Mutual or its insurer subsidiaries and of the Company or any of its
subsidiaries must then act on the recommendation of the committee after
considering all other factors deemed relevant to them.
Each of the 2000 Management Agreement, the 2000 Midwest Management
Agreement, and the 2000 Farmers Casualty Management Agreement has a ten-year
term and automatically renews for an additional ten-year term, provided that any
party to the agreement could terminate its own participation at the end of the
term then in effect by giving at least two years' advance written notice of
non-renewal to the other parties, with the exception that Milbank may terminate
its participation on 120 days' notice. The MIGI Management Agreement continues
until terminated by 180 days' notice. Any party could also terminate its
participation upon events constituting a change of control or
26
potential change of control (as defined in the 2000 Management Agreement, the
2000 Midwest Management Agreement and the 2000 Farmers Casualty Management
Agreement) of the Company, or upon agreement of the parties. The agreement
automatically terminates with respect to a party (and only that party) if such
party is subject to insolvency proceedings.
Also in place during 2003 was the Stop Loss Reinsurance Agreement (the
"Stop Loss") between State Auto Mutual and the Company. Under the Stop Loss, if
the State Auto Pool's (as defined below) statutory loss and loss adjustment
expense ratio (the "Loss Ratio") was between 70.75% and 80%, State Auto Mutual
reinsured State Auto P&C and certain of its affiliates 27% of the State Auto
Pool's losses in excess of a Loss Ratio of 70.75% to 80%. State Auto P&C and
certain of its affiliates were responsible for their share of the State Auto
Pool's losses over the 80% threshold. State Auto Mutual had the right to
participate in the profits of the State Auto Pool. State Auto Mutual assumed 27%
of the State Auto Pool's underwriting profits attributable to a Loss Ratio less
than 69.25% but more than 50.99%. The Stop Loss had a 27-month term expiring on
December 31, 2003. During 2003, State Auto Mutual paid the Company $5.6 million
for reinsured losses in the second and third calendar quarters, while the
Company paid State Auto Mutual $12.8 million as part of the underwriting profit
earned by the Company from State Auto Pool in the first and fourth calendar
quarters.
Since January 1987, State Auto P&C and State Auto Mutual have participated
in an intercompany pooling arrangement (the "State Auto Pool" or the "Pooling
Arrangement") which has been amended from time to time, including amendments
adding participants to the Pooling Arrangement and adjusting pooling
percentages. Under the terms of the Pooling Arrangement, State Auto P&C and the
other pool participants cede all of their direct insurance business to State
Auto Mutual. All of State Auto Mutual's property and casualty insurance business
is also included in the pooled business, except for voluntary assumed
reinsurance business. State Auto Mutual then cedes a percentage of the pooled
business to State Auto P&C and the other pool participants and retains the
balance. Parties to the Pooling Arrangement and their allocated pooling
percentages as of December 31, 2003, were as follows: State Auto
Mutual -- 18.3%; State Auto P&C -- 59%; Milbank -- 17%; Farmers Casualty -- 3%;
SAWI -- 1%; SAOH -- 1%; and State Auto Florida Insurance Company
("SAFL") -- 0.7%.
Stateco undertakes on behalf of State Auto Mutual, State Auto P&C, Milbank,
National, SAWI, Farmers Casualty, Mid-Plains, SAOH, SAFL, and each of the MIGI
Insurers the responsibility of managing those companies' investable assets. In
consideration of this service, Stateco charges such companies an annual fee,
paid quarterly, based on a percentage of the average investable assets of each
company. The percentage currently set is 0.4% for bonds and 0.5% for equities,
with a 0.1% bonus available if the stock portfolio return exceeds that of the
S&P 500 Index for the same period. During 2003, the following companies incurred
the following fees to Stateco: State Auto Mutual -- $1.6 million; State Auto
P&C -- $4.2 million; Milbank -- $1.2 million; National -- $258,000;
SAWI -- $83,000; Farmers Casualty -- $180,000; Mid-Plains -- $38,000;
SAOH -- $75,000; SAFL -- $63,000; Meridian Security -- $306,000; Meridian
Citizens Security -- $74,000; and Meridian Citizens Mutual -- $64,000. The
Company believes the fee charged by Stateco is comparable to those charged by
independent investment managers under similar circumstances.
The Company's wholly owned subsidiary, S.I.S., develops and sells software
for use by insurance companies and insurance agencies. S.I.S sells its software
and software support services to its affiliated insurers and to nonaffiliated
entities. In 2003, affiliated insurers paid $821,000 to S.I.S
27
for its services and products. S.I.S. believes its fees for software development
and software licensing charged to affiliates reflect what a third party would
pay S.I.S. for similar services.
