10-K 1 l86881ae10-k.txt STATE AUTO FINANCIAL CORPORATION 10-K 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------------- FORM 10-K [x] Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2000 or [ ] Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 (no fee required) For the transition period from ___________ to _____________ Commission File Number 0-19289 STATE AUTO FINANCIAL CORPORATION -------------------------------- (exact name of Registrant as specified in its charter) Ohio 31-1324304 ------------------------------ ------------------------------------ (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 518 East Broad Street, Columbus, Ohio 43215-3976 ------------------------------------- ---------- (Address of principal executive office) (Zip Code) Registrant's telephone number, including area code: (614) 464-5000 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Common Shares, without par value -------------------------------- (Title of class) Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes __X__ No ____ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. _____ On March 16, 2001, the aggregate market value (based on the closing sales price on that date) of the voting stock held by non-affiliates of the Registrant was $197,499,763. On March 16, 2001, the Registrant had 38,694,461 Common Shares outstanding. 2 DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the Registrant's Proxy Statement relating to the annual meeting of shareholders to be held May 25, 2001, which Proxy Statement will be filed within 120 days of December 31, 2000, are incorporated by reference in Part III, Items 10, 11, 12 and 13 of this report. 3 PART I ITEM 1. BUSINESS (A) GENERAL DEVELOPMENT OF BUSINESS State Auto Financial Corporation, an Ohio corporation formed April 18, 1990 ("State Auto Financial" or "STFC"), is an insurance holding company headquartered in Columbus, Ohio, which engages, through its subsidiaries, primarily in the property and casualty insurance business. State Auto Financial is approximately 68% owned by State Automobile Mutual Insurance Company, an Ohio property and casualty insurance company formed in 1921 ("Mutual"). State Auto Financial owns 100% of the outstanding shares of State Auto Property and Casualty Insurance Company, a South Carolina corporation ("State Auto P&C"), Milbank Insurance Company, a South Dakota corporation ("Milbank"), Farmers Casualty Insurance Company, an Iowa corporation ("Farmers Casualty"), State Auto Insurance Company, an Ohio corporation ("SAIC"), and State Auto National Insurance Company, an Ohio corporation ("National"). State Auto P&C, Milbank and Farmers Casualty are regional standard insurers engaged primarily in writing personal and commercial automobile, homeowners, commercial multi-peril, workers' compensation and fire insurance. SAIC provides standard personal insurance to its policyholders through the use of leading edge technology within the independent agency system. National writes non-standard personal automobile insurance in 18 states. While Mutual originally acquired Milbank, Mutual sold Milbank to STFC in July 1998. State Auto Financial issued approximately 5.1 million common shares of STFC to Mutual in exchange for 100% of the outstanding shares of Milbank and as a result, Milbank became a wholly owned subsidiary of State Auto Financial. Since the transaction was a combination of entities under common control, it has been accounted for similar to a pooling of interest. On January 1, 1999, Farmers Casualty, an Iowa domiciled standard property casualty insurer writing in Iowa and Kansas, became a wholly owned subsidiary of STFC, following completion of its plan of conversion from a mutual insurer. In August 1998, STFC contributed $9.0 million in capital to Farmers Casualty in the form of a surplus note. On completion of Farmers Casualty's conversion, STFC exchanged the surplus note for all the issued and outstanding shares of Farmers Casualty. Farmers Casualty owns 100% of the outstanding shares of Mid-Plains Insurance Company ("Mid-Plains"), an Iowa based insurer which principally writes nonstandard auto insurance in Iowa and Kansas. In May 1999, SAIC was formed by STFC. It began operations in Ohio upon receiving its Ohio certificate of authority in January 2000. Initially, SAIC writes standard personal lines in Ohio utilizing leading edge technology to the maximum extent feasible. In addition to the above-described insurers, effective as of January 1, 1997, Mutual acquired 100% of the outstanding shares of Midwest Security Insurance Company ("Midwest Security"), a Wisconsin domiciled standard personal lines property and casualty insurer. Midwest Security participates in the pooling arrangement discussed below. See "Pooling Arrangement" in the "Narrative Description of Business." In addition, in connection with this transaction, Mutual and State Auto Financial entered into an Option Agreement whereby, subject to the approval of the Office of the Insurance Commissioner of the State of Wisconsin, State Auto Financial may purchase Midwest Security at any time over the option term of five years at a price calculated pursuant to a formula set forth in the Option Agreement. State Auto P&C, Mutual, Milbank, Midwest Security, Farmers Casualty and SAIC, all of which participate in a pooling arrangement, are collectively referred to hereafter as the "Pooled Companies." See "Pooling Arrangement" in the "Narrative Description of Business." The Pooled Companies, National, and Mid-Plains are collectively referred to as the "State Auto Group." 4 At this time, the insurers in the State Auto Group market their insurance products through approximately 14,000 independent insurance agents associated with approximately 2,200 agencies in 26 states. The State Auto Group's insurance products are marketed primarily in the central and eastern part of the United States, excluding New York, New Jersey and the New England States. Another wholly owned subsidiary of State Auto Financial, Stateco Financial Services, Inc., an Ohio corporation ("Stateco"), provides investment management services to affiliated insurance companies and insurance premium finance services to customers of State Auto P&C, Mutual and Milbank. See "Investment Management Services" and "Insurance Premium Finance Services" in the "Narrative Description of Business." Strategic Insurance Software, Inc. ("S.I.S."), an Ohio corporation wholly owned by STFC, develops and sells software for the processing of insurance transactions, management of insurance policy data and electronic interfacing of insurance policy information between insurance companies and agencies. See "Insurance Software Business" in the "Narrative Description of Business." 518 Property Management and Leasing, LLC ("518 PML"), an Ohio limited liability company, engages in the business of owning and leasing real and personal property to affiliated companies. The members of 518 PML are State Auto P&C and Stateco. See "Property Leasing Business" in the "Narrative Description of Business." State Auto Financial and its subsidiaries, State Auto P&C, Milbank, Farmers Casualty, SAIC, National, Mid-Plains, Stateco, S.I.S., and 518 PML, are collectively referred to as the "Company." IN ANY REFERENCE TO FINANCIAL INFORMATION FOR 1998 AND PRIOR PERIODS, IT IS UNDERSTOOD THAT, UNLESS OTHERWISE STATED, ALL REFERENCES TO THE COMPANY INCLUDE ONLY STATE AUTO P&C, STATECO, MILBANK, NATIONAL, S.I.S. AND 518 PML, AND EXCLUDE FARMERS CASUALTY AND MID-PLAINS WHILE FINANCIAL INFORMATION FOR 1999 EXCLUDES ONLY SAIC. Since January 1, 1987, State Auto P&C has participated in a quota share reinsurance pooling arrangement with Mutual. While it has been modified several times since 1987, as of January 1, 1999, the then current pool participants and percentages of participation were State Auto Mutual (49%), State Auto P&C (37%), Milbank (10%), Midwest Security (1%), and Farmers Casualty (3%). As of January 1, 2000, it was further amended adding SAIC as a participant and modifying the pooling percentages as follows: Mutual (46%), State Auto P&C (39%), Milbank (10%), Midwest Security (1%), Farmers Casualty (3%), and SAIC (1%), and those percentages remain in effect. See "Pooling Arrangement" in the "Narrative Description of Business." Prior to January 1, 2000, State Auto P&C provided executive management services for all insurance affiliates within the State Auto Group pursuant to an Amended and Restated Management Agreement dated April 1, 1994 (the "Amended and Restated Management Agreement"), the Midwest Management Agreement (defined below), and the Farmers Casualty Management Agreement (defined below). Mutual provided non-executive employees and facilities for such entities through December 31, 1999. See "Management Agreement" in the "Narrative Description of Business." Effective January 1, 2000, any individuals providing services to any of the companies in the State Auto Group who were not already employees of State Auto P&C became employees of State Auto P&C. In conjunction with this change, the foregoing management agreements were replaced with a Management and Operations Agreement dated January 1, 2000 (the "2000 Management Agreement"), a 2000 Midwest Management Agreement (as defined below) and a 2000 Farmers Casualty Management Agreement (defined below). See "Management Agreement" in the "Narrative Description of Business." 5 (B) FINANCIAL INFORMATION ABOUT INDUSTRY SEGMENTS. See Note 14 to the Company's Consolidated Financial Statements, included in Item 8, "Financial Statements and Supplementary Data" regarding the Company's reportable segments. Additional information regarding the Company's segments is provided in the "Narrative Description of Business." (C) SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995. Statements contained in this Form 10-K which are not historical in nature may be "forward-looking" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to certain risks and uncertainties that could cause the Company's actual results to differ materially from those projected. Forward-looking statements may be identified, preceded by, followed by, or otherwise include, without limitation, words such as "plans," "believes," "expects," "anticipates," "intends," "estimates," or similar expressions. For a discussion of certain risks and uncertainties that could cause the Company's actual results to differ materially from those projected, see Item 7 - Forward-Looking Statements; Certain Factors Affecting Future Results. (D) NARRATIVE DESCRIPTION OF BUSINESS. PROPERTY AND CASUALTY INSURANCE POOLING ARRANGEMENT Since January 1987, State Auto P&C and Mutual have participated in a quota share reinsurance pooling arrangement (the "Pooling Arrangement"). Under the terms of the Pooling Arrangement, State Auto P&C ceded all of its insurance business to Mutual. All of Mutual's property and casualty insurance business was also included in the pooled business. Mutual then ceded a percentage of the pooled business to State Auto P&C and retained the balance. From January 1987 through December 31, 1991, State Auto P&C assumed 20% of the pooled business. Effective January 1, 1992, State Auto P&C increased its percentage of the pool to 30%. Effective January 1, 1995, the Pooling Arrangement was amended to include all of the property and casualty business of Milbank. Concurrently with the inclusion of Milbank, the participation percentages were amended as follows: Mutual 55%, State Auto P&C 35% and Milbank 10%. Effective January 1, 1998, Midwest Security was added to the Pooling Arrangement and concurrently the participation percentages were amended as follows: Mutual 52%, State Auto P&C 37%, Milbank 10%, and Midwest Security 1%. With the addition of Farmers Casualty to the State Auto Group, it was added to the Pooling Arrangement and concurrently the pooling percentages were also amended as follows: Mutual 49%, State Auto P&C 37%, Milbank 10%, Midwest Security 1% and Farmers Casualty 3%. Effective January 1, 2000, the Pooling Arrangement was amended through the Reinsurance Pooling Agreement Amended and Restated as of January 1, 2000 (the "2000 Pooling Agreements"). The 2000 Pooling Agreement: 1) added SAIC as a party; 2) modified the pooling percentages to: Mutual 46%, State Auto P&C 39%, Milbank 10%, Midwest Security 1%, Farmers Casualty 3% and SAIC 1%; 3) increased the exclusion for the Catastrophe Assumption Agreement written by State Auto P&C from $100.0 million excess of $120.0 million to $135.0 million excess of $120.0 million (see "Reinsurance" in the "Narrative Description of Business"); and 4) excluded voluntary assumed reinsurance from third parties underwritten by Mutual from and after January 1, 2000. The pooling percentages are reviewed by management at least annually, and more often if deemed appropriate by management or the Board of Directors of each company, to determine whether any adjustments should be made. Future adjustments in the pooling percentages are expected to be based on the performance of the insurance operations of the current pool participants, the growth in direct premiums written of each company as it relates to the pooling percentages, the combined ratio of the pooled business and the net premiums written of the pooled business in relation to the statutory capital 6 and surplus of each participant, among other factors. Management of each of the Pooled Companies makes recommendations to a four-member coordinating committee consisting of two members of Mutual's Board of Directors and two members of State Auto Financial's Board of Directors. The coordinating committee reviews and evaluates various factors relevant to the pooling percentages and recommends any appropriate pooling change to the Boards of both Mutual and State Auto Financial. See "Management Agreement" in the "Narrative Description of Business." The Pooling Arrangement is terminable by any party on 90 days notice or by mutual agreement of the parties. Neither Mutual, State Auto P&C, Milbank, Farmers Casualty, Midwest Security, nor SAIC currently intends to terminate the pooling arrangement. The Pooling Arrangement is designed to produce more uniform and stable underwriting results for each of the Pooled Companies than any one company would experience individually by spreading the risk among each of the participants. Under the terms of the Pooling Arrangement, all premiums, incurred losses, loss expenses and other underwriting expenses are prorated among the companies on the basis of their participation in the pool. One effect of the Pooling Arrangement is to provide each participant with an identical mix of property and casualty insurance business on a net basis. The 2000 Pooling Agreement contains a provision which excludes from the scope of the Pooling Arrangement catastrophic loss claims and loss adjustment expenses incurred by State Auto P&C, Mutual, Milbank, National, Midwest Security, Farmers Casualty, SAIC, and Mid-Plains in the amount of $135.0 million in excess of $120.0 million as well as the premium for such exposures. State Auto P&C has become the reinsurer for each insurer in the State Auto Group for this layer of reinsurance under a Catastrophe Assumption Agreement. Effective November 2000, these limits in the Catastrophe Assumption Agreement were amended to $115.0 million excess of $120.0 million, which layer of reinsurance continues to be excluded from the 2000 Pooling Agreement. See "Reinsurance" in the "Narrative Description of Business." MANAGEMENT AGREEMENT Prior to January 1, 2000, the Company operated and managed its business in conjunction with Mutual under a management agreement which was restructured pursuant to an Amended and Restated Management Agreement effective April 1, 1994. Under this agreement, State Auto P&C provided executive management services for Mutual, Milbank, and National, overseeing the insurance operations of these companies. A management fee was paid by Mutual, Milbank, and National for the services provided by State Auto P&C equal to 2% of the five year average of annual statutory statement "surplus as regards policyholders," less valuations for managed subsidiaries, of each managed company. The Amended and Restated Management Agreement also imposed a performance standard which could result in State Auto P&C not being entitled to the fee for a particular quarter if a managed company's performance did not meet the standard incorporated in the agreement. In 1999, the managed companies paid a management fee of $7.1 million to State Auto P&C. In addition to the above-described Amended and Restated Management Agreement, State Auto P&C and Mutual entered into a Management Agreement with Midwest Security effective as of January 1, 1997 (the "Midwest Management Agreement"), and with Farmers Casualty and Mid-Plains effective as of January 1, 1999 (the "Farmers Casualty Management Agreement"). Effective January 1, 2000, each of these agreements was replaced (see below). Under each of these prior agreements, Mutual provided clerical and non-executive employees to Midwest Security, Farmers Casualty and Mid-Plains. Under the Midwest Management Agreement, the Company provided executive management services to Midwest Security in return for a management fee. Under this agreement, the Company's management fee was based on direct written premium of Midwest Security. The fee set for 1999 was 0.75% of direct written premium of Midwest Security and included a performance standard, as well. In 1999, Midwest Security paid a management fee of $131,000 to State Auto P&C. Under the Farmers Casualty Management Agreement, specific services were assignable to State Auto P&C by resolution of the Boards of Farmers Casualty and Mid-Plains. The fee due was dependent on the scope of the services assigned but it was capped at 0.75% of direct written premium. 7 As mentioned above, as of January 1, 2000, the 2000 Management Agreement (the "2000 Management Agreement") (became effective among State Auto P&C, Mutual, Milbank, National, SAIC, Stateco, S.I.S. and 518 PML. The 2000 Midwest Management Agreement (the "2000 Midwest Management Agreement") became effective among State Auto P&C, Mutual and Midwest Security, while the 2000 Farmers Casualty Management Agreement (the "2000 Farmers Casualty Management Agreement") became effective among State Auto P&C, Mutual, Farmers Casualty and Mid-Plains. Under these management agreements, every person providing services to the Company, Mutual and Midwest Security is specifically designated an employee of State Auto P&C. Under these management agreements, employees of State Auto P&C perform every service required in the management and operation of each party to the agreement. All costs incurred by Mutual with respect to underwriting expenses and loss expenses incurred on behalf of Mutual, State Auto P&C, Milbank, Midwest Security, Farmers Casualty and SAIC are shared through the 2000 Pooling Agreement. See "Pooling Arrangement" in the "Narrative Description of Business". For those insurers not party to the 2000 Pooling Agreement, National and Mid-Plains, expenses directly attributable to a particular company continue to be charged to that company and expenses of personnel who are not dedicated entirely to work for a particular company are allocated among the companies based on an estimate of time devoted by such personnel to each company for which services are rendered. Each party to the 2000 Management Agreement pays State Auto P&C a quarterly fee equal to 4% of the three year average of the Managed Companies' surplus (less other Managed Companies). Under the 2000 Midwest Management Agreement, Midwest Security pays State Auto P&C a fee equal to 0.75% of its direct written premium of Midwest Security and Farmers Casualty and Mid-Plains pay 0.75% of direct written premium under the 2000 Farmers Casualty Agreement. The 2000 Management Agreement imposes a performance standard which could result in State Auto P&C not being entitled to the fee for a particular quarter if a managed company's performance does not meet the performance standard incorporated in the agreement. In 2000, the managed companies paid a management fee of $19.0 million to State Auto P&C. The Ohio Department of Insurance (the "Department") has requested that, beginning in 2001, Mutual file an analysis on a quarterly basis with the Department that justifies the apportionment of the service fee paid by Mutual to State Auto P&C under the 2000 Management Agreement under the accounting guidance outlined in Statement of Statutory Accounting Principles No. 70 - Allocation of Expenses ("SSAP No. 70"). The Company believes its accounting for such service fee is consistent with all statutory accounting principles. However, there can be no assurance that all or any part of the service fee paid by Mutual will be justified to the Department's satisfaction, which may affect the amount of such fee recognized as revenue by Company. The 2000 Management Agreement and 2000 Midwest Management Agreement set forth 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 a four-member coordinating committee consisting of two directors of Mutual, who represent the interests of Mutual and its subsidiary, and two directors of the Company, who represent the interests of State Auto Financial and its subsidiaries. This committee reviews and evaluates the business opportunity using such factors as it considers relevant. Based upon such review and evaluation, this committee then makes recommendations to the respective boards of directors as to whether or not such business opportunity should be pursued and if so, by which company. The Boards of Directors of Mutual, State Auto Financial and, when appropriate, a subsidiary, must then act on the recommendation of the committee after considering all other factors they deem relevant. Each of the 2000 Management Agreement, the 2000 Midwest Management Agreement and the 2000 Farmers Casualty Management Agreement has a ten-year term ending December 31, 2009, and automatically renews for an additional ten-year term unless sooner terminated in accordance with its terms. The 2000 Management Agreement may also be terminated by any of the managed companies upon events constituting a change of control or potential change of control (as defined in the 2000 Management Agreement) of the Company, upon agreement between a managed company and State Auto P&C and, the agreement is terminated automatically with respect to a party if it is subject to insolvency proceedings. If the 2000 Management Agreement is terminated for any reason, the Company would have to locate facilities to continue its operations. Investment management services are provided by Stateco. See "Investment Management Services" in the "Narrative Description of Business." 8 STANDARD INSURANCE SEGMENT The Company's share of the business written by the Pooled Companies constitutes the Company's standard insurance segment. This includes personal and commercial property and casualty insurance lines, including automobile, homeowners, commercial multi-peril, workers' compensation, liability, fire and other lines of business. Independent insurance agencies constitute the Company's sales force for both the standard insurance products and the non-standard insurance products. Footnote 14 in the Company's Consolidated Financial Statements included herewith sets forth the amount of the Company's net earned premiums by line of insurance for both standard lines and nonstandard lines. As mentioned above, the insurance business of Mutual, State Auto P&C, Milbank, Midwest Security, Farmers Casualty, and as of January 1, 2000, SAIC, is combined through the Pooling Arrangement. This Pooling Arrangement effectively gives each of the Pooled Companies an identical mix of personal and commercial business as written by all six insurers. The Pooled Companies products' sales are predominantly personal lines. The insurance businesses of National and Mid-Plains, are not included in the Pooling Arrangement. Except for reinsurance arrangements between each of these companies and Mutual, 100% of each Company's business remains in the Company. Both National's and Mid-Plains' products are personal lines auto insurance products written for non-standard risks, with less restrictive underwriting criteria and higher rates than those applicable to standard risks. The Company uses computer-based underwriting procedures for its personal lines business. Under such procedures, applications for such business may be accepted or rejected based upon established underwriting guidelines. Applications that do not meet guidelines for automated acceptance are referred to personal lines specialists who review the applications and assess exposure. During the underwriting process, risks are also reviewed to determine whether or not they are acceptable as submitted by the independent agents as preferred, standard or non-standard risks. While personal lines specialists have underwriting and sales responsibilities, the Company has begun experimenting with a new sales effort in personal lines. It has created a position called Personal Lines Sales Specialist, whose primary responsibilities are to have regular personal contact with a group of agencies for the purpose of making those agencies more aware of the Company's personal lines product portfolio. The following table sets forth the statutory loss ratios by line of insurance and the combined ratio for the standard insurance segment of the Company's business, prepared in accordance with accounting practices prescribed or permitted by state insurance authorities, for the periods indicated. The loss ratio is the ratio of incurred losses and associated expenses to net earned premiums ("loss ratio"). The combined ratio is a traditional measure of underwriting profitability. The combined ratio is the sum of (a) the loss ratio; and (b) the ratio of expenses incurred for commissions, premium taxes, administrative and other underwriting expenses, to net written premium ("expense ratio"). When the combined ratio is under 100%, underwriting results are generally considered profitable. Conversely, when the combined ratio is over 100%, underwriting results are generally considered unprofitable. The combined ratio does not reflect investment income or federal income taxes. The Company's operating income depends on income from underwriting operations, investments and management fees. 9

Year Ended December 31(1) ----------------------------------------- 2000 1999 1998 ---- ---- ---- Loss ratios: Automobile...................................... 66.7% 65.2% 65.7% Homeowners and Farmowners.................. 78.8% 75.3% 86.0% Commercial multi-peril..................... 63.0% 69.9% 57.1% Workers' compensation...................... 65.2% 41.1% 51.1% Fire and allied lines...................... 58.8% 89.2% 81.8% Other commercial liability................. 80.7% 61.4% 61.2% Other personal lines....................... 34.6% 36.3% 32.3% Other commercial lines..................... 9.7% 28.4% 20.0% ---- ---- ---- Total loss ratio................................ 67.6% 67.0% 67.9% Expense ratio................................... 27.1% 29.5% 29.8% ---- ---- ---- Combined ratio.................................. 94.7% 96.5% 97.7% ==== ==== ====

------------------ (1) This reflects a combination of the loss ratios of State Auto P&C, Milbank, Farmers Casualty and SAIC after giving effect to reinsurance and the 2000 Pooling Agreement, the 99 Pooling Agreement and the Amended and Restated Reinsurance Pooling Agreement effective January 1, 1998 (the "98 Pooling Agreement"), respectively. ------------------ NON-STANDARD INSURANCE SEGMENT In October 1991, State Auto Financial formed National to write personal automobile insurance for nonstandard risks. National began writing insurance in Ohio in 1992. It is now licensed in 22 states and active in 18, and is scheduled to begin operations in Florida during 2001. In addition to National, as of January 1, 1999, the Company writes nonstandard auto insurance through Mid-Plains. Mid-Plains operates in Kansas and Iowa. The Company currently does not contemplate combining the operations of Mid-Plains and National. Nonstandard automobile products provide insurance for private passenger automobile risks that are typically rejected or canceled by standard market companies because insureds have poor loss experience or a history of late payments of premium. Nonstandard products are priced to account for the additional risk and expenses normally associated with this market. The following table sets forth the statutory loss ratios and combined ratios of National and Mid-Plains, which are engaged in the nonstandard segment of the business. Year Ended December 31 ------------------------------------------ 2000 1999 1998 ---- ---- ---- Loss Ratio Automobile 81.4% 71.7% 75.0% Expense Ratio 25.2% 29.9% 25.0% ----- ----- ----- Combined Ratio 106.6% 101.6% 100.0% ===== ===== ===== MARKETING In its 26 states of operation, the State Auto Group markets its products through approximately 14,000 insurance agents associated with approximately 2,200 independent insurance agencies. State Auto Financial's acquisition of Farmers Casualty gave the Company the opportunity to enter its 25th and 26th states of operation effective January 1, 1999, adding approximately 200 agencies and 1,200 agents to market its products. Prior to 1999, Farmers Casualty marketed personal lines only; the Company introduced commercial lines to Farmers Casualty's agents in Kansas during 1999 and Iowa agents during 2000. 10 None of the companies in the State Auto Group has any contracts with managing general agencies. State Auto National markets non-standard products exclusively through the Company's network of independent agents. As noted above, State Auto National is licensed in 22 states and operates in 18 states in 2000. Mid-Plains markets nonstandard auto insurance in Iowa and Kansas through the agency network of Farmers Casualty in those states. See "Non-Standard Automobile Insurance" in the "Narrative Description of Business." Because independent insurance agents significantly influence which insurance company their customers select, management views the Company's independent insurance agents as its primary customers. Management strongly supports the independent agency system and believes that maintenance of a strong agency system is essential for the Company's present and future success. As such, the Company continually develops programs and procedures to enhance agency relationships. Examples include regular travel by senior management and branch office staff to meet with agents, in person, in their home states, training opportunities, an agent stock purchase plan and an agent stock option plan. The Company actively helps its agencies develop professional sales skills within their staff. The training programs include both products and sales training in concentrated programs in the Company's home office. Further, the training programs include disciplined follow-up and coaching for an extended time. The Company takes a leadership role in the insurance industry with respect to agency automation, promoting single entry multi-company interface using industry standards, especially through software developed and marketed by S.I.S. (SEMCI Partner(R)). Since agents and their customers realize better service and efficiencies through automation, they value their relationship with the Company and it makes the Company attractive to new agency appointments. The Company shares the cost of approved advertising with selected agencies. The Company provides agents with certain travel and cash incentives if they achieve certain sales and underwriting profit levels. Further, the Company recognizes its very top agencies as Inner Circle Agents. Inner Circle Agents are rewarded with additional trip and financial incentives, including additional profit sharing bonus and additional contributions to their Inner Circle Agent Stock Purchase Plan, which is part of the Agent Stock Purchase Plan described below. To strengthen agency commitment to producing profitable business and further develop its agency relationships, the Company's Agent Stock Purchase Plan offers its agents the opportunity to use commission income to purchase the Company's stock. The Company's transfer agent administers the plan using commission dollars assigned by the agents to purchase shares on the open market through a broker. As of year-end 2000, 278 agencies participated in this agent stock purchase plan. In addition to the Agent Stock Purchase Plan, the Company has created an Agent Stock Option Plan incentive for a select group of agencies which represent the Company. If an agent/agency meets specific annual production and profitability requirements during a five-year period the agent participates in the plan, that agent/agency vests State Auto Financial stock options granted annually at the market price on the day of the grant. Vested options are exercisable and have a 10-year term from date of grant. Under the Company's agency agreements with its independent insurance agencies, each agent the Company licenses is authorized to sell and bind coverage in accordance with established procedures. They are also authorized to collect and remit premiums. The authority of agents to bind an insurance company is common practice in the property and casualty insurance industry. The Company controls risk by its right to terminate coverage on a policy bound by the agent. In addition, the Company does not grant binding authority for risks it considers to present a greater than normal exposure to loss. Each agency receives a percentage of direct premiums written as a commission. As bonus compensation, the 11 agency receives a share of the underwriting profits generated by their policies. This is subject to certain qualifying conditions as set forth in the agency agreement. The Company receives premiums on products marketed in Alabama, Arkansas, Florida, Georgia, Illinois, Indiana, Iowa, Kansas, Kentucky, Maryland, Michigan, Minnesota, Mississippi, Missouri, North Carolina, North Dakota, Ohio, Oklahoma, Pennsylvania, South Carolina, South Dakota, Tennessee, Utah, Virginia, West Virginia and Wisconsin. During 2000, the seven states that contributed the greatest percentage of direct premiums written to the State Auto Group were Ohio (21.0%), Kentucky (11.0%), Tennessee (7.0%), South Carolina (6.0%), Pennsylvania (5.0%), North Carolina (5.0%) and Maryland (4.0%). CLAIMS Insurance claims on policies written by the Company are usually investigated and settled by staff claims adjusters. The Company's claims policy emphasizes timely investigation of claims, settlement of meritorious claims for equitable amounts, maintenance of adequate reserves for claims, and control of external claims adjustment expenses. This claims policy is designed to support the Company's marketing efforts by providing agents and policyholders with prompt service. Claim settlement authority levels are established for each adjuster, supervisor and manager based on his or her level of expertise and experience. Upon receipt, each claim is reviewed and assigned to an adjuster based upon its type, severity and class of insurance. The claims department is responsible for reviewing the claim, obtaining necessary documentation and establishing loss and expense reserves of certain claims. Any property or casualty claims estimated to reach $100,000 or above are sent to the home office to be supervised by claims department specialists. In territories in which there is not sufficient volume to justify having full-time adjusters, the Company uses independent appraisers and adjusters to evaluate and settle claims under the supervision of claims department personnel. The Company attempts to minimize claims costs by settling as many claims as possible through its internal claims staff and, if possible, by settling disputes regarding automobile physical damage and property insurance claims (first party claims) through arbitration. In addition, selected agents have authority to settle small first party claims which improves claims service. The Company's in-house trial counsel operation in Cleveland, Ohio, which represents insureds in third party litigation, continues its operation, having added a fourth attorney in 1998. The Company also has added a third lawyer to the in-house trial counsel's office in Baltimore, Maryland. It has no immediate plans to add in-house trial counsel in any other territories where it operates. The third party, proprietary bodily injury evaluation software which claims representatives use to help them value bodily injury claims, except for the most severe injury cases, continues to be a valuable tool for the Company. The Central Claims Department ("CCD") created in the Company's home office in 1998 has expanded in size since its inception, both in terms of the volume of claims handled and the number of individuals working in the unit without a net increase in the number of employees in the Claims Department. The Claims Department also provides 24 hour, 7 days a week claim service through associates in the home office. RESERVES Loss reserves are management's best estimates at a given point in time of what an insurer expects to pay to claimants, based on facts, circumstances and historical trends then known. It can be expected that the ultimate liability will exceed or be less than such estimates. During the loss settlement period, additional facts regarding individual claims may become known, and consequently it often becomes necessary to refine and adjust the estimates of liability. The Company maintains reserves for the eventual payment of losses and loss expenses for both reported claims and incurred claims that have not yet been reported. Loss expense reserves are intended 12 to cover the ultimate costs of settling all losses, including investigation and litigation costs from such losses. Reserves for reported losses are established on either a case-by-case or formula basis depending on the type and circumstances of the loss. The case-by-case reserve amounts are determined based on the Company's reserving practices, which take into account the type of risk, the circumstances surrounding each claim and policy provisions relating to types of loss. The formula reserves are based on historical paid loss data for similar claims with provisions for trend changes caused by inflation. Loss and loss expense reserves for incurred claims that have not yet been reported are estimated based on many variables including historical and statistical information, inflation, legal developments, storm loss estimates, and economic conditions. Loss reserves are reviewed on a regular basis and as new data becomes available, estimates are updated resulting in adjustments to loss reserves. Although management uses many resources to calculate reserves, there is no precise method for determining the ultimate liability. The Company does not discount loss reserves for financial statement purposes. 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, 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 Mutual. As of December 31, 2000, there has been no adverse development of these reserves. In the event Mutual becomes financially impaired, and subject to regulatory restrictions, it may be unable to make any such reimbursement. The following table presents one-year development information on changes in the reserve for loss and loss expenses of the Company for the three years ended December 31, 2000.

