-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, DF4tAo67K3jRlaAK7L+DXGlvZlFVoSyt/8jp0EavTLXZapwUnYeIWhA523bETiWM pRrnPgUgU7/G8jqOlewqow== 0000950152-00-002206.txt : 20000329 0000950152-00-002206.hdr.sgml : 20000329 ACCESSION NUMBER: 0000950152-00-002206 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 12 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000328 FILER: COMPANY DATA: COMPANY CONFORMED NAME: STATE AUTO FINANCIAL CORP CENTRAL INDEX KEY: 0000874977 STANDARD INDUSTRIAL CLASSIFICATION: FIRE, MARINE & CASUALTY INSURANCE [6331] IRS NUMBER: 311324304 STATE OF INCORPORATION: OH FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 000-19289 FILM NUMBER: 580621 BUSINESS ADDRESS: STREET 1: 518 E BROAD ST CITY: COLUMBUS STATE: OH ZIP: 43215-3976 BUSINESS PHONE: 6144645000 MAIL ADDRESS: STREET 1: 518 EAST BROAD STREET CITY: COLUMBUS STATE: OH ZIP: 43215 10-K405 1 STATE AUTO FINANCIAL CORPORATION 10-K405 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, 1999 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. X --- On March 8, 2000, 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 $96,800,944. On March 8, 2000, the Registrant had 38,368,918 Common Shares outstanding. 2 Page 2 DOCUMENTS INCORPORATED BY REFERENCE 1. Portions of the Registrant's Proxy Statement relating to the annual meeting of shareholders to be held May 26, 2000, which Proxy Statement will be filed within 120 days of December 31, 1999, are incorporated by reference in Part III, Items 10, 11, 12 and 13 of this report. 3 Page 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 69% 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"), 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. 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. Any reference to prior years' financial information of State Auto Financial Corporation and subsidiaries has been restated to include the financial position and operations of Milbank. On January 1, 1999, Farmers Casualty Insurance Company ("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"), which is an Iowa based insurer, which principally writes nonstandard auto insurance in Iowa and Kansas. In May 1999, State Auto Insurance Company, an Ohio corporation ("SAIC"), was formed by STFC. It began operations in Ohio upon receiving its Ohio certificate of authority in January 2000. Initially, SAIC will write 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 the pooling arrangement are collectively referred to hereafter as the "Pooled Companies." 4 Page 4 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." At this time, the insurers in the State Auto Group market their insurance products through approximately 13,000 independent insurance agents associated with approximately 2,200 agencies in 26 states. STFC'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 formed by State Auto Financial in January 1995, began operations in July 1995. S.I.S. 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. S.I.S. is a wholly owned subsidiary of State Auto Financial as of January 2000. See "Insurance Software Business" in the "Narrative Description of Business." In December 1997, 518 Property Management and Leasing, LLC ("518 PML") was organized. 518 PML is an Ohio limited liability company formed to engage 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, Stateco, National, Milbank, S.I.S., 518 PML, Farmers Casualty, Mid-Plains and SAIC 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 AND PRIOR PERIODS EXCLUDES SAIC. Since January 1, 1987, State Auto P&C has participated in an underwriting 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 has been further amended. 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, 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 Page 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 herein expressing the beliefs of management and the other statements, which are not historical facts contained in this report, are forward looking statements 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. Such statements include, without limitation, those pertaining to the weather related catastrophes impacting the Company's losses, product offerings, the Year 2000 discussion, statements relating to the new insurer, State Auto Insurance Company, the legislative and regulatory environment, including but not limited to the Gramm Leach Bliley Act of 1999 and sales forecasts. These risks and uncertainties include, but are not limited to, legislative changes at both the state and federal level, state and federal regulatory rule making promulgation's, class action litigation involving the insurance industry and judicial decisions affecting claims, policy coverages and the general costs of doing business, the impact of competitive products and pricing, product development, geographic spread of risk, weather and weather-related events, other types of catastrophic events, 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, shortages of programmers, other types of technical and professional employees, and regulatory or governmental systems breakdowns, and other risks indicated in the Company's filing with the Securities and Exchange Commission, including the Company's Management's Discussion and Analysis for its year ended December 31, 1999. (d) NARRATIVE DESCRIPTION OF BUSINESS. PROPERTY AND CASUALTY INSURANCE POOLING ARRANGEMENT Since January 1987, State Auto P&C and Mutual have participated in an intercompany 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 Agreement'). The 2000 Pooling Agreement: 1) adds SAIC as a party; 2) modifies the pooling percentages to: Mutual 46%, State Auto P&C 39%, Milbank 10%, Midwest Security 1%, Farmers Casualty 3% and SAIC 1%; 3) increases the exclusion for the Catastrophe Assumption Agreement written by State Auto P&C from 6 Page 6 $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) excludes 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 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 '99 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 and Mid-Plains in the amount of $100.0 million in excess of $120.0 million but less than $220.0 million and 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. As noted above, this has been increased to $135.0 million excess of $120.0 million, but less than $255.0 million pursuant to 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. Investment management services are provided by Stateco. See "Investment Management Services" in the "Narrative Description of Business." 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 7 Page 7 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. Under the Amended and Restated Management Agreement, Mutual provided the Company with the facilities, clerical personnel and other non-executive employees necessary to run its day-to-day operations. While these employees have been registered as employees of Mutual, the Company has deemed them its common law employees as well. 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, and from January 1, 1999 forward, Farmers Casualty, continue to be shared pro rata among Mutual, State Auto P&C, Milbank, Midwest Security and Farmers Casualty through the 99 Pooling Agreement. "See Pooling Arrangement" in the "Narrative Description of Business." For companies not participating in the 99 Pooling Agreement or the 2000 Pooling Agreement, e.g., 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. Mutual also charges rent to each company which has dedicated space within Mutual's facilities (currently National and Stateco). As mentioned above, as of January 1, 2000, the 2000 Management Agreement became effective among State Auto P&C, Mutual, Milbank, National, SAIC, Stateco, S.I.S. and 518 PML, while the 2000 Midwest Management Agreement and the 2000 Farmers Casualty Management Agreement became effective among State Auto P&C, Mutual and Midwest Security and Farmers Casualty and Mid-Plains. Under these management agreements, every person providing services to the Company, Mutual and Midwest are specifically designated as employees 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. Each party to the 2000 Management Agreement pays State Auto P&C a fee equal to 4% of the three year average of the Managed Companies' surplus (less other Managed Companies) (subject to regulatory approval). 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 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 8 Page 8 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. 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. Commercial lines became available in Kansas during the fourth quarter of 1999 and are expected to be available in Iowa sometime during the second quarter of 2000. The insurance business of National, with the exception of amounts reinsured with Mutual, is not included in the pooling arrangement and, therefore, remains 100% in the Company. As of January 1, 1999, the same is true for business written by Mid-Plains. See "Pooling Arrangement" in the "Narrative Description of Business." 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. Personal lines specialists continue to have significant responsibility for encouraging the Company's agency force to sell its personal lines products. 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 Page 9
Year Ended December 31(1) ----------------------------------- 1999 1998 1997 ---- ---- ---- Loss ratios: Automobile .......................... 65.2% 65.7% 63.3% Homeowners and Farmowners ...... 75.3% 86.0% 71.6% Commercial multi-peril ......... 69.9% 57.1% 72.8% Workers' compensation .......... 41.1% 51.1% 64.2% Fire and allied lines .......... 89.2% 81.8% 59.3% Other commercial liability...... 61.4% 61.2% 64.9% Other personal lines ........... 36.3% 32.3% 34.6% Other commercial lines ......... 28.4% 20.0% 16.8% ---- ---- ---- Total loss ratio .................... 67.0% 67.9% 64.2% Expense ratio ....................... 29.5% 29.8% 29.5% ---- ---- ---- Combined ratio ...................... 96.5% 97.7% 93.7% ==== ==== ====
- ---------- (1) This reflects a combination of the loss ratios of State Auto P&C, Milbank, and Farmers Casualty after giving effect to reinsurance and the 99 Pooling Agreement. - ------------------ 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, having added Maryland, South Carolina and South Dakota to its operating territory in 1999. 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 ---------------------------------- 1999 1998 1997 ---- ---- ---- Loss Ratio Automobile 71.7% 75.0% 79.8% Expense Ratio 29.9% 25.0% 20.6% ----- ----- ----- Combined Ratio 101.6% 100.0% 100.4% ====== ====== ====== MARKETING In its 26 states of operation, the State Auto Group markets its products through approximately 13,000 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. Farmers Casualty markets personal lines only; the Company introduced commercial lines to Farmers Casualty's agents in Kansas during the fourth quarter of 1999 and anticipates doing so for its Iowa agents during the second quarter of 2000. 10 Page 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 operated in 18 states in 1999. Three of these were added in 1999. At least one more additional state is expected to be added 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 1999, 273 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 11 Page 11 agency receives a percentage of direct premiums written as a commission. As bonus compensation, the 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 1999, the seven states that contributed the greatest percentage of direct premiums written to the State Auto Group were Ohio (22.0%), Kentucky (11.0%), Tennessee (8.0%), South Carolina (6.0%), North Carolina (6.0%), Minnesota (5.0%) and Pennsylvania (5.0%). 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. Presently, the Company also has a two lawyer 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 glass network utilized in settling glass claims has been generally effective. 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. 12 Page 12 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 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, 1999, 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, 1999:
Year Ended December 31 ----------------------------------------- 1999 1998 1997 --------- --------- --------- (in thousands) Reserve for losses and loss expenses At beginning of year(1) $ 205,034 $ 194,155 $ 199,480 --------- --------- --------- Provision for losses and loss Expenses occurring: Current year 271,507 255,885 225,666 Prior years(2) (6,878) (13,591) (17,432) --------- --------- --------- Total 264,629 242,294 208,234 --------- --------- --------- Loss and loss expense payments For claims occurring during: Current year 168,512 157,988 134,890 Prior years 100,349 86,671 78,669 --------- --------- --------- Total 268,861 244,659 213,559 --------- --------- --------- Impact of acquisition of Farmers Casualty And Mid-Plains, 1/1/99 13,247 -- -- Impact of pooling change 1/1/99 and 1/1/98 (3) 7,633 13,244 -- --------- --------- --------- Reserve for losses and loss expenses at end of year (1) $ 221,682 $ 205,034 $ 194,155 ========= ========= =========
- --------------- (1) This line item is net of reinsurance recoverable on losses and loss expenses payable of approximately $10,807,000, $12,416,000, and $21,056,000 for the years 1999, 1998, and 1997, respectively. 13 Page 13 (2) This line item shows redundancies in the provision for losses and loss expenses attributable to prior years in the amounts of approximately $6,878,000, $13,591,000, and $17,432,000 for the years 1999, 1998, and 1997, respectively. These decreases have resulted primarily from moderating trends in the frequency and severity of losses and loss expenses due to medical cost containment, tort reform and lower rates of inflation. This along with fundamental improvements primarily in the auto liability and worker's compensation lines of business resulted in incurred losses and loss expenses developing favorably. (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. - ---------------- The following table sets forth the development of reserves for losses and loss expenses from 1989 through 1999 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, 1999, the Company had paid 78.1% of the currently estimated losses and loss expenses that had been incurred, but not paid, as of December 31, 1990. 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 an $8.4 million redundancy over nine years. That amount has been included in operations over the nine 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 1992, but incurred in 1989, will be included in the cumulative redundancy amount for years 1989, 1990 and 1991. 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. An amount of assets equal to the increase in net liabilities was transferred to the Company from Mutual in 1992, 1995, 1998 and 1999 in conjunction with each year's respective pooling change. The amount of the assets transferred from Mutual in 1992, 1995, 1998 and 1999 has been netted against and has reduced the cumulative amounts paid for years prior to 1992, 1995, 1998 and 1999, respectively. 14 Page 14 [See table on following page.] 15 Page 15
State Auto Financial Corp. Years Ended December 31 ------------------------------------------------------------------------------- 1989 1990 1991 1992 1993 1994 1995 (Dollars in Thousands) Net liability for losses and loss expenses payable $58,203 $65,464 $71,139 $119,044 $123,337 $126,743 $206,327 Paid (cumulative) as of: One year later 48.1% 43.3% 12.2% 41.3% 42.2% 1.5% 38.2% Two years later 68.8% 46.1% 43.0% 60.9% 41.3% 29.1% 55.4% Three years later 70.9% 62.9% 58.7% 60.6% 55.6% 44.5% 63.3% Four years later 79.9% 71.8% 58.4% 68.0% 64.5% 51.0% 68.5% Five years later 84.4% 72.1% 63.9% 71.9% 67.2% 55.5% Six years later 83.3% 75.5% 67.5% 72.5% 69.7% Seven years later 86.0% 77.8% 67.7% 74.2% Eight years later 87.7% 77.1% 69.7% Nine years later 86.8% 78.1% Ten years later 87.5% Net liability re-estimate as of: One year later 98.0% 95.4% 91.2% 92.7% 93.7% 87.4% 87.0% Two years later 97.4% 92.1% 87.2% 90.5% 90.0% 77.1% 86.4% Three years later 95.9% 89.7% 85.4% 87.6% 85.0% 77.0% 83.2% Four years later 95.4% 88.1% 84.5% 85.6% 86.3% 72.9% 81.6% Five years later 95.0% 89.7% 82.3% 87.3% 82.8% 70.9% Six years later 96.1% 88.4% 86.7% 84.5% 81.6% Seven years later 95.5% 93.2% 83.1% 83.0% Eight years later 100.1% 89.5% 81.0% Nine years later 97.2% 87.2% Ten years later 95.2% Cumulative redundancy (deficiency) $2,822 $8,367 $13,533 $20,267 $22,717 $36,868 $37,918 Cumulative redundancy (deficiency) 4.8% 12.8% 19.0% 17.0% 18.4% 29.1% 18.4% Gross* liability - end of year $224,771 $245,929 $277,783 $412,553 Reinsurance recoverable $105,727 $122,591 $151,040 $206,226 Net liability - end of year $119,044 $123,337 $126,743 $206,327 Gross liability re-estimated - latest 93.8% 94.7% 84.6% 86.9% Reinsurance recoverable re-estimated - latest 106.0% 107.9% 96.0% 92.1% Net liability re-estimated - latest 83.0% 81.6% 70.9% 81.6% State Auto Financial Corp. Years Ended December 31 ------------------------------------------------------ 1996 1997 1998 1999 Net liability for losses and loss expenses payable $199,480 $194,155 $205,034 $221,682 Paid (cumulative) as of: One year later 39.4% 32.7% 38.7% --- Two years later 54.1% 56.7% Three years later 66.2% Four years later Five years later Six years later Seven years later Eight years later Nine years later Ten years later Net liability re-estimate as of: One year later 91.3% 93.0% 96.6% --- Two years later 87.3% 92.0% Three years later 86.7% Four years later Five years later Six years later Seven years later Eight years later Nine years later Ten years later Cumulative redundancy $26,476 $15,531 $6,943 --- Cumulative redundancy 13.3% 8.0% 3.4% --- Gross* liability - end of year $410,658 $402,718 $414,268 Reinsurance recoverable $211,178 $208,563 $209,234 Net liability - end of year $199,480 $194,155 $205,034 Gross liability re-estimated - latest 91.4% 95.1% 98.7% Reinsurance recoverable re-estimated - latest 95.9% 98.0% 100.8% Net liability re-estimated - latest 86.7% 92.0% 96.6%
* Gross liability includes: Direct & assumed losses & loss expenses payable. 16 Page 16 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"):
1999 1998 1997 ---- ---- ---- (in thousands) GAAP losses and loss expenses payable $232,489 $217,450 $215,211 Less: ceded reinsurance recoverable on losses and loss expenses payable 10,807 12,416 21,056 Add: salvage and subrogation Recoverable 13,505 12,817 10,870 ------------- ------------- -------------- STAT losses and loss expenses payable $235,187 $217,851 $205,025 ============= ============= ==============
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. Catastrophe reinsurance has been arranged for property business, including automobile physical damage. Effective November 19, 1999, the Company and Mutual replaced the structured financing piece of their catastrophe reinsurance program, originally placed in July 1996 with the program described below. 17 Page 17 Each of State Auto P&C, Mutual, Milbank, Midwest Security, National, Farmers Casualty, Mid-Plains and SAIC retain the first $40.0 million of each occurrence. $80.0 million of traditional reinsurance is available above the $40.0 million retention with a co-participation of 5%. 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 $135.0 million to be used to cover such catastrophe losses. This arrangement, effective November 19, 1999, replaced the prior structured contingent financing transaction State Auto Financial had with Chase Manhattan Bank. 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 $135.0 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 $135.0 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. This Bank One contingent financing transaction is a 364 day commitment and may be renewed on mutual agreement of the parties. Changes were made in 1999 to National's agreement with Mutual. The excess of loss portion, in which Mutual assumes all liability losses in excess of National's $50,000 retention, remained the same. However, the 20% liability quota share, within the $50,000 retention, was reduced to 8.5%, while a 20% quota share was extended to the physical damage coverages. Effective January 1, 1999, Mutual entered into an excess of loss agreement with Mid-Plains, State Auto's other non-standard company. Pursuant to the terms of this agreement, Mutual provides $450,000 of reinsurance above a $50,000 retention for Mid-Plains 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, National, Milbank, Midwest Security, Farmers Casualty, Mid-Plains, and SAIC 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, National, Milbank, Farmers Casualty, and SAIC to State Auto Financial. Pursuant to these laws, all transactions within the holding company system affecting Mutual, State Auto P&C, National, Milbank, Midwest Security, Farmers Casualty, Mid-Plains, or SAIC 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. 18 Page 18 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. 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, National, Milbank, Farmers Casualty, and SAIC 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 Dakota and Iowa, 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 $28.9 million is available for payment to State Auto Financial as a dividend from State Auto P&C, National, Milbank, Farmers Casualty, and SAIC during 2000 without prior approval from the South Carolina, Ohio, South Dakota and Iowa Insurance Departments, respectively, under current law. 19 Page 19 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 1999 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, 1999, each insurer 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 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. 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. 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 2.0% 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 20 Page 20 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 $527.8 million, and $481.8 million at December 31, 1999 and 1998, 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, 1999 and 1998, respectively, the equity portfolio totaled $55.5 million and $42.2 million. The table below provides information about the quality of the Company's fixed maturity portfolio. Bond Portfolio Quality Investment Grade Corporates and Municipals 79.2% U.S. Governments 16.0% U.S. Government Agencies 4.8% The following table sets forth the Company's investment results for the periods indicated: Year Ended December 31 ------------------------------------- 1999 1998 1997 ---- ---- ---- (Dollars in thousands) Average invested assets (1) $633,989 $571,152 $519,298 Net investment income (2) $34,262 $32,506 $31,107 Average yield 5.4% 5.7% 6.0% - -------------- (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 April 1993. These services are provided to all insurance companies affiliated with the Company or Mutual, including Mutual, Midwest Security, State Auto P&C, Milbank, National, Farmers Casualty, Mid-Plains, and SAIC. 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 based on performance and the size of the portfolio managed for each affiliate. 21 Page 21 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. 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 initial 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. Revenue from 518 PML is not material to the Company at this time. In late 1999, it also began to lease motor vehicles to Mutual for use in its business operations. YEAR 2000 See discussion included in Part II - Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations." COMPETITION The property and casualty insurance industry is highly competitive. Price competition has been very intense during recent years. This was particularly true in regards to both commercial lines and personal lines, particularly auto insurance in 1999. 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. 22 Page 22 EMPLOYEES As of March 3, 2000, the Company had 1,350 employees, which is a change from past practice. See "Management Agreement" In the "Narrative Description of the Business". 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 (1) Age During the Past Five Years of the Company Since (2) ------------------------------ --- -------------------------- ------------------------ Robert L. Bailey, 66 Chairman of the Board of STFC, 3/93 to 1991 Chairman present; Chief Executive Officer of STFC, 5/91 to 5/99; President of STFC, 5/91 to 5/96; Chairman of the Board of Mutual, 3/93 to present; Chief Executive Officer of Mutual, 5/89 to 5/99; President of Mutual, 1983 to 5/96 Robert H. Moone, 56 President and Chief Executive Officer 1991 President and of STFC, 5/99 to present; President and Chief Executive Officer Chief Operating Officer of STFC, 5/96 to 5/99; Executive Vice President, 11/93 to 5/96 and prior thereto Vice President of STFC; President and Chief Executive Officer of Mutual, 5/99 to present; President and Chief Operating Officer of Mutual, 5/96 to 5/99; Executive Vice President, 11/93 to 5/96 and prior thereto, Senior Vice President of Mutual Steven J. Johnston, 40 Senior Vice President, Treasurer and 1994 Senior Vice President, Chief Financial Officer of STFC and Treasurer and Chief Mutual 8/99 to present; Vice President, Financial Officer Treasurer and Chief Financial Officer of STFC and Mutual, 4/97 to 8/99; Vice President of STFC and Mutual, 5/95 to 4/97; Assistant Vice President of Mutual, 8/92 to 5/95 John R. Lowther, 49 Vice President, Secretary and General 1991 Vice President, Secretary Counsel of STFC, 5/91 to present; Vice and General Counsel President, Secretary and General Counsel of Mutual, 8/89 to present Michael F. Dodd, 62 Senior Vice President of STFC, 5/91 to 1991 Senior Vice President present; Senior Vice President of Mutual, 2/89 to present Terrence L. Bowshier, 47 Vice President, 3/2000 to present; Vice 1991 Vice President President and Comptroller of STFC and Mutual, 5/91 to 3/2000 James E. Duemey, 53 Vice President and Investment Officer 1991 Vice President and of STFC and Mutual, 5/91 to present Investment Officer William D. Hansen, 34 Vice President of Mutual 3/2000 to 2000 Vice President present Terrence P. Higerd, 55 Vice President of STFC, 5/91 to 1991 Vice President present; Vice President of Mutual, 6/87 to present
23 Page 23
Name of Executive Officer and Principal Occupation(s) An Executive Officer Position(s) with Company (1) Age During the Past Five Years of the Company Since (2) - ----------------------------- --- -------------------------- ------------------------ Noreen W. Johnson, 51 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, 9/92 to 3/97 Robert A. Lett, 60 Vice President of STFC, 3/98 to 1994 Vice President present; Vice President of Mutual, 2/88 to present Mark A. Blackburn, 48 Vice President of STFC and Mutual, 8/99 1999 Vice President to present John B. Melvin, 50 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, (3) 50 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, (3) 46 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, 41 Vice President of Mutual 3/2000 to 2000 Vice President present Cynthia A. Powell, 39 Vice President of Mutual 3/2000 to 2000 Vice President present
(1) Except for Mr. Bailey, each of the executive officers is elected annually by the respective company's Board of Directors to serve until the next annual meeting and until his or her successor is elected and qualified. Mr. Bailey has executed an employment agreement effective January 1, 1996, which is for a five-year term. (2) 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. (3) 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 approximately 270,000 square feet of office space. The Company and Mutual also have regional underwriting and claims office facilities, which they share through the Amended and Restated Management Agreement. These facilities include 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 24 Page 24 policyholders. Farmers Casualty leases an office in West Des Moines, Iowa where Company employees service Farmers Casualty's and Mid-Plains' policyholders and agents. 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, 2000, there were 941 shareholders of record of the Company's common shares. MARKET PRICE RANGE, COMMON STOCK(1) Initial Public Offering -- June 28, 1991, $2.25. The high and low sale prices for each quarterly period for the past two years as reported by Nasdaq are: 1998 HIGH LOW DIVIDEND ---- ---- --- -------- First Quarter $20.00 $14.25 $.023 Second Quarter 19.88 15.13 .023 Third Quarter 16.63 12.25 .025 Fourth Quarter $14.75 $11.44 $.025 1999 First Quarter $12.375 $10.25 $.025 Second Quarter 13.875 9.375 .025 Third Quarter 13.625 9.563 .0275 Fourth Quarter $11.75 $ 8.875 $.0275 (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. 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. ITEM 6. SELECTED FINANCIAL DATA - ------- ----------------------- "Selected Consolidated Financial Data" is as follows: 25 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) SELECTED CONSOLIDATED FINANCIAL DATA
YEAR ENDED DECEMBER 31 ---------------------- 1999(*) 1998(*) 1997 1996 1995(*) 1994 -------- ------- ------- ------- ------- ------- STATEMENTS OF INCOME DATA: (Dollars in thousands, except per share data) Earned premiums $392,058 356,210 320,050 304,472 296,364 225,297 Net investment income $ 34,262 32,506 31,107 29,863 28,461 22,189 Management services income $ 8,727 7,945 7,367 6,774 6,377 5,170 Net realized gains on investments $ 2,555 2,925 3,043 2,788 1,758 1,595 Other income $ 3,269 2,473 1,409 1,200 525 147 ------------------------------------------------------------------------- Total revenues $440,871 402,059 362,976 345,097 333,485 254,398 ------------------------------------------------------------------------- Income before federal income taxes $ 56,985 49,605 56,638 34,792 40,953 20,294 ------------------------------------------------------------------------- Net income $ 42,816 37,497 40,998 26,407 29,894 15,835 ------------------------------------------------------------------------- Earnings per common share:(1)(2) Basic $ 1.05 .89 .99 .64 .73 .39 ------------------------------------------------------------------------- Diluted $ 1.03 .87 .97 .63 .72 .39 ------------------------------------------------------------------------- Cash dividends per common share(1) $ .11 .10 .09 .08 .07 .06 ------------------------------------------------------------------------- BALANCE SHEET DATA AT YEAR END: Total investments $627,305 579,966 526,363 499,277 479,908 350,639 Total assets $759,945 717,520 664,384 605,385 579,194 487,282 Debt obligation to affiliate $ 45,500 - - - - - Total stockholders' equity $317,687 340,824 297,258 247,619 225,763 175,852 Book value per common share(1) $ 8.29 8.11 7.11 5.98 5.48 4.29 STATUTORY RATIOS: Loss ratio 67.4 68.4 65.2 72.7 68.6 75.4 Expense ratio 29.5 29.4 28.9 27.3 31.0 28.2 Combined ratio 96.9 97.8 94.1 100.0 99.6 103.6 Industry combined ratio(3) 107.5 105.6 101.6 105.8 106.5 108.5 Ratio of net premiums written to statutory capital and surplus 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 1999 from A.M. Best. (*) Reflects change in pooling arrangement, effective January 1, 1999, 1998 and 1995. 26 Page 25 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 P&C, in addition to its insurance operations, currently provides management and operations services under management agreements effective as of January 1, 2000, for all State Auto Insurance Companies, which include: Milbank; Farmers Casualty; SAIC; National; Mid-Plains; State Automobile Mutual Insurance Company (Mutual), a majority shareholder of State Auto Financial; and Mutual's wholly owned subsidiary, Midwest Security Insurance Company (Midwest Security); and, until June 30, 1997, State Auto Life Insurance Company (State Auto Life was sold by Mutual effective July 1997). Pursuant to this management and operations agreement, State Auto P&C received cash equal to the net plan benefit liabilities assumed relating to the transfer of all employees from Mutual, Stateco (as defined below) and S.I.S. (as defined below) to State Auto P&C, effective January 1, 2000. Prior to January 1, 2000, State Auto P&C provided executive management services to the foregoing entities. 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 in the state of Ohio, its first state of operation. 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 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. The prior years' financial information includes the financial position and operations of Milbank. 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. 27 Page 26 Stateco Financial Services, Inc. (Stateco), a wholly owned subsidiary of State Auto Financial, provides investment management services to affiliated companies and also provides insurance premium finance services to customers of State Auto P&C, Milbank and Mutual. Strategic Insurance Software, Inc. (S.I.S.), a wholly owned subsidiary, develops and sells software for the processing of insurance transactions, database management for insurance agents and electronic interfacing of information between insurance companies and agents. 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 Property Management and Leasing, LLC (518 PML), an Ohio limited liability company, was formed in December 1997 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, the only members of 518 PML, contributed capital to 518 PML with State Auto P&C contributing real property and Stateco contributing $7.0 million in cash and real property. State Auto Financial, State Auto P&C, Milbank, Farmers Casualty, SAIC, National, Mid-Plains, Stateco, S.I.S. and 518 PML are referred to collectively herein as the "Company." State Auto P&C, Milbank and Farmers Casualty (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. Since 1995, State Auto P&C and Milbank have participated in the Pooling Arrangement with Mutual. During 1997, the aggregate pooling participation percentage of the Pooled Subsidiaries was 45% (State Auto P&C - 35% and Milbank - 10%). 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 1999, State Auto P&C, Milbank, Farmers Casualty, National, Mid-Plains, Mutual and Midwest Security are referred to collectively as the "State Auto Insurance Companies," while State Auto P&C, Mutual, Milbank, Farmers Casualty and Midwest Security are referred to as the "Pooled Companies." RESULTS OF OPERATIONS 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. 28 Page 27 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 continues 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 exhibits a significantly higher than average retention rate than any other age group. The Company's underwriting experience in commercial lines showed some deterioration during 1999, which has prompted management to commence a careful review of adherence to its underwriting guidelines in these lines of business. This could be expected to have a future impact on earned premium. This same approach to underwriting has 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 continues 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. In proposing the 2001 fiscal year budget, President Clinton continued to focus attention on the property and casualty insurance industry. One of the more significant revenue raising proposals contained in the budget directly affects property and casualty insurance companies. Property and casualty insurance companies are currently limited on the deductibility of the investment income earned on tax exempt fixed maturities and certain dividends received to 85%. This reduction was the result of the Tax Act of 1986. President Clinton has proposed an additional limitation of 10% (i.e., deductibility of 29 Page 28 investment income earned from tax exempt fixed maturities and certain dividends received would be limited to 75%). The current proposal would be effective for taxable years beginning after the date of enactment, with respect to investments acquired on or after the date of first committee action. President Clinton had proposed a similar action for the 2000 and 1999 fiscal year budgets. Municipalities continue to lobby very effectively against such action as property and casualty insurance companies and other financial service industries are the largest investors in municipalities' fixed maturities. If this revenue raising proposal passes as currently proposed, certain tax exempt securities would become less appealing to the property and casualty insurance industry as the relative spread between after tax yields on tax-exempt and taxable fixed income maturities would narrow. Management services income, which includes income generated from the investment management services segment and executive management services provided to affiliated companies by 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. EFT is expected to be offered to insureds in additional states in 2000. 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 30 Page 29 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. 1998 COMPARED TO 1997 Net income for the Company decreased 8.5% in 1998. The Company's statutory combined ratios for 1998 and 1997 were 97.8% and 94.1%, respectively. Impacting the Company's results for 1998 was an increase in the level of catastrophe losses compared to 1997. In fact, 1998 was the second worst catastrophe year in the Company's history. Consolidated earned premiums increased 11.3% in 1998. This increase was principally the results of a change in the Pooled Subsidiaries aggregate pooled participation percentage (discussed above) which increased consolidated earned premiums by 7.1%. The standard insurance segment's internal growth, as written by the Pooled Companies (for 1998 includes State Auto P&C, Milbank, Mutual and Midwest Security), excluding the impact of the change in the Pooled Subsidiaries aggregate pooled participation percentages, increased consolidated earned premiums by 2.9%. The Company's nonstandard insurance segment's internal growth (i.e., National) increased consolidated earned premiums by 1.3% from the previous period. State Auto P&C and Milbank, which represents State Auto Financial's standard insurance segment, achieved a 10.7% increase in the standard segment's earned premiums in both personal and commercial lines in 1998. Of the 10.7% increase, 7.6% was due to the change in the Pooling Arrangement and 3.1% was due to internal growth. With respect to personal lines, in both 1998 and 1997, the Pooled Companies' produced an increase of approximately 1.0% in its direct written premiums despite a significant increase in aggressive price competition in this book of business. Contributing favorably to the personal lines business over the last few years has been the Company's Prime of Life that targets the age groups 50 and older. This program, which was first introduced by the Company in late 1995, has consistently generated 25% of the Company's new homeowner and automobile personal lines of business. The continued growth of this program is gradually improving the profile of the Company's personal lines book of business. This is likely to continue as more and more baby boomers age into eligibility. The commercial lines direct written premium of the Pooled Companies increased in 1998 approximately 3.3%. The rate of growth on the Company's commercial lines has slowed in recent years. This is due primarily to a reduction in premiums in the Company's workers' compensation line of business, which reflects rate reductions driven by decreases in loss costs as promulgated by various rating bureaus. The workers' compensation line of business represents approximately 10% of the Pooled Companies' commercial business at the end of 1998. The nonstandard segment (National) increased its earned premiums in 1998 19.0%. This segment's growth has slowed compared to prior year levels due to aggressive underwriting action designed to improve profitability in Tennessee and Arkansas (National's two largest states), a more restrictive underwriting posture with several larger producers in its other states and rate increases implemented during 1997 in several operating states. While these actions have resulted in a decrease in growth over prior year levels, National's statutory loss experience has improved over comparative prior 31 Page 30 periods. See discussion below. National began operations in four new states during 1998: Indiana, Pennsylvania, Utah and Wisconsin. In 1998 premium growth was harder to achieve than it has been in some time. While commercial lines pricing continued to be very aggressive, the personal lines part of our business is also seeing intense price competition, with increased marketing activity among major players in personal lines auto insurance. This adversely affected the Pooled Companies ability to generate new business because management has continued to stress responsible pricing and diligent underwriting in contrast to much of its competition. At least annually, the State Auto Insurance Companies reviews each line of business to ensure that it is appropriately priced. As a result, much of the premium growth noted above within the standard insurance segment was attributable to the State Auto Insurance Companies' ability to put into place price increases on the existing book of business as opposed to the sale of new units. The Company has attempted to address the difficulties of securing growth by making selective acquisitions, which afford opportunities for increased writings in new, desirable states of operation. Within the last eight years, entry into new states, other than Oklahoma, has been by acquisition. In 1993, Mutual acquired Milbank which took the State Auto Insurance Companies into South and North Dakota, Minnesota and Utah. In 1997 Mutual acquired Midwest Security, thus entering Wisconsin. In 1999, State Auto Financial acquired Farmers Casualty and Mid-Plains taking the State Auto Insurance Companies into Iowa and Kansas. Though all of these acquisitions have been primarily personal lines companies, they have taken the Company into additional targeted states with an established independent agency force with an existing book of business on which to build. Management believes this reduces start up costs and permits faster growth in new states than has been the case with starting in a new state from scratch. With an established agency force, the Company has a "ready made" distribution force for offering an expanded product portfolio, including commercial lines and additional personal lines products. Net investment income increased 4.5% in 1998. Contributing to the increase over previous years was an increase in cash flow from operations and a general increase in investable assets over previous year's levels. Total cost of investable assets at December 31, 1998 and 1997, respectively, was $590.8 million and $535.2 million. Additionally, in 1998 the Pooled Subsidiaries received approximately $19.7 million in conjunction with the change in the pooling arrangement. The investment yields, based on fixed and equity securities at cost, were 5.7% and 6.0% for the annual periods ending 1998 and 1997, respectively. Contributing to the decrease in the investment yields over these periods has been a decline in the overall market fixed maturity interest rate environment from the previous comparable periods as well as a gradual shift in the composition of the fixed maturity portfolio from taxable to tax-exempt fixed maturities. At December 31, 1998 and 1997, respectively, tax exempt securities comprised approximately 71% and 59% of the fixed maturity portfolio. Despite these lower yielding rates, the Company has no intention of compromising the quality of its portfolio for higher yielding, more risky investments. Additionally, the Company began a program in late 1997 to build on the equity portfolio to enhance growth of statutory surplus over the long term, which continued in 1998. 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 by Stateco and State Auto P&C, respectively, increased $0.6 million in 1998. Other income primarily includes revenue from S.I.S.'s sales of its software products and, beginning in 1998, rental income on property leased by 518 PML to affiliate. In 1998, other income increased 76%. 518 PML's commencement of leasing operations in 1998 increased other income 19% while S.I.S.' increase in software sales over 1997 contributed a 47% increase. Losses and loss expenses, as a percentage of earned premiums, were 68.0% and 65.1% for years 1998 and 1997, respectively. As previously discussed, the Company experienced increased levels in storm-related catastrophe losses in 1998, primarily in the standard insurance segment. The second 32 Page 31 quarter 1998 was impacted by storm-related catastrophe losses occurring in nearly all operating states and the third quarter was adversely affected by several Midwestern wind and hail storms. The impact of the 1998 catastrophe losses amounted to 8.1 GAAP loss ratio points whereas catastrophe losses in 1997 totaled 2.4 GAAP loss ratio points. Despite the higher level of catastrophe losses as compared to 1997, the Company did not experience any significant loss activity from hurricanes Bonnie, Earl and Georges. The relatively low level of hurricane losses within the last three years validates the Company's strategy of closely monitoring concentration of risks subject to coastal losses. Absent the increased level of catastrophes, the Company's underlying book remained strong and in fact, reflects improvement from prior years, validating the Company's philosophy of responsible underwriting versus emphasis on premium growth achieved through irresponsible pricing or risk selection. Losses and loss expenses, as a percentage of earned premiums, for the nonstandard insurance segment, were 74.4% and 79.4% for the years ended 1998 and 1997, respectively. The 1997 ratio was the result of underwriting problems that occurred in two of the segment's larger states of operations as previously discussed. In early 1997, National implemented rate increases in these two states and took a more aggressive underwriting posture with several of its larger agencies in an effort to control the underwriting losses this segment was beginning to experience. In an effort to reduce its exposures to any one type of catastrophic loss, the Company, in recent years, has sought to geographically diversify into regions of the country not exposed to earthquakes and hurricanes. As previously discussed, this has been accomplished through the acquisitions of Milbank, Midwest Security, Farmers Casualty and Mid-Plains. While some states are not subject to the threats of hurricanes or earthquakes, virtually all have some windstorm and or hail exposure. Along with the increasing geographic dispersion of the Company's underwriting risk portfolio, the Company continues to refine its methods of monitoring its exposures to all types of catastrophe hazards. Acquisition and operating expenses, as a percentage of earned premiums (the "expense ratio"), were 29.3% and 29.5% for the years 1998 and 1997, respectively. The decrease in the expense ratio in 1998 can be attributed to a reduced amount of Quality Performance Bonus paid to employees compared to that paid in 1997, but this was partially offset by an increase in guaranty fund assessments. In an attempt to improve the efficiency of its operations and thereby reduce overall operating expenditures in the long-term, the Company has been making strides in the use of technology to streamline its personal and commercial operations, specifically in the area of electronic upload and download with its agencies using the APT industry standard. The advent of electronic transfers between the agent and the Company should have a long-term positive impact on the Company's expenses as the Company has been able to reduce its paper and postage costs as well as stabilize its employee count which should continue as this process expands to more agencies and lines of business. Additionally, it should improve the efficiency and effectiveness of the operations of both the agent and the Company through quicker response time and increased accuracy. In addition to the use of technology, the Company is realigning its claims procedures in order to improve service and reduce settlement expenses. The Company extensively trains its claims handlers, whose professionalism is exhibited by the low number of complaints received by the Company and various state insurance regulators. While the Company trains each claim representative to handle all types of claims, the Company recognizes that many claims are small and routine in nature. Rather than have a thoroughly trained representative spend time on these claims, the Company has established a Central Claims Department staffed by persons who focus exclusively on these losses. This allows for quicker response time to the insured, allows the fully trained claims representative to focus on the more serious claims, and reduces the use of independent adjusters. 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 1998 other expense increased 58.2%. S.I.S.' operating expenses increased over 1997 contributing an increase of 20% to other expense. Also contributing to this increase was an increase in 33 Page 32 write-offs of premium receivable during 1998, primarily in the nonstandard insurance segment. This segment has sought to improve its premium receivable collections by retaining the services of a third party whose business is receivables collection. Additionally, there was a general increase in corporate expenses over 1997. The effective Federal tax rate was 24% and 27% for the years ended 1998 and 1997, respectively. During 1997 and continuing into 1998, the Company continued to shift its fixed maturity portfolio from taxable to tax exempt securities. Additionally, in 1998 income before federal income taxes decreased due to an increase in storm related catastrophes compared to 1997. As a result of these two factors, tax exempt income comprised a larger proportion of income before federal income taxes in 1998 versus 1997. 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. 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 for these three segments for the years ended 1999, 1998 and 1997: 1999 1998 1997 ---- ---- ---- (in thousands) Standard insurance $48,225 40,310 48,376 Nonstandard insurance 1,647 1,313 1,192 Investment management services 5,191 4,908 4,901 The fluctuations in segment profit for the standard insurance segment, as discussed above, is the result of an increase in the level of catastrophe losses in 1998 as compared to 1999 and 1997. As noted above, the nonstandard insurance segment has been focusing since 1997 on improving its loss experience through implementation of a more restrictive underwriting posture and rate increases implemented during 1997 in several operating states. The result of these actions by this segment, as noted above, has improved this segment's statutory loss ratio as well as its segment profit. 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. 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 1999, net cash provided by operating activities decreased to $48.9 million from $56.7 million in 1998. This decrease is due to the cash transfer of $11.4 million to the Pooled Subsidiaries in connection with 1999 amended Pooling Arrangement, as discussed above, whereas in 1998, the cash transfer relating to the 1998 amended Pooling Arrangement was $19.7 million. In 1998, net cash provided by operating activities increased to $56.7 million from $28.9 million in 1997. This increase is due to the cash transfer of $19.7 million to the Pooled Subsidiaries in connection with the 1998 amended Pooling 34 Page 33 Arrangement as well as a general increase in cash flows that resulted from a change in pool percentages from previous periods. 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 maturities and equity securities, respectively, of $207.8 million and $25.6 million in 1999, $193.9 million and $17.1 million in 1998 and $137.6 million and $13.7 million in 1997. As market interest rates on fixed maturities began to decline over the last three years, the Company began experiencing a significantly higher number of calls on fixed maturities than in previous years. Cash flows provided by maturities, calls and principal reductions of fixed maturities were $37.3 million in 1999, $47.8 million in 1998 and $28.2 million in 1997. 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 and its affiliates. The total construction cost of the building, including land cost, was approximately $6.4 million. 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 70%, 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. Also impacting cash used in financing activities during 1999 was a repurchase program of the Company's 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 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%. Repayment of principal shall begin no later than 2001. In 1996, the State Auto Insurance Companies negotiated a change in their catastrophe reinsurance program. In 1998, Midwest Security and 1999, Farmers Casualty and Mid-Plains, became parties to the catastrophe reinsurance program. The amount retained by the State Auto Insurance Companies is $40.0 million for each occurrence, an increase of $20.0 million over the prior program. For up to $80.0 million in losses, excess of $40.0 million, traditional reinsurance coverage is provided. State Auto P&C assumed catastrophe reinsurance from Mutual, Milbank, Midwest Security, Farmers Casualty, National and Mid-Plains in the amount of $100 million excess of $120 million. Effective November 1999, the catastrophe reinsurance program was renegotiated whereby State Auto P&C assumes $135 million excess of $120 million. This layer of $135 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 $135.0 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. 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 35 Page 34 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 20, 2000, State Auto Financial has not exercised its right to acquire Midwest Security. On March 3, 2000, the Board of Directors of State Auto Financial declared a quarterly cash dividend of $0.0275 per common share, payable on March 31, 2000, to shareholders of record on March 15, 2000. This is the 35th 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. During 1998, State Auto Financial's authorized common shares increased to 100 million and the Board declared a two-for-one stock split to be distributed July 8, 1998, to shareholders of record on June 18, 1998. The impact of this stock split has been appropriately reflected in the accompanying consolidated financial statements. The maximum amount of dividends that may be paid to State Auto Financial during 2000 by its insurance subsidiaries without prior approval under current law is limited to $28.9 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, 1999, 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, 1999, the Company had no fixed maturity investments rated below investment grade, nor any mortgage loans. As of December 31, 1999, the Company had fixed maturities with a fair value of $527.8 million designated as available for sale compared to $481.8 million at December 31, 1998. During 1999, the Company continued its program to increase its equity portfolio to enhance growth of statutory surplus over the long term. At December 31, 1999 and 1998, respectively, the equity portfolio totaled $55.5 million and $42.2 million, respectively. 36 Page 35 MARKET RISK Investable assets comprise approximately 86% of the Company's total assets. Of the total investments, 88% are invested in fixed maturities, 8.5% 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, 1999, the Company's fixed maturity portfolio had an average maturity of 12.7 years. For the insurance subsidiaries, the maximum investment in any single note or bond is limited to 2.0% 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 1999 market conditions were characterized by increasing equity market prices and declining fixed maturity market prices. The Company's equity portfolio increased in value during 1999 because new monies being allocated during the year were used to acquire new equity positions and market values increased during the year. For the year, equity securities experienced a $3.3 million increase in unrealized holding gains. The market value of the available for sale fixed maturity portfolio was adversely impacted during the year as a result of rising interest rates. In 1999, the fixed maturity security market experienced the worst year since 1994 and the second worst since 1973 for market rates on fixed maturities. High quality issues, a characteristic of the Company's fixed maturity portfolio, were the worst performers. As a result of these market conditions, the Company experienced a decline of $34.1 million on the market value of its available for sale fixed maturity portfolio through December 31, 1999. 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. The Company has minimal exposure to foreign currency exchange rate risk and it does not own any derivative financial instruments. To provide the Company greater flexibility in order to manage its market risk exposures, the Company has segregated a portion of its fixed maturity investments, 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. 37 Page 36 PRINCIPAL AMOUNT MATURING IN: (Dollars in thousands)
2000 2001 2002 2003 2004 Thereafter Total Fair Value ---- ---- ---- ---- ---- ---------- ----- ---------- Fixed interest rate securities $18,610 32,961 38,846 14,794 29,316 446,158 580,685 $571,857 Average Interest rate 6.7% 6.3% 5.9% 5.3% 5.6% 6.0% 6.0%
YEAR 2000 In prior years, the Company discussed the nature and progress of its plans to become Year 2000 ready. In late 1999, the Company completed its remediation and testing of systems. As a result of those planning and implementation efforts, the Company experienced no significant disruptions in mission critical information technology, agent management systems, upload/download software and non-information technology systems and believes those systems successfully responded to the Year 2000 date change. The Company expensed approximately $0.5 million during 1999 in connection with remediating its systems. The Company is not presently aware of any material problems resulting from year 2000 issues, whether with its products, its internal systems, or the products and services of third parties. The Company will continue to monitor its mission critical computer applications and those of its suppliers and vendors throughout the year 2000 to ensure that any latent Year 2000 matters that may arise are addressed promptly. 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. SAFE HARBOR STATEMENT UNDER THE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995 Statements contained herein expressing the beliefs of management and the other statements, which are not historical facts contained in this report, are forward looking statements 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. Such statements include, without limitation, those pertaining to the weather related catastrophes impacting the Company's losses, product offerings, the Year 2000 discussion, statements relating to the new insurer, State Auto Insurance Company, the legislative and regulatory environment, including but not limited to the Gramm Leach Bliley Act of 1999 and sales forecasts. These risks and uncertainties include, but are not limited to, legislative changes at both the state and federal level, state and federal regulatory rule making promulgation's, class action litigation involving the insurance industry and judicial decisions affecting claims, policy coverages and the general costs of doing business, the impact of competitive products and pricing, product development, geographic spread of risk, weather and 38 Page 37 weather-related events, other types of catastrophic events, 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, shortages of programmers, other types of technical and professional employees, and regulatory or governmental systems breakdowns, and other risks indicated in the Company's filing with the Securities and Exchange Commission, including the Company's Management's Discussion and Analysis for its year ended December 31, 1999. 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: 39 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) 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, 1999 and 1998 and the related consolidated statements of income, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. 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, 1999 and 1998, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. /s/ Ernst & Young LLP Columbus, Ohio February 18, 2000 40 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) CONSOLIDATED BALANCE SHEETS - --------------------------------------------------------------------------------
DECEMBER 31 ----------- 1999 1998 ---- ---- (dollars in thousands, ASSETS except share data) Fixed maturities: Held to maturity, at amortized cost (fair value $44,051 and $57,826, respectively) ........................................................................... $ 43,981 55,926 Available for sale, at fair value (amortized cost $544,051 and $464,008, respectively) ........................................................................... 527,806 481,844 Equity securities, available for sale, at fair value (cost $39,303 and $29,233, respectively) 55,518 42,196 ------------------------ Total investments ........................................................................... 627,305 579,966 Cash and cash equivalents ................................................................... 24,560 32,605 Surplus note receivable ..................................................................... -- 9,000 Deferred policy acquisition costs ........................................................... 28,936 24,799 Accrued investment income and other assets .................................................. 17,977 19,542 Net prepaid pension expense ................................................................. 18,931 16,378 Reinsurance recoverable on losses and loss expenses payable ................................. 10,807 12,416 Prepaid reinsurance premiums ................................................................ 15,784 13,007 Deferred federal income taxes ............................................................... 1,828 -- Property and equipment, at cost, net of accumulated depreciation of $2,191 and $1,980, respectively .................................................................. 11,288 7,927 Goodwill .................................................................................... 2,529 1,880 ------------------------ Total assets ................................................................................ $ 759,945 717,520 ------------------------ LIABILITIES AND STOCKHOLDERS' EQUITY Losses and loss expenses payable ............................................................ $ 232,489 217,450 Unearned premiums ........................................................................... 153,570 144,081 Note payable to affiliate ................................................................... 45,500 -- Federal income taxes: Current ................................................................................... 1,322 2,608 Deferred .................................................................................. -- 8,095 Other liabilities ........................................................................... 4,041 3,578 Due to affiliates ........................................................................... 5,336 884 ------------------------ Total liabilities ........................................................................... 442,258 376,696 ------------------------ 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; 42,355,438 and 42,039,892 shares issued, respectively, at stated value of $2.50 per share .............. 105,888 105,100 Less 4,034,342 and 13,212 treasury shares, respectively, at cost .......................... (46,588) (167) Additional paid-in capital ................................................................ 42,562 41,539 Accumulated other comprehensive income .................................................... 156 20,276 Retained earnings ......................................................................... 215,669 174,076 ------------------------ Total stockholders' equity .................................................................. 317,687 340,824 ------------------------ Total liabilities and stockholders' equity .................................................. $ 759,945 717,520 ------------------------
See accompanying notes to consolidated financial statements. One 41 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) CONSOLIDATED STATEMENTS OF INCOME - --------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31 ---------------------- 1999 1998 1997 ---- ---- ---- (dollars in thousands, except per share amount) Earned premiums ............................................. $392,058 356,210 320,050 Net investment income ....................................... 34,262 32,506 31,107 Management services income from affiliates .................. 8,727 7,945 7,367 Net realized gains on investments ........................... 2,555 2,925 3,043 Other income (includes $1,676, $1,316 and $889, respectively, from affiliates) .......................................... 3,269 2,473 1,409 ----------------------------------- Total revenues .............................................. 440,871 402,059 362,976 ----------------------------------- Losses and loss expenses .................................... 264,628 242,294 208,234 Acquisition and operating expenses .......................... 111,772 104,224 94,351 Interest expense to affiliate ............................... 955 -- -- Other expense ............................................... 6,531 5,936 3,753 ----------------------------------- Total expenses .............................................. 383,886 352,454 306,338 ----------------------------------- Income before federal income taxes .......................... 56,985 49,605 56,638 ----------------------------------- Federal income tax expense (benefit): Current ................................................... 12,136 12,271 14,130 Deferred .................................................. 2,033 (163) 1,510 ----------------------------------- Total federal income taxes .................................. 14,169 12,108 15,640 ----------------------------------- Net income .................................................. $ 42,816 37,497 40,998 ----------------------------------- Earnings per common share: Basic ..................................................... $ 1.05 .89 .99 ----------------------------------- Diluted ................................................... $ 1.03 .87 .97 ----------------------------------- Dividends paid per common share ............................. $ .11 .10 .09 -----------------------------------
See accompanying notes to consolidated financial statements. Two 42 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, 1996 41,408 $103,520 - - $ 38,702 $ 7,529 $ 97,868 $ 247,619 --------------------------------------------------------------------------------------------------- Net income 40,998 40,998 Unrealized gains, net of tax and reclassification adjustment 7,232 7,232 -------- Comprehensive income 48,230 -------- Issuance of common stock 421 1,052 993 2,045 Tax benefit from stock options exercised 515 515 Treasury shares acquired on stock option exercises 8 (90) (90) Change in minority interest of subsidiary (2) (2) Cash dividends paid (1,059) (1,059) --------------------------------------------------------------------------------------------------- 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 ---------------------------------------------------------------------------------------------------
Three 43 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 ---------------------- 1999 1998 1997 ---- ---- ---- (in thousands) Cash flows from operating activities: Net income....................................................................... $42,816 37,497 40,998 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization, net ............................................. 3,257 2,666 2,324 Net realized gains on investments .............................................. (2,555) (2,925) (3,043) Changes in operating assets and liabilities: Deferred policy acquisition costs ............................................ (2,159) (1,151) (2,407) Accrued investment income and other assets ................................... 1,218 (2,232) (3,133) Net prepaid pension expense .................................................. (2,116) (1,029) (1,890) Reinsurance recoverable on losses and loss expenses payable and prepaid reinsurance premiums ........................... (4,721) 272 (6,682) Other liabilities and due to/from affiliates, net ............................ 3,554 4,546 (5,728) Losses and loss expenses payable ............................................. (7,099) (3,258) (610) Unearned premiums............................................................. 4,031 2,449 8,236 Federal income taxes.......................................................... 1,290 167 871 ------------------------------------------- Cash provided from the change in the reinsurance pool participation percentage ..................................................... 11,419 19,708 -- ------------------------------------------- Net cash provided by operating activities ......................................... 48,935 56,710 28,936 ------------------------------------------- Cash flows from investing activities: Purchase of fixed maturities - available for sale ............................... (207,768) (193,881) (137,599) Purchase of equity securities ................................................... (25,567) (17,051) (13,718) Maturities, calls and principal reductions of fixed maturities - held to maturity.................................................................... 11,776 23,106 10,680 Maturities, calls and principal reductions of fixed maturities - available for sale........................................................................ 25,516 24,654 17,545 Sale of fixed maturities - available for sale ................................... 113,671 111,085 98,745 Sale of equity securities........................................................ 17,369 8,306 9,997 Purchase of surplus notes receivable ............................................ -- (9,000) -- Net cash acquired on acquisition of Farmers Casualty and Mid-Plains ............. 11,568 -- -- Net additions of property and equipment ......................................... (3,459) (2,816) (911) --------------------------------------------- Net cash used in investing activities ............................................. (56,894) (55,597) (15,261) --------------------------------------------- Cash flows from financing activities: Net proceeds from issuance of debt to affiliate ................................. 45,500 -- -- Net proceeds from issuance of common stock ...................................... 1,928 1,780 2,470 Payments to acquire treasury shares ............................................. (46,199) -- -- Payment of dividends............................................................. (1,315) (1,219) (1,059) ------------------------------------------- Net cash provided by (used in) financing activities ............................... (86) 561 1,411 ------------------------------------------- Net increase (decrease) in cash and cash equivalents .............................. (8,045) 1,674 15,086 ------------------------------------------- Cash and cash equivalents at beginning of year .................................... 32,605 30,931 15,845 ------------------------------------------- Cash and cash equivalents at end of year .......................................... $ 24,560 32,605 30,931 ------------------------------------------- See accompanying notes to consolidated financial statements.