State Auto Mutual has guaranteed the adequacy of State Auto P&C's loss and
loss expense reserves as of December 31, 1990. Pursuant to the guarantee, State
Auto Mutual has agreed to reimburse State Auto P&C for any losses and loss
expenses in excess of State Auto P&C's December 31, 1990 reserves ($65.5
million) that may develop from claims that have occurred on or prior to that
date. This guarantee ensures that any deficiency in the reserves of State Auto
P&C as of December 31, 1990, under the pooling arrangement percentages effective
on December 31, 1990, will be reimbursed by State Auto Mutual. As of December
31, 2003, there had been no adverse development of this liability.
State Auto P&C, State Auto Mutual, Milbank, National, SAWI, Farmers
Casualty, Mid-Plains, SAOH, SAFL, and the MIGI Insurers (collectively the "State
Auto Group") together participate in a catastrophe reinsurance program. Under
this program, the members of the State Auto Group, on a combined basis, retain
the first $40.0 million of catastrophe losses that affect at least two
individual risks. For catastrophe losses incurred by the State Auto Group up to
$80.0 million, in excess of $40.0 million, traditional reinsurance coverage is
provided with a co-participation of 5%. For catastrophe losses incurred by the
State Auto Group up to $100.0 million, in excess of $120.0 million, in exchange
for a premium paid by each reinsured company, State Auto P&C acts as the
catastrophe reinsurer for the State Auto Group under the terms of an
inter-company catastrophe reinsurance agreement. This layer of reinsurance has
been excluded from the Pooling Arrangement. To provide funding if the State Auto
Group were to incur catastrophe losses in excess of $120.0 million, the Company
has implemented a structured contingent financing arrangement with a financial
institution and a syndicate of other lenders (the "Lenders") to provide up to
$100.0 million for reinsurance purposes. In the event of such a loss, this
arrangement provides that the Company would sell redeemable preferred shares to
SAF Funding Corporation, a special purpose company ("SPC"), which would borrow
the money necessary for such purchase from the Lenders. The Company would then
contribute to State Auto P&C the funds received from the sale of its preferred
shares, thereby preserving the statutory surplus of State Auto P&C. State Auto
P&C would use the contributed capital to pay its direct catastrophe losses and
losses assumed under the intercompany catastrophe reinsurance agreement. The
Company is obligated to repay SPC (which would repay the Lenders) by redeeming
the preferred shares over a five-year period. In the event of a default by the
Company, the obligation to repay SPC has been secured by a Put Agreement among
the Company, State Auto Mutual and the Lenders, under which State Auto Mutual
would be obligated to either purchase the preferred shares from SPC or repay SPC
for the loan(s) outstanding. This funding arrangement, if exercised, would have
the impact of adding up to $100.0 million of additional debt to the Company
while providing needed cash to pay claims, while at the same time preserving the
investment portfolio of the Company in the short term. There have been no losses
assumed by State Auto P&C under this intercompany catastrophe reinsurance
agreement. During 2003, the following members of the State Auto Group paid the
following amount of premiums to State Auto P&C under the terms of this
inter-company catastrophe reinsurance agreement: State Auto Mutual -- $2.5
million; Milbank -- $306,000; National -- $154,000; SAWI -- $113,000; Farmers
Casualty -- $109,000; Mid-Plains -- $7,000; SAOH -- $28,000; and the MIGI
Insurers -- $275,000. The Company believes that the premiums charged by State
Auto P&C under this inter-company catastrophe reinsurance agreement are
comparable to the premiums that would be charged by independent reinsurers under
similar reinsurance arrangements.
28
The Company's wholly owned subsidiary, 518 PML, leases an office building
it owns near Nashville, Tennessee, to State Auto Mutual for its Nashville
Regional Office. 518 PML received $506,000 from State Auto Mutual in rent for
the Nashville Regional Office in 2003. In addition, 518 PML leases office
buildings it owns in Greer, South Carolina, and West Des Moines, Iowa to State
Auto Mutual for its Southern Regional Office and Des Moines Branch Office,
respectively. 518 PML received $530,000 in rent from State Auto Mutual for the
South Carolina location and $196,000 in rent for the Iowa location in 2003. The
Company believes these rents reflect market rates.