Year Ended December 31 -------------------------------------------- 2000 1999 1998 --------- --------- --------- (in thousands) Reserve for losses and loss expenses At beginning of year (1) $ 221,682 $ 205,034 $ 194,155 --------- --------- --------- Provision for losses and loss Expenses occurring: Current year 277,805 271,507 255,885 Prior years(2) (5,638) (6,878) (13,591) --------- --------- --------- Total 272,167 264,629 242,294 --------- --------- --------- Loss and loss expense payments For claims occurring during: Current year 164,620 168,512 157,988 Prior years 104,871 100,349 86,671 --------- --------- --------- Total 269,491 268,861 244,659 --------- --------- --------- Impact of acquisition of Farmers Casualty and Mid-Plains, 1/1/99 -- 13,247 -- Impact of pooling change 1/1/00, 1/1/99 and 1/1/98 (3) 12,295 7,633 13,244 --------- --------- --------- Reserve for losses and loss expenses at end of year (1) $ 236,653 $ 221,682 $ 205,034 ========= ========= =========

--------------- (1) This line item is net of reinsurance recoverable on losses and loss expenses payable of approximately, $7,930,000, $10,807,000, and $12,416,000 for the years 2000, 1999, and 1998, respectively. 13 (2) This line item shows redundancies in the provision for losses and loss expenses attributable to prior years in the amounts of approximately $5,638,000, $6,878,000, and $13,591,000 for the years 2000, 1999, and 1998, respectively. The change in the redundancy over the three year period ending December 31, 2000 has resulted primarily from less favorable development in the long-tail lines such as general liability, commercial auto liability, workers' compensation and no-fault insurance. (3) This line item represents the increase in loss and loss expense reserves due to the Company's change in pooling participation percentages effective January 1, 2000, 1999 and 1998, respectively. ---------------- The following table sets forth the development of reserves for losses and loss expenses from 1990 through 2000 for the Company. "Net liability for losses and loss expenses payable" sets forth the estimated liability for unpaid losses and loss expenses recorded at the balance sheet date, net of reinsurance recoverables, for each of the indicated years. This liability represents the estimated amount of losses and loss expenses for claims arising in the current and all prior years that are unpaid at the balance sheet date, including losses incurred but not reported to the Company. The lower portion of the table shows the re-estimated amounts of the previously reported reserve based on experience as of the end of each succeeding year. The estimate is increased or decreased as more information becomes known about the claims incurred. The upper section of the table shows the cumulative amounts paid with respect to the previously reported reserve as of the end of each succeeding year. For example, through December 31, 2000, the Company had paid 70.2% of the currently estimated losses and loss expenses that had been incurred, but not paid, as of December 31, 1991. The amounts on the "cumulative redundancy (deficiency)" line represent the aggregate change in the estimates over all prior years. For example, the 1990 reserve has developed a $9.2 million redundancy through December 31, 2000. That amount has been included in operations over the ten years and did not have a significant effect on income of any one year. The effects on income caused by changes in estimates of the reserves for losses and loss expenses for the most recent three years are shown in the foregoing three-year loss development table. In evaluating the information in the table, it should be noted that each amount includes the effects of all changes in amounts for prior periods. For example, the amount of the redundancy related to losses settled in 1995, but incurred in 1992, will be included in the cumulative redundancy amount for years 1992, 1993 and 1994. The table does not present accident or policy year development data, which readers may be more accustomed to analyzing. Conditions and trends that have affected the development of the liability in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate future redundancies or deficiencies based on this table. Effective January 1, 1992, the pooling percentage was changed whereby State Auto P&C increased its share in the pooled losses and loss expenses from 20% to 30%. This increase is reflected in the 1992 column. Effective January 1, 1995, the pooling percentage was again changed adding Milbank to the pool and increasing State Auto P&C's share in the pooled losses and loss expenses from 30% to 35%. This increase is reflected in the 1995 column. In 1998, 1999 and 2000, the pooling arrangement was amended to increase the Company's share of premiums, losses and expenses. An amount of assets equal to the increase in net liabilities was transferred to the Company from Mutual in 1992, 1995, 1998, 1999 and 2000 in conjunction with each year's respective pooling change. The amount of the assets transferred from Mutual in 1992, 1995, 1998, 1999 and 2000 has been netted against and has reduced the cumulative amounts paid for years prior to 1992, 1995, 1998, 1999 and 2000, respectively. [See table on following page.] 14

State Auto Financial Corp. Years Ended December 31 ------------------------------------------------------------------------------------------------------ 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 (Dollars in Thousands) Net liability for losses and loss expenses payable $65,464 $71,139 $119,044 $123,337 $126,743 $206,327 $199,480 $194,155 $205,034 $221,682 $236,657 Paid (cumulative) as of: One year later 43.3% 12.2% 41.3% 42.2% 1.5% 38.2% 39.4% 32.7% 35.4% 41.8% -- Two years later 46.1% 43.0% 60.9% 41.3% 29.1% 55.4% 54.1% 54.6% 61.6% Three years later 62.9% 58.7% 60.6% 55.6% 44.5% 63.3% 65.0% 70.1% Four years later 71.8% 58.4% 68.0% 64.5% 51.0% 67.7% 73.2% Five years later 72.1% 63.9% 71.9% 67.2% 54.6% 71.9% Six years later 75.5% 67.5% 72.5% 69.0% 58.8% Seven years later 77.8% 67.7% 73.7% 72.1% Eight years later 77.1% 69.0% 75.2% Nine years later 77.5% 70.2% Ten years later 78.5% Net liability re-estimate as of: One year later 95.4% 91.2% 92.7% 93.7% 87.4% 87.0% 91.3% 93.0% 96.6% 97.5% -- Two years later 92.1% 87.2% 90.5% 90.0% 77.1% 86.4% 87.3% 92.0% 96.7% Three years later 89.7% 85.4% 87.6% 85.0% 77.0% 83.2% 86.7% 91.9% Four years later 88.1% 84.5% 85.6% 86.3% 72.9% 81.6% 87.0% Five years later 89.7% 82.3% 87.3% 82.8% 70.9% 81.3% Six years later 88.4% 86.7% 84.5% 81.6% 70.0% Seven years later 93.2% 83.1% 83.0% 80.8% Eight years later 89.5% 81.0% 82.0% Nine years later 87.2% 79.4% Ten years later 85.9% Cumulative redundancy (deficiency) $9,239 $14,671 $21,371 $23,701 $38,042 $38,624 $25,919 $15,696 $6,812 $5,638 -- Cumulative redundancy (deficiency) 14.1% 20.6% 18.0% 19.2% 30.0% 18.7% 13.0% 8.1% 3.3% 2.5% -- Gross* liability - end of year $224,771 $245,929 $277,783 $412,553 $410,658 $402,718 $414,268 $438,747 Reinsurance receivable $105,727 $122,591 $151,040 $206,226 $211,178 $208,563 $209,234 $217,065 Net liability - end of year $119,044 $123,337 $126,743 $206,327 $199,480 $194,155 $205,034 $221,682 Gross liability re-estimated - latest 94.9% 97.4% 92.0% 83.7% 89.3% 92.3% 98.2% 96.0% Reinsurance receivable re-estimated - latest 109.4% 114.1% 110.4% 86.1% 91.5% 92.7% 99.7% 94.6% Net liability re-estimated - latest 82.1% 80.8% 70.0% 81.3% 87.0% 91.9% 96.7% 97.5%

* Gross liability includes: Direct & assumed losses & loss expenses payable. 15 The following table is a reconciliation as of each December 31 of losses and loss expenses payable, computed under generally accepted accounting principles ("GAAP"), to losses and loss expenses payable, computed under statutory accounting principles used by insurance companies for reporting to state insurance regulators ("STAT"):

2000 1999 1998 ---- ---- ---- (in thousands) GAAP losses and loss expenses payable $244,583 $232,489 $217,450 Less: ceded reinsurance recoverable on losses and loss expenses payable 7,930 10,807 12,416 Add: salvage and subrogation Recoverable 13,402 13,505 12,817 -------- -------- -------- STAT losses and loss expenses payable $250,055 $235,187 $217,851 ======== ======== ========

REINSURANCE The Company, Mutual and Midwest Security follow the customary industry practice of reinsuring a portion of their exposures and paying to the reinsurers a portion of the premiums received on all policies. Insurance is ceded principally to reduce net liability on individual risks or for individual loss occurrences, including catastrophic losses. Effective January 1, 2000, reinsurance premiums and reimbursements are allocated among State Auto P&C, Milbank, Mutual, Midwest Security, Farmers Casualty and SAIC according to their relative pooling percentages. National and Mid-Plains do not directly participate in the Pooling Arrangement. Although reinsurance does not legally discharge State Auto P&C, Mutual, National, Milbank, Midwest Security, Farmers Casualty, Mid-Plains or SAIC from primary liability for the full amount of limits applicable under their policies, it does make the assuming reinsurer liable to the extent of the reinsurance ceded. Each member of the State Auto Group has separate working reinsurance treaties for property and casualty lines with several reinsurers arranged through a reinsurance broker. Under the property excess of loss treaty, each member of the State Auto Group is responsible for the first $2.0 million of each defined loss and the reinsurers are responsible for 100% of the excess over $2.0 million up to $10.0 million of such defined loss, depending upon the nature of the injury or damage. The rates for this reinsurance are negotiated annually. The terms of the casualty excess of loss program provide that each company in the State Auto Group is responsible for the first $2.0 million of a covered loss. The reinsurers are responsible for 100% of the loss excess of $2.0 million and up to $5.0 million. Also, certain unusual claim situations involving bodily injury liability, property damage liability, uninsured motorist, personal injury protection and workers' compensation insurance are covered by an arrangement which provides for $10.0 million of coverage above a $5.0 million retention for each loss occurrence. This layer of reinsurance sits above the $3.0 million excess of $2.0 million arrangement. In addition, the State Auto Group has secured other reinsurance to limit the net cost of large loss events for certain types of coverages. Included are umbrella liability losses which are reinsured up to a limit of $15.0 million above a maximum $600,000 retention. The State Auto Group also makes use of the facultative market for unique risk situations and participates in involuntary pools and associations in certain states. State Auto P&C, Mutual, Milbank, Midwest Security, National, Farmers Casualty, Mid-Plains and SAIC combined retain the first $40 million of each occurrence. Eighty ($80) million dollars of traditional reinsurance is available above the $40 million retention with a co-participation of the above named companies of 5%. 16 In the event the State Auto Group incurs catastrophe losses in excess of $120.0 million, State Auto Financial has implemented a structured contingent financing transaction with Bank One ("Bank One") to provide up to $115.0 million to be used to cover such catastrophe losses. This arrangement, effective November 17, 2000, replaced the prior structured contingent financing transaction State Auto Financial had with Bank One effective November 19, 1999. Under this arrangement, in the event of such a loss, State Auto Financial would issue and sell redeemable preferred shares to SAF Funding Corporation, a special purpose company ("SPC"), which will borrow the money necessary for such purchase from Bank One and a syndicate of other lenders (the "Lenders"). State Auto Financial will contribute to State Auto P&C the proceeds from the sale of its preferred shares. State Auto P&C has assumed catastrophe reinsurance from Mutual, Milbank, Midwest Security, National, Farmers Casualty, Mid-Plains, and SAIC, pursuant to a Catastrophe Assumption Agreement in the amount of $115.0 million excess of $120.0 million. State Auto P&C will use the contributed capital to pay its direct catastrophe losses and losses assumed under the Catastrophe Assumption Agreement. State Auto Financial is obligated to repay SPC (which will repay the Lenders) by redeeming the preferred shares over a six-year period. This layer of $115.0 million in excess of $120.0 million has been excluded from the Pooling Arrangement as well by virtue of the 2000 Pooling Agreement. See "Pooling Arrangement" in the "Narrative Description of Business." In addition, State Auto Financial's obligation to repay SPC has been secured by a Put Agreement among State Auto Financial, Mutual and the Lenders, under which, in the event of a default by State Auto Financial as described in the Credit Agreement or in the Put Agreement, Mutual would be obligated to put either the preferred shares or the loan(s) outstanding. National has a reinsurance agreement with Mutual pursuant to which Mutual assumes all liability losses in excess of National's first $50,000 of retention. Mutual further provides National with an 8.5% quota share within the $50,000 retention on liability coverages and a 20% quota share on physical damage coverages. Mid-Plains also has a reinsurance agreement with Mutual pursuant to which Mutual reinsures Mid-Plains for $450,000 in excess of Mid-Plains' first $50,000 of retention on liability coverages. REGULATION Most states have enacted legislation that regulates insurance holding company systems. Ohio, the domiciliary state of Mutual, National, and SAIC, has adopted legislation regulating the activities of those companies. South Carolina has adopted legislation regulating the activities of State Auto P&C as the South Carolina domiciled member of the holding company system, as have South Dakota and Wisconsin, which are the domiciliary regulators of Milbank and Midwest Security, respectively, and Iowa which regulates Farmers Casualty and Mid-Plains. Each insurance company in the holding company system is required to register with the insurance supervisory agency of its state of domicile and furnish information concerning the operations of companies within the holding company system that may materially affect the operations, management or financial condition of the insurers within the system. Pursuant to these laws, the respective insurance departments may examine Mutual, State Auto P&C, Milbank, Midwest Security, Farmers Casualty, SAIC, National and Mid-Plains at any time, require disclosure of material transactions involving insurer members of the holding company system and require prior notice and an opportunity to disapprove of certain "extraordinary" transactions, including, but not limited to, extraordinary dividends from State Auto P&C, Milbank, Farmers Casualty, SAIC and National to State Auto Financial. Pursuant to these laws, all transactions within the holding company system affecting Mutual, State Auto P&C, Milbank, Midwest Security, Farmers Casualty, SAIC, National or Mid-Plains must be fair and equitable. In addition, approval of the applicable Insurance Commissioner is required prior to the consummation of transactions affecting the control of an insurer. South Carolina insurance law provides that no person may acquire direct or indirect control of State Auto P&C unless that person has obtained the prior written approval of the Chief Insurance Commissioner of South Carolina for such acquisition. Ohio has similar statutory provisions in place which would be applicable to National and SAIC, as does South Dakota for Milbank, Wisconsin for Midwest Security and Iowa for Farmers Casualty and Mid-Plains. 17 In addition to being regulated by the insurance department of its state of domicile, each insurance company is subject to supervision and regulation in the states in which it transacts business, and such supervision and regulation relate to numerous aspects of an insurance company's business operations and financial condition. The primary purpose of such supervision and regulation is to ensure financial stability of insurance companies for the protection of policyholders. The laws of the various states establish insurance departments with broad regulatory powers relative to granting and revoking licenses to transact business, regulating trade practices, licensing agents, approving policy forms, setting reserve requirements, determining the form and content of required statutory financial statements, prescribing the types and amount of investments permitted and requiring minimum levels of statutory capital and surplus. Although premium rate regulation varies among states and lines of insurance, such regulations generally require approval of the regulatory authority prior to any changes in rates. In addition, all of the states in which the State Auto Group transacts business have enacted laws which restrict these companies' underwriting discretion. Examples of these laws include restrictions on policy terminations, restrictions on agency terminations and laws requiring companies to accept any applicant for automobile insurance. These laws may adversely affect the ability of the insurers in the State Auto Group to earn a profit on their underwriting operations. Insurance companies are required to file detailed annual reports with the supervisory agencies in each of the states in which they do business and their business and accounts are subject to examination by such agencies at any time. There can be no assurance that such regulatory requirements will not become more stringent in the future and have an adverse effect on the operations of the State Auto Group. Dividends. State Auto P&C, Milbank, Farmers Casualty, SAIC and National are subject to regulations and restrictions under which payment of non-extraordinary dividends from statutory surplus can be made to State Auto Financial during the year without prior approval of regulatory authorities. State Auto Financial's insurer subsidiaries are permitted to pay dividends without prior approval from their respective domiciliary insurance departments unless the dividend is an "extraordinary dividend." While the statutes affecting each insurer subsidiary of State Auto Financial have different words, there is a common thread that runs through each state's statute regulating extraordinary dividends. That thread is the basic definition of an extraordinary dividend which is the greater of 10% of the insurer's surplus or net income. In three states, Ohio, South Carolina and South Dakota, there is excluded from the net income of the insurer a distribution of the insurers own securities. In South Carolina, net realized capital gains and losses are excluded from the calculation of annual net income. In South Dakota, annual net income excludes net realized capital gains that exceed 20% of net unrealized capital gains. The laws of South Carolina, Iowa and Ohio also require advance notice of payment of an ordinary dividend. In addition, by acting within a statutory time frame, the insurance commissioner in each state has the authority to limit ordinary dividends if an insurer's surplus as regards policyholders is not reasonable in relation to the insurer's outstanding liabilities and adequate to its financial needs. Pursuant to these rules, a total of $44.9 million is available for payment to State Auto Financial as a dividend from State Auto P&C, Milbank, Farmers Casualty, SAIC and National during 2001 without prior approval from the South Carolina, South Dakota, Iowa and Ohio Insurance Departments, respectively, under current law. Rate and Related Regulation. The Company is not aware of any adverse legislation or regulation that has been adopted by any state where the Company did business during 2000 which would present material obstacles to the Company's overall business. In an attempt to make capital and surplus requirements more accurately reflect the underwriting risk of different lines of insurance as well as investment risks that attend insurers' operations, the NAIC has tested insurer's risk-based capital requirements since 1994. As of December 31, 2000, each insurer 18 affiliated with the Company exceeded all standards tested by the formula applying risk-based capital requirements. While the insurance industry is regulated by the states, federal financial services reform legislation enacted into law in late 1999 will likely affect the property casualty insurance business. This federal legislation, known as the Gramm Leach Bliley Act, generally permits "financial holding companies" to own insurers. This new law is expected to have an impact on the property casualty industry marketplace, although the nature and extent of the impact is yet uncertain. It could increase the level of competition; it could bring additional capital into the insurance marketplace, which could have a negative impact on product pricing. It also is unclear how insurers owned by "financial holding companies" will be regulated as compared with other insurers. The legislation could have an adverse affect on state regulation, which has its own set of uncertain consequences. This change in the federal law will have ramifications on the Company as well as the insurance business as a whole. The Company is still assessing the impact of this law change on its business. Enhanced privacy regulation is one consequence of Gramm Leach Bliley. Virtually every state has sought to impose additional restrictions on insurers in sharing information among affiliates which could increase the Company's expenses. The property and casualty insurance industry is also affected by court decisions. Premium rates are actuarially determined to enable an insurance company to generate an underwriting profit. These rates contemplate a certain level of risk. The courts may modify, in a number of ways, the level of risk which insurers had expected to assume including eliminating exclusions, multiplying limits of coverage, creating rights for policyholders not intended to be included in the contract and interpreting applicable statutes expansively to create obligations on insurers not originally considered when the statute was passed. Courts have also undone legal reforms passed by legislatures, which reforms were intended to reduce a litigant's rights of action or amounts recoverable and so reduce the costs borne by the insurance mechanism. These court decisions can adversely affect an insurer's profitability. They also create pressure on rates charged for coverages adversely affected and this can cause a legislative response resulting in rate suppression that can adversely affect an insurer. The Ohio Supreme Court has issued several decisions expanding the scope of uninsured and underinsured motorists coverage for policies issued in Ohio beyond what the insurance industry expected or intended. Much of this expansion has had retroactive effect. The Company has reviewed these court decisions and determined their impact not to be material to the Company's financial position. It is not possible to anticipate the impact of future decisions affecting this coverage. INVESTMENTS The Company's investment portfolio is managed to provide growth of statutory surplus in order to facilitate increased premium writings over the long term while maintaining the ability to service current insurance operations. The primary objectives are to generate income, preserve capital and maintain liquidity. The Company's investment portfolio is managed separately from that of Mutual and its affiliates and investment results are not shared by each of the Pooled Companies through the pooling arrangement. The investment management services on behalf of the Company and Mutual and its subsidiaries are performed by Stateco, although investment policies to be implemented by Stateco continue to be set for each company through the Investment Committee of its Board of Directors. See "Investment Management Services" in the "Narrative Description of Business." The Company's decision to make a specific investment is influenced primarily by the following factors: (a) investment risks; (b) general market conditions; (c) relative valuations of investment vehicles; (d) general market interest rates; (e) the Company's liquidity requirements at any given time; and (f) the Company's current federal income tax position and relative spread between after tax yields on tax-exempt and taxable fixed income investments. The Company has investment policy guidelines with respect to purchasing fixed income investments which preclude investments in bonds that are rated below investment grade by a recognized rating service. The maximum investment in any single note or bond is limited to 5.0% of assets, other than obligations of the U.S. government or government agencies, for which there is no limit. Investments in equity securities are selected based on their potential for 19 appreciation as well as ability to continue paying dividends. (See discussion regarding Market Risk included in Part II - Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations"). Strategies as to specific investments can change depending on the Company's current federal tax position, market interest rates and general market conditions. Consequently, pursuant to the Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities," the Company segregates a portion of its fixed maturity investments for the purpose of providing greater flexibility in the investment portfolio. Fixed maturities that are purchased with the intention and ability of holding them until maturity are categorized as held-to-maturity and carried at amortized cost. Fixed maturities that may be sold, thereby providing the Company the flexibility noted above, are categorized as available-for-sale and are carried at fair value. Fixed maturities available-for-sale totaled $653.3, and $527.8 million at December 31, 2000 and 1999, respectively. During 1997, the Company began a program to build on the equity portfolio to enhance growth of surplus over the long term. At December 31, 2000 and 1999, respectively, the equity portfolio totaled $58.3 and $55.5 million. The table below provides information about the quality of the Company's fixed maturity portfolio: Bond Portfolio Quality Investment Grade Corporates and Municipals 81.9% (Rated AA or better) U.S. Governments 13.3% U.S. Government Agencies 4.8% The following table sets forth the Company's investment results for the periods indicated: Year Ended December 31 ------------------------------------- 2000 1999 1998 ---- ---- ---- (Dollars in thousands) Average invested assets (1) $712,627 $633,989 $571,152 Net investment income (2) $38,915 $34,262 $32,506 Average yield 5.5% 5.4% 5.7% -------------- (1) Average of the aggregate invested assets at the beginning and end of each period. Invested assets include fixed maturities at amortized cost, equity securities at cost and cash equivalents. (2) Net investment income is net of investment expenses and does not include realized or unrealized investment gains or losses or provision for income taxes. -------------- INVESTMENT MANAGEMENT SERVICES Stateco has been providing investment management services since 1993. These services are provided to all insurance companies affiliated with the Company or Mutual, including Mutual, Midwest Security, State Auto P&C, Milbank, Farmers Casualty, SAIC, National and Mid-Plains. Stateco has entered into an Investment Management Agreement with each of these entities, pursuant to which Stateco manages the investment portfolios of these companies and receives an investment management fee 20 based on performance and the size of the portfolio managed for each affiliate. The Investment Committee of each insurer's Board of Directors sets investment policies to be followed by Stateco. INSURANCE PREMIUM FINANCE SERVICES Through Stateco, the Company provides insurance premium finance services to certain policyholders of Mutual, State Auto P&C and Milbank. Premiums for property and casualty insurance are typically payable at the time a policy is placed in force or renewed. On certain large commercial policies, the premium cost may be difficult for a policyholder to pay in one sum. Stateco makes loans to commercial insurance policyholders for the term of an insurance policy to enable them to pay the insurance premium in installments over the term of the policy, and retains a contractual right to cancel the insurance policy if the loan installment is not paid on a timely basis. Stateco's revenue from its insurance premium finance services is not material to the Company at this time. INSURANCE SOFTWARE BUSINESS S.I.S. is developing and selling software used by insurance companies and agencies to allow more efficient and effective electronic management and communication of policyholder data from insurers to agents (download) and from agents to insurers (upload). S.I.S.' principal product, SEMCI Partner(R), is an alternative to significantly more costly agency management systems. S.I.S. believes SEMCI Partner(R), will be attractive to a substantial segment of independent insurance agencies. While S.I.S.' principal customer from a revenue standpoint is Mutual, it has sold and continues to sell SEMCI Partner(R) directly to agents, including agents who do not represent the State Auto Group. S.I.S.' revenue from SEMCI Partner(R) and other S.I.S. software sales is not material to the Company at this time. S.I.S, which had been a majority-owned subsidiary of the Company through December 31, 1999, is now a wholly owned subsidiary, after it repurchased shares owned by employees and officers of S.I.S. PROPERTY LEASING BUSINESS As noted above, the Company formed 518 PML, an Ohio limited liability company, in December 1997. The members of 518 PML are Stateco and State Auto P&C. Stateco contributed $7.0 million in cash and a parcel of real property located in Goodlettsville, Tennessee, while State Auto P&C contributed real property located in Greer, South Carolina. 518 PML constructed an office building on the real estate in Goodlettsville, which it leased to Mutual commencing in May 1999, for Mutual's Nashville Regional Office facility. 518 PML has leased the Greer property to Mutual to use as its Southern Regional Office facility. In December 2000, 518 PML acquired an office building in West Des Moines, Iowa, that Farmers Casualty had leased for its insurance operations. 518 PML has leased the West Des Moines property to Mutual to use as its Des Moines Regional Office facility. In late 1999, it also began to lease motor vehicles to Mutual for use in its business operations. Revenue from 518 PML is not material to the Company at this time. COMPETITION The property and casualty insurance industry is highly competitive. Price competition has been very intense during recent years. This continued to be true in regards to both commercial lines and personal lines, particularly auto insurance in 2000. Several "national" carriers' active marketing efforts with respect to personal lines auto insurance have had an impact on the market for this coverage. The Company competes with numerous insurance companies, many of which are substantially larger and have considerably greater financial resources. In addition, because the Company's products are marketed exclusively through independent insurance agencies, most of which represent more than one company, the Company faces competition within each agency. See "Marketing" in the "Narrative Description of Business." The Company competes through underwriting criteria, appropriate pricing, and quality service to the policyholder and the agent and through a fully developed agency relations program. 21 PROPOSED TRANSACTIONS WITH MERIDIAN MUTUAL AND MIGI On October 25, 2000, Mutual entered into agreements with Meridian Mutual Insurance Company, an Indiana mutual insurance company ("Meridian Mutual"), and Meridian Insurance Group, Inc., an Indiana corporation ("MIGI"), pursuant to which Meridian Mutual will be merged with and into Mutual, with Mutual continuing as the surviving corporation of the merger (the "Mutual Merger"), and MIGI will be acquired by Mutual through the merger of a wholly owned subsidiary of Mutual with and into MIGI (the "MIGI Merger"). The public shareholders of MIGI will receive $30.00 per share in cash in connection with the MIGI Merger. Each merger is conditioned upon the consummation of the other merger, the receipt of all insurance regulatory approvals, and receipt of antitrust clearance. In addition, the MIGI Merger must be approved by the shareholders of MIGI, and the Mutual Merger must be approved by the policyholders of both Meridian Mutual and Mutual and reapproved by the board of directors of each of Meridian Mutual and Mutual. Meridian Mutual and Mutual have each agreed to vote all MIGI common shares owned by them in favor of the MIGI Merger. Together, these two mutual companies own approximately 57% of MIGI's outstanding common shares. It is anticipated that the Mutual Merger and the MIGI Merger will be completed during the first half of 2001. Meridian Mutual is the controlling company of the "Meridian Mutual Group," which group consists of the following: (i) Meridian Mutual; (ii) MIGI, a publicly traded corporation which is approximately 48.3% owned by Meridian Mutual; (iii) MIGI's direct and indirect subsidiaries, which are Meridian Security Insurance Company, an Indiana-domiciled insurance company ("Meridian Security"), Meridian Citizens Security Insurance Company, an Indiana-domiciled insurance company ("Meridian Citizens Security"), and Insurance Company of Ohio, an Ohio-domiciled insurance company ("ICO"); and (iv) Meridian Citizens Mutual Insurance Company, an Indiana-domiciled mutual insurance company ("Meridian Citizens Mutual"). As of December 31, 2000, the Meridian Mutual Group had approximately 610 employees. The Meridian Mutual Group markets its insurance products through approximately 8,300 independent insurance agents associated with approximately 1,400 agencies in 18 states. Additionally, these insurance products are marketed directly to consumers in two states. The Meridian Mutual Group's insurance products are marketed primarily in the east, mid, and west-central parts of the United States. The following describes certain matters which will occur in the event that the Mutual Merger and the MIGI Merger are consummated: o Through the merger of Meridian Mutual with and into Mutual, the insurance business of Meridian Mutual will become part of the pooling arrangement with the other Pooled Companies. See "Pooling Arrangement" in the "Narrative Description of Business" included elsewhere in this Item 1. Meridian Mutual had approximately $252.3 million in total direct written premiums in 2000. The principal lines of business of Meridian Mutual, based upon direct written premiums for the year ended December 31, 2000, were personal and commercial automobile (approximately 54%), commercial multi-peril (approximately 16%), homeowners and farmowners multi-peril (approximately 14%), and workers' compensation (approximately 11%). o The independent agency system of the Meridian Mutual Group will become part of the independent agency system of the State Auto Group. See "Marketing" in the "Narrative Description of Business" included elsewhere in this Item 1. o As soon as practicable, it is anticipated that all of the employees of the Meridian Mutual Group will become employees of State Auto P&C. Subject to receipt of the regulatory approvals, it is anticipated that MIGI and its insurance subsidiaries and affiliates will enter into agreements with State Auto P&C and Mutual pursuant to which State Auto P&C would perform various functions on behalf of these companies in exchange for a fee and 22 Mutual would provide the use of certain facilities and equipment in exchange for the reimbursement of the costs associated with such usage. See "Management Agreement" in the "Narrative Description of Business" included elsewhere in this Item 1. o Subject to receipt of regulatory approvals, it is anticipated that MIGI's insurance subsidiaries and affiliates will enter into an investment management agreement with Stateco pursuant to which Stateco would manage the investment portfolios of these companies in exchange for an investment management fee. See "Investment Management Services" in the "Narrative Description of Business" included elsewhere in this Item 1. o Subject to receipt of regulatory approvals, it is anticipated that MIGI's insurance subsidiaries and affiliates will become part of the State Auto Group's reinsurance arrangements, including the structured contingent financing arrangements with Bank One. See "Reinsurance" in the "Narrative Description of Business" included elsewhere in this Item 1. EMPLOYEES As of February 27, 2001, the Company had 1,375 employees. Employees of the Company are not covered by any collective bargaining agreement. Management of the Company considers its relationship with its employees to be excellent. EXECUTIVE OFFICERS OF THE REGISTRANT