Four 44 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 National Insurance Company (National), an Ohio corporation - State Auto Insurance Company (SAIC), an Ohio corporation - Stateco Financial Services, Inc. (Stateco), an Ohio corporation - Strategic Insurance Software, Inc. (S.I.S.), an Ohio corporation, and majority-owned subsidiary 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. The prior years' financial information includes the financial position and operations of Milbank. The following provides financial information for Milbank included in the accompanying financial statements for the year ended December 31, 1997: 1997 ---- Revenues ......................................................... $73,416 Net income ....................................................... $ 7,039 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 intercompany balances and transactions have been eliminated in consolidation. (b) DESCRIPTION OF BUSINESS The Company, through State Auto P&C, Milbank and Farmers Casualty, 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, 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, National and Mid-Plains are chartered and licensed as property and casualty insurers in the states of South Carolina, South Dakota, Iowa, Ohio 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 (the Departments) and the regulations of each state in which they operate. These property and casualty insurance companies undergo periodic financial examination by their Departments and insurance regulatory agencies of the states that choose to participate. Through State Auto P&C, the Company also provides executive management services to its affiliated insurance companies. 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 is chartered and licensed as a property and casualty insurer in the state of Ohio. Through Stateco, the Company provides investment management services to affiliated companies Five 45 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED and also provides insurance premium finance services 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 in December 1997 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. State Auto P&C contributed real property, while Stateco contributed $7.0 million in cash and real property. (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, 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 and the recoverability of deferred policy acquisition costs. In connection with the determination of these items, 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 ---------------------- 1999 1998 1997 ---- ---- ---- (dollars in thousands) Balance, beginning of year ............................ $24,799 22,440 20,033 Acquisition of Farmers Casualty and Mid-Plains ...................... 730 -- -- Acquisition costs deferred ........................ 95,848 87,573 79,249 Amortized to expense during the year ................. 92,441 85,214 76,842 Balance, end -------------------------------------- of year ......................... $28,936 24,799 22,440 -------------------------------------- (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 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 net 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 Six 46 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 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. (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 $1,347,000 and $1,089,000 at December 31, 1999 and 1998, 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, for unreported claims and loss expenses. The liability for unpaid losses and loss expenses, net of estimated salvage and subrogation recoverable of $13,505,000 and $12,817,000 at December 31, 1999 and 1998, 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 executive management services provided by State Auto P&C and income for investment management services provided by Stateco. Executive management income is recognized quarterly based on a percentage of the five year average adjusted annual statutory surplus of each company managed except for Midwest Security Insurance Company (Midwest Security), a wholly-owned subsidiary of Mutual, which is 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 $1,248,000 and $1,567,000 are included in accrued investment income and other assets at December 31, 1999 and 1998, respectively. Software amortization, included in other expenses, was $614,000, $673,000 and $489,000 in 1999, 1998 and 1997, 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 and its subsidiaries. Farmers Casualty and Mid-Plains will 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 Seven 47 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED liabilities are determined based on differences between financial reporting and tax bases of assets 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 For purposes of the statements of cash flows, 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 and excludes any impact of changes in minority interest of subsidiaries. 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) NEW ACCOUNTING STANDARD In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities" (SFAS No. 133), which was required to be adopted in years beginning after June 15, 2000. SFAS No. 133 requires companies to recognize all derivatives on the balance sheet at fair value. Management believes SFAS No. 133 will not have a material impact on the Company upon adoption. (p) RECLASSIFICATIONS Certain items in the 1998 and 1997 consolidated financial statements have been reclassified to conform with the 1999 presentation. Eight 48 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (2) INVESTMENTS Realized and unrealized gains and losses are summarized as follows:
YEAR ENDED DECEMBER 31 ---------------------- 1999 1998 1997 ---- ---- ---- (dollars in thousands) Realized gains: Fixed maturities available for sale ....................... $ 1,336 1,588 914 Equity securities ......................................... 3,642 1,449 2,464 --------------------------------- Total realized gains ........................................ 4,978 3,037 3,378 --------------------------------- Realized losses: Fixed maturities available for sale ....................... 488 32 236 Equity securities ......................................... 1,896 80 99 Other ..................................................... 39 -- -- --------------------------------- Total realized losses ....................................... 2,423 112 335 --------------------------------- Net realized gains on investments ........................... $ 2,555 2,925 3,043 --------------------------------- Increase (decrease) in unrealized holding gains -- Fixed maturities held to maturity ............................... $ (1,830) (371) 1,464 --------------------------------- Increase in unrealized holding gains -- Equity securities ................................................ $ 3,252 6,014 3,426 Increase (decrease) in unrealized holding gains -- Fixed maturities available for sale at fair value ............... (34,081) 2,657 7,819 Change in deferred unrealized gain .......................... (125) (186) (119) Deferred federal income taxes thereon ....................... 10,834 (2,970) (3,894) --------------------------------- Increase (decrease) in net unrealized holding gains or losses $(20,120) 5,515 7,232 ---------------------------------
Nine 49 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 securities and available for sale securities are summarized as follows:
GROSS GROSS COST OR UNREALIZED UNREALIZED AMORTIZED HOLDING HOLDING FAIR HELD TO MATURITY AT DECEMBER 31, 1999: COST GAINS 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 ------------------------------------
GROSS GROSS COST OR UNREALIZED UNREALIZED AMORTIZED HOLDING HOLDING FAIR HELD TO MATURITY AT DECEMBER 31, 1998: COST GAINS LOSSES VALUE ---- ----- ------ ----- (dollars in thousands) U.S. Treasury securities and obligations of U.S. government corporations and agencies ......... $ 6,291 145 -- 6,436 Obligations of states and political subdivisions 7,055 508 -- 7,563 Mortgage-backed securities ..................... 42,580 1,247 -- 43,827 ------------------------------------ Total .......................................... $ 55,926 1,900 -- 57,826 ------------------------------------ AVAILABLE FOR SALE AT DECEMBER 31, 1998: U.S. Treasury securities and obligations of U.S. government corporations and agencies ......... $ 79,089 2,812 24 81,877 Obligations of states and political subdivisions 363,532 14,346 261 377,617 Corporate securities ........................... 8,996 798 -- 9,794 Mortgage-backed securities ..................... 12,391 185 20 12,556 ------------------------------------ Total fixed maturities ....................... 464,008 18,141 305 481,844 Equity securities .............................. 29,233 14,081 1,118 42,196 ------------------------------------ Total .......................................... $493,241 32,222 1,423 524,040 ------------------------------------
Deferred federal income taxes on the net unrealized holding gain for available for sale investments was $84,000 and $10,919,000 at December 31, 1999 and 1998, respectively. Ten 50 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, 1999, 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 ........... $ 600 600 7,560 7,535 Due after 1 year through 5 years ... 2,288 2,274 52,012 53,024 Due after 5 years through 10 years.. 5,038 5,181 132,865 132,657 Due after 10 years ................. 2,002 2,065 328,166 310,529 ----------------------------------------------- 9,928 10,120 520,603 503,745 Mortgage-backed securities ......... 34,053 33,931 23,448 24,061 ----------------------------------------------- $43,981 44,051 544,051 527,806 -----------------------------------------------
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 $20,473,000 and $17,666,000 were on deposit as required by law or specific escrow agreement at December 31, 1999 and 1998, respectively. Components of net investment income are summarized as follows: YEAR ENDED DECEMBER 31 ---------------------- 1999 1998 1997 ---- ---- ---- (dollars in thousands) Fixed maturities ................. $32,096 30,182 29,784 Equity securities ................ 678 477 372 Surplus note receivable .......... -- 235 -- Cash and cash equivalents ........ 1,707 1,908 1,210 ------------------------------------- Investment income ................ 34,481 32,802 31,366 ------------------------------------- Investment expenses .............. 219 296 259 ------------------------------------- Net investment income ............ $34,262 32,506 31,107 ------------------------------------- The Company has not held or issued 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 AND SURPLUS NOTE RECEIVABLE: The carrying amounts reported in the balance sheet for these instruments approximate their fair value. Eleven 51 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 ---------------------- 1999 1998 1997 --------- ------- ------- (dollars in thousands) Losses and loss expenses payable, net of reinsurance recoverables, at beginning of year ........................................... $ 205,034 194,155 199,480 Incurred related to: Current year ................................................... 271,507 255,885 225,666 Prior years .................................................... (6,878) (13,591) (17,432) --------------------------------------- Total incurred ................................................... 264,629 242,294 208,234 --------------------------------------- Paid related to: Current year ................................................... 168,512 157,988 134,890 Prior years .................................................... 100,349 86,671 78,669 --------------------------------------- Total paid ....................................................... 268,861 244,659 213,559 --------------------------------------- Impact of pooling change, January 1, 1999 and 1998 (note 6) ...... 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 ................................................. $ 221,682 205,034 194,155 ---------------------------------------
The liability for losses and loss expenses decreased by $6,878,000 in 1999, $13,591,000 in 1998 and $17,432,000 in 1997, for claims that had occurred in prior years. These decreases have resulted primarily from moderating trends in the frequency and severity of losses and loss expenses due to medical cost containment, tort reform and lower inflation. This along with fundamental improvements primarily in the auto liability and workers' compensation lines of business resulted in incurred losses and loss expenses developing favorably. 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. Twelve 52 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 sheet and income statement, is as follows:
DECEMBER 31 ----------- 1999 1998 ---- ---- (dollars in thousands) Losses and loss expenses payable: Direct ...................................... $222,152 207,013 Assumed ..................................... 7,710 10,437 Ceded ....................................... (10,807) (11,504) --------------------- Net losses and loss expenses payable ....... $219,055 205,946 --------------------- Unearned premiums: Direct ...................................... $151,867 139,838 Assumed ..................................... 1,703 4,243 Ceded ....................................... (3,090) (4,568) --------------------- Net unearned premiums ...................... $150,480 139,513 ---------------------
YEAR ENDED DECEMBER 31 ---------------------- 1999 1998 1997 ---- ---- ---- (dollars in thousands) Written premiums: Direct ................................. $436,150 387,762 375,248 Assumed ................................ 8,281 13,942 14,356 Ceded .................................. (11,216) (16,731) (17,465) -------- ------- ------- Net written premiums .................. $433,215 384,973 372,139 -------- ------- ------- Earned premiums: Direct ................................. $429,577 384,869 366,451 Assumed ................................ 10,822 14,386 14,917 Ceded .................................. (13,698) (17,026) (17,560) -------- ------- ------- Net earned premiums ................... $426,701 382,229 363,808 -------- ------- ------- Losses and loss expenses incurred: Direct ................................. $289,162 266,160 247,348 Assumed ................................ 10,803 13,644 14,875 Ceded .................................. (9,736) (8,355) (8,968) -------- ------- ------- Net losses and loss expenses incurred.. 290,229 271,449 253,255 -------- ------- -------
Thirteen 53 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 and Farmers Casualty (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. During 1997 the aggregate pooling participation percentage of the Pooled Subsidiaries was 45%. 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 conjuction with this change in pool participation, the Pooled Subsidiaries, which effective January 1, 2000 includes SAIC, 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 sheet and income statements for the Pooling Arrangement between the Pooled Subsidiaries and Mutual: DECEMBER 31 ----------- 1999 1998 ---- ---- (dollars in thousands) Losses and loss expenses payable: Ceded .................................... $(206,258) (197,730) Assumed .................................. 208,885 196,818 --------------------------- Net assumed (ceded) ..................... 2,627 (912) --------------------------- Unearned premiums: Ceded .................................... $(143,514) (131,461) Assumed .................................. 130,820 123,022 --------------------------- Net ceded ............................... $ (12,694) (8,439) --------------------------- Fourteen 54 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 ---------------------- 1999 1998 1997 ---- ---- ---- (dollars in thousands) Written premiums: Ceded .............................. $(403,679) (359,590) (348,676) Assumed ............................ 356,609 330,410 300,351 Earned premiums: Ceded .............................. $(395,698) (356,638) (342,309) Assumed ............................ 358,700 328,144 296,046 Losses and loss expenses incurred: Ceded .............................. $(268,536) (252,795) (236,456) Assumed ............................ 242,935 223,641 191,436 During 1996, Mutual, State Auto P&C, Milbank and National negotiated a change in their catastrophe reinsurance program. In 1998, Midwest Security and 1999, Farmers Casualty and Mid-Plains, 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, National and Mid-Plains in the amount of $100 million excess of $120 million. Effective November 1999, the catastrophe reinsurance program was renegotiated whereby State Auto P&C assumes $135 million excess of $120 million. Under this agreement, the Company has assumed from Mutual and its affiliate premiums written and earned of $2,355,000, $2,475,000 and $2,505,000 for 1999, 1998 and 1997, respectively. There have been no losses assumed under this agreement. This layer of $135 million in excess of $120 million 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 up to $135 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 $47 million and $40 million related to premium balances due to Mutual from agents and insureds at December 31, 1999 and 1998, respectively. Fifteen 55 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 expense on the loan from Mutual was $955,000 in 1999. (d) MANAGEMENT SERVICES State Auto P&C provides Mutual and its insurance affiliate executive management services to oversee the insurance operations of these companies. Revenue relating to these services amount to $5,628,000, $4,908,000 and $4,563,000 in 1999, 1998 and 1997, respectively. Stateco provides Mutual and its affiliate investment management services. Revenue related to these services amount to $3,099,000, $3,037,000 and $2,804,000 in 1999, 1998 and 1997, 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 $1,109,000, $1,048,000 and $889,000 in 1999, 1998 and 1997, 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 $567,000 and $268,000 in 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 reimbursed by Mutual to State Auto P&C in conformance with pooling percentages in place at that time. As of December 31, 1999, 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 ---------------------- 1999 1998 1997 AMOUNT % AMOUNT % AMOUNT % ------ - ------ - ------ - (dollars in thousands) Amount at statutory rate ........................... $ 19,947 35 17,361 35 19,823 35 Tax-free interest and dividends received deduction.. (6,315) (11) (5,423) (11) (4,368) (8) Other, net ......................................... 537 1 170 -- 185 -- --------------------------------------------------------------- Effective tax rate ................................. $ 14,169 25 12,108 24 15,640 27 ---------------------------------------------------------------
The tax effects of temporary differences that give rise to significant portions of deferred tax assets and deferred tax liabilities at December 31, 1999 and 1998 are presented below: 1999 1998 ---- ---- (dollars in thousands) Deferred tax assets: Unearned premiums not deductible ......................... $ 9,597 8,885 Losses and loss expenses payable discounting ............. 8,375 8,257 Other .................................................... 2,229 1,604 ------------------ Total deferred tax assets .............................. 20,201 18,746 ------------------ Sixteen 56 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED Deferred tax liabilities: Deferral of policy acquisition costs ........... 10,128 8,680 Net pension expense ............................ 6,631 5,732 Unrealized holding gain on investments ......... 84 10,919 Other .......................................... 1,530 1,510 ---------------------- Total deferred tax liabilities ............... 18,373 26,841 ---------------------- Net deferred tax assets (liabilities) ........ $ 1,828 (8,095) ---------------------- 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 1999, 1998 and 1997 were $12,621,000, $11,768,000 and $14,254,000, respectively. (8) PENSION BENEFIT PLANS State Auto P&C, Stateco and S.I.S., pursuant to an intercompany agreement, are participants, together with Mutual, in a defined benefit pension plan that covers substantially all employees of Mutual and the Company. The assets of the plan are represented primarily by U.S. government and agency obligations, bonds, and common stocks. 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. Information regarding the funded status and net periodic pension benefit for the Company's participation in the plan is as follows:
DECEMBER 31 ----------- 1999 1998 ---- ---- (in thousands) CHANGE IN BENEFIT OBLIGATION Benefit obligation at beginning of year ................................... $ 44,758 39,727 Transfer in benefit obligation at beginning of year due to pooling change.. 2,615 -- Service cost .............................................................. 2,047 1,686 Interest cost ............................................................. 3,278 2,977 Actuarial loss ............................................................ (4,286) 4,024 Benefits paid ............................................................. (4,396) (3,656) ---------------------- Benefit obligation at end of year ......................................... $ 44,016 44,758 ---------------------- CHANGE IN PLAN ASSETS Fair value of plan assets at beginning of year ............................ $75,453 64,565 Transfer in plan assets at beginning of year due to pooling change ........ 4,313 -- Actual return on plan assets .............................................. 9,513 11,984 Asset gain ................................................................ -- 2,560 Benefits paid ............................................................. (4,396) (3,656) ---------------------- Fair value of plan assets at end of year .................................. $ 84,883 75,453 ---------------------- Funded status ............................................................. $ 40,867 30,695 Unrecognized net actuarial gain ........................................... (22,441) (14,816) Unrecognized prior service cost ........................................... 1,472 1,587 Unrecognized transition asset ............................................. (967) (1,088) ---------------------- Net prepaid pension expense ............................................... $ 18,931 16,378 ----------------------
Seventeen 57 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 ---------------------- 1999 1998 1997 ---- ---- ---- (in thousands) COMPONENTS OF NET PERIODIC BENEFIT Service cost ........................... $ 2,047 1,686 1,548 Interest cost .......................... 3,278 2,977 2,760 Expected return on plan assets ......... (6,125) (5,430) (4,742) Amortization of prior service cost ..... 114 114 114 Amortization of transition asset ....... (124) (121) (121) Amortization of net gain ............... 7 (8) (3) --------------------------------- Net periodic benefit ................... $ (803) (782) (444) --------------------------------- YEAR ENDED DECEMBER 31 ---------------------- 1999 1998 1997 ---- ---- ---- WEIGHTED-AVERAGE ASSUMPTIONS AS OF DECEMBER 31 Discount rate ................................. 8.00% 7.00 7.25 Expected long-term rate of return on assets ... 9.00% 9.00 9.00 Rates of increase in compensation levels ...... 5.00% 4.50 4.50 State Auto P&C, Stateco and S.I.S. are also participants with Mutual in a defined contribution plan that covers substantially all employees of Mutual and 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 $852,000, $782,000 and $726,000 for the years 1999, 1998 and 1997, respectively. (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 splits 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). (c) DIVIDEND RESTRICTIONS AND STATUTORY FINANCIAL INFORMATION State Auto P&C, Milbank, National, Farmers Casualty and SAIC 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 $28.9 million is available for payment to State Auto Financial in 2000 without prior approval. Eighteen 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 ----------- 1999 1998 ---- ---- (dollars in thousands) Statutory capital and surplus of insurance subsidiaries ........ $ 283,233 232,407 Net assets of noninsurance parent and affiliates ............... (21,378) 28,677 ------------------------ 261,855 261,084 Add (subtract) cumulative effect of adjustments: Deferred policy acquisition costs ............................ 28,936 24,799 Losses and loss expenses payable ............................. 13,505 12,817 Net prepaid pension expense .................................. 18,945 16,368 Deferred federal income taxes ................................ 1,636 (7,899) Excess of statutory loss liabilities over case basis amounts.. 4,856 11,482 Fixed maturities at fair value ............................... (15,204) 18,809 Goodwill ..................................................... 2,529 1,880 Other, net ................................................... 629 1,484 ------------------------ Stockholders' equity per accompanying consolidated financial statements ....................................... $317,687 340,824 ------------------------
YEAR ENDED DECEMBER 31 --------------------------------- 1999 1998 1997 ---- ---- ---- (dollars in thousands) Statutory net income of insurance subsidiaries ... $ 36,601 28,696 35,660 Net income of noninsurance parent and affiliates.. 2,944 3,227 2,581 ----------------------------------- 39,545 31,923 38,241 Increases (decreases): Deferred policy acquisition costs .............. 3,407 2,359 2,407 Losses and loss expenses payable ............... 15 1,947 258 Net prepaid pension expense .................... 2,578 1,791 1,898 Deferred federal income taxes .................. (2,265) 279 (1,344) Goodwill amortization .......................... (258) (198) (198) Other, net ..................................... (206) (604) (264) ------------------------------------ Net income per accompanying consolidated financial statements .......................... $ 42,816 37,497 40,998 ------------------------------------
(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. Ninteen 59 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED (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, the Company also follows APB 25 and related Interpretations, as the Company deems such employees to be common law employees of the Company. Compensation cost charged against operations in 1999 was $137,000 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: 1999 1998 1997 ---- ---- ---- (in thousands, except per share figures) Pro forma net earnings ........................... $41,414 35,700 40,045 Pro forma net earnings per common share Basic ........................................ $ 1.02 0.85 0.96 Diluted ...................................... $ 1.00 0.83 0.94 The fair value of options granted in 1999, 1998 and 1997 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: 1999 1998 1997 ---- ---- ---- Fair value ....................................... $4.49 $6.10 $3.00 Dividend yield ................................... .90% .75% 1.00% Risk free interest rate .......................... 5.77% 5.31% 5.85% Expected volatility factor ....................... .32 .31 .30 Expected life (years) ............................ 5.7 6.6 2.2 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 option, 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 of Mutual, State Auto P&C, Stateco and S.I.S. The nonemployee directors' plan provides each nonemployee director an option to purchase 1,000 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 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 3,600,000 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 Mutual, State Auto P&C, Stateco and S.I.S. 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 Twenty 60 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED 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, 1999, 1,558,000 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 1999 were as follows: fair value of $4.02; dividend yield of .90%; expected volatility factor of .30; risk-free interest rate of 6.80%; and expected life of the option of 9.7 years. Expense of $105,000 associated with this plan was recognized in 1999. A summary of the Company's stock option activity and related information for these plans for the years ended December 31, 1999, 1998 and 1997, follows:
1999 1998 1997 --------------------------- ------------------------- ------------------------ 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 2,272 $ 6.76 2,019 $ 5.04 2,261 $4.79 Granted 453 11.24 339 16.31 37 9.31 Exercised (165) 3.34 (86) 4.02 (276) 3.49 Canceled (14) 10.52 -- -- (3) 7.32 ------ ------ ------ Outstanding, end of year 2,546 $ 7.76 2,272 $ 6.76 2,019 $5.04 ------ ------ ------
A summary of information pertaining to options outstanding and exercisable as of December 31, 1999 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 $5.00 812 2.8 $ 3.87 812 $ 3.87 $5.01 - $10.00 1,024 5.6 6.58 982 6.48 Greater than $10.01 710 8.7 13.90 273 15.97 ----- ----- 2,546 5.6 $ 7.76 2,067 $ 6.71 ----- ------
Twenty-one 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 ---------------------- 1999 1998 1997 ---- ---- ---- (in thousands, except per share data) Numerator: Net earnings for basic and diluted earnings per common share.. $ 42,816 37,497 40,998 -------------------------------------- Denominator: Weighted average shares for basic net earnings per common share .......................................... 40,780 41,887 41,544 Effect of dilutive stock options ............................. 746 1,014 906 Adjusted weighted average shares for diluted net earnings per common share ..................... 41,526 42,901 42,450 -------------------------------------- Basic net earnings per common share ............................ $ 1.05 0.89 0.99 -------------------------------------- Diluted net earnings per common share .......................... $ 1.03 0.87 0.97 --------------------------------------
(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, 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 --------------------------------------
YEAR ENDED DECEMBER 31, 1997 ---------------------------- BEFORE-TAX TAX (EXPENSE) NET-OF-TAX AMOUNT OR BENEFIT AMOUNT ------ ---------- ------ ( in thousands) Net unrealized holding gains on securities: Net unrealized holding gains ................................ $ 11,125 (3,894) 7,232 -------------------------------------- Other comprehensive income .................................... $ 11,125 (3,894) 7,232 --------------------------------------
Twenty-two 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 three reportable segments: standard insurance, nonstandard insurance and investment 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 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 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 determining reportable segments. The following provides financial information regarding the Company's reportable segments:
1999 1998 1997 ---- ---- ---- (in thousands) REVENUES FROM EXTERNAL CUSTOMERS: Standard insurance ................. $ 398,185 365,510 332,126 Nonstandard insurance .............. 32,973 27,064 22,893 Investment management services ..... 3,371 3,328 3,422 All other .......................... 3,537 2,906 1,424 --------------------------------------- Total revenues from external customers 438,066 398,808 359,865 Intersegment revenues: Standard insurance ................. 120 90 75 Investment management services ..... 2,575 2,363 2,107 All other .......................... 1,676 1,167 728 --------------------------------------- Total intersegment revenues .......... 4,371 3,620 2,910 --------------------------------------- Total revenue ........................ 442,437 402,428 362,775 --------------------------------------- Reconciling items: Intersegment revenues .............. (4,371) (3,620) (2,910) Corporate revenues ................. 250 326 68 Net realized gains on investment ... 2,555 2,925 3,043 --------------------------------------- Total consolidated revenues .......... $ 440,871 402,059 362,976 ======================================= SEGMENT PROFIT: Standard insurance ................. $ 48,225 40,310 48,376 Nonstandard insurance .............. 1,647 1,313 1,192 Investment management services ..... 5,191 4,908 4,901 All other .......................... 1,238 1,323 269 --------------------------------------- Total segment profit ............... 56,301 47,854 54,738
Twenty-three 63 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
1999 1998 1997 ---- ---- ---- (in thousands) Reconciling items: Corporate expenses ................................. (1,863) (1,104) (1,120) Net realized gains on investment ................... 2,555 2,925 3,043 Miscellaneous adjustment in consolidation .......... (8) (70) (23) ---------------------------------------- Total consolidated income before federal income taxes $ 56,985 49,605 56,638 ---------------------------------------- NET INVESTMENT INCOME: Standard insurance ................................. $ 29,060 27,710 26,984 Nonstandard insurance .............................. 1,839 1,383 1,315 Investment management services ..................... 272 292 598 All other .......................................... 268 432 62 ---------------------------------------- Total net investment income .......................... 31,439 29,817 28,959 Reconciling items: Corporate net investment income .................... 249 326 41 Reclassification adjustments in consolidation ...... 2,574 2,363 2,107 ---------------------------------------- Total consolidated net investment income ........... $ 34,262 32,506 31,107 ---------------------------------------- DEPRECIATION AND AMORTIZATION EXPENSE: Standard insurance ................................. $ 2,175 1,865 1,796 Nonstandard insurance .............................. (11) 13 8 Investment management services ..................... 26 25 10 All other .......................................... 1,067 763 510 ---------------------------------------- Total depreciation and amortization expense .......... $ 3,257 2,666 2,324 ---------------------------------------- SEGMENT ASSETS: Standard insurance ................................. $ 708,384 641,195 586,042 Nonstandard insurance .............................. 44,670 37,997 35,037 Investment management services ..................... 6,367 7,449 13,115 All other .......................................... 14,940 15,741 3,385 ---------------------------------------- Total segment assets ............................... 774,361 702,382 637,579 Reconciling items: Corporate expenses ................................. 1,223 10,979 2,212 Reclassification adjustments in consolidation ...... (15,639) (3,583) (968) ---------------------------------------- Total consolidated assets ............................ $ 759,945 709,778 638,823 ---------------------------------------- EXPENDITURE FOR ADDITIONS TO LONG-LIVED ASSETS: Standard insurance ................................. $ 346 51 109 Investment management services ..................... 101 209 771 All other .......................................... 3,118 2,556 31 ---------------------------------------- Total expenditure for additions to long-lived assets $ 3,565 2,816 911 ----------------------------------------
Twenty-four 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:
1999 1998 1997 ---- ---- ---- (in thousands) Earned premiums Standard insurance: Automobile .............................. $204,155 186,283 167,241 Homeowners and farmowners ............... 63,666 57,983 51,865 Commercial multi-peril .................. 23,902 21,791 19,812 Workers' compensation ................... 10,764 12,006 12,605 Fire and allied ......................... 25,763 23,698 21,310 Other and products liability ............ 20,052 17,313 15,364 Other lines ............................. 12,873 11,545 10,354 ---------------------------------- Total standard insurance earned premiums .. 361,175 330,619 298,551 Nonstandard insurance: Automobile .............................. 30,883 25,591 21,499 ---------------------------------- Total nonstandard insurance earned premiums 30,883 25,591 21,499 ---------------------------------- Total earned premiums ..................... 392,058 356,210 320,050 Investment management services ............ 3,099 3,036 2,804 Net investment income ..................... 34,012 32,180 31,066 Other income .............................. 8,897 7,382 5,945 ---------------------------------- Total revenues from external customers .... $438,066 398,808 359,865 ----------------------------------
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)
FOR THREE MONTHS ENDED ---------------------- MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, --------- -------- ------------- ------------ 1999 (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 -----------------------------------------------
Twenty-five 65 STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED
FOR THREE MONTHS ENDED ---------------------- MARCH 31, JUNE 30, SEPTEMBER 30, DECEMBER 31, --------- -------- ------------- ------------ 1998 (dollars in thousands, except per share amounts) Total revenues ......................... $99,361 99,823 102,212 100,663 Income before federal income taxes ..... 15,874 3,296 13,469 16,966 Net earnings ........................... 11,531 2,780 10,552 12,634 Net earnings per common share (note 9a): Basic ............................... 0.27 0.07 0.25 0.30 Diluted ............................. 0.27 0.06 0.25 0.29 --------------------------------------------
(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. In the opinion of management, the effects, if any, of such litigation are not expected to be material to the consolidated financial statements. 66 38 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, 1999, 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, 1999, 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, 1999, 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, 1999, 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, 1999 and 1998 Consolidated Statements of Income for each of the three years in the period ended December 31, 1999 Consolidated Statements of Stockholders' Equity for each of the three years in the period ended December 31, 1999 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1999 Notes to Consolidated Financial Statements 67 Page 39 (a)(2) LISTING OF FINANCIAL STATEMENT SCHEDULES The following financial statement schedules of the Company for the years 1999, 1998, and 1997 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
Page 40 (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. 33-40643 Articles of Incorporation 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. 33-89400 Amended and Restated Articles of Incorporation 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 ended Amendment to the Amended and Restated Articles of December 31, 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 Code of Regulations on Form S-1 (see Exhibit 3(b) therein) 4 State Auto Financial Corporation's Amended and Restated See Exhibit 3(A) and 3(B) Articles of Incorporation, and Articles 1, 3, 5 and 9 of the Company's Amended and Restated Code of Regulations 10(A) Guaranty Agreement between State Automobile Mutual 1933 Act Registration Statement No. 33-40643 Insurance Company and State Auto Property and Casualty on Form S-1 (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 Financial Corporation and each of its directors 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) 10(H) Lease Agreement between Longhollow Associates Limited 1933 Act Registration Statement No. 33-40643 Partnership and State Automobile Mutual Insurance on Form S-1 (see Exhibit 10(j) therein) Company dated July 8, 1988, as amended _________________________________ *Constitutes either a management contract or a compensatory plan or arrangement required to be filed as an Exhibit
69
Page 41 10(I) 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(J) 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(K)* 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(L)* 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(M)* State Auto Insurance Companies Non-Qualified Incentive Form 10-K Annual Report for year ended Deferred Compensation Plan December 31, 1995 (see Exhibit 10(T) therein) 10(N)* Robert L. Bailey Employment Contract Form 10-K Annual Report for year ended December 31, 1995 (see Exhibit 10(X) therein) 10(O)* 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(P)* 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(Q) 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(R) 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(S) 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 Insurance Company 10(T) $135,000,000 Credit Agreement among SAF Funding Included herein Corporation, as Borrower, the Lenders and Bank One, NA as Agent dated as of November 19, 1999 10(U) Put Agreement among State Automobile Mutual Insurance Included herein Company, State Auto Financial Corporation and Bank One, NA as Agent dated as of November 19, 1999 10(V) Standby Purchase Agreement between State Auto Financial Included herein Corporation and SAF Funding Corporation 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 10(W) Reinsurance Pooling Agreement amended and restated as of Included herein January 1, 2000 by and among State Automobile 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(X) Management and Operations Agreement as of January 1, 2000 Included herein among State 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., 518 Property Management and Leasing, LLC 10(Y) Property Catastrophe Overlying Excess of Loss Reinsurance Included herein contract issued to 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 by State Auto Property and Casualty Insurance Company 10(Z) First Amendment to the Management and Operations Included herein Agreement effective January 1, 2000 among State 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(AA) First Amendment to the June 1, 1999 Credit Agreement dated Included herein Nov. 1, 1999 between State Auto Financial Corporation and State Automobile Mutual Insurance Company 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, 1997 Jr., Robert J. Murchake, Paul W. Huesman, George R. (see Exhibit 24(C) therein) Manser, David L. Bickelhaupt, and 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) 27 Financial Data Schedule Included herein
(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, 1999. (c) EXHIBITS -------- The exhibits have been submitted as a separate section of this report following the financial statement schedules. 71 Page 43 (d) FINANCIAL STATEMENT SCHEDULES ----------------------------- The financial statement schedules have been submitted as a separate section of this report following the signatures. 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: March 28, 2000 /s/Robert H. Moone --------------------------- Robert H. Moone President and Chief Executive Officer 72 Page 44 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/ Robert L. Bailey Chairman of the Board March 28, 2000 - -------------------------- Robert L. Bailey /s/ Steven J. Johnston Chief Financial Officer, March 28, 2000 - -------------------------- Senior Vice President, Treasurer Steven J. Johnston (principal financial officer and principal accounting officer) John R. Lowther* Secretary and Director March 28, 2000 - ------------------------------------ John R. Lowther Urlin G. Harris, Jr.* Director March 28, 2000 - -------------------------- Urlin G. Harris, Jr. David L. Bickelhaupt* Director March 28, 2000 - -------------------------- David L. Bickelhaupt David J. D'Antoni* Director March 28, 2000 - -------------------------- David J. D'Antoni Paul W. Huesman* Director March 28, 2000 - -------------------------- Paul W. Huesman William J. Lhota* Director March 28, 2000 - -------------------------- William J. Lhota George R. Manser* Director March 28, 2000 - -------------------------- George R. Manser /s/Robert H. Moone President March 28, 2000 - -------------------------- Chief Executive Officer Robert H. Moone (principal executive officer)
73 45 *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 March 28, 2000 - ----------------------------- 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 1933 Act Registration Statement No. 33-40643 Restated Articles of Incorporation 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. 33-89400 Amended and Restated Articles of Incorporation 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 ended Amendment to the Amended and Restated Articles of December 31, 1998 (see Exhibit 3(A)(3) therein) Incorporation as of June 2, 1998 3(B) State Auto Financial Corporation's Amended and 1933 Act Registration Statement No. 33-40643 Restated Code of Regulations on Form S-1 (see Exhibit 3(b) therein) 4 State Auto Financial Corporation's Amended and See Exhibit 3(A) and 3(B) Restated Articles of Incorporation, and Articles 1, 3, 5 and 9 of the Company's Amended and Restated Code of Regulations 10(A) Guaranty Agreement between State Automobile Mutual 1933 Act Registration Statement No. 33-40643 Insurance Company and State Auto Property and on Form S-1 (see Exhibit 10 (d) therein) Casualty Insurance Company dated as of May 16, 1991 10(B) Form of Indemnification Agreement between State Auto 1933 Act Registration Statement No. 33-40643 Financial Corporation and each of its directors 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) 10(H) Lease Agreement between Longhollow Associates 1933 Act Registration Statement No. 33-40643 Limited Partnership and State Automobile Mutual on Form S-1 (see Exhibit 10 (j) therein) Insurance Company dated July 8, 1988, as amended
- ------------------------------------ *Constitutes either a management contract or a compensatory plan or arrangement required to be filed as an Exhibit 75 10(I) 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(J) 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(K)* 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(L)* 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(M)* State Auto Insurance Companies Non-Qualified Incentive Form 10-K Annual Report for year ended December 31, 1995 Deferred Compensation Plan (see Exhibit 10(T) therein) 10(N)* Robert L. Bailey Employment Contract Form 10-K Annual Report for year ended December 31, 1995 (see Exhibit 10(X) therein) 10(O)* 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(P)* Amendment Number 1 to the 1991 Directors' Stock Option Form 10-K Annual Report for the year ended December 31, Plan 1996 (see Exhibit 10(EE) therein) 10(Q) 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(R) Agreement and Plan of Reorganization dated July 7, 1998, Form 8-K filed on July 7, 1998 (see Exhibit 10(JJ) therein) by and among State Auto Financial Corporation, SAF Acquisition Corp., State Automobile Mutual Insurance Company and Milbank Insurance Company and the Closing Agreement dated July 7, 1998 10(S) Credit Agreement dated as of June 1, 1999 between State Form 10-Q for the period ended June 30, 1999 Auto Financial Corporation and State Automobile Mutual Insurance Company 10(T) $135,000,000 Credit Agreement among SAF Funding Included herein Corporation, as Borrower, the Lenders and Bank One, NA as Agent dated as of November 19, 1999 10(U) Put Agreement among State Automobile Mutual Insurance Included herein Company, State Auto Financial Corporation and Bank One, NA as Agent dated as of November 19, 1999 10(V) Standby Purchase Agreement between State Auto Financial Included herein Corporation and SAF Funding Corporation dated as of November 19, 1999
- --------------------------------- *Constitutes either a management contract or a compensatory plan or arrangement required to be filed as an Exhibit 76 10(W) Reinsurance Pooling Agreement amended and restated as of Included herein January 1, 2000 by and among State Automobile 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(X) Management and Operations Agreement as of January 1, 2000 Included herein among State 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., 518 Property Management and Leasing, LLC 10(Y) Property Catastrophe Overlying Excess of Loss Reinsurance Included herein contract issued to 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 by State Auto Property and Casualty Insurance Company 10(Z) First Amendment to the Management and Operations Included herein Agreement effective January 1, 2000 among State 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(AA) First Amendment to the June 1, 1999 Credit Agreement Included herein dated Nov. 1, 1999 between State Auto Financial Corporation and State Automobile Mutual Insurance Company 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., Robert J. Murchake, Paul W. Huesman, George R. 1997 (see Exhibit 24(C) therein) Manser, David L. Bickelhaupt, and 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) 27 Financial Data Schedule Included herein
77 Item 14(d) Financial Statement Schedules 78
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES SCHEDULE I(a) - SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 1999 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 $36,940 $36,805 $36,940 States, municipalities and political subdivisions 7,041 7,246 7,041 ---------------- ---------------- --------------- Total fixed maturities - held to maturity $43,981 $44,051 $43,981 ================ ================ =============== SCHEDULE I(b) - SUMMARY OF INVESTMENTS - OTHER THAN INVESTMENTS IN RELATED PARTIES DECEMBER 31, 1999 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 $97,314 $95,642 $95,642 States, municipalities and political subdivisions 439,241 424,793 424,793 Public utilities 4,091 3,820 3,820 All other corporate bonds 3,405 3,551 3,551 ---------------- ---------------- --------------- Total fixed maturities $544,051 $527,806 $527,806 ---------------- ---------------- --------------- Equity securities: Public utilities 1,923 2,647 2,647 Banks, trust and insurance companies 4,948 5,336 5,336 Industrial, miscellaneous and all other 32,432 47,535 47,535 ---------------- ---------------- --------------- Total equity securities 39,303 55,518 55,518 ---------------- ---------------- --------------- Total investments - available for sale $583,354 $583,324 $583,324 ================ ================ ===============
79
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONDENSED BALANCE SHEETS December 31 ----------------------------------- ASSETS 1999 1998 ---- ---- (dollars in thousands) Investments in common stock of subsidiaries (equity method) $360,974 $329,104 Surplus note receivable -- 9,000 Cash 650 1,220 Real estate 444 461 Other assets 578 759 Federal income tax benefit 1,034 647 --------------- ---------------- Total assets $363,680 $341,191 =============== ================ LIABILITIES AND STOCKHOLDERS' EQUITY Note payable to affiliate $45,500 - Due to affiliates 167 122 Accrued expenses 325 245 --------------- ---------------- Total liabilities 45,992 367 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; 42,355,438 and 42,039,892 shares issued, respectively, at stated value of $2.50 per share 105,888 105,100 Less 4,304,342 and 13,212 treasury shares, respectively, at cost (46,588) (167) Additional paid-in capital 42,562 41,539 Accumulated other comprehensive income 211 20,276 Retained earnings 215,614 174,076 --------------- ---------------- Total stockholders' equity 317,687 340,824 --------------- ---------------- Total liabilities and stockholders' equity $363,680 $341,191 =============== ================
80
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONTINUED CONDENSED STATEMENTS OF INCOME Year ended December 31 --------------------------------------------------- 1999 1998 1997 ---- ---- ---- (in thousands) Investment income $249 $326 $68 Rental income 37 33 27 Net realized gains on investments 1 2 -- ---------------- --------------- ---------------- Total revenue 287 361 95 ---------------- --------------- ---------------- Interest expense to affiliate 955 -- -- Total operating expenses 1,176 1,456 1,215 ---------------- --------------- ---------------- Loss before federal income taxes (1,844) (1,095) (1,120) Federal income tax benefit (645) (394) (378) --------------------------------------------------- Net loss before equity in undistributed net earnings of subsidiaries (1,199) (701) (742) Equity in undistributed net earnings of subsidiaries 44,015 38,198 41,740 ---------------- --------------- ---------------- Net Income $42,816 $37,497 $40,998 ================ =============== ================
81
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES SCHEDULE II - CONDENSED FINANCIAL INFORMATION OF REGISTRANT CONTINUED CONDENSED STATEMENTS OF CASH FLOWS Year Ended December 31 --------------------------------------------------- 1999 1998 1997 ---- ---- ---- (in thousands) Cash flows from operating activities: Net income $42,758 $37,497 $40,998 -------- -------- -------- Adjustments to reconcile net income to net cash used in operating activities: Depreciation and amortization, net 160 17 16 Equity in undistributed earnings of subsidiaries (43,957) (38,198) (41,740) Changes in operating assets and liabilities: Change in accrued expenses and due to affiliates 125 58 36 Change in other assets 185 (505) 60 Change in federal income taxes (387) 305 (492) -------- -------- -------- Net cash used in operating activities (1,116) (826) (1,122) -------- -------- -------- Cash flows from investing activities: Capitalization of subsidiary (12,030) -- -- Dividends received from subsidiaries 12,663 9,004 1,250 Purchase of surplus notes receivable -- (9,000) -- Additions to real estate (1) (20) (769) -------- -------- -------- Net cash (used in) provided by investing activities 632 (16) 481 -------- -------- -------- Cash flows from financing activities: Proceeds from issuance of debt to affiliate 45,500 -- -- Net proceeds from sale of common stock 1,928 1,780 2,470 Payments to acquire treasury stock (46,199) -- -- Payment of dividends (1,315) (1,219) (1,059) -------- -------- -------- Net cash provided by (used in) financing activities (86) 561 1,411 -------- -------- -------- Net increase (decrease) in cash and invested cash (570) (281) 770 -------- -------- -------- Cash and cash equivalents at beginning of year 1,220 1,501 731 -------- -------- -------- Cash and cash equivalents at end of year $650 $1,220 $1,501 ======== ======== ======== Supplemental Disclosures: - ------------------------- Federal income taxes received ($517) ($902) ($401) ======== ======== ======== Noncash investing activity: Capitalization of subsidiary -- -- $738 ======== ======== ========
82 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 subsidiaries 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 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%. Repayment of principal shall begin no later than 2001. 83
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES SCHEDULE III - SUPPLEMENTARY INSURANCE INFORMATION YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 (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, 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 $23,619 $206,910 $134,403 -- $330,709 Nonstandard insurance segment 1,180 10,540 9,678 -- 25,501 -------- -------- -------- --------- -------- Total 24,799 217,450 144,081 -- 356,210 ======== ======== ======== ========= ======== Year ended December 31, 1997 Standard insurance segment 298,626 Nonstandard insurance segment 21,424 -------- Total 320,050 ======== 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, 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 ======= ======== ======= ======== ======== Year ended December 31, 1997 Standard insurance segment 26,984 191,228 72,029 17,395 302,931 Nonstandard insurance segment 1,315 17,006 4,813 (666) 23,389 Investment management services 598 -- -- -- -- All other 62 -- -- -- -- Corporate 41 -- -- 780 -- Reclassification adjustments in consolidation 2,107 -- -- -- -- ------- -------- ------- -------- -------- Total 31,107 208,234 76,842 17,509 326,320 ======= ======== ======= ======== ========
84
STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES SCHEDULE IV - REINSURANCE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997 (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 12-31-99 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% Year ended 12-31-97 property-casualty earned premiums $366,451 $ 17,560 $342,309 $ 14,917 $298,551 $320,050 4.7% - -------------- (1) These columns include the effect of intercompany pooling. (2) Calculated as earned premiums assumed from outside companies to net amount.