In 1999, the Company entered into a line of credit agreement with State
Auto Mutual pursuant to which State Auto Mutual loaned $45.5 million to the
Company to fund the Company's then-existing stock repurchase program. Principal
on this loan, which is currently $45.5 million, is due on demand, with final
payment due on or prior to December 31, 2005. The interest rate for this loan is
adjusted annually on each January 1 to reflect adjustments in the then current
prime lending rate as well as the Company's current financial position. The
interest rate for this loan was 2.5% in 2003 and will be 2.25% in 2004. In 2003,
the Company paid $1.6 million in interest to State Auto Mutual on this loan.
On September 30, 2002, Milbank entered into a surplus contribution note
with Meridian Security pursuant to which Meridian Security loaned $15,000,000 to
Milbank. The purpose of this surplus contribution note was to lower Milbank's
net written premium to statutory surplus ratio. This note was repaid on December
9, 2003. Interest expense was $819,000 in 2003.
INDEPENDENT PUBLIC ACCOUNTANTS
PROPOSAL TWO: RATIFICATION OF SELECTION OF INDEPENDENT PUBLIC ACCOUNTANTS
The Audit Committee has selected Ernst & Young LLP ("Ernst & Young") as
independent public accountants for the Company for 2004. Although not required,
the Board of Directors is submitting this selection to the shareholders for
ratification. Ernst & Young has served as the independent public accountants for
the Company since 1994. The Audit Committee and the Board of Directors believe
that the reappointment of Ernst & Young for 2004 is appropriate because of the
firm's reputation, qualifications, and experience. The favorable vote of a
majority of the outstanding Common Shares present in person or by proxy at the
Annual Meeting is required to approve the ratification of the selection of Ernst
& Young. The effect of an abstention is the same as a "no" vote. Broker
non-votes will not have a positive or negative effect on the outcome of this
proposal.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" RATIFICATION OF THE
SELECTION OF ERNST & YOUNG AS THE INDEPENDENT PUBLIC ACCOUNTANTS FOR THE COMPANY
FOR 2004.
The Audit Committee will reconsider the appointment of Ernst & Young if its
selection is not ratified by shareholders. Even if the selection of Ernst &
Young is ratified by shareholders, the Audit Committee, in its discretion, could
decide to terminate the engagement of Ernst & Young and to engage another firm
of independent public accountants if the Audit Committee determines such action
to be necessary or desirable.
Representatives of Ernst & Young will be present at the Annual Meeting and
will have an opportunity to make a statement if they desire to do so. Such
representatives will be available to respond to appropriate questions.
29
AUDIT AND OTHER SERVICES FEES
Aggregate fees billed to or incurred by the Company for services performed
for the years ending December 31, 2003, and December 31, 2002, respectively, by
Ernst & Young were as follows:
2003 2002
-------- --------
Audit fees(1)......................................... $451,527 $336,318
Audit related fees(2) (5)............................. $ 12,123 $ 47,456
Tax fees(3)(5)........................................ $ 7,288 $ 46,400
All other fees(4) (5)................................. 0 $ 2,650
-------- --------
Total................................................. $470,938 $432,824
======== ========
---------------
(1) Includes services rendered for the audit of the Company's annual financial
statements, review of financial statements included in the Company's
quarterly reports on Form 10-Q and other audit services normally provided by
Ernst & Young in connection with statutory and regulatory filings or
engagements.
(2) Includes services rendered in connection with the audit of employee benefit
plans and merger and acquisition activity.
(3) Includes services for tax consulting and compliance, including tax return
preparation.
(4) Represents services related to corporate finance assistance and internet
accounting service.
(5) The Audit Committee has considered whether the provision of these services
is compatible with maintaining the principal accountant's independence.
After November 2002, the Audit Committee must pre-approve any non-audit
services performed by the Company's independent auditors to the extent such
services are not prohibited by law from being performed by such independent
auditors. See "Audit Committee's Pre-Approval Policies and Procedures."
AUDIT COMMITTEE'S PRE-APPROVAL POLICIES AND PROCEDURES
The Audit Committee has adopted a policy under which audit and non-audit
services to be rendered by the Company's independent public accountants are
pre-approved. The Audit Committee's policy is to pre-approve all auditing
services and the Company's use of the independent public accountants to perform
any non-audit or tax services which are not prohibited by Section 10A(g) of the
Securities Exchange Act of 1934, subject to the de minimus exception for
non-audit services described in Section 10A(i)(1)(B) of such Act. No services
were provided by Ernst & Young in 2003 that were approved by the Audit Committee
under SEC Regulation S-X Section 2-01(c)(7)(i)(C) (which addresses certain
services considered de minimus approved by the Audit Committee after such
services have been performed).