Name of Executive Officer and Principal Occupation(s) An Executive Officer Position(s) with Company Age During the Past Five Years of the Company Since (1) ------------------------- --- -------------------------- ------------------------ Robert H. Moone, 57 Chairman of the Board of STFC and 1991 Chairman, President and Mutual, 1/1/01 to present; Chief Chief Executive Officer Executive Officer of STFC and Mutual, 5/99 to present; President of STFC and Mutual, 5/96 to present; Executive Vice President, 11/93 to 5/96 and prior thereto Vice President of STFC and Mutual Mark A. Blackburn, 49 Senior Vice President of STFC and 1999 Senior Vice President Mutual, 3/01 to present; Vice President of STFC and Mutual, 8/99 to 3/01; Executive Vice President of Grange Mutual Casualty Insurance Company 4/96 to 4/99; and for more than five years prior thereto, Vice President of General Reinsurance Corporation Michael F. Dodd, 63 Senior Vice President of STFC, 5/91 to 1991 Senior Vice President present; Senior Vice President of Mutual, 2/89 to present Steven J. Johnston, 41 Senior Vice President of STFC and 1994 Senior Vice President, Mutual, 8/99 to present; Treasurer and Treasurer and Chief Chief Financial Officer of STFC and Financial Officer Mutual, 4/97 to present; Vice President of STFC and Mutual, 5/95 to 8/99 John R. Lowther, 50 Senior Vice President of STFC and 1991 Senior Vice President, Mutual, 3/01 to present; Secretary and Secretary and General Counsel of STFC, 5/91 to General Counsel present and of Mutual 8/89 to present; Vice President of STFC, 5/91 to 3/00 and of Mutual 8/89 to 3/00

23

Name of Executive Officer and Principal Occupation(s) An Executive Officer Position(s) with Company Age During the Past Five Years of the Company Since (1) ------------------------- --- -------------------------- ------------------------ Terrence L. Bowshier, 48 Vice President of STFC and Mutual, 3/00 1991 Vice President to present; Vice President and Comptroller of STFC and Mutual, 5/91 to 3/00 James E. Duemey, 54 Vice President and Investment Officer 1991 Vice President of STFC and Mutual, 5/91 to present and Investment Officer William D. Hansen, 35 Vice President of Mutual, 3/00 to 2000 Vice President present; Vice President of STFC, 5/00 to present; Assistant Vice President of Mutual 5/95 to 3/00 Terrence P. Higerd, 56 Vice President of STFC, 5/91 to 1991 Vice President present; Vice President of Mutual, 6/87 to present Noreen W. Johnson, 52 Vice President of STFC and Mutual, 3/98 1998 Vice President to present; Assistant Vice President of Mutual, 3/97 to 3/98; employee of Mutual since 9/92 Robert A. Lett, 61 Vice President of STFC, 3/98 to 1994 Vice President present; Vice President of Mutual, 2/88 to present John B. Melvin, 51 Vice President of STFC, 3/98 to 1994 Vice President present; Vice President of Mutual, 11/93 to present; and prior thereto an officer of Mutual Cathy B. Miley, (2) 51 Vice President of STFC, 3/98 to 1995 Vice President present; Vice President of Mutual, 3/95 to present; Assistant Vice President of Mutual, 8/92 to 3/95 Richard L. Miley, (2) 47 Vice President of STFC, 3/98 to 1995 Vice President present; Vice President of Mutual, 5/95 to present; Assistant Vice President of Mutual, 8/87 to 5/95 John M. Petrucci, 42 Vice President of Mutual, 3/00 to 2000 Vice President present; Vice President of STFC, 5/00 to present; employee of Mutual since 9/96; employee of Allstate Insurance Companies, 9/85 to 9/96 Cynthia A. Powell, 40 Vice President of Mutual, 3/00 to 2000 Vice President present; Assistant Vice President, 8/96 to 3/00; Vice President of STFC 5/00 to present; Assistant Vice President of STFC, 4/97 to 5/00; employee of Mutual since 6/90

(1) Each of the foregoing executive officers has been designated by the Company's Board of Directors as an officer for purposes of Section 16 of the Securities Exchange Act of 1934. (2) Richard L. Miley and Cathy B. Miley are husband and wife. ITEM 2. PROPERTIES Because the operations of the Company and Mutual are integrated with one another pursuant to the terms of the 2000 Management Agreement, the Company and Mutual share their operating facilities. See Item 1, "Management Agreement" in the "Narrative Description of Business." The Company's and Mutual's corporate headquarters are located in Columbus, Ohio in buildings owned by Mutual that contain 24 approximately 270,000 square feet of office space. The Company and Mutual also have regional underwriting and claims office facilities, including a 6,600 square foot branch office in Cleveland, Ohio, owned by Mutual, and a 29,000 square foot branch office in Cincinnati, Ohio, owned by Mutual. In May 1999, an office building constructed by 518 PML containing 38,000 square feet was completed and leased to Mutual as its Nashville Regional Office. Mutual also leases the regional office facility in Greer, South Carolina, from 518 PML. Milbank owns an office facility in Milbank, South Dakota, where Company employees provide services to Milbank agents and policyholders. Midwest Security leases an office facility in Onalaska, Wisconsin, where Company employees service Midwest Security's agents and policyholders. In December 2000, 518 PML acquired a 21,600 square foot office building in West Des Moines, Iowa, that is now leased to Mutual as its Des Moines Regional Office. Mutual also leases a number of small offices throughout its operating area for the claims operations of Mutual and the Company. ITEM 3. LEGAL PROCEEDINGS The Company is a party to a number of lawsuits arising in the ordinary course of its insurance business. Management of the Company believes that the ultimate resolution of these lawsuits will not, individually or in the aggregate, have a material, adverse effect on the financial condition of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Not applicable. PART II ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED SHAREHOLDER MATTERS STOCK TRADING Common shares are traded in the Nasdaq National Market System under the symbol STFC. As of March 8, 2001, there were 920 shareholders of record of the Company's common shares. MARKET PRICE RANGE, COMMON STOCK(1) Initial Public Offering -- June 28, 1991, $2.25(1). The high and low sale prices for each quarterly period for the past two years as reported by Nasdaq are: 1999 HIGH LOW DIVIDEND ---- ---- --- -------- First Quarter $12.375 $10.250 $0.0250 Second Quarter 13.875 9.375 0.0250 Third Quarter 13.625 9.563 0.0275 Fourth Quarter $11.750 $ 8.875 $0.0275 2000 First Quarter $ 9.750 $ 7.125 $0.0275 Second Quarter 12.125 7.938 0.0275 Third Quarter 13.625 10.438 0.0300 Fourth Quarter $18.000 $11.250 $0.0300 (1) Adjusted for a March 1993 two-for-one, a July 1996 three-for-two common stock split effected in the form of a stock dividend and a July 1998 two-for-one common stock split, respectively. 25 Additionally, see Liquidity and Capital Resources section of "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Item 7 of this Form 10-K Annual Report for a discussion of regulatory restrictions of applicable dividends payable by the Company's insurance subsidiaries. ITEM 6. SELECTED FINANCIAL DATA "Selected Consolidated Financial Data" is as follows:

YEAR ENDED DECEMBER 31 ---------------------- 2000* 1999* 1998* 1997 1996 1995* 1994 ----- ----- ----- ---- ---- ----- ---- STATEMENTS OF INCOME DATA: (Dollars in thousands, except per share data) Earned premiums $397,967 392,058 356,210 320,050 304,472 296,364 225,297 Net investment income $ 38,915 34,262 32,506 31,107 29,863 28,461 22,189 Management services income $ 17,594 8,727 7,945 7,367 6,774 6,377 5,170 Net realized gains on investments $ 5,255 2,555 2,925 3,043 2,788 1,758 1,595 Other income $ 3,043 3,269 2,473 1,409 1,200 525 147 -------------------------------------------------------------------------- Total revenues $462,774 440,871 402,059 362,976 345,097 333,485 254,398 -------------------------------------------------------------------------- Income before federal income taxes $ 61,444 56,985 49,605 56,638 34,792 40,953 20,294 -------------------------------------------------------------------------- Net income $ 47,714 42,816 37,497 40,998 26,407 29,894 15,835 -------------------------------------------------------------------------- Earnings per common share (1)(2): Basic $ 1.24 1.05 .89 .99 .64 .73 .39 -------------------------------------------------------------------------- Diluted $ 1.21 1.03 .87 .97 .63 .72 .39 -------------------------------------------------------------------------- Cash dividends per common share (1) $ .12 .11 .10 .09 .08 .07 .06 -------------------------------------------------------------------------- BALANCE SHEET DATA AT YEAR END: Total investments $750,870 627,305 579,966 526,363 499,277 479,908 350,639 Total assets $898,106 759,945 717,520 664,384 605,385 579,194 487,282 Note payable to affiliate $ 45,500 45,500 -- -- -- -- -- Total stockholders' equity $386,059 317,687 340,824 297,258 247,619 225,763 175,852 Book value per common share (1) $ 10.01 8.29 8.11 7.11 5.98 5.48 4.29 STATUTORY RATIOS: Loss ratio 68.5 67.4 68.4 65.2 72.7 68.6 75.4 Expense ratio 27.0 29.5 29.4 28.9 27.3 31.0 28.2 Combined ratio 95.5 96.9 97.8 94.1 100.0 99.6 103.6 Industry combined ratio (3) 109.2 107.7 105.6 101.6 105.8 106.5 108.5 Ratio of net premiums written to statutory capital and surplus 1.32 1.47 1.63 1.71 1.91 2.12 1.77