EX-10.T 2 EXHIBIT 10(T) 1 Exhibit 10(T) ================================================================================ $135,000,000 CREDIT AGREEMENT among SAF FUNDING CORPORATION, as Borrower, THE LENDERS NAMED HEREIN and BANK ONE, NA, as Agent Dated as of November 19, 1999 ================================================================================ BANC ONE CAPITAL MARKETS, INC., as Lead Arranger and Sole Book Runner 2 TABLE OF CONTENTS
Section Page - ------- ---- ARTICLE I - DEFINITIONS.............................................................................................1 ARTICLE II - THE CREDITS...........................................................................................10 2.1 Commitment...............................................................................................10 2.2 Required Payments; Termination...........................................................................10 2.3 Ratable Loans............................................................................................10 2.4 Types of Advances........................................................................................10 2.5 Commitment Fee; Reductions in Aggregate Commitment; Mandatory Reductions in Aggregate Commitment; Mandatory Prepayments............................................................11 2.6 Minimum Amount of Each Advance...........................................................................11 2.7 Optional Principal Payments..............................................................................11 2.8 Method of Selecting Types and Interest Periods for New Advances..........................................11 2.9 Conversion and Continuation of Outstanding Advances......................................................12 2.10 Changes in Interest Rate, etc............................................................................12 2.11 Rates Applicable After Default...........................................................................13 2.12 Method of Payment........................................................................................13 2.13 Noteless Agreement; Evidence of Indebtedness.............................................................13 2.14 Telephonic Notices.......................................................................................14 2.15 Interest Payment Dates; Interest and Fee Basis...........................................................14 2.16 Notification of Advances, Interest Rates, Prepayments and Commitment Reductions..........................14 2.17 Lending Installations....................................................................................15 2.18 Non-Receipt of Funds by the Agent........................................................................15 2.19 Extension of Commitment Termination Date.................................................................15 ARTICLE III - YIELD PROTECTION; TAXES..............................................................................17 3.1 Yield Protection.........................................................................................17 3.2 Changes in Capital Adequacy Regulations..................................................................17 3.3 Availability of Types of Advances........................................................................18 3.4 Funding Indemnification..................................................................................18 3.5 Taxes....................................................................................................18 3.6 Lender Statements; Survival of Indemnity.................................................................20 ARTICLE IV - CONDITIONS PRECEDENT..................................................................................20 4.1 Conditions to Effectiveness..............................................................................20 4.2 Each Advance.............................................................................................22 ARTICLE V - REPRESENTATIONS AND WARRANTIES.........................................................................23 5.1 Corporate Existence......................................................................................23 5.2 Financial Condition......................................................................................23 5.3 Litigation...............................................................................................23 5.4 No Breach................................................................................................23 5.5 Action...................................................................................................24
3 5.6 Approvals................................................................................................24 5.7 Taxes....................................................................................................24 5.8 Use of Credit............................................................................................24 5.9 Special Purpose Company..................................................................................24 5.10 Capitalization...........................................................................................24 5.11 ERISA....................................................................................................24 5.12 Year 2000................................................................................................25 5.13 Investment Company.......................................................................................25 5.14 True and Complete Disclosure.............................................................................25 ARTICLE VI - COVENANTS.............................................................................................25 6.1 Financial Statements, Etc................................................................................25 6.2 Litigation...............................................................................................26 6.3 Existence, Etc...........................................................................................26 6.4 Limited Purpose Company..................................................................................27 6.5 Use of Proceeds..........................................................................................27 6.6 Modifications of Certain Documents.......................................................................27 6.7 Year 2000................................................................................................27 ARTICLE VII - DEFAULTS.............................................................................................28 ARTICLE VIII - ACCELERATION, WAIVERS, AMENDMENTS AND REMEDIES......................................................29 8.1 Acceleration.............................................................................................29 8.2 Amendments...............................................................................................29 ARTICLE IX - GENERAL PROVISIONS....................................................................................30 9.1 Survival of Representations..............................................................................30 9.2 Governmental Regulation..................................................................................30 9.3 Headings.................................................................................................31 9.4 Entire Agreement.........................................................................................31 9.5 Several Obligations; Benefits of this Agreement..........................................................31 9.6 Expenses; Indemnification................................................................................31 9.7 Numbers of Documents.....................................................................................31 9.8 Accounting...............................................................................................32 9.9 Severability of Provisions...............................................................................32 9.10 Nonliability of Lenders..................................................................................32 9.11 Confidentiality..........................................................................................32 9.12 Nonreliance..............................................................................................32 9.13 Disclosure...............................................................................................32 ARTICLE X - THE AGENT..............................................................................................33 10.1 Appointment; Nature of Relationship......................................................................33 10.2 Powers...................................................................................................33 10.3 General Immunity.........................................................................................33 10.4 No Responsibility for Loans, Recitals, etc...............................................................33 10.5 Action on Instructions of Lenders........................................................................34 10.6 Employment of Agents and Counsel.........................................................................34
Page ii 4 10.7 Reliance on Documents; Counsel...........................................................................34 10.8 Agent's Reimbursement and Indemnification................................................................34 10.9 Notice of Default........................................................................................35 10.10 Rights as a Lender.......................................................................................35 10.11 Lender Credit Decision...................................................................................35 10.12 Successor Agent..........................................................................................35 10.13 Agent's Fee..............................................................................................36 10.14 Delegation to Affiliates.................................................................................36 10.15 Execution of Pledge and Put Agreements...................................................................36 10.16 Collateral Releases......................................................................................36 10.17 Consents Under Other Loan Documents......................................................................37 ARTICLE XI - SETOFF; RATABLE PAYMENTS..............................................................................37 11.1 Setoff...................................................................................................37 11.2 Ratable Payments.........................................................................................37 ARTICLE XII - BENEFIT OF AGREEMENT; ASSIGNMENTS; PARTICIPATIONS....................................................37 12.1 Successors and Assigns...................................................................................37 12.2 Participations...........................................................................................38 12.3 Assignments..............................................................................................39 12.4 Dissemination of Information.............................................................................40 12.5 Tax Treatment............................................................................................40 ARTICLE XIII - NOTICES.............................................................................................40 13.1 Notices..................................................................................................40 13.2 Change of Address........................................................................................40 ARTICLE XIV - COUNTERPARTS.........................................................................................40 ARTICLE XV - CHOICE OF LAW; CONSENT TO JURISDICTION; WAIVER OF JURY TRIAL..........................................41 15.1 CHOICE OF LAW............................................................................................41 15.2 CONSENT TO JURISDICTION..................................................................................41 15.3 WAIVER OF JURY TRIAL.....................................................................................41 ARTICLE XVI - NO RECOURSE..........................................................................................41
Page iii 5 SCHEDULES --------- Schedule 1 Commitments EXHIBITS -------- Exhibit A Opinion Exhibit B Compliance Certificate Exhibit C Form of Assignment Exhibit D Money Transfer Instructions Exhibit E Note Page iv 6 CREDIT AGREEMENT This Agreement, dated as of November 19, 1999, is among SAF Funding Corporation, a Delaware corporation, the Lenders and Bank One, NA, a national banking association having its principal office in Chicago, Illinois, as Agent. The parties hereto agree as follows: RECITALS: --------- A. The Borrower has requested the Lenders to make financial accommodations to it in the aggregate principal amount of $135,000,000, the proceeds of which the Borrower will use to finance the purchase from State Auto Financial of the Preferred Stock under the Standby Purchase Agreement; and B. The Lenders are willing to extend such financial accommodations on the terms and conditions set forth herein. NOW, THEREFORE, in consideration of the mutual covenants and undertakings herein contained, and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Borrower, the Lenders and the Agent hereby agree as follows: ARTICLE I DEFINITIONS ----------- As used in this Agreement: "ABR Advance" means an Advance which, except as otherwise provided in Section 2.11, bears interest at the Alternate Base Rate. "Advance" means a borrowing hereunder, (a) made by the Lenders on the same Borrowing Date, or (b) converted or continued by the Lenders on the same date of conversion or continuation, consisting, in either case, of the aggregate amount of the several Loans of the same Type and, in the case of Eurodollar Loans, for the same Interest Period. "Affiliate" of any Person means any other Person directly or indirectly controlling, controlled by or under common control with such Person. A Person shall be deemed to control another Person if the controlling Person owns 10% or more of any class of voting securities (or other ownership interests) of the controlled Person or possesses, directly or indirectly, the power to direct or cause the direction of the management or policies of the controlled Person, whether through ownership of stock, by contract or otherwise. "Agent" means Bank One in its capacity as contractual representative of the Lenders pursuant to Article X, and not in its individual capacity as a Lender, and any successor Agent appointed pursuant to Article X. 7 "Aggregate Commitment" means the aggregate of the Commitments of all the Lenders, as reduced from time to time pursuant to the terms hereof. "Agreement" means this credit agreement, as it may be amended or modified and in effect from time to time. "Agreement Accounting Principles" means generally accepted accounting principles as in effect from time to time, applied in a manner consistent with that used in preparing the financial statements referred to in Section 5.2. "Alternate Base Rate" means, for any day, a rate of interest per annum equal to the higher of (a) the Corporate Base Rate for such day and (b) the sum of the Federal Funds Effective Rate for such day plus 1/2% per annum. "Applicable Margin" shall mean 1% per annum; provided, however, that if, as of the last day of any fiscal quarter of State Auto Mutual, the Statutory Surplus (as defined in the Put Agreement) of State Auto Mutual, as reflected in the most recent annual or quarterly financial statements of State Auto Mutual delivered pursuant to Section 4.1(a) or (b) of the Put Agreement (the "Financials"), is less than $575,000,000, then the Applicable Margin shall be 1.25% per annum until such time as the Lenders receive Financials from State Auto Mutual indicating that the Statutory Surplus of State Auto Mutual as reflected therein is $575,000,000 or more. Adjustments, if any, to the Applicable Margin shall be effective five Business Days after the Lenders have received the applicable Financials. "Arranger" means Banc One Capital Markets, Inc., a Delaware corporation, and its successors, in its capacity as Lead Arranger and Sole Book Runner. "Article" means an article of this Agreement unless another document is specifically referenced. "Authorized Officer" means any of the President, the Treasurer or any Vice President of the Borrower, acting singly. "Bank One" means Bank One, NA, a national banking association having its principal office in Chicago, Illinois, in its individual capacity, and its successors. "Basic Documents" shall mean, collectively, the Loan Documents, the Preferred Stock Certificates and the Standby Purchase Agreement. "Borrower" means SAF Funding Corporation, a Delaware corporation, and its successors and assigns. "Borrowing Date" means a date on which an Advance is made hereunder. "Borrowing Notice" is defined in Section 2.8. "Business Day" means (a) with respect to any borrowing, payment or rate selection of Eurodollar Advances, a day (other than a Saturday or Sunday) on which banks generally are -2- 8 open in Chicago and New York for the conduct of substantially all of their commercial lending activities, interbank wire transfers can be made on the Fedwire system and dealings in United States dollars are carried on in the London interbank market and (b) for all other purposes, a day (other than a Saturday or Sunday) on which banks generally are open in Chicago for the conduct of substantially all of their commercial lending activities and interbank wire transfers can be made on the Fedwire system. "Capital Lease Obligations" shall mean, for any Person, all obligations of such Person to pay rent or other amounts under a lease of (or other agreement conveying the right to use) Property to the extent such obligations are required to be classified and accounted for as a capital lease on a balance sheet of such Person under Agreement Accounting Principles, and, for purposes of this Agreement, the amount of such obligations shall be the capitalized amount thereof, determined in accordance with Agreement Accounting Principles. "Code" means the Internal Revenue Code of 1986, as amended, reformed or otherwise modified from time to time. "Commitment" means, for each Lender, the obligation of such Lender to make Loans not exceeding the amount set forth on Schedule 1 hereto or as set forth in any Notice of Assignment relating to any assignment that has become effective pursuant to Section 12.3.2, as such amount may be modified from time to time pursuant to the terms hereof. "Commitment Termination Date" means November 17, 2000, or any later date as may be specified as the Commitment Termination Date in accordance with Section 2.19 or any earlier date on which the Aggregate Commitment is reduced to zero or otherwise terminated pursuant to the terms hereof. "Company Pledge Agreement" shall mean a Pledge and Security Agreement of even date herewith between the Borrower and the Agent, as the same shall be modified and supplemented and in effect from time to time. "Conversion/Continuation Notice" is defined in Section 2.9. "Corporate Base Rate" means a rate per annum equal to the corporate base rate or prime rate of interest announced by Bank One or by its parent, Bank One Corporation, from time to time, changing when and as said corporate base rate or prime rate changes. "Default" means an event described in Article VII. "Dividend Payment" shall mean dividends (in cash, Property or obligations) on, or other payments or distributions on account of, or the setting apart of money for a sinking or other analogous fund for, or the purchase, redemption, retirement or other acquisition of, any shares of any class of stock of the Borrower or of any warrants, options or other rights to acquire the same (or to make any payments to any Person, such as "phantom stock" payments, where the amount thereof is calculated with reference to the fair market or equity value of the Borrower), but excluding dividends payable solely in shares of common stock of the Borrower. "Effective Date" is defined in Section 4.1. -3- 9 "Equity Rights" shall mean, with respect to any Person, any subscriptions, options, warrants, commitments, preemptive rights or agreements of any kind (including, without limitation, any stockholders' or voting trust agreements) for the issuance, sale, registration or voting of, or securities convertible into, any additional shares of capital stock of any class, or partnership or other ownership interests of any type in, such Person. "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended from time to time. "ERISA Affiliate" shall mean any corporation or trade or business that is a member of any group of organizations (a) described in Section 414(b) or (c) of the Code of which the Borrower is a member and (b) solely for purposes of potential liability under Section 302(c)(11) of ERISA and Section 412(c)(11) of the Code and the lien created under Section 302(f) of ERISA and Section 412(n) of the Code, described in Section 414(m) or (o) of the Code of which the Borrower is a member. "Eurodollar Advance" means an Advance which, except as otherwise provided in Section 2.11, bears interest at the applicable Eurodollar Rate. "Eurodollar Base Rate" means, with respect to a Eurodollar Advance for the relevant Interest Period, the applicable British Bankers' Association Interest Settlement Rate for deposits in U.S. dollars appearing on Reuters Screen FRBD as of 11:00 a.m. (London time) two Business Days prior to the first day of such Interest Period, and having a maturity equal to such Interest Period, provided that, (a) if Reuters Screen FRBD is not available to the Agent for any reason, the applicable Eurodollar Base Rate for the relevant Interest Period shall instead be the applicable British Bankers' Association Interest Settlement Rate for deposits in U.S. dollars as reported by any other generally recognized financial information service as of 11:00 a.m. (London time) two Business Days prior to the first day of such Interest Period, and having a maturity equal to such Interest Period, and (b) if no such British Bankers' Association Interest Settlement Rate is available to the Agent, the applicable Eurodollar Base Rate for the relevant Interest Period shall instead be the rate determined by the Agent to be the rate at which Bank One or one of its Affiliate banks offers to place deposits in U.S. dollars with first-class banks in the London interbank market at approximately 11:00 a.m. (London time) two Business Days prior to the first day of such Interest Period, in the approximate amount of Bank One's relevant Eurodollar Loan and having a maturity equal to such Interest Period. "Eurodollar Loan" means a Loan which, except as otherwise provided in Section 2.11, bears interest at the applicable Eurodollar Rate. "Eurodollar Rate" means, with respect to a Eurodollar Advance for the relevant Interest Period, the sum of (a) the quotient of (i) the Eurodollar Base Rate applicable to such Interest Period, divided by (ii) one minus the Reserve Requirement (expressed as a decimal) applicable to such Interest Period, plus (b) the Applicable Margin. "Excluded Taxes" means, in the case of each Lender or applicable Lending Installation and the Agent, taxes imposed on its overall net income, and franchise taxes imposed on it, by (a) the jurisdiction under the laws of which such Lender or the Agent is incorporated or -4- 10 organized or (b) the jurisdiction in which the Agent's or such Lender's principal executive office or such Lender's applicable Lending Installation is located. The Borrower has no obligation to pay Excluded Taxes. "Exhibit" refers to an exhibit to this Agreement, unless another document is specifically referenced. "Facility Termination Date" means the date which is the sixth anniversary of the Commitment Termination Date. "Federal Funds Effective Rate" means, for any day, an interest rate per annum equal to the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers on such day, as published for such day (or, if such day is not a Business Day, for the immediately preceding Business Day) by the Federal Reserve Bank of New York, or, if such rate is not so published for any day which is a Business Day, the average of the quotations at approximately 10:00 a.m. (Chicago time) on such day on such transactions received by the Agent from three Federal funds brokers of recognized standing selected by the Agent in its sole discretion. "Guarantee" shall mean a guarantee, an endorsement, a contingent agreement to purchase or to furnish funds for the payment or maintenance of, or otherwise to be or become contingently liable under or with respect to, the Indebtedness, other obligations, net worth, working capital or earnings of any Person, or a guarantee of the payment of dividends or other distributions upon the stock or equity interests of any Person, or an agreement to purchase, sell or lease (as lessee or lessor) Property, products, materials, supplies or services primarily for the purpose of enabling a debtor to make payment of such debtor's obligations or an agreement to assure a creditor against loss, and including, without limitation, causing a bank or other financial institution to issue a letter of credit or other similar instrument for the benefit of another Person, but excluding endorsements for collection or deposit in the ordinary course of business. The terms "Guarantee" and "Guaranteed" used as a verb shall have a correlative meaning. "Indebtedness" shall mean, for any Person: (a) obligations created, issued or incurred by such Person for borrowed money (whether by loan, the issuance and sale of debt securities or the sale of Property to another Person subject to an understanding or agreement, contingent or otherwise, to repurchase such Property from such Person); (b) obligations of such Person to pay the deferred purchase or acquisition price of Property or services; (c) Indebtedness of others secured by a Lien on the Property of such Person, whether or not the respective Indebtedness so secured has been assumed by such Person; (d) obligations of such Person in respect of letters of credit or similar instruments issued or accepted by banks and other financial institutions for account of such Person; (e) Capital Lease Obligations of such Person; and (f) Indebtedness of others Guaranteed by such Person. "Initial Commitment Termination Date" shall have the meaning assigned to such term in Section 2.19 hereof. "Interest Period" means, with respect to a Eurodollar Advance, a period of three months commencing on a Business Day selected by the Borrower pursuant to this Agreement. Such -5- 11 Interest Period shall end on the day which corresponds numerically to such three months thereafter, provided, however, that if there is no such numerically corresponding day in such third succeeding month, such Interest Period shall end on the last Business Day of such third succeeding month. If an Interest Period would otherwise end on a day which is not a Business Day, such Interest Period shall end on the next succeeding Business Day, provided, however, that if said next succeeding Business Day falls in a new calendar month, such Interest Period shall end on the immediately preceding Business Day. "Interest Rate Protection Agreement" shall mean, for any Person, an interest rate swap, cap or collar agreement or similar arrangement between such Person and one or more financial institutions providing for the transfer or mitigation of interest risks either generally or under specific contingencies. For purposes hereof, the "credit exposure" at any time of any Person under an Interest Rate Protection Agreement to which such Person is a party shall be determined at such time in accordance with the standard methods of calculating credit exposure under similar arrangements as prescribed from time to time by the Agent, taking into account potential interest rate movements and the respective termination provisions and notional principal amount and term of such Interest Rate Protection Agreement. "Investment" shall mean, for any Person: (a) the acquisition (whether for cash, Property, services or securities or otherwise) of capital stock, bonds, notes, debentures, partnership or other ownership interests or other securities of any other Person or any agreement to make any such acquisition (including, without limitation, any "short sale" or any sale of any securities at a time when such securities are not owned by the Person entering into such sale); (b) the making of any deposit with, or advance, loan or other extension of credit to, any other Person (including the purchase of Property from another Person subject to an understanding or agreement, contingent or otherwise, to resell such Property to such Person); (c) the entering into of any Guarantee of, or other contingent obligation with respect to, Indebtedness or other liability of any other Person and (without duplication) any amount committed to be advanced, lent or extended to such Person; or (d) the entering into of any Interest Rate Protection Agreement. "Lenders" means the lending institutions listed on the signature pages of this Agreement and their respective successors and assigns. "Lending Installation" means, with respect to a Lender or the Agent, the office, branch, subsidiary or affiliate of such Lender or the Agent listed on the signature pages hereof or on a Schedule or otherwise selected by such Lender or the Agent pursuant to Section 2.17. "Lien" shall mean, with respect to any Property, any mortgage, lien, pledge, charge, security interest or encumbrance of any kind in respect of such Property. For purposes of this Agreement and the other Loan Documents, a Person shall be deemed to own subject to a Lien any Property that it has acquired or holds subject to the interest of a vendor or lessor under any conditional sale agreement, capital lease or other title retention agreement (other than an operating lease) relating to such Property. "Loan" means, with respect to a Lender, such Lender's term loan made pursuant to Article II (or any conversion or continuation thereof). -6- 12 "Loan Documents" means this Agreement and any Notes issued pursuant to Section 2.13, the Pledge Agreements and the Put Agreement. "Material Adverse Effect" means a material adverse effect on (a) the business, Property, condition (financial or otherwise), results of operations, or prospects of the Borrower, (b) the ability of the Borrower to perform its obligations under the Loan Documents to which it is a party, or (c) the validity or enforceability of any of the Loan Documents or the rights or remedies of the Agent or the Lenders thereunder. "Multiemployer Plan" shall mean a multiemployer plan defined as such in Section 3(37) of ERISA to which contributions have been made by the Borrower and that is covered by Title IV of ERISA. "Non-U.S. Lender" is defined in Section 3.5(d). "Note" means any promissory note issued at the request of a Lender pursuant to Section 2.13 in the form of Exhibit E. "Notice of Assignment" is defined in Section 12.3.2. "Obligations" means all unpaid principal of and accrued and unpaid interest on the Loans, all accrued and unpaid fees and all expenses, reimbursements, indemnities and other obligations of the Borrower to the Lenders or to any Lender, the Agent or any indemnified party arising under the Loan Documents. "Other Taxes" is defined in Section 3.5(b). "Parent" shall mean Broad Street Contract Services, Inc., a Delaware corporation. "Parent Pledge Agreement" shall mean a Pledge Agreement of even date herewith between the Parent and the Agent, as the same shall be modified and supplemented and in effect from time to time. "Participants" is defined in Section 12.2.1. "Payment Date" means the last Business Day of each March, June, September and December. "Permitted Investments" shall mean: (a) direct obligations of the United States of America, or of any agency thereof, or obligations guaranteed as to principal and interest by the United States of America, or of any agency thereof, in either case maturing not more than 90 days from the date of acquisition thereof; (b) certificates of deposit issued by any bank or trust company organized under the laws of the United States of America or any state thereof and having capital, surplus and undivided profits of at least $500,000,000, maturing not more than 90 days from the date of acquisition thereof; and (c) commercial paper rated A-1 or better or P-1 by Standard & Poor's Ratings Services, a division of The McGraw-Hill Companies, Inc., or Moody's Investors Services, Inc., respectively, maturing not more than 90 days from the date of acquisition thereof; in each case so long as the same (i) provide for the payment of principal and -7- 13 interest (and not principal alone or interest alone) and (ii) are not subject to any contingency regarding the payment of principal or interest. "Person" means any natural person, corporation, firm, joint venture, partnership, limited liability company, association, enterprise, trust or other entity or organization, or any government or political subdivision or any agency, department or instrumentality thereof. "Plan" shall mean an employee benefit or other plan established or maintained by the Borrower and that is covered by Title IV of ERISA, other than a Multiemployer Plan. "Pledge Agreements" shall mean the Company Pledge Agreement and the Parent Pledge Agreement. "Preferred Stock" shall mean the Class A Preferred Stock issued from time to time by State Auto Financial to the Borrower under the Standby Purchase Agreement. "Preferred Stock Certificates" shall mean the certificates evidencing the Preferred Stock. "Principal Payment Dates" shall mean, with respect to any Loan, each of the 2nd, 4th, 6th, 8th, 10th, 12th, 14th, 16th, 18th, 20th, 22nd and 24th Payment Dates immediately following the making of such Loan. "Property" shall mean any right or interest in or to property of any kind whatsoever, whether real, personal or mixed and whether tangible or intangible. "Purchasers" is defined in Section 12.3.1. "Put Agreement" shall mean a Put Agreement of even date herewith between the State Auto Obligors and the Agent, as the same shall be modified and supplemented and in effect from time to time. "Redemption Value" shall mean, with respect to any Preferred Stock, the "Redemption Value" for such Preferred Stock set forth in the Preferred Stock Certificates evidencing such Preferred Stock. "Regulation D" means Regulation D of the Board of Governors of the Federal Reserve System as from time to time in effect and any successor thereto or other regulation or official interpretation of said Board of Governors relating to reserve requirements applicable to member banks of the Federal Reserve System. "Regulation U" means Regulation U of the Board of Governors of the Federal Reserve System as from time to time in effect and any successor or other regulation or official interpretation of said Board of Governors relating to the extension of credit by banks for the purpose of purchasing or carrying margin stocks applicable to member banks of the Federal Reserve System. -8- 14 "Regulations A, D, U and X" shall mean, respectively, Regulations A, D, U and X of the Board of Governors of the Federal Reserve System (or any successor), as the same may be modified and supplemented and in effect from time to time. "Required Lenders" means Lenders in the aggregate having at least 51% of the Aggregate Commitment or, if the Aggregate Commitment has been terminated, Lenders in the aggregate holding at least 51% of the aggregate unpaid principal amount of the outstanding Advances. "Reserve Requirement" means, with respect to an Interest Period, the maximum aggregate reserve requirement (including all basic, supplemental, marginal and other reserves) which is imposed under Regulation D on Eurocurrency liabilities. "Schedule" refers to a specific schedule to this Agreement, unless another document is specifically referenced. "Section" means a numbered section of this Agreement, unless another document is specifically referenced. "Standby Purchase Agreement" shall mean the Standby Purchase Agreement of even date herewith between State Auto Financial and the Borrower, as the same shall be modified and supplemented and in effect from time to time. "State Auto Financial" shall mean State Auto Financial Corporation, an Ohio corporation. "State Auto Mutual" shall mean State Automobile Mutual Insurance Company, an Ohio mutual insurance company. "State Auto Obligors" shall mean State Auto Mutual and State Auto Financial. "State Auto P&C" shall mean State Auto Property and Casualty Insurance Company, a South Carolina corporation. "Subsidiary" of a Person means (i) any corporation more than 50% of the outstanding securities having ordinary voting power of which shall at the time be owned or controlled, directly or indirectly, by such Person or by one or more of its Subsidiaries or by such Person and one or more of its Subsidiaries, or (ii) any partnership, limited liability company, association, joint venture or similar business organization more than 50% of the ownership interests having ordinary voting power of which shall at the time be so owned or controlled. "Taxes" means any and all present or future taxes, duties, levies, imposts, deductions, charges or withholdings, and any and all liabilities with respect to the foregoing, but excluding Excluded Taxes and Other Taxes. "Transferee" is defined in Section 12.4. "Type" means, with respect to any Advance, its nature as an ABR Advance or a Eurodollar Advance. -9- 15 "Unmatured Default" means an event which but for the lapse of time or the giving of notice, or both, would constitute a Default. "Wholly-Owned Subsidiary" of a Person means (a) any Subsidiary all of the outstanding voting securities of which shall at the time be owned or controlled, directly or indirectly, by such Person or one or more Wholly-Owned Subsidiaries of such Person, or by such Person and one or more Wholly-Owned Subsidiaries of such Person, or (b) any partnership, limited liability company, association, joint venture or similar business organization 100% of the ownership interests having ordinary voting power of which shall at the time be so owned or controlled. "Year 2000 Issues" means anticipated costs, problems and uncertainties associated with the inability of certain computer applications to effectively handle data including dates on and after January 1, 2000, as such inability affects the business, operations and financial condition of the Borrower and its Subsidiaries and of the Borrower's and its Subsidiaries' material customers, suppliers and vendors. "Year 2000 Program" is defined in Section 5.12. The foregoing definitions shall be equally applicable to both the singular and plural forms of the defined terms. ARTICLE II THE CREDITS ----------- 2.1 Commitment. From and including the date of this Agreement and prior to the Commitment Termination Date, each Lender severally agrees, on the terms and conditions set forth in this Agreement, to make Loans to the Borrower from time to time in amounts not to exceed in the aggregate at any one time outstanding the amount of its Commitment. Loans paid or prepaid may not be reborrowed. The Commitments to lend hereunder shall expire on the Commitment Termination Date. 2.2 Required Payments; Termination. The Borrower hereby promises to pay to the Agent for account of each Lender the principal of each Loan made by such Lender in twelve installments payable on the Principal Payment Dates for such Loan. The first eleven of such installments shall be equal to one-twelfth of the principal amount of such Loan and the twelfth such installment shall be equal to the balance thereof. Any outstanding Advances and all other unpaid Obligations shall be paid in full by the Borrower on the Facility Termination Date. 2.3 Ratable Loans. Each Advance hereunder shall consist of Loans made from the several Lenders ratably in proportion to the ratio that their respective Commitments bear to the Aggregate Commitment. 2.4 Types of Advances. The Advances may be ABR Advances or Eurodollar Advances, or a combination thereof, selected by the Borrower in accordance with Sections 2.8 and 2.9. -10- 16 2.5 Commitment Fee; Reductions in Aggregate Commitment; Mandatory Reductions in Aggregate Commitment; Mandatory Prepayments. (a) The Borrower agrees to pay to the Agent for the account of each Lender a commitment fee of 0.20% per annum on the daily unused portion of such Lender's Commitment from the date hereof to and including the Commitment Termination Date, payable on each Payment Date hereafter and on the Commitment Termination Date. (b) The Borrower may permanently reduce the Aggregate Commitment in whole, or in part ratably among the Lenders in the minimum amount of $10,000,000 and in multiples of $5,000,000 in excess thereof, upon at least three Business Days' written notice to the Agent, which notice shall specify the amount of any such reduction, provided, however, that the amount of the Aggregate Commitment may not be reduced below the aggregate principal amount of the outstanding Advances. All accrued commitment fees shall be payable on the effective date of any termination of the obligations of the Lenders to make Loans hereunder. (c) If (i) the Borrower shall sell, assign, transfer or otherwise dispose of all or any portion of the Preferred Stock, (ii) the Agent shall sell the Preferred Stock to State Auto Mutual pursuant to the Put Agreement or (iii) the Preferred Stock shall at any time be repurchased, redeemed or otherwise retired by State Auto Financial (whether pursuant to the terms of such Preferred Stock or otherwise), the Borrower will prepay Loans in a principal amount equal to the aggregate Redemption Value of the Preferred Stock so sold, assigned, transferred or otherwise disposed of. In addition, if the aggregate outstanding principal amount of the Loans shall at any time exceed either (x) the Aggregate Commitment or (y) the aggregate Redemption Value of the Preferred Stock issued and outstanding at such time, the Borrower will prepay the Loans in an amount equal to such excess. Prepayments of the Loans shall be applied to the installments of the Loans in the inverse order or the maturities of the installments thereof. 2.6 Minimum Amount of Each Advance. Each Eurodollar Advance shall be in the minimum amount of $10,000,000 (and in multiples of $5,000,000 if in excess thereof), and each ABR Advance shall be in the minimum amount of $10,000,000 (and in multiples of $5,000,000 if in excess thereof), provided, however, that any ABR Advance may be in the amount of the unused Aggregate Commitment. 2.7 Optional Principal Payments. The Borrower may from time to time pay, without penalty or premium, all outstanding ABR Advances, or, in a minimum aggregate amount of $10,000,000 or any integral multiple of $5,000,000 in excess thereof, any portion of the outstanding ABR Advances upon two Business Days' prior notice to the Agent. The Borrower may from time to time pay, subject to the payment of any funding indemnification amounts required by Section 3.4 but without penalty or premium, all outstanding Eurodollar Advances, or, in a minimum aggregate amount of $10,000,000 or any integral multiple of $5,000,000 in excess thereof, any portion of the outstanding Eurodollar Advances upon three Business Days' prior notice to the Agent. Principal payments shall be applied to the principal installments payable under Section 2.2 in the inverse order of maturity. 2.8 Method of Selecting Types and Interest Periods for New Advances. The Borrower shall select the Type of Advance. The Borrower shall give the Agent irrevocable notice (a "Borrowing Notice") not later than 10:00 a.m. (Chicago time) at least one Business Day -11- 17 before the Borrowing Date of each ABR Advance and three Business Days before the Borrowing Date for each Eurodollar Advance, specifying: (a) the Borrowing Date, which shall be a Business Day, of such Advance, (b) the aggregate amount of such Advance, and (c) the Type of Advance selected. Not later than noon (Chicago time) on each Borrowing Date, each Lender shall make available its Loan or Loans in funds immediately available in Chicago to the Agent at its address specified pursuant to Article XIII. The Agent will make the funds so received from the Lenders available to the Borrower at the Agent's aforesaid address. 2.9 Conversion and Continuation of Outstanding Advances. ABR Advances shall continue as ABR Advances unless and until such ABR Advances are converted into Eurodollar Advances pursuant to this Section 2.9 or are repaid in accordance with Section 2.7. Each Eurodollar Advance shall continue as a Eurodollar Advance until the end of the then applicable Interest Period therefor, at which time such Eurodollar Advance shall be automatically converted into an ABR Advance unless (i) such Eurodollar Advance is or was repaid in accordance with Section 2.7 or (ii) the Borrower shall have given the Agent a Conversion/Continuation Notice (as defined below) requesting that, at the end of such Interest Period, such Eurodollar Advance continue as a Eurodollar Advance for another Interest Period. Subject to the terms of Section 2.6, the Borrower may elect from time to time to convert all or any part of an ABR Advance into a Eurodollar Advance. The Borrower shall give the Agent irrevocable notice (a "Conversion/Continuation Notice") of each conversion of an ABR Advance into a Eurodollar Advance or continuation of a Eurodollar Advance not later than 10:00 a.m. (Chicago time) at least three Business Days prior to the date of the requested conversion or continuation, specifying: (a) the requested date, which shall be a Business Day, of such conversion or continuation, (b) the aggregate amount and Type of the Advance which is to be converted or continued, and (c) the amount of such Advance which is to be converted into or continued as a Eurodollar Advance. 2.10 Changes in Interest Rate, etc. Each ABR Advance shall bear interest on the outstanding principal amount thereof, for each day from and including the date such Advance is made or is automatically converted from a Eurodollar Advance into an ABR Advance pursuant to Section 2.9, to but excluding the date it is paid or is converted into a Eurodollar Advance pursuant to Section 2.9 hereof, at a rate per annum equal to the Alternate Base Rate for such day. Changes in the rate of interest on that portion of any Advance maintained as an ABR Advance will take effect simultaneously with each change in the Alternate Base Rate. Each Eurodollar Advance shall bear interest on the outstanding principal amount thereof from and including the first day of the Interest Period applicable thereto to (but not including) the last day of such -12- 18 Interest Period at the interest rate determined by the Agent as applicable to such Eurodollar Advance based upon the Borrower's selections under Sections 2.8 and 2.9 and otherwise in accordance with the terms hereof. No Interest Period may end after the Facility Termination Date. The Borrower shall select Interest Periods so that it is not necessary to repay any portion of a Eurodollar Advance prior to the last day of the applicable Interest Period in order to make a mandatory repayment required pursuant to Section 2.2. 2.11 Rates Applicable After Default. Notwithstanding anything to the contrary contained in Section 2.8 or 2.9, during the continuance of a Default or Unmatured Default the Required Lenders may, at their option, by notice to the Borrower (which notice may be revoked at the option of the Required Lenders notwithstanding any provision of Section 8.2 requiring unanimous consent of the Lenders to changes in interest rates), declare that no Advance may be made as, converted into or continued as a Eurodollar Advance. During the continuance of a Default the Required Lenders may, at their option, by notice to the Borrower (which notice may be revoked at the option of the Required Lenders notwithstanding any provision of Section 8.2 requiring unanimous consent of the Lenders to changes in interest rates), declare that (a) each Eurodollar Advance shall bear interest for the remainder of the applicable Interest Period at the rate otherwise applicable to such Interest Period plus 2% per annum and (b) each ABR Advance shall bear interest at a rate per annum equal to the Alternate Base Rate in effect from time to time plus 2% per annum, provided that, during the continuance of a Default under Section 7.4, 7.5 or 7.6, the interest rates set forth in clauses (a) and (b) above shall be applicable to all Advances without any election or action on the part of the Agent or any Lender. 2.12 Method of Payment. All payments of the Obligations hereunder shall be made, without setoff, deduction, or counterclaim, in immediately available funds to the Agent at the Agent's address specified pursuant to Article XIII, or at any other Lending Installation of the Agent specified in writing by the Agent to the Borrower, by noon (Chicago time) on the date when due and shall be applied ratably by the Agent among the Lenders. Each payment delivered to the Agent for the account of any Lender shall be delivered promptly by the Agent to such Lender in the same type of funds that the Agent received at its address specified pursuant to Article XIII or at any Lending Installation specified in a notice received by the Agent from such Lender. The Agent is hereby authorized to charge the account of the Borrower maintained with Bank One for each payment of principal, interest and fees as it becomes due hereunder. 2.13 Noteless Agreement; Evidence of Indebtedness. (a) Each Lender shall maintain in accordance with its usual practice an account or accounts evidencing the indebtedness of the Borrower to such Lender resulting from each Loan made by such Lender from time to time, including the amounts of principal and interest payable and paid to such Lender from time to time hereunder. (b) The Agent shall also maintain accounts in which it will record (i) the amount of each Loan made hereunder and the Type thereof, (ii) the amount of any principal or interest due and payable or to become due and payable from the Borrower to each Lender hereunder and (iii) the amount of any sum received by the Agent hereunder from the Borrower and each Lender's share thereof. -13- 19 (c) The entries maintained in the accounts maintained pursuant to paragraphs (a) and (b) above shall be prima facie evidence of the existence and amounts of the Obligations therein recorded; provided, however, that the failure of the Agent or any Lender to maintain such accounts or any error therein shall not in any manner affect the obligation of the Borrower to repay the Obligations in accordance with their terms. (d) Any Lender may request that its Loans be evidenced by a promissory note (a "Note"). In such event, the Borrower shall prepare, execute and deliver to such Lender a Note payable to the order of such Lender in a form supplied by the Agent. Thereafter, the Loans evidenced by such Note and interest thereon shall at all times (including after any assignment pursuant to Section 12.3) be represented by one or more Notes payable to the order of the payee named therein or any assignee pursuant to Section 12.3, except to the extent that any such Lender or assignee subsequently returns any such Note for cancellation and requests that such Loans once again be evidenced as described in paragraphs (a) and (b) above. 2.14 Telephonic Notices. The Borrower hereby authorizes the Lenders and the Agent to extend, convert or continue Advances, effect selections of Types of Advances and to transfer funds based on telephonic notices made by any person or persons the Agent or any Lender in good faith believes to be acting on behalf of the Borrower, it being understood that the foregoing authorization is specifically intended to allow Borrowing Notices and Conversion/Continuation Notices to be given telephonically. The Borrower agrees to deliver promptly to the Agent a written confirmation, if such confirmation is requested by the Agent or any Lender, of each telephonic notice signed by an Authorized Officer. If the written confirmation differs in any material respect from the action taken by the Agent and the Lenders, the records of the Agent and the Lenders shall govern absent manifest error. 2.15 Interest Payment Dates; Interest and Fee Basis. Interest accrued on each ABR Advance shall be payable on each Payment Date, commencing with the first such Payment Date to occur after the date hereof, on any date on which the ABR Advance is prepaid, whether due to acceleration or otherwise, and at maturity. Interest accrued on that portion of the outstanding principal amount of any ABR Advance converted into a Eurodollar Advance on a day other than a Payment Date shall be payable on the date of conversion. Interest accrued on each Eurodollar Advance shall be payable on the last day of its applicable Interest Period, on any date on which the Eurodollar Advance is prepaid, whether by acceleration or otherwise, and at maturity. Interest on Eurodollar Loans and commitment fees shall be calculated for actual days elapsed on the basis of a 360-day year. Interest on Base Rate Loans shall be calculated for actual days elapsed on the basis of a year of 365 or 366 days, as the case may be. Interest shall be payable for the day an Advance is made but not for the day of any payment on the amount paid if payment is received prior to noon (Chicago time) at the place of payment. If any payment of principal of or interest on an Advance shall become due on a day which is not a Business Day, such payment shall be made on the next succeeding Business Day and, in the case of a principal payment, such extension of time shall be included in computing interest in connection with such payment. 2.16 Notification of Advances, Interest Rates, Prepayments and Commitment Reductions. Promptly after receipt thereof, the Agent will notify each Lender of the contents of each Aggregate Commitment reduction notice, Borrowing Notice, Conversion/Continuation -14- 20 Notice, and repayment notice received by it hereunder. The Agent will notify each Lender of the interest rate applicable to each Eurodollar Advance promptly upon determination of such interest rate and will give each Lender prompt notice of each change in the Alternate Base Rate. 2.17 Lending Installations. Each Lender may book its Loans at any Lending Installation selected by such Lender and may change its Lending Installation from time to time. All terms of this Agreement shall apply to any such Lending Installation and the Loans and any Notes issued hereunder shall be deemed held by each Lender for the benefit of any such Lending Installation. Each Lender may, by written notice to the Agent and the Borrower in accordance with Article XIII, designate replacement or additional Lending Installations through which Loans will be made by it and for whose account Loan payments are to be made. 2.18 Non-Receipt of Funds by the Agent. Unless the Borrower or a Lender, as the case may be, notifies the Agent prior to the date on which it is scheduled to make payment to the Agent of (a) in the case of a Lender, the proceeds of a Loan or (b) in the case of the Borrower, a payment of principal, interest or fees to the Agent for the account of the Lenders, that it does not intend to make such payment, the Agent may assume that such payment has been made. The Agent may, but shall not be obligated to, make the amount of such payment available to the intended recipient in reliance upon such assumption. If such Lender or the Borrower, as the case may be, has not in fact made such payment to the Agent, the recipient of such payment shall, on demand by the Agent, repay to the Agent the amount so made available together with interest thereon in respect of each day during the period commencing on the date such amount was so made available by the Agent until the date the Agent recovers such amount at a rate per annum equal to (i) in the case of payment by a Lender, the Federal Funds Effective Rate for such day for the first three days and, thereafter, the interest rate applicable to the relevant Loan or (ii) in the case of payment by the Borrower, the interest rate applicable to the relevant Loan. 2.19 Extension of Commitment Termination Date. (a) The Borrower may, by notice to the Agent (which shall promptly notify the Lenders) given not less than 60 days and not more the 90 days prior to the initial Commitment Termination Date (the "Initial Commitment Termination Date"), request that the Lenders extend the Commitment Termination Date for an additional 364 days from the Initial Commitment Termination Date; provided that in no event may the Borrower request more than one such extension. Each Lender, acting in its sole discretion, shall, by notice (which shall be irrevocable) to the Borrower and the Agent given no earlier than the date that is 30 days prior to the Initial Commitment Termination Date (herein, the "Consent Date") and no later than the date that is three Business Days after the Consent Date, advise the Borrower whether or not such Lender agrees to such extension; provided that each Lender that determines not to extend the Commitment Termination Date ("Non-Extending Lender") shall notify the Agent (which shall notify the Lenders) of such fact promptly after such determination (but in any event no later than the date three Business Days after the Consent Date) and any Lender that does not advise the Borrower on or prior to the date three Business Days after the Consent Date that such Lender agrees to such extension shall be deemed to be a Non-Extending Lender. The election of any Lender to agree to such extension shall not obligate any other Lender to so agree. (b) The Borrower may, at any time prior to the Initial Commitment Termination Date, replace any Non-Extending Lender, by giving not less than ten Business Days' -15- 21 prior notice to the Agent (which shall promptly notify such Non-Extending Lender), that it intends to replace such Non-Extending Lender with respect to its rights and obligations (including, without limitation, its Commitments) as a "Lender" under this Agreement (collectively, the "Transferred Interest") with one or more banks or other financial institutions (including, but not limited to, any other Lender or an affiliate of any Lender) selected by the Borrower and acceptable to the Agent (each, a "Replacement Lender"). Upon the Initial Commitment Termination Date (and as a condition to the extension thereof), (i) the Borrower shall pay or cause to be paid to such Non-Extending Lender being replaced an amount equal to all fees and other amounts then owing to such Non-Extending Lender hereunder and under any other Basic Document in respect of the Transferred Interest (all or a portion of which amount may constitute consideration for an assignment by such Non-Extending Lender of all or a portion of the Transferred Interest) and (ii) such Non-Extending Lender shall assign to each Replacement Lender, pursuant to an Assignment Agreement substantially in the form of Exhibit C hereto, a portion of the Transferred Interest specified by the Borrower, whereupon (x) each Replacement Lender shall become a "Lender" for all purposes of this Agreement having the Commitments in the amount of such Non-Extending Lender's Commitments assumed by it and all of the rights and obligations under this Agreement of "Lender(s)" holding the Transferred Interest and (y) such Non-Extending Lender shall cease to be responsible or liable for, and shall cease to be entitled to the rights and benefits of, all or any portion of the Transferred Interest. (c) If (and only if) the sum of the aggregate amount of the Commitments of Lenders having agreed so to extend the Initial Commitment Termination Date on or prior to the Initial Commitment Termination Date plus the aggregate amount of the Commitments of the Replacement Lenders shall equal or exceed 50% of the aggregate amount of the Commitments in effect immediately prior to the Initial Commitment Termination Date, then, effective as of the Initial Commitment Termination Date, the Initial Commitment Termination Date shall be extended to the date falling 364 days after the Initial Commitment Termination Date (except that, if such date is not a Business Day, such Commitment Termination Date as so extended shall be the next preceding Business Day); provided that the Commitment of each Non-Extending Lender shall terminate on the Initial Commitment Termination Date. (d) Notwithstanding the foregoing clauses (a) through (c), the extension of the Initial Commitment Termination Date shall not be effective with respect to any Lender unless: (i) no Unmatured Default or Default shall have occurred and be continuing on each of the date of the notice requesting such extension (the "Request Date"), the Consent Date and the Initial Commitment Termination Date; (ii) each of the representations and warranties made by the Borrower in Article V hereof shall be true and complete on and as of each of the Request Date, the Consent Date and the Initial Commitment Termination Date with the same force and effect as if made on and as of such date (or, if any such representation or warranty is expressly stated to have been made as of a specific date, as of such specific date); (iii) no Loans shall be outstanding on each of the Request Date, the Consent Date and the Initial Commitment Termination Date; and -16- 22 (iv) on each of the Request Date and the Initial Commitment Termination Date, the Agent shall have received the respective certificate required to be delivered by State Auto Mutual on such date pursuant to Section 4.20 of the Put Agreement. ARTICLE III YIELD PROTECTION; TAXES ----------------------- 3.1 Yield Protection. If, on or after the date of this Agreement, the adoption of any law or any governmental or quasi-governmental rule, regulation, policy, guideline or directive (whether or not having the force of law), or any change in the interpretation or administration thereof by any governmental or quasi-governmental authority, central bank or comparable agency charged with the interpretation or administration thereof, or compliance by any Lender or applicable Lending Installation with any request or directive (whether or not having the force of law) of any such authority, central bank or comparable agency: (a) subjects any Lender or any applicable Lending Installation to any Taxes, or changes the basis of taxation of payments (other than with respect to Excluded Taxes) to any Lender in respect of its Eurodollar Loans, or (b) imposes or increases or deems applicable any reserve, assessment, insurance charge, special deposit or similar requirement against assets of, deposits with or for the account of, or credit extended by, any Lender or any applicable Lending Installation (other than reserves and assessments taken into account in determining the interest rate applicable to Eurodollar Advances), or (c) imposes any other condition the result of which is to increase the cost to any Lender or any applicable Lending Installation of making, funding or maintaining its Eurodollar Loans or reduces any amount receivable by any Lender or any applicable Lending Installation in connection with its Eurodollar Loans, or requires any Lender or any applicable Lending Installation to make any payment calculated by reference to the amount of Eurodollar Loans held or interest received by it, by an amount deemed material by such Lender, and the result of any of the foregoing is to increase the cost to such Lender or applicable Lending Installation of making or maintaining its Eurodollar Loans or Commitment or to reduce the return received by such Lender or applicable Lending Installation in connection with such Eurodollar Loans or Commitment, then, within 15 days of demand by such Lender, the Borrower shall pay such Lender such additional amount or amounts as will compensate such Lender for such increased cost or reduction in amount received. 3.2 Changes in Capital Adequacy Regulations. If a Lender determines the amount of capital required or expected to be maintained by such Lender, any Lending Installation of such Lender or any corporation controlling such Lender is increased as a result of a Change, then, within 15 days of demand by such Lender, the Borrower shall pay such Lender the amount necessary to compensate for any shortfall in the rate of return on the portion of such increased -17- 23 capital which such Lender determines is attributable to this Agreement, its Loans or its Commitment to make Loans hereunder (after taking into account such Lender's policies as to capital adequacy). "Change" means (a) any change after the date of this Agreement in the Risk-Based Capital Guidelines or (b) any adoption of or change in any other law, governmental or quasi-governmental rule, regulation, policy, guideline, interpretation, or directive (whether or not having the force of law) after the date of this Agreement which affects the amount of capital required or expected to be maintained by any Lender or any Lending Installation or any corporation controlling any Lender. "Risk-Based Capital Guidelines" means (i) the risk-based capital guidelines in effect in the United States on the date of this Agreement, including transition rules, and (ii) the corresponding capital regulations promulgated by regulatory authorities outside the United States implementing the July 1988 report of the Basle Committee on Banking Regulation and Supervisory Practices Entitled "International Convergence of Capital Measurements and Capital Standards," including transition rules, and any amendments to such regulations adopted prior to the date of this Agreement. 3.3 Availability of Types of Advances. If any Lender determines that maintenance of its Eurodollar Loans at a suitable Lending Installation would violate any applicable law, rule, regulation, or directive, whether or not having the force of law, or if the Required Lenders determine that (a) deposits of a type and maturity appropriate to match fund Eurodollar Advances are not available or (b) the interest rate applicable to Eurodollar Advances does not accurately reflect the cost of making or maintaining Eurodollar Advances, then the Agent shall suspend the availability of Eurodollar Advances and require any affected Eurodollar Advances to be repaid or converted to ABR Advances, subject to the payment of any funding indemnification amounts required by Section 3.4. 3.4 Funding Indemnification. If any payment of a Eurodollar Advance occurs on a date which is not the last day of the applicable Interest Period, whether because of acceleration, prepayment or otherwise, or a Eurodollar Advance is not made on the date specified by the Borrower for any reason other than default by the Lenders, the Borrower will indemnify each Lender for any loss or cost incurred by it resulting therefrom, including, without limitation, any loss or cost in liquidating or employing deposits acquired to fund or maintain such Eurodollar Advance. 3.5 Taxes. (a) All payments by the Borrower to or for the account of any Lender or the Agent hereunder or under any Note shall be made free and clear of and without deduction for any and all Taxes. If the Borrower shall be required by law to deduct any Taxes from or in respect of any sum payable hereunder to any Lender or the Agent, (i) the sum payable shall be increased as necessary so that after making all required deductions (including deductions applicable to additional sums payable under this Section 3.5) such Lender or the Agent (as the case may be) receives an amount equal to the sum it would have received had no such deductions been made, (ii) the Borrower shall make such deductions, (iii) the Borrower shall pay the full amount deducted to the relevant authority in accordance with applicable law and (iv) the Borrower shall furnish to the Agent the original copy of a receipt evidencing payment thereof within 30 days after such payment is made. (b) In addition, the Borrower hereby agrees to pay any present or future stamp or documentary taxes and any other excise or property taxes, charges or similar levies which -18- 24 arise from any payment made hereunder or under any Note or from the execution or delivery of, or otherwise with respect to, this Agreement or any Note ("Other Taxes"). (c) The Borrower hereby agrees to indemnify the Agent and each Lender for the full amount of Taxes or Other Taxes (including, without limitation, any Taxes or Other Taxes imposed on amounts payable under this Section 3.5) paid by the Agent or such Lender and any liability (including penalties, interest and expenses) arising therefrom or with respect thereto. Payments due under this indemnification shall be made within 30 days of the date the Agent or such Lender makes demand therefor pursuant to Section 3.6. (d) Each Lender that is not incorporated under the laws of the United States of America or a state thereof (each a "Non-U.S. Lender") agrees that it will, not less than ten Business Days after the date of this Agreement (or, in the case of a Lender which becomes a party hereto after the date hereof, on or prior to the date such Lender becomes a party hereto), (i) deliver to each of the Borrower and the Agent two duly completed copies of United States Internal Revenue Service Form 1001 or 4224, certifying in either case that such Lender is entitled to receive payments under this Agreement without deduction or withholding of any United States federal income taxes, and (ii) deliver to each of the Borrower and the Agent a United States Internal Revenue Form W-8 or W-9, as the case may be, and certify that it is entitled to an exemption from United States backup withholding tax. Each Non-U.S. Lender further undertakes to deliver to each of the Borrower and the Agent (x) renewals or additional copies of such form (or any successor form) on or before the date that such form expires or becomes obsolete, and (y) after the occurrence of any event requiring a change in the most recent forms so delivered by it, such additional forms or amendments thereto as may be reasonably requested by the Borrower or the Agent. All forms or amendments described in the preceding sentence shall certify that such Lender is entitled to receive payments under this Agreement without deduction or withholding of any United States federal income taxes, unless an event (including without limitation any change in treaty, law or regulation) has occurred prior to the date on which any such delivery would otherwise be required which renders all such forms inapplicable or which would prevent such Lender from duly completing and delivering any such form or amendment with respect to it and such Lender advises the Borrower and the Agent that it is not capable of receiving payments without any deduction or withholding of United States federal income tax. (e) For any period during which a Non-U.S. Lender has failed to provide the Borrower with an appropriate form pursuant to clause (d) above (unless such failure is due to a change in treaty, law or regulation, or any change in the interpretation or administration thereof by any governmental authority, occurring subsequent to the date on which a form originally was required to be provided), such Non-U.S. Lender shall not be entitled to indemnification under this Section 3.5 with respect to Taxes imposed by the United States; provided that, should a Non-U.S. Lender which is otherwise exempt from or subject to a reduced rate of withholding tax become subject to Taxes because of its failure to deliver a form required under clause (d), above, the Borrower shall take such steps as such Non-U.S. Lender shall reasonably request to assist such Non-U.S. Lender to recover such Taxes. (f) Any Lender that is entitled to an exemption from or reduction of withholding tax with respect to payments under this Agreement or any Note pursuant to the law -19- 25 of any relevant jurisdiction or any treaty shall deliver to the Borrower (with a copy to the Agent), at the time or times prescribed by applicable law, such properly completed and executed documentation prescribed by applicable law as will permit such payments to be made without withholding or at a reduced rate. (g) If the U.S. Internal Revenue Service or any other governmental authority of the United States or any other country or any political subdivision thereof asserts a claim that the Agent did not properly withhold tax from amounts paid to or for the account of any Lender (because the appropriate form was not delivered or properly completed, because such Lender failed to notify the Agent of a change in circumstances which rendered its exemption from withholding ineffective, or for any other reason), such Lender shall indemnify the Agent fully for all amounts paid, directly or indirectly, by the Agent as tax, withholding therefor, or otherwise, including penalties and interest, and including taxes imposed by any jurisdiction on amounts payable to the Agent under this subsection, together with all costs and expenses related thereto (including attorneys fees and time charges of attorneys for the Agent, which attorneys may be employees of the Agent). The obligations of the Lenders under this Section 3.5(g) shall survive the payment of the Obligations and termination of this Agreement. 