FUTURE SHAREHOLDER PROPOSALS
Proposals of shareholders intended to be presented at the Annual Meeting of
Shareholders to be held in May 2005 must be received by the Company at its
principal executive offices for inclusion in the Proxy Statement and form of
proxy on or prior to 120 days in advance of the first anniversary date of this
Proxy Statement. If a shareholder intends to present a proposal at the 2005
Annual Meeting, but does not seek to include such proposal in the Company's
Proxy Statement and form of proxy, such proposal must be received by the Company
on or prior to 45 days in advance of the first
30
anniversary of the date of this Proxy Statement or the persons named in the form
of proxy for the 2005 Annual Meeting will be entitled to use their discretionary
voting authority should such proposal then be raised at such meeting, without
any discussion of the matter in the Company's Proxy Statement or form of proxy.
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires
the Company's officers, directors and persons who own more than 10% of the
Common Shares to file statements of beneficial ownership of the Company's Common
Shares. Based solely on a review of copies of the forms filed under Section
16(a) and furnished to the Company, the Company believes that all applicable
Section 16(a) filing requirements were complied with during 2003.
OTHER MATTERS
Management does not know of any other matters which may come before the
Annual Meeting. However, if any other matters properly come before the Annual
Meeting, it is the intention of the persons named in the accompanying form of
proxy to vote the proxy in accordance with their judgment on such matters.
The Company will bear the cost of solicitation of proxies. In addition to
the use of the mails, proxies may be solicited personally or by telephone or
electronic mail. Proxies may be solicited by directors, officers, and regular
employees of the Company, who will not receive any additional compensation for
their solicitation services. The Company will reimburse banks, brokers, and
nominees for their out-of-pocket expenses incurred in sending proxy material to
the beneficial owners of shares held by them. If there are follow-up requests
for proxies, the Company may employ other persons for such purpose.
JOHN R. LOWTHER
Secretary
31
DETACH CARD
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STATE AUTO FINANCIAL CORPORATION ANNUAL MEETING OF SHAREHOLDERS
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS OF THE COMPANY
The undersigned hereby appoints Robert H. Moone, and in the event he is unable
to so act, Steven J. Johnston, Mark A. Blackburn and John R. Lowther, and any
one or more of them, Proxies, with full power of substitution, to represent and
vote all common shares, without par value, of State Auto Financial Corporation
(the "Company") which the undersigned would be entitled to vote if personally
present at the Annual Meeting of Shareholders to be held at the Company's
principal executive offices located at 518 East Broad Street, Columbus, Ohio, on
Friday, May 28, 2004, at 10:00 A.M., local time, and at any and all adjournments
thereof.
Proposal 1 -- ELECTION OF THE FOLLOWING WITHHELD [ ]
NOMINEES AS CLASS I DIRECTORS: for all Nominees
FOR all Nominees [ ]
(except as marked to the contrary)
Paul W. Huesman, John R. Lowther and Robert H. Moone.
TO WITHHOLD AUTHORITY TO VOTE FOR ANY INDIVIDUAL NOMINEE(S) PRINT THE NAMES
IN THE SPACE BELOW
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Proposal 2 -- Ratification of selection of Ernst & Young LLP as the Company's
independent public accountants for 2004.
[ ] FOR [ ] AGAINST [ ] ABSTAIN
The named proxies are authorized to vote, in their discretion, upon such
other matters (none known at the time of solicitation of this proxy) as may
properly come before the Annual Meeting or any adjournment thereof.
(CONTINUED, AND TO BE SIGNED ON OTHER SIDE)
DETACH CARD
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State Auto Financial Corporation
(Continued from the other side)
The shares represented by this Proxy will be voted as directed by the
shareholder. IF NO DIRECTION IS GIVEN WHEN THE DULY EXECUTED PROXY IS RETURNED,
SUCH SHARES WILL BE VOTED "FOR ALL NOMINEES" IN PROPOSAL 1 AND "FOR" PROPOSAL 2.
[ ] I PLAN TO ATTEND MEETING
Please mark, date and sign as your
name appears below and return in
the enclosed envelope. If acting
as executor, administrator,
trustee, guardian, etc., you
should so indicate when signing.
If the signer is a corporation,
please sign the full corporate
name by a duly authorized officer.
If shares are held jointly, each
stockholder named should sign.
Date..............................
..................................
Signature
..................................
Signature