(1) Adjusted for a July 1998 2-for-1 common stock split as well as a July 1996 3-for-2 common stock split effected in the form of a stock dividend. (2) The earnings per share amounts prior to 1997 have been restated as required to comply with SFAS No. 128. (3) Preliminary industry information for 2000 from A.M. Best. * Reflects change in pooling arrangement, effective January 1, 2000, 1999, 1998 and 1995. 26 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS "Management's Discussion and Analysis of Financial Condition and Results of Operations" is as follows: OVERVIEW State Auto Financial Corporation ("State Auto Financial"), through its principal insurance subsidiaries, State Auto Property and Casualty Insurance Company ("State Auto P&C"), Milbank Insurance Company ("Milbank"), Farmers Casualty Insurance Company ("Farmers Casualty") and State Auto Insurance Company ("SAIC"), provides personal and commercial insurance for the standard insurance market primarily in the Midwest and eastern United States, excluding New York, New Jersey, and the New England states. Their principal lines of business include personal and commercial auto, homeowners, commercial multi-peril, workers' compensation, general liability and fire insurance. State Auto National Insurance Company ("National") and Mid-Plains Insurance Company ("Mid-Plains") write personal automobile insurance for risks in the nonstandard insurance market. State Auto P&C, Milbank, Farmers Casualty, SAIC, National and Mid-Plains products are marketed through independent agents. State Auto Financial and its subsidiaries are referred to collectively herein as the "Company." Through State Auto P&C, the Company provides management and operations services under the Midwest Management Agreement (as defined below), the Farmers Casualty Management Agreement (as defined below) and the Mutual Management Agreement (as defined below) each effective as of January 1, 2000 (collectively the "2000 Management Agreement"), for insurance and noninsurance affiliates. As of January 1, 2000, all individuals providing services to any of the State Auto Companies who were not already employees of State Auto P&C became employees of State Auto P&C. Under the 2000 Management Agreement, State Auto P&C through its employees, is responsible for performing all organizational, operational, and management functions for each of the managed companies. For its performance of these services, State Auto P&C is paid quarterly a management and operations services fee based on formulas outlined in the 2000 Management Agreement. This fee from a managed company may be deferred or withheld if a managed company's performance does not meet performance criteria set forth in the 2000 Management Agreement. The Ohio Department of Insurance (the "Department") has requested that State Automobile Mutual Insurance Company ("Mutual") file an analysis on a quarterly basis, starting with the quarter beginning January 1, 2001, with the Department that justifies the apportionment of the service fee paid by Mutual to State Auto P&C under the 2000 Management Agreement under the accounting guidance outlined in Statement of Statutory Accounting Principles No. 70 - Allocation of Expenses ("SSAP No. 70"). The Company believes its accounting for such service fee is consistent with all statutory accounting principles. However, there can be no assurance that all or any part of the service fee paid by Mutual will be justified to the Department's satisfaction, which may affect the amount of such fee recognized as revenue by the Company. See Item 7-Forward-Looking Statements; Certain Factors Affecting Future Results. Pursuant to the 2000 Management Agreement, the Company received cash of $28.1 million equal to the net plan benefit liabilities assumed relating to the above described transfer of those individuals who were employees of Mutual as of January 1, 2000. Prior to January 1, 2000, State Auto P&C provided only executive management services to all insurance affiliates. The Midwest Management Agreement is a management agreement under which State Auto P&C provides management and operations services to Midwest Security Insurance Company, a Wisconsin domiciled, wholly owned subsidiary of Mutual ("Midwest Security"). The Farmers Casualty Management Agreement is a management agreement under which State Auto P&C provides management and operations services to Farmers Casualty and Mid-Plains. The Mutual Management Agreement is a management agreement under which State Auto P&C provides management and operations services to Mutual, Milbank, National and SAIC, and other non-insurance affiliates. SAIC was formed in 1999 to engage in the business of providing standard personal insurance to its policyholders through the use of leading edge technology within the independent agency system. Effective January 1, 2000, SAIC became licensed as a property and casualty insurer and began operating in the state of Ohio. On July 7, 1998, State Auto Financial acquired all of the outstanding shares of Milbank from Mutual pursuant to the Option Agreement dated August 1993. The purchase price of Milbank was approximately $81.9 million. The transaction was effected through an exchange with Mutual of 27 approximately 5.1 million State Auto Financial common shares for all the issued and outstanding capital stock of Milbank. This exchange of Milbank shares for State Auto Financial common shares increased Mutual's ownership of State Auto Financial to approximately 70% of its issued and outstanding shares. Since the transaction was a combination of entities under common control, it has been accounted for similar to a pooling of interests. In August 1998, State Auto Financial purchased $9.0 million of surplus notes from Farmers Casualty Company Mutual ("FCCM"), an Iowa domiciled property casualty insurer for the standard insurance market. In 1998, a plan to convert FCCM into a stock insurance company was approved by the board of FCCM, its policyholders and the Iowa Division of Insurance. The plan of conversion provided that State Auto Financial, in exchange for the redemption of the surplus notes, would acquire the newly issued shares of Farmers Casualty. Effective January 1, 1999, FCCM, renamed Farmers Casualty Insurance Company, became a wholly owned subsidiary of State Auto Financial. In addition, Farmers Casualty owns 100% of the outstanding shares of Mid-Plains, an Iowa domiciled property casualty insurer, which principally writes nonstandard auto insurance. Through Stateco Financial Services, Inc. ("Stateco"), a wholly owned subsidiary, the Company provides investment management services to affiliated companies and also provides insurance premium finance services to customers of State Auto P&C, Milbank and Mutual. Through Strategic Insurance Software, Inc. (S.I.S.), a wholly owned subsidiary, the Company develops and sells software for the processing of insurance transactions, database management systems for insurance agents and electronic interfacing of information between insurance companies and agents. S.I.S. sells its services and products to affiliated companies and their agents and markets similar services and products to nonaffiliated insurers and their agencies. 518 Property and Management and Leasing, LLC (518 PML), an Ohio limited liability company, is engaged in the business of owning and leasing real and personal property to affiliated companies. The members of 518 PML are State Auto P&C and Stateco. State Auto P&C, Milbank, Farmers Casualty and SAIC (the "Pooled Subsidiaries"), the companies comprising the standard insurance segment, participate in a quota share reinsurance pooling arrangement (the "Pooling Arrangement") with Mutual. The Pooling Arrangement provides that the Pooled Subsidiaries cede to Mutual all of their insurance business and assume from Mutual an amount equal to their respective participation percentages as outlined in the Pooling Arrangement. Effective January 1, 1998, the Pooled Subsidiaries aggregate participation in the Pooling Arrangement increased from 45% to 47% (State Auto P&C - 37% and Milbank - 10%) and Midwest Security became a participant in the Pooling Arrangement. On January 1, 1999, Farmers Casualty was acquired by State Auto Financial and became a participant in the Pooling Arrangement on that same date, at which time the Pooled Subsidiaries' aggregate participation increased to 50% (State Auto P&C - 37%, Milbank - 10% and Farmers Casualty - 3%). In conjunction with these changes in pool participation, the Pooled Subsidiaries received cash from Mutual of $11.4 million and $19.7 million, which related to the additional net insurance liabilities assumed by the Pooled Subsidiaries on January 1, 1999 and 1998, respectively. Effective January 1, 2000, the Pooling Arrangement was amended to make SAIC a participant in the Pooling Arrangement and the Pooled Subsidiaries aggregate participation increased to 53% (State Auto P&C - 39%, Milbank - 10%, Farmers Casualty - 3% and SAIC - 1%). In conjunction with this change in pool participation, the Pooled Subsidiaries received cash from Mutual of $18.6 million, which related to the additional net insurance liabilities assumed by the Pooled Subsidiaries on January 1, 2000. All parties that participate in the Pooling Arrangement have an A. M. Best rating of A+ (Superior). In discussing Results of Operations for 2000, State Auto P&C, Milbank, Farmers Casualty, SAIC, National, Mid-Plains, Mutual and Midwest Security are referred to collectively as the "State Auto Insurance Companies", while for 1999, the State Auto Insurance Companies and Pooled Subsidiaries exclude SAIC. State Auto P&C, Milbank, Farmers Casualty and SAIC are collectively referred to below as 28 the "Pooled Subsidiaries", while the Pooled Subsidiaries, Mutual and Midwest are collectively referred to below as the "Pooled Companies." RESULTS OF OPERATIONS 2000 COMPARED TO 1999 Net income for the Company increased 11.4% in 2000. Contributing to this increase was an improvement in the Company's statutory combined ratio to 95.5% in 2000 from 96.9% in 1999. Positively impacting the Company's operations in 2000 was a change in the services provided by State Auto P&C that generated an increase in management services income. See discussion below. Consolidated earned premiums increased 1.5% in 2000. This increase was principally the result of the change in the Pooled Subsidiaries' aggregate pooled participation percentage from 50% to 53% (referred to above). This action increased consolidated earned premiums 5.5%. The standard insurance segment's internal growth, as written by the Pooled Companies, excluding the impact of the change in the Pooling Arrangement, decreased consolidated earned premiums by 2.8%. The Company's nonstandard insurance segment's internal growth also decreased consolidated earned premiums by approximately 0.9%. Also negatively impacting the Company's consolidated earned premiums by approximately 0.3%, was a return of premiums to the policyholders in the state of North Carolina as a result of a rate reduction dating back to 1994 that was mandated by the Insurance Department of that state. In 1994 and 1996, the North Carolina Rate Bureau ("NCRB") filed an auto rate increase which was challenged by the North Carolina Insurance Department. The parties agreed to a settlement of the dispute in late March 2000, which resulted in a rate reduction for the 1994 rate filing and the 1996 rate filing being approved as originally filed by the NCRB. Consequently, the Company was required to return approximately $1.1 million in disputed premiums, plus $530,000 in interest. The interest portion of the returned premium has been reflected in the miscellaneous expense line item. As noted in prior reports, during 1999, the underwriting performance of the Companies' commercial lines book of business written by its standard segment began to evidence deterioration from previous performance levels. This prompted management to commence a careful review of its underwriters' adherence to the Company's underwriting guidelines for commercial lines. This action had a negative impact on direct written premiums in 1999 that continued into the first half of 2000. During the latter half of 2000, the Company saw commercial lines sales activity increase over 1999 levels. The Pooled Companies experienced 6.0% growth in its commercial lines direct written premiums over 1999. The Company's personal lines of business within its standard segment continued to feel the effects of extreme price competition even though, during the first half of 2000, there was some evidence that an increasing number of companies were reacting to continuing underwriting losses by increasing rates. The Company's rate of decline in internal growth in these lines has diminished in the last half of 2000, but internal growth remained negative. The Company believes that its underwriting and pricing discipline was a key factor in the Company's underwriting results for the year, particularly as compared to other property casualty insurers. The Company believes that its strategy of taking modest price increases on a regularly scheduled basis and continuing its diligence in risk selection has positioned it to take advantage of this change in the market that the Company perceives is occurring. The Company is active in the personal and commercial lines markets, developing new products to enhance its product portfolio; appointing new agents in its operating territories; and refining its pricing levels for the markets and lines it believes offer the most profit potential. The Company's nonstandard insurance segment (National and Mid-Plains) earned premium was $27.4 million in 2000 and $30.9 million in 2000, an 11.3% decrease. Intense price competition by certain market leaders is generally believed to be responsible for the internal growth performance for the year 2000. Production levels in this segment did begin to improve over the last half of 2000 but that improvement was not sufficient to make internal growth positive for the year. 29 Net investment income increased $4.7 million (13.6%) in 2000. Contributing to the increase over the previous year was the cash transfers to the Company in conjunction with the change in the Pooling Arrangement and transfer of employees to State Auto P&C referred to above. Total cost of investable assets at December 31, 2000 and 1999, respectively was $741.1 million and $651.9 million. The investment yield, based on fixed and equity securities at cost, were 5.5% and 5.4% for the annual periods ending 2000 and 1999, respectively. The Company continued to shift the composition of its fixed maturity portfolio from taxables to tax-exempt fixed maturities. At December 31, 2000 and 1999, respectively, tax exempt securities comprised approximately 82% and 76% of the fixed maturity portfolio. Additionally, during 2000 the Company continued to experience a number of calls on its higher yielding fixed maturities. Monies from these calls were reinvested at the then lower yielding rates. See further discussion regarding investments at the Liquidity and Capital Resources and Investments and Market Risk sections included herein. Management services income increased $8.9 million to $17.6 million for the year ended December 31, 2000. This increase is largely attributable to the change in the nature of the management services provided by State Auto P&C as discussed above. The Department has requested that, beginning in 2001, Mutual file an analysis on a quarterly basis with the Department that justifies the apportionment of the service fee paid by Mutual to State Auto P&C under statutory accounting guidance outlined in SSAP No. 70. See "Overview." Losses and loss expenses, as a percentage of earned premiums (the "loss ratio"), were 68.4% and 67.5% for the years 2000 and 1999, respectively. The increase in the current year loss ratio was largely the result of the Company experiencing a relatively small number of large unusual commercial claims in its standard insurance segment. Management noted that these large commercial losses did not impact any one line of business or geographic region and does not believe the nature of these claims indicates deterioration in core underwriting operations. See discussion above regarding management's response to its perception of the current underwriting environment. Additionally, the Company's nonstandard segment experienced an increase in its losses over 1999 levels particularly in those states where National began operations in 1999. The nonstandard segment is particularly volatile for new states due to the relatively small level of premium earned in the initial years of operation. Management has been monitoring the premium rate adequacy in these new states and has reacted throughout 2000 accordingly by increasing rates in these new states. Acquisition and operating expenses, as a percentage of earned premiums (the "expense ratio"), were 28.8% and 28.5% for the years 2000 and 1999, respectively. The increase in the expense ratio is impacted by the fixed costs such as salaries, depreciation and utilities which comprised a larger portion of earned premiums in 2000 than they did in 1999 as a result of the Company's less than anticipated premium writings in 2000. Interest expense relates to the line of credit agreement the Company entered into with Mutual during the second quarter of 1999 to assist in the funding of its stock repurchase program. See additional discussion in the "Liquidity and Capital Resources" section included herein. Other expense increased $0.3 million to $6.9 million for the year ending December 31, 2000. Other expense for 2000 included the interest the Company paid on the North Carolina premium rate refunds, discussed above. The effective federal tax rate was 22% and 25% for the years ended 2000 and 1999, respectively. During 2000, the Company continued to shift its fixed maturity portfolio from taxable to tax-exempt securities. As a result of this continued shift, tax exempt income comprised a larger proportion of income before federal income taxes in 2000 than in 1999. For additional clarification, see the reconciliation between actual federal income taxes and the amount computed at the statutory rate as detailed in footnote 7 in the notes to the Company's consolidated financial statements. 30 1999 COMPARED TO 1998 Net income for the Company increased 14.1% in 1999. The Company's statutory combined ratios for 1999 and 1998 were 96.9% and 97.8%, respectively. A decrease in the level of catastrophe losses for 1999 compared to 1998 positively impacted the Company's results. Consolidated earned premiums increased 10.1% in 1999. This increase was principally the result of the change in the Pooled Subsidiaries aggregate pooled participation percentage from 47% to 50% (discussed above) and the addition of Farmers Casualty to the pool. These actions increased consolidated earned premiums by 8.6%. The standard insurance segment's internal growth, as written by the Pooled Companies, excluding the impact of the changes in the Pooling Arrangement and the addition of Farmers Casualty to the pool, decreased consolidated earned premiums by 0.10%. The addition of Mid-Plains to the nonstandard insurance segment increased consolidated earned premiums 2.1%. However, the nonstandard insurance segment decreased consolidated earned premiums by 0.50%. Like many other insurers in its industry, 1999 was a difficult year for so-called internal growth for the Company. In its standard insurance segment, management continued to stress responsible pricing and sound underwriting despite a significant increase in aggressive price competition in both personal and commercial lines. The Company's personal lines program, Prime of Life, that targets the 50 and over age group, continues to generate approximately 25% of the Company's new homeowner and automobile lines of business. This age group also typically exhibits a significantly higher than average retention rate as a whole among all policyholders in a group than any other age group. The Company's underwriting experience in commercial lines showed some deterioration during 1999, which prompted management to commence a careful review of adherence to its underwriting guidelines in these lines of business. This same approach to underwriting also had an impact on the Company's nonstandard insurance segment, which experienced a decrease in its earned premiums in 1999. This was the continuing result of significant auto physical damage rate increases, the continuation of a more restrictive underwriting posture first implemented by the Company in this segment throughout most of its operating states in 1998 and increased competition in this market segment during 1999. While these actions have resulted in a decrease in the volume of business over the last several reporting periods, this segment's statutory loss experience continued to improve over comparative prior periods. The statutory loss ratio for the year ended December 31, 1999 decreased to 71.7% from 75.0% for the same period in 1998. Offsetting the decrease in earned premium was National's entry into three new states of operation during 1999: South Carolina in the first quarter; Maryland in the second quarter; and South Dakota in the fourth quarter. Net investment income increased 5.4% in 1999. Contributing to the increase over the previous year was the transfer to the Company of approximately $11.4 million in conjunction with the change in the Pooling Arrangement, the addition of Farmers Casualty and Mid-Plains to the Company's operations and a general increase in investable assets over the previous 1998 period. Total cost of investable assets at December 31, 1999 and 1998, respectively was $651.9 million and $590.8 million. The investment yields, based on fixed and equity securities at cost, were 5.4% and 5.7% for the annual periods ending 1999 and 1998, respectively. Contributing to the decrease in the 1999 yield was the continual shift in the composition of the fixed maturity portfolio from taxable to tax-exempt fixed maturities. At December 31, 1999 and 1998, respectively, tax exempt securities comprised approximately 76% and 71% of the fixed maturity portfolio. Additionally, in 1999, the Company continued to experience a number of calls on its higher yielding fixed maturities. Monies from these calls were reinvested at the then lower yielding rates. Another contributing factor was the Company continuing to build on its equity portfolio to enhance growth of statutory surplus over the long term, a program that began in late 1997. See further discussion regarding investments at the "Investments and Market Risk" sections included herein. Management services income, which includes income generated from the investment management services segment and executive management services provided to affiliated companies by 31 Stateco and State Auto P&C, respectively, increased $0.8 million in 1999. The executive management services provided by State Auto P&C primarily generated the increase. Other income includes revenue primarily from sales of software products to affiliates and third parties by the Company's insurance software subsidiary, S.I.S., as well as leasing revenue on real and personal property leased by 518 PML to affiliates. During 1999, other income increased 32.2%. Revenue generated from sales of software to third parties increased other income during 1999 by approximately 18.0%, while revenue generated through leasing transactions with affiliates increased other income by approximately 12.0%. Losses and loss expenses, as a percentage of earned premiums, were 67.5% and 68.0% for the years 1999 and 1998, respectively. As previously noted, during 1999, the Company experienced a decrease in the level of catastrophe losses compared to the same 1998 periods. The impact of the 1999 catastrophe losses amounted to 4.7 GAAP loss ratio points whereas catastrophe losses in 1998 totaled 8.1 GAAP loss ratio points. Offsetting the improvement in the 1999 catastrophe levels was an increase in the amount of commercial claims impacting the year to date results. This is being addressed in the manner described above in the discussion concerning commercial lines underwriting. Acquisition and operating expenses, as a percentage of earned premiums (the "expense ratio"), were 28.5% and 29.3% for the years 1999 and 1998, respectively. The decrease in the expense ratio in 1999 can be attributed to a reduced amount of Quality Performance Bonus earned by employees compared to that earned in 1998. The Company continued in 1999 to make strides in the use of technology to streamline its personal and commercial operations as more agencies participated in electronic upload and download using the APT industry standard. Additionally, in 1999, the Company began the use of electronic funds transfer (EFT) between the Company and the insured in several operating states for personal automobile business. In 1998, the Company realigned its claims procedures by establishing a Central Claims Department (the "Department") staffed by trained claim representatives who focus exclusively on losses that are small and routine in nature. The establishment of the Department has allowed for quicker response time to the insured and allows the fully trained claims representative to focus on the more serious claims, thereby reducing the use of independent adjusters. During 1999, the staffing in this Department was expanded as it began handling claims for additional states of operation. Interest expense relates to the line of credit agreement State Auto Financial entered into with Mutual during the second quarter of 1999 to assist in the funding of its repurchase program. See additional discussion in the Liquidity and Capital Resources section below. Other expense includes those operating expenses associated with general corporate expenses, S.I.S., 518 PML and Stateco's investment management services (the investment management services segment). In 1999, other expense increased 10.0%, which is primarily attributable to an increase in S.I.S.'s operating expenses from 1998. The effective Federal tax rate was 25% and 24% for the years ended 1999 and 1998, respectively. In 1999, income before federal income taxes increased due to an increase in income from operations compared to 1998. Additionally, during 1999 the Company continued to shift its fixed maturity portfolio from taxable to tax-exempt securities. (See related net investment income discussion above.) As a result of this continued shift, tax exempt income comprised a similar proportion of income before federal income taxes in 1999 to that of 1998. For additional clarification, see the reconciliation between actual federal income taxes and the amount computed at the statutory rate as detailed in footnote 7 in the notes to the Company's consolidated financial statements. 32 REPORTABLE SEGMENTS The Company's segment profits of the standard insurance segment, the non-standard insurance segment, and the investment management services segment, are monitored by management on an unconsolidated basis, as reflected in footnote 14 on Reportable Segments in the Company's consolidated financial statements and therefore do not reflect adjustments for transactions with other segments. The following table reflects segment profit or loss for these three segments for the years ended 2000, 1999, and 1998: 2000 1999 1998 ---- ---- ---- (in thousands) Standard insurance $35,579 $41,146 $34,341 Nonstandard insurance (116) 1,647 1,313 Investment management services 5,354 5,191 4,908 Management and Operations services $17,552 $ 6,330 $ 5,290 The fluctuations in segment profit for the standard insurance segment, as discussed above, is due to a decline in its underwriting income due to an increase in the level of commercial losses, as discussed above. The improvement in segment profit in 1999 compared to 1998 was the result of a decrease in the level of catastrophe losses for this year. Prior to 1997, the nonstandard segment focused on improving its loss experience through implementation of a more restrictive underwriting posture and rate increases in several operating states. While this segment showed improvement as a result of these actions, 2000 experienced significant losses in several of its new states of operation. As discussed above, management continually monitors this segment's premium rate adequacy given the nature of the risks that are written through the nonstandard market. The investment management services segment profit increased slightly due to increasing market rates within the fixed maturity market. This segment's revenue is based on the average market value of the portfolio of the companies managed, which is largely comprised of fixed maturities. With the change in the interest rate environment throughout 2000, the average market value of the portfolio of the companies managed increased throughout 2000. The increase in the investment management services segment's profit from 1998 to 1999 was primarily the result of the acquisition of Farmers Casualty and Mid-Plains, effective January 1, 1999, at which time this segment began providing investment management services to these companies. Segment profits related to management and operations services has increased from that in previous years due to the change in the management and operations agreement as discussed in Note 1 (j) in the consolidated financial statements. For additional information on the Company's reportable segments, see footnote 14 on "Reportable Segments" in the Company's consolidated financial statements. LIQUIDITY AND CAPITAL RESOURCES Liquidity refers to the ability of a company to generate adequate amounts of cash to meet its needs for both long and short-term cash obligations as they come due. The Company's significant sources of cash are premiums, investment income and investments as they mature. The Company continually monitors its investment and reinsurance programs to ensure they are appropriately structured to enable the insurance subsidiaries to meet anticipated and unanticipated short and long-term cash requirements without the need to sell investments to meet fluctuations in claim payments. In 2000, net cash provided by operating activities increased to $87.7 million from $48.9 million in 1999. This increase was due to a cash transfer of $18.6 million to the Pooled Subsidiaries in connection with the 2000 amended Pooling Arrangement, as well as a cash transfer of $28.1 million to State Auto P&C relating to the net plan benefit liabilities assumed in connection with the 2000 Management Agreement. In 1999, net cash provided by operating activities decreased to $48.9 million from $56.7 million in 1998. The 1999 decrease was due to the cash transfer of $11.4 million to the Pooled Subsidiaries in connection with the 1999 amended Pooling Arrangement, as discussed above, whereas in 33 1998, the cash transfer relating to the 1998 amended Pooling arrangement was $19.7 million. Over the last three years, operating cash flows have been sufficient to meet the operating needs of the Company while providing opportunities for increased investment and financing needs. Management does not anticipate any significant changes in its operating cash flow. Net cash used in investing activities reflects cash flows used in purchases of fixed maturity and equity securities, respectively, of $187.7 million and $15.8 million in 2000, $207.8 million and $25.6 million in 1999, and $193.9 million and $17.1 million in 1998. During 1998 and continuing into 2000, market interest rates on fixed maturities declined from previous years' levels, and the Company experienced a significantly higher number of calls on fixed maturities than in previous years. During 2000, this call activity slowed somewhat from previous year's levels. Cash flows provided by maturities, calls and principal reductions of fixed maturities were $27.0 million in 2000, $37.3 million in 1999 and $47.8 million in 1998. During 1998, 518 PML began construction of a building in Goodlettsville, Tennessee that was completed in 1999. The building is currently being leased to Mutual. The total construction cost of the building, including land cost, was approximately $6.4 million. Overall, net cash used in investing activities was $90.9 million in 2000, $56.9 million in 1999 and $55.6 million in 1998. The increase in the 2000 investing activities was the result of the Company investing the proceeds received on the cash transfers discussed under cash flows from operating activities. Net cash provided by or used in financing activities consists of proceeds from issuance of common stock and payment of dividends to shareholders. Mutual, whose ownership in State Auto Financial is approximately 68%, has waived its right to receipt of the dividends declared by State Auto Financial in an effort to enhance the statutory surplus of the insurance subsidiaries of State Auto Financial for use in support of underwriting operations. Prior to the declaration of each dividend by State Auto Financial, Mutual's directors review the facts and circumstances then present in deciding whether to waive such dividend. Impacting cash used in financing activities during 2000 was State Auto Financial's Board of Directors approving a plan to repurchase up to 1.0 million shares of its common stock from the public over a period ending December 31, 2001. Through March 15, 2001, State Auto Financial repurchased 25,122 shares. Impacting 1999 was a previous repurchase program of State Auto Financial's common stock. During the second quarter of 1999, State Auto Financial's Board of Directors approved a plan to repurchase up to 4.0 million shares of its outstanding common stock over a period ending December 31, 2000. Repurchases were transacted to maintain the same ownership ratios between Mutual and the public as it existed in May 1999, with 69% repurchased from Mutual and 31% from the public. Through December 31, 1999, all 4.0 million shares were repurchased, with approximately 2.7 million shares repurchased from Mutual and 1.3 million shares from the public. In conjunction with the stock repurchase plan, State Auto Financial entered into a line of credit agreement with Mutual for $45.5 million, at an interest rate of 6.0%. The interest rate adjusts each January 1 based on a formula set forth in the note. During 2001 the interest rate is 5.0%. Commencing in 2001, principal is due upon demand from Mutual. In 1996, the State Auto Insurance Companies negotiated a change in their catastrophe reinsurance program. In 1998, Midwest Security, 1999, Farmers Casualty and Mid-Plains, and 2000, SAIC, became parties to the catastrophe reinsurance program. The amount retained by the State Auto Insurance Companies is $40.0 million for each occurrence. For up to $80.0 million in losses, excess of $40.0 million, traditional reinsurance coverage is provided. Effective November 1999, State Auto P&C assumed catastrophe reinsurance from Mutual, Milbank, Midwest Security, Farmers Casualty, SAIC, National and Mid-Plains in the amount of $135 million excess of $120 million. Effective November 2000, the catastrophe reinsurance program was renegotiated whereby State Auto P&C now assumes $115 million excess of $120 million. This layer of $115 million in excess of $120 million has been excluded from the Pooling Arrangement. There have been no losses assumed under this agreement. To provide funding if the State Auto Insurance Companies were to incur catastrophe losses in excess of $120.0 million, State Auto Financial entered into a structured contingent financing transaction with a financial institution and a syndicate of other lenders (the Lenders) to provide up to $115.0 million for 34 reinsurance purposes. In the event of such a loss, this arrangement provides that State Auto Financial 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. State Auto Financial would then contribute to State Auto P&C the funds received from the sale of its preferred shares. State Auto P&C would use the contributed capital to pay its direct catastrophe losses and losses assumed under the catastrophe reinsurance agreement. State Auto Financial is obligated to repay SPC (which would repay the Lenders) by redeeming the preferred shares over a six-year period. In the event of a default by State Auto Financial, the obligation to repay SPC has been secured by a Put Agreement among State Auto Financial, Mutual and the Lenders, under which Mutual would be obligated to put either the preferred shares or the loan(s) outstanding. On March 11, 1997, Mutual acquired 100% of the outstanding shares of Midwest Security, effective as of January 1, 1997. In connection with this purchase, Mutual and State Auto Financial entered into an Option Agreement granting State Auto Financial the right to purchase Midwest Security from Mutual within five years at a price determined by a formula set out in the Option Agreement. As of March 23, 2001, State Auto Financial has not exercised its right to acquire Midwest Security. On March 2, 2001, the Board of Directors of State Auto Financial declared a quarterly cash dividend of $0.03 per common share, payable on March 30, 2001, to shareholders of record on March 15, 2001. This is the 39th consecutive cash dividend declared by State Auto Financial's Board since State Auto Financial had its initial public offering of common stock on June 28, 1991. State Auto Financial has increased cash dividends to shareholders for eight consecutive years. The maximum amount of dividends that may be paid to State Auto Financial during 2001 by its insurance subsidiaries without prior approval under current law is limited to $44.9 million. The Company is required to notify the insurance subsidiaries' respective State Insurance Commissioner within five business days after declaration of all dividends and at least ten days prior to payment. Additionally, the domiciliary Commissioner of each insurer subsidiary has the authority to limit a dividend when the Commissioner determines, based on factors set forth in the law, that an insurer's surplus is not reasonable in relation to the insurer's outstanding liabilities and adequate to its financial needs. Such restrictions are not expected to limit the capacity of State Auto Financial to meet its cash obligations. The National Association of Insurance Commissioners (NAIC) maintains risk-based capital requirements for property and casualty insurers. Risk-based capital is a formula that attempts to evaluate the adequacy of statutory capital and surplus in relation to investment and insurance risks such as asset quality, loss reserve adequacy and other business factors. Applying the risk-based capital requirements as of December 31, 2000, each of the State Auto Insurance Companies exceeded all standards established by the formula. OTHER DISCLOSURES INVESTMENTS Stateco performs investment management services (the investment management services segment) on behalf of the Company and Mutual and its subsidiary. The Investment Committee of each insurer's Board of Directors sets investment policies to be followed by Stateco. The primary investment objectives of the Company are to generate income, preserve capital and maintain adequate liquidity for the payment of claims. Fixed maturities that are purchased with the intention and ability of holding them until maturity are categorized as held to maturity and carried at amortized cost. Fixed maturities that may be sold due to changing investment strategies are categorized as available for sale and are carried at fair value. At December 31, 2000, the Company had no fixed maturity investments rated below investment grade, nor any mortgage loans. 35 As of December 31, 2000, the Company had fixed maturities with a fair value of $653.3 million designated as available for sale compared to $527.8 million at December 31, 1999. During 2000, the Company continued its program to increase its equity portfolio to enhance growth of statutory surplus over the long term. At December 31, 2000 and 1999, respectively, the equity portfolio totaled $58.3 and $55.5 million, respectively. The Company's current investment strategy does not rely on the use of derivative financial instruments. MARKET RISK Investable assets comprise approximately 86% of the Company's total assets. Of the total investments, 90% are invested in fixed maturities, 7.6% in equity securities and the remaining in cash and cash equivalents. The Company's decision to make a specific investment is influenced primarily by the following factors: (a) investment risks; (b) general market conditions; (c) relative valuations of investment vehicles; (d) general market interest rates; (e) the Company's liquidity requirements at any given time; and (f) the Company's current federal income tax position and relative spread between after tax yields on tax-exempt and taxable fixed income investments. The fixed maturity portfolio is managed in a ladder-maturity style and considers business mix and liability payout patterns to ensure adequate cash flow to meet claims as they are presented. At December 31, 2000, the Company's fixed maturity portfolio had an average maturity of 12.5 years and a duration of 5.6 years. For the insurance subsidiaries, the maximum investment in any single note or bond is limited to 5.0% of statutory assets, other than obligations of the U.S. government or government agencies, for which there is no limit. The fixed maturity portfolio is very high in quality with all holdings either in Government obligations, municipal, or corporate obligations rated AA or better by the major bond rating agencies. The Company does not intend to change its investment policy on the quality of its fixed maturity investments. Investments in equity securities are selected based on their potential for appreciation as well as ability to continue paying dividends. Additional information regarding the composition of investments, along with maturity schedules regarding investments in fixed maturities, is included in footnote 2 of the consolidated financial statements. The Company's primary market risk exposures are to changes in market prices for equity securities and changes in interest rates and credit ratings for fixed maturity securities. In 2000, market conditions were characterized by decreasing equity market prices and increasing fixed maturity market prices. The Company's equity portfolio increased from $55.5 million at December 31, 1999 to $58.3 million at December 31, 2000 as new monies were allocated during the year to acquire new equity positions. Though the Company continued to hold unrealized gains on this portfolio, equity securities held at year end experienced a $2.1 million decrease in unrealized holding gains from December 31, 1999. The market value of the available for sale fixed maturity portfolio was positively impacted during the year as a result of declining interest rates. In 2000, the fixed maturity security market experienced a significant decline in interest rates in response to the Federal Reserve Board's monetary policy and easing inflationary pressures. As a result of these market conditions, the Company experienced an increase of $33.2 million on the market value of its available for sale fixed maturity portfolio through December 31, 2000. As previously discussed, in order to maximize investment income the Company manages its fixed maturity portfolio in a ladder-maturity style to ensure adequate cash flow to meet claims as they are presented for payment. It is not anticipated that fixed maturity investments would need to be sold in order to meet claim payments in the future. In fact, the Company has never had to sell assets to meet payment of its claims. 36 To provide the Company greater flexibility in order to manage its market risk exposures, the Company has segregated a portion of its fixed maturity portfolio, approximately 94% at December 31, 2000, in accordance with SFAS No. 115, as available for sale. Also, the Company does not maintain a trading portfolio. The following table provides information about the Company's fixed maturity investments used for purposes other than trading that are sensitive to changes in interest rates. The table presents principal cash flows from maturities, anticipated calls and estimated prepayments, or pay downs from holdings in mortgage backed securities. The table also presents the average interest rate for each period presented. PRINCIPAL AMOUNT MATURING IN: (Dollars in thousands)

2001 2002 2003 2004 2005 Thereafter Total Fair Value ---- ---- ---- ---- ---- ---------- ----- ---------- Fixed interest rate securities $41,814 36,120 17,485 26,202 21,581 525,365 668,567 $692,558 Average Interest rate 6.3% 6.2% 5.5% 5.6% 6.6% 6.0% 6.0%