3.6 Lender Statements; Survival of Indemnity. To the extent reasonably possible, each Lender shall designate an alternate Lending Installation with respect to its Eurodollar Loans to reduce any liability of the Borrower to such Lender under Sections 3.1, 3.2 and 3.5 or to avoid the unavailability of Eurodollar Advances under Section 3.3, so long as such designation is not, in the judgment of such Lender, disadvantageous to such Lender. Each Lender shall deliver a written statement of such Lender to the Borrower (with a copy to the Agent) as to the amount due, if any, under Section 3.1, 3.2, 3.4 or 3.5. Such written statement shall set forth in reasonable detail the calculations upon which such Lender determined such amount and shall be final, conclusive and binding on the Borrower in the absence of manifest error. Determination of amounts payable under such Sections in connection with a Eurodollar Loan shall be calculated as though each Lender funded its Eurodollar Loan through the purchase of a deposit of the type and maturity corresponding to the deposit used as a reference in determining the Eurodollar Rate applicable to such Loan, whether in fact that is the case or not. Unless otherwise provided herein, the amount specified in the written statement of any Lender shall be payable on demand after receipt by the Borrower of such written statement. The obligations of the Borrower under Sections 3.1, 3.2, 3.4 and 3.5 shall survive payment of the Obligations and termination of this Agreement. ARTICLE IV CONDITIONS PRECEDENT -------------------- 4.1 Conditions to Effectiveness. This Agreement shall become effective on the date (the "Effective Date") on which the Agent receives (with sufficient copies for the Lenders) each of the following documents: (a) This Agreement. This Agreement, duly executed and delivered by the Borrower, each Lender and the Agent. -20- 26 (b) Pledge Agreements. The Company Pledge Agreement, duly executed and delivered by the Borrower and the Agent, and the Parent Pledge Agreement, duly executed and delivered by the Parent and the Agent and the certificates identified in Annex 1 thereto, accompanied by undated stock powers executed in blank. In addition, the Borrower and the Parent shall have taken such other action (including, without limitation, delivering to the Agent, for filing, Uniform Commercial Code financing statements) as the Agent shall have requested in order to perfect the security interests created pursuant to the Pledge Agreements. (c) Put Agreement. The Put Agreement, duly executed and delivered by the State Auto Obligors and the Agent. (d) Standby Purchase Agreement. The Standby Purchase Agreement, duly executed and delivered by the State Auto Obligors and the Borrower. (e) Articles of Incorporation; Good Standing Certificates. Copies of the articles or certificate of incorporation of the Borrower and the Parent (each, an "Obligor"), together with all amendments, and a certificate of good standing, each certified by the appropriate governmental officer in its jurisdiction of incorporation. (f) By-Laws; Resolutions. Copies, certified by the Secretary or Assistant Secretary of each Obligor, of its by-laws and of its Board of Directors' resolutions and of resolutions or actions of any other body authorizing the execution of the Loan Documents to which each such Obligor is a party. (g) Incumbency Certificate. An incumbency certificate, executed by the Secretary or Assistant Secretary of each Obligor, which shall identify by name and title and bear the signatures of the Authorized Officers and any other officers of such Obligor authorized to sign the Loan Documents to which such Obligor is a party, upon which certificate the Agent and the Lenders shall be entitled to rely until informed of any change in writing by the Borrower. (h) Officer's Certificate. A certificate, signed by the chief financial officer of the Borrower, stating that on the Effective Date no Default or Unmatured Default has occurred and is continuing. (i) Opinion. A written opinion of the Borrower's counsel, addressed to the Lenders in substantially the form of Exhibit A. (j) Notes. Any Notes requested by a Lender pursuant to Section 2.13 payable to the order of each such requesting Lender. (k) Money Transfer Instructions. Written money transfer instructions, in substantially the form of Exhibit D, addressed to the Agent and signed by an Authorized Officer, together with such other related money transfer authorizations as the Agent may have reasonably requested. (l) Year 2000 Information. Information satisfactory to the Agent and the Required Lenders regarding the Borrower's Year 2000 Program. -21- 27 (m) Documents Required by Put Agreement. Each of the documents required to be delivered by State Auto Mutual pursuant to Section 4.18 of the Put Agreement. (n) Payment of Chase Credit Agreement. All principal, interest and other amounts due under that certain Credit Agreement, dated as of August 16, 1996, among the Borrower, the financial institutions party thereto and The Chase Manhattan Bank, as agent, and all other "Basic Documents" identified therein shall have been paid in full and such agreement and all related documents shall be terminated, and the Borrower shall have executed and delivered to the Agent such documents as the Agent shall require in connection therewith. (o) Other Documents. Such other documents as any Lender or its counsel may have reasonably requested. 4.2 Each Advance. The Lenders shall not be required to make any Advance unless on the applicable Borrowing Date: (a) There exists no Default or Unmatured Default; (b) The representations and warranties contained in Article V and in Article III of the Put Agreement are true and correct as of such Borrowing Date except to the extent any such representation or warranty is stated to relate solely to an earlier date, in which case such representation or warranty shall have been true and correct on and as of such earlier date; (c) All legal matters incident to the making of such Advance shall be satisfactory to the Lenders and their counsel; (d) Concurrently therewith, (i) the Borrower shall receive Preferred Stock having an aggregate liquidation preference equal to the aggregate principal amount of such Loan and shall deliver the same, together with an undated stock power executed in blank, to the Agent in pledge subject to the Company Pledge Agreement and (ii) all of the conditions precedent to the purchase of the Preferred Stock under the Standby Purchase Agreement shall be satisfied (and the Agent shall receive evidence satisfactory to it that such conditions precedent shall be so satisfied) or (with the consent of the Agent and each Lender) waived; and (e) the Agent shall have received each of the documents required to be delivered by State Auto Mutual pursuant to Section 4.19 of the Put Agreement. Each Borrowing Notice with respect to each such Advance shall constitute a representation and warranty by the Borrower that the conditions contained in Sections 4.2(a) and (b) have been satisfied. Any Lender may require a duly completed compliance certificate in substantially the form of Exhibit B as a condition to making an Advance. -22- 28 ARTICLE V REPRESENTATIONS AND WARRANTIES ------------------------------ The Borrower represents and warrants to the Lenders that: 5.1 Corporate Existence. The Borrower: (a) is a corporation, partnership or other entity duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization; (b) has all requisite corporate or other power, and has all material governmental licenses, authorizations, consents and approvals necessary to own its assets and carry on its business as now being or as proposed to be conducted; (c) is qualified to do business and is in good standing in all jurisdictions in which the nature of the business conducted by it makes such qualification necessary; and (d) has no Subsidiaries. 5.2 Financial Condition. The Borrower has heretofore furnished to each of the Lenders the balance sheet of the Borrower as at December 31, 1998 and the related statements of income, retained earnings and cash flows for the Borrower for the fiscal year ended on such date, with the opinion thereon of Ernst & Young LLP, and the unaudited balance sheet of the Borrower as at June 30, 1999 and the related statements of income, retained earnings and cash flows of the Borrower for the three-month period ended on such date. All such financial statements present fairly in all material respects the financial condition of the Borrower as at said dates and the results of its operations for the fiscal year and three-month period ended on said dates (subject, in the case of such financial statements as at June 30, 1999, to normal year-end audit adjustments), all in accordance with Agreement Accounting Principles. The Borrower does not have on the date hereof and will not have on the Effective Date any material contingent liabilities, liabilities for taxes, unusual forward or long-term commitments or unrealized or anticipated losses from any unfavorable commitments, except as referred to or reflected or provided for in said pro forma balance sheet as at said date. Since June 30, 1999, there has been no material adverse change in the condition (financial or otherwise), operations, business or prospects of the Borrower from that set forth in said financial statements as at said date. 5.3 Litigation. There are no legal or arbitral proceedings, or any proceedings by or before any governmental or regulatory authority or agency, now pending or (to the knowledge of the Borrower) threatened against the Borrower or any of its Property. 5.4 No Breach. None of the execution and delivery of this Agreement and the Notes and the other Loan Documents to which it is a party, the consummation of the transactions herein and therein contemplated or compliance with the terms and provisions hereof and thereof will conflict with or result in a breach of, or require any consent under, the charter or by-laws of the Borrower, or any applicable law or regulation, or any order, writ, injunction or decree of any court or governmental authority or agency, or any agreement or instrument to which the Borrower is a party or by which it or any of its Property is bound or to which it is subject, or constitute a default under any such agreement or instrument, or (except for the Liens created pursuant to the Company Pledge Agreement) result in the creation or imposition of any Lien upon any Property of the Borrower pursuant to the terms of any such agreement or instrument. -23- 29 5.5 Action. The Borrower has all necessary corporate power, authority and legal right to execute, deliver and perform its obligations under each of the Loan Documents to which it is a party; the execution, delivery and performance by the Borrower of each of the Loan Documents to which it is a party have been duly authorized by all necessary corporate action on its part (including, without limitation, any required shareholder approvals); and this Agreement has been duly and validly executed and delivered by the Borrower and constitutes, and each of the Loan Documents to which it is a party when executed and delivered will constitute, its legal, valid and binding obligation, enforceable against the Borrower in accordance with its terms, except as such enforceability may be limited by (a) bankruptcy, insolvency, reorganization, moratorium or similar laws of general applicability affecting the enforcement of creditors' rights and (b) the application of general principles of equity (regardless of whether such enforceability is considered in a proceeding in equity or at law). 5.6 Approvals. No authorizations, approvals or consents of, and no filings or registrations with, any governmental or regulatory authority or agency, or any securities exchange, are necessary for the execution, delivery or performance by the Borrower of this Agreement or any of the other Loan Documents to which it is a party or for the legality, validity or enforceability hereof or thereof. 5.7 Taxes. As of the date hereof, the Borrower has not been required to file any Federal or other tax returns. As of the date of each borrowing, the Borrower will have filed all Federal income tax returns and all other material tax returns (if any) that are required to be filed by it and will have paid all taxes due pursuant to such returns or pursuant to any assessment received by the Borrower. The charges, accruals and reserves on the books of the Borrower in respect of taxes and other governmental charges are, in the opinion of the Borrower, adequate. 5.8 Use of Credit. No part of the proceeds of any Loan will be used to buy or carry Margin Stock (as such term is defined in Regulations U and X) in violation of Regulation U or X. The Preferred Stock does not constitute Margin Stock (as so defined). 5.9 Special Purpose Company. On the date hereof, the Borrower is not engaged in any business or transaction other than as permitted by Section 6.4 hereof. 5.10 Capitalization. The authorized capital stock of the Borrower consists, on the date hereof, of an aggregate of 1000 shares of common stock, no par value, of which 1000 shares are duly and validly issued and outstanding, each of which shares is fully paid and nonassessable. As of the date hereof, there are no outstanding Equity Rights with respect to the Borrower and there are no outstanding obligations of the Borrower to repurchase, redeem, or otherwise acquire any shares of capital stock of the Borrower nor are there any outstanding obligations of the Borrower to make payments to any Person, such as "phantom stock" payments, where the amount thereof is calculated with reference to the fair market value or equity value of the Borrower. 5.11 ERISA. The Borrower does not have any ERISA Affiliates. The Borrower does not maintain or contribute to any Plan or Multiemployer Plan. -24- 30 5.12 Year 2000. The Borrower has made a full and complete assessment of the Year 2000 Issues and has a realistic and achievable program for remediating the Year 2000 Issues on a timely basis (the "Year 2000 Program"). Based on such assessment and on the Year 2000 Program the Borrower does not reasonably anticipate that Year 2000 Issues will have a Material Adverse Effect. 5.13 Investment Company. The Borrower is not, nor after giving effect to any Advance will it be, an "investment company" or a company "controlled" by an "investment company" within the meaning of the Investment Company Act of 1940, as amended. 5.14 True and Complete Disclosure. The information, reports, financial statements, exhibits and schedules furnished in writing by the Borrower to the Agent or any Lender in connection with the negotiation, preparation or delivery of this Agreement and the other Loan Documents or included herein or therein or delivered pursuant hereto or thereto, when taken as a whole do not contain any untrue statement of material fact or omit to state any material fact necessary to make the statements herein or therein, in light of the circumstances under which they were made, not misleading. All written information furnished after the date hereof by the Borrower to the Agent and the Lenders in connection with this Agreement and the other Loan Documents and the transactions contemplated hereby and thereby will be true, complete and accurate in every material respect, or (in the case of projections) based on reasonable estimates, on the date as of which such information is stated or certified. There is no fact known to the Borrower that could have a Material Adverse Effect that has not been disclosed herein, in the other Loan Documents or in a report, financial statement, exhibit, schedule, disclosure letter or other writing furnished to the Agent for use in connection with the transactions contemplated hereby or thereby. ARTICLE VI COVENANTS --------- During the term of this Agreement, unless the Required Lenders shall otherwise consent in writing: 6.1 Financial Statements, Etc. The Borrower shall deliver to each of the Lenders: (a) as soon as available and in any event within 45 days after the end of each quarterly fiscal period of each fiscal year of the Borrower, statements of income, retained earnings and cash flows of the Borrower for such period and for the period from the beginning of the respective fiscal year to the end of such period, and the related balance sheet of the Borrower as at the end of such period, setting forth in each case in comparative form the corresponding figures for the corresponding periods in the preceding fiscal year, accompanied by a certificate of a senior officer of the Borrower, which certificate shall state that said financial statements present fairly in all material respects the financial condition and results of operations of the Borrower in accordance with Agreement Accounting Principles, as at the end of, and for, such period (subject to normal year-end audit adjustments); -25- 31 (b) promptly after the Borrower knows or has reason to believe that any Unmatured Default or Default has occurred, a notice of such Unmatured Default or Default stating that such notice is a "Notice of Default" and describing the same in reasonable detail and, together with such notice or as soon thereafter as possible, a description of the action that the Borrower has taken or proposes to take with respect thereto; (c) promptly after its receipt thereof, copies of all written notices, requests, directions, instructions or other communications received by the Borrower from any State Auto Obligor under the Standby Purchase Agreement or otherwise; and (d) from time to time such other information regarding the financial condition, operations, business or prospects of the Borrower as any Lender or the Agent may reasonably request. The Borrower will furnish to each Lender, at the time it furnishes each set of financial statements pursuant to paragraph (a) above, a certificate of a senior officer of the Borrower to the effect that no Unmatured Default or Default has occurred and is continuing (or, if any Unmatured Default or Default has occurred and is continuing, describing the same in reasonable detail and describing the action that the Borrower has taken or proposes to take with respect thereto). 6.2 Litigation. The Borrower will promptly give to each Lender notice of all legal or arbitral proceedings, and of all proceedings by or before any governmental or regulatory authority or agency, and any material development in respect of such legal or other proceedings, affecting the Borrower. 6.3 Existence, Etc. The Borrower will: (a) preserve and maintain its legal existence and all of its material rights, privileges, licenses and franchises; (b) comply in all material respects with the requirements of all applicable laws, rules, regulations and orders of governmental or regulatory authorities; (c) pay and discharge all taxes, assessments and governmental charges or levies imposed on it or on its income or profits or on any of its Property prior to the date on which penalties attach thereto, except for any such tax, assessment, charge or levy the payment of which is being contested in good faith and by proper proceedings and against which adequate reserves are being maintained; (d) maintain all of its Properties used or useful in its business in good working order and condition, ordinary wear and tear excepted; (e) keep adequate records and books of account, in which complete entries will be made in accordance with Agreement Accounting Principles; and (f) permit representatives of any Lender or the Agent, during normal business hours, to examine, copy and make extracts from its books and records, to inspect any of its -26- 32 Properties, and to discuss its business and affairs with its officers, all to the extent reasonably requested by such Lender or the Agent (as the case may be). 6.4 Limited Purpose Company. Notwithstanding anything herein to the contrary, the Borrower shall not: (a) create, incur, assume or have outstanding any Indebtedness or other liabilities or obligations except for obligations under or in respect of the Loan Documents; (b) own any Property except for the Preferred Stock and dividends thereon; (c) enter into any transaction of merger, consolidation or amalgamation, or liquidate, wind up or dissolve itself (or suffer any liquidation or dissolution); (d) create, incur or permit to exist any Lien (other than the Lien created by the Company Pledge Agreement) on or in respect of, or convey, sell, lease, assign, transfer or otherwise dispose of, any of its Property; (e) make or hold any Investment, except operating deposit accounts with banks and Permitted Investments; (f) declare or make any Dividend Payment at any time; (g) enter into any transaction (including, without limitation, the purchase or sale of any Property or service) with, or make any payment or transfer to, any Affiliate except in the ordinary course of business and pursuant to the reasonable requirements of the Borrower's business and upon fair and reasonable terms no less favorable to the Borrower than the Borrower would obtain in a comparable arms-length transaction with a Person which is not an Affiliate; (h) create or acquire any Subsidiaries; or (i) otherwise engage in any business or transaction other than the transactions contemplated by (and consistent with) the Basic Documents and incidental thereto. 6.5 Use of Proceeds. The Borrower will use the proceeds of the Loans hereunder solely to finance the purchase from State Auto Financial of the Preferred Stock under the Standby Purchase Agreement (in compliance with all applicable legal and regulatory requirements); provided that neither the Agent nor any Lender shall have any responsibility as to the use of any of such proceeds. 6.6 Modifications of Certain Documents. The Borrower will not consent to any modification, supplement or waiver of any of the provisions of, or assignment of any rights or obligations of any other Person under, any Basic Document without the prior consent of the Agent (with the approval of the Required Lenders). 6.7 Year 2000. The Borrower will take all such actions as are reasonably necessary to successfully implement the Year 2000 Program and to assure that Year 2000 Issues will not have a Material Adverse Effect. At the request of the Agent or any Lender, the Borrower will -27- 33 provide a description of the Year 2000 Program, together with any updates or progress reports with respect thereto. ARTICLE VII DEFAULTS -------- The occurrence of any one or more of the following events shall constitute a Default: 7.1 The Borrower shall default in the payment when due (whether at stated maturity or upon mandatory or optional prepayment) of any principal of or interest on any Loan, any fee or any other amount payable by it hereunder or under any other Loan Document to which it is a party; or 7.2 Any representation, warranty or certification made or deemed made herein or in any other Loan Document to which the Borrower or the Parent is a party (or in any modification or supplement hereto or thereto) by the Borrower or the Parent, or any certificate furnished to any Lender or the Agent pursuant to the provisions hereof or thereof, shall prove to have been false or misleading as of the time made or furnished in any material respect; or 7.3 The Borrower shall default in the performance of any of its obligations under any of Sections 6.4, 6.5 or 6.6 hereof; the Borrower or the Parent shall default in the performance of any of its obligations under the Company Pledge Agreement or the Parent Pledge Agreement, as the case may be; or the Borrower or the Parent shall default in the performance of any of its other obligations in this Agreement or any other Loan Document to which it is a party and such default shall continue unremedied for a period of 30 or more days after the occurrence of such default; or 7.4 The Borrower or the Parent shall admit in writing its inability to, or be generally unable to, pay its debts as such debts become due; or 7.5 The Borrower or the Parent shall (a) apply for or consent to the appointment of, or the taking of possession by, a receiver, custodian, trustee, examiner or liquidator of itself or of all or a substantial part of its Property, (b) make a general assignment for the benefit of its creditors, (c) commence a voluntary case under the Bankruptcy Code, (d) file a petition seeking to take advantage of any other law relating to bankruptcy, insolvency, reorganization, liquidation, dissolution, arrangement or winding-up, or composition or readjustment of debts, (e) fail to controvert in a timely and appropriate manner, or acquiesce in writing to, any petition filed against it in an involuntary case under the Bankruptcy Code or (f) take any corporate action for the purpose of effecting any of the foregoing; or 7.6 A proceeding or case shall be commenced, without the application or consent of the Borrower or the Parent, in any court of competent jurisdiction, seeking (a) its reorganization, liquidation, dissolution, arrangement or winding-up, or the composition or readjustment of its debts, (b) the appointment of a receiver, custodian, trustee, examiner, liquidator or the like of the Borrower or the Parent or of all or any substantial part of its respective Property or (c) similar -28- 34 relief in respect of the Borrower or the Parent under any law relating to bankruptcy, insolvency, reorganization, winding-up, or composition or adjustment of debts, and such proceeding or case shall continue undismissed, or an order, judgment or decree approving or ordering any of the foregoing shall be entered and continue unstayed and in effect, for a period of 60 or more days, or an order for relief against the Borrower shall be entered in an involuntary case under the Bankruptcy Code; or 7.7 The Parent shall fail to own and control, beneficially (free and clear of all Liens other than Liens created pursuant to the Basic Documents), 100% of the capital stock issued by the Borrower (irrespective of whether or not at the time securities or other ownership interests issued by the Borrower or any other class or classes might have voting power by reason of the happening of any contingency); or 7.8 The Liens created by the Pledge Agreements shall at any time not constitute valid and perfected Liens on the collateral intended to be covered thereby (to the extent perfection by filing, registration, recordation or possession is required herein or therein) in favor of the Agent, free and clear of all other Liens, or, except for expiration in accordance with its terms, either Pledge Agreement shall for whatever reason be terminated or cease to be in full force and effect, or the enforceability thereof shall be contested by the Borrower or the Parent; or 7.9 A Put Event under, and as defined in, the Put Agreement. ARTICLE VIII ACCELERATION, WAIVERS, AMENDMENTS AND REMEDIES ---------------------------------------------- 8.1 Acceleration. If any Default described in Section 7.4, 7.5 or 7.6 occurs with respect to the Borrower, the obligations of the Lenders to make Loans hereunder shall automatically terminate and the Obligations shall immediately become due and payable without any election or action on the part of the Agent or any Lender. If any other Default occurs, the Required Lenders (or the Agent with the consent of the Required Lenders) may terminate or suspend the obligations of the Lenders to make Loans hereunder, or declare the Obligations to be due and payable, or both, whereupon the Obligations shall become immediately due and payable, without presentment, demand, protest or notice of any kind, all of which the Borrower hereby expressly waives. If, within 30 days after acceleration of the maturity of the Obligations or termination of the obligations of the Lenders to make Loans hereunder as a result of any Default (other than any Default as described in Section 7.4, 7.5 or 7.6 with respect to the Borrower) and before any judgment or decree for the payment of the Obligations due shall have been obtained or entered, the Required Lenders (in their sole discretion) shall so direct, the Agent shall, by notice to the Borrower, rescind and annul such acceleration and/or termination. 8.2 Amendments. Subject to the provisions of this Article VIII, the Required Lenders (or the Agent with the consent in writing of the Required Lenders) and the Borrower may enter into agreements supplemental hereto for the purpose of adding or modifying any provisions to the Loan Documents or changing in any manner the rights of the Lenders or the Borrower -29- 35 hereunder or waiving any Default hereunder; provided, however, that no such supplemental agreement shall, without the consent of all of the Lenders: (a) Extend the final maturity of any Loan or postpone any regularly scheduled payment of principal of any Loan or forgive all or any portion of the principal amount thereof, or reduce the rate or extend the time of payment of interest or fees thereon. (b) Reduce the percentage specified in the definition of Required Lenders. (c) Extend the Facility Termination Date, or reduce the amount or extend the payment date for, the mandatory payments required under Section 2.2, or increase the amount of the Aggregate Commitment or of the Commitment of any Lender hereunder, or permit the Borrower to assign its rights under this Agreement. (d) Amend this Section 8.2. (e) Release, or agree to subordinate the Lenders' Liens with respect to, all or substantially all of the Collateral. No amendment of any provision of this Agreement relating to the Agent shall be effective without the written consent of the Agent. The Agent may waive payment of the fee required under Section 12.3.2 without obtaining the consent of any other party to this Agreement. (f) Preservation of Rights. No delay or omission of the Lenders or the Agent to exercise any right under the Loan Documents shall impair such right or be construed to be a waiver of any Default or an acquiescence therein, and the making of a Loan notwithstanding the existence of a Default or the inability of the Borrower to satisfy the conditions precedent to such Loan shall not constitute any waiver or acquiescence. Any single or partial exercise of any such right shall not preclude other or further exercise thereof or the exercise of any other right, and no waiver, amendment or other variation of the terms, conditions or provisions of the Loan Documents whatsoever shall be valid unless in writing signed by the Lenders required pursuant to Section 8.2, and then only to the extent in such writing specifically set forth. All remedies contained in the Loan Documents or by law afforded shall be cumulative and all shall be available to the Agent and the Lenders until the Obligations have been paid in full. ARTICLE IX GENERAL PROVISIONS ------------------ 9.1 Survival of Representations. All representations and warranties of the Borrower contained in this Agreement shall survive the making of the Loans herein contemplated. 9.2 Governmental Regulation. Anything contained in this Agreement to the contrary notwithstanding, no Lender shall be obligated to extend credit to the Borrower in violation of any limitation or prohibition provided by any applicable statute or regulation. -30- 36 9.3 Headings. Section headings in the Loan Documents are for convenience of reference only, and shall not govern the interpretation of any of the provisions of the Loan Documents. 9.4 Entire Agreement. The Loan Documents embody the entire agreement and understanding among the Borrower, the Agent and the Lenders and supersede all prior agreements and understandings among the Borrower, the Agent and the Lenders relating to the subject matter thereof other than the fee letter described in Section 10.13. 9.5 Several Obligations; Benefits of this Agreement. The respective obligations of the Lenders hereunder are several and not joint and no Lender shall be the partner or agent of any other (except to the extent to which the Agent is authorized to act as such). The failure of any Lender to perform any of its obligations hereunder shall not relieve any other Lender from any of its obligations hereunder. This Agreement shall not be construed so as to confer any right or benefit upon any Person other than the parties to this Agreement and their respective successors and assigns, provided, however, that the parties hereto expressly agree that the Arranger shall enjoy the benefits of the provisions of Sections 9.6, 9.10 and 10.11 to the extent specifically set forth therein and shall have the right to enforce such provisions on its own behalf and in its own name to the same extent as if it were a party to this Agreement. 9.6 Expenses; Indemnification. (a) The Borrower shall reimburse the Agent and the Arranger for any costs, internal charges and out-of-pocket expenses (including reasonable attorneys' fees and time charges of attorneys for the Agent, which attorneys may be employees of the Agent) paid or incurred by the Agent or the Arranger in connection with the preparation, negotiation, execution, delivery, syndication, review, amendment, modification, and administration of the Loan Documents. The Borrower also agrees to reimburse the Agent, the Arranger and the Lenders for any costs, internal charges and out-of-pocket expenses (including attorneys' fees and time charges of attorneys for the Agent, the Arranger and the Lenders, which attorneys may be employees of the Agent, the Arranger or the Lenders) paid or incurred by the Agent, the Arranger or any Lender in connection with the collection and enforcement of the Loan Documents. (b) The Borrower hereby further agrees to indemnify the Agent, the Arranger, each Lender, their respective affiliates, and each of their directors, officers and employees against all losses, claims, damages, penalties, judgments, liabilities and expenses (including, without limitation, all expenses of litigation or preparation therefor whether or not the Agent, the Arranger, any Lender or any affiliate is a party thereto) which any of them may pay or incur arising out of or relating to this Agreement, the other Loan Documents, the transactions contemplated hereby or the direct or indirect application or proposed application of the proceeds of any Loan hereunder except to the extent that they are determined in a final non-appealable judgment by a court of competent jurisdiction to have resulted from the gross negligence or willful misconduct of the party seeking indemnification. The obligations of the Borrower under this Section 9.6 shall survive the termination of this Agreement. 9.7 Numbers of Documents. All statements, notices, closing documents, and requests hereunder shall be furnished to the Agent with sufficient counterparts so that the Agent may furnish one to each of the Lenders. -31- 37 9.8 Accounting. Except as provided to the contrary herein, all accounting terms used herein shall be interpreted and all accounting determinations hereunder shall be made in accordance with Agreement Accounting Principles. 9.9 Severability of Provisions. Any provision in any Loan Document that is held to be inoperative, unenforceable, or invalid in any jurisdiction shall, as to that jurisdiction, be inoperative, unenforceable, or invalid without affecting the remaining provisions in that jurisdiction or the operation, enforceability, or validity of that provision in any other jurisdiction, and to this end the provisions of all Loan Documents are declared to be severable. 9.10 Nonliability of Lenders. The relationship between the Borrower on the one hand and the Lenders and the Agent on the other hand shall be solely that of borrower and lender. Neither the Agent, the Arranger nor any Lender shall have any fiduciary responsibilities to the Borrower. Neither the Agent, the Arranger nor any Lender undertakes any responsibility to the Borrower to review or inform the Borrower of any matter in connection with any phase of the Borrower's business or operations. The Borrower agrees that neither the Agent, the Arranger nor any Lender shall have liability to the Borrower (whether sounding in tort, contract or otherwise) for losses suffered by the Borrower in connection with, arising out of, or in any way related to, the transactions contemplated and the relationship established by the Loan Documents, or any act, omission or event occurring in connection therewith, unless it is determined in a final non-appealable judgment by a court of competent jurisdiction that such losses resulted from the gross negligence or willful misconduct of the party from which recovery is sought. Neither the Agent, the Arranger nor any Lender shall have any liability with respect to, and the Borrower hereby waives, releases and agrees not to sue for, any special, indirect or consequential damages suffered by the Borrower in connection with, arising out of, or in any way related to the Loan Documents or the transactions contemplated thereby. 9.11 Confidentiality. The Agent and each Lender agrees to hold any confidential information which it may receive from the Borrower pursuant to this Agreement in confidence, except for disclosure (a) to its Affiliates and to other Lenders and their respective Affiliates, so long as such Affiliate or other Lender agrees to be bound by the provisions of this Section, (b) to legal counsel, accountants, and other professional advisors to such Lender or to a Transferee, (c) to regulatory officials, (d) to any Person as requested pursuant to or as required by law, regulation, or legal process, (e) to any Person in connection with any legal proceeding to which such Lender is a party, (f) to such Lender's direct or indirect contractual counterparties in swap agreements or to legal counsel, accountants and other professional advisors to such counterparties, and (g) permitted by Section 12.4. 9.12 Nonreliance. Each Lender hereby represents that it is not relying on or looking to any margin stock (as defined in Regulation U of the Board of Governors of the Federal Reserve System) for the repayment of the Loans provided for herein. 9.13 Disclosure. The Borrower and each Lender hereby (a) acknowledge and agree that Bank One and/or its Affiliates from time to time may hold investments in, make other loans to or have other relationships with the Borrower and its Affiliates, and (b) waive any liability of Bank One or such Affiliate of Bank One to the Borrower or any Lender, respectively, arising out -32- 38 of or resulting from such investments, loans or relationships other than liabilities arising out of the gross negligence or willful misconduct of Bank One or its Affiliates. ARTICLE X THE AGENT --------- 10.1 Appointment; Nature of Relationship. Bank One, NA is hereby appointed by each of the Lenders as its contractual representative (herein referred to as the "Agent") hereunder and under each other Loan Document, and each of the Lenders irrevocably authorizes the Agent to act as the contractual representative of such Lender with the rights and duties expressly set forth herein and in the other Loan Documents. The Agent agrees to act as such contractual representative upon the express conditions contained in this Article X. Notwithstanding the use of the defined term "Agent," it is expressly understood and agreed that the Agent shall not have any fiduciary responsibilities to any Lender by reason of this Agreement or any other Loan Document and that the Agent is merely acting as the contractual representative of the Lenders with only those duties as are expressly set forth in this Agreement and the other Loan Documents. In its capacity as the Lenders' contractual representative, the Agent (a) does not hereby assume any fiduciary duties to any of the Lenders, (b) is a "representative" of the Lenders within the meaning of Section 9-105 of the Uniform Commercial Code and (c) is acting as an independent contractor, the rights and duties of which are limited to those expressly set forth in this Agreement and the other Loan Documents. Each of the Lenders hereby agrees to assert no claim against the Agent on any agency theory or any other theory of liability for breach of fiduciary duty, all of which claims each Lender hereby waives. 10.2 Powers. The Agent shall have and may exercise such powers under the Loan Documents as are specifically delegated to the Agent by the terms of each thereof, together with such powers as are reasonably incidental thereto. The Agent shall have no implied duties to the Lenders, or any obligation to the Lenders to take any action thereunder except any action specifically provided by the Loan Documents to be taken by the Agent. 10.3 General Immunity. Neither the Agent nor any of its directors, officers, agents or employees shall be liable to the Borrower, the Lenders or any Lender for any action taken or omitted to be taken by it or them hereunder or under any other Loan Document or in connection herewith or therewith except to the extent such action or inaction is determined in a final non-appealable judgment by a court of competent jurisdiction to have arisen from the gross negligence or willful misconduct of such Person. 10.4 No Responsibility for Loans, Recitals, etc. Neither the Agent nor any of its directors, officers, agents or employees shall be responsible for or have any duty to ascertain, inquire into, or verify (a) any statement, warranty or representation made in connection with any Loan Document or any borrowing hereunder; (b) the performance or observance of any of the covenants or agreements of any obligor under any Loan Document, including, without limitation, any agreement by an obligor to furnish information directly to each Lender; (c) the satisfaction of any condition specified in Article IV, except receipt of items required to be delivered solely to the Agent; (d) the existence or possible existence of any Default or Unmatured Default; (e) the -33- 39 validity, enforceability, effectiveness, sufficiency or genuineness of any Loan Document or any other instrument or writing furnished in connection therewith; (f) the value, sufficiency, creation, perfection or priority of any Lien in any collateral security; or (g) the financial condition of the Borrower or any guarantor of any of the Obligations or of any of the Borrower's or any such guarantor's respective Subsidiaries. The Agent shall have no duty to disclose to the Lenders information that is not required to be furnished by the Borrower to the Agent at such time, but is voluntarily furnished by the Borrower to the Agent (either in its capacity as Agent or in its individual capacity). 10.5 Action on Instructions of Lenders. The Agent shall in all cases be fully protected in acting, or in refraining from acting, hereunder and under any other Loan Document in accordance with written instructions signed by the Required Lenders, and such instructions and any action taken or failure to act pursuant thereto shall be binding on all of the Lenders. The Lenders hereby acknowledge that the Agent shall be under no duty to take any discretionary action permitted to be taken by it pursuant to the provisions of this Agreement or any other Loan Document unless it shall be requested in writing to do so by the Required Lenders. The Agent shall be fully justified in failing or refusing to take any action hereunder and under any other Loan Document unless it shall first be indemnified to its satisfaction by the Lenders pro rata against any and all liability, cost and expense that it may incur by reason of taking or continuing to take any such action. 10.6 Employment of Agents and Counsel. The Agent may execute any of its duties as Agent hereunder and under any other Loan Document by or through employees, agents, and attorneys-in-fact and shall not be answerable to the Lenders, except as to money or securities received by it or its authorized agents, for the default or misconduct of any such agents or attorneys-in-fact selected by it with reasonable care. The Agent shall be entitled to advice of counsel concerning the contractual arrangement between the Agent and the Lenders and all matters pertaining to the Agent's duties hereunder and under any other Loan Document. 10.7 Reliance on Documents; Counsel. The Agent shall be entitled to rely upon any Note, notice, consent, certificate, affidavit, letter, telegram, statement, paper or document believed by it to be genuine and correct and to have been signed or sent by the proper person or persons, and, in respect to legal matters, upon the opinion of counsel selected by the Agent, which counsel may be employees of the Agent. 10.8 Agent's Reimbursement and Indemnification. The Lenders agree to reimburse and indemnify the Agent ratably in proportion to their respective Commitments (or, if all Commitments have been terminated, in proportion to their Commitments immediately prior to such termination) (a) for any amounts not reimbursed by the Borrower for which the Agent is entitled to reimbursement by the Borrower under the Loan Documents, (b) for any other expenses incurred by the Agent on behalf of the Lenders, in connection with the preparation, execution, delivery, administration and enforcement of the Loan Documents (including, without limitation, for any expenses incurred by the Agent in connection with any dispute between the Agent and any Lender or between two or more of the Lenders) and (c) for any liabilities, obligations, losses, damages, penalties, actions, judgments, suits, costs, expenses or disbursements of any kind and nature whatsoever which may be imposed on, incurred by or asserted against the Agent in any way relating to or arising out of the Loan Documents or any -34- 40 other document delivered in connection therewith or the transactions contemplated thereby (including, without limitation, for any such amounts incurred by or asserted against the Agent in connection with any dispute between the Agent and any Lender or between two or more of the Lenders), or the enforcement of any of the terms of the Loan Documents or of any such other documents, provided that (i) no Lender shall be liable for any of the foregoing to the extent any of the foregoing is found in a final non-appealable judgment by a court of competent jurisdiction to have resulted from the gross negligence or willful misconduct of the Agent and (ii) any indemnification required pursuant to Section 3.5(g) shall, notwithstanding the provisions of this Section 10.8, be paid by the relevant Lender in accordance with the provisions thereof. The obligations of the Lenders under this Section 10.8 shall survive payment of the Obligations and termination of this Agreement. 10.9 Notice of Default. The Agent shall not be deemed to have knowledge or notice of the occurrence of any Default or Unmatured Default hereunder unless the Agent has received written notice from a Lender or the Borrower referring to this Agreement describing such Default or Unmatured Default and stating that such notice is a "notice of default". In the event that the Agent receives such a notice, the Agent shall give prompt notice thereof to the Lenders. 10.10 Rights as a Lender. In the event the Agent is a Lender, the Agent shall have the same rights and powers hereunder and under any other Loan Document with respect to its Commitment and its Loans as any Lender and may exercise the same as though it were not the Agent, and the term "Lender" or "Lenders" shall, at any time when the Agent is a Lender, unless the context otherwise indicates, include the Agent in its individual capacity. The Agent and its Affiliates may accept deposits from, lend money to, and generally engage in any kind of trust, debt, equity or other transaction, in addition to those contemplated by this Agreement or any other Loan Document, with the Borrower or any of its Subsidiaries in which the Borrower or such Subsidiary is not restricted hereby from engaging with any other Person. The Agent, in its individual capacity, is not obligated to remain a Lender. 10.11 Lender Credit Decision. Each Lender acknowledges that it has, independently and without reliance upon the Agent, the Arranger or any other Lender and based on the financial statements prepared by the Borrower and such other documents and information as it has deemed appropriate, made its own credit analysis and decision to enter into this Agreement and the other Loan Documents. Each Lender also acknowledges that it will, independently and without reliance upon the Agent, the Arranger or any other Lender and based on such documents and information as it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under this Agreement and the other Loan Documents. 10.12 Successor Agent. The Agent may resign at any time by giving written notice thereof to the Lenders and the Borrower, such resignation to be effective upon the appointment of a successor Agent or, if no successor Agent has been appointed, forty-five days after the retiring Agent gives notice of its intention to resign. The Agent may be removed at any time with or without cause by written notice received by the Agent from the Required Lenders, such removal to be effective on the date specified by the Required Lenders. Upon any such resignation or removal, the Required Lenders shall have the right to appoint, on behalf of the Borrower and the Lenders, a successor Agent. If no successor Agent shall have been so appointed by the Required Lenders within thirty days after the resigning Agent's giving notice of -35- 41 its intention to resign, then the resigning Agent may appoint, on behalf of the Borrower and the Lenders, a successor Agent. Notwithstanding the previous sentence, the Agent may at any time without the consent of the Borrower or any Lender, appoint any of its Affiliates which is a commercial bank as a successor Agent hereunder. If the Agent has resigned or been removed and no successor Agent has been appointed, the Lenders may perform all the duties of the Agent hereunder and the Borrower shall make all payments in respect of the Obligations to the applicable Lender and for all other purposes shall deal directly with the Lenders. No successor Agent shall be deemed to be appointed hereunder until such successor Agent has accepted the appointment. Any such successor Agent shall be a commercial bank having capital and retained earnings of at least $100,000,000. Upon the acceptance of any appointment as Agent hereunder by a successor Agent, such successor Agent shall thereupon succeed to and become vested with all the rights, powers, privileges and duties of the resigning or removed Agent. Upon the effectiveness of the resignation or removal of the Agent, the resigning or removed Agent shall be discharged from its duties and obligations hereunder and under the Loan Documents. After the effectiveness of the resignation or removal of an Agent, the provisions of this Article X shall continue in effect for the benefit of such Agent in respect of any actions taken or omitted to be taken by it while it was acting as the Agent hereunder and under the other Loan Documents. In the event that there is a successor to the Agent by merger, or the Agent assigns its duties and obligations to an Affiliate pursuant to this Section 10.12, then the term "Corporate Base Rate" as used in this Agreement shall mean the prime rate, base rate or other analogous rate of the new Agent. 10.13 Agent's Fee. The Borrower agrees to pay to the Agent, for its own account, the fees agreed to by the Borrower and the Agent pursuant to that certain letter agreement dated September 28, 1999, or as otherwise agreed from time to time. 10.14 Delegation to Affiliates. The Borrower and the Lenders agree that the Agent may delegate any of its duties under this Agreement to any of its Affiliates. Any such Affiliate (and such Affiliate's directors, officers, agents and employees) which performs duties in connection with this Agreement shall be entitled to the same benefits of the indemnification, waiver and other protective provisions to which the Agent is entitled under Articles IX and X. 10.15 Execution of Pledge and Put Agreements. The Lenders hereby empower and authorize the Agent to execute and deliver to the Borrower on their behalf the Pledge Agreements and all related financing statements and any financing statements, agreements, documents or instruments as shall be necessary or appropriate to effect the purposes of the Pledge Agreements. Each Lender hereby approves the terms of the Put Agreement and agrees to be bound thereby including, without limitation, Section 5.10(b) of the Put Agreement and authorizes and directs the Agent to enter into the Put Agreement on behalf of such Lender. 10.16 Collateral Releases. The Lenders hereby empower and authorize the Agent to execute and deliver to the Borrower on their behalf any agreements, documents or instruments as shall be necessary or appropriate to effect any releases of collateral which shall be permitted by the terms hereof or of any other Loan Document or which shall otherwise have been approved by the Required Lenders (or, if required by the terms of Section 8.2, all of the Lenders) in writing. -36- 42 10.17 Consents Under Other Loan Documents. Except as otherwise provided in Section 8.2 hereof with respect to this Agreement, the Agent may, with the prior consent of the Required Lenders (but not otherwise), consent to any modification, supplement or waiver under any of the other Loan Documents or the Standby Purchase Agreement, provided that without the prior written consent of each Lender, the Agent shall not (except as provided herein or in the other Loan Documents) terminate any Loan Document, release either State Auto Obligor from its liability under the Put Agreement, release any collateral or otherwise terminate any Lien under any Loan Document providing for collateral security, agree to additional obligations being secured by such collateral security (unless the Lien for such additional obligation shall be junior to the Lien in favor of the other obligations secured by such Loan Document) or modify, supplement or waive any provision in Section 3 of the Standby Purchase Agreement. ARTICLE XI SETOFF; RATABLE PAYMENTS ------------------------ 11.1 Setoff. In addition to, and without limitation of, any rights of the Lenders under applicable law, if the Borrower becomes insolvent, however evidenced, or any Default occurs, any and all deposits (including all account balances, whether provisional or final and whether or not collected or available) and any other Indebtedness at any time held or owing by any Lender or any Affiliate of any Lender to or for the credit or account of the Borrower may be offset and applied toward the payment of the Obligations owing to such Lender, whether or not the Obligations, or any part thereof, shall then be due. 11.2 Ratable Payments. If any Lender, whether by setoff or otherwise, has payment made to it upon its Loans (other than payments received pursuant to Section 2.19(b), 3.1, 3.2, 3.4 or 3.5) in a greater proportion than that received by any other Lender, such Lender agrees, promptly upon demand, to purchase a portion of the Loans held by the other Lenders so that after such purchase each Lender will hold its ratable proportion of Loans. If any Lender, whether in connection with setoff or amounts which might be subject to setoff or otherwise, receives collateral or other protection for its Obligations or such amounts which may be subject to setoff, such Lender agrees, promptly upon demand, to take such action necessary such that all Lenders share in the benefits of such collateral ratably in proportion to their Loans. In case any such payment is disturbed by legal process, or otherwise, appropriate further adjustments shall be made. ARTICLE XII BENEFIT OF AGREEMENT; ASSIGNMENTS; PARTICIPATIONS ------------------------------------------------- 12.1 Successors and Assigns. The terms and provisions of the Loan Documents shall be binding upon and inure to the benefit of the Borrower and the Lenders and their respective successors and assigns, except that (a) the Borrower shall not have the right to assign its rights or obligations under the Loan Documents and (b) any assignment by any Lender must be made in -37- 43 compliance with Section 12.3. The parties to this Agreement acknowledge that clause (b) of this Section 12.1 relates only to absolute assignments and does not prohibit assignments creating security interests, including, without limitation, any pledge or assignment by any Lender of all or any portion of its rights under this Agreement and any Note to a Federal Reserve Bank; provided, however, that no such pledge or assignment creating a security interest shall release the transferor Lender from its obligations hereunder unless and until the parties thereto have complied with the provisions of Section 12.3. The Agent may treat the Person which made any Loan or which holds any Note as the owner thereof for all purposes hereof unless and until such Person complies with Section 12.3; provided, however, that the Agent may in its discretion (but shall not be required to) follow instructions from the Person which made any Loan or which holds any Note to direct payments relating to such Loan or Note to another Person. Any assignee of the rights to any Loan or any Note agrees by acceptance of such assignment to be bound by all the terms and provisions of the Loan Documents. Any request, authority or consent of any Person, who at the time of making such request or giving such authority or consent is the owner of the rights to any Loan (whether or not a Note has been issued in evidence thereof), shall be conclusive and binding on any subsequent holder or assignee of the rights to such Loan. 12.2 Participations. 12.2.1. Permitted Participants; Effect. Any Lender may, in the ordinary course of its business and in accordance with applicable law, at any time sell to one or more banks or other entities ("Participants") participating interests in any Loan owing to such Lender, any Note held by such Lender, any Commitment of such Lender or any other interest of such Lender under the Loan Documents. In the event of any such sale by a Lender of participating interests to a Participant, such Lender's obligations under the Loan Documents shall remain unchanged, such Lender shall remain solely responsible to the other parties hereto for the performance of such obligations, such Lender shall remain the owner of its Loans and the holder of any Note issued to it in evidence thereof for all purposes under the Loan Documents, all amounts payable by the Borrower under this Agreement shall be determined as if such Lender had not sold such participating interests, and the Borrower and the Agent shall continue to deal solely and directly with such Lender in connection with such Lender's rights and obligations under the Loan Documents. 12.2.2. Voting Rights. Each Lender shall retain the sole right to approve, without the consent of any Participant, any amendment, modification or waiver of any provision of the Loan Documents other than any amendment, modification or waiver with respect to any Loan or Commitment in which such Participant has an interest which forgives principal, interest or fees or reduces the interest rate or fees payable with respect to any such Loan or Commitment, extends the Facility Termination Date, postpones any date fixed for any regularly-scheduled payment of principal of, or interest or fees on, any such Loan or Commitment, releases any guarantor of any such Loan or releases all or substantially all of the collateral, if any, securing any such Loan. 12.2.3. Benefit of Setoff. The Borrower agrees that each Participant shall be deemed to have the right of setoff provided in Section 11.1 in respect of its participating interest in amounts owing under the Loan Documents to the same extent as -38- 44 if the amount of its participating interest were owing directly to it as a Lender under the Loan Documents, provided that each Lender shall retain the right of setoff provided in Section 11.1 with respect to the amount of participating interests sold to each Participant. The Lenders agree to share with each Participant, and each Participant, by exercising the right of setoff provided in Section 11.1, agrees to share with each Lender, any amount received pursuant to the exercise of its right of setoff, such amounts to be shared in accordance with Section 11.2 as if each Participant were a Lender. 12.3 Assignments. 12.3.1. Permitted Assignments. Any Lender may, in the ordinary course of its business and in accordance with applicable law, at any time assign to one or more banks or other entities ("Purchasers") all or any part of its rights and obligations under the Loan Documents. Such assignment shall be substantially in the form of Exhibit C or in such other form as may be agreed to by the parties thereto. The consent of the Borrower and the Agent shall be required prior to an assignment becoming effective with respect to a Purchaser which is not a Lender or an Affiliate thereof; provided, however, that if a Default has occurred and is continuing, the consent of the Borrower shall not be required. Such consent shall not be unreasonably withheld or delayed. Each such assignment with respect to a Purchaser which is not a Lender or an Affiliate thereof shall (unless each of the Borrower and the Agent otherwise consents) be in an amount not less than the lesser of (a) $5,000,000 or (b) the remaining amount of the assigning Lender's Commitment (calculated as at the date of such assignment) or outstanding Loans (if the applicable Commitment has been terminated). 12.3.2. Effect; Effective Date. Upon (a) delivery to the Agent of an assignment, together with any consents required by Section 12.3.1, and (b) payment of a $3,500 fee to the Agent for processing such assignment (unless such fee is waived by the Agent), such assignment shall become effective on the effective date specified in such assignment. The assignment shall contain a representation by the Purchaser to the effect that none of the consideration used to make the purchase of the Commitment and Loans under the applicable assignment agreement constitutes "plan assets" as defined under ERISA and that the rights and interests of the Purchaser in and under the Loan Documents will not be "plan assets" under ERISA. On and after the effective date of such assignment, such Purchaser shall for all purposes be a Lender party to this Agreement and any other Loan Document executed by or on behalf of the Lenders and shall have all the rights and obligations of a Lender under the Loan Documents, to the same extent as if it were an original party hereto, and no further consent or action by the Borrower, the Lenders or the Agent shall be required to release the transferor Lender with respect to the percentage of the Aggregate Commitment and Loans assigned to such Purchaser. Upon the consummation of any assignment to a Purchaser pursuant to this Section 12.3.2, the transferor Lender, the Agent and the Borrower shall, if the transferor Lender or the Purchaser desires that its Loans be evidenced by Notes, make appropriate arrangements so that new Notes or, as appropriate, replacement Notes are issued to such transferor Lender and new Notes or, as appropriate, replacement Notes, are issued to such Purchaser, in each case in principal amounts reflecting their respective Commitments, as adjusted pursuant to such assignment. -39- 45 12.4 Dissemination of Information. The Borrower authorizes each Lender to disclose to any Participant or Purchaser or any other Person acquiring an interest in the Loan Documents by operation of law (each a "Transferee") and any prospective Transferee any and all information in such Lender's possession concerning the creditworthiness of the Borrower and its Subsidiaries, including without limitation any information contained in any Reports; provided that each Transferee and prospective Transferee agrees to be bound by Section 9.11 of this Agreement. 12.5 Tax Treatment. If any interest in any Loan Document is transferred to any Transferee which is organized under the laws of any jurisdiction other than the United States or any State thereof, the transferor Lender shall cause such Transferee, concurrently with the effectiveness of such transfer, to comply with the provisions of Section 3.5(d). ARTICLE XIII NOTICES ------- 13.1 Notices. Except as otherwise permitted by Section 2.14 with respect to borrowing notices, all notices, requests and other communications to any party hereunder shall be in writing (including electronic transmission, facsimile transmission or similar writing) and shall be given to such party: (a) in the case of the Borrower or the Agent, at its address or facsimile number set forth on the signature pages hereof, (b) in the case of any Lender, at its address or facsimile number set forth on Schedule 1 hereto or (c) in the case of any party, at such other address or facsimile number as such party may hereafter specify for the purpose by notice to the Agent and the Borrower in accordance with the provisions of this Section 13.1. Each such notice, request or other communication shall be effective (i) if given by facsimile transmission, when transmitted to the facsimile number specified in this Section and confirmation of receipt is received, (ii) if given by mail, 72 hours after such communication is deposited in the mails with first class postage prepaid, addressed as aforesaid, or (iii) if given by any other means, when delivered (or, in the case of electronic transmission, received) at the address specified in this Section; provided that notices to the Agent under Article II shall not be effective until received. 13.2 Change of Address. The Borrower, the Agent and any Lender may each change the address for service of notice upon it by a notice in writing to the other parties hereto. ARTICLE XIV COUNTERPARTS ------------ This Agreement may be executed in any number of counterparts, all of which taken together shall constitute one agreement, and any of the parties hereto may execute this Agreement by signing any such counterpart. This Agreement shall be effective when it has been executed by the Borrower, the Agent and the Lenders and each party has notified the Agent by facsimile transmission or telephone that it has taken such action. -40- 46 ARTICLE XV CHOICE OF LAW; CONSENT TO JURISDICTION; WAIVER OF JURY TRIAL ------------------------------------------------------------ 15.1 CHOICE OF LAW. THE LOAN DOCUMENTS (OTHER THAN THOSE CONTAINING A CONTRARY EXPRESS CHOICE OF LAW PROVISION) SHALL BE CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS (INCLUDING, WITHOUT LIMITATION, 735 ILCS SECTION 105/5-1 ET SEQ, BUT OTHERWISE WITHOUT REGARD TO THE CONFLICT OF LAWS PROVISIONS) OF THE STATE OF ILLINOIS, BUT GIVING EFFECT TO FEDERAL LAWS APPLICABLE TO NATIONAL BANKS. 15.2 CONSENT TO JURISDICTION. THE BORROWER HEREBY IRREVOCABLY SUBMITS TO THE NON-EXCLUSIVE JURISDICTION OF ANY UNITED STATES FEDERAL OR ILLINOIS STATE COURT SITTING IN CHICAGO, ILLINOIS IN ANY ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO ANY LOAN DOCUMENTS AND THE BORROWER HEREBY IRREVOCABLY AGREES THAT ALL CLAIMS IN RESPECT OF SUCH ACTION OR PROCEEDING MAY BE HEARD AND DETERMINED IN ANY SUCH COURT AND IRREVOCABLY WAIVES ANY OBJECTION IT MAY NOW OR HEREAFTER HAVE AS TO THE VENUE OF ANY SUCH SUIT, ACTION OR PROCEEDING BROUGHT IN SUCH A COURT OR THAT SUCH COURT IS AN INCONVENIENT FORUM. NOTHING HEREIN SHALL LIMIT THE RIGHT OF THE AGENT OR ANY LENDER TO BRING PROCEEDINGS AGAINST THE BORROWER IN THE COURTS OF ANY OTHER JURISDICTION. ANY JUDICIAL PROCEEDING BY THE BORROWER AGAINST THE AGENT OR ANY LENDER OR ANY AFFILIATE OF THE AGENT OR ANY LENDER INVOLVING, DIRECTLY OR INDIRECTLY, ANY MATTER IN ANY WAY ARISING OUT OF, RELATED TO, OR CONNECTED WITH ANY LOAN DOCUMENT SHALL BE BROUGHT ONLY IN A COURT IN CHICAGO, ILLINOIS. 15.3 WAIVER OF JURY TRIAL. THE BORROWER, THE AGENT AND EACH LENDER HEREBY WAIVE TRIAL BY JURY IN ANY JUDICIAL PROCEEDING INVOLVING, DIRECTLY OR INDIRECTLY, ANY MATTER (WHETHER SOUNDING IN TORT, CONTRACT OR OTHERWISE) IN ANY WAY ARISING OUT OF, RELATED TO, OR CONNECTED WITH ANY LOAN DOCUMENT OR THE RELATIONSHIP ESTABLISHED THEREUNDER. ARTICLE XVI NO RECOURSE ----------- The obligations of the Borrower and the Parent under the Loan Documents shall be satisfied solely from the Preferred Stock and the stock required to be pledged to the Agent and the Lenders under the Parent Pledge Agreement and the proceeds thereof. Moreover, no -41- 47 recourse shall be had for any obligation owing to any Lender or the Administrative Agent under any Loan Document or for the payment of any fee due to any Lender or the Agent under any Loan Document or any other obligation or claim arising out of or based upon any Loan Document against any stockholder, employee, officer, director, affiliate or incorporator of the Borrower, the Parent or Lord Securities Corporation based on their status as such or their actions in connection therewith, except to the extent resulting from the fraud or willful misconduct of such stockholder, employee, officer, director, affiliate or incorporator, as the case may be. The provisions of this Article XVI shall survive the termination of any or all Loan Documents and, with respect to any Lender or the Agent, the resignation or replacement thereof. [signature page follows] -42- 48 IN WITNESS WHEREOF, the Borrower, the Lenders and the Agent have executed this Agreement as of the date first above written. SAF FUNDING CORPORATION By: /s/ Richard L. Taiano --------------------------------------- Title: Vice President ------------------------------------ Address: 2 Wall Street New York, New York 10005 Attn: Richard Taiano Telephone: (212) 346-9006 Facsimile: (212) 346-9012 BANK ONE, NA, Individually and as Agent By: /s/ Cynthia W. Priest --------------------------------------- Title: First Vice President ------------------------------------ Address: 1 Bank One Plaza Chicago, Illinois 60670 Attn: Cynthia W. Priest Telephone: (312) 732-9565 Facsimile: (312) 732-4033 S-1 [TO CREDIT AGREEMENT] 49 FIRSTAR BANK, NA, Individually By: /s/ James C. Blythe --------------------------------------- Title: Vice President ------------------------------------ Address: 175 South Third Street 4th Floor Columbus, Ohio 43215-5134 Attn: Celia V. Conlon Telephone: (614) 232-8194 Facsimile: (614) 232-8098 S-2 [TO CREDIT AGREEMENT] 50 THE HUNTINGTON NATIONAL BANK, Individually By: /s/ Nancy J. Cracolice --------------------------------- Title: Vice President ------------------------------ Address: 41 South High Street HC0810 8th Floor Columbus, Ohio 43215 Attn: Nancy J. Cracolice Telephone: (614) 480-4401 Facsimile: (614) 480-5791 S-3 [TO CREDIT AGREEMENT] 51 MELLON BANK, N.A., Individually By: /s/ Maria E. Totin -------------------------------- Title: Credit Manager ----------------------------- Address: One Mellon Bank Center Room 4401 Pittsburgh, PA 15258-0001 Attn: Maria E. Totin Telephone: (412) 236-1625 Facsimile: (412) 234-8087 S-4 [TO CREDIT AGREEMENT] 52 NATIONAL CITY BANK, Individually By: /s/ Rick Mariotti -------------------------------- Title: Assistant Vice President ----------------------------- Address: 155 E. Broad Street 3rd Floor Columbus, Ohio 43251-0033 Attn: Rick Mariotti Telephone: (614) 463-7305 Facsimile: (614) 463-6770 S-5 [TO CREDIT AGREEMENT] 53 THE INDUSTRIAL BANK OF JAPAN, LIMITED, Individually By: /s/ Walter Wolff -------------------------------- Title: Joint General Manager ----------------------------- Address: 227 West Monroe Street Suite 2600 Chicago, Illinois 60606 Attn: Koichi Zaiki Telephone: (312) 855-8254 Facsimile: (312) 855-8200 S-6 [TO CREDIT AGREEMENT] 54 KEYBANK NATIONAL ASSOCIATION, Individually By: /s/ Sherrie I. Manson -------------------------------- Title: Vice President ----------------------------- Address: 127 Public Square Large Corporate - 6th Floor Cleveland, Ohio 44114 Attn: Sherrie Manson Telephone: (216) 689-3443 Facsimile: (216) 689-4981 S-7 [TO CREDIT AGREEMENT] 55 PARK NATIONAL BANK By: /s/ Thomas Button -------------------------------- Title: Vice President ----------------------------- Address: 140 East Town Street Columbus, Ohio 43215 Attn: Tom Button Telephone: (614) 228-0283 Facsimile: (614) 228-0205 S-8 [TO CREDIT AGREEMENT] 56 SCHEDULE 1 ---------- COMMITMENTS - ----------------------------------------------------------- ---------------------------------------------------------