IMPACT OF SIGNIFICANT EXTERNAL CONDITIONS Inflation can have a significant impact on property and casualty insurers because premium rates are established before the amount of losses and loss expenses are known. When establishing rates, the Company attempts to anticipate increases from inflation subject to limitations imposed for competitive pricing. Inflation has been modest over the last several years thereby allowing pricing of premiums to keep pace with inflation on certain lines of business. The Company considers inflation when estimating liabilities for losses and loss expenses, particularly for claims having a long period between occurrence and settlement. The liabilities for losses and loss expenses are management's estimates of the ultimate net cost of underlying claims and expenses and are not discounted for the time value of money. In times of high inflation, the normally higher yields on investment income may partially offset potentially higher claims and expenses. FORWARD-LOOKING STATEMENTS; CERTAIN FACTORS AFFECTING FUTURE RESULTS Statements contained in this Form 10-K or any other reports or documents prepared by the Company or made by management may be "forward-looking" within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to certain risks and uncertainties that could cause the Company's actual results to differ materially from those projected. Forward-looking statements may be identified, preceded by, followed by, or otherwise include, without limitation, words such as "plans," "believes," "expects," "anticipates," "intends," "estimates," or similar expressions. The following factors, among others, in some cases have affected and in the future could affect the Company's actual financial performance. o As discussed in Item 1 of this Form 10-K, Mutual has entered into agreements with Meridian Mutual and MIGI pursuant to which Meridian Mutual will be merged with and into Mutual, with Mutual continuing as the surviving corporation of the merger, and MIGI will be acquired by Mutual. In addition, during the past several years, Mutual and the Company have acquired other insurance companies, such as Milbank, Farmers Casualty, and Midwest Security, and it is anticipated that Mutual and the Company will continue to pursue acquisitions of other insurance companies in the future. Acquisitions involve numerous risks and uncertainties, including the following: obtaining necessary regulatory approvals of the acquisition may prove to be more difficult than anticipated; integrating the acquired business may prove to be 37 more costly or difficult than anticipated; integrating the acquired business without material disruption to existing operations may prove to be more difficult than anticipated; anticipated cost savings may not be fully realized (or not realized within the anticipated time frame) or additional or unexpected costs may be incurred; and retaining key employees of the acquired business may prove to be more difficult than anticipated. In addition, other companies in the insurance industry have similar acquisition strategies. There can be no assurance that any future acquisitions will be successfully integrated into the Company's operations, that competition for acquisitions will not intensify or that the Company will be able to complete such acquisitions on acceptable terms and conditions. In addition, the costs of unsuccessful acquisition efforts may adversely affect the Company's financial performance. o The Company's financial results are subject to the occurrence of weather-related and other types of catastrophic events, none of which are within the Company's control. o The Company's operations are subject to changes occurring in the legislative, regulatory and judicial environment, including but not limited to changes related to the implementation of the Gramm Leach Bliley Act of 1999. Risks and uncertainties related to the legislative, regulatory, and judicial environment include, but are not limited to, legislative changes at both the state and federal level, state and federal regulatory rulemaking promulgations and adjudications that may affect the Company specifically, its affiliates or the industry generally, class action and other litigation involving the insurance industry and judicial decisions affecting claims, policy coverages and the general costs of doing business. Many of these changes are beyond the Company's control. o The laws of the various states establish insurance departments with broad regulatory powers relative to approving intercompany arrangements, such as management, pooling, and investment management agreements, granting and revoking licenses to transact business, regulating trade practices, licensing agents, approving policy forms, setting reserve requirements, determining the form and content of required statutory financial statements, prescribing the types and amount of investments permitted and requiring minimum levels of statutory capital and surplus. The Ohio Department of Insurance (the "Department") has requested that, beginning in 2001, Mutual file an analysis on a quarterly basis with the Department that justifies the apportionment of the service fee paid by Mutual to State Auto P&C under the 2000 Management Agreement under statutory accounting guidance outlined in SSAP No. 70. The Company believes that its accounting for such service fee is consistent with all statutory accounting principles. However, there can be no assurance that all or any part of the service fee paid by Mutual will be justified to the Department's satisfaction, which may affect the amount of such fee recognized as revenue by Company. In addition, although premium rate regulation varies among states and lines of insurance, such regulations generally require approval of the regulatory authority prior to any changes in rates. Furthermore, all of the states in which the State Auto Group transacts business have enacted laws which restrict these companies' underwriting discretion. Examples of these laws include restrictions on agency terminations and laws requiring companies to accept any applicant for automobile insurance. These laws may adversely affect the ability of the insurers in the State Auto Group to earn a profit on their underwriting operations. o The property and casualty insurance industry is highly competitive. Price competition has been very intense during recent years. This continued to be true in regards to both commercial lines and personal lines, particularly auto insurance in 2000. Several "national" carriers' active marketing efforts with respect to personal lines auto insurance have had an impact on the market for this coverage. The Company competes with numerous insurance companies, many of which are substantially larger and have considerably greater financial resources. In addition, because the Company's products are marketed exclusively through independent insurance agencies, most of which represent more than one company, the Company faces competition within each agency. The Company competes through 38 underwriting criteria, appropriate pricing, and quality service to the policyholder and the agent and through a fully developed agency relations program. See "Marketing" in the "Narrative Description of Business" in Item 1. o The Company is subject to numerous other factors which effects its operations, including, without limitation, the development of new insurance products, geographic spread of risk, fluctuations of securities markets, economic conditions, technological difficulties and advancements, availability of labor and materials in storm hit areas, late reported claims, previously undisclosed damage, utilities and financial institution disruptions, and shortages of technical and professional employees. ITEM 7(A). QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK "Qualitative and Quantitative Disclosures About Market Risk" is included in Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations" under Market Risk. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The Consolidated Financial Statements, including the Notes to Consolidated Financial Statements and the Report of Independent Auditors are as follows: REPORT OF INDEPENDENT AUDITORS The Board of Directors and Stockholders State Auto Financial Corporation We have audited the accompanying consolidated balance sheets of State Auto Financial Corporation and subsidiaries as of December 31, 2000 and 1999 and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 2000. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of State Auto Financial Corporation and subsidiaries as of December 31, 2000 and 1999, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2000, in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP Columbus, Ohio February 20, 2001, except for Note 17, as to which the date is March 30, 2001 39 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) CONSOLIDATED BALANCE SHEETS --------------------------------------------------------------------------------

DECEMBER 31 ----------- 2000 1999 ---- ---- (dollars in thousands, except share data) ASSETS Fixed maturities: Held to maturity, at amortized cost (fair value $40,225 and $44,051, respectively) .............................. $ 39,307 43,981 Available for sale, at fair value (amortized cost $636,302 and $544,051, respectively) ............................ 653,251 527,806 Equity securities, available for sale, at fair value (cost $44,220 and $39,303, respectively) .......................... 58,312 55,518 ---------------------- Total Investments ................................................... 750,870 627,305 Cash and cash equivalents ........................................... 21,305 24,560 Deferred policy acquisition costs ................................... 32,458 28,936 Accrued investment income and other assets .......................... 19,795 17,977 Due from affiliate .................................................. 1,405 -- Net prepaid pension expense ......................................... 37,738 18,931 Reinsurance recoverable on losses and loss expenses payable ......... 7,930 10,807 Prepaid reinsurance premiums ........................................ 11,575 15,784 Deferred federal income taxes ....................................... -- 1,828 Property and equipment, at cost, net of accumulated depreciation of $2,785 and $2,191, respectively ................... 12,760 11,288 Goodwill ............................................................ 2,270 2,529 ---------------------- Total assets ........................................................ $ 898,106 759,945 ====================== LIABILITIES AND STOCKHOLDERS' EQUITY Losses and loss expenses payable .................................... $ 244,583 232,489 Unearned premiums ................................................... 160,387 153,570 Note payable to affiliate ........................................... 45,500 45,500 Postretirement benefit liabilities .................................. 55,841 2,498 Federal Income Taxes: Current ........................................................... 2,903 1,322 Deferred .......................................................... 1,490 -- Other liabilities ................................................... 1,343 1,543 Due to affiliates ................................................... -- 5,336 ---------------------- Total liabilities ................................................... 512,047 442,258 ---------------------- Commitments and contingencies ....................................... -- -- Stockholders' equity: Class A Preferred stock (nonvoting), without par value ............ Authorized 2,500,000 shares; none issued ........................ -- -- Class B Preferred stock, without par value. Authorized 2,500,000 shares; none issued ................................... -- -- Common stock, without par value. Authorized 100,000,000 shares; 42,625,723 and 42,355,438 shares issued, respectively, at stated value of $2.50 per share ................................. 106,564 105,888 Less 4,071,012 and 4,034,342 treasury shares, respectively, at cost (47,038) (46,588) Additional paid-in capital ........................................ 44,208 42,562 Accumulated other comprehensive income ............................ 20,317 156 Retained earnings ................................................. 262,008 215,669 ---------------------- Total stockholders' equity .......................................... 386,059 317,687 ---------------------- Total liabilities and stockholders' equity .......................... $ 898,106 759,945 ======================

See accompanying notes to consolidated financial statements. 40 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) CONSOLIDATED STATEMENTS OF INCOME --------------------------------------------------------------------------------

YEAR ENDED DECEMBER 31 ----------------------- 2000 1999 1998 ---- ---- ---- (dollars in thousands, except per share amount) Earned premiums ............................................... $ 397,967 392,058 356,210 Net investment income ......................................... 38,915 34,262 32,506 Management services income from affiliates .................... 17,594 8,727 7,945 Net realized gains on investments ............................. 5,255 2,555 2,925 Other income (includes $1,546, $1,676 and $1,316, respectively, from affiliates) .............................. 3,043 3,269 2,473 --------------------------------------- Total revenues ................................................ 462,774 440,871 402,059 --------------------------------------- Losses and loss expenses ...................................... 272,167 264,628 242,294 Acquisition and operating expenses ............................ 119,569 111,772 104,224 Interest expense to affiliate ................................. 2,730 955 -- Other expenses ................................................ 6,864 6,531 5,936 --------------------------------------- Total expenses ................................................ 401,330 383,886 352,454 --------------------------------------- Income before federal income taxes ............................ 61,444 56,985 49,605 --------------------------------------- Federal income tax expense (benefit): Current ..................................................... 14,408 12,136 12,271 Deferred .................................................... (678) 2,033 (163) --------------------------------------- Total federal income taxes .................................... 13,730 14,169 12,108 --------------------------------------- Net income .................................................... $ 47,714 42,816 37,497 ======================================= Earnings per common share: Basic ....................................................... $ 1.24 1.05 .89 ======================================= Diluted ..................................................... $ 1.21 1.03 .87 ======================================= Dividends paid per common share ............................... $ .12 .11 .10 =======================================

See accompanying notes to consolidated financial statements. 41 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY (IN THOUSANDS) --------------------------------------------------------------------------------

ACCUMULATED ADDITIONAL OTHER COMMON COMMON TREASURY TREASURY PAID-IN COMPREHENSIVE RETAINED SHARES STOCK SHARES STOCK CAPITAL INCOME EARNINGS TOTAL ------ -------- --------- -------- --------- ------------ --------- -------- BALANCE-DECEMBER 31, 1997 41,829 $104,572 8 $ (90) $40,210 $14,761 $137,805 $297,258 ------ -------- ----- -------- ------- ------- -------- -------- Net income 37,497 37,497 Unrealized gains, net of tax and reclassification adjustment 5,515 5,515 -------- Comprehensive income 43,012 -------- Issuance of common stock 211 528 1,295 1,823 Tax benefit from stock options exercised 34 34 Treasury shares acquired on stock option exercises 5 (77) (77) Change in minority interest of subsidiary (7) (7) Cash dividends paid (1,219) (1,219) ------ -------- ----- -------- ------- ------- -------- -------- BALANCE-DECEMBER 31, 1998 42,040 105,100 13 (167) 41,539 20,276 174,076 340,824 ------ -------- ----- -------- ------- ------- -------- -------- Net income 42,816 42,816 Unrealized losses, net of tax and reclassification adjustment (20,120) (20,120) -------- Comprehensive income 22,696 -------- Issuance of common stock 315 788 1,139 1,927 Tax benefit from stock options exercised 258 258 Treasury shares acquired on stock option exercises 21 (222) (222) Treasury shares acquired under repurchase program 4,000 (46,199) (46,199) Stock options granted 242 242 Change in minority interest of subsidiary (616) 92 (524) Cash dividends paid (1,315) (1,315) ------ -------- ----- -------- ------- ------- -------- -------- BALANCE-DECEMBER 31, 1999 42,355 105,888 4,034 (46,588) 42,562 156 215,669 317,687 ------ -------- ----- -------- ------- ------- -------- -------- Net income 47,714 47,714 Unrealized gains, net of tax and reclassification adjustment 20,161 20,161 -------- Comprehensive income 67,875 -------- Issuance of common stock 271 676 1,120 1,796 Tax benefit from stock options exercised 189 189 Treasury shares acquired on stock option exercises 12 (149) (149) Treasury shares acquired under repurchase program 25 (301) (301) Stock options granted 524 524 Change in minority interest of subsidiary (187) 22 (165) Cash dividends paid (1,397) (1,397) ------ -------- ----- -------- ------- ------- -------- -------- BALANCE-DECEMBER 31, 2000 42,626 $106,564 4,071 $(47,038) $44,208 $20,317 $262,008 $386,059 ====== ======== ===== ======== ======= ======= ======== ========

42 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) CONSOLIDATED STATEMENTS OF CASH FLOWS --------------------------------------------------------------------------------

YEAR ENDED DECEMBER 31 ---------------------- 2000 1999 1998 ---- ---- ---- (in thousands) Cash flows from operating activities: Net income .......................................... $ 47,714 42,816 37,497 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization, net ................. 3,548 3,257 2,666 Net realized gains on investments .................. (5,255) (2,555) (2,925) Changes in operating assets and liabilities: Deferred policy acquisition costs ................. (1,756) (2,159) (1,151) Accrued investment income and other assets ........ (2,480) 1,218 (2,232) Net prepaid pension expense ....................... (4,168) (2,116) (1,029) Postretirement benefit liabilities ................ 3,746 654 173 Reinsurance recoverable on losses and loss expenses payable and prepaid reinsurance premiums (763) (4,721) 272 Other liabilities and due to/from affiliates, net . (7,106) 2,900 4,373 Losses and loss expenses payable .................. (440) (7,099) (3,258) Unearned premiums ................................. 6,817 4,031 2,449 Federal income taxes .............................. 1,093 1,290 167 Cash provided from the change in the reinsurance pool participation percentage .......................... 18,617 11,419 19,708 Cash provided from transfer of employees ............ 28,098 -- -- --------------------------------------- Net cash provided by operating activities ............. 87,665 48,935 56,710 --------------------------------------- Cash flows from investing activities: Purchase of fixed maturities - available for sale ... (187,724) (207,768) (193,881) Purchase of equity securities ....................... (15,783) (25,567) (17,051) Maturities, calls and principal reductions of fixed maturities - held to maturity ...................... 4,600 11,776 23,106 Maturities, calls and principal reductions of fixed maturities - available for sale .................... 22,355 25,516 24,654 Sale of fixed maturities - available for sale ....... 71,530 113,671 111,085 Sale of equity securities ........................... 16,158 17,369 8,306 Purchase of surplus notes receivable ................ -- -- (9,000) Net cash acquired on acquisition of Farmers Casualty Insurance Company ......................... -- 11,568 -- Net additions of property and equipment ............. (2,066) (3,459) (2,816) --------------------------------------- Net cash used in investing activities ................. (90,930) (56,894) (55,597) --------------------------------------- Cash flows from financing activities: Net proceeds from issuance of debt to affiliate ..... -- 45,500 -- Net proceeds from issuance of common stock .......... 1,708 1,928 1,780 Payments to acquire treasury shares ................. (301) (46,199) -- Payment of dividends ................................ (1,397) (1,315) (1,219) --------------------------------------- Net cash provided by (used in) financing activities ... 10 (86) 561 --------------------------------------- Net increase (decrease) in cash and cash equivalents .. (3,255) (8,045) 1,674 --------------------------------------- Cash and cash equivalents at beginning of year ........ 24,560 32,605 30,931 --------------------------------------- Cash and cash equivalents at end of year .............. $ 21,305 24,560 32,605 =======================================

See accompanying notes to consolidated financial statements. 43 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (a) PRINCIPLES OF CONSOLIDATION The consolidated financial statements of State Auto Financial Corporation include State Auto Financial Corporation (State Auto Financial) and its wholly-owned subsidiaries that consist of: - State Auto Property and Casualty Insurance Company (State Auto P&C), a South Carolina corporation - Milbank Insurance Company (Milbank), a South Dakota corporation - Farmers Casualty Insurance Company (Farmers Casualty), an Iowa corporation - State Auto Insurance Company (SAIC), an Ohio corporation - State Auto National Insurance Company (National), an Ohio corporation - Stateco Financial Services, Inc. (Stateco), an Ohio corporation - Strategic Insurance Software, Inc. (S.I.S.), an Ohio corporation. Mid-Plains Insurance Company (Mid-Plains), an Iowa corporation, is a wholly-owned subsidiary of Farmers Casualty. The financial statements also include the operations and financial position of 518 Property Management and Leasing, LLC (518 PML), whose members are State Auto P&C and Stateco. On July 7, 1998, State Auto Financial exercised its option with State Automobile Mutual Insurance Company (Mutual), pursuant to the Option Agreement dated August 20, 1993, by acquiring the outstanding shares of Milbank. Milbank had been a wholly-owned subsidiary of Mutual since July 1, 1993, but as a result of this transaction, is now a wholly-owned subsidiary of State Auto Financial. The purchase price of Milbank was approximately $81.9 million. The transaction was effected through an exchange with Mutual of approximately 5.1 million State Auto Financial common shares for all the issued and outstanding capital stock of Milbank. Since the transaction was a combination of entities under common control it has been accounted for similar to a pooling-of-interests. State Auto Financial and subsidiaries are referred to herein as "the Companies" or "the Company." State Auto Financial, an Ohio corporation, is a majority-owned subsidiary of Mutual. All significant inter-company balances and transactions have been eliminated in consolidation. (b) DESCRIPTION OF BUSINESS The Company, through State Auto P&C, Milbank, Farmers Casualty and SAIC, provides standard personal and commercial insurance to its policyholders. Their principal lines of business include personal and commercial automobile, homeowners, commercial multi-peril, workers' compensation, general liability and fire insurance. National and Mid-Plains provide nonstandard automobile insurance. State Auto P&C, Milbank, Farmers Casualty, SAIC, National, and Mid-Plains operate primarily in the midwest and eastern United States, excluding New York, New Jersey, and the New England states, through the independent insurance agency system. State Auto P&C, Milbank, Farmers Casualty, SAIC, National and Mid-Plains are chartered and licensed as property and casualty insurers in the states of South Carolina, South Dakota, Iowa, Ohio (SAIC and National) and Iowa, respectively, and are licensed in various other states. As such, they are subject to the regulations of the applicable Departments of Insurance of their respective states of domicile (the Departments) and the regulations of each state in which they operate. These property and casualty insurance companies undergo periodic financial examination by the Departments and insurance regulatory agencies of the states that choose to participate. Through State Auto P&C, effective January 1, 2000, the Company provides management and operation services under new management agreements for all insurance and non-insurance affiliates. Pursuant to these agreements, the Company received approximately $28.1 million equal to the net plan benefit liabilities assumed relating to the transfer to the Company of all employees from Mutual and other affiliated companies. Prior to January 1, 2000, the Company, through State Auto P&C, provided executive insurance management services to all insurance affiliates. SAIC was formed in 1999 to engage in the business of providing standard personal insurance to its policyholders through the use of leading edge technology within the independent agency system. Effective January 1, 2000, SAIC was chartered and licensed as a property and casualty insurer in the state of Ohio and began operations at that time. Through Stateco, the Company provides investment management services to affiliated companies and also provides insurance premium finance services 44 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED to customers of State Auto P&C, Mutual and Milbank. The Company, through S.I.S., develops and sells software for the processing of insurance transactions, database management for insurance agents and electronic interfacing of information between insurance companies and agencies. S.I.S. sells services and products to affiliated companies and their agents and markets similar services and products to nonaffiliated insurers and their agencies. 518 PML, an Ohio limited liability company, was formed to engage in the business of owning and leasing real and personal property to affiliated companies. As of January 1, 1998, State Auto P&C and Stateco became initial members of 518 PML. (c) BASIS OF PRESENTATION The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States, which vary in certain respects from statutory accounting practices followed by State Auto P&C, Milbank, Farmers Casualty, SAIC, National and Mid-Plains that are prescribed or permitted by the Departments. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet, revenues and expenses for the period then ended and the accompanying notes to the financial statements. Such estimates and assumptions could change in the future as more information becomes known which could impact the amounts reported and disclosed herein. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of losses and loss expenses payable. In connection with the determination of this estimate, management uses historical data and current business conditions to formulate estimates including assumptions related to the ultimate cost to settle claims. These estimates by their nature are subject to uncertainties for various reasons. The Company's results of operations and financial condition could be impacted in the future should the ultimate payments required to settle claims vary from the liability currently provided. (d) DEFERRED POLICY ACQUISITION COSTS Acquisition costs, consisting of commissions, premium taxes, and certain underwriting expenses related to the production of property and casualty business, are deferred and amortized ratably over the contract period. The method followed in computing deferred policy acquisition costs limits the amount of such deferred costs to their estimated realizable value. In determining estimated realizable value, the computation gives effect to the premium to be earned, losses and loss expenses to be incurred, and certain other costs expected to be incurred as premium is earned, without credit for anticipated investment income. These amounts are based on estimates and accordingly, the actual realizable value may vary from the estimated realizable value. Net deferred policy acquisition costs were:

YEAR ENDED DECEMBER 31 ---------------------- 2000 1999 1998 ---- ---- ---- (dollars in thousands) Balance, beginning of year ....... $ 28,936 24,799 22,440 Acquisition costs deferred ....... 101,305 96,578 87,573 Amortized to expense during the year .................. 97,783 92,441 85,214 -------- -------- -------- Balance, end of year ............. $ 32,458 28,936 24,799 ======== ======== ========

(e) INVESTMENTS Investments in fixed maturities, where the Companies have the ability and intent to hold to maturity, are carried at amortized cost. Mortgage-backed securities are carried at amortized cost using the scientific method of amortization including anticipated prepayments. Prepayment assumptions are obtained from a pricing service and are based on the current interest rate and economic environment. The retrospective adjustment method is used to value all such securities. For fixed maturities classified as held to maturity, unrealized holding gains or losses are not reflected in the accompanying consolidated financial statements. Investments in fixed maturity and equity securities held as available for sale are carried at fair value. The unrealized holding gains or losses, net of applicable deferred taxes, are shown as a separate component of stockholders' equity as accumulated other comprehensive income and as such are not included in the determination of net income. Gains and losses on the sale of equity securities are computed using the first-in, first-out method. 45 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (f) SURPLUS NOTE RECEIVABLE In August 1998, State Auto Financial purchased $9.0 million of surplus notes from Farmers Casualty Company Mutual (FCCM), an Iowa domiciled standard property casualty insurer. In 1998, a plan to convert FCCM into a stock insurance company was approved by the board of FCCM, its policyholders and the Iowa Division of Insurance. The plan of conversion contemplated that State Auto Financial, in exchange for the redemption of the surplus notes, would acquire the newly issued shares of Farmers Casualty. Effective January 1, 1999, FCCM, renamed Farmers Casualty Insurance Company, became a wholly owned subsidiary of State Auto Financial. (g) GOODWILL Goodwill represents the excess of cost of acquisition over the fair value of the net assets acquired and is being amortized using the straight-line method over 15 years. Accumulated amortization is $1,605,000 and $1,347,000 at December 31, 2000 and 1999, respectively. (h) LOSSES AND LOSS EXPENSES PAYABLE Losses and loss expenses payable are based on formula and case-basis estimates for reported claims, and on estimates, based on experience and perceived trends, for unreported claims and loss expenses. The liability for unpaid losses and loss expenses, net of estimated salvage and subrogation recoverable of $13,403,000 and $13,505,000 at December 31, 2000 and 1999, respectively, has been established to cover the estimated ultimate cost of insured losses. The amounts are necessarily based on estimates of future rates of inflation and other factors, and accordingly there can be no assurance that the ultimate liability will not vary from such estimates. The estimates are continually reviewed and adjusted as necessary; such adjustments are included in current operations (see note 4). Salvage and subrogation recoverables are estimated using historical experience. (i) PREMIUM REVENUES Premiums are recognized as earned using the monthly pro rata method over the contract period. (j) MANAGEMENT SERVICES INCOME Management services income includes income for management and operations services provided by State Auto P&C in 2000 and executive insurance management services provided in 1999 and 1998 and income for investment management services provided by Stateco. Management and operations services income, to the extent certain operational ratios are achieved, is recognized quarterly based on a percentage of the three year average of each managed company's adjusted surplus or equity, whereas in 1999 and 1998 executive management income was based on a five year average of each managed insurer's adjusted statutory surplus. Midwest Security Insurance Company (Midwest Security), a wholly-owned subsidiary of Mutual, is an exception to this, calculating its fee based on a percentage of quarterly direct premiums written. Investment management income is recognized quarterly based on a percentage of the average fair value of investable assets and the performance of the equity portfolio of each company managed. (k) SOFTWARE REVENUE RECOGNITION S.I.S. recognizes revenue from license fees when the product is delivered and service revenue when services are performed. Costs of developing and testing new or enhanced software products are capitalized and are amortized on a product-by-product basis utilizing the straight-line method over a period not to exceed three years. Unamortized software development costs of $626,000 and $1,248,000 are included in accrued investment income and other assets at December 31, 2000 and 1999, respectively. Software amortization, included in other expenses, was $622,000, $614,000 and $673,000 in 2000, 1999 and 1998, respectively. (l) FEDERAL INCOME TAXES The Company files a consolidated federal income tax return and pursuant to an agreement, each entity within the consolidated group pays its share of federal income taxes based on separate return calculations. Milbank filed a consolidated federal income tax return with the Company for periods subsequent to July 1, 1998. Prior to this time, Milbank was included in the consolidated federal income tax return of Mutual. Farmers Casualty and Mid-Plains file a consolidated federal income tax return with the Company for periods subsequent to January 1, 1999. Prior to this time, Farmers Casualty and Mid-Plains filed their own consolidated return. Income taxes are accounted for using the liability method. Using this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets 46 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED and liabilities and are measured using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. (m) CASH EQUIVALENTS The Company considers all highly liquid debt instruments with a maturity of three months or less to be cash equivalents. (n) OTHER COMPREHENSIVE INCOME Comprehensive income is defined as all changes in an enterprise's equity during a period other than those resulting from investments by owners and distributions to owners. Comprehensive income includes net income and other comprehensive income. Other comprehensive income includes all other non-owner related changes to equity and includes net unrealized gains and losses on available-for-sale fixed maturities and equity securities. Separate presentation of the accumulated balance of other comprehensive income within the equity section of the statement of financial position is also required. The Company has presented the required displays of total comprehensive income and its components, within the "Consolidated Statements of Stockholders' Equity." See additional disclosures at note 13. (o) RECLASSIFICATIONS Certain items in the 1999 and 1998 consolidated financial statements and notes thereto have been reclassified to conform with the 2000 presentation. (2) INVESTMENTS Realized and unrealized gains and losses are summarized as follows:

YEAR ENDED DECEMBER 31 ---------------------- 2000 1999 1998 ---- ---- ---- (dollars in thousands) Realized gains: Fixed maturities available for sale ...................... $ 791 1,336 1,588 Equity securities ........................................ 5,959 3,642 1,449 ------------------------------------ Total realized gains ........................................ 6,750 4,978 3,037 ------------------------------------ Realized losses: Fixed maturities available for sale ...................... 827 488 32 Equity securities ........................................ 668 1,896 80 Other .................................................... -- 39 -- ------------------------------------ Total realized losses ....................................... 1,495 2,423 112 ------------------------------------ Net realized gains on investments ........................... $ 5,255 2,555 2,925 ==================================== Increase (decrease) in unrealized holding gains - Fixed maturities held to maturity .............................. $ 848 (1,830) (371) ==================================== Increase (decrease) in unrealized holding gains - Equity securities ............................................... $ (2,123) 3,252 6,014 Increase (decrease) in unrealized holding gains - Fixed maturities available for sale at fair value .............. 33,195 (34,081) 2,657 Change in deferred unrealized gain .......................... (55) (125) (186) Deferred federal income taxes thereon ....................... (10,856) 10,834 (2,970) ------------------------------------ Increase (decrease) in net unrealized holding gains or losses $ 20,161 (20,120) 5,515 ====================================

47 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED The Company's investments in held to maturity and available for sale securities are summarized as follows:

COST OR GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR HELD TO MATURITY AT DECEMBER 31, 2000: COST HOLDING GAINS HOLDING LOSSES VALUE ---- ------------- -------------- ----- (dollars in thousands) U.S. Treasury securities and obligations of U.S. government corporations and agencies ......... $ 2,276 38 -- 2,314 Obligations of states and political subdivisions 7,026 354 -- 7,380 Mortgage-backed securities ..................... 30,005 555 29 30,531 ----------------------------------------------- Total .......................................... $ 39,307 947 29 40,225 =============================================== AVAILABLE FOR SALE AT DECEMBER 31, 2000: U.S. Treasury securities and obligations of U.S. government corporations and agencies ......... $ 66,434 1,250 648 67,036 Obligations of states and political subdivisions 513,311 15,634 874 528,071 Corporate securities ........................... 33,259 897 266 33,890 Mortgage-backed securities ..................... 23,298 978 22 24,254 ----------------------------------------------- Total fixed maturities ....................... 636,302 18,759 1,810 653,251 Equity securities .............................. 44,220 17,768 3,676 58,312 ----------------------------------------------- Total .......................................... $680,522 36,527 5,486 711,563 ===============================================

COST OR GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR HELD TO MATURITY AT DECEMBER 31, 1999: COST HOLDING GAINS HOLDING LOSSES VALUE ---- ------------- -------------- ----- (dollars in thousands) U.S. Treasury securities and obligations of U.S. government corporations and agencies ......... $ 2,887 -- 13 2,874 Obligations of states and political subdivisions 7,041 205 -- 7,246 Mortgage-backed securities ..................... 34,053 372 494 33,931 ----------------------------------------------- Total .......................................... $ 43,981 577 507 44,051 =============================================== AVAILABLE FOR SALE AT DECEMBER 31, 1999: U.S. Treasury securities and obligations of U.S. government corporations and agencies ......... $ 73,866 388 2,673 71,581 Obligations of states and political subdivisions 439,241 3,550 17,998 424,793 Corporate securities ........................... 7,496 214 339 7,371 Mortgage-backed securities ..................... 23,448 789 176 24,061 ----------------------------------------------- Total fixed maturities ....................... 544,051 4,941 21,186 527,806 Equity securities .............................. 39,303 18,925 2,710 55,518 ----------------------------------------------- Total .......................................... $583,354 23,866 23,896 583,324 ===============================================

Deferred federal income taxes on the net unrealized holding gain for available for sale investments was $10,940,000 and $84,000 at December 31, 2000 and 1999, respectively. 48 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED The amortized cost and fair value of fixed maturities segregated by held to maturity and available for sale, at December 31, 2000, by contractual maturity, are summarized as follows:

HELD TO MATURITY AVAILABLE FOR SALE ---------------- ------------------ AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE ---- ----- ---- ----- (dollars in thousands) Due after 1 year or less ......... $ 254 254 15,508 15,578 Due after 1 year through 5 years . 2,022 2,060 43,342 44,648 Due after 5 years through 10 years 7,026 7,380 133,504 137,875 Due after 10 years ............... -- -- 420,650 430,896 ------------------------------------------- 9,302 9,694 613,004 628,997 Mortgage-backed securities ....... 30,005 30,531 23,298 24,254 ------------------------------------------- $39,307 40,225 636,302 653,251 ===========================================

Expected maturities may differ from contractual maturities because the issuers may have the right to call or prepay the obligations with or without call or prepayment penalties. Fixed maturities with carrying values of approximately $21,633,000 and $20,473,000 were on deposit with regulators as required by law or specific escrow agreement at December 31, 2000 and 1999, respectively. Components of net investment income are summarized as follows:

YEAR ENDED DECEMBER 31 ---------------------- 2000 1999 1998 ---- ---- ---- (dollars in thousands) Fixed maturities .................. $36,568 32,096 30,182 Equity securities ................. 848 678 477 Surplus note receivable ........... -- -- 235 Cash and cash equivalents ......... 1,926 1,707 1,908 ------------------------------------- Investment income ................. 39,342 34,481 32,802 ------------------------------------- Investment expenses ............... 427 219 296 ------------------------------------- Net investment income ............. $38,915 34,262 32,506 =====================================

The Company's current investment strategy does not rely on the use of derivative financial instruments. See note 3 for additional fair value disclosures. (3) DISCLOSURES ABOUT FAIR VALUE OF FINANCIAL INSTRUMENTS The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments: Investment securities:Fair values for investments in fixed maturities are based on quoted market prices, where available. For fixed maturities not actively traded, fair values are estimated using values obtained from independent pricing services. The fair values for equity securities are based on quoted market prices. Cash and cash equivalents:The carrying amounts reported in the balance sheets for these instruments approximate their fair value. 49 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (4) LOSSES AND LOSS EXPENSES PAYABLE Activity in the liability for losses and loss expenses is summarized as follows:

YEAR ENDED DECEMBER 31 ---------------------- 2000 1999 1998 ---- ---- ---- (dollars in thousands) Losses and loss expenses payable, net of reinsurance recoverables, at beginning of year ........ $ 221,682 205,034 194,155 Incurred related to: Current year .......................................... 277,805 271,507 255,885 Prior years ........................................... (5,638) (6,878) (13,591) --------------------------------------- Total incurred .......................................... 272,167 264,629 242,294 --------------------------------------- Paid related to: Current year .......................................... 164,620 168,512 157,988 Prior years ........................................... 104,871 100,349 86,671 --------------------------------------- Total paid .............................................. 269,491 268,861 244,659 --------------------------------------- Impact of pooling change, January 1, 2000, 1999 and 1998 (note 6) ......................................... 12,295 7,633 13,244 Impact of acquisition of Farmers Casualty and Mid-Plains, January 1, 1999 (note 1(f)) ........................... -- 13,247 -- --------------------------------------- Losses and loss expenses payable, net of reinsurance recoverables, at end of year .............. $ 236,653 221,682 205,034 =======================================

The liability for losses and loss expenses decreased by $5,638,000 in 2000, $6,878,000 in 1999 and $13,591,000 in 1998, for claims that had occurred in prior years. The change in the redundancy over the three year period ending December 31, 2000 has resulted primarily from less favorable development in the long-tail lines such as general liability, commercial auto liability, workers' compensation and no-fault insurance. Because of the nature of the business written over the years, the Company's management believes that the Company has limited exposure to environmental claim liabilities. 50 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) Notes to Consolidated Financial Statements, Continued (5) REINSURANCE In the ordinary course of business, the Company assumes and cedes reinsurance with other insurers and reinsurers and are members in various pools and associations. See Note 6(a) for discussion of reinsurance with affiliates. The voluntary arrangements provide greater diversification of business and limit the maximum net loss potential arising from large risks and catastrophes. Most of the ceded reinsurance is effected under reinsurance contracts known as treaties; some is by negotiation on individual risks. Although the ceding of reinsurance does not discharge the original insurer from its primary liability to its policyholder, the insurance company that assumes the coverage assumes the related liability. Amounts recoverable from reinsurers are estimated in a manner consistent with the claim liability associated with the reinsured business. The recoverability of these assets depends on the reinsurers' ability to perform under the reinsurance agreements. The Company evaluates and monitors the financial condition and concentrations of credit risk associated with its reinsurers under voluntary reinsurance arrangements to minimize its exposure to significant losses from reinsurer insolvencies. The Company has reported ceded losses and loss expenses payable and prepaid reinsurance premiums with other insurers and reinsurers as assets. All reinsurance contracts provide indemnification against loss or liability relating to insurance risk and have been accounted for as reinsurance. Prior to the reinsurance transaction with Mutual under the pooling arrangement, as discussed in note 6(a), the effect of the Company's reinsurance on its balance sheets and income statements, is as follows:

DECEMBER 31 ----------- 2000 1999 ---- ---- (dollars in thousands) Losses and loss expenses payable: Direct ..................................... $ 229,422 222,152 Assumed .................................... 5,035 7,710 Ceded ...................................... (7,930) (10,807) -------------------------- Net losses and loss expenses payable ...... $ 226,527 219,055 ========================== Unearned premiums: Direct ..................................... $ 159,173 151,867 Assumed .................................... 1,214 1,703 Ceded ...................................... (3,131) (3,090) -------------------------- Net unearned premiums ..................... $ 157,256 150,480 ==========================

YEAR ENDED DECEMBER 31 ---------------------- 2000 1999 1998 ---- ---- ---- (dollars in thousands) Written premiums: Direct ............................... $ 439,623 436,150 387,762 Assumed .............................. 4,678 8,281 13,942 Ceded ................................ (10,905) (11,216) (16,731) --------------------------------------- Net written premiums ................ $ 433,396 433,215 384,973 ======================================= Earned premiums: Direct ............................... $ 432,318 429,577 384,869 Assumed .............................. 5,166 10,822 14,386 Ceded ................................ (10,864) (13,698) (17,026) --------------------------------------- Net earned premiums ................. $ 426,620 426,701 382,229 ======================================= Losses and loss expenses incurred: Direct ............................... $ 297,757 289,162 266,160 Assumed .............................. 3,726 10,803 13,644 Ceded ................................ (2,165) (9,736) (8,355) --------------------------------------- Net losses and loss expenses incurred $ 299,318 290,229 271,449 =======================================

51 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (6) TRANSACTIONS WITH AFFILIATES (a) REINSURANCE State Auto P&C, Milbank, Farmers Casualty and SAIC (the Pooled Subsidiaries) participate in a quota share reinsurance pooling arrangement (the Pooling Arrangement) with Mutual whereby the Pooled Subsidiaries cede to Mutual all of their insurance business and assume from Mutual an amount equal to their respective participation percentages in the Pooling Arrangement. All premiums, losses and loss expenses and underwriting expenses are allocated among the participants on the basis of each company's participation percentage in the Pooling Arrangement. The Pooling Arrangement provides indemnification against loss or liability relating to insurance risk and has been accounted for as reinsurance. Since 1995, State Auto P&C and Milbank have participated in the Pooling Arrangement with Mutual. Effective January 1, 1998, the Pooled Subsidiaries aggregate participation in the Pooling Arrangement increased from 45% to 47% and Midwest Security Insurance Company (Midwest), a wholly-owned subsidiary of Mutual, became a participant in the Pooling Arrangement. On January 1, 1999, Farmers Casualty was acquired by State Auto Financial and became a participant in the Pooling Arrangement on that same date, at which time the Pooled Subsidiaries' aggregate participation increased to 50%. In conjunction with these changes in pool participation, the Pooled Subsidiaries received cash from Mutual of $11.4 million and $19.7 million, which related to the additional net insurance liabilities assumed by the Pooled Subsidiaries on January 1, 1999 and 1998, respectively. Effective January 1, 2000, the Pooling Arrangement was amended to make SAIC a participant in the Pooling Arrangement and the Pooled Subsidiaries aggregate participation increased to 53%. In conjunction with this change in pool participation, the Pooled Subsidiaries received cash from Mutual of $18.6 million, which related to the additional net insurance liabilities assumed by the Pooled Subsidiaries on January 1, 2000. All parties that participate in the Pooling Arrangement have an A. M. Best rating of A+ (Superior). The Pooling Arrangement does not relieve each individual pooled subsidiary of its primary liability as the originating insurer, consequently, there is a concentration of credit risk arising from business ceded to Mutual. As the Pooling Arrangement provides for the right of offset, the Company has reported losses and loss expenses payable and prepaid reinsurance premiums to Mutual as assets only in situations when net amounts ceded to Mutual exceed that assumed. The following provides a summary of the reinsurance transactions on the Company's balance sheets and income statements for the Pooling Arrangement between the Pooled Subsidiaries and Mutual:

DECEMBER 31 ----------- 2000 1999 ---- ---- (dollars in thousands) Losses and loss expenses payable: Ceded ............................... $(212,614) (206,258) Assumed ............................. 222,740 208,885 ------------------------------ Net assumed (ceded) ................ $ 10,126 2,627 ============================== Unearned premiums: Ceded ............................... $(149,854) (143,514) Assumed ............................. 141,410 130,820 ------------------------------ Net ceded .......................... $ (8,444) (12,694) ==============================

52 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

YEAR ENDED DECEMBER 31 ---------------------- 2000 1999 1998 ---- ---- ---- (dollars in thousands) Written premiums: Ceded ........................... $(405,397) (403,679) (359,590) Assumed ......................... 370,576 356,609 330,410 Earned premiums: Ceded ........................... $(399,057) (395,698) (356,638) Assumed ......................... 367,275 358,700 328,144 Losses and loss expenses incurred: Ceded ........................... $(277,340) (268,536) (252,795) Assumed ......................... 250,189 242,935 223,641

During 1996, Mutual, State Auto P&C, Milbank and National negotiated a change in their catastrophe reinsurance program. In 1998, Midwest Security, 1999, Farmers Casualty and Mid-Plains, and 2000, SAIC, became parties to the catastrophe reinsurance program. Collectively, these participants in the catastrophe reinsurance program are referred to as the "State Auto Insurance Companies." State Auto P&C assumed catastrophe reinsurance from Mutual, Milbank, Midwest Security, Farmers Casualty, SAIC, National and Mid-Plains in the amount of $135 million excess of $120 million. Effective November 2000, the catastrophe reinsurance program was renegotiated whereby State Auto P&C assumed $115 million excess of $120 million. Under this agreement, the Company has assumed from Mutual and its affiliate premiums written and earned of $3,129,000, $2,355,000 and $2,475,000 for 2000, 1999 and 1998, respectively. There have been no losses assumed under this agreement. The catastrophe reinsurance program with State Auto P&C has been excluded from the Pooling Arrangement. To protect against a catastrophe loss event, in which the State Auto Insurance Companies would incur catastrophe losses in excess of $120 million, State Auto Financial entered into a structured contingent financing transaction with a financial institution and a syndicate of other lenders (the Lender) to provide (effective November 2000) up to $115 million for reinsurance purposes. In the event of such a loss, this arrangement provides that State Auto Financial 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. This arrangement with the Lenders, SPC and State Auto Financial is a financing arrangement, whereby State Auto Financial would receive cash funding in the event of a catastrophe event as described above. State Auto Financial would then contribute to State Auto P&C the funds received from the sale of its preferred shares. State Auto P&C would use the contributed capital proceeds to pay its direct catastrophe losses and losses assumed under the catastrophe reinsurance agreement. State Auto Financial is obligated to repay SPC by redeeming the preferred shares over a six-year period. In the event of a default by State Auto Financial, the obligation to repay SPC has been secured by a Put Agreement among State Auto Financial, Mutual and the Lenders, under which Mutual would be obligated to put either the preferred shares or the loan(s) outstanding. (b) INTERCOMPANY BALANCES Pursuant to the Pooling Arrangement, Mutual is responsible for the collection of premiums and payment of losses, loss expenses and underwriting expenses of the Pooled Subsidiaries. Unpaid balances are reflected in due to or due from affiliates in the accompanying consolidated balance sheets. Settlements of the intercompany account are made quarterly. No interest is paid on this account. All premium balance receivables and reinsurance recoverable on paid losses from unaffiliated reinsurers are carried by Mutual. The Company had off-balance-sheet credit risk of approximately $60 million and $47 million related to premium balances due to Mutual from agents and insureds at December 31, 2000 and 1999, respectively. 53 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (c) NOTE PAYABLE State Auto Financial entered into a line of credit agreement with Mutual for $45.5 million in conjunction with its stock repurchase program, at an interest rate of 6.0%. See related footnote at note 9 (b). Principal payment is due on demand after December 31, 2000, with final payment to be received on or prior to December 31, 2005. The interest rate is adjustable annually after the year 2000 to reflect adjustments in the then current prime lending rate as well as State Auto Financial's current financial position. Interest rate for the year 2001 is 5.0%. Interest expense on the loan from Mutual was $2,730,000 and $955,000 in 2000 and 1999, respectively. (d) MANAGEMENT SERVICES Effective January 1, 2000, State Auto P&C began providing management and operation services to Mutual and its insurance affiliate. Revenue relating to these services amounted to $14,654,000 in 2000. Prior to 2000, State Auto P&C provided Mutual and its insurance affiliate executive management services to oversee the insurance operations of these companies. Revenue relating to these services amounted to $4,908,000 and $4,563,000 in 1999 and 1998, respectively. Stateco provides Mutual and its affiliate investment management services. Revenue related to these services amount to $2,940,000, $3,099,000 and $3,037,000 in 2000, 1999 and 1998, respectively. (e) OTHER TRANSACTIONS S.I.S. provides insurance software products and services to Mutual and its affiliate. Revenue relating to these services amount to $900,000, $1,109,000 and $1,048,000 in 2000, 1999 and 1998, respectively, and is included in other income. Effective January 1, 1998, 518 PML began leasing assets to Mutual and its affiliate. Revenue relating to these services amount to $646,000, $567,000 and $268,000 in 2000, 1999 and 1998, respectively and is included in other income. State Auto P&C's December 31, 1990 liability for losses and loss expenses of $65,464,000 has been guaranteed by Mutual. Pursuant to the guaranty agreement, all ultimate adverse development of the December 31, 1990 liability, if any, is to be reimbursed by Mutual to State Auto P&C in conformance with pooling percentages in place at that time. As of December 31, 2000, there has been no adverse development of the liability. (7) FEDERAL INCOME TAXES A reconciliation between actual federal income taxes and the amount computed at the indicated statutory rate is as follows:

YEAR ENDED DECEMBER 31 ---------------------- 2000 1999 1998 AMOUNT % AMOUNT % AMOUNT % ------ --- ------ --- ------ --- (dollars in thousands) Amount at statutory rate ......................... $ 21,505 35 19,947 35 17,361 35 Tax-free interest and dividends received deduction (7,918) (13) (6,315) (11) (5,423) (11) Other, net ....................................... 143 -- 537 1 170 -- -------- ----- ------- ----- ------- ----- Effective tax rate ............................... $ 13,730 22 14,169 25 12,108 24 ======== ===== ======= ===== ======= =====

54 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities are presented below:

DECEMBER 31 ----------- 2000 1999 ---- ---- (dollars in thousands) Deferred tax assets: Unearned premiums not deductible ................... $ 10,385 9,597 Losses and loss expenses payable discounting ....... 9,219 8,375 Postretirement benefit liabilities ................. 13,035 -- Other .............................................. 2,110 2,229 ---------------------- Total deferred tax assets ........................ 34,749 20,201 ---------------------- Deferred tax liabilities: Deferral of policy acquisition costs ............... 11,360 10,128 Net pension expense ................................ 12,628 6,631 Unrealized holding gain on investments ............. 10,940 84 Other .............................................. 1,311 1,530 ---------------------- Total deferred tax liabilities ................... 36,239 18,373 ---------------------- Net deferred tax assets (liabilities) ............ $ (1,490) 1,828 ======================

The Company is required to establish a valuation allowance for any portion of the deferred tax asset that management believes will not be realized. In the opinion of management, it is more likely than not that the Company will realize the benefit of the deferred tax assets and, therefore, no such valuation allowance has been established. Federal income taxes paid during 2000, 1999 and 1998 were $12,638,000, $12,621,000 and $11,768,000, respectively. (8) (a) PENSION BENEFIT PLANS Prior to 2000, State Auto P&C, Stateco and S.I.S., pursuant to an intercompany agreement, were participants, together with Mutual, in a defined benefit pension plan and a defined contribution plan that covered substantially all employees of Mutual and the Company. Effective January 1, 2000, all employees of Mutual, Stateco and S.I.S., became employees of State Auto P&C, under new management agreements effective on that same date. See related discussion at Note (1)(b). Pursuant to the new management agreements, the Company paid cash of approximately $14.6 million to Mutual, equal to the net prepaid pension asset received. The assets of the defined benefit pension plan are represented primarily by U.S. government and agency obligations, bonds, and common stocks. The Company's policy is to fund pension costs in accordance with the requirements of the Employee Retirement Income Security Act of 1974. Benefits are determined by applying factors specified in the plan to a participant's defined average annual compensation. 55 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED Information regarding the funded status and net periodic pension benefit for the Company's participation in the defined benefit pension plan is as follows:

DECEMBER 31 ----------- 2000 1999 ---- ---- (in thousands) CHANGE IN BENEFIT OBLIGATION Benefit obligation at beginning of year .................................... $ 44,016 44,758 Transfer in benefit obligation at beginning of year due to employee transfer 39,586 -- Transfer in benefit obligation at beginning of year due to pooling change .. -- 2,615 Service cost ............................................................... 3,339 2,047 Interest cost .............................................................. 6,728 3,278 Changes in plan provisions ................................................. 1,205 -- Actuarial loss ............................................................. (438) (4,286) Benefits paid .............................................................. (7,343) (4,396) -------- ------ Benefit obligation at end of year .......................................... $ 87,093 44,016 -------- ------ CHANGE IN PLAN ASSETS Fair value of plan assets at beginning of year ............................. $ 84,883 75,453 Transfer in plan assets at beginning of year due to employee transfer ...... 76,340 -- Transfer in plan assets at beginning of year due to pooling change ......... -- 4,313 Actual return on plan assets ............................................... 8,778 9,513 Benefits paid .............................................................. (7,343) (4,396) -------------------- Fair value of plan assets at end of year ................................... $162,658 84,883 -------------------- Funded status .............................................................. $ 75,565 40,867 Unrecognized net actuarial gain ............................................ (846) (22,441) Unrecognized prior service cost ............................................ 2,470 1,472 Unrecognized transition asset .............................................. (39,451) (967) -------------------- Net prepaid pension expense ................................................ $ 37,738 18,931 ====================

YEAR ENDED DECEMBER 31 ---------------------- 2000 1999 1998 ---- ---- ---- (in thousands) COMPONENTS OF NET PERIODIC BENEFIT Service cost ............................ $ 3,339 2,047 1,686 Interest cost ........................... 6,728 3,278 2,977 Expected return on plan assets .......... (13,391) (6,125) (5,430) Amortization of prior service cost ...... 207 114 114 Amortization of transition asset ........ (121) (124) (121) Amortization of net (gain) or loss ...... (930) 7 (8) --------------------------------- Net periodic benefit .................... $(4,168) (803) (782) =================================

YEAR ENDED DECEMBER 31 ---------------------- 2000 1999 1998 ---- ---- ---- WEIGHTED-AVERAGE ASSUMPTIONS AS OF DECEMBER 31 Discount rate ................................ 8.00% 8.00% 7.00% Expected long-term rate of return on assets .. 9.00% 9.00% 9.00% Rates of increase in compensation levels ..... 5.00% 5.00% 4.50%

56 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED Effective January 1, 2000, the net prepaid pension expense is carried on the financial statements of the Company and the annual periodic pension benefit or cost is allocated to affiliated companies based on allocations pursuant to intercompany management agreements. The Company's share of the 2000 net periodic benefit was $2.5 million. The Company maintains a defined contribution plan that covers substantially all employees of the Company. Contributions to the plan are based on employee contributions and the level of Company match. The Company's share of the expense under the plan totaled $890,000, $852,000 and $782,000 for the years 2000, 1999 and 1998, respectively. (b) POSTRETIREMENT BENEFITS In addition to pension benefits, the Company provides certain health care and life insurance benefits for its eligible retired employees. Substantially all of the Company's employees may become eligible for these benefits if they retire between age 55 and 65 with 15 years or more of service or if they retire at age 65 or later with 5 years or more of service. Prior to 2000, State Auto P&C, Stateco and S.I.S., pursuant to an intercompany agreement, were participants, together with Mutual, in a postretirement medical and life insurance benefit plan. The postretirement benefit obligation was immaterial to the consolidated balance sheet prior to 2000. Effective January 1, 2000, all employees of Mutual, Stateco and S.I.S., became employees of State Auto P&C, under new management agreements effective on that same date. See related discussion at Note (1)(b). Pursuant to the new management agreements, the Company received cash of approximately $49.6 million from Mutual, equal to the funded status of the postretirement obligation assumed. Plan assets are primarily composed of mutual funds and government securities. The following table presents the funded status for the Company's postretirement benefit obligation and the amounts recognized in the consolidated balance sheet as of December 31, 2000 (in thousands):

2000 ---- CHANGE IN BENEFIT OBLIGATION Obligation at January 1 .................................................... $ 1,064 Transfer in benefit obligation at beginning of year due to employee transfer ............................................. 46,045 Service cost ............................................................... 1,242 Interest cost .............................................................. 3,205 Actuarial gain ............................................................. (5,247) Employee contributions ..................................................... (1,400) -------- Obligation at December 31 .................................................. $ 44,909 ======== CHANGE IN FAIR VALUE OF PLAN ASSETS Fair value of plan assets at January 1 ..................................... $ -- Transfer of plan assets at beginning of year due to employee transfer ...... 1,479 Expected return on assets .................................................. 126 Loss on assets ............................................................. (37) -------- Fair value of plan assets at December 31 ................................... $ 1,568 ======== FUNDED STATUS Funded status at December 31 ............................................... $(43,341) Unrecognized transition asset .............................................. (41) Unrecognized gain .......................................................... (12,099) -------- Accrued liability at December 31 ........................................... $(55,841) ========

57 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED An 8.0% weighted average discount rate was used for 2000 to determine the accumulated postretirement benefit obligation. An 8.5% weighted average rate was used for 2000 to determine the long-term rate of return on plan assets. Net periodic pension costs for the postretirement plan for the year ended December 31, 2000 include the following components:

2000 ---- Service cost ............................................... $ 1,242 Interest cost .............................................. 3,205 Expected return on assets .................................. (126) Amortization of unrecognized amounts ....................... (495) -------- Net periodic benefit cost .................................. $ 3,826 ========

The assumed rate of future increases in per capita cost of health care benefits was 10% for the first year and grading down 1% per year to an ultimate rate of 5%. The health care cost trend rate assumption affects the amounts reported. For example, increasing the assumed health care cost trend rate by one percentage point would increase the accumulated postretirement benefit obligation by approximately $6,100,000 and would increase the medical service and interest cost by approximately $800,000. (9) STOCKHOLDERS' EQUITY (a) STOCK SPLIT On June 2, 1998, State Auto Financial's authorized capital was increased to 100,000,000 shares of common stock and State Auto Financial's Board of Directors declared a two-for-one common stock split. The financial statements, notes and other references to share information and per share data have been given retroactive effect to reflect the stock split for all periods presented. (b) TREASURY SHARES In May 1999, State Auto Financial's Board of Directors approved a plan to repurchase up to 4.0 million shares of its outstanding common stock over a period ending December 31, 2000. Repurchases were transacted to maintain the same ownership ratios between Mutual and the public as it existed in May 1999, with 69% repurchased from Mutual and 31% from the public. Through December 31, 1999 all 4.0 million shares have been repurchased, with approximately 2.7 million shares repurchased from Mutual and 1.3 million shares from the public. In conjunction with the stock repurchase plan, State Auto Financial entered into a line of credit agreement with Mutual. See related footnote at note 6 (c). In May 2000, State Auto Financial's Board of Directors approved a plan to repurchase up to 1.0 million shares of its common stock from the public over a period ending December 31, 2001. Through December 31, 2000, State Auto Financial has repurchased 25,122 shares from the public. Repurchases during 2000 were funded through dividends from subidiaries. (c) DIVIDEND RESTRICTIONS AND STATUTORY FINANCIAL INFORMATION State Auto P&C, Milbank, Farmers Casualty, SAIC and National are subject to regulations and restrictions under which payment of dividends from statutory surplus can be made to State Auto Financial during the year without prior approval of regulatory authorities. Pursuant to these rules, approximately $44.9 million is available for payment to State Auto Financial in 2001 without prior approval. 58 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED Reconciliations of statutory capital and surplus and net income, as determined using statutory accounting practices, to the amounts included in the accompanying consolidated financial statements are as follows:

DECEMBER 31 ----------- 2000 1999 ---- ---- (dollars in thousands) Statutory capital and surplus of insurance subsidiaries ...... $ 325,532 283,233 Net assets of noninsurance parent and affiliates ............. (25,744) (21,378) ------------------------ 299,788 261,855 Increases (decreases): Deferred policy acquisition costs .......................... 32,458 28,936 Losses and loss expenses payable ........................... 13,403 13,505 Net prepaid pension expense ................................ 37,738 18,945 Postretirement benefit liability ........................... (18,478) -- Deferred federal income taxes .............................. (1,854) 1,636 Excess of statutory loss liabilities over case basis amounts 2,567 4,856 Fixed maturities at fair value ............................. 17,250 (15,204) Goodwill ................................................... 2,270 2,529 Other, net ................................................. 917 629 ------------------------ Stockholders' equity per accompanying consolidated financial statements ..................................... $386,059 317,687 =======================

YEAR ENDED DECEMBER 31 ---------------------- 2000 1999 1998 ------ ------ ------ (dollars in thousands) Statutory net income of insurance subsidiaries . $ 43,991 36,601 28,696 Net income of noninsurance parent and affiliates 1,125 2,944 3,227 ------------------------------------ 45,116 39,545 31,923 Increases (decreases): Deferred policy acquisition costs ............ 3,522 3,407 2,359 Losses and loss expenses payable ............. (103) 15 1,947 Net prepaid pension expense .................. 640 2,578 1,791 Postretirement benefit expense ............... (1,150) -- -- Deferred federal income taxes ................ 401 (2,265) 279 Goodwill amortization ........................ (258) (258) (198) Other, net ................................... (454) (206) (604) ------------------------------------ Net income per accompanying consolidated financial statements ........................ $ 47,714 42,816 37,497 ====================================

In March 1998, the National Association of Insurance Commissioners revised the Accounting Practices and Procedures Manual for insurance companies in a process referred to as Codification. The revised manual became effective January 1, 2001. The revised manual has changed, to some extent, prescribed statutory insurance accounting practices and will result in changes to the accounting practices that the insurance subsidiaries of State Auto Financial use to prepare its statutory-basis financial statements. The cumulative effect of changes in accounting principles adopted to conform to the revised Accounting Practices and Procedures Manual will be reported as an adjustment to statutory surplus as of January 1, 2001. The Company estimates that the adoption of Codification, as of January 1, 2001, will increase statutory surplus of the insurance subsidiaries of State Auto Financial by approximately $26.8 million. 59 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (10) PREFERRED STOCK State Auto Financial has authorized two classes of preferred stock. For both classes, upon issuance, the Board of Directors has authority to fix and determine the significant features of the shares issued, including, among other things, the dividend rate, redemption price, redemption rights, conversion features and liquidation price payable in the event of any liquidation, dissolution, or winding up of the affairs of State Auto Financial. See note 6 (a) regarding State Auto Financial's obligation to issue redeemable preferred shares to SPC in connection with its catastrophic reinsurance arrangements with a financial institution. The Class A preferred stock is not entitled to voting rights until, for any period, dividends are in arrears in the amount of six or more quarterly dividends. (11) STOCK INCENTIVE PLANS The Company follows Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related Interpretations in accounting for its employee stock incentive plans. For stock options granted to employees of Mutual in 1999, the Company also followed APB 25 and related Interpretations, as the Company deemed such employees to be common law employees of the Company. Compensation cost charged against operations in 2000 and 1999 were $31,000 and $137,000, respectively, for those employee stock options granted where the exercise price was less than the market price of the underlying stock on the date of grant. Had compensation cost for the Company's plans been determined based on the fair values at the grant dates consistent with the method of SFAS No. 123, "Accounting for Stock-Based Compensation," (SFAS No. 123), the Company's pro forma net earnings and net earnings per share information would have been as follows: 2000 1999 1998 ---- ---- ---- (in thousands, except per share figures) Pro forma net earnings ....................... $ 45,784 41,414 35,700 Pro forma net earnings per common share Basic .................................... $ 1.19 1.02 0.85 Diluted .................................. $ 1.17 1.00 0.83 The fair value of options granted in 2000, 1999 and 1998 were estimated at the date of grant using the Black-Scholes option-pricing model. The weighted average fair values and related assumptions for options granted were as follows: 2000 1999 1998 ---- ---- ---- Fair value .............................. $4.66 $4.49 $6.10 Dividend yield .......................... .90% .90% .75% Risk free interest rate ................. 6.51% 5.77% 5.31% Expected volatility factor .............. .34 .32 .31 Expected life (years) ................... 7.2 5.7 6.6 The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. The Company has stock option plans for certain directors and key employees. The nonemployee directors' plan provides each nonemployee director an option to purchase 1,500 shares of common stock following each annual meeting of the shareholders at an option price equal to the fair market value at the last business day prior to the annual meeting. The Company has reserved 300,000 shares of common stock under this plan. These options are exercisable at issuance to 10 years from date of grant. The key employee's plan provides that qualified stock options 60 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED may be granted at an option price not less than fair market value at date of grant and that nonqualified stock options may be granted at any price determined by the options committee of the Board of Directors. The Company has reserved 5,000,000 shares of common stock under this plan. These options are exercisable at such time or times as may be determined by a committee of the Company's Board of Directors. Normally, for certain employees these options are exercisable from 1 to 10 years from date of grant and 3 to 10 years for remaining employees. The Company has an employee stock purchase plan with a dividend reinvestment feature, under which employees of the Company may choose at two different specified time intervals each year to have up to 6% of their annual base earnings withheld to purchase the Company's common stock. The purchase price of the stock is 85% of the lower of its beginning-of-interval or end-of-interval market price. The Company has reserved 2,400,000 shares of common stock under this plan. At December 31, 2000, 1,699,000 shares have been purchased under this plan. The Company has a stock option incentive plan for certain designated independent insurance agencies that represent the Company and its affiliates. The Company has reserved 400,000 shares of common stock under this plan. The plan provides that the options become exercisable on the first day of the calendar year following the agency's achievement of specific production and profitability requirements over a period not greater than two calendar years from date of grant or a portion thereof in the first calendar year in which an agency commences participation under the plan. Options granted and vested under this plan have a 10-year term. The Company has accounted for the plan in its accompanying financial statements at fair value. The fair value of options granted was estimated at the reporting date or vesting date using the Black-Scholes option-pricing model. The weighted average fair value and related assumptions for 2000 and 1999, respectively, were as follows: fair value of $10.91 and $4.02; dividend yield of .90% for both years; expected volatility factor of .32 and .30; risk-free interest rate of 5.19% and 6.80%; and expected life of the option of 9.0 and 9.7 years. Expense of $493,000 and $105,000 associated with this plan was recognized in 2000 and 1999, respectively. A summary of the Company's stock option activity and related information for these plans for the years ended December 31, 2000, 1999 and 1998, follows:

2000 1999 1998 -------------------------- -------------------------- -------------------------- WEIGHTED - AVERAGE WEIGHTED - AVERAGE WEIGHTED - AVERAGE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE ------- -------------- ------- -------------- ------- -------------- (numbers in thousands, except per share figures) Outstanding, beginning of year 2,546 $ 7.76 2,272 $ 6.76 2,019 $ 5.04 Granted 492 10.29 453 11.24 339 16.31 Exercised (129) 4.32 (165) 3.34 (86) 4.02 Canceled (57) 11.15 (14) 10.52 -- -- ------ ----- ----- Outstanding, end of year 2,852 8.28 2,546 7.76 2,272 6.76 ====== ===== =====

A summary of information pertaining to options outstanding and exercisable as of December 31, 2000 follows:

OPTIONS OUTSTANDING OPTIONS EXERCISABLE ------------------------------------------------- ---------------------------- WEIGHTED - AVERAGE REMAINING WEIGHTED - AVERAGE WEIGHTED - AVERAGE RANGE OF EXERCISE PRICES NUMBER CONTRACTUAL LIFE EXERCISE PRICE NUMBER EXERCISE PRICE ------------------------ ------ ---------------- -------------- ------ -------------- (numbers in thousands, except per share figures) Less than $5.00 734 2.0 $ 3.98 734 $ 3.98 $5.01 - $10.00 1,004 4.9 6.66 961 6.56 Greater than $10.01 1,114 8.5 12.58 537 13.89 ----- ----- 2,852 5.5 8.28 2,232 7.47 ===== =====

61 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (12) NET EARNINGS PER COMMON SHARE The following table sets forth the compilation of basic and diluted net earnings per common share: YEAR ENDED DECEMBER 31 ---------------------- 2000 1999 1998 ---- ---- ---- (in thousands, except per share data) Numerator: Net earnings for basic and diluted earnings per common share .................................. $47,714 42,816 37,497 ----------------------- Denominator: Weighted average shares for basic net earnings per common share .................................. 38,427 40,780 41,887 Effect of dilutive stock options .................... 693 746 1,014 ----------------------- Adjusted weighted average shares for diluted net earnings per common share ............. 39,120 41,526 42,901 ======================= Basic net earnings per common share ................... $ 1.24 1.05 0.89 ======================= Diluted net earnings per common share ................. $ 1.21 1.03 0.87 ======================= (13) OTHER COMPREHENSIVE INCOME The related federal income tax effects of each component of other comprehensive income (loss) are as follows: YEAR ENDED DECEMBER 31, 2000 ---------------------------- BEFORE-TAX TAX (EXPENSE) NET-OF-TAX AMOUNT OR BENEFIT AMOUNT ------ ---------- ------ (in thousands) Net unrealized holding gains on securities: Unrealized holding gains arising during 2000 ........................... $36,272 (12,695) 23,577 Reclassification adjustments for gains realized in net income ................ (5,255) 1,839 (3,416) --------------------------------- Net unrealized holding gains ............ 31,017 (10,856) 20,161 --------------------------------- Other comprehensive income ................ $31,017 (10,856) 20,161 ================================= YEAR ENDED DECEMBER 31, 1999 ---------------------------- BEFORE-TAX TAX (EXPENSE) NET-OF-TAX AMOUNT OR BENEFIT AMOUNT ------ ---------- ------ (in thousands) Net unrealized holding losses on securities: Unrealized holding losses arising during 1999 ........................... $(28,361) 9,926 (18,435) Reclassification adjustments for gains realized in net income ................ (2,593) 908 (1,685) ----------------------------------- Net unrealized holding losses ........... (30,954) 10,834 (20,120) ----------------------------------- Other comprehensive loss .................. $(30,954) 10,834 (20,120) =================================== YEAR ENDED DECEMBER 31, 1998 ---------------------------- BEFORE-TAX TAX (EXPENSE) NET-OF-TAX AMOUNT OR BENEFIT AMOUNT ------ ---------- ------ (in thousands) Net unrealized holding gains on securities: Unrealized holding gains arising during 1998 ........................... $11,410 (3,993) 7,417 Reclassification adjustments for gains realized in net income ................ (2,925) 1,023 (1,902) ---------------------------------- Net unrealized holding gains ............ 8,485 (2,970) 5,515 ---------------------------------- Other comprehensive income ................ $ 8,485 (2,970) 5,515 ================================== 62 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (14) REPORTABLE SEGMENTS The Company has four reportable segments: standard insurance, nonstandard insurance, investment management services and management and operations services (prior to 2000, executive insurance management services). The standard insurance segment provides personal and commercial insurance to its policyholders. Its principal lines of business include personal and commercial automobile, homeowners, commercial multi-peril, workers' compensation, general liability and fire insurance. The nonstandard insurance segment provides personal automobile insurance to policyholders that are typically rejected or canceled by standard insurance carriers because of poor loss experience or a history of late payment of premiums. Both the standard and nonstandard insurance segments operate primarily in the Midwest and Eastern United States, excluding New York, New Jersey, and the New England states, through the independent insurance agency system. The investment management services segment manages the investment portfolios of affiliated insurance companies. The management and operations services segment provides employee services and manages the day to day operations of all affiliated Companies. The Company evaluates performance and allocates resources based on profit or loss from operations, excluding net realized gains on investments on the Company's investment portfolio, before federal income taxes. The Company does not allocate assets to the management and operations services segment. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. Intersegment sales and transfers are priced at estimated market value. The reportable segments are business units that are each managed separately because of the differences in products or service they offer and type of customer they serve. Revenue from segments in the other category is attributable to three other operating segments of the Company; an insurance software development and resale segment, a premium finance segment and a property management and leasing segment. These segments have never met the quantitative thresholds for individual presentation as reportable segments. The following provides financial information regarding the Company's reportable segments: 2000 1999 1998 ---- ---- ---- (in thousands) REVENUES FROM EXTERNAL CUSTOMERS: Standard insurance ...................... $406,602 392,557 360,601 Nonstandard insurance ................... 29,595 32,973 27,064 Investment management services .......... 3,360 3,371 3,328 Management and operations services ...... 14,654 5,628 4,909 All other ............................... 3,227 3,537 2,906 -------------------------------- Total revenues from external customers .... 457,438 438,066 398,808 Intersegment revenues: Standard insurance ...................... 162 120 90 Investment management services .......... 2,884 2,575 2,363 Management and operations services ...... 4,303 1,451 1,060 All other ............................... 1,744 1,676 1,167 -------------------------------- Total intersegment revenues ............... 9,093 5,822 4,680 -------------------------------- Total revenue ............................. 466,531 441,578 403,488 -------------------------------- Reconciling items: Intersegment revenues ................... (9,093) (5,822) (4,680) Corporate revenues ...................... 81 250 326 Net realized gains on investment ........ 5,255 2,555 2,925 -------------------------------- Total consolidated revenues ............... $462,774 440,871 402,059 ================================ 63 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 2000 1999 1998 ---- ---- ---- (in thousands) SEGMENT PROFIT (LOSS): Standard insurance ......................... $ 35,579 41,146 34,341 Nonstandard insurance ...................... (116) 1,647 1,313 Investment management services ............. 5,354 5,191 4,908 Management and operations services ......... 17,552 6,330 5,290 All other .................................. 905 1,238 1,323 ------------------------------ Total segment profit ....................... 59,274 55,552 47,175 Reconciling items: Corporate expenses ......................... (3,085) (1,122) (495) Net realized gains on investment ........... 5,255 2,555 2,925 ------------------------------ Total consolidated income before federal income taxes ............................... $ 61,444 56,985 49,605 ============================== NET INVESTMENT INCOME: Standard insurance ......................... $ 33,436 29,060 27,710 Nonstandard insurance ...................... 1,899 1,839 1,383 Investment management services ............. 360 272 292 All other .................................. 244 268 432 ------------------------------ Total net investment income .................. 35,939 31,439 29,817 Reconciling items: Corporate net investment income ............ 81 249 326 Reclassification adjustments in consolidation ............................ 2,895 2,574 2,363 ------------------------------ Total consolidated net investment income ..... $ 38,915 34,262 32,506 ============================== SEGMENT ASSETS: Standard insurance ......................... $850,080 708,384 641,195 Nonstandard insurance ...................... 48,811 44,670 37,997 Investment management services ............. 6,879 6,367 7,449 All other .................................. 15,543 14,940 15,741 -------- ------- ------- Total segment assets ....................... 921,313 774,361 702,382 Reconciling items: Corporate assets ........................... 1,150 1,223 10,979 Reclassification adjustments in consolidation ............................ (24,357) (15,639) (3,583) -------- ------- ------- Total consolidated assets .................... $898,106 759,945 709,778 ======== ======= ======= 64 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED Revenues from external customers include the following products and services:

2000 1999 1998 ---- ---- ---- (in thousands) Earned premiums Standard insurance: Automobile ........................................................ $203,967 204,155 186,283 Homeowners and farmowners ......................................... 67,247 63,666 57,983 Commercial multi-peril ............................................ 25,349 23,902 21,791 Workers' compensation ............................................. 10,628 10,764 12,006 Fire and allied ................................................... 27,848 25,763 23,698 Other and products liability ...................................... 21,924 20,052 17,313 Other lines ....................................................... 13,603 12,873 11,545 -------------------------------------------------- Total standard insurance earned premiums ............................ 370,566 361,175 330,619 Total nonstandard insurance earned premiums ......................... 27,401 30,883 25,591 -------------------------------------------------- Total earned premiums ............................................... 397,967 392,058 356,210 Investment management services ...................................... 2,940 3,099 3,036 Management and operations services .................................. 14,654 4,908 4,563 Net investment income ............................................... 38,834 34,012 32,180 Other income ........................................................ 3,043 3,989 2,819 -------------------------------------------------- Total revenues from external customers .............................. $457,438 438,066 398,808 ==================================================

The standard insurance segment participates in a reinsurance pooling agreement with other standard insurance affiliates. For discussion regarding this arrangement and the segment's contribution to the pool and participation in the pool, see note 6. Revenues from external customers are derived entirely within the United States. Also, all long-lived assets are located within the United States. (15) QUARTERLY FINANCIAL DATA (UNAUDITED)

2000 ---- FOR THREE MONTHS ENDED ---------------------- MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, --------- -------- ------------- ------------ (dollars in thousands, except per share amounts) Total revenues ............................................ $116,461 113,953 116,328 116,032 Income before federal income taxes ........................ 18,584 16,512 9,131 17,217 Net earnings .............................................. 13,683 12,494 8,006 13,531 Net earnings per common share (note 9a): Basic .................................................. 0.35 0.33 0.21 0.35 Diluted ................................................ 0.35 0.32 0.20 0.34 ==============================================================

65 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED

1999 ---- FOR THREE MONTHS ENDED ---------------------- MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, --------- -------- ------------- ------------ (dollars in thousands, except per share amounts) Total revenues ............................................. $110,931 111,186 110,469 108,294 Income before federal income taxes ......................... 14,661 13,767 10,666 17,891 Net earnings ............................................... 10,880 10,369 8,532 13,035 Net earnings per common share (note 9a): Basic ................................................... 0.25 0.25 0.22 0.33 Diluted ................................................. 0.25 0.25 0.21 0.32 ==============================================================

(16) CONTINGENCIES The Company's insurance subsidiaries are involved in litigation and may become involved in potential litigation arising in the ordinary course of business. Additionally, the insurance subsidiaries may be impacted by adverse court decisions where insurance coverages are expanded beyond the scope originally contemplated in the policy(ies). In the opinion of management, the effects, if any, of such litigation and published court decisions are not expected to be material to the consolidated financial statements. (17) SUBSEQUENT EVENT The Ohio Department of Insurance (the "Department") has requested that Mutual, starting with the quarter beginning January 1, 2001, file an analysis on a quarterly basis with the Department that justifies the apportionment of the service fee paid by Mutual to State Auto P&C under the accounting guidance outlined in Statement of Statutory Accounting Principles No. 70 - Allocation of Expenses. The Company believes that its accounting for such service fee is consistent with all statutory accounting principles. However, there can be no assurance that all or any part of the service fee paid by Mutual will be justified to the Department's satisfaction, which may affect the amount of such fee recognized as revenue by Company. During 2000, service fee revenue, included in management services income from affiliates in the accompanying financial statements, paid by Mutual accounted for $14,538,000 or 3.1 percent of total revenues and $0.24 on a basic and diluted earnings per share, after tax, basis. 66 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information required under this Item with respect to directors will be contained in the Company's proxy statement to be filed within 120 days of December 31, 2000, and is hereby incorporated herein by reference. Information required under this Item with respect to executive officers is contained under the heading "Executive Officers of the Registrant" in Item 1 of this Form 10-K report. ITEM 11. EXECUTIVE COMPENSATION Information required under this Item will be contained in the Company's proxy statement to be filed within 120 days of December 31, 2000, and is hereby incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information required under this Item will be contained in the Company's proxy statement to be filed within 120 days of December 31, 2000, and is hereby incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information required under this Item will be contained in the Company's proxy statement to be filed within 120 days of December 31, 2000, and is hereby incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a)(1) LISTING OF FINANCIAL STATEMENTS The following consolidated financial statements of the Company, are filed as part of this Form 10-K Report and are included in Item 8: Report of Independent Auditors Consolidated Balance Sheets as of December 31, 2000 and 1999 Consolidated Statements of Income for each of the three years in the period ended December 31, 2000 Consolidated Statements of Stockholders' Equity for each of the three years in the period ended December 31, 2000 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2000 Notes to Consolidated Financial Statements 67 (a)(2) LISTING OF FINANCIAL STATEMENT SCHEDULES The following financial statement schedules of the Company for the years 2000, 1999, and 1998, are included in Item 14(d), following the signatures, and should be read in conjunction with the consolidated financial statements contained in this Form 10-K Annual Report. SCHEDULE NUMBER SCHEDULE ------ -------- I(a) & I(b). Summary of Investments - Other Than Investments in Related Parties II. Condensed Financial Information of Registrant III. Supplementary Insurance Information IV. Reinsurance All other schedules are omitted because they are not applicable or the required information is included in the consolidated financial statements or notes thereto. 68 (a)(3) LISTING OF EXHIBITS

If incorporated by reference document Exhibit No. Description of Exhibit with which Exhibit was previously filed with SEC ----------- ---------------------- ---------------------------------------------------------- 3(A)(1) State Auto Financial Corporation's Amended and Restated 1933 Act Registration Statement No. 33-40643 on Form S-1 Articles of Incorporation (see Exhibit 3(a) therein) 3(A)(2) State Auto Financial Corporation's Amendment to the 1933 Act Registration Statement No. 33-89400 on Form S-8 Amended and Restated Articles of Incorporation (see Exhibit 4(b) therein) 3(A)(3) State Auto Financial Corporation Certificate of Form 10-K Annual Report for the year ended December 31, Amendment to the Amended and Restated Articles of 1998 (see Exhibit 3(A)(3) therein) Incorporation as of June 2, 1998 3(B) State Auto Financial Corporation's Amended and Restated 1933 Act Registration Statement No. 33-40643 on Form S-1 Code of Regulations (see Exhibit 3(b) therein) 4 State Auto Financial Corporation's Amended and Restated Form 10-K Annual Report for the year ended December 31, Articles of Incorporation, and Articles 1, 3, 5 and 9 of 1992 (see Exhibit 3(A) and 3(B) therein) the Company's Amended and Restated Code of Regulations 10(A) Guaranty Agreement between State Automobile Mutual 1933 Act Registration Statement No. 33-40643 on Form S-1 Insurance Company and State Auto Property and Casualty (see Exhibit 10 (d) therein) Insurance Company dated as of May 16, 1991 10(B) Form of Indemnification Agreement between State Auto 1933 Act Registration Statement No. 33-40643 on Form S-1 Financial Corporation and each of its directors (see Exhibit 10 (e) therein) 10(C)* State Auto 1991 Quality Performance Bonus Plan 1933 Act Registration Statement No. 33-40643 on Form S-1 (see Exhibit 10 (f) therein) 10(D)* Non-Qualified Deferred Compensation Plan 1933 Act Registration Statement No. 33-40643 on Form S-1 (see Exhibit 10 (g) therein) 10(E)* 1991 Stock Option Plan 1933 Act Registration Statement No. 33-40643 on Form S-1 (see Exhibit 10 (h) therein) 10(F)* Amendment Number 1 to the 1991 Stock Option Plan 1933 Act Registration Statement No. 33-89400 on Form S-8 (see Exhibit 4 (a) therein) 10(G)* 1991 Directors' Stock Option Plan 1933 Act Registration Statement No. 33-40643 on Form S-1 (see Exhibit 10 (i) therein)

--------------------------------- *Constitutes either a management contract or a compensatory plan or arrangement required to be filed as an Exhibit 69

If incorporated by reference document Exhibit No. Description of Exhibit with which Exhibit was previously filed with SEC ----------- ---------------------- ---------------------------------------------------------- 10(H) License Agreement between State Automobile Mutual 1933 Act Registration Statement No. 33-40643 on Form S-1 Insurance Company and Policy Management Systems (see Exhibit 10 (k) therein) Corporation dated December 28, 1984 10(I) Investment Management Agreement between Stateco Form 10-K Annual Report for the year ended December 31, Financial Services, Inc. and State Automobile Mutual 1992 (see Exhibit 10 (N) therein) Insurance Company, effective April 1, 1993 10(J)* Supplemental Executive Retirement Income Plan effective Form 10-K Annual Report for the year ended December 31, December 1, 1992 1992 (see Exhibit 10(O) therein) 10(K)* State Auto Insurance Companies Directors' Deferred Form 10-K Annual Report for year ended December 31, 1995 Compensation Plan (see Exhibit 10(S) therein) 10(L)* State Auto Insurance Companies Amended and Restated Registration Statement on Form S-8, File Non-Qualified Incentive Deferred Compensation Plan No. 333-56338 (see Exhibit 4(e) therein) 10(M)* Amendment Number 2 to the 1991 Stock Option Plan Form 10-K Annual Report for the year ended December 31, 1996 (see Exhibit 10(DD) therein) 10(N)* Amendment Number 1 to the 1991 Directors' Stock Form 10-K Annual Report for the year ended December 31, Option Plan 1996 (see Exhibit 10(EE) therein) 10(O) Option Agreement between State Auto Mutual and State Form 10-K Annual Report for the year ended December 31, Auto Financial dated March 11, 1997 1996 (see Exhibit 10(FF) therein) 10(P) Agreement and Plan of Reorganization dated July 7, Form 8-K filed on July 7, 1998 (see Exhibit 10(JJ) 1998, by and among State Auto Financial Corporation, therein) SAF Acquisition Corp., State Automobile Mutual Insurance Company and Milbank Insurance Company and the Closing Agreement dated July 7, 1998 10(Q) Credit Agreement dated as of June 1, 1999 between Form 10-Q for the period ended June 30, 1999 (see State Auto Financial Corporation and State Automobile Exhibit 10(LL) therein) Mutual Insurance Company 10(R) $135,000,000 Credit Agreement among SAF Funding Form 10-K Annual Report for the year ended December 31, Corporation, as Borrower, the Lenders and Bank One, 1999 (see Exhibit 10(T) therein) NA as Agent dated as of November 19, 1999 10(S) Put Agreement among State Automobile Mutual Insurance Form 10-K Annual Report for the year ended December 31, Company, State Auto Financial Corporation and Bank 1999 (see Exhibit 10(U) therein) One, NA as Agent dated as of November 19, 1999 10(T) Standby Purchase Agreement between State Auto Form 10-K Annual Report for the year ended December 31, Financial Corporation and SAF Funding Corporation 1999 (see Exhibit 10(V) therein) dated as of November 19, 1999

--------------------------------- *Constitutes either a management contract or a compensatory plan or arrangement required to be filed as an Exhibit 70

If incorporated by reference document Exhibit No. Description of Exhibit with which Exhibit was previously filed with SEC ----------- ---------------------- ---------------------------------------------------------- 10(U) Reinsurance Pooling Agreement amended and restated as Form 10-K Annual Report for the year ended December 31, of January 1, 2000 by and among State Automobile 1999 (see Exhibit 10(W) therein) Mutual Insurance Company, State Auto Property and Casualty Insurance Company, Milbank Insurance Company, Midwest Security Insurance Company, Farmers Casualty Insurance Company and State Auto Insurance Company 10(V) Management and Operations Agreement as of January 1, Form 10-K Annual Report for the year ended December 31, 2000 among State Automobile Mutual Insurance Company, 1999 (see Exhibit 10(X) therein) State Auto Financial Corporation, State Auto Property and Casualty Insurance Company, State Auto National Insurance Company, Milbank Insurance Company, State Auto Insurance Company, Stateco Financial Services, Inc., Strategic Insurance Software, Inc., 518 Property Management and Leasing, LLC 10(W) Property Catastrophe Overlying Excess of Loss Form 10-K Annual Report for the year ended December 31, Reinsurance contract issued to State Automobile 1999 (see Exhibit 10(Y) therein) Mutual Insurance Company, State Auto National Insurance Company, Milbank Insurance Company, Midwest Security Insurance Company, Farmers Casualty Insurance Company, Mid-Plains Insurance Company by State Auto Property and Casualty Insurance Company 10(X) First Amendment to the Management and Operations Form 10-K Annual Report for the year ended December 31, Agreement effective January 1, 2000 among State 1999 (see Exhibit 10(Z) therein) Automobile Mutual Insurance Company, State Auto Financial Corporation, State Auto Property and Casualty Insurance Company, State Auto National Insurance Company, Milbank Insurance Company, State Auto Insurance Company, Stateco Financial Services, Inc., Strategic Insurance Software, Inc. and 518 Property Management and Leasing, LLC 10(Y) First Amendment to the June 1, 1999 Credit Agreement Form 10-K Annual Report for the year ended December 31, dated November 1, 1999 between State Auto Financial 1999 (see Exhibit 10(AA) therein) Corporation and State Automobile Mutual Insurance Company 10(Z) Second amendment to the June 1, 1999 Credit Agreement Form 10-Q for the period ended March 31, dated December 1, 1999 between State Auto Financial 2000 (see Exhibit 10(BB) therein) Corporation and State Automobile Mutual Insurance Company 10(AA) Audit Committee Charter Included herein 10(BB)* Employment Agreement and Executive Agreement between Included herein State Auto Financial Corporation and Robert H. Moone 10(CC)* Form of Executive Agreement between State Auto Included herein Financial Corporation and certain executive officers 10(DD) First Amendment to the Reinsurance Pooling Agreement Included herein Amended and Restated as of January 1, 2000 by and among State Auto Property and Casualty Insurance Company, State Automobile Mutual Insurance Company, Milbank Insurance Company, Midwest Security Insurance Company, Farmers Casualty Insurance Company and State Auto Insurance Company

--------------------------------- *Constitutes either a management contract or a compensatory plan or arrangement required to be filed as an Exhibit 71

If incorporated by reference document Exhibit No. Description of Exhibit with which Exhibit was previously filed with SEC ----------- ---------------------- ---------------------------------------------------------- 10(EE) Addendum No. 1 of the Property Catastrophe Overlying Included herein Excess of Loss Reinsurance Contract by and among State Auto Property and Casualty Insurance Company, State Automobile Mutual Insurance Company, State Auto National Insurance Company, Milbank Insurance Company, Midwest Security Insurance Company, Farmers Casualty Insurance Company, Mid-Plains Insurance Company and State Auto Insurance Company dated November 17, 2000 10(FF)* 2000 Stock Option Plan Definitive Proxy Statement on Form DEF 14A, File No. 000-19289, for Annual Meeting of Shareholders held on May 26, 2000 (see Appendix A therein) 10(GG)* 2000 Directors Stock Option Plan Definitive Proxy Statement on Form DEF 14A, File No. 000-19289, for Annual Meeting of Shareholders held on May 26, 2000 (see Appendix B therein) 21 List of Subsidiaries of State Auto Financial Included herein Corporation 23 Consent of Independent Auditors Included herein 24(A) Powers of Attorney - William J. Lhota, Urlin G. Form 10-Q for the period ended June 30, 1997 (see Harris, Jr., Paul W. Huesman, George R. Manser, and Exhibit 24(C) therein) David J. D'Antoni 24(B) Power of Attorney - John R. Lowther Form 10-Q for the period ended March 31, 1998 (see Exhibit 24(D) therein) 24(C) Power of Attorney - Robert H. Moone Form 10-K Annual Report for the year ended December 31, 1998 (see Exhibit 24(E) therein) 24(D) Power of Attorney - Richard K. Smith Included herein

--------------------------------- *Constitutes either a management contract or a compensatory plan or arrangement required to be filed as an Exhibit (b) REPORTS ON FORM 8-K The Company did not file any Form 8-K current reports during the fourth quarter of the Company's fiscal year ended December 31, 2000. (c) EXHIBITS The exhibits have been submitted as a separate section of this report following the financial statement schedules. (d) FINANCIAL STATEMENT SCHEDULES The financial statement schedules have been submitted as a separate section of this report following the signatures. 72 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. STATE AUTO FINANCIAL CORPORATION Dated: April 2 2001 /s/Robert H. Moone ---------------------------------- Robert H. Moone Chairman, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.

Name Title Date ---- ----- ---- /s/Steven J. Johnston Chief Financial Officer, April 2, 2001 ------------------------------------- Senior Vice President, Treasurer Steven J. Johnston (principal financial officer and principal accounting officer) John R. Lowther* Secretary and Director April 2, 2001 ------------------------------------ John R. Lowther Urlin G. Harris, Jr.* Director April 2, 2001 ------------------------------------ Urlin G. Harris, Jr. David J. D'Antoni* Director April 2, 2001 ------------------------------------ David J. D'Antoni Paul W. Huesman* Director April 2, 2001 ------------------------------------ Paul W. Huesman William J. Lhota* Director April 2, 2001 ------------------------------------ William J. Lhota George R. Manser* Director April 2, 2001 ------------------------------------ George R. Manser Richard K. Smith* Director April 2, 2001 ------------------------------------ Richard K. Smith /s/Robert H. Moone Chairman, President and April 2, 2001 ------------------------------------ Chief Executive Officer Robert H. Moone (principal executive officer)

73 *Steven J. Johnston by signing his name hereto, does sign this document on behalf of the person indicated above pursuant to a Power of Attorney duly executed by such person. /s/ Steven J. Johnston April 2, 2001 ------------------------------------ Steven J. Johnston Attorney in Fact 74 Item 14(c) Exhibit Index (a)(3) LISTING OF EXHIBITS -------------------

If incorporated by reference document with Exhibit No. Description of Exhibit which Exhibit was previously filed with SEC ----------- ---------------------- ------------------------------------------- 3(A)(1) State Auto Financial Corporation's Amended and Restated 1933 Act Registration Statement No. Articles of Incorporation 33-40643 on Form S-1 (see Exhibit 3(a) therein) 3(A)(2) State Auto Financial Corporation's Amendment to the 1933 Act Registration Statement No. Amended and Restated Articles of Incorporation 33-89400 on Form S-8 (see Exhibit 4(b) therein) 3(A)(3) State Auto Financial Corporation Certificate of Form 10-K Annual Report for the year Amendment to the Amended and Restated Articles of ended December 31, 1998 (see Exhibit Incorporation as of June 2, 1998 3(A)(3) therein) 3(B) State Auto Financial Corporation's Amended and Restated 1933 Act Registration Statement No. Code of Regulations 33-40643 on Form S-1 (see Exhibit 3(b) therein) 4 State Auto Financial Corporation's Amended and Restated Form 10-K Annual Report for the year Articles of Incorporation, and Articles 1, 3, 5 and 9 of ended December 31, 1992 (see Exhibit the Company's Amended and Restated Code of Regulations 3(A) and 3(B) therein) 10(A) Guaranty Agreement between State Automobile Mutual 1933 Act Registration Statement No. Insurance Company and State Auto Property and Casualty 33-40643 on Form S-1 (see Exhibit 10 Insurance Company dated as of May 16, 1991 (d) therein) 10(B) Form of Indemnification Agreement between State Auto 1933 Act Registration Statement No. Financial Corporation and each of its directors 33-40643 on Form S-1 (see Exhibit 10 (e) therein) 10(C)* State Auto 1991 Quality Performance Bonus Plan 1933 Act Registration Statement No. 33-40643 on Form S-1 (see Exhibit 10 (f) therein) 10(D)* Non-Qualified Deferred Compensation Plan 1933 Act Registration Statement No. 33-40643 on Form S-1 (see Exhibit 10 (g) therein) 10(E)* 1991 Stock Option Plan 1933 Act Registration Statement No. 33-40643 on Form S-1 (see Exhibit 10 (h) therein) 10(F)* Amendment Number 1 to the 1991 Stock Option Plan 1933 Act Registration Statement No. 33-89400 on Form S-8 (see Exhibit 4 (a) therein) 10(G)* 1991 Directors' Stock Option Plan 1933 Act Registration Statement No. 33-40643 on Form S-1 (see Exhibit 10 (i) therein)

---------- *Constitutes either a management contract or a compensatory plan or arrangement required to be filed as an Exhibit 75

10(H) License Agreement between State Automobile Mutual 1933 Act Registration Statement No. Insurance Company and Policy Management Systems 33-40643 on Form S-1 (see Exhibit 10 Corporation dated December 28, 1984 (k) therein) 10(I) Investment Management Agreement between Stateco Form 10-K Annual Report for the year Financial Services, Inc. and State Automobile Mutual ended December 31, 1992 (see Exhibit 10 Insurance Company, effective April 1, 1993 (N) therein) 10(J)* Supplemental Executive Retirement Income Plan effective Form 10-K Annual Report for the year December 1, 1992 ended December 31, 1992 (see Exhibit 10(O) therein) 10(K)* State Auto Insurance Companies Directors' Deferred Form 10-K Annual Report for year ended Compensation Plan December 31, 1995 (see Exhibit 10(S) therein) 10(L)* State Auto Insurance Companies Amended and Restated Registration Statement on Form S-8, Non-Qualified Incentive Deferred Compensation Plan File No. 333-56338 (see Exhibit 4(e) therein) 10(M)* Amendment Number 2 to the 1991 Stock Option Plan Form 10-K Annual Report for the year ended December 31, 1996 (see Exhibit 10(DD) therein) 10(N)* Amendment Number 1 to the 1991 Directors' Stock Option Form 10-K Annual Report for the year Plan ended December 31, 1996 (see Exhibit 10(EE) therein) 10(O) Option Agreement between State Auto Mutual and State Form 10-K Annual Report for the year Auto Financial dated March 11, 1997 ended December 31, 1996 (see Exhibit 10(FF) therein) 10(P) Agreement and Plan of Reorganization dated July 7, 1998, Form 8-K filed on July 7, 1998 (see by and among State Auto Financial Corporation, SAF Exhibit 10(JJ) therein) Acquisition Corp., State Automobile Mutual Insurance Company and Milbank Insurance Company and the Closing Agreement dated July 7, 1998 10(Q) Credit Agreement dated as of June 1, 1999 between State Form 10-Q for the period ended June 30, Auto Financial Corporation and State Automobile Mutual 1999 (see Exhibit 10(LL) therein) Insurance Company 10(R) $135,000,000 Credit Agreement among SAF Funding Form 10-K Annual Report for the year Corporation, as Borrower, the Lenders and Bank One, NA ended December 31, 1999 (see Exhibit as Agent dated as of November 19, 1999 10(T) therein) 10(S) Put Agreement among State Automobile Mutual Insurance Form 10-K Annual Report for the year Company, State Auto Financial Corporation and Bank One, ended December 31, 1999 (see Exhibit NA as Agent dated as of November 19, 1999 10(U) therein 10(T) Standby Purchase Agreement between State Auto Financial Form 10-K Annual Report for the year Corporation and SAF Funding Corporation dated as of ended December 31, 1999 (see Exhibit November 19, 1999 10(V) therein

---------- *Constitutes either a management contract or a compensatory plan or arrangement required to be filed as an Exhibit 76

10(U) Reinsurance Pooling Agreement amended and restated as Form 10-K Annual Report for the year of January 1, 2000 by and among State Automobile Mutual ended December 31, 1999 (see Exhibit Insurance Company, State Auto Property and Casualty 10(W) therein) Insurance Company, Milbank Insurance Company, Midwest Security Insurance Company, Farmers Casualty Insurance Company and State Auto Insurance Company 10(V) Management and Operations Agreement as of January 1, Form 10-K Annual Report for the year 2000 among State Automobile Mutual Insurance Company, ended December 31, 1999 (see Exhibit State Auto Financial Corporation, State Auto Property 10(X) therein) and Casualty Insurance Company, State Auto National Insurance Company, Milbank Insurance Company, State Auto Insurance Company, Stateco Financial Services, Inc., Strategic Insurance Software, Inc., 518 Property Management and Leasing, LLC 10(W) Property Catastrophe Overlying Excess of Loss Form 10-K Annual Report for the year Reinsurance contract issued to State Automobile Mutual ended December 31, 1999 (see Exhibit Insurance Company, State Auto National Insurance 10(Y) therein) Company, Milbank Insurance Company, Midwest Security Insurance Company, Farmers Casualty Insurance Company, Mid-Plains Insurance Company by State Auto Property and Casualty Insurance Company 10(X) First Amendment to the Management and Operations Form 10-K Annual Report for the year Agreement effective January 1, 2000 among State ended December 31, 1999 (see Exhibit Automobile Mutual Insurance Company, State Auto 10(Z) therein) Financial Corporation, State Auto Property and Casualty Insurance Company, State Auto National Insurance Company, Milbank Insurance Company, State Auto Insurance Company, Stateco Financial Services, Inc., Strategic Insurance Software, Inc. and 518 Property Management and Leasing, LLC 10(Y) First Amendment to the June 1, 1999 Credit Agreement Form 10-K Annual Report for the year dated November 1, 1999 between State Auto Financial ended December 31, 1999 (see Exhibit Corporation and State Automobile Mutual Insurance 10(AA) therein) Company 10(Z) Second amendment to the June 1, 1999 Credit Agreement Form 10-Q for the period ended March dated December 1, 1999 between State Auto Financial 31, 2000 (see Exhibit 10(BB) therein) Corporation and State Automobile Mutual Insurance Company 10(AA) Audit Committee Charter Included herein 10(BB) Employment Agreement and Executive Agreement between Included herein State Auto Financial Corporation and Robert H. Moone 10(CC) Form of Executive Agreement between State Auto Included herein Financial and certain executive officers 10(DD) First Amendment to the Reinsurance Pooling Agreement Included herein Amended and Restated as of January 1, 2000 by and among State Auto Property and Casualty Insurance Company, State Automobile Mutual Insurance Company, Milbank Insurance Company, Midwest Security Insurance Company, Farmers Casualty Insurance Company and State Auto Insurance Company 10(EE) Addendum No. 1 of the Property Catastrophe Overlying Included herein Excess of Loss Reinsurance Contract by and among State Auto Property and Casualty Insurance Company, State Automobile Mutual Insurance Company, State Auto National Insurance Company, Milbank Insurance Company, Midwest Security Insurance Company, Farmers Casualty Insurance Company, Mid-Plains Insurance Company and State Auto Insurance Company

77

10(FF)* 2000 Stock Option Plan Definitive Proxy Statement on Form DEF 14A, File No. 000-19289, for Annual Meeting of Shareholders held on May 26, 2000 (see Appendix A therein) 10(GG)* 2000 Directors Stock Option Plan Definitive Proxy Statement on Form DEF 14A, File No. 000-19289, for Annual Meeting of Shareholders held on May 26, 2000 (see Appendix B therein) 21 List of Subsidiaries of State Auto Financial Corporation Included herein 23 Consent of Independent Auditors Included herein 24(A) Powers of Attorney - William J. Lhota, Urlin G. Harris, Form 10-Q for the period ended June 30, Jr., Paul W. Huesman, George R. Manser, and David J. 1997 (see Exhibit 24(C) therein) D'Antoni 24(B) Power of Attorney - John R. Lowther Form 10-Q for the period ended March 31, 1998 (see Exhibit 24(D) therein) 24(C) Power of Attorney - Robert H. Moone Form 10-K Annual Report for the year ended December 31, 1998 (see Exhibit 24(E) therein) 24(D) Power of Attorney - Richard K. Smith Included herein

---------- *Constitutes either a management contract or a compensatory plan or arrangement required to be filed as an Exhibit 78 Item 14(d) Financial Statement Schedules 79 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES SCHEDULE I(a) - SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 2000

Column A Column B Column C Column D -------- -------- -------- -------- HELD TO MATURITY Amount at which shown in the Type of Investment Cost Value balance sheet ------------------ ---- ----- ------------- (in thousands) Fixed maturities: Bonds: United States Government and government agencies and authorities $32,281 $32,845 $32,281 States, municipalities and political subdivisions 7,026 7,380 7,026 ------- ------- ------- Total fixed maturities - held to maturity $39,307 $40,225 $39,307 ======= ======= =======

SCHEDULE I(b) - SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 2000

Column A Column B Column C Column D -------- -------- -------- -------- AVAILABLE FOR SALE Amount at which shown in the Type of Investment Cost Value balance sheet ------------------ ---- ----- ------------- (in thousands) Fixed maturities: Bonds: United States Government and government agencies and authorities $ 89,732 $ 91,290 $ 91,290 States, municipalities and political subdivisions 513,311 528,071 528,071 Public utilities 7,807 7,835 7,835 All other corporate bonds 25,452 26,055 26,055 -------- -------- -------- Total fixed maturities $636,302 $653,251 $653,251 -------- -------- -------- Equity securities: Public utilities 2,340 2,791 2,791 Banks, trust and insurance companies 7,654 8,538 8,538 Industrial, miscellaneous and all other 34,226 46,983 46,983 -------- -------- -------- Total equity securities 44,220 58,312 58,312 -------- -------- -------- Total investments - available for sale $680,522 $711,563 $711,563 ======== ======== ========

80 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEETS

December 31 ------------------- ASSETS 2000 1999 ---- ---- (dollars in thousands) Investments in common stock of subsidiaries (equity method) $428,591 $360,974 Cash 591 650 Real estate 425 444 Other assets 559 578 Federal income tax benefit 1,945 1,034 -------- -------- Total assets $432,111 $363,680 ======== ======== LIABILITIES AND STOCKHOLDERS' EQUITY Note payable to affiliate $ 45,500 $ 45,500 Due to affiliates 102 167 Accrued expenses 450 325 -------- -------- Total liabilities 46,052 45,992 STOCKHOLDERS' EQUITY Class A Preferred stock (nonvoting), without par value. Authorized 2,500,000 shares; none issued -- -- Class B Preferred stock, without par value Authorized 2,500,000 shares; none issued -- -- Common stock, without par value. Authorized 100,000,000 shares; 42,625,723 and 42,355,438 shares issued, respectively, at stated value of $2.50 per share 106,564 105,888 Less 4,071,012 and 4,034,342 treasury shares, respectively, at cost (47,038) (46,588) Additional paid-in capital 44,208 42,562 Accumulated other comprehensive income 20,367 211 Retained earnings 261,958 215,614 -------- -------- Total stockholders' equity 386,059 317,687 -------- -------- Total liabilities and stockholders' equity $432,111 $363,679 ======== ========

81 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONTINUED CONDENSED STATEMENTS OF INCOME

Year ended December 31 --------------------------------- 2000 1999 1998 ---- ---- ---- (in thousands) Investment income $ 81 $ 249 $ 326 Rental income 37 37 33 Net realized gains on investments -- 1 2 ------- ------- ------- Total revenue 118 287 361 ------- ------- ------- Interest expense to affiliate 2,730 955 -- Total operating expenses 1,859 1,176 1,456 ------- ------- ------- Loss before federal income taxes (4,471) (1,844) (1,095) Federal income tax benefit (1,573) (645) (394) ------- ------- ------- Net loss before equity in undistributed net earnings of subsidiaries (2,898) (1,199) (701) Equity in undistributed net earnings of subsidiaries 50,612 44,015 38,198 ------- ------- ------- Net Income $47,714 $42,816 $37,497 ======= ======= =======

82 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONTINUED CONDENSED STATEMENTS OF CASH FLOWS

Year Ended December 31 -------------------------------- 2000 1999 1998 ---- ---- ---- (in thousands) Cash flows from operating activities: Net income $ 47,714 $ 42,816 $ 37,497 -------- -------- -------- Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization, net 484 102 17 Equity in undistributed earnings of subsidiaries (50,612) (43,957) (38,198) Changes in operating assets and liabilities: Change in accrued expenses and due to affiliates 60 125 58 Change in other assets (19) 185 (505) Change in federal income taxes (721) (387) 305 -------- -------- -------- Net cash used in operating activities (3,094) (1,116) (826) -------- -------- -------- Cash flows from investing activities: Capitalization of subsidiary -- (12,030) -- Dividends received from subsidiaries 3,025 12,663 9,004 Purchase of surplus notes receivable -- -- (9,000) Additions to real estate -- (1) (20) -------- -------- -------- Net cash (used in) provided by investing activities 3,025 632 (16) -------- -------- -------- Cash flows from financing activities: Proceeds from issuance of debt to affiliate -- 45,500 -- Net proceeds from sale of common stock 1,707 1,928 1,780 Payments to acquire treasury stock (300) (46,199) -- Payment of dividends (1,397) (1,315) (1,219) -------- -------- -------- Net cash provided by (used in) financing activities 10 (86) 561 -------- -------- -------- Net increase (decrease) in cash and invested cash (59) (570) (281) -------- -------- -------- Cash and cash equivalents at beginning of year 650 1,220 1,501 -------- -------- -------- Cash and cash equivalents at end of year $ 591 $ 650 $ 1,220 ======== ======== ======== Supplemental Disclosures: ------------------------- Federal income taxes received $ 852 $ 517 $ 902 ======== ======== ========

83 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONTINUED NOTE A - BASIS OF PRESENTATION In the parent company-only financial statements, State Auto Financial Corporation's investment in subsidiaries is stated at cost plus equity in undistributed earnings of subsidiares and net unrealized gains and losses on investments. The parent company-only financial statements should be read in conjunction with the Company's consolidated financial statements. Note B - Stock Repurchase Plan During the second quarter 2000, State Auto Financial's Board of Directors approved a plan to repurchase up to 1.0 million shares of its common stock from the public over a period ending December 31, 2001. Through December 31, 2000, State Auto Financial has repurchased 25,122 shares. In May 1999, State Auto Financial's Board of Directors approved a plan to repurchase up to 4.0 million shares of its outstanding common stock over a period ending December 31, 2000. Repurchases were transacted to maintain the same ownership ratios between Mutual and the public as it existed in May 1999, with 69% repurchased from Mutual and 31% from the public. Through December 31, 1999 all 4.0 million shares have been repurchased, with approximately 2.7 million shares repurchased from Mutual and 1.3 million shares from the public. In conjunction with the stock repurchase plan, State Auto Financial entered into a line of credit agreement with Mutual for $45.5 million, at an interest rate of 6.0%. The interest rate adjusts each January 1 based on a formula set forth in the note. During 2001 the interest rate is 5.0%. Principal payment is due on demand from Mutual after December 31, 2000, with final payment to be received on or prior to December 31, 2005. 84 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (in thousands)

Column A Column B Column C Column D Column E Column F -------- -------- -------- -------- -------- -------- Future policy Other policy benefits, losses, claims and Deferred policy claims and Unearned benefits Premium Segment acquisition cost loss expenses premiums payable revenue ------- ---------------- ------------- -------- ------- ------- Year ended December 31, 2000 Standard insurance segment $31,292 $228,516 $151,781 -- $370,566 Nonstandard insurance segment 1,166 16,067 8,606 -- 27,401 ----------------- ---------------- --------------- ---------------- ---------------- Total 32,458 244,583 160,387 -- 397,967 ================= ================ =============== ================ ================ Year ended December 31, 1999 Standard insurance segment $27,877 $217,149 $145,462 -- $361,175 Nonstandard insurance segment 1,059 15,340 8,108 -- 30,883 ----------------- ---------------- --------------- ---------------- ---------------- Total 28,936 232,489 153,570 -- 392,058 ================= ================ =============== ================ ================ Year ended December 31, 1998 Standard insurance segment $330,619 Nonstandard insurance segment 25,591 ---------------- Total 356,210 ================

Column G Column H Column I Column J Column K -------- -------- -------- -------- -------- Amortization Benefits,claims, of deferred losses and policy Net investment settlement acquisition Other operating Premiums income expenses costs expenses written ------ -------- ----- -------- ------- Year ended December 31, 2000 Standard insurance segment $33,436 $250,071 $92,955 $19,122 $373,867 Nonstandard insurance segment 1,899 22,096 4,828 1,259 27,837 Investment management services 360 -- -- -- -- All other 244 -- -- -- -- Corporate 81 -- -- 1,405 -- Reclassification adjustments in consolidation 2,895 -- -- -- -- ------- -------- ------- ------- -------- Total 38,915 272,167 97,783 21,786 401,704 ======= ======== ======= ======= ======== Year ended December 31, 1999 Standard insurance segment $29,060 $242,409 $86,609 $16,716 $359,084 Nonstandard insurance segment 1,839 22,219 5,832 1,866 29,416 Investment management services 272 -- -- -- -- All other 268 -- -- -- -- Corporate 249 -- -- 749 -- Reclassification adjustments in consolidation 2,574 -- -- -- -- ------- -------- ------- ------- -------- Total 34,262 264,628 92,441 19,331 388,500 ======= ======== ======= ======= ======== Year ended December 31, 1998 Standard insurance segment $27,710 $223,311 $80,766 $17,124 $332,975 Nonstandard insurance segment 1,383 18,983 4,448 1,208 25,292 Investment management services 292 -- -- -- -- All other 432 -- -- -- -- Corporate 326 -- -- 678 -- Reclassification adjustments in consolidation 2,363 -- -- -- -- ------- -------- ------- ------- -------- Total 32,506 242,294 85,214 19,010 358,267 ======= ======== ======= ======= ========

85 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES SCHEDULE IV - REINSURANCE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998 (in thousands, except percentages)

Column A Column B Column C Column D Column E Column F -------- -------- -------- -------- -------- -------- Percentage Ceded to Assumed from of amount Outside Affiliated Outside Affiliated assumed Gross Amount Companies Companies(1) Companies Companies(1) Net Amount to net(2) ------------ --------- ------------ --------- ------------ ---------- --------- Year ended 12-31-00 property-casualty earned premiums $432,318 $10,864 $399,057 $ 5,166 $370,404 $397,967 1.3% Year ended 12-31-99 property-casualty earned premiums $429,577 $13,698 $395,698 $10,822 $361,055 $392,058 2.8% Year ended 12-31-98 property-casualty earned premiums $384,869 $17,026 $356,638 $14,386 $330,619 $356,210 4.0%

---------- (1) These columns include the effect of intercompany pooling. (2) Calculated as earned premiums assumed from outside companies to net amount.