Lender Commitment ------ ---------- - ----------------------------------------------------------- --------------------------------------------------------- Bank One, NA $ 20,000,000 - ----------------------------------------------------------- --------------------------------------------------------- Firstar Bank, NA $ 20,000,000 - ----------------------------------------------------------- --------------------------------------------------------- The Huntington National Bank $ 20,000,000 - ----------------------------------------------------------- --------------------------------------------------------- Mellon Bank, N.A. $ 20,000,000 - ----------------------------------------------------------- --------------------------------------------------------- National City Bank $ 20,000,000 - ----------------------------------------------------------- --------------------------------------------------------- The Industrial Bank of Japan, Limited $ 15,000,000 - ----------------------------------------------------------- --------------------------------------------------------- Keybank National Association $ 15,000,000 - ----------------------------------------------------------- --------------------------------------------------------- Park National Bank $ 5,000,000 - ----------------------------------------------------------- --------------------------------------------------------- Aggregate Commitment $ 135,000,000 -------------------- - ----------------------------------------------------------- ---------------------------------------------------------
57 EXHIBIT A FORM OF OPINION November 19, 1999 The Agent and the Lenders who are parties to the Credit Agreement described below. Gentlemen/Ladies: We are counsel for SAF Financial Corporation, a Delaware corporation (the "Borrower"), and have represented the Borrower in connection with its execution and delivery of a Credit Agreement dated as of November 19, 1999 (the "Agreement"), among the Borrower, the Lenders named therein, and Bank One, NA, as Agent, and providing for Advances in an aggregate principal amount not exceeding $100,000,000 at any one time outstanding. All capitalized terms used in this opinion and not otherwise defined herein shall have the meanings attributed to them in the Agreement. We have examined the Borrower's [DESCRIBE CONSTITUTIVE DOCUMENTS OF BORROWER AND APPROPRIATE EVIDENCE OF AUTHORITY TO ENTER INTO THE TRANSACTION], the Loan Documents and such other matters of fact and law which we deem necessary in order to render this opinion. Based upon the foregoing, it is our opinion that: l. The Borrower is a corporation duly and properly incorporated, validly existing and in good standing under the laws of its jurisdiction of incorporation and has all requisite authority to conduct its business in each jurisdiction in which its business is conducted. 2. The execution and delivery by the Borrower of the Loan Documents to which it is a party and the performance by the Borrower of its obligations thereunder have been duly authorized by proper corporate proceedings on the part of the Borrower and will not: (a) require any consent of the Borrower's shareholders or members (other than any such consent as has already been given and remains in full force and effect); (b) violate (i) any law, rule, regulation, order, writ, judgment, injunction, decree or award binding on the Borrower or (ii) the Borrower's articles or certificate of incorporation, by-laws or other management agreement, or (iii) the provisions of any A-1 58 indenture, instrument or agreement to which the Borrower is a party or is subject, or by which it, or its Property, is bound, or conflict with or constitute a default thereunder; or (c) result in, or require, the creation or imposition of any Lien in, of or on the Property of the Borrower pursuant to the terms of any indenture, instrument or agreement binding upon the Borrower. 3. The Loan Documents to which the Borrower is a party have been duly executed and delivered by the Borrower and constitute legal, valid and binding obligations of the Borrower enforceable against the Borrower in accordance with their terms except to the extent the enforcement thereof may be limited by bankruptcy, insolvency or similar laws affecting the enforcement of creditors' rights generally and subject also to the availability of equitable remedies if equitable remedies are sought. 4. There is no litigation, arbitration, governmental investigation, proceeding or inquiry pending or, to the best of our knowledge after due inquiry, threatened against the Borrower which, if adversely determined, could reasonably be expected to have a Material Adverse Effect. 5. No order, consent, adjudication, approval, license, authorization, or validation of, or filing, recording or registration with, or exemption by, or other action in respect of any governmental or public body or authority, or any subdivision thereof, which has not been obtained by the Borrower, is required to be obtained by the Borrower in connection with the execution and delivery of the Loan Documents, the borrowings under the Agreement, the payment and performance by the Borrower of the Obligations, or the legality, validity, binding effect or enforceability of any of the Loan Documents. 6. The provisions of the Pledge Agreements are sufficient to create in favor of the Lenders a security interest in all right, title and interest of the Borrower in those items and types of collateral described in the Pledge Agreements in which a security interest may be created under Articles 8 or 9 of the Uniform Commercial Code as in effect on the date hereof in Illinois. Financing statements on Form UCC-1's have been duly executed by the Borrower and have been duly filed in each filing office indicated in Exhibit A hereto under the Uniform Commercial Code in effect in each state in which said filing offices are located. The description of the collateral set forth in said financing statements is sufficient to perfect a security interest in the items and types of collateral described therein in which a security interest may be perfected by the filing of a financing statement under the Uniform Commercial Code as in effect in such states. Such filings are sufficient to perfect the security interest created by the Pledge Agreements in all right, title and interest of the Borrower in those items and types of collateral described in the Pledge Agreements in which a security interest may be perfected by the filing of a financing statement under the Uniform Commercial Code in such states, except that we express no opinion as to personal property affixed to real property in such manner as to become a fixture under the laws of any state in which the collateral may be located and we call your attention to the fact that the Lenders' security interest in certain of such collateral may not be perfected by filing financing statements under the Uniform Commercial Code. A-2 59 This opinion may be relied upon by the Agent, the Lenders and their participants, assignees and other transferees. Very truly yours, A-3 60 EXHIBIT B COMPLIANCE CERTIFICATE To: The Lenders parties to the Credit Agreement Described Below This Compliance Certificate is furnished pursuant to that certain Credit Agreement dated as of November 19, 1999 (as amended, modified, renewed or extended from time to time, the "Agreement") among SAF Funding Corporation (the "Borrower"), the lenders party thereto and Bank One, NA, as Agent for the Lenders. Unless otherwise defined herein, capitalized terms used in this Compliance Certificate have the meanings ascribed thereto in the Agreement. THE UNDERSIGNED HEREBY CERTIFIES THAT: 1. I am the duly elected of the Borrower; ------------- 2. I have reviewed the terms of the Agreement and I have made, or have caused to be made under my supervision, a detailed review of the transactions and conditions of the Borrower during the accounting period covered by the attached financial statements; 3. The examinations described in paragraph 2 did not disclose, and I have no knowledge of, the existence of any condition or event which constitutes a Default or Unmatured Default during or at the end of the accounting period covered by the attached financial statements or as of the date of this Certificate, except as set forth below; and Described below are the exceptions, if any, to paragraph 3 by listing, in detail, the nature of the condition or event, the period during which it has existed and the action which the Borrower has taken, is taking, or proposes to take with respect to each such condition or event: - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- The foregoing certifications, together with the financial statements delivered with this Certificate in support hereof, are made and delivered this __ day of __________ , ___. -------------------------- B-1 61 EXHIBIT C ASSIGNMENT AGREEMENT This Assignment Agreement (this "Assignment Agreement") between _______ ________ (the "Assignor") and ____________________________ (the "Assignee") is dated as of ____________, _______. The parties hereto agree as follows: 1. PRELIMINARY STATEMENT. The Assignor is a party to a Credit Agreement (which, as it may be amended, modified, renewed or extended from time to time is herein called the "Credit Agreement") described in Item 1 of Schedule 1 attached hereto ("Schedule 1"). Capitalized terms used herein and not otherwise defined herein shall have the meanings attributed to them in the Credit Agreement. 2. ASSIGNMENT AND ASSUMPTION. The Assignor hereby sells and assigns to the Assignee, and the Assignee hereby purchases and assumes from the Assignor, an interest in and to the Assignor's rights and obligations under the Credit Agreement and the other Loan Documents, such that after giving effect to such assignment the Assignee shall have purchased pursuant to this Assignment Agreement the percentage interest specified in Item 3 of Schedule 1 of all outstanding rights and obligations under the Credit Agreement and the other Loan Documents relating to the facilities listed in Item 3 of Schedule 1. The aggregate Commitment (or Loans, if the applicable Commitment has been terminated) purchased by the Assignee hereunder is set forth in Item 4 of Schedule 1. 3. EFFECTIVE DATE. The effective date of this Assignment Agreement (the "Effective Date") shall be the later of the date specified in Item 5 of Schedule 1 or two Business Days (or such shorter period agreed to by the Agent) after this Assignment Agreement, together with any consents required under the Credit Agreement, are delivered to the Agent. In no event will the Effective Date occur if the payments required to be made by the Assignee to the Assignor on the Effective Date are not made on the proposed Effective Date. 4. PAYMENT OBLIGATIONS. In consideration for the sale and assignment of Loans hereunder, the Assignee shall pay the Assignor, on the Effective Date, the amount agreed to by the Assignor and the Assignee. On and after the Effective Date, the Assignee shall be entitled to receive from the Agent all payments of principal, interest and fees with respect to the interest assigned hereby. The Assignee will promptly remit to the Assignor any interest on Loans and fees received from the Agent which relate to the portion of the Commitment or Loans assigned to the Assignee hereunder for periods prior to the Effective Date and not previously paid by the Assignee to the Assignor. In the event that either party hereto receives any payment to which the other party hereto is entitled under this Assignment Agreement, then the party receiving such amount shall promptly remit it to the other party hereto. 5. RECORDATION FEE. The Assignor and Assignee each agree to pay one-half of the recordation fee required to be paid to the Agent in connection with this Assignment Agreement unless otherwise specified in Item 6 of Schedule 1. C-1 62 6. REPRESENTATIONS OF THE ASSIGNOR; LIMITATIONS ON THE ASSIGNOR'S LIABILITY. The Assignor represents and warrants that (i) it is the legal and beneficial owner of the interest being assigned by it hereunder, (ii) such interest is free and clear of any adverse claim created by the Assignor and (iii) the execution and delivery of this Assignment Agreement by the Assignor is duly authorized. It is understood and agreed that the assignment and assumption hereunder are made without recourse to the Assignor and that the Assignor makes no other representation or warranty of any kind to the Assignee. Neither the Assignor nor any of its officers, directors, employees, agents or attorneys shall be responsible for (i) the due execution, legality, validity, enforceability, genuineness, sufficiency or collectability of any Loan Document, including without limitation, documents granting the Assignor and the other Lenders a security interest in assets of the Borrower or any guarantor, (ii) any representation, warranty or statement made in or in connection with any of the Loan Documents, (iii) the financial condition or creditworthiness of the Borrower or any guarantor, (iv) the performance of or compliance with any of the terms or provisions of any of the Loan Documents, (v) inspecting any of the property, books or records of the Borrower, (vi) the validity, enforceability, perfection, priority, condition, value or sufficiency of any collateral securing or purporting to secure the Loans or (vii) any mistake, error of judgment, or action taken or omitted to be taken in connection with the Loans or the Loan Documents. 7. REPRESENTATIONS AND UNDERTAKINGS OF THE ASSIGNEE. The Assignee (i) confirms that it has received a copy of the Credit Agreement, together with copies of the financial statements requested by the Assignee and such other documents and information as it has deemed appropriate to make its own credit analysis and decision to enter into this Assignment Agreement, (ii) agrees that it will, independently and without reliance upon the Agent, the Assignor or any other Lender and based on such documents and information at it shall deem appropriate at the time, continue to make its own credit decisions in taking or not taking action under the Loan Documents, (iii) appoints and authorizes the Agent to take such action as agent on its behalf and to exercise such powers under the Loan Documents as are delegated to the Agent by the terms thereof, together with such powers as are reasonably incidental thereto, (iv) confirms that the execution and delivery of this Assignment Agreement by the Assignee is duly authorized, (v) agrees that it will perform in accordance with their terms all of the obligations which by the terms of the Loan Documents are required to be performed by it as a Lender, (vi) agrees that its payment instructions and notice instructions are as set forth in the attachment to Schedule 1, (vii) confirms that none of the funds, monies, assets or other consideration being used to make the purchase and assumption hereunder are "plan assets" as defined under ERISA and that its rights, benefits and interests in and under the Loan Documents will not be "plan assets" under ERISA, (viii) agrees to indemnify and hold the Assignor harmless against all losses, costs and expenses (including, without limitation, reasonable attorneys' fees) and liabilities incurred by the Assignor in connection with or arising in any manner from the Assignee's non-performance of the obligations assumed under this Assignment Agreement, and (ix) if applicable, attaches the forms prescribed by the Internal Revenue Service of the United States certifying that the Assignee is entitled to receive payments under the Loan Documents without deduction or withholding of any United States federal income taxes. C-2 63 8. GOVERNING LAW. This Assignment Agreement shall be governed by the internal law, and not the law of conflicts, of the State of Illinois. 9. NOTICES. Notices shall be given under this Assignment Agreement in the manner set forth in the Credit Agreement. For the purpose hereof, the addresses of the parties hereto (until notice of a change is delivered) shall be the address set forth in the attachment to Schedule 1. 10. COUNTERPARTS; DELIVERY BY FACSIMILE. This Assignment Agreement may be executed in counterparts. Transmission by facsimile of an executed counterpart of this Assignment Agreement shall be deemed to constitute due and sufficient delivery of such counterpart and such facsimile shall be deemed to be an original counterpart of this Assignment Agreement. IN WITNESS WHEREOF, the duly authorized officers of the parties hereto have executed this Assignment Agreement by executing Schedule 1 hereto as of the date first above written. C-3 64 SCHEDULE 1 to Assignment Agreement 1. Description and Date of Credit Agreement: Credit Agreement, dated as of November 19, 1999, among SAF Funding Corporation, the financial institutions party thereto (the "Lenders") and Bank One, NA, as agent for the Lenders. 2. Date of Assignment Agreement:_______________, ____ 3. Amounts (As of Date of Item 2 above):
Facility Facility Facility Facility 1* 2* 3* 4* a. Assignee's percentage of each Facility purchased under the Assignment Agreement** % % % % b. Amount of each Facility purchased under the Assignment Agreement*** $ $ $ $
4. Assignee's Commitment (or Loans with respect to terminated Commitments) purchased hereunder: $_______________ 5. Proposed Effective Date: _______________________ 6. Non-standard Recordation Fee Arrangement N/A*** [Assignor/Assignee to pay 100% of fee] [Fee waived by Agent] Accepted and Agreed: [NAME OF ASSIGNOR] [NAME OF ASSIGNEE] By:_____________________________ By:_____________________________ Title:__________________________ Title:__________________________ C-4 65 ACCEPTED AND CONSENTED TO**** ACCEPTED AND CONSENTED TO**** BY [NAME OF BORROWER] BY BANK ONE, NA, AS AGENT By:_____________________________ By:_____________________________ Title:__________________________ Title:__________________________ * Insert specific facility names per Credit Agreement ** Percentage taken to 10 decimal places *** If fee is split 50-50, pick N/A as option **** Delete if not required by Credit Agreement C-5 66 Attachment to SCHEDULE 1 to ASSIGNMENT AGREEMENT ADMINISTRATIVE INFORMATION SHEET -------------------------------- Attach Assignor's Administrative Information Sheet, which must include notice addresses for the Assignor and the Assignee (Sample form shown below) ASSIGNOR INFORMATION -------------------- CONTACT: - -------- Name:_____________________________ Telephone No.:_________________________ Fax No.:__________________________ Telex No.:_____________________________ Answerback:____________________________ PAYMENT INFORMATION: - -------------------- Name & ABA # of Destination Bank:______________________________________________ ______________________________________________ Account Name & Number for Wire Transfer:_______________________________________ _______________________________________ Other Instructions:____________________________________________________________ _______________________________________________________________________________ ADDRESS FOR NOTICES FOR ASSIGNOR:______________________________________________ - -------------------------------- ______________________________________________ ______________________________________________ ASSIGNEE INFORMATION -------------------- CREDIT CONTACT: - --------------- Name:_____________________________ Telephone No.:_________________________ Fax No.:__________________________ Telex No.:_____________________________ Answerback:____________________________ KEY OPERATIONS CONTACTS: - ------------------------ Booking Installation:_________________ Booking Installation:_________________ Name:_________________________________ Name:_________________________________ Telephone No.:________________________ Telephone No.:________________________ Fax No.:______________________________ Fax No.:______________________________ Telex No.:____________________________ Telex No.:____________________________ Answerback:___________________________ Answerback:___________________________ C-6 67 PAYMENT INFORMATION: - -------------------- Name & ABA # of Destination Bank:______________________________________________ ______________________________________________ Account Name & Number for Wire Transfer:_______________________________________ _______________________________________ Other Instructions:____________________________________________________________ _______________________________________________________________________________ ADDRESS FOR NOTICES FOR ASSIGNEE:______________________________________________ - -------------------------------- ______________________________________________ ______________________________________________ C-7 68 BANK ONE INFORMATION -------------------- Assignee will be called promptly upon receipt of the signed agreement. INITIAL FUNDING CONTACT: SUBSEQUENT OPERATIONS CONTACT: - ------------------------ ------------------------------ Name:_____________________ Name:_________________________ Telephone No.: (312)______ Telephone No.: (312)__________ Fax No.: (312)___________ Fax No.: (312)________________ Bank One Telex No.: 190201 (Answerback: FNBC UT) INITIAL FUNDING STANDARDS: - -------------------------- Libor - Fund 2 days after rates are set. BANK ONE WIRE INSTRUCTIONS: Bank One, NA, ABA # 071000013 - --------------------------- LS2 Incoming Account # 481152860000 Ref:________________ ADDRESS FOR NOTICES FOR BANK ONE: 1 Bank One Plaza, Chicago, IL 60670 - --------------------------------- Attn: Agency Compliance Division, Suite IL1-0353 Fax No. (312) 732-2038 or (312) 732-4339 C-8 69 EXHIBIT D LOAN/CREDIT RELATED MONEY TRANSFER INSTRUCTION To Bank One, NA, as Agent (the "Agent") under the Credit Agreement Described Below. Re: Credit Agreement, dated as of November 19, 1999 (as the same may be amended or modified, the "Credit Agreement"), among SAF Funding Corporation (the "Borrower"), the Lenders named therein and the Agent. Capitalized terms used herein and not otherwise defined herein shall have the meanings assigned thereto in the Credit Agreement. The Agent is specifically authorized and directed to act upon the following standing money transfer instructions with respect to the proceeds of Advances or other extensions of credit from time to time until receipt by the Agent of a specific written revocation of such instructions by the Borrower; provided, however, that the Agent may otherwise transfer funds as hereafter directed in writing by the Borrower in accordance with Section 13.1 of the Credit Agreement or based on any telephonic notice made in accordance with Section 2.14 of the Credit Agreement. Facility Identification Number(s)______________________________________________ Customer/Account Name__________________________________________________________ Transfer Funds To______________________________________________________________ ______________________________________________________________ For Account No.________________________________________________________________ Reference/Attention To_________________________________________________________ Authorized Officer (Customer Representative) Date___________________________ ____________________________________________ _______________________________ (Please Print) Signature Bank Officer Name Date___________________________ ____________________________________________ _______________________________ (Please Print) Signature (Deliver Completed Form to Credit Support Staff For Immediate Processing) D-1 70 EXHIBIT E NOTE [Date] SAF Funding Corporation, a Delaware corporation (the "Borrower"), promises to pay to the order of ____________________________________ (the "Lender") the aggregate unpaid principal amount of all Loans made by the Lender to the Borrower pursuant to Article II of the Agreement (as hereinafter defined), in immediately available funds at the main office of Bank One, NA in Chicago, Illinois, as Agent, together with interest on the unpaid principal amount hereof at the rates and on the dates set forth in the Agreement. The Borrower shall pay the principal of and accrued and unpaid interest on the Loans in full on the Facility Termination Date. The Lender shall, and is hereby authorized to, record on the schedule attached hereto, or to otherwise record in accordance with its usual practice, the date and amount of each Loan and the date and amount of each principal payment hereunder. This Note is one of the Notes issued pursuant to, and is entitled to the benefits of, the Credit Agreement dated as of November 19, 1999 (which, as it may be amended or modified and in effect from time to time, is herein called the "Agreement"), among the Borrower, the lenders party thereto, including the Lender, and Bank One, NA, as Agent, to which Agreement reference is hereby made for a statement of the terms and conditions governing this Note, including the terms and conditions under which this Note may be prepaid or its maturity date accelerated. This Note is secured pursuant to the Pledge Agreements and guaranteed pursuant to the Guaranty, all as more specifically described in the Agreement, and reference is made thereto for a statement of the terms and provisions thereof. Capitalized terms used herein and not otherwise defined herein are used with the meanings attributed to them in the Agreement. SAF FUNDING CORPORATION By:__________________________________ Print Name:__________________________ Title:_______________________________ D-2 71 SCHEDULE OF LOANS AND PAYMENTS OF PRINCIPAL TO NOTE OF SAF FUNDING CORPORATION DATED _____________ , ____ Principal Maturity Principal Amount of of Interest Amount Unpaid Date Loan Period Paid Balance - -------------------------------------------------------------------------------- D-3 EX-10.U 3 EXHIBIT 10(U) 1 Exhibit 10(U) ================================================================================ PUT AGREEMENT among STATE AUTOMOBILE MUTUAL INSURANCE COMPANY, STATE AUTO FINANCIAL CORPORATION, and BANK ONE, NA, as Agent Dated as of November 19, 1999 ================================================================================ 2 PUT AGREEMENT This Put Agreement, dated as of November 19, 1999, is among State Automobile Mutual Insurance Company, a mutual insurance company duly organized and validly existing under the laws of the State of Ohio ("State Auto Mutual"), State Auto Financial Corporation, a corporation duly organized and validly existing under the laws of the State of Ohio ("State Auto Financial" and, together with State Auto Mutual, the "State Auto Obligors"), and Bank One, NA, as agent (in such capacity, together with its successors in such capacity, the "Agent") for the Lenders party to the Credit Agreement referred to below. RECITALS: --------- A. SAF Funding Corporation (the "Borrower"), the lenders party thereto from time to time (the "Lenders") and the Agent are parties to a Credit Agreement, dated as of November 19, 1999 (as modified and supplemented and in effect from time to time, the "Credit Agreement"), providing, subject to the terms and conditions thereof, for term loans to be made by the Lenders to the Borrower in an aggregate principal amount not exceeding $135,000,000. B. The proceeds of the term loans made to the Borrower under the Credit Agreement are to be used by the Borrower to purchase certain preferred stock of State Auto Financial pursuant to a Standby Purchase Agreement, dated as of the date hereof, among the Borrower and State Auto Financial (as modified and supplemented and in effect from time to time as permitted hereby, the "Standby Purchase Agreement"). NOW, THEREFORE, to induce the Lenders to enter into the Credit Agreement and to make loans thereunder and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto agree as follows: ARTICLE I DEFINITIONS ----------- 1.1 Definitions and Accounting Terms. Capitalized terms used but not defined herein shall have the respective meanings, assigned to such terms in the Credit Agreement. In addition, as used herein, the following terms shall have the following meanings (all terms defined in this Section 1.1 or in other provisions of this Agreement in the singular to have the same meanings when used in the plural and vice versa): "Affiliate" shall mean any Person that directly or indirectly controls, or is under common control with, or is controlled by, State Auto Mutual. As used in this definition, "control" (including, with its correlative meanings, "controlled by" and "under common control with") shall mean possession, directly or indirectly, of power to direct or cause the direction of management or policies (whether through ownership of securities or partnership or other 3 ownership interests, by contract or otherwise), provided that, in any event, any Person that owns directly or indirectly securities having 5% or more of the voting power for the election of directors or other governing body of a corporation or 5% or more of the partnership or other ownership interests of any other Person (other than as a limited partner of such other Person) will be deemed to control such corporation or other Person. Notwithstanding the foregoing, (a) no individual shall be an Affiliate solely by reason of his or her being a director, officer or employee of State Auto Mutual or any of its Subsidiaries and (b) State Auto Mutual and its Subsidiaries shall not be deemed to be Affiliates of one another. "Agreement Accounting Principles" means generally accepted accounting principles as in effect from time to time. "Applicable Insurance Regulatory Authority" shall mean, when used with respect to any Insurance Entity, the insurance department or similar administrative authority or agency located in the State in which such Insurance Entity is domiciled. "Assumed Reinsurance" shall mean reinsurance assumed by any Insurance Entity from another Person (other than from another Insurance Entity). "Capital Expenditures" shall mean, for any period, expenditures (including, without limitation, the aggregate amount of Capital Lease Obligations incurred during such period) made by State Auto Mutual or any of its Subsidiaries to acquire or construct fixed assets, plant and equipment (including renewals, improvements and replacements, but excluding repairs) during such period computed in accordance with Agreement Accounting Principles. "Ceded Reinsurance" shall mean reinsurance ceded by any Insurance Entity to any other Person (other than to another Insurance Entity), other than Surplus Relief Reinsurance. "Environmental Claim" shall mean, with respect to any Person, any written or oral notice, claim, demand or other communication (collectively, a "claim") by any other Person alleging or asserting such Person's liability for investigatory costs, cleanup costs, governmental response costs, damages to natural resources or other Property, personal injuries, fines or penalties arising out of, based on or resulting from (a) the presence, or Release into the environment, of any Hazardous Material at any location, whether or not owned by such Person, or (b) circumstances forming the basis of any violation, or alleged violation, of any Environmental Law. The term "Environmental Claim" shall include, without limitation, any claim by any governmental authority for enforcement, cleanup, removal, response, remedial or other actions or damages pursuant to any applicable Environmental Law, and any claim by any third party seeking damages, contribution, indemnification, cost recovery, compensation or injunctive relief resulting from the presence of Hazardous Materials or arising from alleged injury or threat of injury to health, safety or the environment. "Environmental Laws" shall mean any and all present and future Federal, state, local and foreign laws, rules or regulations, and any orders or decrees, in each case as now or hereafter in effect, relating to the regulation or protection of human health, safety or the environment or to emissions, discharges, releases or threatened releases of pollutants, contaminants, chemicals or toxic or hazardous substances or wastes into the indoor or outdoor environment, including, without limitation, ambient air, soil, surface water, ground water, wetlands, land or subsurface strata, or otherwise relating to the manufacture, processing, -2- 4 distribution, use, treatment, storage, disposal, transport or handling of pollutants, contaminants, chemicals or toxic or hazardous substances or wastes. "Equity Public Offering" shall mean a public issuance or sale by State Auto Mutual or any of its Material Subsidiaries after the Closing Date pursuant to a registration statement filed under the Securities Act of 1933, as amended, of any common stock. "ERISA" shall mean the Employee Retirement Income Security Act of 1974, as amended from time to time. "ERISA Affiliate" shall mean any corporation or trade or business that is a member of any group of organizations (a) described in Section 414(b) or (c) of the Code of which State Auto Mutual is a member and (b) solely for purposes of potential liability under Section 302(c)(11) of ERISA and Section 412(c)(11) of the Code and the lien created under Section 302(f) of ERISA and Section 412(n) of the Code, described in Section 414(m) or (o) of the Code of which State Auto Mutual is a member. "Excluded Taxes" means, in the case of each Lender or applicable Lending Installation and the Agent, taxes imposed on its overall net income, and franchise taxes imposed on it, by (a) the jurisdiction under the laws of which such Lender or the Agent is incorporated or organized or (b) the jurisdiction in which the Agent's or such Lender's principal executive office or such Lender's applicable Lending Installation is located. "Farmers Casualty" means Farmers Casualty Insurance Company, an Iowa domiciled property and casualty insurance company. "Fixed Charge Coverage Ratio" means the ratio of (a) the sum of (i) the greater of (A) 10% of the aggregate amount of statutory capital and surplus of each Subsidiary of State Auto Financial which is engaged in the insurance business as of the most recently ended calendar year (determined without duplication in accordance with SAP) or (B) the aggregate net income earned by each Subsidiary of State Auto Financial which is engaged in the insurance business for the most recently ended four fiscal quarters (determined without duplication in accordance with SAP), plus (ii) cash on hand at State Auto Financial at the end of the most recently ended fiscal quarter, plus (iii) the aggregate net income of each Subsidiary of State Auto Financial which is not engaged in the insurance business for the most recently ended four fiscal quarters (determined without duplication in accordance with Agreement Accounting Principles) to (b) the sum of (i) interest payments on the Loans for the most recent four quarters, plus (ii) scheduled principal amortization payments on the Loans for the four fiscal quarters following the date of determination. "Hazardous Material" shall mean, collectively, (a) any petroleum or petroleum products, flammable materials, explosives, radioactive materials, asbestos, urea formaldehyde foam insulation, and transformers or other equipment that contain polychlorinated biphenyls ("PCB's"), (b) any chemicals or other materials or substances that are now or hereafter become defined as or included in the definition of "hazardous substances", "hazardous wastes", "hazardous materials", "extremely hazardous wastes", "restricted hazardous wastes", "toxic substances", "toxic pollutants", "contaminants", "pollutants" or words of similar import under -3- 5 any Environmental Law and (c) any other chemical or other material or substance, exposure to which is now or hereafter prohibited, limited or regulated under any Environmental Law. "Indebtedness" shall mean, for any Person: (a) obligations created, issued or incurred by such Person for borrowed money (whether by loan, the issuance and sale of debt securities or the sale of Property to another Person subject to an understanding or agreement, contingent or otherwise, to repurchase such Property from such Person); (b) obligations of such Person to pay the deferred purchase or acquisition price of Property or services, other than trade accounts payable (other than for borrowed money) arising, and accrued expenses incurred, in the ordinary course of business so long as such trade accounts payable are payable within 90 days of the date the respective goods are delivered or the respective services are rendered; (c) Indebtedness of others secured by a Lien on the Property of such Person, whether or not the respective indebtedness so secured has been assumed by such Person; (d) obligations of such Person in respect of letters of credit or similar instruments issued or accepted by banks and other financial institutions for account of such Person; (e) Capital Lease Obligations of such Person; and (f) Indebtedness of others Guaranteed by such Person; provided that Indebtedness shall not include (i) obligations with respect to insurance policies, annuities, guaranteed investment contracts and similar products underwritten by, or Reinsurance Agreements or Retrocession Agreements entered into by, an Insurance Entity in the ordinary course of its business and (ii) obligations with respect to Surplus Relief Reinsurance ceded by an Insurance Entity. "Insurance Entity" shall mean, collectively, State Auto Mutual and the Subsidiaries of State Auto Mutual licensed to underwrite property and casualty insurance. "Intercompany Pooling Arrangement" shall mean the pooling arrangement among State Auto Mutual, State Auto P&C, Milbank, Midwest Security and Farmers Casualty pursuant to which (a) State Auto P&C cedes to State Auto Mutual all of its insurance business, (b) Milbank cedes to State Auto Mutual its property and casualty insurance business, (c) Midwest Security cedes to State Auto Mutual its property and casualty insurance business, (d) Farmers Casualty cedes to State Auto Mutual its property and casualty insurance business and (e) State Auto Mutual retains its property and casualty insurance business, whereupon all such businesses are pooled and a portion thereof is then ceded from State Auto Mutual to each of State Auto P&C, Milbank, Midwest Security and Farmers Casualty and the balance thereof is retained by State Auto Mutual, as such arrangement may be modified and supplemented and in effect from time to time. "Interest Rate Protection Agreement" shall mean, for any Person, an interest rate swap, cap or collar agreement or similar arrangement between such Person and one or more financial institutions providing for the transfer or mitigation of interest risks either generally or under specific contingencies. For purposes hereof, the "credit exposure" at any time of any Person under an Interest Rate Protection Agreement to which such Person is a party shall be determined at such time in accordance with the standard methods of calculating credit exposure under similar arrangements as prescribed from time to time by the Agent, taking into account potential interest rate movements and the respective termination provisions and notional principal amount and term of such Interest Rate Protection Agreement. -4- 6 "Investment" shall mean, for any Person: (a) the acquisition (whether for cash, Property, services or securities or otherwise) of capital stock, bonds, notes, debentures, partnership or other ownership interests or other securities of any other Person or any agreement to make any such acquisition (including, without limitation, any "short sale" or any sale of any securities at a time when such securities are not owned by the Person entering into such sale); (b) the making of any deposit with, or advance, loan or other extension of credit or capital contribution to, any other Person (including the purchase of Property from another Person subject to an understanding or agreement, contingent or otherwise, to resell such Property to such Person), but excluding any such advance, loan or extension of credit having a term not exceeding 90 days arising in connection with the sale of inventory or supplies by such Person in the ordinary course of business; (c) the entering into of any Guarantee of, or other contingent obligation with respect to, Indebtedness or other liability of any other Person and (without duplication) any amount committed to be advanced, lent or extended to such Person; or (d) the entering into of any Interest Rate Protection Agreement. "License" shall have the meaning assigned to such term in Section 3.17 hereof. "Material Adverse Effect" shall mean a material adverse effect on (a) the Property, business, operations, financial condition, prospects, liabilities or capitalization of State Auto Mutual and its Subsidiaries taken as a whole, (b) the ability of State Auto Mutual to perform its obligations under this Agreement, (c) the validity or enforceability of any of the Basic Documents or (d) the rights and remedies of the Lenders and the Agent under any of the Basic Documents. "Material Subsidiary" shall mean, as at any time, any of State Auto Financial, State Auto P&C, Milbank, State Auto National Insurance Company, and any other Subsidiary of State Auto Mutual that holds, directly or indirectly, more than 5% of the consolidated assets of State Auto Mutual and its Subsidiaries at such time or that accounts for more than 5% of the consolidated revenues of State Auto Mutual and its Subsidiaries at such time. "Midwest Security" means Midwest Security Insurance Company, a Wisconsin domiciled property and casualty insurance company. "Milbank" shall mean Milbank Insurance Company, a South Dakota domiciled property and casualty insurance company. "Multiemployer Plan" shall mean a multiemployer plan defined as such in Section 3(37) of ERISA to which contributions have been made by State Auto Mutual or any ERISA Affiliate and that is covered by Title IV of ERISA. "NAIC" shall mean the National Association of Insurance Commissioners and any successor thereto. "Net Available Proceeds" shall mean, with respect to any Equity Public Offering, the aggregate amount of all cash received by State Auto Mutual and its Material Subsidiaries in respect of such Equity Public Offering net of reasonable expenses incurred by State Auto Mutual and its Material Subsidiaries in connection therewith. -5- 7 "Obligations" shall have the meaning assigned to such term in Section 2.4 hereof. "Other Taxes" is defined in Section 2.7(b). "PBGC" shall mean the Pension Benefit Guaranty Corporation or any entity succeeding to any or all of its functions under ERISA. "Plan" shall mean an employee benefit or other plan established or maintained by State Auto Mutual or any ERISA Affiliate and that is covered by Title IV of ERISA, other than a Multiemployer Plan. "Pledged Stock" shall mean the Preferred Stock pledged pursuant to the Company Pledge Agreement to the Agent for the benefit of the Lenders and all related rights in connection therewith. "Premium to Surplus Ratio" shall mean, with respect to any Person as at any date of determination thereof, the ratio (determined with respect to such Person and its Subsidiaries in accordance with SAP) of (a) net premiums written during the four consecutive calendar quarters ending on or most recently ended prior to such date of determination to (b) Statutory Surplus as at the last day of the calendar quarter ending on or most recently ended prior to such date of determination. "Put Event" shall mean one or more of the following events shall have occurred and be continuing: (a) a Default; (b) either State Auto Obligor shall default in the payment when due of any amount payable by it hereunder or State Auto Financial shall default in the payment when due of any amount payable by it under the Standby Purchase Agreement; (c) State Auto Mutual or any of its Material Subsidiaries shall default in the payment when due of any principal of or interest on any of its other Indebtedness aggregating $5,000,000 or more; or any event specified in any note, agreement, indenture or other document evidencing or relating to any such Indebtedness shall occur if the effect of such event is to cause, or (with the giving of any notice or the lapse of time or both) to permit the holder or holders of such Indebtedness (or a trustee or agent on behalf of such holder or holders) to cause, such Indebtedness to become due, or to be prepaid in full (whether by redemption, purchase, offer to purchase or otherwise), prior to its stated maturity or to have the interest rate thereon reset to a level so that securities evidencing such Indebtedness trade at a level specified in relation to the par value thereof; or State Auto Mutual or any of its Material Subsidiaries shall default in the payment when due of any amount aggregating $10,000,000 or more under any Interest Rate Protection Agreement; or State Auto Mutual or any of its Material Subsidiaries shall default under any Interest Rate Protection Agreement if the effect of such default is to cause, or (with the giving of any notice or the lapse of time or both) to permit, termination or liquidation payment or payments by State Auto Mutual or any of its Material Subsidiaries aggregating $5,000,000 or more to become due; -6- 8 (d) any representation, warranty or certification made or deemed made herein or in any other Basic Document (or in any modification or supplement hereto or thereto) by either State Auto Obligor party thereto, or any certificate furnished to any Lender or the Agent pursuant to the provisions hereof or thereof, shall prove to have been false or misleading as of the time made or furnished in any material respect; (e) State Auto Mutual shall default in the performance of any of its obligations under any of Sections 4.5 through 4.9 or 4.12 through 4.17 hereof, State Auto Financial shall default in the performance of any of its obligations under the Standby Purchase Agreement; or either State Auto Obligor shall default in the performance of any of its other obligations under this Agreement and such default shall continue unremedied for a period of 30 or more days after the occurrence of such default; (f) State Auto Mutual or any of its Material Subsidiaries shall admit in writing its inability to, or be generally unable to, pay its debts as such debts become due; (g) State Auto Mutual or any of its Material Subsidiaries shall (i) apply for or consent to the appointment of, or the taking of possession by, a receiver, custodian, trustee, examiner or liquidator of itself or of all or a substantial part of its Property, (ii) make a general assignment for the benefit of its creditors, (iii) commence a voluntary case under the Bankruptcy Code, (iv) file a petition seeking to take advantage of any other law relating to bankruptcy, insolvency, reorganization, liquidation, dissolution, arrangement or winding-up, or composition or readjustment of debts, (v) fail to controvert in a timely and appropriate manner, or acquiesce in writing to, any petition filed against it in an involuntary case under the Bankruptcy Code or (vi) take any corporate action for the purpose of effecting any of the foregoing; (h) a proceeding or case shall be commenced, without the application or consent of State Auto Mutual or any of its Material Subsidiaries, in any court of competent jurisdiction, seeking (i) its reorganization, liquidation, dissolution, arrangement or winding-up, or the composition or readjustment of its debts, (ii) the appointment of a receiver, custodian, trustee, examiner, liquidator or the like of State Auto Mutual or such Material Subsidiary or of all or any substantial part of its Property or (iii) similar relief in respect of State Auto Mutual or such Material Subsidiary under any law relating to bankruptcy, insolvency, reorganization, winding-up, or composition or adjustment of debts, and such proceeding or case shall continue undismissed, or an order, judgment or decree approving or ordering any of the foregoing shall be entered and continue unstayed and in effect, for a period of 60 or more days; or an order for relief against State Auto Mutual or such Material Subsidiary shall be entered in an involuntary case under the Bankruptcy Code; (i) any Applicable Insurance Regulatory Authority shall appoint a rehabilitator, receiver, custodian, trustee, conservator or liquidator or the like (collectively, a "conservator") for any Insurance Entity, or cause possession of all or any substantial portion of the property of any Insurance Entity to be taken by any conservator (or any Insurance Regulatory Authority shall commence any action to effect any of the foregoing); -7- 9 (j) a final judgment or judgments for the payment of money of $10,000,000 or more in the aggregate (exclusive of judgment amounts fully covered by insurance where the insurer has admitted liability in respect of such judgment) or of $25,000,000 or more in the aggregate (regardless of insurance coverage) shall be rendered by one or more courts, administrative tribunals or other bodies having jurisdiction against State Auto Mutual or any of its Subsidiaries and the same shall not be discharged (or provision shall not be made for such discharge), or a stay of execution thereof shall not be procured, within 30 days from the date of entry thereof and State Auto Mutual or the relevant Material Subsidiary shall not, within said period of 30 days, or such longer period during which execution of the same shall have been stayed, appeal therefrom and cause the execution thereof to be stayed during such appeal; (k) an event or condition specified in Section 4.1(j) hereof shall occur or exist with respect to any Plan or Multiemployer Plan and, as a result of such event or condition, together with all other such events or conditions, State Auto Mutual or any ERISA Affiliate shall incur or in the opinion of the Required Lenders shall be reasonably likely to incur a liability to a Plan, a Multiemployer Plan or the PBGC (or any combination of the foregoing) that, in the determination of the Required Lenders, would (either individually or in the aggregate) have a Material Adverse Effect; (l) a reasonable basis shall exist for the assertion against State Auto Mutual or any of its Subsidiaries, or any predecessor in interest of State Auto Mutual or any of its Subsidiaries or Affiliates, of (or there shall have been asserted against State Auto Mutual or any of its Subsidiaries) an Environmental Claim that, in the judgment of the Required Lenders is reasonably likely to be determined adversely to State Auto Mutual or any of its Subsidiaries, and the amount thereof (either individually or in the aggregate) is reasonably likely to have a Material Adverse Effect (insofar as such amount is payable by State Auto Mutual or any of its Subsidiaries but after deducting any portion thereof that is reasonably expected to be paid by other creditworthy Persons jointly and severally liable therefor); (m) during any period of (i) 12 consecutive months if no Loans are outstanding or (ii) 25 consecutive months if any Loans are outstanding, a majority of the Board of Directors of State Auto Mutual, State Auto Financial or State Auto P&C, as the case may be, shall no longer be composed of individuals (x) who were members of said Board on the first day of such period, (y) whose election or nomination to said Board was approved by individuals referred to in clause (x) above constituting at the time of such election or nomination at least a majority of said Board or (z) whose election or nomination to said Board was approved by individuals referred to in clauses (x) and (y) above constituting at the time of such election or nomination at least a majority of said Board; (n) except for expiration in accordance with its terms, any material provision of this Agreement or the Standby Purchase Agreement shall for whatever reason be terminated or cease to be in full force and effect without the consent of the Lenders as specified in Section 10.17 of the Credit Agreement, or the validity or enforceability thereof shall be contested by either State Auto Obligor; -8- 10 (o) any "person" or "group" of "persons" (within the meaning of Section 13(d) of the Securities and Exchange Act of 1934, as amended) shall have the power, directly or indirectly, to vote or direct the voting of a greater number of the voting capital stock issued by State Auto Financial than State Auto Mutual; or State Auto Financial shall fail to own and control, beneficially (free and clear of all Liens), all of the capital stock issued by State Auto P&C (in each case irrespective of whether or not at the time securities or other ownership interests issued by State Auto Financial or State Auto P&C, as the case may be, or any other class or classes might have voting power by reason of the happening of any contingency); or (p) the rating published by A.M. Best & Co. for (i) State Auto Mutual shall be less than (x) "A", at any time prior to the date of the occurrence of the catastrophe relating to the initial Loans under the Credit Agreement, (y) "B+", at any time during the period commencing on the first anniversary of the date of the occurrence of such catastrophe to but excluding the fourth anniversary thereof, and (z) "A-", at any time thereafter, or (ii) State Auto P&C shall be less than "A" at any time prior to the date of the occurrence of such catastrophe. "Put Notice" shall mean an instrument executed by the Agent substantially in the form of Exhibit A hereto. "Put Purchase Date" shall mean the date specified in a Put Notice as the date on which State Auto Mutual shall purchase all of the Loans or the Pledged Stock, as specified therein. "Reinsurance Agreement" shall mean any agreement, contract, treaty or other arrangement providing for Ceded Reinsurance by any Insurance Entity or any Subsidiary of such Insurance Entity. "Release" shall mean any release, spill, emission, leaking, pumping, injection, deposit, disposal, discharge, dispersal, leaching or migration into the indoor or outdoor environment, including, without limitation, the movement of Hazardous Materials through ambient air, soil, surface water, ground water, wetlands, land or subsurface strata. "Retrocession Agreement" shall mean any agreement, contract, treaty or other arrangement (other than Surplus Relief Reinsurance) whereby any Insurance Entity or any Subsidiary of such Insurance Entity cedes reinsurance to other insurers (other than to another Insurance Entity or any of its Subsidiaries). "Risk-Based Capital Ratio" shall mean, with respect to any Person as at any date of determination thereof, the ratio of (a) Total Adjusted Capital (as defined by the NAIC) for such Person as at such date of determination to (b) Authorized Control Level Risk-Based Capital (as defined by the NAIC) for such Person as at such date of determination. "SAP" shall mean, with respect to any Insurance Entity, the accounting procedures and practices prescribed or permitted by the Applicable Insurance Regulatory Authority, applied on a basis consistent with those that, in accordance with the last sentence of -9- 11 Section 1.2(a) hereof, are to be used in making the calculations for purposes of determining compliance with this Agreement. "State Auto P&C" shall mean State Auto Property and Casualty Insurance Company, a South Carolina corporation. "Statutory Statement" shall mean, as to any Insurance Entity, a statement of the condition and affairs of such Insurance Entity, prepared in accordance with statutory accounting practices required or permitted by the Applicable Insurance Regulatory Authority, and filed with the Applicable Insurance Regulatory Authority. "Statutory Surplus" shall mean, as at any date for any Insurance Entity, the aggregate amount of surplus as regards policyholders (determined without duplication in accordance with SAP) of such Insurance Entity. "Surplus Relief Reinsurance" shall mean any transaction in which any Insurance Entity or any Subsidiary of such Insurance Entity cedes business under a reinsurance agreement that would be considered a "financing-type" reinsurance agreement as determined by the independent certified public accountants of State Auto Mutual in accordance with principles published by the Financial Accounting Standards Board or the Second Edition of the AICPA Audit Guide for Stock Life Insurance Companies (pp. 91-92), as the same may be revised from time to time. "Taxes" means any and all present or future taxes, duties, levies, imposts, deductions, charges or withholdings, and any and all liabilities with respect to the foregoing, but excluding Excluded Taxes and Other Taxes. "Tax Sharing Agreement" shall mean any tax sharing or allocation agreement to which State Auto Mutual or any of its Subsidiaries is a party and all tax indemnity agreements as to which State Auto Mutual or any of its Subsidiaries is the beneficiary or obligor. "Wholly Owned Subsidiary" shall mean, with respect to any Person, any corporation, partnership or other entity of which all of the equity securities or other ownership interests (other than, in the case of a corporation, directors' qualifying shares) are directly or indirectly owned or controlled by such Person or one or more Wholly Owned Subsidiaries of such Person or by such Person and one or more Wholly Owned Subsidiaries of such Person. "Year 2000 Program" is defined in Section 3.19. 1.2 Accounting Terms and Determinations. (a) Except as otherwise expressly provided herein, all accounting terms used herein shall be interpreted, and all financial statements and certificates and reports as to financial matters required to be delivered to the Agent hereunder shall (unless otherwise disclosed to the Agent in writing at the time of delivery thereof in the manner described in subsection (b) below) be prepared, in accordance with Agreement Accounting Principals or with statutory accounting practices applied on a basis consistent with those used in the preparation of the latest financial statements furnished to the Agent hereunder (which, prior to the delivery of the first financial -10- 12 statements under Section 4.1 hereof, shall mean the audited, or annual statutory, financial statements as at December 31, 1998 referred to in Section 3.2 hereof). All calculations made for the purposes of determining compliance with this Agreement shall (except as otherwise expressly provided herein) be made by application of Agreement Accounting Principles or with statutory accounting practices applied on a basis consistent with those used in the preparation of the latest annual or quarterly financial statements furnished to the Agent pursuant to Section 4.1 hereof (or, prior to the delivery of the first financial statements under Section 4.1 hereof, used in the preparation of the audited, or annual statutory, financial statements as at December 31, 1998 referred to in Section 3.2 hereof) unless (i) State Auto Mutual shall have objected to determining such compliance on such basis at the time of delivery of such financial statements or (ii) the Required Lenders (through the Agent) shall so object in writing within 30 days after delivery of such financial statements, in either of which events such calculations shall be made on a basis consistent with those used in the preparation of the latest financial statements as to which such objection shall not have been made (which, if objection is made in respect of the first financial statements delivered under Section 4.1 hereof, shall mean the audited, or annual statutory, financial statements referred to in Section 3.2 hereof). (b) State Auto Mutual shall deliver to the Agent at the same time as the delivery of any annual or quarterly financial statement under Section 4.1 hereof (i) a description in reasonable detail of any material variation between the application of accounting principles, or statutory accounting practices, employed in the preparation of such statement and the application of accounting principles, or statutory accounting practices, employed in the preparation of the next preceding annual or quarterly financial statements as to which no objection has been made in accordance with the last sentence of subsection (a) above and (ii) reasonable estimates of the difference between such statements arising as a consequence thereof. (c) To enable the ready and consistent determination of compliance with the covenants set forth in Article IV hereof, State Auto Mutual will not change the last day of its fiscal year from December 31, or the last days of the first three fiscal quarters in each of its fiscal years from March 31, June 30 and September 30 of each year, respectively. -11- 13 ARTICLE II PUT --- 2.1 Put. At any time after the occurrence and during the continuance of a Put Event, the Agent may (with the approval of the Required Lenders but not otherwise), by delivering to State Auto Mutual a Put Notice, require State Auto Mutual to purchase (a) from each Lender, all (but not less than all) of such Lender's Loans, Notes and Commitment or (b) from the Agent, all (but not less than all) of the Pledged Stock. In the event that a Put Event has occurred and the Agent (with the consent of the Required Lenders) has elected to deliver a Put Notice, it shall first attempt to require State Auto Mutual to purchase the Pledged Stock; provided that if the Agent shall not be able, promptly (and in any event within 5 Business Days of any such election) after the occurrence of such Put Event, to sell the Pledged Stock to State Auto Mutual as contemplated hereby, it may deliver a Put Notice requiring the purchase of each Lender's Loans, Notes and Commitments. 2.2 Purchase of Loans. (a) If such Put Notice requires that State Auto Mutual purchase each Lender's Loans, Notes and Commitment, then, on the Put Purchase Date specified in such Put Notice (which Put Purchase Date shall be at least three Business Days after the date of delivery of such Put Notice), (i) State Auto Mutual shall purchase from each Lender, and each Lender shall sell, assign and transfer to State Auto Mutual, all of such Lender's Loans, Notes and Commitment, as specified in such Put Notice and (ii) State Auto Mutual shall pay to the Agent for account of each Lender an aggregate amount equal to the sum of (x) the aggregate outstanding principal amount of Loans of such Lender plus (y) all accrued and unpaid interest thereon to the Put Purchase Date plus (z) all other amounts then payable to such Lender under the Basic Documents in respect thereof (including all amounts that would be payable under Section 3.4 of the Credit Agreement as if such portion of such Lender's Loans were being prepaid on the Put Purchase Date) (such amounts to be determined by the Agent and notified in writing by the Agent to State Auto Mutual prior to such Put Purchase Date). Upon the occurrence of any Put Event referred to in clause (g), (h) or (i) of the definition of such term in Section 1.1 hereof, State Auto Mutual shall automatically and without any action (including, without limitation the giving of notice) on the part of any other Person be required to purchase the entire principal amount of the Loans then outstanding. (b) Such sale, assignment and transfer shall be without recourse to each Lender and without representation and warranty by such Lender, except that such Lender will represent and warrant to State Auto Mutual that, on the Put Purchase Date, such Lender is the legal and beneficial owner of such portion of such Lender's Loans, Notes and Commitment so sold, assigned and transferred, free and clear of any adverse claim. Upon such sale, assignment and transfer and to the extent thereof, State Auto Mutual shall have the obligations, rights and benefits of a "Lender" under the Credit Agreement holding the Commitment and Loans so sold, assigned and transferred and each Lender shall be released from the Commitment so sold, assigned and transferred. -12- 14 2.3 Purchase of Pledged Stock. If such Put Notice requires that State Auto Mutual purchase the Pledged Stock, then, on the Put Purchase Date specified in such Put Notice (which Put Purchase Date shall be at least three Business Days after the date of delivery of such Put Notice), (a) State Auto Mutual shall purchase from the Agent, and the Agent shall sell, assign and transfer to State Auto Mutual, the Pledged Stock, (b) State Auto Mutual shall pay to the Agent, for account of the Lenders, an amount equal to the aggregate liquidation preference of such Pledged Stock and all accrued but unpaid dividends thereon (such amount to be determined by the Agent and notified in writing by the Agent to State Auto Mutual prior to such Put Purchase Date) and (c) the Agent shall apply such amount to the payment of the Obligations owing to the Lenders under the Credit Documents. 2.4 Obligations Unconditional. The obligations of State Auto Mutual under Sections 2.1, 2.2, 2.3 and 5.3 hereof are absolute, unconditional and irrevocable, irrespective of the value, genuineness, validity, regularity or enforceability of the obligations of the Borrower or any other Person under the Credit Agreement, the Notes, the Pledge Agreements or any other agreement or instrument referred to therein (collectively, the "Obligations"), or any substitution, release or exchange of any other guarantee of or security for any of the Obligations, and, to the fullest extent permitted by applicable law, irrespective of any other circumstance whatsoever that might otherwise constitute a legal or equitable discharge or defense available to State Auto Mutual, it being the intent of this Section 2.4 that the obligations of State Auto Mutual hereunder shall be absolute, unconditional and irrevocable under any and all circumstances. Without limiting the generality of the foregoing, it is agreed that the occurrence of any one or more of the following shall not alter or impair the liability of State Auto Mutual hereunder which shall remain absolute, unconditional and irrevocable as described above: (a) at any time or from time to time, without notice to State Auto Mutual, the time for any performance of or compliance with any of the Obligations shall be extended, or such performance or compliance shall be waived; (b) any of the acts mentioned in any of the provisions of the Credit Agreement, the Notes, the Pledge Agreements or any other agreement or instrument referred to therein shall be done or omitted; (c) the maturity of any of the Obligations shall be accelerated, or any of the Obligations shall be modified, supplemented or amended in any respect, or any right under this Agreement, the Notes, the Pledge Agreements or any other agreement or instrument referred to therein shall be waived or any guarantee of any of the Obligations or any security therefor shall be released or exchanged in whole or in part or otherwise dealt with; or (d) any change in the financial condition (including, without limitation, insolvency or bankruptcy) of the Borrower. State Auto Mutual hereby expressly waives all of the defenses referred to above and diligence, presentment, demand of payment, protest and all notices whatsoever (other than the Put Notice), and any requirement that the Agent or any Lender exhaust any right, power or remedy or proceed against the Borrower under the Credit Agreement, the Notes, the Pledge Agreements or any other -13- 15 agreement or instrument referred therein, or against any other Person under any other guarantee of, or security for, any of the Obligations. 2.5 Reinstatement. If for any reason any payment received by the Agent in respect of any of the Obligations prior to the consummation by State Auto Mutual of a purchase contemplated by Section 2.2 or 2.3 hereof is rescinded or must be otherwise restored by any Lender for any reason, whether as a result of any proceedings in bankruptcy, insolvency or reorganization or otherwise, following the consummation of such purchase, State Auto shall purchase from such Lender, and such Lender shall sell, assign and transfer to State Auto Mutual, all of the right, title and interest of such Lender in and to the payment so rescinded or otherwise restored, and upon such sale, assignment and transfer, State Auto Mutual shall pay to such Lender an amount equal to the payment so rescinded or otherwise restored. State Auto Mutual hereby agrees that it will indemnify the Agent and such Lender on demand for all reasonable costs and expenses (including, without limitation, fees of counsel) incurred by the Agent or such Lender in connection with such rescission or restoration. 2.6 Payments. (a) Except to the extent otherwise provided herein, all payments to be made by State Auto Mutual under this Agreement shall be made in Dollars, in immediately available funds, without deduction, set-off or counterclaim, to the Agent at an account designated by the Agent to State Auto Mutual in writing, not later than 12:00 noon (Chicago time) time on the date on which such payment shall become due (each such payment made after such time on such due date to be deemed to have been made on the next succeeding Business Day). (b) The Agent may (but shall not be obligated to) debit the amount of any such payment that is not made by such time to any ordinary deposit account of State Auto Mutual with the Agent (with notice to State Auto Mutual), provided that the Agent's failure to give such notice shall not affect the validity thereof. 2.7 Taxes. (a) All payments by State Auto Mutual to or for the account of any Lender or the Agent hereunder shall be made free and clear of and without deduction for any and all Taxes. If State Auto Mutual shall be required by law to deduct any Taxes from or in respect of any sum payable hereunder to any Lender or the Agent, (i) the sum payable shall be increased as necessary so that after making all required deductions (including deductions applicable to additional sums payable under this Section 2.7) such Lender or the Agent (as the case may be) receives an amount equal to the sum it would have received had no such deductions been made, (ii) State Auto Mutual shall make such deductions, (iii) State Auto Mutual shall pay the full amount deducted to the relevant authority in accordance with applicable law and (iv) State Auto Mutual shall furnish to the Agent the original copy of a receipt evidencing payment thereof within 30 days after such payment is made. (b) In addition, State Auto Mutual hereby agrees to pay any present or future stamp or documentary taxes and any other excise or property taxes, charges or similar levies which arise from any payment made hereunder or from the execution or delivery of, or otherwise with respect to, this Agreement ("Other Taxes"). -14- 16 (c) State Auto Mutual hereby agrees to indemnify the Agent and each Lender for the full amount of Taxes or Other Taxes (including, without limitation, any Taxes or Other Taxes imposed on amounts payable under this Section 2.7) paid by the Agent or such Lender and any liability (including penalties, interest and expenses) arising therefrom or with respect thereto. Payments due under this indemnification shall be made within 30 days of the date the Agent or such Lender makes demand therefor. (d) For any period during which a Lender that is not incorporated under the laws of the United States of America or a state thereof (each a "Non-U.S. Lender") has failed to provide the Borrower with an appropriate form pursuant to Section 3.5(d) of the Credit Agreement (unless such failure is due to a change in treaty, law or regulation, or any change in the interpretation or administration thereof by any governmental authority, occurring subsequent to the date on which a form originally was required to be provided), such Non-U.S. Lender shall not be entitled to indemnification under this Section 2.7 with respect to Taxes imposed by the United States; provided that, should a Non-U.S. Lender which is otherwise exempt from or subject to a reduced rate of withholding tax become subject to Taxes because of its failure to deliver a form required under Section 3.5(d) of the Credit Agreement, State Auto Mutual shall take such steps as such Non-U.S. Lender shall reasonably request to assist such Non-U.S. Lender to recover such Taxes. ARTICLE III REPRESENTATIONS AND WARRANTIES Each State Auto Obligor represents and warrants (with respect to itself and its Subsidiaries only) to the Agent and the Lenders that: 3.1 Corporate Existence. Each of such State Auto Obligor and its Material Subsidiaries: (a) is a corporation, partnership or other entity duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization; (b) has all requisite corporate or other power, and has all material governmental licenses, authorizations, consents and approvals necessary to own its assets and carry on its business as now being or as proposed to be conducted; and (c) is qualified to do business and is in good standing in all jurisdictions in which the nature of the business conducted by it makes such qualification necessary and where failure so to qualify could (either individually or in the aggregate) have a Material Adverse Effect. 3.2 Financial Condition. (a) State Auto Mutual has heretofore furnished to each of the Lenders consolidated balance sheets of State Auto Financial and its Subsidiaries as at December 31, 1998 and the related consolidated statements of income, retained earnings and cash flows of State Auto Financial and its Subsidiaries for the fiscal year ended on said date, with the opinion thereon of Ernst & Young LLP, and the unaudited consolidated balance sheets of State Auto -15- 17 Financial and its Subsidiaries as at June 30, 1999 and the related consolidated statements of income, retained earnings and cash flows of State Auto Financial and its Subsidiaries for the three-month period ended on such date. All such financial statements present fairly in all material respects the consolidated financial condition of State Auto Financial and its Subsidiaries as at said dates and the consolidated results of their operations for the fiscal year and three-month period ended on said dates (subject, in the case of such financial statements as at June 30, 1999, to normal year-end audit adjustments), all in accordance with generally accepted accounting principles and practices applied on a consistent basis. None of State Auto Financial nor any of its Material Subsidiaries has on the date hereof any material contingent liabilities, liabilities for taxes, unusual forward or long-term commitments or unrealized or anticipated losses from any unfavorable commitments, except as referred to or reflected or provided for in said balance sheets as at said dates. Since June 30, 1999, there has been no material adverse change in the consolidated financial condition, operations, business or prospects taken as a whole of State Auto Financial and its Subsidiaries from that set forth in said financial statements as at June 30, 1999. (b) State Auto Mutual has heretofore furnished to each of the Lenders the annual Statutory Statement of each Insurance Entity for the fiscal year ended December 31, 1998, and the quarterly Statutory Statement of each Insurance Entity for the fiscal quarter ended June 30, 1999, in each case as filed with the Applicable Insurance Regulatory Authority. All such Statutory Statements present fairly in all material respects the financial condition of each Insurance Entity as at, and the results of operations for, the fiscal year ended December 31, 1998, and fiscal quarter ended June 30, 1999, in accordance with statutory accounting practices prescribed or permitted by the Applicable Insurance Regulatory Authority. Since June 30, 1999, there has been no material adverse change in the consolidated financial condition, operations, business or prospects taken as a whole of State Auto Mutual from that set forth in said Statutory Statement as at June 30, 1999. 3.3 Litigation. There are no legal or arbitral proceedings, or any proceedings by or before any governmental or regulatory authority or agency, now pending or (to the knowledge such State Auto Obligor) threatened against State Auto Mutual or any of its Subsidiaries that, if adversely determined could (either individually or in the aggregate) have a Material Adverse Effect. 3.4 No Breach. None of the execution and delivery of this Agreement and the other Basic Documents to which such State Auto Obligor is a party, the consummation of the transactions herein and therein contemplated or compliance with the terms and provisions hereof and thereof (including, without limitation, issuance of the Preferred Stock) will conflict with or result in a breach of, or require any consent under, the charter or by-laws (or equivalent documents) of such State Auto Obligor, or any applicable law or regulation, or any order, writ, injunction or decree of any court or governmental authority or agency, or any agreement or instrument to which State Auto Mutual or any of its Subsidiaries is a party or by which any of them or any of their Property is bound or to which any of them is subject, or constitute a default under any such agreement or instrument, or result in the creation or imposition of any Lien upon any Property of State Auto Mutual or any of its Subsidiaries pursuant to the terms of any such agreement or instrument. -16- 18 3.5 Action. Such State Auto Obligor has all necessary corporate power, authority and legal right to execute, deliver and perform its obligations under each of the Basic Documents to which it is a party and, in the case of State Auto Financial, to issue the Preferred Stock; the execution, delivery and performance by such State Auto Obligor of each of the Basic Documents to which it is a party (and, in the case of State Auto Financial, the issuance of the Preferred Stock) have been duly authorized by all necessary corporate action on its part (including, without limitation, any required shareholder approvals); and this Agreement has been duly and validly executed and delivered by such State Auto Obligor and constitutes, and each of the other Basic Documents to which such State Auto Obligor is a party when executed and delivered will constitute, its legal, valid and binding obligation, enforceable against such State Auto Obligor in accordance with its terms, except as such enforceability may be limited by (a) bankruptcy, insolvency, reorganization, moratorium or similar laws of general applicability affecting the enforcement of creditors' rights and (b) the application of general principles of equity (regardless of whether such enforceability is considered in a proceeding in equity or at law). 3.6 Approvals. No authorizations, approvals or consents of, and no filings or registrations with, any governmental or regulatory authority or agency, or any securities exchange (other than any authorizations, approvals, consents, filings and registrations heretofore duly made or obtained and in full force and effect), are necessary for the execution, delivery or performance by either State Auto Obligor of this Agreement or any of the other Basic Documents to which it is a party (or, in the case of State Auto Financial, for the issuance of the Preferred Stock) or for the legality, validity or enforceability hereof or thereof. 3.7 ERISA. Each Plan, and, to the knowledge of the such State Auto Obligor, each Multiemployer Plan, is in compliance in all material respects with, and has been administered in all material respects in compliance with, the applicable provisions of ERISA, the Code and any other Federal or state law, and no event or condition has occurred and is continuing as to which State Auto Mutual would be under an obligation to furnish a report to the Agent under Section 4.1(j) hereof. 3.8 Taxes. State Auto Mutual and its Subsidiaries are members of an affiliated group of corporations filing consolidated returns for Federal income tax purposes, of which State Auto Mutual is the "common parent" (within the meaning of Section 1504 of the Code) of such group. State Auto Mutual and its Material Subsidiaries have filed all Federal income tax returns and all other material tax returns that are required to be filed by them and have paid all taxes due pursuant to such returns or pursuant to any assessment received by State Auto Mutual or any of its Material Subsidiaries. The charges, accruals and reserves on the books of State Auto Mutual and its Material Subsidiaries in respect of taxes and other governmental charges are, in the opinion of State Auto Mutual, adequate. State Auto Mutual has not given or been requested to give a waiver of the statute of limitations relating to the payment of any Federal, state, local and foreign taxes or other impositions. 3.9 Investment Company Act. Neither State Auto Mutual nor any of its Subsidiaries is an "investment company", or a company "controlled" by an "investment company", within the meaning of the Investment Company Act of 1940, as amended. -17- 19 3.10 Public Utility Holding Company Act. Neither State Auto Mutual nor any of its Subsidiaries is a "holding company" or an "affiliate" of a "holding company" or a "subsidiary company" of a "holding company", within the meaning of the Public Utility Holding Company Act of 1935, as amended. 3.11 Material Agreements and Liens. (a) Part A of Schedule I hereto is a complete and correct list of each credit agreement, loan agreement, indenture, purchase agreement, guarantee, letter of credit or other arrangement providing for or otherwise relating to any Indebtedness or any extension of credit (or commitment for any extension of credit) to, or guarantee by, State Auto Mutual or any of its Subsidiaries, outstanding on the date hereof the aggregate principal or face amount of which equals or exceeds (or may equal or exceed) $5,000,000, and the aggregate principal or face amount outstanding or that may become outstanding under each such arrangement is correctly described in Part A of said Schedule I. (b) Part B of Schedule I hereto is a complete and correct list of each Lien securing Indebtedness of any Person outstanding on the date hereof the aggregate principal or face amount of which equals or exceeds (or may equal or exceed) $5,000,000 and covering any Property of State Auto Mutual or any of its Subsidiaries, and the aggregate Indebtedness secured (or that may be secured) by each such Lien and the Property covered by each such Lien is correctly described in Part B of said Schedule I. 3.12 Environmental Matters. Each of State Auto Mutual and its Subsidiaries has obtained all environmental, health and safety permits, licenses and other authorizations required under all Environmental Laws to carry on its business as now being or as proposed to be conducted, except to the extent failure to have any such permit, license or authorization would not (either individually or in the aggregate) have a Material Adverse Effect. Each of such permits, licenses and authorizations is in full force and effect and each of State Auto Mutual and its Subsidiaries is in compliance with the terms and conditions thereof, and is also in compliance with all other limitations, restrictions, conditions, standards, prohibitions, requirements, obligations, schedules and timetables contained in any applicable Environmental Law or in any regulation, code, plan, order, decree, judgment, injunction, notice or demand letter issued, entered, promulgated or approved thereunder, except to the extent failure to comply therewith would not (either individually or in the aggregate) have a Material Adverse Effect. 3.13 Capitalization. The authorized capital stock of State Auto Financial consists, on the date hereof, of an aggregate of 105,000,000 shares consisting of (a) 100,000,000 shares of common stock, no par value, of which 40,565,812 shares are duly and validly issued and outstanding, each of which shares is fully paid and nonassessable, (b) 2,500,000 shares of Class A Preferred Stock, no par value, none of which shares are issued and outstanding and (c) 2,500,000 shares of Class B Preferred Stock, no par value, none of which shares are issued and outstanding. Upon issuance, each share of Class A Preferred Stock will benefit from the Terms and Conditions of Class A Preferred Stock attached to form of Class A Preferred Stock Certificate attached to the Standby Purchase Agreement as Exhibit A. As of the date hereof, 70% of such issued and outstanding shares of common stock are owned beneficially and of record by State Auto Mutual. As of the date hereof, (i) except for this Agreement and the -18- 20 Standby Purchase Agreement and as set forth in Part A of Schedule III hereto, there are no outstanding Equity Rights with respect to State Auto Financial and (ii) except as set forth in Part B of Schedule III hereto, there are no outstanding obligations of State Auto Financial or any of its Subsidiaries to repurchase, redeem, or otherwise acquire any shares of capital stock of State Auto Financial nor are there any outstanding obligations of State Auto Financial or any of its Subsidiaries to make payments to any Person, such as "phantom stock" payments, where the amount thereof is calculated with reference to the fair market value or equity value of State Auto Financial or any of its Subsidiaries. 3.14 Subsidiaries, Etc. (a) Set forth in Part A of Schedule II hereto is a complete and correct list of all Subsidiaries of State Auto Mutual on the date hereof and a specification of which of such Subsidiaries are Insurance Entities and which are Material Subsidiaries. (b) Set forth in Part B of Schedule II hereto is a complete and correct list of all Investments (other than (x) Investments disclosed in Part A of said Schedule II hereto and any other Investments existing as of the date hereof permitted under Section 4.9 hereof and (y) Guarantees of Indebtedness the aggregate principal or face amount of which Indebtedness is less than $5,000,000) held by State Auto Mutual or any of its Subsidiaries in any Person on the date hereof and, for each such Investment, (i) the identity of the Person or Persons holding such Investment and (ii) the nature of such Investment. Except as disclosed in Part B of Schedule II hereto, each of State Auto Mutual and its Subsidiaries owns, free and clear of all Liens, all such Investments. 3.15 True and Complete Disclosure. The information, reports, financial statements, exhibits and schedules furnished in writing by or on behalf of the State Auto Obligors to the Agent or any Lender in connection with the negotiation, preparation or delivery of this Agreement and the other Basic Documents or included herein or therein or delivered pursuant hereto or thereto, when taken as a whole do not contain any untrue statement of material fact or omit to state any material fact necessary to make the statements herein or therein, in light of the circumstances under which they were made, not misleading. All written information furnished after the date hereof by State Auto Mutual and its Subsidiaries to the Agent and the Lenders in connection with this Agreement and the other Basic Documents and the transactions contemplated hereby and thereby will be true, complete and accurate in every material respect, or (in the case of projections) based on reasonable estimates, on the date as of which such information is stated or certified. There is no fact known to either State Auto Obligor that could have a Material Adverse Effect that has not been disclosed herein, in the other Basic Documents or in a report, financial statement, exhibit, schedule, disclosure letter or other writing furnished to the Agent for use in connection with the transactions contemplated hereby or thereby. 3.16 No Reliance. State Auto Mutual has made, independently and without reliance upon the Agent or any Lender, and based on such documents and information as it has deemed appropriate, its own decision to enter into this Agreement and has made (and will continue to make), independently and without reliance upon the Agent or any Lender, and based -19- 21 on such documents and information as it has deemed appropriate (or shall deem appropriate at the time), its own legal, credit and tax analysis of the transactions contemplated hereby. 3.17 Insurance Licenses. Schedule T to the most recent Statutory Statement of each Insurance Entity described in Section 3.2(b) hereof lists, as of the date hereof, all of the jurisdictions in which each of the Insurance Entities holds active licenses (including, without limitation, licenses or certificates of authority from Applicable Insurance Regulatory Authorities), permits or authorizations to transact insurance and reinsurance business or to act as an insurance agent or broker (collectively, the "Licenses"). Each Insurance Entity is in compliance in all material respects with each license held by it. No License (to the extent material) is the subject of a proceeding for suspension or revocation or any similar proceedings, there is no sustainable basis for such a suspension or revocation, and to the knowledge of each State Auto Obligor no such suspension or revocation has been threatened by any licensing authority except in any such case where such proceedings would not have a Material Adverse Effect. 3.18 Year 2000. Each State Auto Obligor has made a full and complete assessment of the Year 2000 Issues and has a realistic and achievable program for remediating the Year 2000 Issues on a timely basis (the "Year 2000 Program"). Based on such assessment and on the Year 2000 Program no State Auto Obligor reasonably anticipates that Year 2000 Issues will have a Material Adverse Effect. ARTICLE IV COVENANTS OF STATE AUTO MUTUAL ------------------------------ State Auto Mutual covenants and agrees with the Agent that, so long as any Obligations are outstanding or any Commitments are in effect: 4.1 Financial Statements Etc. State Auto Mutual shall deliver to the Agent (with sufficient copies for each of the Lenders): (a) as soon as available and in any event within 60 days after the end of each quarterly fiscal period of each fiscal year of State Auto Financial, consolidated statements of income, retained earnings and cash flows of State Auto Financial and its Subsidiaries for such period and for the period from the beginning of the respective fiscal year to the end of such period, and the related consolidated balance sheets of State Auto Financial and its Subsidiaries as at the end of such period, setting forth in each case in comparative form the corresponding consolidated figures for the corresponding periods in the preceding fiscal year (except that, in the case of balance sheets, such comparison shall be to the last day of the prior fiscal year), accompanied by a certificate of a senior financial officer of State Auto Financial, which certificate shall state that said consolidated financial statements present fairly in all material respects the consolidated financial condition and results of operations of State Auto Financial and its Subsidiaries in accordance with generally accepted accounting principles, consistently applied, as at the end of, and for, such period (subject to normal year-end audit adjustments); -20- 22 (b) as soon as available and in any event within 90 days after the end of each fiscal year of State Auto Financial, consolidated statements of income, retained earnings and cash flows of State Auto Financial and its Subsidiaries for such fiscal year and the related consolidated balance sheets of State Auto Financial and its Subsidiaries as at the end of such fiscal year, setting forth in each case in comparative form the corresponding consolidated figures for the preceding fiscal year, and accompanied by an opinion thereon of independent certified public accountants of recognized national standing, which opinion shall state that said consolidated financial statements present fairly in all material respects the consolidated financial condition and results of operations of State Auto Financial and its Subsidiaries as at the end of, and for, such fiscal year in accordance with generally accepted accounting principles; (c) promptly after filing with the Applicable Insurance Regulatory Authority and in any event within 45 days after the end of each for the first three quarterly fiscal periods of each fiscal year of each Insurance Entity, its quarterly Statutory Statement for such quarterly fiscal period, together with the opinion thereon of a senior financial officer of such Insurance Entity stating that such Statutory Statement presents the financial condition of such Insurance Entity for such quarterly fiscal period in accordance with statutory accounting practices required or permitted by the Applicable Insurance Regulatory Authority; (d) promptly after filing with the Applicable Insurance Regulatory Authority and in any event within 90 days after the end of each fiscal year of each Insurance Entity, the annual Statutory Statement of such Insurance Entity for such year, together with (i) the opinion thereon of a senior financial officer of such Insurance Entity stating that said annual Statutory Statement presents the financial condition of such Insurance Entity for such fiscal year in accordance with statutory accounting practices required or permitted by the Applicable Insurance Regulatory Authority and (ii) a certificate of a valuation actuary affirming the adequacy of reserves taken by such Insurance Entity in respect of future policyholder benefits as at the end of such fiscal year (as shown on such Statutory Statement); (e) within 180 days after the end of each fiscal year of each Insurance Entity, the report of Ernst & Young LLP (or other independent certified public accountants of recognized national standing) on the annual Statutory Statements delivered pursuant to Section 4.1(d) hereof; (f) promptly upon their becoming available, copies of all registration statements and regular periodic reports, if any, that State Auto Mutual or any of its Material Subsidiaries shall have filed with the Securities and Exchange Commission (or any governmental agency substituted therefor) or any national securities exchange; (g) promptly upon the mailing thereof to the policyholders of State Auto Mutual generally and to the shareholders of State Auto Financial, copies of all financial statements, reports and proxy statements so mailed; -21- 23 (h) promptly after State Auto Mutual receives the results of a triennial examination by the NAIC of the financial condition and operations of State Auto Mutual and/or any of its Material Subsidiaries, a copy thereof; (i) promptly following the delivery or receipt by State Auto Mutual or any of its Material Subsidiaries of any correspondence, notice or report to or from any Applicable Insurance Regulatory Authority that relates, to any material extent, to the financial viability of State Auto Mutual or any of its Material Subsidiaries, a copy thereof; (j) as soon as possible, and in any event within ten days after either State Auto Obligor knows or has reason to believe that any of the events or conditions specified below with respect to any Plan or Multiemployer Plan has occurred or exists, a statement signed by a senior financial officer of State Auto Mutual setting forth details respecting such event or condition and the action, if any, that State Auto Mutual or its ERISA Affiliate proposes to take with respect thereto (and a copy of any report or notice required to be filed with or given to the PBGC by State Auto Mutual or an ERISA Affiliate with respect to such event or condition): (i) any reportable event, as defined in Section 4043(c) of ERISA and the regulations issued thereunder, with respect to a Plan, as to which the PBGC has not by regulation waived the requirement of Section 4043(a) of ERISA that it be notified within 30 days of the occurrence of such event (provided that a failure to meet the minimum funding standard of Section 412 of the Code or Section 302 of ERISA, including, without limitation, the failure to make on or before its due date a required installment under Section 412(m) of the Code or Section 302(e) of ERISA, shall be a reportable event regardless of the issuance of any waivers in accordance with Section 412(d) of the Code); and any request for a waiver under Section 412(d) of the Code for any Plan; (ii) the distribution under Section 4041 of ERISA of a notice of intent to terminate any Plan or any action taken by State Auto Mutual or an ERISA Affiliate to terminate any Plan; (iii) the institution by the PBGC of proceedings under Section 4042 of ERISA for the termination of, or the appointment of a trustee to administer, any Plan, or the receipt by State Auto Mutual or any ERISA Affiliate of a notice from a Multiemployer Plan that such action has been taken by the PBGC with respect to such Multiemployer Plan; (iv) the complete or partial withdrawal from a Multiemployer Plan by State Auto Mutual or any ERISA Affiliate that results in liability under Section 4201 or 4204 of ERISA (including the obligation to satisfy secondary liability as a result of a purchaser default) or the receipt by State Auto Mutual or any ERISA Affiliate of notice from a Multiemployer Plan that it is in reorganization or insolvency pursuant to Section 4241 or 4245 of ERISA or that it intends to terminate or has terminated under Section 4041A of ERISA; -22- 24 (v) the institution of a proceeding by a fiduciary of any Multiemployer Plan against State Auto Mutual or any ERISA Affiliate to enforce Section 515 of ERISA, which proceeding is not dismissed within 30 days; and (vi) the adoption of an amendment to any Plan that, pursuant to Section 401(a)(29) of the Code or Section 307 of ERISA, would result in the loss of tax-exempt status of the trust of which such Plan is a part if State Auto Mutual or an ERISA Affiliate fails to timely provide security to the Plan in accordance with the provisions of said Sections; (k) within five Business Days after receipt, notice from any Applicable Insurance Regulatory Authority of any threatened or actual proceeding for suspension or revocation of any License or any similar proceeding with respect to any such License; (l) promptly, notice of any denial of coverage, litigation, or arbitration arising out of any Reinsurance Agreements to which any Insurance Entity is a party which denial, litigation or arbitration involves $5,000,000 or more; (m) promptly after either State Auto Obligor knows or has reason to believe that any Put Event (or any event that with notice or lapse of time or both would become a Put Event) has occurred, a notice of such Put Event (or such event) describing the same in reasonable detail and, together with such notice or as soon thereafter as possible, a description of the action that State Auto Mutual has taken or proposes to take with respect thereto; (n) at the time it furnishes each set of financial statements pursuant to paragraph (a) or (b) above, a certificate of a senior financial officer of State Auto Mutual (i) to the effect that no Put Event (or any event that with notice or lapse of time or both would become a Put Event) has occurred and is continuing (or, if any Put Event (or any such event) has occurred and is continuing, describing the same in reasonable detail and describing the action that State Auto Mutual has taken or proposes to take with respect thereto) and (ii) setting forth in reasonable detail the computations necessary to determine whether the State Auto Obligors are in compliance with Section 4.10 hereof as of the end of the respective quarterly fiscal period or fiscal year; and (o) from time to time such other information regarding the financial condition, operations, business or prospects of State Auto Mutual or any of its Subsidiaries (including, without limitation, any Plan or Multiemployer Plan and any reports or other information required to be filed under ERISA) as the Agent may reasonably request. 4.2 Litigation. State Auto Mutual will promptly give to the Agent (with sufficient copies for each Lender) notice of all legal or arbitral proceedings, and of all proceedings by or before any governmental or regulatory authority or agency, and any material development in respect of such legal or other proceedings, affecting State Auto Mutual or any of its Subsidiaries, except proceedings that, if adversely determined, would not (either individually or in the aggregate) have a Material Adverse Effect. 4.3 Existence. Etc. State Auto Mutual will: -23- 25 (a) and will cause each of its Material Subsidiaries to, preserve and maintain its legal existence and all of its material rights, privileges, licenses and franchises (provided that nothing in this Section 4.3 shall prohibit any transaction expressly permitted under Section 4.5 hereof); (b) and will cause each of its Subsidiaries to, comply with the requirements of all applicable laws, rules, regulations and orders of governmental or regulatory authorities if failure to comply with such requirements could (either individually or in the aggregate) have a Material Adverse Effect; (c) and will cause each of its Material Subsidiaries to, pay and discharge all taxes, assessments and governmental charges or levies imposed on it or on its income or profits or on any of its Property prior to the date on which penalties attach thereto, except for any such tax, assessment, charge or levy the payment of which is being contested in good faith and by proper proceedings and against which adequate reserves are being maintained; (d) and will cause each of its Material Subsidiaries to, keep adequate records and books of account, in which complete entries will be made in accordance with generally accepted accounting principles (or, in the case of an Insurance Entity, statutory accounting principles) consistently applied; and (e) and will cause each of its Material Subsidiaries to, permit representatives of any Lender or the Agent, during normal business hours, to examine, copy and make extracts from its books and records, to inspect any of its Properties, and to discuss its business and affairs with its officers, all to the extent reasonably requested by such Lender or the Agent (as the case may be). 4.4 Insurance. State Auto Mutual will, and will cause each of its Material Subsidiaries to, maintain insurance with financially sound and reputable insurance companies, and with respect to Property and risks of a character usually maintained by corporations engaged in the same or similar business similarly situated, against loss, damage and liability of the kinds and in the amounts customarily maintained by such corporations (including general liability insurance, director's and officer's liability insurance, property insurance and worker's compensation insurance), provided that, nothing in this Section 4.4 shall be deemed to require State Auto Mutual or any of its Material Subsidiaries to enter into any Reinsurance Agreement and provided, further, that State Auto Mutual and its Material Subsidiaries may self-insure against such hazards and risks, and in such amounts as is customary for corporations of a similar size and in similar lines of business. 4.5 Prohibition of Fundamental Changes. (a) State Auto Mutual will not, nor will it permit any of its Material Subsidiaries to, enter into any transaction of merger or consolidation or amalgamation, or liquidate, wind up or dissolve itself (or suffer any liquidation or dissolution). (b) State Auto Mutual will not, nor will it permit any of its Material Subsidiaries to, acquire any business or Property from, or capital stock of, or be a party to any -24- 26 acquisition of, any Person except for purchases of inventory and other Property to be sold or used in the ordinary course of business, Assumed Reinsurance in the ordinary course of business, Investments permitted under Section 4.9 hereof, and Capital Expenditures. (c) State Auto Mutual will not, nor will it permit any of its Material Subsidiaries to, convey, sell, lease, transfer or otherwise dispose of, in one transaction or a series of transactions, all or a substantial part of its business or Property, whether now owned or hereafter acquired. (d) Notwithstanding the foregoing provisions of this Section 4.5: (i) any Subsidiary of State Auto Mutual may be merged or consolidated with or into: (x) State Auto Mutual if State Auto Mutual shall be the continuing or surviving corporation or (y) any other such Subsidiary; provided that (A) if any such transaction (other than a transaction described in clause (B) below) shall be between a Subsidiary and a Wholly Owned Subsidiary, the Wholly Owned Subsidiary shall be the continuing or surviving corporation and (B) if any such transaction shall be between State Auto Financial and any other such Subsidiary, State Auto Financial shall be the surviving corporation; (ii) any Material Subsidiary of State Auto Mutual may sell, lease, transfer or otherwise dispose of any or all of its Property (upon voluntary liquidation or otherwise) to State Auto Mutual or a Wholly Owned Subsidiary of State Auto Mutual; (iii) State Auto Mutual may merge or consolidate with or acquire any other Person if (w) in the case of a merger or consolidation, State Auto Mutual is the surviving corporation, (x) after giving effect thereto, no Put Event (and no event that with notice or lapse of time or both would constitute a Put Event) would exist hereunder, (y) the business activity engaged in by such other Person would be permitted under Section 4.13 hereof if such other Person were a Subsidiary of State Auto Mutual prior to such merger or consolidation and (z) the aggregate amount of the Statutory Surplus (determined as at the date of the relevant merger, consolidation or acquisition) of all such other Persons that have been the subject of any merger, consolidation or acquisition pursuant to this clause (iii) after the date hereof (other than any such merger, consolidation or acquisition financed solely with Net Available Proceeds) shall be less than $250,000,000; and (iv) any Material Subsidiary of State Auto Mutual may merge or consolidate with or acquire any other Person if (w) in the case of a merger or consolidation, the surviving corporation is a Wholly Owned Subsidiary of State Auto Mutual; provided, that in the case of any merger or consolidation involving State Auto Financial, the surviving corporation is State Auto Financial, (x) after giving effect thereto, no Put Event (and no event that with notice or lapse of time or both would constitute a Put Event) would exist hereunder, (y) the business activity engaged in by such other Person would be permitted under Section 4.13 hereof if such other Person were a Subsidiary of State Auto Mutual prior to such merger or consolidation and (z) the aggregate amount of the Statutory Surplus (determined as at the date of the relevant merger, consolidation or acquisition) of all such other Persons that have been the subject of any merger, consolidation or -25- 27 acquisition pursuant to this clause (iv) during any calendar year (other than any such merger, consolidation or acquisition financed solely with Net Available Proceeds) shall be less than $100,000,000. 4.6 Limitation on Liens. State Auto Mutual will not, nor will it permit any of its Material Subsidiaries to, create, incur, assume or suffer to exist any Lien upon any of its Property, whether now owned or hereafter acquired, except: (a) Liens in existence on the date hereof and listed in Part B of Schedule I hereto; (b) Liens imposed by any governmental authority for taxes, assessments or charges not yet due or that are being contested in good faith and by appropriate proceedings if adequate reserves with respect thereto are maintained on the books of State Auto Mutual or the affected Material Subsidiaries, as the case may be, in accordance with Agreement Accounting Principles (or, in the case of any Insurance Entity, SAP); (c) carriers', warehousemen's, mechanics', materialmen's, repairmen's or other like Liens arising in the ordinary course of business that are not overdue for a period of more than 30 days or that are being contested in good faith and by appropriate proceedings and Liens securing judgments but only to the extent for an amount and for a period not resulting in a Put Event under clause (j) of the definition of "Put Event" in Section 1.1 hereof; (d) pledges or deposits under worker's compensation, unemployment insurance and other social security legislation; (e) deposits to secure the performance of bids, trade contracts (other than for Indebtedness), leases, statutory obligations, surety and appeal bonds, performance bonds and other obligations of a like nature incurred in the ordinary course of business; (f) easements, rights-of-way, restrictions and other similar encumbrances incurred in the ordinary course of business and encumbrances consisting of zoning restrictions, easements, licenses, restrictions on the use of Property or minor imperfections in title thereto that do not in any case materially detract from the value of the Property subject thereto or interfere with the ordinary conduct of the business of State Auto Mutual or any of its Material Subsidiaries; (g) Liens arising under escrows, trusts, custodianships, separate accounts, funds withheld procedures, and similar deposits, arrangements, or agreements established with respect to insurance policies, annuities, guaranteed investment contracts and similar products underwritten by, or Reinsurance Agreements entered into by, any Insurance Entity in the ordinary course of business; (h) deposits with insurance regulatory authorities; -26- 28 (i) Liens on Property of any corporation that becomes a Subsidiary of State Auto Mutual after the date hereof, provided that such Liens are in existence at the time such corporation becomes a Subsidiary of State Auto Mutual and were not created in anticipation thereof; (j) Liens upon real and/or tangible personal Property acquired after the date hereof (by purchase, construction or otherwise) by State Auto Mutual or any of its Material Subsidiaries, each of which Liens either (i) existed on such Property before the time of its acquisition and was not created in anticipation thereof or (ii) was created solely for the purpose of securing Indebtedness representing, or incurred to finance, refinance or refund, the cost (including the cost of construction) of such Property; provided that (x) no such Lien shall extend to or cover any Property of State Auto Mutual or such Material Subsidiary other than the Property so acquired and improvements thereon and (y) the principal amount of Indebtedness secured by any such Lien shall at no time exceed 80% of the fair market value (as determined in good faith by a senior financial officer of State Auto Mutual) of such Property at the time it was acquired (by purchase, construction or otherwise); and (k) additional Liens upon real and/or personal Property created after the date hereof, provided that the aggregate Indebtedness secured thereby and incurred on and after the date hereof shall not exceed $15,000,000 in the aggregate at any one time outstanding. 4.7 Indebtedness. State Auto Mutual will not, nor will it permit any of its Material Subsidiaries to, create, incur or suffer to exist any Indebtedness except: (a) Indebtedness created pursuant hereto; (b) Indebtedness outstanding on the date hereof and listed in Part A of Schedule I hereto; (c) Indebtedness of Material Subsidiaries of State Auto Mutual to State Auto Mutual or to other Material Subsidiaries of State Auto Mutual; and (d) additional Indebtedness of State Auto Mutual and its Material Subsidiaries (including, without limitation, Capital Lease Obligations and other Indebtedness secured by Liens permitted under Sections 4.6(j) or 4.6(k) hereof) up to but not exceeding $15,000,000 at any one time outstanding. 4.8 Sale/Leaseback Transactions. State Auto Mutual will not, nor will it permit any of its Material Subsidiaries to, enter into any an arrangement with any Person (other than State Auto Mutual or any of its Material Subsidiaries) providing for the leasing to State Auto Mutual or any of its Material Subsidiaries for a period of more than five years of any Property which has been or is to be sold or transferred by State Auto Mutual or such Material Subsidiary to such Person or to any other Person (other than State Auto Mutual or any of its Material Subsidiaries), to which funds have been or are to be advanced by such Person on the security of the Property subject to such lease (a "Sale/Leaseback Transaction") if, after giving effect thereto, the Value (as defined below) of all Sale/Leaseback Transactions at such time -27- 29 would exceed 10% of the Statutory Surplus of State Auto Mutual at such time. For purposes of this Section 4.8, "Value" shall mean, with respect to any Sale/Leaseback Transaction as at any time, the amount equal to the greater of (a) the net proceeds of the sale or transfer of the Property subject to such Sale/Leaseback Transaction and (b) the fair value, in the opinion of the board of directors of State Auto Mutual of such Property at the time of entering into such Sale/Leaseback Transaction, in either case divided first by the number of full years of the term of the lease and then multiplied by the number of full years of such term remaining at the time of determination, without regard to any renewal or extension options contained in such lease. 4.9 Investments. (a) State Auto Mutual will not, nor will it permit any of its Material Subsidiaries to, make or permit to remain outstanding any Investments except (i) Investments outstanding on the date hereof and identified in Part B of Schedule II hereto, (ii) operating deposit accounts with banks, (iii) Permitted Investments, (iv) Investments by State Auto Mutual and its Material Subsidiaries in State Auto Mutual and its Subsidiaries, (v) Interest Rate Protection Agreements, provided that, without limiting the obligation of State Auto Mutual under Section 4.12 hereof, when entering into any Interest Rate Protection Agreement that at the time has, or at any time in the future may give rise to, any credit exposure, the aggregate credit exposure under all Interest Rate Protection Agreements (excluding the Interest Rate Protection Agreement being entered into pursuant to Section 4.12 hereof) shall not exceed $10,000,000, and (vi) Investments of Insurance Entities not prohibited by clause (b) of this Section 4.9. (b) State Auto Mutual will not permit any Insurance Entity to make any Investment if, on the date of which such Investment is made and after giving effect thereto, the aggregate value of Investments (other than equity Investments) held by such Insurance Entity that are rated lower than "2" by the NAIC or are not rated by the NAIC would exceed 5% of the value of total invested assets. As used in this Section 4.9(b), the "value" of an Investment refers to the value of such Investment that would be shown on the most recent Statutory Statement of the relevant Insurance Entity prepared in accordance with SAP. 4.10 Certain Financial Covenants. (a) Statutory Surplus. State Auto Mutual will not permit its Statutory Surplus at any time to be less than (a) $495,671,189, at any time prior to the occurrence of a catastrophe giving rise to Loans being outstanding under the Credit Agreement (provided that no Loans are outstanding at such time) and (b) $425,000,000, at any time during the period from and including the date of occurrence of a catastrophe giving rise to Loans being outstanding under the Credit Agreement to but excluding the date all Loans shall have been required to be repaid in full pursuant to the terms of the Credit Agreement. State Auto Mutual will not permit the Statutory Surplus of State Auto P&C to be less than $135,467,450 at any time prior to the occurrence of a catastrophe giving rise to Loans being outstanding under the Credit Agreement (provided that no Loans are outstanding at such time). (b) Risk-Based Capital Ratio. State Auto Mutual will not permit its Risk-Based Capital Ratio at any time to be less than (a) 4.00 to 1, at any time prior to the occurrence of a catastrophe giving rise to Loans being outstanding under the Credit Agreement (provided -28- 30 that no Loans are outstanding at such time) and (b) 3.00 to 1, at any time during the period from and including the date of occurrence of a catastrophe giving rise to Loans being outstanding under the Credit Agreement to but excluding the date all Loans shall have been required to be repaid in full pursuant to the terms of the Credit Agreement. State Auto Mutual will not permit the Risk-Based Capital Ratio of State Auto P&C to be less than 4.00 to 1 at any time prior to the occurrence of a catastrophe giving rise to Loans being outstanding under the Credit Agreement (provided that no Loans are outstanding at such time). (c) Premium to Surplus. State Auto Mutual will not permit its Premium to Surplus Ratio at any time to exceed (a) 2.00 to 1, at any time prior to the occurrence of a catastrophe giving rise to Loans being outstanding under the Credit Agreement (provided that no Loans are outstanding at such time) and (b) 3.00 to 1, at any time during the period from and including the date of occurrence of a catastrophe giving rise to Loans being outstanding under the Credit Agreement to but excluding the date all Loans shall have been required to be repaid in full pursuant to the terms of the Credit Agreement. State Auto Mutual will not permit the Premium to Surplus Ratio of State Auto P&C to exceed 3.00 to 1 at any time prior to the occurrence of a catastrophe giving rise to Loans being outstanding under the Credit Agreement (provided that no Loans are outstanding at such time). (d) Fixed Charge Coverage Ratio. State Auto Financial will not permit its Fixed Charge Coverage Ratio, determined as of the end of each of its fiscal quarters, to be less than 1.00 to 1.00 at any time during the period from and including the date of occurrence of a catastrophe giving rise to Loans being outstanding under the Credit Agreement to but excluding the date all Loans shall have been required to be repaid in full pursuant to the terms of the Credit Agreement. 4.11 NAIC Ratio. In the event that the NAIC or any Applicable Insurance Regulatory Authority shall at any time promulgate any risk-based capital ratio requirements or guidelines, State Auto Mutual will cause each Insurance Entity to comply with the minimum requirements or guidelines applicable to it as established by the NAIC or such Applicable Insurance Regulatory Authority. 4.12 Interest Rate Protection Agreements. State Auto Mutual will within five days after the date of each purchase of Preferred Stock under the Standby Purchase Agreement, cause State Auto Financial to enter into, and thereafter maintain in full force and effect, one or more Interest Rate Protection Agreements with one or more of the Lenders (and/or with a bank or other financial institution having capital, surplus and undivided profits of at least $500,000,000), that effectively would enable State Auto Financial (in a manner satisfactory to the Agent) to protect itself against floating interest rates as to a notional principal amount at least equal to 100% of the aggregate Redemption Value of the Preferred Stock for a period of at least six years measured from the date of the purchase of the Preferred Stock. 4.13 Lines of Business. State Auto Mutual will not, nor will it permit any of its Subsidiaries to, engage to any substantial extent in any line or lines of business activity other than the business of owning and operating property and casualty insurance companies as conducted on the date hereof and businesses related or incidental thereto (it being understood that the businesses of Strategic Insurance Software, Inc., Stateco Financial Services, Inc. and 518 -29- 31 Property Management and Leasing, LLC, to the extent conducted as of the date hereof, are related to the business of owning and operating property and casualty insurance companies). It is also understood and agreed that the foregoing includes State Auto Mutual assuming reinsurance with premiums in an aggregate amount not to exceed $15,000,000 from third parties. 4.14 Ceded Reinsurance. State Auto Mutual will not, nor will it permit any other Insurance Entity to: (a) enter into any Reinsurance Agreement with any Person other than (i) another Insurance Entity, (ii) any Person for which the most recently published rating by A.M. Best & Co. is "B+" or higher or, if such Person is not rated by A.M. Best & Co., which has a Statutory Surplus (or the equivalent thereof) of not less than $100,000,000, (iii) any Person that posts security under such Reinsurance Agreement in an amount equal to the total liabilities assumed by such Person, through a letter of credit issued by an "authorized bank" (as such term is defined by the Applicable Insurance Regulatory Authority) or cash collateral deposit or (iv) any other reinsurers acceptable to the Agent, provided however, that for purposes of the foregoing clause (ii), any "NA" designation shall not be considered a rating of A.M. Best & Co.; (b) enter into any Reinsurance Agreement or Reinsurance Agreements with Lloyd's of London if the aggregate amount of reinsurance ceded thereby would exceed 15% of the aggregate premium volume of reinsurance ceded by the Insurance Entities. (c) enter into any Surplus Relief Reinsurance except with another Insurance Entity; or (d) enter into any Reinsurance Agreement or Reinsurance Agreements if such Reinsurance Agreements will result in a 20% or more reduction of net premium volume for the Insurance Entities in any 12-month period. 4.15 Transactions with Affiliates. Except as expressly permitted by this Agreement, State Auto Mutual will not, nor will it permit any of its Material Subsidiaries to, directly or indirectly: (a) make any Investment in an Affiliate; (b) transfer, sell, lease, assign or otherwise dispose of any Property to an Affiliate; (c) merge into or consolidate with or purchase or acquire Property from an Affiliate; or (d) enter into any other transaction directly or indirectly with or for the benefit of an Affiliate (including, without limitation, Guarantees and assumptions of obligations of an Affiliate); provided that (i) any Affiliate who is an individual may serve as a director, officer or employee of State Auto Mutual or any of its Material Subsidiaries and receive reasonable compensation for his or her services in such capacity and (ii) State Auto Mutual and its Material Subsidiaries may enter into transactions (other than extensions of credit by State Auto Mutual or any of its Material Subsidiaries to an Affiliate) providing for the leasing of Property, the rendering or receipt of services or the purchase or sale of inventory and other Property in the ordinary course of business if the monetary or business consideration arising therefrom would be substantially as advantageous to State Auto Mutual and its Material Subsidiaries as the monetary or business consideration that would obtain in a comparable transaction with a Person not an Affiliate. -30- 32 4.16 Modifications of Certain Documents. State Auto Mutual will not, and will not permit any of its Subsidiaries to, (a) consent to any modification, supplement or waiver of (i) the charter or by-laws of State Auto Mutual, (ii) the charter or by-laws of State Auto Financial, (iii) any material term of any Retrocession Agreement or Reinsurance Agreement relating to property and catastrophic risk insurance other than the Intercompany Pooling Arrangement or (iv) without the prior consent of the Agent (with the approval of the Required Lenders, such approval not to be unreasonably withheld), the Intercompany Pooling Agreement if such modification, supplement or waiver would result in the ceding to State Auto Mutual of [70]% or more of the catastrophic loss risk subject to such arrangement or (b) in any manner alter or change the preferences, rights or powers of the Preferred Stock or permit State Auto Financial to issue any additional securities so as to affect adversely the Preferred Stock. 4.17 Indemnity for Certain Costs. State Auto Financial agrees with the Agent that it will indemnify the Borrower, promptly upon demand therefor, for all or any portion of (a) the fees, costs and expenses payable by the Borrower under Article III of the Credit Agreement including, without limitation, in the event that interest for any Lender in respect of any period is computed at the Base Rate, for the excess (if any) of the amount of such interest computed at the Base Rate for such period over the amount of interest that would have been payable in respect of such period had such interest been computed at the relevant Eurodollar Rate for such period and (b) the excess of interest in respect of any period payable by the Borrower under Section 2.11 of the Credit Agreement at 2% over the interest in respect of such period that would have been payable had the relevant Default not occurred. Each of State Auto Financial, State Auto Mutual and the Agent agrees that the Borrower shall be a third-party beneficiary of this Agreement. 4.18 Delivery of Documents on the Closing Date. On the Closing Date, State Auto Mutual will deliver to the Agent (with sufficient copies for each Lender) each of the following documents each of which shall be satisfactory to the Agent in form and substance: (a) certified copies of the charter and by-laws (or equivalent documents) of each State Auto Obligor and of all corporate authority for such State Auto Obligor (including, without limitation, board of director resolutions and evidence of the incumbency, including specimen signatures, of officers) with respect to the execution, delivery and performance of such of the Basic Documents to which such State Auto Obligor is intended to be a party and each other document to be delivered by such State Auto Obligor from time to time in connection herewith (and the Agent and each Lender may conclusively rely on such certificate until it receives notice in writing from State Auto Mutual to the contrary); (b) a certificate of a senior officer of State Auto Mutual, dated the Closing Date, to the effect that (i) no Put Event (and no event that with notice or lapse of time or both would become a Put Event) shall have occurred and be continuing and (ii) the representations and warranties made by the State Auto Obligors in Article III hereof shall be true and complete on and as of the Closing Date with the same force and effect as if made on and as of the Closing Date (or, if any such representation or warranty is expressly stated to have been made as of a specific date, as of such specific date); -31- 33 (c) an opinion, dated the Closing Date, of John Lowther, general counsel of each State Auto Obligor, substantially in form of Exhibit B hereto and covering such other matters as the Agent or any Lender may reasonably request (and each State Auto Obligor hereby instructs such counsel to deliver such opinion to the Lenders and the Agent); (d) certified true, correct and complete copies of all Retrocession Agreements and Reinsurance Agreements in effect on the Closing Date; (e) certified true, correct and complete copies of all Tax Sharing Agreements in effect on the Closing Date; (f) evidence that the transactions contemplated by the Basic Documents shall have been approved by each Applicable Insurance Regulatory Authority with respect to State Auto Mutual, State Auto P&C and Milbank; and (g) such other documents as the Agent or any Lender or counsel to Bank One may reasonably request. 4.19 Delivery of Documents on Each Borrowing Date. On the date of each borrowing by the Borrower under the Credit Agreement (and as a condition thereto), State Auto Mutual will deliver to the Agent (with sufficient copies for each Lender) each of the following documents each of which shall be satisfactory to the Agent in form and substance: (a) a certificate of a senior officer of State Auto Mutual, dated the date of such borrowing, (1) to the effect that, both immediately prior to the making of such Loan and also after giving effect thereto and to the intended use thereof, (i) no Put Event (and no event that with notice or lapse of time or both would become a Put Event) shall have occurred and be continuing and (ii) the representations and warranties made by the State Auto Obligors in Article III hereof (excluding, in the case of the representation and warranty made by the State Auto Obligors in the last sentence of clauses (a) and (b) of Section 3.2 hereof, any such change to the extent such change results from the catastrophic loss claims and/or loss adjustment expenses to which the borrowing by the Borrower under the Credit Agreement and related issuance of Preferred Stock relates) shall be true and complete on and as of such date of borrowing with the same force and effect as if made on and as of such date of borrowing (or, if any such representation or warranty is expressly stated to have been made as of a specific date, as of such specific date) and (2) describing in reasonable detail the catastrophic loss claims and/or loss adjustment expenses to which such borrowing relates; (b) such other documents as the Agent or any Lender or counsel to Bank One may reasonably request (including, without limitation, opinions of counsel to the State Auto Obligors relating to the issuance of the Preferred Stock in connection with such borrowing). 4.20 Delivery of Documents in Connection with the Extension of the Commitment Termination Date. On each of the "Request Date" and the "Existing Commitment Termination Date" (in each case as defined in Section 2.19 of the Credit Agreement) State Auto -32- 34 Mutual will deliver to the Agent (with sufficient copies for each Lender) each of the following documents each of which shall be satisfactory to the Agent in form and substance: (a) a certificate of a senior officer of State Auto Mutual, dated such date, to the effect that (i) no Put Event (and no event that with notice or lapse of time or both would become a Put Event) shall have occurred and be continuing and (ii) the representations and warranties made by the State Auto Obligors in Article III hereof shall be true and complete on and as of such date of borrowing with the same force and effect as if made on and as of such date of borrowing (or, if any such representation or warranty is expressly stated to have been made as of a specific date, as of such specific date). (b) a certificate of a senior officer of State Auto Mutual, dated such date, to the effect that (i) the "Probable Maximum Loss" (as defined below) of the State Auto Obligors for the 250-year return period shall not exceed (x) $220,000,000 for earthquake peril and (y) $150,000,000 for hurricane peril and (ii) attached thereto is a true, correct and complete copy of the report prepared by the applicable Modelling Firm (as defined below) in connection with the calculation referred to in the definition of "Probable Maximum Loss" below. For purposes of this clause (b), "Probable Maximum Loss" shall mean, for any date, the "probable maximum loss" as most recently calculated prior to such date by Risk Management Solutions, Inc., Applied Insurance Research, EQECAT Inc., Tillinghast (a Towers Perrin Company) or another independent modelling firm satisfactory to the Agent (each, a "Modelling Firm"). 4.21 Consent to Assignment, etc. (a) To the extent contemplated by the Company Pledge Agreement, or otherwise after and during the continuance of a Default, the Agent and any designee or assignee thereof shall be entitled to exercise any and all rights of the Borrower under the Standby Purchase Agreement and the Pledged Stock in accordance with the terms of the Standby Purchase Agreement and such Pledged Stock, and State Auto Financial shall comply in all respects with such exercise. Without limiting the generality of the foregoing, to the extent contemplated by the Company Pledge Agreement, or otherwise after and during the continuance of a Default, the Agent and any designee or assignee thereof shall have the full right and power to enforce directly against State Auto Financial all obligations of State Auto Financial under the Standby Purchase Agreement and the Pledged Stock and otherwise to exercise all remedies thereunder and to make all demands and give all notices and make all requests required or permitted to be made by the Borrower under the Standby Purchase Agreement or the Pledged Stock. Nothing herein shall require the Agent or such designee or assignee to cure any default of the Borrower under the Standby Purchase Agreement or to perform any act, duty or obligation of the Borrower under the Standby Purchase Agreement, but shall only give them the option so to do. (b) State Auto Financial will not, without the prior written consent of the Agent, (i) cancel, suspend or terminate the Standby Purchase Agreement or consent to or accept any such cancellation, suspension or termination thereof, (ii) amend, supplement or otherwise modify the Standby Purchase Agreement or (iii) petition, request or take any other legal or -33- 35 administrative action which seeks, or may reasonably be expected, to so rescind, cancel, terminate or suspend or amend or modify the Standby Purchase Agreement. (c) A foreclosure of, or other exercise of remedies under, the Company Pledge Agreement or any sale thereunder by the Agent or its assignee or designee, whether by judicial proceedings or under any power of sale contained therein, or any conveyance from the Borrower to the Agent, the Lenders or any such assignee or designee, in lieu thereof, shall not require the consent of State Auto Financial. (d) Upon the exercise by the Agent of any of the remedies set forth in Section 5.05 of the Company Pledge Agreement, the Agent may assign its rights and interests and the rights and interests of the Borrower under the Standby Purchase Agreement and/or the Pledged Stock to any other Person. (e) State Auto Financial will not be released from any of its obligations under the Standby Purchase Agreement or the Pledged Stock pursuant to any assignment or transfer (including by reason of a merger, consolidation, sale of substantially all of its assets or otherwise), and shall not delegate any of its obligations under the Standby Purchase Agreement or the Pledged Stock, unless the Agent shall have previously consented in writing to such release or delegation, as the case may be. ARTICLE V MISCELLANEOUS ------------- 5.1 Waiver. No failure on the part of the Agent or any Lender to exercise and no delay in exercising, and no course of dealing with respect to, any right, power or privilege under this Agreement shall operate as a waiver thereof, nor shall any single or partial exercise of any right, power or privilege under this Agreement preclude any other or further exercise thereof or the exercise of any other right, power or privilege. The remedies provided herein are cumulative and not exclusive of any remedies provided by law. 5.2 Notices. All notices, requests and other communications to any party hereunder shall be in writing (including electronic transmission, facsimile transmission or similar writing) and shall be given to such party at its address or facsimile number set forth on the signature pages hereof or at such other address or facsimile number as such party may hereafter specify for the purpose by notice to the Agent and the Borrower in accordance with the provisions of this Section 5.2. Each such notice, request or other communication shall be effective (a) if given by facsimile transmission, when transmitted to the facsimile number specified in this Section and confirmation of receipt is received, (b) if given by mail, 72 hours after such communication is deposited in the mails with first class postage prepaid, addressed as aforesaid, or (c) if given by any other means, when delivered (or, in the case of electronic transmission, received) at the address specified in this Section. 5.3 Expenses; Indemnification. (a) State Auto Mutual and State Auto Financial jointly and severally agree to reimburse the Agent for any costs, internal charges and out-of-pocket expenses (including reasonable attorneys' fees and time charges of attorneys for -34- 36 the Agent, which attorneys may be employees of the Agent) paid or incurred by the Agent in connection with the preparation, negotiation, execution, delivery, syndication, review, amendment, modification, and administration of the Basic Documents. State Auto Mutual and State Auto Financial also jointly and severally agree to reimburse the Agent and the Lenders for any costs, internal charges and out-of-pocket expenses (including attorneys' fees and time charges of attorneys for the Agent and the Lenders, which attorneys may be employees of the Agent or the Lenders) paid or incurred by the Agent or any Lender in connection with the collection and enforcement of the Loan Documents. (b) State Auto Mutual and State Auto Financial hereby jointly and severally agree to indemnify the Agent, each Lender, their respective affiliates, and each of their directors, officers and employees against all losses, claims, damages, penalties, judgments, liabilities and expenses (including, without limitation, all expenses of litigation or preparation therefor whether or not the Agent any Lender or any affiliate is a party thereto) which any of them may pay or incur arising out of or relating to this Agreement, the other Basic Documents, the transactions contemplated hereby or the direct or indirect application or proposed application of the proceeds of any Loan except to the extent that they are determined in a final non-appealable judgment by a court of competent jurisdiction to have resulted from the gross negligence or willful misconduct of the party seeking indemnification. The obligations of State Auto Mutual and State Auto Financial under this Section 5.3 shall survive the termination of this Agreement. 5.4 Amendments, Etc. Except as otherwise expressly provided in this Agreement, any provision of this Agreement may be modified or supplemented only by an instrument in writing signed by each State Auto Obligor and the Agent (with the consent of the Lenders as specified in Section 10.17 of the Credit Agreement), and any provision of this Agreement may be waived by the Agent (with the consent of the Lenders as specified in Section 10.17 of the Credit Agreement). 5.5 Successors and Assigns. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and permitted assigns, provided, that neither State Auto Obligor may assign any of its rights or obligations hereunder without the prior consent of the Agent (with the consent of all of the Lenders). 5.6 Captions. The captions and section headings appearing herein are included solely for convenience of reference and are not intended to affect the interpretation of any provision of this Agreement. 5.7 Counterparts. This Agreement may be executed in any number of counterparts, all of which taken together shall constitute one and the same instrument and any of the parties hereto may execute this Agreement by signing any such counterpart. 5.8 CHOICE OF LAW. THE BASIC DOCUMENTS (OTHER THAN THOSE CONTAINING A CONTRARY EXPRESS CHOICE OF LAW PROVISION) SHALL BE CONSTRUED IN ACCORDANCE WITH THE INTERNAL LAWS (INCLUDING, WITHOUT LIMITATION, 735 ILCS SECTION 105/5-1 ET SEQ, BUT OTHERWISE WITHOUT REGARD TO THE CONFLICT OF LAWS PROVISIONS) OF -35- 37 THE STATE OF ILLINOIS, BUT GIVING EFFECT TO FEDERAL LAWS APPLICABLE TO NATIONAL BANKS. 5.9 CONSENT TO JURISDICTION. EACH STATE AUTO OBLIGOR HEREBY IRREVOCABLY SUBMITS TO THE NON-EXCLUSIVE JURISDICTION OF ANY UNITED STATES FEDERAL OR ILLINOIS STATE COURT SITTING IN CHICAGO, ILLINOIS IN ANY ACTION OR PROCEEDING ARISING OUT OF OR RELATING TO ANY LOAN DOCUMENTS AND EACH STATE AUTO OBLIGOR HEREBY IRREVOCABLY AGREES THAT ALL CLAIMS IN RESPECT OF SUCH ACTION OR PROCEEDING MAY BE HEARD AND DETERMINED IN ANY SUCH COURT AND IRREVOCABLY WAIVES ANY OBJECTION IT MAY NOW OR HEREAFTER HAVE AS TO THE VENUE OF ANY SUCH SUIT, ACTION OR PROCEEDING BROUGHT IN SUCH A COURT OR THAT SUCH COURT IS AN INCONVENIENT FORUM. NOTHING HEREIN SHALL LIMIT THE RIGHT OF THE AGENT OR ANY LENDER TO BRING PROCEEDINGS AGAINST ANY STATE AUTO OBLIGOR IN THE COURTS OF ANY OTHER JURISDICTION. ANY JUDICIAL PROCEEDING BY ANY STATE AUTO OBLIGOR AGAINST THE AGENT OR ANY LENDER OR ANY AFFILIATE OF THE AGENT OR ANY LENDER INVOLVING, DIRECTLY OR INDIRECTLY, ANY MATTER IN ANY WAY ARISING OUT OF, RELATED TO, OR CONNECTED WITH ANY LOAN DOCUMENT SHALL BE BROUGHT ONLY IN A COURT IN CHICAGO, ILLINOIS. 5.10 WAIVER OF JURY TRIAL. EACH STATE AUTO OBLIGOR, THE AGENT AND EACH LENDER HEREBY WAIVE TRIAL BY JURY IN ANY JUDICIAL PROCEEDING INVOLVING, DIRECTLY OR INDIRECTLY, ANY MATTER (WHETHER SOUNDING IN TORT, CONTRACT OR OTHERWISE) IN ANY WAY ARISING OUT OF, RELATED TO, OR CONNECTED WITH ANY LOAN DOCUMENT OR THE RELATIONSHIP ESTABLISHED THEREUNDER. 5.11 Treatment of Certain Information; Confidentiality. (a) Each State Auto Obligor acknowledges that from time to time financial advisory, investment banking and other services may be offered or provided to State Auto Mutual or one or more of its Subsidiaries (in connection with this Agreement or otherwise) by any Lender or by one or more subsidiaries or affiliates of such Lender and such State Auto Obligor hereby authorizes each Lender to share any information delivered to such Lender by or on behalf of State Auto Mutual and its Subsidiaries pursuant to this Agreement, or in connection with the decision of such Lender to enter into the Credit Agreement, to any such subsidiary or affiliate, it being understood that any such subsidiary or affiliate receiving such information shall be bound by the provisions of paragraph (b) below as if it were a Lender hereunder. Such authorization shall survive the termination of this Agreement. (b) The Agent and each Lender agrees to hold any confidential information which it may receive from either State Auto Obligor pursuant to this Agreement in confidence, except for disclosure (i) to its Affiliates and to other Lenders and their respective Affiliates, so long as such Affiliate or other Lender agrees to be bound by the provisions of this Section, (ii) to legal counsel, accountants, and other professional advisors to such Lender or to a Transferee, (iii) -36- 38 to regulatory officials, (iv) to any Person as requested pursuant to or as required by law, regulation, or legal process, (v) to any Person in connection with any legal proceeding to which such Lender is a party, (vi) to such Lender's direct or indirect contractual counterparties in swap agreements or to legal counsel, accountants and other professional advisors to such counterparties, and (vii) permitted by Section 12.4 of the Credit Agreement. 5.12 No Liability. Except as expressly provided herein, neither the Agent nor any Lender shall be responsible or have any liability for (a) any statements, warranties or representations made in or in connection with the Credit Agreement, any other Basic Document or any other instrument or document furnished pursuant thereto, or the execution, legality, validity, enforceability, genuineness, sufficiency or value of the Credit Agreement, any other Basic Document or any other instrument or document furnished pursuant thereto and (b) the financial condition of the Borrower or any other Person or any other obligation of or the performance or observance by the Borrower, any other Person or any other obligor of any of their respective obligations under the Credit Agreement or any other Basic Document or any other instrument or document furnished pursuant thereto. 5.13 Further Assurances. Each State Auto Obligor agrees that, from time to time upon the written request of the Agent, such State Auto Obligor will execute and deliver such further documents and do such other acts and things as the Lender may reasonably request in order fully to effect the purposes of this Agreement. 5.14 Severability of Provisions. Any provision in any Basic Document that is held to be inoperative, unenforceable, or invalid in any jurisdiction shall, as to that jurisdiction, be inoperative, unenforceable, or invalid without affecting the remaining provisions in that jurisdiction or the operation, enforceability, or validity of that provision in any other jurisdiction, and to this end the provisions of all Basic Documents are declared to be severable. 5.15 Third-Party Beneficiaries. Each State Auto Obligor agrees that each Lender shall be a third-party beneficiary of this Agreement and shall be entitled to enforce its rights hereunder as fully as if it were a party hereto. [signature page follows] -37- 39 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed and delivered as of the day and year first above written. STATE AUTOMOBILE MUTUAL INSURANCE COMPANY By: /s/ Steven J. Johnston --------------------------------------- Title: Senior Vice President ------------------------------------ Address for Notices: State Automobile Mutual Insurance Company 518 East Broad Street Columbus, Ohio 43215 Attention: John Lowther, Esq. Telecopier No.: (614) 464-4911 Telephone No.: (614) 464-5052 STATE AUTO FINANCIAL CORPORATION By: /s/ Steven J. Johnston --------------------------------------- Title: Senior Vice President ------------------------------------ Addresses for Notices: State Automobile Mutual Insurance Company 518 East Broad Street Columbus, Ohio 43215 Attention: John Lowther, Esq. Telecopier No.: (614) 464-4911 Telephone No.: (614) 464-5052 S-1 [TO PUT AGREEMENT] 40 BANK ONE, NA By: /s/ Thomas A. Kiepura II --------------------------------------- Title: Assistant Vice President ------------------------------------ Addresses for Notices: 1 Bank One Plaza Chicago, Illinois 60670 Attention: Cynthia W. Priest Telecopier No.: (312) 732-4033 Telephone No.: (312) 732-9565 S-2 [TO PUT AGREEMENT] 41 Put Agreement Schedule I Part A Indebtedness in Excess of $5,000,000 State Auto Financial owes State Auto Mutual $30,000,000 under a Credit Agreement dated May 1999. On November 11, 1999, the boards of directors of State Auto Financial and State Auto Mutual are expected to approve an additional $20,000,000 line of credit from State Auto Mutual to State Auto Financial. These monies have been used to effect a stock repurchase program. 42 Put Agreement Schedule I Part B Liens None 43 Put Agreement Schedule II Part A Subsidiaries of State Auto Mutual See attached Organizational Chart. 44 ORGANIZATIONAL STRUCTURE OF STATE AUTO HOLDING COMPANY SYSTEM - - - - - - - - - l Public l l 31% l - - - - - - - - - l l l ====================================== 69% ======================================= l State Auto Financial Corporation l----------------------------------l State Automobile Mutual Insurance l l Ohio Corporation l l Company Ohio Corporation* l ====================================== ======================================= l l l l l =========================== l ======================== l 100% l State Auto Property & l 15% l 100% l Midwest Security l l--------l Casualty South l-------l l--------l Ins. Co. Wisconsin l l l Carolina Corporation* l l l l Corporation* l l =========================== l l ======================== l l l l l ==================== l l =========================== l l l l ======================== l 100% l State Auto National l l l 518 Property l l 100% l Associated Services l l--------l Ins. Co. l l-----l Management and l l--------l Agency Ohio l l l Ohio Corporation* l l l Leasing, LLC l l l Corporation l l =========================== l l l l ======================== l l ==================== l l l l l =========================== l l ======================== l 100% l Stateco Financial l 85% l l 100% l Facilitators, Inc. l l--------l Services, Inc. l-------l l--------l South Carolina l l l Ohio Corporation l l l Corporation l l =========================== l ======================== l l l l l =========================== l ======================== ==================== l 100% l Strategic Ins. l l 100% l Columbus Marketing, l 52% l Call Insurance l l--------l Software, Inc. l l--------l Inc. Ohio l------l Agency Ohio l l l Ohio Corporation l l Corporation l l Corporation l l =========================== ======================== ==================== l l l ============================= l 100% l Milbank Insurance l l--------l Company South l l l Dakota Corporation* l l ============================= l l l ============================= ========================= l 100% l Farmers Casualty l 100% l Mid-Plains l l--------l Insurance Company l--------l Insurance Company l l l Iowa Corporation* l l Iowa Corporation* l l ============================= ========================= l l l ============================= l 100% l State Auto l l--------l Insurance Company l l Ohio Corporation* l =============================
*Insurance Entities 45 Put Agreement Schedule II Part B Investments 1. See Forms "Schedule D" attached for: State Auto Mutual State Auto P&C State Auto National Milbank Insurance Company Midwest Security Insurance Company Farmers Casualty Insurance Company Mid-Plains Insurance Company 518 Property Management and Leasing, LLC Stateco Financial Services, Inc. Strategic Insurance Software, Inc. Reflecting information as of September 30, 1999 2. As of September 30, 1999, State Auto Mutual had in place 34 loans to its independent agencies with a total amount outstanding of $3,639,728.38. 46 Put Agreement Schedule III Part A Equity Rights As of November 1, 1999, State Auto Financial has granted 2,481,469 stock options to members of management under State Auto Financial's 1991 Stock Option Plan of which 2,355,811 are outstanding. As of November 1, 1999, State Auto Financial has granted 174,000 stock options to "outside" directors on the boards of directors of State Auto Financial and State Auto Mutual pursuant to the terms of the 1991 Directors' Stock Option Plan. State Auto Financial also has registered 2,400,000 shares to be issued pursuant to an Employee Stock Purchase Plan (the "ESPP") of which 1,473,805 shares have been purchased pursuant to the ESPP as of November 1, 1999. State Auto Financial intends to register 400,000 shares as part of an agents' stock option plan. Options for 16,538 option shares have been issued under this plan but are not exercisable at this time. 47 Put Agreement Schedule III Part B In August 1999, Strategic Insurance Software, Inc. ("S.I.S.") completed the repurchase of all shares of S.I.S. from holders other than State Auto Financial except for 60,000 shares, which the holders thereof (2 individuals) are contractually obligated to sell no later than January 4, 2000. 48 EXHIBIT A to the Put Agreement [Form of Put Notice] [Date] State Automobile Mutual Insurance Company State Auto Financial Corporation [Address] Re: Put Agreement dated as of November 19, 1999, between State Automobile Mutual Insurance Company, State Auto Financial Corporation and Bank One, NA, as Agent. Dear Ladies and Gentlemen: Reference is made to the Put Agreement dated as of November 19, 1999 (as modified and supplemented and in effect from time to time, the "Put Agreement"), among State Automobile Mutual Insurance Company ("State Auto Mutual"), State Auto Financial Corporation and Bank One, NA, as Agent. Capitalized terms used but not defined herein shall have the respective meanings assigned to such terms in the Put Agreement. [Pursuant to Section 2.2 of the Put Agreement, the undersigned hereby requires that State Auto Mutual purchase all of each Lender's Loans, Note and Commitment. The aggregate purchase price payable by State Auto Mutual for all such Loans, Notes and Commitments shall be $_______________ representing the sum of (a) principal of such Loans in the amount of $_______________, plus (b) accrued and unpaid interest thereon in the amount of $______________, plus (c) other amounts payable under the Basic Documents in respect thereof in the amount of $_______________.] [Pursuant to Section 2.3 of the Put Agreement, the undersigned hereby requires that State Auto Mutual purchase all of the Pledged Stock for an aggregate purchase price equal to $_______________ representing the sum of (a) the aggregate Redemption Value of such Pledged Stock in the amount of $_____________, plus (b) accrued and unpaid dividends thereon in the amount of $_______________.] The Put Purchase Date for such purchase shall be _______________, _____. BANK ONE, NA, as Agent By -------------------------------------------- Title: --------------------------------------- A-1 49 EXHIBIT B to the Put Agreement [Form of Opinion of General Counsel of the State Auto Obligors] November 19, 1999 To each of the Lenders party to the Credit Agreement referred to below and Bank One, NA, as Agent Ladies and Gentlemen: I am the general counsel of State Automobile Mutual Insurance Company ("State Auto Mutual") and State Auto Financial Corporation ("State Auto Financial" and, together with State Auto Mutual, the "State Auto Obligors") and have acted as counsel to the State Auto Obligors in connection with (i) the Put Agreement dated as of November 19, 1999 (the "Put Agreement") among the State Auto Obligors and Bank One, NA, in its capacity as Agent (the "Agent") on behalf of the lenders party to a Credit Agreement dated as of November 19, 1999, among SAF Funding Corporation, the Agent and (ii) the agreements, instruments and other documents referred to in the next paragraph. All capitalized terms used but not defined herein have the respective meanings given to such terms in the Put Agreement. This opinion letter is delivered to you pursuant to Section 4.18(c) of the Put Agreement. In rendering the opinions expressed below, I have examined the following agreements, instruments and other documents: (a) the Credit Agreement; (b) the Pledge Agreements; (c) the Put Agreement; (d) the Standby Purchase Agreement (collectively with the Put Agreement, the "State Auto Agreements"); and (e) such records of the State Auto Obligors and such other documents as I have deemed necessary as a basis for the opinions expressed below. In my examination, I have assumed the genuineness of all signatures, the authenticity of all documents submitted to me as originals and the conformity with authentic original documents of all documents submitted to me as copies. When relevant facts were not independently established, I have relied upon certificates of governmental officials and appropriate representatives of the State Auto Obligors and upon representations made in or pursuant to the State Auto Agreements. B-1 50 In rendering the opinions expressed below, I have assumed, with respect to all of the documents referred to in this opinion letter, that (except, to the extent set forth in the opinions expressed below, as to the State Auto Obligors): (i) such documents have been duly authorized by, have been duly executed and delivered by, and constitute legal, valid, binding and enforceable obligations of, all of the parties to such documents; (ii) all signatories to such documents have been duly authorized; and (iii) all of the parties to such documents are duly organized and validly existing and have the power and authority (corporate, partnership or other) to execute, deliver and perform such documents. Based upon and subject to the foregoing and subject also to the comments and qualifications set forth below, and having considered such questions of law as I have deemed necessary as a basis for the opinions expressed below, I am of the opinion that: 1. State Auto Mutual is a mutual insurance company duly organized, validly existing and in good standing under the laws of the State of Ohio. State Auto Financial is a corporation duly organized, validly existing and in good standing under the laws of the State of Ohio. 2. Each State Auto Obligor has all requisite corporate power and authority to execute and deliver, and to perform its obligations and to incur liabilities under, the State Auto Agreements to which it is a party. 3. The execution, delivery and performance by each State Auto Obligor of, and the incurrence by such State Auto Obligor of liabilities under, each State Auto Agreement to which such State Auto Obligor is a party, have been duly authorized by all necessary corporate action on the part of such State Auto Obligor. 4. Each State Auto Agreement has been duly executed and delivered by each State Auto Obligor party thereto. 5. Under Ohio conflict of laws principles, the stated choice of Illinois law to govern the State Auto Agreements will be honored by the courts of the State of Ohio and the State Auto Agreements will be construed in accordance with, and will be treated as being governed by, the law of the State of Illinois. However, if the State Auto Agreements were stated to be governed by and construed in accordance with the law of the State of Ohio, or if an Ohio court were to apply the law of the State of Ohio to the State Auto Agreements, each State Auto Agreement would constitute the legal, valid and binding obligation of each State Auto Obligor party thereto, enforceable against such State Auto Obligor in accordance with its terms, except as may be limited by bankruptcy, insolvency, reorganization, moratorium, fraudulent conveyance or transfer or other similar laws relating to or affecting the rights of creditors generally and except as the enforceability of the State Auto Agreements is subject to the application of general principles of equity (regardless of whether considered in a proceeding in equity or at 51 law), including, without limitation, (a) the possible unavailability of specific performance, injunctive relief or any other equitable remedy and (b) concepts of materiality, reasonableness, good faith and fair dealing. 6. No authorization, approval or consent of, and no filing or registration with, any governmental or regulatory authority or agency of the United States of America or the State of Ohio (other than any authorizations, approvals, consents, filings and registrations heretofore duly made or obtained and in full force and effect) is required on the part of either State Auto Obligor for the execution, delivery or performance by such State Auto Obligor of, or for the incurrence by such State Auto Obligor of any liabilities under, the State Auto Agreements to which such State Auto Obligor is a party. 7. The execution, delivery and performance by each State Auto Obligor of, and the consummation by such State Auto Obligor of the transactions contemplated by, the State Auto Agreements to which such State Auto Obligor is a party do not and will not (a) violate any provision of the Articles of Incorporation or Code of Regulations of such State Auto Obligor, (b) violate any applicable law, rule or regulation of the United States of America or the State of Ohio, (c) violate any order, writ, injunction or decree of any court or governmental authority or agency or any arbitral award applicable to such State Auto Obligor of which I have knowledge (after due inquiry) or (d) result in a breach of, constitute a default under, require any consent under, or result in the acceleration or required prepayment of any indebtedness pursuant to the terms of, any agreement or instrument of which I have knowledge (after due inquiry) to which such State Auto Obligor or any of its Subsidiaries is a party or by which any of them is bound or to which any of them is subject, or result in the creation or imposition of any Lien upon any Property of such State Auto Obligor or any of its Subsidiaries pursuant to the terms of any such agreement or instrument. 8. I have no knowledge (after due inquiry) of any legal or arbitral proceedings, or any proceedings by or before any governmental or regulatory authority or agency, now pending or threatened against or affecting either State Auto Obligor or any of their respective Properties that, if adversely determined, could have a Material Adverse Effect. 9. State Auto Financial has duly authorized and reserved for issuance 2,500,000 shares of Class A Preferred Stock. The foregoing opinions are subject to the following comments and qualifications: (A) The enforceability of Section 5.3 of the Put Agreement and Section 7.6 of the Standby Purchase Agreement may be limited by (i) laws rendering unenforceable indemnification contrary to Federal or state securities laws and the public policy underlying such laws and (ii) laws limiting the enforceability of provisions exculpating or exempting a party from, or requiring indemnification of a party for, its own action or inaction, to the extent such action or inaction involves gross negligence, recklessness or willful or unlawful conduct. 52 (B) The enforceability of provisions in the State Auto Agreements to the effect that terms may not be waived or modified except in writing may be limited under certain circumstances. (C) I express no opinion as to the first sentence of Section 5.08 of the Put Agreement or the second sentence of Section 8.7 of the Standby Purchase Agreement, insofar as either such sentence relates to the subject matter jurisdiction of the United States District Court for the Northern District of Illinois sitting in Chicago, Illinois to adjudicate any controversy related to the applicable State Auto Agreement. The foregoing opinions are limited to matters involving the Federal laws of the United States of America and the law of the State of Ohio, and I do not express any opinion as to the laws of any other jurisdiction. The opinions contained in this letter are rendered only as of the date hereof and I undertake no obligation to update this letter or the opinions contained herein after the date hereof. The opinions contained in this letter only constitute my professional judgment as to the consequences of and the applicability of certain laws to the documents and agreements referred to and the parties thereto and should not be considered to be a guarantee of any particular result. At the request of my clients, this opinion letter is provided to you by me in my capacity as counsel to the State Auto Obligors, and this opinion letter may not be relied upon by any Person for any purpose other than in connection with the transactions contemplated by the Basic Documents without, in each instance, my prior written consent. Very truly yours, EX-10.V 4 EXHIBIT 10(V) 1 Exhibit 10(V) ================================================================================ STANDBY PURCHASE AGREEMENT between STATE AUTO FINANCIAL CORPORATION and SAF FUNDING CORPORATION Dated as of November 19, 1999 ================================================================================ 2 TABLE OF CONTENTS
Section Page - ------- ---- ARTICLE I - DEFINITIONS AND ACCOUNTING TERMS.....................................1 1.1 Definitions and Accounting Terms.........................................1 ARTICLE II - PURCHASE OF PREFERRED STOCK.........................................6 2.1 Purchases................................................................6 2.2 Notices of Purchases.....................................................6 2.3 Commitment Fee...........................................................6 ARTICLE III - CONDITIONS TO PURCHASE.............................................6 ARTICLE IV - REPRESENTATIONS AND WARRANTIES OF STATE AUTO FINANCIAL..............7 4.1 Corporate Existence......................................................7 4.2 Litigation...............................................................7 4.3 No Breach................................................................8 4.4 Action...................................................................8 4.5 Approvals................................................................8 4.6 Capitalization...........................................................8 4.7 True and Complete Disclosure.............................................9 ARTICLE V - REPRESENTATIONS AND WARRANTIES OF THE COMPANY........................9 5.1 Investment...............................................................9 5.2 No Agreement to Transfer.................................................9 5.3 Knowledge and Experience.................................................9 5.4 Access to Information....................................................9 5.5 Risk....................................................................10 5.6 Restrictions on Transfer................................................10 ARTICLE VI - COVENANTS..........................................................10 6.1 Transfer................................................................10 6.2 Redemption..............................................................10 6.3 Use of Proceeds.........................................................10 ARTICLE VII - REGISTRATION RIGHTS...............................................11 7.1 Demand Registration.....................................................11 7.2 Piggyback Registrations.................................................12 7.3 Registration Procedures.................................................14 7.4 Underwritten Offerings..................................................17 7.5 Holdback Agreements By State Auto Financial and Other Securityholders...18 7.6 Indemnification.........................................................19 7.7 Covenants Relating to Rule 144..........................................22 7.8 References to holders of Registrable Securities.........................22
3 ARTICLE VIII - MISCELLANEOUS....................................................22 8.1 Waiver..................................................................22 8.2 Notices.................................................................23 8.3 Amendments, Etc.........................................................23 8.4 Successors and Assigns..................................................23 8.5 Captions................................................................23 8.6 Counterparts............................................................23 8.7 Governing Law; Submission to Jurisdiction...............................23 8.8 Waiver of Jury Trial....................................................23 8.9 Further Assurances......................................................24 8.10 Payments by State Auto Financial........................................24 8.11 Payments Received by the Company under Basic Documents..................24 8.12 Third-Party Beneficiaries...............................................24 8.13 Severability............................................................24
SCHEDULES Schedule I Equity Rights and Repurchase Obligations EXHIBITS Exhibit A Class A Preferred Stock Certificate Exhibit B Purchase Notice Exhibit C Opinion of General Counsel of State Auto Financial - ii - 4 STANDBY PURCHASE AGREEMENT This Standby Purchase Agreement, dated as of November 19, 1999, is by and between State Auto Financial Corporation, a corporation duly organized and validly existing under the laws of the State of Ohio ("State Auto Financial"), and SAF Funding Corporation, a Delaware corporation (the "Company"). RECITALS: --------- A. State Auto Financial seeks to raise funds for catastrophic loss claims and/or loss adjustment expenses that may be made from time to time for residential and commercial property under insurance coverage underwritten by State Automobile Mutual Insurance Company, an Ohio mutual insurance company ("State Auto Mutual"), and certain of its affiliates, which have been reinsured by State Auto Property and Casualty Insurance Company, a South Carolina corporation ("State Auto P&C"). B. State Auto Financial intends to raise such funds through the issuance and sale by State Auto Financial and the purchase by the Company, from time to time, of State Auto Financial's Class A Preferred Stock, no par value per share (the "Class A Preferred Stock"). C. State Auto Financial desires to issue and sell its Class A Preferred Stock from time to time to the Company in accordance with the terms and conditions set forth in this Agreement. NOW, THEREFORE, for and in consideration of the mutual representations, warranties, covenants and agreements contained herein, and intending to be legally bound hereby, the parties hereto agree as follows: ARTICLE I DEFINITIONS AND ACCOUNTING TERMS 1.1 Definitions and Accounting Terms. As used herein, the following terms shall have the following meanings (all terms defined in this Section 1.1 or in other provisions of this Agreement in the singular to have the same meanings when used in the plural and vice versa): "Agent" shall mean Bank One, NA, as agent under the Credit Agreement. "Basic Documents" shall have the meaning assigned thereto in the Credit Agreement. "Commission" shall mean the United States Securities and Exchange Commission, or any successor governmental agency or authority. "Commitment" shall have the meaning assigned thereto in the Credit Agreement. 5 "Company Pledge Agreement" shall mean the Pledge and Security Agreement, dated as of the date hereof, among the Company and the Agent, as modified and supplemented and in effect from time to time. "Credit Agreement" shall mean the Credit Agreement, dated as of the date hereof, among the Company, the Agent and the Lenders, as modified and supplemented and in effect from time to time. "Cutback Registration" shall mean any Demand Registration or Piggyback Registration to be effected as an underwritten Public Offering in which the Managing Underwriter with respect thereto advises State Auto Financial and the Requesting Holders in writing that, in its opinion, the number of securities requested to be included in such registration (including securities of State Auto Financial which are not Registrable Securities) exceed the number which can be sold in such offering without a material reduction in the selling price anticipated to be received for the securities to be sold in such Public Offering. "Demand Registration" shall mean any registration of Registrable Securities under the Securities Act effected in accordance with Section 7.1 hereof. "Effective Long-Form Registration" shall mean a Long-Form Registration that results in an Effective Registration. "Effective Registration" shall mean a Demand Registration which (a) has been declared or ordered effective in accordance with the rules of the Commission, (b) has been kept effective for the period of time contemplated by Section 7.3(b) hereof and (c) has resulted in the Registrable Securities requested to be included in such registration actually being sold (except by reason of some act or omission on the part of the Requesting Holders); provided that for purposes of this Agreement (i) a Cutback Registration shall not be an Effective Registration and (ii) a Demand Registration in which State Auto Financial includes securities for sale for the account of State Auto Financial shall not be an Effective Registration. "Effective Short-Form Registration" shall mean a Short-Form Registration that results in an Effective Registration. "Exchange Act" shall mean the Securities Exchange Act of 1934, as amended, and the rules and regulations promulgated thereunder. "Form S-1" shall mean Form S-1 promulgated by the Commission under the Securities Act, or any successor or similar long-form registration statement. "Form S-2" shall mean Form S-2 promulgated by the Commission under the Securities Act, or any successor or similar short-form registration statement. "Form S-3" shall mean Form S-3 promulgated by the Commission under the Securities Act, or any successor or similar short-form registration statement. "Indemnified Party" shall mean a party entitled to indemnity in accordance with Section 7.6 hereof. - 2 - 6 "Indemnifying Party" shall mean a party obligated to provide indemnity in accordance with Section 7.6 hereof. "Inspectors" shall have the meaning assigned thereto in Section 7.3(j) hereof. "Lenders" shall have the meaning assigned thereto in the Credit Agreement. "Lien" shall mean, with respect to any Property, any mortgage, lien, pledge, charge, security interest or encumbrance of any kind in respect of such Property. For purposes of this Agreement, a Person shall be deemed to own subject to a Lien any Property that it has acquired or holds subject to the interest of a vendor or lessor under any conditional sale agreement, capital lease or other title retention agreement (other than an operating lease) relating to such Property. "Loans" shall have the meaning assigned thereto in the Credit Agreement. "Long-Form Registration" shall mean a Demand Registration effected by the filing of a registration statement on Form S-1 with the Commission. "Losses" shall have the meaning assigned thereto in Section 7.6(a) hereof. "Majority Lenders" shall have the meaning assigned thereto in the Credit Agreement. "Managing Underwriter" shall mean, with respect to any Public Offering, the underwriter or underwriters managing such Public Offering. "Material Adverse Effect" shall mean a material adverse effect on (a) the Property, business, operations, financial condition, prospects, liabilities or capitalization of State Auto Mutual and its Subsidiaries taken as a whole, (b) the ability of State Auto Financial to issue the Class A Preferred Stock to or perform its obligations under this Agreement, (c) the ability of State Auto Mutual or State Auto Financial to perform its respective obligations under the Put Agreement, (d) the validity or enforceability of any of the Basic Documents or (e) the rights and remedies of the Lenders and the Agent under any of the Basic Documents. "NASD" shall mean the National Association of Securities Dealers. "Notice of Demand Registration" shall have the meaning assigned thereto in Section 7.1(a) hereof. "Notice of Piggyback Registration" shall have the meaning assigned thereto in Section 7.2(a) hereof. "Piggyback Registration" shall mean any registration of equity securities of State Auto Financial under the Securities Act (other than a registration in respect of a dividend reinvestment or similar plan for stockholders of State Auto Financial or on Form S-4 or Form S-8 promulgated by the Commission, or any successor or similar forms thereto), whether - 3 - 7 for sale for the account of State Auto Financial or for the account of any holder of securities of State Auto Financial (other than Registrable Securities). "Property" shall mean any right or interest in or to property of any kind whatsoever, whether real, personal or mixed and whether tangible or intangible. "Public Offering" shall mean any offering of any equity securities of State Auto Financial to the public, either on behalf of State Auto Financial or any of its securityholders, pursuant to an effective registration statement under the Securities Act. "Purchase Commitment" shall mean the obligation of the Company to purchase Class A Preferred Stock with an aggregate original Redemption Value of not more than $135,000,000. "Purchase Commitment Termination Date" shall mean November 17, 2000; provided that if the "Commitment Termination Date" under the Credit Agreement is extended as provided therein, the Purchase Commitment Termination Date shall, automatically and without any action on the part of State Auto Financial or the Company, be extended to the date to which said "Commitment Termination Date" has been so extended. "Purchase Date" shall have the meaning assigned thereto in Section 2.2 hereof. "Purchase Notice" shall mean a Purchase Notice substantially in the form of Exhibit B hereto. "Put Agreement" shall mean the Put Agreement, dated as of the date hereof, among State Auto Mutual, State Auto Financial and the Agent, as modified and supplemented and in effect from time to time. "Put Dishonor" shall mean the failure of State Auto Mutual for any reason after its receipt of a Put Notice (as defined in the Put Agreement) to comply with its obligations under the Put Agreement to purchase each Lender's Loans, Notes and Commitment (each, as defined in the Put Agreement) or the Class A Preferred Stock, as specified in such Put Notice. "Put Event" shall have the meaning assigned thereto in the Put Agreement. "Quarterly Dates" shall mean the last Business Day of March, June, September and December in each year, the first of which shall be the first such day after the day hereof. "Records" shall have the meaning assigned thereto in Section 7.3(j) hereof. "Redemption Value" shall mean, with respect to any Class A Preferred Stock, the "Redemption Value" for such Class A Preferred Stock set forth in the certificate evidencing such Class A Preferred Stock. "Registrable Securities" shall mean (a) any shares of Class A Preferred Stock purchased pursuant to Section 2.1 hereof and (b) any additional shares of Class A Preferred Stock issued or distributed by way of a dividend, stock split or other distribution in respect of - 4 - 8 such Class A Preferred Stock purchased pursuant to Section 2.1 hereof, or acquired by way of any rights offering or similar offering made in respect of such Class A Preferred Stock. As to any particular Registrable Securities, once issued such securities shall cease to be Registrable Securities when (i) a registration statement with respect to the sale of such securities shall have become effective under the Securities Act and such securities shall have been disposed of in accordance with such registration statement, (ii) they shall have been distributed to the public pursuant to Rule 144 or (iii) they shall have ceased to be outstanding. "Registration Expenses" shall mean all expenses incident to State Auto Financial's performance of or compliance with its obligations under this Agreement to effect the registration of Registrable Securities in a Demand Registration or a Piggyback Registration, including, without limitation, all registration, filing, securities exchange listing and NASD fees, all registration, filing, qualification and other fees and expenses of complying with securities or blue sky laws, all word processing, duplicating and printing expenses, messenger and delivery expenses, the fees and disbursements of counsel for State Auto Financial and of its independent public accountants, including the expenses of any special audits or "cold comfort" letters required by or incident to such performance and compliance, the reasonable fees and disbursements of a single counsel and single firm of accountants retained by the holders of a majority of the Registrable Securities being registered, premiums and other costs of policies of insurance against liabilities arising out of the Public Offering of the Registrable Securities being registered and any fees and disbursements of underwriters customarily paid by issuers or sellers of securities, but excluding underwriting discounts and commissions and transfer taxes, if any, in respect of Registrable Securities, which shall be payable by each holder thereof. "Registration Request" shall have the meaning assigned thereto in Section 7.1 hereof. "Requesting Holders" shall mean, with respect to any Demand Registration or Piggyback Registration, the holders of Registrable Securities requesting to have Registrable Securities included in such registration in accordance with this Agreement. "Rule 144" shall mean Rule 144 promulgated by the Commission under the Securities Act, and any successor provision thereto. "Securities Act" shall mean the Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder. "Short-Form Registration" shall mean a Demand Registration effected by the filing of a registration statement on Form S-2 or Form S-3 with the Commission. "State Auto Mutual" shall mean the meaning assigned thereto in the first Whereas clause of this Agreement. "State Auto P&C" shall mean the meaning assigned thereto in the first Whereas clause of this Agreement. "Subsidiary" shall mean, with respect to any Person, any corporation, partnership or other entity of which at least a majority of the securities or other ownership interests having - 5 - 9 by the terms thereof ordinary voting power to elect a majority of the board of directors or other persons performing similar functions of such corporation, partnership or other entity (irrespective of whether or not at the time securities or other ownership interests of any other class or classes of such corporation, partnership or other entity shall have or might have voting power by reason of the happening of any contingency) is at the time directly or indirectly owned or controlled by such Person or one or more Subsidiaries of such Person or by such Person and one or more Subsidiaries of such Person. ARTICLE II PURCHASE OF PREFERRED STOCK 2.1 Purchases. The Company agrees, on the terms and conditions of this Agreement, to purchase from State Auto Financial in one or more transactions, Class A Preferred Stock with an aggregate Redemption Value of not more than $135,000,000. The purchase price payable by the Company for each share of Class A Preferred Stock shall be equal to the Redemption Value thereof. 2.2 Notices of Purchases. State Auto Financial shall give the Company notice of each purchase hereunder by delivering to the Company a Purchase Notice not less than four Business Days prior to the date of such purchase (the "Purchase Date"). Not later than 2:00 p.m. New York time on the Purchase Date specified for each such purchase, the Company shall make available the amount of the purchase price of the Class A Preferred Stock to be purchased by it by depositing in immediately available funds such purchase price in an account designated by State Auto Financial. 2.3 Commitment Fee. State Auto Financial shall pay to the Company a commitment fee on the daily average unused amount (based on the aggregate Redemption Value of not more than $135,000,000 of Class A Preferred Stock) of the Company's Purchase Commitment, for the period from and including the date hereof to but not including the earlier of the date such Purchase Commitment is terminated and the Purchase Commitment Termination Date, at a rate per annum equal to 0.20%. Accrued commitment fees shall be payable on each Quarterly Date and on the earlier of the date the Purchase Commitments are terminated and the Purchase Commitment Termination Date. ARTICLE III CONDITIONS TO PURCHASE The obligations of the Company to purchase any Class A Preferred Stock hereunder is subject to the following conditions: (a) Purchase Notice. The Company shall have received a Purchase Notice with respect to such purchase, duly completed and executed. - 6 - 10 (b) Opinion of Counsel to the Company. The Company shall have received an opinion, dated the Purchase Date, of John Lowther, general counsel of State Auto Financial, substantially in the form of Exhibit C hereto and covering such other matters as the Company may reasonably request. (c) Certificates. The Company shall have received duly executed stock certificates, substantially in the form of Exhibit A hereto, evidencing the aggregate number of shares of Class A Preferred Stock to be purchased by the Company on such Purchase Date. (d) Catastrophic Loss. Any one or more of State Auto Mutual, State Auto P&C, Milbank Insurance Company, Farmers Casualty Insurance Company, Midwest Security Insurance Company and State Auto National Insurance Company shall have incurred liability in excess of $120,000,000 in the aggregate in respect of catastrophic loss claims and/or loss adjustment expenses resulting from the occurrence of a single catastrophic event and the Company shall have received a certificate of a senior financial officer of State Auto Financial to such effect. (e) Officer's Certificate. The Company shall have received a certificate of a senior financial officer of State Auto Financial to the effect that, both immediately prior to such purchase and also after giving effect thereto and to the intended use thereof (i) no Put Event (or an event with notice or lapse of time or both would become a Put Event) shall have occurred and be continuing; and (ii) the representations and warranties made by State Auto Financial in Article IV hereof shall be true and complete on and as of the date of such purchase with the same force and effect as if made on and as of such date (or, if any such representation or warranty is expressly stated to have been made as of a specific date, as of such specific date). ARTICLE IV REPRESENTATIONS AND WARRANTIES OF STATE AUTO FINANCIAL State Auto Financial represents and warrants to the Company that: 4.1 Corporate Existence. Each of State Auto Financial and its Subsidiaries: (a) is a corporation, partnership or other entity duly organized, validly existing and in good standing under the laws of the jurisdiction of its organization; (b) has all requisite corporate or other power, and has all material governmental licenses, authorizations, consents and approvals necessary to own its assets and carry on its business as now being or as proposed to be conducted; and (c) is qualified to do business and is in good standing in all jurisdictions in which the nature of the business conducted by it makes such qualification necessary and where failure so to qualify could (either individually or in the aggregate) have a Material Adverse Effect. 4.2 Litigation. There are no legal or arbitral proceedings, or any proceedings by or before any governmental or regulatory authority or agency, now pending or (to the knowledge of State Auto Financial) threatened against State Auto Financial or any of its Subsidiaries that, if adversely determined could (either individually or in the aggregate) have a Material Adverse Effect. - 7 - 11 4.3 No Breach. None of the execution and delivery of this Agreement, the consummation of the transactions herein and therein contemplated or compliance with the terms and provisions hereof and thereof (including issuance of the Class A Preferred Stock) will conflict with or result in a breach of, or require any consent under, the charter or by-laws (or equivalent documents) of State Auto Financial, or any applicable law or regulation, or any order, writ, injunction or decree of any court or governmental authority or agency, or any agreement or instrument to which State Auto Financial or any of its Subsidiaries is a party or by which any of them or any of their Property is bound or to which any of them is subject, or constitute a default under any such agreement or instrument, or result in the creation or imposition of any Lien upon any Property of State Auto Financial or any of its Subsidiaries pursuant to the terms of any such agreement or instrument. 4.4 Action. State Auto Financial has all necessary corporate power, authority and legal right to execute, deliver and perform its obligations under this Agreement and to issue the Class A Preferred Stock; the execution, delivery and performance by State Auto Financial of this Agreement (and the issuance of the Class A Preferred Stock) have been duly authorized by all necessary corporate action on its part (including, without limitation, any required shareholder approvals); and this Agreement has been duly and validly executed and delivered by State Auto Financial and constitutes, its legal, valid and binding obligation, enforceable against State Auto Financial in accordance with its terms, except as such enforceability may be limited by (a) bankruptcy, insolvency, reorganization, moratorium or similar laws of general applicability affecting the enforcement of creditors' rights and (b) the application of general principles of equity (regardless of whether such enforceability is considered in a proceeding in equity or at law). 4.5 Approvals. No authorizations, approvals or consents of, and no filings or registrations with, any governmental or regulatory authority or agency, or any securities exchange (other than any authorizations, approvals, consents, filings and registrations heretofore duly made or obtained and in full force and effect), are necessary for the execution, delivery or performance by State Auto Financial of this Agreement (or for the issuance of the Class A Preferred Stock) or for the legality, validity or enforceability hereof. 4.6 Capitalization. The authorized capital stock of State Auto Financial consists, on the date hereof, of an aggregate of 105,000,000 shares consisting of (a) 100,000,000 shares of common stock, no par value, of which 40,565,812 shares are duly and validly issued and outstanding, each of which shares is fully paid and nonassessable, (b) 2,500,000 shares of Class A Preferred Stock, no par value, none of which shares issued and outstanding and (c) 2,500,000 shares of Class B Preferred Stock, no par value, none of which shares are issued and outstanding. As of the date hereof, 70% of such issued and outstanding shares of common stock are owned beneficially and of record by State Auto Mutual. Upon issuance, each share of Class A Preferred Stock will benefit from the Terms and Conditions of Class A Preferred Stock attached to form of Class A Preferred Stock Certificate attached hereto as Exhibit A. As of the date hereof, (i) except for this Agreement, the Put Agreement and as set forth in Part A of Schedule I hereto, there are no outstanding Equity Rights with respect to State Auto Financial and (ii) except as set forth in Part B of Schedule I hereto, there are no outstanding obligations of State Auto Financial or any of its Subsidiaries to repurchase, redeem, or otherwise acquire any shares of capital stock of State Auto Financial nor are there any outstanding obligations of State Auto Financial or any - 8 - 12 of its Subsidiaries to make payments to any Person, such as "phantom stock" payments, where the amount thereof is calculated with reference to the fair market value or equity value of State Auto Financial or any of its Subsidiaries. All shares of Class A Preferred Stock purchased by the Company hereunder will, when so purchased, be duly and validly issued and outstanding, fully paid and nonassessable. 4.7 True and Complete Disclosure. The information, reports, financial statements, exhibits and schedules furnished in writing by or on behalf of State Auto Financial and State Auto Mutual to the Company, the Agent or any Lender in connection with the negotiation, preparation or delivery of this Agreement and the other Basic Documents or included herein or therein or delivered pursuant hereto or thereto, when taken as a whole do not contain any untrue statement of material fact or omit to state any material fact necessary to make the statements herein or therein, in light of the circumstances under which they were made, not misleading. All written information furnished after the date hereof by State Auto Mutual and its Subsidiaries to the Company, the Agent and the Lenders in connection with this Agreement and the other Basic Documents and the transactions contemplated hereby and thereby will be true, complete and accurate in every material respect, or (in the case of projections) based on reasonable estimates, on the date as of which such information is stated or certified. There is no fact known to State Auto Financial that could have a Material Adverse Effect that has not been disclosed herein, in the other Basic Documents or in a report, financial statement, exhibit, schedule, disclosure letter or other writing furnished to the Agent for use in connection with the transactions contemplated hereby or thereby. ARTICLE V REPRESENTATIONS AND WARRANTIES OF THE COMPANY The Company represents and warrants to State Auto Financial that: 5.1 Investment. The Company will purchase the Class A Preferred Stock only for its own account, for investment purposes and not with a view to resale or distribution, and not on behalf of any other person or entity. 5.2 No Agreement to Transfer. Except as set forth in this Agreement, the Credit Agreement, the Put Agreement and the Company Pledge Agreement, the Company is not a party to any agreement, arrangement or understanding concerning the transfer of the Class A Preferred Stock or any interest therein to any other person or entity. 5.3 Knowledge and Experience. The Company has (a) adequate knowledge and experience in financial and business matters to be able to evaluate the merits and risks of its investment in State Auto Financial and the Class A Preferred Stock under this Agreement, or (b) the advice or representation of a person or entity having such knowledge and experience. 5.4 Access to Information. The Company has access to sufficient information regarding State Auto Financial, including, without limitation, State Auto Financial's filings under the Securities Exchange Act of 1934, as amended. The Company has requested information concerning State Auto Financial and has been given an opportunity to ask questions and receive - 9 - 13 answers concerning State Auto Financial and the terms and conditions of this Agreement in order to evaluate the merits and risks of its investment in State Auto Financial and the Class A Preferred Stock under this Agreement. 5.5 Risk. The Company is able to bear the economic risk of its investment in State Auto Financial and the Class A Preferred Stock under this Agreement and to hold the Class A Preferred Stock for purposes of investment. 5.6 Restrictions on Transfer. (a) The Class A Preferred Stock which the Company will acquire hereunder (i) will not be registered by reason of an exemption from registration under Section 3(b) or 4(2) of the Securities Act of 1933, as amended (the "Securities Act"), or Regulation D promulgated thereunder and (ii) is not publicly traded, no market exists for the Class A Preferred Stock and the Company must hold the Class A Preferred Stock indefinitely unless a subsequent transfer or other disposition is registered under the Securities Act or is exempt from registration at the time of such transfer or other disposition. (b) In the absence of an effective registration with respect to any proposed transfer of the Class A Preferred Stock (other than any transfer thereof as contemplated by the Company Pledge Agreement or the Put Agreement), State Auto Financial may require, as a condition to such transfer, a legal opinion by counsel of its choice, in form and substance as it may determine, or other documentation satisfactory to its Board of Directors, that an exemption from registration is available for the proposed transfer, and a restrictive legend to that effect will be set forth on the stock certificates representing the Class A Preferred Stock. ARTICLE VI COVENANTS 6.1 Transfer. Except as contemplated by the Company Pledge Agreement and the Put Agreement, the Company shall not sell, offer for sale or otherwise transfer or dispose of the Class A Preferred Stock or any interest therein, unless pursuant to a registration or exemption from registration under the Securities Act and all applicable state securities laws then in effect. 6.2 Redemption. State Auto Financial shall redeem the Class A Preferred Stock at the times, in the amounts, at the prices and on such other terms and conditions as are described in the stock certificates evidencing such Class A Preferred Stock. 6.3 Use of Proceeds. State Auto Financial shall use the proceeds of the sale of Class A Preferred Stock hereunder solely for the purpose of contributing such proceeds to State Auto P&C for it to use to pay direct and assumed catastrophic loss claims and/or loss adjustment expenses resulting from the catastrophic event to which such sale relates. - 10 - 14 ARTICLE VII REGISTRATION RIGHTS 7.1 Demand Registration. (a) Demand Registration. At any time after the occurrence of a Put Dishonor, upon the written request of the holders of a majority of the Registrable Securities requesting that State Auto Financial effect the registration under the Securities Act of all or part of such holders' Registrable Securities and specifying the number of Registrable Securities to be registered and the intended method of disposition thereof (a "Registration Request"), State Auto Financial will promptly, and in no event more than ten (10) Business Days after receipt of such Registration Request, give written notice (a "Notice of Demand Registration") of such request to all other holders of Registrable Securities, and thereupon will use its best efforts to effect the registration under the Securities Act of: (i) the Registrable Securities which State Auto Financial has been so requested to register by such holders of a majority of the Registrable Securities; and (ii) all other Registrable Securities the holders of which have made written requests to State Auto Financial for registration thereof within 20 days after the giving of the Notice of Demand Registration (which requests shall specify the intended method of disposition thereof), all to the extent requisite to permit the disposition (in accordance with the intended methods thereof) of the Registrable Securities so to be registered. If requested by the holders of a majority of the Registrable Securities requested to be included in any Demand Registration, the method of disposition of all Registrable Securities included in such registration shall be an underwritten offering effected in accordance with Section 7.4(a) hereof. Subject to paragraph (e) of this Section 7.1, State Auto Financial may include in such registration other securities for sale for its own account or for the account of any other Person. If any security holders of State Auto Financial (other than the holders of Registrable Securities in such capacity) register securities of State Auto Financial in a Demand Registration in accordance with this Section 7.1, such holders shall pay the fees and expenses of their counsel and their pro rata share, on the basis of the respective amounts of the securities included in such registration on behalf of each such holder, of the Registration Expenses if the Registration Expenses for such registration are not paid by State Auto Financial for any reason. (b) Limitations on Demand Registrations. Notwithstanding anything herein to the contrary, State Auto Financial shall not be required to honor a request for a Demand Registration if: (i) a Put Dishonor shall not have occurred; (ii) in the case of a Long-Form Registration, State Auto Financial has previously effected one Effective Long-Form Registration; - 11 - 15 (iii) in the case of a Short-Form Registration, State Auto Financial has previously effected one Effective Short-Form Registration; or (iv) such request is received by State Auto Financial less than 90 days following the effective date of any previous registration statement filed in connection with a Demand Registration, regardless of whether any holder of Registrable Securities exercised its rights under this Agreement with respect to such registration. (c) Registration Statement Form. Demand Registrations shall be on such appropriate registration form promulgated by the Commission as shall be selected by State Auto Financial, and shall be reasonably acceptable to the holders of a majority of the Registrable Securities to which such registration relates, and shall permit the disposition of such Registrable Securities in accordance with the intended method or methods specified in their request for such registration; provided that such registration form is available under the terms of this Agreement. Notwithstanding the foregoing, if State Auto Financial selects a Form S-3 and the use of such form is available under the terms of this Agreement and is permitted by law, the holders of a majority of the Registrable Securities to which such registration relates may notify State Auto Financial in writing that, in the judgment of such holders (or, if applicable, the Managing Underwriter), the inclusion of some or all of the information required in a more detailed form specified in such notice is of material importance to the success of the Public Offering of such Registrable Securities, in which case State Auto Financial shall supplement or amend the Form S-3 to include such information. (d) Registration Expenses. State Auto Financial will pay all Registration Expenses incurred in connection with any Demand Registration. (e) Priority in Cutback Registrations. If a Demand Registration becomes a Cutback Registration, State Auto Financial will include in any such registration to the extent of the number which the Managing Underwriter advises State Auto Financial can be sold in such offering (i) first, Registrable Securities requested to be included in such registration by the Requesting Holders, pro rata on the basis of the number of Registrable Securities requested to be included by such holders and (ii) second, other securities of State Auto Financial proposed to be included in such registration, allocated among the holders thereof in accordance with the priorities then existing among State Auto Financial and the holders of such other securities; and any securities so excluded shall be withdrawn from and shall not be included in such Demand Registration. 7.2 Piggyback Registrations. (a) Right to Include Registrable Securities. If, at any time after the occurrence of a Put Dishonor, State Auto Financial at any time proposes after any shares of Class A Preferred Stock have been purchased hereunder to effect a Piggyback Registration, it will each such time give prompt written notice (a "Notice of Piggyback Registration"), at least 30 days prior to the anticipated filing date, to all holders of Registrable Securities of its intention to do so and of such holders' rights under this Section 7.2, which Notice of Piggyback Registration shall include a description of the intended method of disposition of such securities. Upon the written request of any such holder made within 15 days after receipt of a Notice of Piggyback - 12 - 16 Registration (which request shall specify the Registrable Securities intended to be disposed of by such holder and the intended method of disposition thereof), State Auto Financial will use its best efforts to include in the registration statement relating to such Piggyback Registration all Registrable Securities which State Auto Financial has been so requested to register. Notwithstanding the foregoing, if, at any time after giving a Notice of Piggyback Registration and prior to the effective date of the registration statement filed in connection with such registration, State Auto Financial shall determine for any reason not to register or to delay registration of such securities, State Auto Financial may, at its election, give written notice of such determination to each holder of Registrable Securities and, thereupon, (i) in the case of a determination not to register, shall be relieved of its obligation to register any Registrable Securities in connection with such registration (but not from its obligation to pay the Registration Expenses in connection therewith), without prejudice, however, to the rights of any Requesting Holder entitled to do so to request that such registration be effected as a Demand Registration under Section 7.1 hereof, and (ii) in the case of a determination to delay registering, shall be permitted to delay registering any Registrable Securities for the same period as the delay in registering such other securities. No registration effected under this Section 7.2 shall relieve State Auto Financial of its obligations to effect a Demand Registration under Section 7.1 hereof. (b) Registration Expenses. State Auto Financial will pay all Registration Expenses incurred in connection with each Piggyback Registration. (c) Priority in Cutback Registrations. If a Piggyback Registration becomes a Cutback Registration, State Auto Financial will include in such registration to the extent of the amount of the securities which the Managing Underwriter advises State Auto Financial can be sold in such offering: (i) if such registration as initially proposed by State Auto Financial was solely a primary registration of its securities, (x) first, the securities proposed by State Auto Financial to be sold for its own account, and (y) second any Registrable Securities requested to be included in such registration by Requesting Holders, pro rata on the basis of the number of Registrable Securities requested to be included by such holders, and (z) third, any other securities of State Auto Financial proposed to be included in such registration, allocated among the holders thereof in accordance with the priorities then existing among State Auto Financial and such holders; and (ii) if such registration as initially proposed by State Auto Financial was in whole or in part requested by holders of securities of State Auto Financial, other than holders of Registrable Securities in their capacities as such, pursuant to demand registration rights, (x) first, such securities held by the holders initiating such registration and, if applicable, any securities proposed by State Auto Financial to be sold for its own account, allocated in accordance with the priorities then existing among State Auto Financial and such holders, and (y) second any Registrable Securities requested to be included in such registration by Requesting Holders, pro rata on the basis of the number of Registrable Securities requested to be included by such holders, and (z) third, any other securities of State Auto Financial proposed to be included in such registration, allocated among the holders thereof in accordance with the priorities then existing among State Auto Financial and the holders of such other securities; - 13 - 17 and any securities so excluded shall be withdrawn from and shall not be included in such Piggyback Registration. 7.3 Registration Procedures. If and whenever State Auto Financial is required to use its best efforts to effect the registration of any Registrable Securities under the Securities Act pursuant to Section 7.1 or 7.2 hereof, State Auto Financial will use its best efforts to effect the registration and sale of such Registrable Securities in accordance with the intended methods of disposition thereof specified by the Requesting Holders. Without limiting the foregoing, State Auto Financial in each such case will, as expeditiously as possible: (a) prepare and file with the Commission the requisite registration statement to effect such registration and use its best efforts to cause such registration statement to become effective as soon as practicable, provided that as far in advance as practical before filing such registration statement or any amendment or supplement thereto, State Auto Financial will furnish to the Requesting Holders copies of reasonably complete drafts of all such documents proposed to be filed (including exhibits), and any such holder shall have the opportunity to object to any information pertaining solely to such holder that is contained therein and State Auto Financial will make the corrections reasonably requested by such holder with respect to such information prior to filing any such registration statement or amendment; (b) prepare and file with the Commission such amendments and supplements to such registration statement and any prospectus used in connection therewith as may be necessary to maintain the effectiveness of such registration statement and to comply with the provisions of the Securities Act with respect to the disposition of all Registrable Securities covered by such registration statement, in accordance with the intended methods of disposition thereof, until the earlier of (i) such time as all of such securities have been disposed of in accordance with the intended methods of disposition by the seller or sellers thereof set forth in such registration statement and (ii) 180 days after such registration statement becomes effective; (c) promptly notify each Requesting Holder and the underwriter or underwriters, if any (i) when such registration statement or any prospectus used in connection therewith, or any amendment or supplement thereto, has been filed and, with respect to such registration statement or any post-effective amendment thereto, when the same has become effective; (ii) of any written request by the Commission for amendments or supplements to such registration statement or prospectus; (iii) of the notification to State Auto Financial by the Commission of its initiation of any proceeding with respect to the issuance by the Commission of, or of the issuance by the Commission of, any stop order suspending the effectiveness of such registration statement (and State Auto Financial shall promptly attempt to have such order withdrawn); and - 14 - 18 (iv) of the receipt by State Auto Financial of any notification with respect to the suspension of the qualification of any Registrable Securities for sale under the applicable securities or blue sky laws of any jurisdiction; (d) furnish to each seller of Registrable Securities covered by such registration statement such number of conformed copies of such registration statement and of each amendment and supplement thereto (in each case including all exhibits and documents incorporated by reference), such number of copies of the prospectus contained in such registration statement (including each preliminary prospectus and any summary prospectus) and any other prospectus filed under Rule 424 promulgated under the Securities Act relating to such holder's Registrable Securities, and such other documents, as such seller may reasonably request to facilitate the disposition of its Registrable Securities; (e) use its best efforts to register or qualify all Registrable Securities covered by such registration statement under such other securities or blue sky laws of such jurisdictions as each holder thereof shall reasonably request, to keep such registration or qualification in effect for so long as such registration statement remains in effect, and take any other action which may be reasonably necessary or advisable to enable such holder to consummate the disposition in such jurisdictions of the Registrable Securities owned by such holder, except that State Auto Financial shall not for any such purpose be required (i) to qualify generally to do business as a foreign corporation in any jurisdiction wherein it would not but for the requirements of this paragraph (e) be obligated to be so qualified, (ii) to subject itself to taxation in any such jurisdiction or (iii) to consent to general service of process in any jurisdiction; (f) use its best efforts to cause all Registrable Securities covered by such registration statement to be registered with or approved by such other governmental agencies or authorities as may be necessary to enable each holder thereof to consummate the disposition of such Registrable Securities; (g) furnish to each Requesting Holder a signed counterpart, addressed to such holder (and the underwriters, if any), of (i) an opinion of counsel for State Auto Financial, dated the effective date of such registration statement (or, if such registration includes an underwritten Public Offering, dated the date of any closing under the underwriting agreement), reasonably satisfactory in form and substance to such holder, and (ii) a "comfort" letter, dated the effective date of such registration statement (and, if such registration includes an underwritten Public Offering, dated the date of any closing under the underwriting agreement), signed by the independent public accountants who have certified State Auto Financial's financial statements included in such registration statement, in each case covering substantially the same matters with respect to such registration statement (and the prospectus included therein) and, in the case of the accountants' letter, with respect to events subsequent to the date of such financial statements, as are customarily covered in opinions of issuer's counsel and in accountants' letters delivered to the underwriters in underwritten Public - 15 - 19 Offerings of securities and, in the case of the accountants' letter, such other financial matters, as such holder (or the underwriters, if any) may reasonably request; (h) notify each holder of Registrable Securities covered by such registration statement, at any time when a prospectus relating thereto is required to be delivered under the Securities Act, of the happening of any event as a result of which any prospectus included in such registration statement, as then in effect, includes an untrue statement of a material fact or omits to state any material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading, and at the request of any such holder promptly prepare and furnish to such holder a reasonable number of copies of a supplement to or an amendment of such prospectus as may be necessary so that, as thereafter delivered to the purchasers of such securities, such prospectus shall not include an untrue statement of a material fact or omit to state a material fact required to be stated therein or necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading; (i) otherwise use its best efforts to comply with all applicable rules and regulations of the Commission, and make available to its securityholders, as soon as reasonably practicable, an earnings statement covering the period of at least twelve (12) months, but not more than eighteen (18) months, beginning with the first full calendar month after the effective date of such registration statement, which earnings statement shall satisfy the provisions of Section 11(a) of the Securities Act and Rule 158 promulgated thereunder; (j) make available for inspection by any Requesting Holder, any underwriter participating in any disposition pursuant to such registration statement and any attorney, accountant or other agent retained by any such seller or underwriter (collectively, the "Inspectors"), all financial and other records, pertinent corporate documents and properties of State Auto Financial (collectively, the "Records") as shall be reasonably necessary to enable them to exercise their due diligence responsibility, and cause State Auto Financial's officers, directors and employees to supply all information reasonably requested by any such Inspector in connection with such registration statement, and permit the Inspectors to participate in the preparation of such registration statement and any prospectus contained therein and any amendment or supplement thereto. Records which State Auto Financial determines, in good faith, to be confidential and which it notifies the Inspectors are confidential shall not be disclosed by the Inspectors unless (i) the disclosure of such Records is necessary to avoid or correct a misstatement or omission in the registration statement, (ii) the release of such Records is ordered pursuant to a subpoena or other order from a court of competent jurisdiction or (iii) the information in such Records has been made generally available to the public. The seller of Registrable Securities agrees by acquisition of such Registrable Securities that it will, upon learning that disclosure of such Records is sought in a court of competent jurisdiction, give notice to State Auto Financial and allow State Auto Financial, at State Auto Financial's expense, to undertake appropriate action to prevent disclosure of the Records deemed confidential; (k) provide a transfer agent and registrar for all Registrable Securities covered by such registration statement not later than the effective date of such registration statement; and - 16 - 20 (l) use its best efforts to cause all Registrable Securities covered by such registration statement to be listed, upon official notice of issuance, on any securities exchange on which any of the securities of the same class as the Registrable Securities are then listed. State Auto Financial may require each holder of Registrable Securities as to which any registration is being effected to, and each such holder, as a condition to including Registrable Securities in such registration, shall, furnish State Auto Financial with such information and affidavits regarding such holder and the distribution of such securities as State Auto Financial may from time to time reasonably request in writing in connection with such registration. Each holder of Registrable Securities agrees by acquisition of such Registrable Securities that upon receipt of any notice from State Auto Financial of the happening of any event of the kind described in paragraph (h) of this Section 7.3, such holder will forthwith discontinue such holder's disposition of Registrable Securities pursuant to the registration statement relating to such Registrable Securities until such holder's receipt of the copies of the supplemented or amended prospectus contemplated by such paragraph (h) and, if so directed by State Auto Financial, will deliver to State Auto Financial (at State Auto Financial's expense) all copies, other than permanent file copies, then in such holder's possession of the prospectus relating to such Registrable Securities current at the time of receipt of such notice. In the event State Auto Financial shall give any such notice, the period referred to in paragraph (b) of this Section 7.3 shall be extended by a number of days equal to the number of days during the period from and including the giving of notice pursuant to paragraph (h) of this Section 7.3 and to and including the date when each holder of any Registrable Securities covered by such registration statement shall receive the copies of the supplemented or amended prospectus contemplated by such paragraph (h). 7.4 Underwritten Offerings. (a) Underwritten Demand Offerings. In the case of any underwritten Public Offering being effected pursuant to a Demand Registration, the Managing Underwriter and any other underwriter or underwriters with respect to such offering shall be selected, after consultation with State Auto Financial, by the holders of a majority of the Registrable Securities to be included in such underwritten offering with the consent of State Auto Financial, which consent shall not be unreasonably withheld. State Auto Financial shall enter into an underwriting agreement in customary form with such underwriter or underwriters, which shall include, among other provisions, indemnities to the effect and to the extent provided in Section 7.6 hereof and shall take all such other actions as are reasonably requested by the Managing Underwriter in order to expedite or facilitate the registration and disposition of the Registrable Securities. The holders of Registrable Securities to be distributed by such underwriters shall be parties to such underwriting agreement and may, at their option, require that any or all of the representations and warranties by, and the other agreements on the part of, State Auto Financial to and for the benefit of such underwriters also be made to and for their benefit and that any or all of the conditions precedent to the obligations of such underwriters under such underwriting agreement also be conditions precedent to their obligations. No holder of Registrable Securities shall be required to make any representations or warranties to or agreements with State Auto Financial or the underwriters other than representations, warranties - 17 - 21 or agreements regarding such holder and its ownership of the securities being registered on its behalf and such holder's intended method of distribution and any other representation required by law. No Requesting Holder may participate in such underwritten offering unless such holder agrees to sell its Registrable Securities on the basis provided in such underwriting agreement and completes and executes all questionnaires, powers of attorney, indemnities and other documents reasonably required under the terms of such underwriting agreement. If any Requesting Holder disapproves of the terms of an underwriting, such holder may elect to withdraw therefrom and from such registration by notice to State Auto Financial and the Managing Underwriter, and each of the remaining Requesting Holders shall be entitled to increase the number of Registrable Securities being registered to the extent of the Registrable Securities so withdrawn in the proportion which the number of Registrable Securities being registered by such remaining Requesting Holder bears to the total number of Registrable Securities being registered by all such remaining Requesting Holders. (b) Underwritten Piggyback Offerings. If State Auto Financial at any time proposes to register any of its securities in a Piggyback Registration and such securities are to be distributed by or through one or more underwriters, State Auto Financial will, subject to the provisions of Section 7.2(c) hereof, use its best efforts, if requested by any holder of Registrable Securities, to arrange for such underwriters to include the Registrable Securities to be offered and sold by such holder among the securities to be distributed by such underwriters, and such holders shall be obligated to sell their Registrable Securities in such Piggyback Registration through such underwriters on the same terms and conditions as apply to the other Company securities to be sold by such underwriters in connection with such Piggyback Registration. The holders of Registrable Securities to be distributed by such underwriters shall be parties to the underwriting agreement between State Auto Financial and such underwriter or underwriters and may, at their option, require that any or all of the representations and warranties by, and the other agreements on the part of, State Auto Financial to and for the benefit of such underwriters also be made to and for their benefit and that any or all of the conditions precedent to the obligations of such underwriters under such underwriting agreement also be conditions precedent to their obligations. No holder of Registrable Securities shall be required to make any representations or warranties to or agreements with State Auto Financial or the underwriters other than representations, warranties or agreements regarding such holder and its ownership of the securities being registered on its behalf and such holder's intended method of distribution and any other representation required by law. No Requesting Holder may participate in such underwritten offering unless such holder agrees to sell its Registrable Securities on the basis provided in such underwriting agreement and completes and executes all questionnaires, powers of attorney, indemnities and other documents reasonably required under the terms of such underwriting agreement. If any Requesting Holder disapproves of the terms of an underwriting, such holder may elect to withdraw therefrom and from such registration by notice to State Auto Financial and the Managing Underwriter, and each of the remaining Requesting Holders shall be entitled to increase the number of Registrable Securities being registered to the extent of the Registrable Securities so withdrawn in the proportion which the number of Registrable Securities being registered by such remaining Requesting Holder bears to the total number of Registrable Securities being registered by all such remaining Requesting Holders. 7.5 Holdback Agreements By State Auto Financial and Other Securityholders. Unless the Managing Underwriter otherwise agrees, State Auto Financial and each holder of - 18 - 22 Registrable Securities agrees not to effect any public sale or distribution of its equity securities, or any securities convertible into or exchangeable or exercisable for such securities, during the 14 days prior to and the 180 days after the effective date of the registration statement filed in connection with an underwritten offering made pursuant to a Demand Registration (or for such shorter period of time as is sufficient and appropriate, in the opinion of the Managing Underwriter, in order to complete the sale and distribution of the securities included in such registration), except as part of such underwritten registration and except pursuant to registrations on Form S-4 or Form S-8 promulgated by the Commission or any successor or similar forms thereto. State Auto Financial also agrees, unless the Managing Underwriter otherwise agrees, to cause each holder of its equity securities which is a party to a registration rights agreement with State Auto Financial entered into on or after the date hereof, and each holder of its equity securities, or of any securities convertible into or exchangeable or exercisable for such securities, in each case purchased from State Auto Financial, at any time after the date of this Agreement (other than in a Public Offering), to agree, to the extent permitted by law, not to effect any such public sale or distribution of such securities (including a sale under Rule 144), during such period, except as part of such underwritten registration. 7.6 Indemnification. (a) Indemnification by State Auto Financial. State Auto Financial shall, to the full extent permitted by law, indemnify and hold harmless each seller of Registrable Securities included in any registration statement filed in connection with a Demand Registration or a Piggyback Registration, its directors and officers, and each other Person, if any, who controls any such seller within the meaning of the Securities Act, against any losses, claims, damages, expenses or liabilities, joint or several (together, "Losses"), to which such seller or any such director or officer or controlling Person may become subject under the Securities Act or otherwise, insofar as such Losses (or actions or proceedings, whether commenced or threatened, in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in any such registration statement, any preliminary prospectus, final prospectus or summary prospectus contained therein, or any amendment or supplement thereto, or any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein (in the case of a prospectus, in the light of the circumstances under which they were made) not misleading, and State Auto Financial will reimburse such seller and each such director, officer and controlling Person for any legal or any other expenses reasonably incurred by them in connection with investigating or defending any such Loss (or action or proceeding in respect thereof); provided that State Auto Financial shall not be liable in any such case to the extent that any such Loss (or action or proceeding in respect thereof) arises out of or is based upon an untrue statement or alleged untrue statement or omission or alleged omission made in any such registration statement, preliminary prospectus, final prospectus, summary prospectus, amendment or supplement in reliance upon and in conformity with written information furnished to State Auto Financial through an instrument duly executed by such seller specifically stating that it is for use in the preparation thereof. Such indemnity shall remain in full force and effect regardless of any investigation made by or on behalf of such seller or any such director, officer or controlling Person, and shall survive the transfer of such securities by such seller. State Auto Financial shall also indemnify each other Person who participates (including as an underwriter) in the offering or sale of Registrable Securities, their officers and directors and each other Person, if any, who controls - 19 - 23 any such participating Person within the meaning of the Securities Act to the same extent as provided above with respect to sellers of Registrable Securities. (b) Indemnification by the Sellers. Each holder of Registrable Securities which are included or are to be included in any registration statement filed in connection with a Demand Registration or a Piggyback Registration, as a condition to including Registrable Securities in such registration statement, shall, to the full extent permitted by law, indemnify and hold harmless State Auto Financial, its directors and officers, and each other Person, if any, who controls State Auto Financial within the meaning of the Securities Act, against any Losses to which State Auto Financial or any such director or officer or controlling Person may become subject under the Securities Act or otherwise, insofar as such Losses (or actions or proceedings, whether commenced or threatened, in respect thereof) arise out of or are based upon any untrue statement or alleged untrue statement of any material fact contained in any such registration statement, any preliminary prospectus, final prospectus or summary prospectus contained therein, or any amendment or supplement thereto, or any omission or alleged omission to state therein a material fact required to be stated therein or necessary to make the statements therein (in the case of a prospectus, in the light of the circumstances under which they were made) not misleading, if such untrue statement or alleged untrue statement or omission or alleged omission was made in reliance upon and in conformity with written information furnished to State Auto Financial through an instrument duly executed by such seller specifically stating that it is for use in the preparation of such registration statement, preliminary prospectus, final prospectus, summary prospectus, amendment or supplement; provided however, that the obligation to provide indemnification pursuant to this Section 7.6(b) shall be several, and not joint and several, among such Indemnifying Parties on the basis of the number of Registrable Securities included in such registration statement and the aggregate amount which may be recovered from any holder of Registrable Securities pursuant to the indemnification provided for in this Section 7.6(b) in connection with any registration and sale of Registrable Securities shall be limited to the total proceeds received by such holder from the sale of such Registrable Securities. Such indemnity shall remain in full force and effect regardless of any investigation made by or on behalf of State Auto Financial or any such director, officer or controlling Person and shall survive the transfer of such securities by such seller. Such holders shall also indemnify each other Person who participates (including as an underwriter) in the offering or sale of Registrable Securities, their officers and directors and each other Person, if any, who controls any such participating Person within the meaning of the Securities Act to the same extent as provided above with respect to State Auto Financial. (c) Notices of Claims, etc. Promptly after receipt by an Indemnified Party of notice of the commencement of any action or proceeding involving a claim referred to in the preceding paragraph (a) or (b) of this Section 7.6, such Indemnified Party will, if a claim in respect thereof is to be made against an Indemnifying Party pursuant to such paragraphs, give written notice to the latter of the commencement of such action, provided that the failure of any Indemnified Party to give notice as provided herein shall not relieve the Indemnifying Party of its obligations under the preceding paragraphs of this Section 7.6, except to the extent that the Indemnifying Party is actually prejudiced by such failure to give notice. In case any such action is brought against an Indemnified Party, the Indemnifying Party shall be entitled to participate in and, unless, in the reasonable judgment of any Indemnified Party, a conflict of interest between such Indemnified Party and any Indemnifying Party exists with respect to such claim, to assume - 20 - 24 the defense thereof, jointly with any other Indemnifying Party similarly notified to the extent that it may wish, with counsel reasonably satisfactory to such Indemnified Party, and after notice from the Indemnifying Party to such Indemnified Party of its election so to assume the defense thereof, the Indemnifying Party shall not be liable to such Indemnified Party for any legal or other expenses subsequently incurred by the latter in connection with the defense thereof other than reasonable costs of investigation; provided that the Indemnified Party may participate in such defense at the Indemnified Party's expense; and provided further that the Indemnified Party or Indemnified Parties shall have the right to employ one counsel to represent it or them if, in the reasonable judgment of the Indemnified Party or Indemnified Parties, it is advisable for it or them to be represented by separate counsel by reason of having legal defenses which are different from or in addition to those available to the Indemnifying Party, and in that event the reasonable fees and expenses of such one counsel shall be paid by the Indemnifying Party. If the Indemnifying Party is not entitled to, or elects not to, assume the defense of a claim, it will not be obligated to pay the fees and expenses of more than one counsel for the Indemnified Parties with respect to such claim, unless in the reasonable judgment of any Indemnified Party a conflict of interest may exist between such Indemnified Party and any other Indemnified Parties with respect to such claim, in which event the Indemnifying Party shall be obligated to pay the fees and expenses of such additional counsel for the Indemnified Parties or counsels. No Indemnifying Party shall consent to entry of any judgment or enter into any settlement without the consent of the Indemnified Party. No Indemnifying Party shall be subject to any liability for any settlement made without its consent, which consent shall not be unreasonably withheld. (d) Contribution. If the indemnity and reimbursement obligation provided for in any paragraph of this Section 7.6 is unavailable or insufficient to hold harmless an Indemnified Party in respect of any Losses (or actions or proceedings in respect thereof) referred to therein, then the Indemnifying Party shall contribute to the amount paid or payable by the Indemnified Party as a result of such Losses (or actions or proceedings in respect thereof) in such proportion as is appropriate to reflect the relative fault of the Indemnifying Party on the one hand and the Indemnified Party on the other hand in connection with statements or omissions which resulted in such Losses, as well as any other relevant equitable considerations. The relative fault shall be determined by reference to, among other things, whether the untrue or alleged untrue statement of a material fact or the omission or alleged omission to state a material fact relates to information supplied by the Indemnifying Party or the Indemnified Party and the parties' relative intent, knowledge, access to information and opportunity to correct or prevent such untrue statement or omission. The parties hereto agree that it would not be just and equitable if contributions pursuant to this paragraph were to be determined by pro rata allocation or by any other method of allocation which does not take account of the equitable considerations referred to in the first sentence of this paragraph. The amount paid by an Indemnified Party as a result of the Losses referred to in the first sentence of this paragraph shall be deemed to include any legal and other expenses reasonably incurred by such Indemnified Party in connection with investigating or defending any Loss which is the subject of this paragraph. No Indemnified Party guilty of fraudulent misrepresentation (within the meaning of Section 11(f) of the Securities Act) shall be entitled to contribution from the Indemnifying Party if the Indemnifying Party was not guilty of such fraudulent misrepresentation. - 21 - 25 (e) Other Indemnification. Indemnification similar to that specified in the preceding paragraphs of this Section 7.6 (with appropriate modifications) shall be given by State Auto Financial and each seller of Registrable Securities with respect to any required registration or other qualification of securities under any federal or state law or regulation of any governmental authority other than the Securities Act. The provisions of this Section 7.6 shall be in addition to any other rights to indemnification or contribution which an Indemnified Party may have pursuant to law, equity, contract or otherwise. (f) Indemnification Payments. The indemnification required by this Section 7.6 shall be made by periodic payments of the amount thereof during the course of the investigation or defense, as and when bills are received or Losses are incurred. 7.7 Covenants Relating to Rule 144. The Company will file reports in compliance with the Exchange Act, will comply with all rules and regulations of the Commission applicable in connection with the use of Rule 144 and take such other actions and furnish such holder with such other information as such holder may request in order to avail itself of such rule or any other rule or regulation of the Commission allowing such holder to sell any Registrable Securities without registration and will, at its expense, forthwith upon the request of any holder of Registrable Securities, deliver to such holder a certificate, signed by State Auto Financial's principal financial officer, stating (a) State Auto Financial's name, address and telephone number (including area code), (b) State Auto Financial's Internal Revenue Service identification number, (c) State Auto Financial's Commission file number, (d) the number of shares of each class of Stock outstanding as shown by the most recent report or statement published by State Auto Financial, and (e) whether State Auto Financial has filed the reports required to be filed under the Exchange Act for a period of at least 90 days prior to the date of such certificate and in addition has filed the most recent annual report required to be filed thereunder. 7.8 References to holders of Registrable Securities. For purposes of this Agreement, references to holders of the Registrable Securities or holders of a majority of the Registrable Securities shall be deemed to refer to the pledgee of the Registered Securities under the Pledge and Security Agreement dated as of even date herewith between the Company and the Agent (as modified and supplemented and in effect from time to time, the "Pledge Agreement") for so long as the Pledge Agreement shall remain in effect. ARTICLE VIII MISCELLANEOUS 8.1 Waiver. No failure on the part of the either party hereto to exercise and no delay in exercising, and no course of dealing with respect to, any right, power or privilege under this Agreement shall operate as a waiver thereof, nor shall any single or partial exercise of any right, power or privilege under this Agreement preclude any other or further exercise thereof or the exercise of any other right, power or privilege. The remedies provided herein are cumulative and not exclusive of any remedies provided by law. - 22 - 26 8.2 Notices. All notices, requests and other communications to any party hereunder shall be in writing (including electronic transmission, facsimile transmission or similar writing) and shall be given to such party at its address or facsimile number set forth on the signature pages hereof at such other address or facsimile number as such party may hereafter specify for the purpose by notice to the Agent and the Borrower in accordance with the provisions of this Section 8.2. Each such notice, request or other communication shall be effective (a) if given by facsimile transmission, when transmitted to the facsimile number specified in this Section and confirmation of receipt is received, (b) if given by mail, 72 hours after such communication is deposited in the mails with first class postage prepaid, addressed as aforesaid, or (c) if given by any other means, when delivered (or, in the case of electronic transmission, received) at the address specified in this Section. 8.3 Amendments, Etc. Except as otherwise expressly provided in this Agreement and subject to the Credit Agreement and the Put Agreement, any provision of this Agreement may be modified or supplemented only by an instrument in writing signed by each of State Auto Financial and the Company (with the consent of the Agent and the Lenders as specified in the Credit Agreement), and any provision of this Agreement may be waived by the Company (with the consent of the Agent and the Lenders as specified in the Credit Agreement). 8.4 Successors and Assigns. This Agreement shall be binding upon and inure to the benefit of the parties hereto and their respective successors and permitted assigns, provided, that State Auto Financial may not assign any of its rights or obligations hereunder without the prior consent of the Company (with the consent of the Agent and all of the Lenders). 8.5 Captions. The captions and section headings appearing herein are included solely for convenience of reference and are not intended to affect the interpretation of any provision of this Agreement. 8.6 Counterparts. This Agreement may be executed in any number of counterparts, all of which taken together shall constitute one and the same instrument and any of the parties hereto may execute this Agreement by signing any such counterpart. 8.7 Governing Law; Submission to Jurisdiction. This Agreement shall be governed by, and construed in accordance with, the law of the State of Illinois. Each of State Auto Financial and the Company hereby submits to the nonexclusive jurisdiction of the United States District Court for the Northern District of Illinois and of the Supreme Court of the State of Illinois sitting in Cook County (including its Appellate Division), and of any other appellate court in the State of Illinois, for the purposes of all legal proceedings arising out of or relating to this Agreement or the transactions contemplated hereby. Each of State Auto Financial and the Company hereby irrevocably waives, to the fullest extent permitted by applicable law, any objection that it may now or hereafter have to the laying of the venue of any such proceeding brought in such a court and any claim that any such proceeding brought in such a court has been brought in an inconvenient forum. 8.8 Waiver of Jury Trial. EACH OF STATE AUTO FINANCIAL AND THE COMPANY HEREBY IRREVOCABLY WAIVES, TO THE FULLEST EXTENT PERMITTED BY APPLICABLE LAW, ANY AND ALL RIGHT TO TRIAL BY JURY - 23 - 27 IN ANY LEGAL PROCEEDING ARISING OUT OF OR RELATING TO THIS AGREEMENT OR THE TRANSACTIONS CONTEMPLATED HEREBY. 8.9 Further Assurances. State Auto Financial agrees that, from time to time upon the written request of the Agent, State Auto Financial will execute and deliver such further documents and do such other acts and things as the Company, the Agent or any Lender (through the Agent) may reasonably request in order fully to effect the purposes of this Agreement. 8.10 Payments by State Auto Financial. The Company hereby instructs State Auto Financial to make any payments required to be made by State Auto Financial hereunder or otherwise in respect of the Class A Preferred Stock (including, without limitation, any amounts payable upon any redemption of the Class A Preferred Stock, any dividends payable on the Class A Preferred Stock and the commitment fee payable under Section 2.3 hereof) directly to the Agent, for the benefit of the Lenders. Each such payment shall be made by State Auto Financial in accordance with the provisions of the Credit Agreement. 8.11 Payments Received by the Company under Basic Documents. Any amounts paid to the Company under any of the Basic Documents (other than the proceeds of the Loans made under the Credit Agreement) shall be applied as directed by State Auto Financial. 8.12 Third-Party Beneficiaries. Each of State Auto Financial and the Company agrees that the Agent and each Lender shall be third-party beneficiaries of this Agreement and shall be entitled to enforce its respective rights hereunder as fully as if it were a party hereto. 8.13 Severability. If any provision hereof is invalid and unenforceable in any jurisdiction, then, to the fullest extent permitted by law, (a) the other provisions hereof shall remain in full force and effect in such jurisdiction in order to carry out the intentions of the parties hereto as nearly as may be possible and (b) the invalidity or unenforceability of any provision hereof in any jurisdiction shall not affect the validity or enforceability of such provision in any other jurisdiction. [signature page follows] - 24 - 28 IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be duly executed and delivered as of the day and year first above written. STATE AUTO FINANCIAL CORPORATION By /s/ Steven J. Johnston --------------------------------------- Title: Senior Vice President ----------------------------------- Address for Notices: State Auto Financial Corporation 5 18 East Broad Street Columbus, Ohio 43215 Attention: John Lowther, Esq. Telecopier No.: 614-464-4911 Telephone No.: 614-464-5052 SAF FUNDING CORPORATION By /s/ Richard L. Taiano --------------------------------------- Title: Vice President ----------------------------------- Address for Notices: SAF Funding Corporation 2 Wall Street New York, New York 10005 Attention: Richard Taiano Telecopier No.: 212-346-9012 Telephone No.: 212-346-9006 S-1 [TO STANDBY PURCHASE AGREEMENT] 29 Standby Purchase Agreement Schedule I Part A Equity Rights As of November 1, 1999, State Auto Financial has granted 2,481,469 stock options to members of management under State Auto Financial's 1991 Stock Option Plan of which 2,355,811 are outstanding. As of November 1, 1999, State Auto Financial has granted 174,000 stock options to "outside" directors on the boards of directors of State Auto Financial and State Auto Mutual pursuant to the terms of the 1991 Directors' Stock Option Plan. State Auto Financial also has registered 2,400,000 shares to be issued pursuant to an Employee Stock Purchase Plan (the "ESPP") of which 1,473,805 shares have been purchased pursuant to the ESPP as of November 1, 1999. State Auto Financial intends to register 400,000 shares as part of an agents' stock option plan. Options for 16,538 option shares have been issued under this plan but are not exercisable at this time. 30 Standby Purchase Agreement Schedule I Part B In August 1999, Strategic Insurance Software, Inc. ("S.I.S.") completed the repurchase of all shares of S.I.S. from holders other than State Auto Financial except for 60,000 shares, which the holders thereof (two individuals) are contractually obligated to sell no later than January 4, 2000. 31 EXHIBIT A to the Standby Purchase Agreement [Form Class A Preferred Stock Certificate] 32 [Front of Class A Preferred Stock Certificate] CERTIFICATE NUMBER SHARES - ------ ------ - ---------------- ---------------- STATE AUTO FINANCIAL CORPORATION Incorporated under the laws of the State of Ohio CUSIP __________ SEE REVERSE SIDE FOR CERTAIN TRANSFER RESTRICTIONS AND OTHER IMPORTANT INFORMATION This is to Certify that ______________________________ is the owner of ______________________________________________________________________ FULLY PAID AND NON-ASSESSABLE SHARES OF CLASS A PREFERRED STOCK NO PAR VALUE OF State Auto Financial Corporation transferable on the books of the Corporation by the holder hereof in person or by duly authorized Attorney upon surrender of this Certificate properly endorsed. WITNESS the seal of the Corporation and the signatures of its duly authorized officers. - -------------------------- ------------------------------ Secretary Chief Executive Officer ------------------------------ President 33 [Reverse of Class A Preferred Stock Certificate] STATE AUTO FINANCIAL CORPORATION The Corporation will furnish upon request and without charge to each shareholder the powers, designations, preferences and relative, participating, optional or other special rights of each class of stock series within a class of stock of the Corporation, as well as the qualifications, limitations and restrictions relating to those preferences and/or rights. THE SHARES EVIDENCED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, AND MAY BE REOFFERED AND SOLD ONLY IF REGISTERED PURSUANT TO THE PROVISIONS OF SAID SECURITIES ACT OR IF AN EXEMPTION FROM REGISTRATION IS AVAILABLE. In addition, the shares evidenced by this certificate are subject to the restrictions on transfer set forth in the Terms and Conditions attached hereto. 34 TERMS AND CONDITIONS of CLASS A PREFERRED STOCK of STATE AUTO FINANCIAL CORPORATION - -------------------------------------------------------------------------------- Pursuant to Section 1701.14 of the Ohio General Corporation Law - -------------------------------------------------------------------------------- Section 1. General. The certificate to which these Terms and Conditions are attached represents one or more shares of Class A Preferred Stock, no par value (the "Class A Preferred Stock"), of State Auto Financial Corporation, an Ohio corporation (the "Corporation"). The stated value and liquidation preference per share of the Class A Preferred Stock shall be equal to $1,000,000 (the "Redemption Value"). Section 2. Definitions. Capitalized terms used herein shall have the meanings set forth in this Section 2: "Applicable Redemption Dates" means, with respect to any shares of Class A Preferred Stock, each of the 2nd, 4th, 6th, 8th, 10th, 12th, 14th, l6th, 18th, 20th, 22nd and 24th Quarterly Dates immediately following the date of issuance of such shares of Class A Preferred Stock. "Bank One" means Bank One, NA and any successor entity. "Board of Directors" means the Board of Directors of the Corporation. "Business Day" shall mean any day on which (a) commercial banks are not authorized or required to close in New York City or Chicago and (b) (prior to the Rate Conversion Date) dealings in Dollar deposits are carried out in the London interbank market. "By-Laws" means the Code of Regulations of the Corporation, as amended or restated from time to time. "Certificate of Incorporation" means the Articles of Incorporation of the Corporation as amended or restated from time to time. "Class A Preferred Stock" has the meaning assigned to such term in Section 1 hereof. 35 "Class B Preferred Stock" means all Class B Preferred Stock, no par value, issued by the Corporation. "Common Stock" means all common stock, of any series and of any par value or no par value issued by the Corporation. "Corporation" means State Auto Financial Corporation, an Ohio corporation. "Credit Agreement" means the Credit Agreement dated as of November 19, 1999, between SAF Funding, the Lenders party thereto and Bank One, as Agent, as modified and supplemented and in effect from time to time, a copy of which is maintained on file in the Principal Corporate Office. "Dividend Rate" means, for each Eurodollar Rate Period relating to any Class A Preferred Stock, the Eurodollar Rate for such Eurodollar Rate Period plus 1% per annum; provided, however, that if, as of the last day of any fiscal quarter of State Auto Mutual, the Statutory Surplus of State Auto Mutual, as reflected in the most recent annual or quarterly financial statements of State Auto Mutual delivered pursuant to Section 4.1(a) or (b) of the Put Agreement (the "Financials"), is less than $575,000,000, then the "Dividend Rate" shall be the Eurodollar Rate for such Eurodollar Rate Period plus 1.25% per annum until such time as the Lenders receive Financials from State Auto Mutual indicating that the Statutory Surplus of State Auto Mutual as reflected therein is $575,000,000 or more; provided, further, that from and after the Rate Conversion Date, the "Dividend Rate" means a rate per annum equal to 8%. Adjustments, if any, to the Dividend Rate shall be effective five Business Days after the Lenders have received the applicable Financials. "Dollars" and "$" mean lawful money of the United States of America. "Eurodollar Base Rate" means, with respect to any shares of Class A Preferred Stock for the relevant Eurodollar Rate Period, the applicable British Bankers' Association Interest Settlement Rate for deposits in U.S. dollars appearing on Reuters Screen FRBD as of 11:00 a.m. (London time) two Business Days prior to the first day of such Interest Period, and having a maturity equal to such Eurodollar Rate Period, provided that, (a) if Reuters Screen FRBD is not available to Bank One for any reason, the applicable Eurodollar Base Rate for the relevant Eurodollar Rate Period shall instead be the applicable British Bankers' Association Interest Settlement Rate for deposits in U.S. dollars as reported by any other generally recognized financial information service as of 11:00 a.m. (London time) two Business Days prior to the first day of such Eurodollar Rate Period, and having a maturity equal to such Eurodollar Rate Period, and (b) if no such British Bankers' Association Interest Settlement Rate is available to Bank One, the applicable Eurodollar Base Rate for the relevant Eurodollar Rate Period shall instead be the rate determined by Bank One to be the rate at which Bank One or one of its Affiliate banks offers to place deposits in U.S. dollars with first-class banks in the London interbank market at approximately 11:00 a.m. (London time) two Business Days prior to the first day of such Eurodollar Rate Period, in the approximate amount of the aggregate Redemption Value of such shares of Class A Preferred Stock and having a maturity equal to such Interest Period. 36 "Eurodollar Rate" means, for any shares of Class A Preferred Stock for any Eurodollar Rate Period, the sum of (a) the quotient of (i) the Eurodollar Base Rate applicable to such Eurodollar Rate Period, divided by (ii) one minus the Reserve Requirement (expressed as a decimal) applicable to such Eurodollar Period. "Eurodollar Rate Period" means, with respect to any shares of Class A Preferred Stock, each period commencing on the date such Class A Preferred Stock is issued or (in the case of a continuation of one Eurodollar Rate Period to the next) the last day of the next preceding Eurodollar Rate Period for such Class A Preferred Stock and ending on the numerically corresponding day in the third calendar month thereafter, except that each Eurodollar Rate Period that commences on the last Business Day of a calendar month (or on any day for which there is no numerically corresponding day in the appropriate subsequent calendar month) shall end on the last Business Day of the appropriate subsequent calendar month. Notwithstanding the foregoing: (a) no Eurodollar Rate Period may commence before and end after any Applicable Redemption Date unless, after giving effect thereto, the aggregate Redemption Value of shares of Class A Preferred Stock having Eurodollar Rate Periods that end after such Applicable Redemption Date shall be equal to or less than the aggregate Redemption Value of shares of Class A Preferred Stock scheduled to be outstanding after giving effect to the redemption payments required to be made on such Applicable Redemption Date; and (b) each Eurodollar Rate Period that would otherwise end on a day that is not a Business Day shall end on the next succeeding Business Day (or, if such next succeeding Business Day falls in the next succeeding calendar month, on the next preceding Business Day); and (c) notwithstanding clause (a) above, no Eurodollar Rate Period shall have a duration of less than three months. "Federal Funds Effective Rate" means, for any day, an interest rate per annum equal to the weighted average of the rates on overnight Federal funds transactions with members of the Federal Reserve System arranged by Federal funds brokers on such day, as published for such day (or, if such day is not a Business Day, for the immediately preceding Business Day) by the Federal Reserve Bank of New York, or, if such rate is not so published for any day which is a Business Day, the average of the quotations at approximately 10:00 a.m. (Chicago time) on such day on such transactions received by Bank One from three Federal funds brokers of recognized standing selected by Bank One in its sole discretion. "Holder" means SAF Funding or any subsequent holder of shares of Class A Preferred Stock. "Loans" means the Loans made to SAF Funding under the Credit Agreement. "Person" means any person or entity of any nature whatsoever, specifically including an individual, a firm, a company, a corporation, a partnership, a trust, a limited liability company or other entity. "Principal Corporate Office" means the principal corporate office of the Corporation located at 518 East Broad Street, Columbus, Ohio 43215. "Quarterly Dates" means the last Business Day of March, June, September and December in each year, the first of which shall be the last Business Day of December, 1999. 37 "Rate Conversion Date" shall mean the first date upon which the Holder is a person or entity other than any of SAF Funding, State Automobile Mutual Insurance Company, an Ohio mutual insurance company, any Lender party to the Credit Agreement or the Agent under the Credit Agreement. "Redemption Value" has the meaning assigned to such term in Section 1 hereof. "Reserve Requirement" has the meaning assigned to such term in the Credit Agreement. "SAF Funding" means SAF Funding Corporation, a Delaware corporation. "Secretary" means the Secretary of the Corporation. "Trigger Event" means the occurrence of (a) any "Event of Default" described in the Credit Agreement (other than those events described in Section 7.5 or 7.6 thereof) and the acceleration of the Loans thereunder; or (b) an "Event of Default" described in Section 7.5 or 7.6 of the Credit Agreement. Section 3. Dividends and Distributions. (a) The Holder, in preference to the holders of shares of Class B Preferred Stock and the holders of shares of Common Stock shall be entitled to receive, when, as and if declared by the Board of Directors out of funds of the Corporation legally available for the payment of dividends, dividends at the Dividend Rate on the Redemption Value of each share, payable in arrears in cash. Accrued dividends on the Class A Preferred Stock shall be payable on the last day of each Eurodollar Rate Period for the applicable Class A Preferred Stock and upon the redemption of any Class A Preferred Stock (but only on the aggregate Redemption Value of the Class A Preferred Stock so redeemed), provided that after the Rate Conversion Date, said dividends shall be payable quarterly on the last Business Day of March, June, September and December of each year. (b) Dividends payable with respect to any share of Class A Preferred Stock shall begin to accrue at the Dividend Rate and be cumulative from the date of issuance of such Class A Preferred Stock (whether or not such dividends have been declared and whether or not there shall be net profits or net assets of the Corporation legally available for the payment of such dividends). Dividends paid on the shares of Class A Preferred Stock in an amount less than the total amount of such dividends at the time accrued and payable on such shares shall be allocated pro rata on a share-by-share basis among all such shares at the time outstanding. The Board of Directors may fix a record date for the determination of Holder entitled to receive payment of a dividend declared thereon, which record date shall be no more than thirty (30) days prior to the date fixed for the payment thereof. (c) The Holder shall not be entitled to receive any dividends or other distributions except as provided in these Terms and Conditions. (d) Whenever (i) any dividend payable pursuant to paragraph (a) of this Section 3 has not been paid when due, thereafter and until all accrued and unpaid dividends 38 payable pursuant to paragraph (a) of this Section 3 have been paid in full or (ii) the Corporation shall not have redeemed shares of Class A Preferred Stock on the date such redemption is required pursuant to Section 5 hereof, thereafter and until such redemption payment shall have been made the Corporation shall not (A) declare or pay dividends on any shares of Class B Preferred Stock or Common Stock or make any other distributions on any shares of Class B Preferred Stock or Common Stock, whether upon liquidation, redemption or otherwise; or (B) redeem or purchase or otherwise acquire for consideration any shares of Class B Preferred Stock or Common Stock, whether upon liquidation, redemption, or otherwise. Section 4. Voting Rights. Except as provided in the Certificate of Incorporation, and except for any voting rights provided by law, the Holder shall have no voting rights and its consent shall not be required for the taking of any corporate action. Section 5. Redemption. (a) On each of the first eleven Applicable Redemption Dates for any shares of Class A Preferred Stock the Corporation shall redeem, without prior notice to the Holder, out of funds legally available therefor, one-twelfth of the number of shares of Class A Preferred Stock issued on the date of issuance of such shares of Class A Preferred Stock, by paying to the Holder the aggregate Redemption Value for such Class A Preferred Stock so redeemed plus any accrued but unpaid dividends thereon. On the twelfth Applicable Redemption Date for such shares of Class A Preferred Stock the Corporation shall redeem, without prior notice to the Holder, out of funds legally available therefor, the balance of the number of shares of Class A Preferred Stock issued on such date of issuance, by paying to the Holder the aggregate Redemption Value for such Class A Preferred Stock so redeemed plus any accrued but unpaid dividends thereon. (b) Upon the occurrence and during the continuance of any Trigger Event, the Holder may require the Corporation to redeem out of funds of the Corporation legally available therefor, all or any portion of the Class A Preferred Stock for a redemption price equal to the aggregate Redemption Value for the Class A Preferred Stock so redeemed plus any accrued but unpaid dividends thereon. Upon written notice delivered by the Holder to the President of the Corporation, such Redemption Value plus such dividends shall be immediately due and payable. (c) The Corporation may, by delivering written notice that is received by the Holder not later than 10:00 a.m. New York time on the third Business Day prior to the date of the relevant redemption, redeem out of funds of the Corporation legally available therefor, all or any portion of the Class A Preferred Stock for a redemption price equal to the aggregate Redemption Value for the Class A Preferred Stock so redeemed plus any accrued but unpaid dividends thereon. (d) From and after the date of a redemption, unless default shall be made by the Corporation in providing for the payment of the aggregate Redemption Value for the Class A Preferred Stock so redeemed plus accrued but unpaid dividends thereon, all dividends on the Class A Preferred Stock so redeemed shall cease to accrue, and from and after the date of redemption so specified, unless default shall be made by the Corporation as aforesaid, all rights 39 of the Holder with respect to such shares, except the right to receive such Redemption Value and dividends, shall cease and terminate. Section 6. Reacquired Shares. Any shares of Class A Preferred Stock redeemed, purchased or otherwise acquired by the Corporation in any manner whatsoever shall be retired and canceled promptly after the acquisition thereof and shall be restored to the status of authorized but unissued shares of Class A Preferred Stock of the Corporation and may thereafter be issued. Upon any redemption pursuant to Section 5 hereof of a fractional number of shares of Class A Preferred Stock, the Corporation shall reissue to the Holder Class A Preferred Stock having an aggregate Redemption Value equal to the $1,000,000 multiplied by the sum of 1 minus such fractional number. Section 7. Liquidation, Dissolution or Winding Up. In the event of any liquidation, dissolution or winding up of the Corporation, whether voluntary or involuntary, the Holder shall be entitled to receive out of the assets of the Corporation available for distribution to its stockholders an amount equal to the Redemption Value per share plus all accrued and unpaid dividends thereon to the date of such payment, and no distribution shall be made to the holders of shares of Common Stock, the Class B Preferred Stock or any other capital stock of the Corporation unless prior thereto the Holder shall have received an amount equal to the Redemption Value per share plus all accrued and unpaid dividends thereon, to the date of such payment. Section 8. Rank. The Class A Preferred Stock shall rank as to dividends and distribution of assets prior to the Class B Preferred Stock, the Common Stock and all other shares of stock of the Corporation. Section 9. Payments. Except to the extent otherwise provided herein, all payments to be made by the Corporation in respect of the Class A Preferred Stock shall be made in Dollars, in immediately available funds, without deduction, set-off or counterclaim, to the Holder at an account designated by the Holder, not later than 12:00 p.m. New York time on the date on which such payment shall become due (each such payment made after such time on such due date to be deemed to have been made on the next succeeding Business Day). If the due date of any payment hereunder would otherwise fall on a day that is not a Business Day, such date shall be extended to the next succeeding Business Day, and dividends shall be payable on the aggregate Redemption Value of any shares of Class A Preferred Stock for the period of such extension. Section 10. Fiscal Year. The Corporation will not change the last day of its fiscal year from December 31 of each year. 40 EXHIBIT B to the Standby Purchase Agreement [Form of Purchase Notice] [Date] SAF Funding Corporation - ----------------------------- - ----------------------------- - ----------------------------- Re: Standby Purchase Agreement dated as of November 19, 1999, among State Auto Financial Corporation and SAF Funding Corporation (as modified and supplemented and in effect from time to time, the "Standby Purchase Agreement"). Ladies and Gentlemen: Reference is made to the Standby Purchase Agreement referred to above. Capitalized terms used but not defined herein shall have the respective meanings assigned to such terms in the Standby Purchase Agreement. Pursuant to Section 2.2 of the Standby Purchase Agreement, State Auto Financial hereby notifies you that it intends to sell to you ________ shares of Class A Preferred Stock with an aggregate Redemption Value of $____________________(1) on _____________, 199__(2). STATE AUTO FINANCIAL CORPORATION By ------------------------------------------- Title: ------------------------------------ - ---------- (1) Insert an amount at least equal to $10,000,000 or a larger multiple of $1,000,000. (2) Insert a date falling on or after the fourth Business Day following the date of this Purchase Notice. 41 EXHIBIT C to the Standby Purchase Agreement [Form of Opinion of General Counsel of State Auto Financial) ------------------, ---- SAF Funding Corporation (the "Company") To Bank One, NA, as Agent (the "Agent") under, and each of the Lenders party to, the Credit Agreement dated as of November 19, 1999, among the Company, the Agent and such Lenders Ladies and Gentlemen: I am the general counsel of State Auto Financial Corporation ("State Auto Financial") and have acted as counsel to State Auto Financial in connection with the Standby Purchase Agreement dated as of November 19, 1999 (the "Standby Purchase Agreement") between State Auto Financial and the Company, pursuant to which the Company has agreed to purchase, from time to time, a certain number of shares of State Auto Financial's Class A Redeemable Preferred Stock, no par value per share (the "Class A Preferred Stock"). This opinion letter is delivered to you pursuant to Section 3(b) of the Standby Purchase Agreement in connection with the proposed issuance and sale by State Auto Financial, and the purchase by the Company, on the date hereof, of ____ shares of the Class A Preferred Stock (the "Purchased Stock"). In rendering the opinions expressed below, I have examined the following agreements, instruments and other documents: (a) the Standby Purchase Agreement; (b) certificates evidencing the Purchased Stock (the "Purchased Stock Certificates"); and (c) such records of State Auto Financial and such other documents as I have deemed necessary as a basis for the opinions expressed below. In my examination, I have assumed the genuineness of all signatures, the authenticity of all documents submitted to me as originals and the conformity with authentic original documents of all documents submitted to me as copies. When relevant facts were not independently established, I have relied upon certificates of governmental officials and appropriate representatives of State Auto Financial and upon representations made in or pursuant to the Standby Purchase Agreement. 42 Based upon and subject to the foregoing and subject also to the comments and qualifications set forth below, and having considered such questions of law as I have deemed necessary as a basis for the opinions expressed below, I am of the opinion that: 1. State Auto Financial is a corporation duly organized, validly existing and in good standing under the laws of the State of Ohio. 2. State Auto Financial has all requisite corporate power and authority to issue and sell the Purchased Stock and execute and deliver the Purchased Stock Certificates. 3. The issuance and sale of the Purchased Stock to the Company and execution and delivery by State Auto Financial of the Purchased Stock Certificates have been duly authorized by all necessary corporate action on the part of State Auto Financial. 4. The Purchased Stock Certificates have been duly executed and delivered by State Auto Financial. 5. No authorization, approval or consent of, and no filing or registration with, any governmental or regulatory authority or agency of the United States of America or the State of Ohio (other than any authorizations, approvals, consents, filings and registrations heretofore duly made or obtained and in full force and effect) is required on the part of State Auto Financial for issuance and sale of the Purchased Stock to the Company and the execution and delivery of the Purchased Stock Certificates. 6. The issuance and sale of the Purchased Stock to the Company and the execution and delivery of the Purchased Stock do not and will not (a) violate any provision of the Articles of Incorporation or Code of Regulations of State Auto Financial, (b) violate any applicable law, rule or regulation of the United States of America or the State of Ohio, (c) violate any order, writ, injunction or decree of any court or governmental authority or agency or any arbitral award applicable to State Auto Financial of which I have knowledge (after due inquiry) or (d) result in a breach of, constitute a default under, require any consent under, or result in the acceleration or required prepayment of any indebtedness pursuant to the terms of, any agreement or instrument of which I have knowledge (after due inquiry) to which such State Auto Financial or any of its Subsidiaries is a party or by which any of them is bound or to which any of them is subject, or result in the creation or imposition of any Lien upon any Property of State Auto Financial or any of its Subsidiaries pursuant to the terms of any such agreement or instrument. 7. The Purchased Shares are validly issued and outstanding, are fully paid and non-assessable and have, and entitle the holders thereof to, the relative rights and preferences set forth with respect to the Class A Preferred Stock in the Purchased Stock Certificates. 8. I have no knowledge (after due inquiry) of any legal or arbitral proceedings, or any proceedings by or before any governmental or regulatory authority or 43 agency, now pending or threatened against or affecting State Auto Financial or any of its Property that, if adversely determined, could have a Material Adverse Effect (excluding any Material Adverse Effect resulting from the catastrophic loss claims and/or loss adjustment expenses to which the issuance of the Purchased Stock relates). The foregoing opinions are limited to matters involving the Federal laws of the United States of America and the law of the State of Ohio, and I do not express any opinion as to the laws of any other jurisdiction. The opinions contained in this letter are rendered only as of the date hereof and I undertake no obligation to update this letter or the opinions contained herein after the date hereof. The opinions contained in this letter only constitute my professional judgment as to the consequences of and the applicability of certain laws to the documents and agreements referred to and the parties thereto and should not be considered to be a guarantee of any particular result. At the request of my clients, this opinion letter is provided to you by me in my capacity as counsel to State Auto Financial, and this opinion letter may not be relied upon by any Person for any purpose other than in connection with the transactions contemplated by the Basic Documents without, in each instance, my prior written consent. Very truly yours, EX-10.W 5 EXHIBIT 10(W) 1 Exhibit 10(W) Reinsurance Pooling Agreement Amended and Restated As of January 1, 2000 By and among State Automobile Mutual Insurance Company State Auto Property and Casualty Insurance Company Milbank Insurance Company Midwest Security Insurance Company Farmers Casualty Insurance Company State Auto Insurance Company 2 Page 1 REINSURANCE POOLING AGREEMENT ----------------------------- AMENDED AND RESTATED -------------------- AS OF JANUARY 1, 2000 --------------------- This Reinsurance Pooling Agreement Amended and Restated effective as of 12:01 a.m., Eastern Standard Time, January 1, 2000 (the "2000 Pooling Agreement") is by and among State Automobile Mutual Insurance Company, 518 East Broad Street, Columbus, Ohio (hereinafter referred to as "State Auto Mutual"), State Auto Property and Casualty Insurance Company, 112 South Main Street, Greer, South Carolina (hereinafter referred to as "State Auto P&C"), Milbank Insurance Company, East Highway 12, Milbank, South Dakota (hereinafter referred to as "Milbank"), Midwest Security Insurance Company, 2700 Midwest Drive, Onalaska, Wisconsin (hereinafter referred to as "Midwest Security"), Farmers Casualty Insurance Company, 1300 Woodland Drive, West Des Moines, Iowa (hereinafter referred to as "Farmers Casualty") and State Auto Insurance Company, 518 East Broad Street, Columbus, Ohio ("State Auto IC"). (State Auto Mutual, State Auto P&C, Milbank, Midwest Security, Farmers Casualty and State Auto IC are herein collectively referred to as the "Pooled Companies" and individually as a "Pooled Company"). BACKGROUND INFORMATION ---------------------- The Pooled Companies have determined that their business operations should be conducted by employees of State Auto P&C on behalf of each of the Pooled Companies and that State Auto Mutual should remain as the agent for each of the Pooled Companies with respect to collecting and disbursing funds as required by the Pooled Companies' business operations. These arrangements have been effected through the Management Agreement dated January 1, 2000 (the "2000 Management Agreement"), as to Midwest Security through the Amended and Restated Management Agreement dated effective January 1, 2000 (the "2000 Midwest Management Agreement"), as to Farmers Casualty through the Amended and Restated Management Agreement dated effective January 1, 2000 (the "2000 Farmers Casualty Management Agreement") and by means of mutual reinsurance on a percentage basis as herein provided. State Auto Mutual and State Auto P&C originally entered into an intercompany Reinsurance Agreement effective as of 12:01 a.m., January 1, 1987 (the "Reinsurance Agreement"). The Reinsurance Agreement has since been amended by an Addendum effective January 1, 1987, adding insolvency and arbitration provisions; by Amendment Number 1 effective as of January 1, 1992 amending the pooling percentages from 20% State Auto P&C - 80% State Auto Mutual to 30% and 70% respectively; by Amendment Number 2 effective as of January 1, 1991 excluding post retirement health care benefits liability as a pooled expense and as of January 1, 1994 excluding post employment benefits liability as a pooled expense; and by Amendment Number 3 effective as of January 1, 1995 adding Milbank as a party and adjusting the pooling percentages as follows: State Auto P&C 35%, State Auto Mutual 55% and Milbank 10% and by an Amended and Restated Reinsurance Pooling Agreement dated July 1, 1996 (the "7/1/96 Reinsurance Agreement"), which excluded from the Reinsurance Agreement catastrophic loss claims and loss adjustment expenses incurred by State Auto Mutual, 3 Page 2 State Auto P&C and Milbank in the amount of $100,000,000 in excess of $120,000,000 of such losses and loss adjustment expense and the premiums for such exposure; and by an Amended and Restated Reinsurance Pooling Agreement effective January 1, 1998 (the "'98 Pooling Agreement") which added Midwest Security as a party and adjusted the Respective Percentages (as defined below) to State Auto P&C 37%, State Auto Mutual 52%, Milbank 10%, and Midwest Security 1%; and by a Reinsurance Pooling Agreement Amended and Restated as of January 1, 1999 (hereafter referred to as the "'99 Pooling Agreement") which added Farmers Casualty as a party and adjusted the Respective Percentages to State Auto P&C-37%, State Auto Mutual-49%, Milbank-10%, Farmers Casualty-3%, Midwest Security-1%. In addition to the foregoing amendments to the pooling arrangement as set forth in the various agreements, each of these agreements and this 2000 Pooling Agreement is subject to the Guaranty Agreement dated as of May 16, 1991 between State Auto Mutual and State Auto P&C (the "Reserve Guaranty Agreement"). The parties desire to amend and restate the '99 Pooling Agreement as the 2000 Pooling Agreement, to provide for the continuation of the pooling arrangement it effects, including the above-described previous amendments and the additional amendments incorporated herein, which include the following: to remove from the scope of the 2000 Pooling Agreement the premiums, losses, underwriting and administrative expenses attributable to State Auto Mutual's voluntary assumption of reinsurance from third parties which are unaffiliated with State Auto Mutual, which voluntary assumed reinsurance contracts/treaties initially commenced on or after January 1, 1999 (this January 1, 1999 and after voluntary third party assumption reinsurance is hereafter referred to as the "State Auto Mutual Reinsurance Book"); to add State Auto IC as a new party; to remove an exclusion for post retirement health care benefits liabilities; and post employment benefits liabilities and to adjust the Respective Percentages as set forth below. STATEMENT OF AGREEMENT ---------------------- In consideration of the mutual covenants set forth herein and INTENDING TO BE LEGALLY BOUND HEREBY, the parties hereto hereby agree as follows: 1. DEFINITIONS: As used in this Agreement: (a) "Net Liabilities" shall mean all direct liabilities plus reinsurance assumed minus reinsurance ceded, except as otherwise expressly excluded below, provided that the parties hereto expressly understand and agree that Net Liabilities excludes any and all liabilities arising out of the State Auto Mutual Reinsurance Book for such reinsurance assumed on and after January 1, 2000. (b) "Net Premiums" shall mean all direct premiums plus reinsurance assumed minus reinsurance ceded, except as otherwise expressly excluded below, provided that the parties hereto expressly understand and agree that Net Premiums excludes any and all premiums arising out of the State Auto 4 Page 3 Mutual Reinsurance Book for such reinsurance assumed on and after January 1, 2000. c. "Respective Percentage" shall be: As to State Auto IC 1% As to Farmers Casualty 3% As to Midwest Security 1% As to Milbank 10% As to State Auto P&C 39% As to State Auto Mutual 46% 2. CESSION: (a) STATE AUTO P&C CESSION: State Auto Mutual hereby reinsures and assumes and State Auto P&C hereby cedes and transfers to State Auto Mutual all Net Liabilities incurred under or in connection with all contracts and policies of insurance issued by State Auto P&C outstanding and in force as of and subsequent to 12:01 a.m. Eastern Standard Time, January 1, 2000. Such liabilities shall include State Auto P&C's reserves for unearned premiums, outstanding losses and loss expenses (including unreported losses) and all other outstanding underwriting and administrative expenses as evidenced by State Auto P&C's books and records at the close of business on December 31, 1999, but shall not include intercompany balances, liabilities incurred in connection with the investment transactions of State Auto P&C, liabilities for dividends to stockholders declared and unpaid, other liabilities not incurred in connection with underwriting operations and liabilities arising out of the State Auto Mutual Reinsurance Book. It is further agreed State Auto Mutual shall receive the Net Premiums for said contracts and policies. (b) MILBANK CESSION: State Auto Mutual hereby reinsures and assumes and Milbank hereby cedes and transfers to State Auto Mutual all Net Liabilities incurred under or in connection with all contracts and policies of insurance issued by Milbank outstanding and in force as of and subsequent to 12:01 a.m. EST, January 1, 2000. Such liabilities shall include Milbank's reserves for unearned premiums, outstanding losses and loss expenses (including unreported losses) and all other outstanding underwriting and administrative expenses as evidenced by Milbank's books and records at the close of business on December 31, 1999, but shall not include intercompany balances, liabilities incurred in connection with the investment transactions of Milbank, liabilities for dividends to stockholders declared and unpaid, other liabilities not incurred in connection with underwriting operations and liabilities arising out of the State 5 Page 4 Auto Mutual Reinsurance Book. It is further agreed that State Auto Mutual shall receive the Net Premiums for said contracts and policies. (c) MIDWEST SECURITY CESSION: State Auto Mutual hereby reinsures and assumes and Midwest Security hereby cedes and transfers to State Auto Mutual all Net Liabilities incurred under or in connection with all contracts and policies of insurance issued by Midwest Security outstanding and in force as of and subsequent to 12:01 a.m. EST, January 1, 2000. Such liabilities shall include Midwest Security's reserves for unearned premiums, outstanding losses and loss expenses (including unreported losses) and all other outstanding underwriting and administrative expenses as evidenced by Midwest Security's books and records at the close of business on December 31, 1999, but shall not include intercompany balances, liabilities incurred in connection with the investment transactions of Midwest Security, liabilities for dividends to stockholders declared and unpaid, other liabilities not incurred in connection with underwriting operations and liabilities arising out of the State Auto Mutual Reinsurance Book. It is further agreed that State Auto Mutual shall receive the Net Premiums for said contracts and policies. (d) FARMERS CASUALTY CESSION: State Auto Mutual hereby reinsures and assumes and Farmers Casualty hereby cedes and transfers to State Auto Mutual all Net Liabilities incurred under or in connection with all contracts and policies of insurance issued by Farmers Casualty outstanding and in force as of and subsequent to 12:01 a.m. EST, January 1, 2000. Such liabilities shall include Farmers Casualty's reserves for unearned premiums, outstanding losses and loss expenses (including unreported losses) and all other outstanding underwriting and administrative expenses as evidenced by Farmers Casualty's books and records at the close of business on December 31, 1999, but shall not include intercompany balances, liabilities incurred in connection with the investment transactions of Farmers Casualty, liabilities for dividends to stockholders declared and unpaid, other liabilities not incurred in connection with underwriting operations and liabilities arising out of the State Auto Mutual Reinsurance Book. It is further agreed that State Auto Mutual shall receive the Net Premiums for said contracts and policies. (e) STATE AUTO IC CESSION: State Auto Mutual hereby reinsures and assumes and State Auto IC hereby cedes and transfers to State Auto Mutual all Net Liabilities incurred under or in connection with all contracts and policies of 6 Page 5 insurance issued by State Auto IC outstanding and in force as of and subsequent to 12:01 a.m. EST, January 1, 2000. Such liabilities shall include State Auto IC's reserves for unearned premiums, outstanding losses and loss expenses (including unreported losses) and all other outstanding underwriting and administrative expenses as evidenced by State Auto IC's books and records at the close of business on December 31, 1999, but shall not include intercompany balances, liabilities incurred in connection with the investment transactions of State Auto IC, liabilities for dividends to stockholders declared and unpaid, other liabilities not incurred in connection with underwriting operations and liabilities arising out of the State Auto Mutual Reinsurance Book. It is further agreed that State Auto Mutual shall receive the Net Premiums for said contracts and policies. 3. ASSETS TRANSFER TO STATE AUTO MUTUAL: (a) STATE AUTO P&C: In consideration of the agreements herein contained, State Auto P&C hereby agrees that there has been or will be assigned and transferred to State Auto Mutual an amount, in cash or other assets, equal to the aggregate of all liabilities of State Auto P&C assumed by State Auto Mutual under paragraph 2(a) hereof, less a ceding commission equal to the sum of the acquisition expenses associated with the unearned premium reserves which are transferred as provided herein. There have been included among the assets assigned and transferred to State Auto Mutual by State Auto P&C all of the right, title and interest of State Auto P&C in and to all assets relative to the underwriting operations of State Auto P&C, due or that became due, as evidenced by its books and records at the close of business on December 31, 1999, not including investments, accrued investment income, intercompany balances and bank deposits. (b) MILBANK: In consideration of the agreements herein contained, Milbank hereby agrees that there has been or will be assigned and transferred to State Auto Mutual an amount, in cash or other assets, equal to the aggregate of all liabilities of Milbank assumed by State Auto Mutual under paragraph 2(b) hereof, less a ceding commission equal to the sum of the acquisition expenses associated with the unearned premium reserves which are transferred as provided herein. There shall be included among the assets assigned and transferred to State Auto Mutual by Milbank all of the right, title and interest of Milbank in and to all assets relative to the underwriting operations of Milbank due or that 7 Page 6 may become due as evidenced by its books and records at the close of business on December 31, 1999 not including investments, accrued investment income, intercompany balances and bank deposits. (c) MIDWEST SECURITY: In consideration of the agreements herein contained, Midwest Security hereby agrees that there has been or will be assigned and transferred to State Auto Mutual an amount, in cash or other assets, equal to the aggregate of all liabilities of Midwest Security assumed by State Auto Mutual under paragraph 2(c) hereof, less a ceding commission equal to the sum of the acquisition expenses associated with the unearned premium reserves which are transferred as provided herein. There shall be included among the assets assigned and transferred to State Auto Mutual by Midwest Security all of the right, title and interest of Midwest Security in and to all assets relative to the underwriting operations of Midwest Security due or that may become due as evidenced by its books and records at the close of business on December 31, 1999, not including investments, accrued investment income, intercompany balances and bank deposits. (d) FARMERS CASUALTY: In consideration of the agreements herein contained, Farmers Casualty hereby agrees that there has been or will be assigned and transferred to State Auto Mutual an amount, in cash or other assets, equal to the aggregate of all liabilities of Farmers Casualty assumed by State Auto Mutual under paragraph 2(d) hereof, less a ceding commission equal to the sum of the acquisition expenses associated with the unearned premium reserves which are transferred as provided herein. There shall be included among the assets assigned and transferred to State Auto Mutual by Farmers Casualty all of the right, title and interest of Farmers Casualty in and to all assets relative to the underwriting operations of Farmers Casualty due or that may become due as evidenced by its books and records at the close of business on December 31, 1999, not including investments, accrued investment income, intercompany balances and bank deposits. (e) State Auto IC: In consideration of the agreements herein contained, State Auto IC hereby agrees that there has been or will be assigned and transferred to State Auto Mutual an amount, in cash or other assets, equal to the aggregate of all liabilities of State Auto IC assumed by State Auto Mutual under paragraph 2(e) hereof, less a ceding commission equal to the sum of the acquisition expenses associated with the unearned premium reserves which are transferred as provided herein. There shall be included 8 Page 7 among the assets assigned and transferred to State Auto Mutual by State Auto IC all of the right, title and interest of State Auto IC in and to all assets relative to the underwriting operations of State Auto IC due or that may become due as evidenced by its books and records at the close of business on December 31, 1999, not including investments, accrued investment income, intercompany balances and bank deposits. 4. ASSUMPTION OF REINSURANCE: (a) STATE AUTO P&C: State Auto P&C hereby reinsures and assumes and State Auto Mutual hereby cedes and transfers to State Auto P&C its Respective Percentage of all Net Liabilities under all contracts and policies of insurance, (including those ceded by State Auto P&C and reinsured by State Auto Mutual as provided in paragraph 2(a)), on which State Auto Mutual is subject to liability and which are outstanding and in force on or after the effective date hereof. Such liabilities shall include reserves for unearned premiums, outstanding losses (including unreported losses) and loss expenses and all other underwriting and administrative expenses, but shall not include intercompany balances, liabilities for federal income taxes, liabilities incurred in connection with investment transactions, liabilities for dividends to stockholders declared and unpaid, other liabilities not incurred in connection with underwriting operations and liabilities arising out of the State Auto Mutual Reinsurance Book. (b) MILBANK: Milbank hereby reinsures and assumes and State Auto Mutual hereby cedes and transfers to Milbank its Respective Percentage of all Net Liabilities under all contracts and policies of insurance, (including those ceded by Milbank and reinsured by State Auto Mutual as provided in paragraph 2(b)), on which State Auto Mutual is subject to liability and which are outstanding and in force on or after the effective date hereof. Such liabilities shall include reserves for unearned premiums, outstanding losses (including unreported losses) and loss expenses and all other underwriting and administrative expenses, but shall not include intercompany balances, liabilities for federal income taxes, liabilities incurred in connection with investment transactions, liabilities for dividends to stockholders declared and unpaid, other liabilities not incurred in connection with underwriting operations and liabilities arising out of the State Auto Mutual Reinsurance Book. (c) MIDWEST SECURITY: Midwest Security hereby reinsures and assumes and State Auto Mutual hereby cedes and transfers to Midwest Security its Respective Percentage of all 9 Page 8 Net Liabilities under all contracts and policies of insurance, (including those ceded by Midwest Security and reinsured by State Auto Mutual as provided in paragraph 2(c)), on which State Auto Mutual is subject to liability and which are outstanding and in force on or after the effective date hereof. Such liabilities shall include reserves for unearned premiums, outstanding losses (including unreported losses) and loss expenses and all other underwriting and administrative expenses, but shall not include intercompany balances, liabilities for federal income taxes, liabilities incurred in connection with investment transactions, liabilities for dividends to stockholders declared and unpaid, other liabilities not incurred in connection with underwriting operations and liabilities arising out of the State Auto Mutual Reinsurance Book. (d) FARMERS CASUALTY: Farmers Casualty hereby reinsures and assumes and State Auto Mutual hereby cedes and transfers to Farmers Casualty its Respective Percentage of all Net Liabilities under all contracts and policies of insurance, (including those ceded by Farmers Casualty and reinsured by State Auto Mutual as provided in paragraph 2(d)), on which State Auto Mutual is subject to liability and which are outstanding and in force on or after the effective date hereof. Such liabilities shall include reserves for unearned premiums, outstanding losses (including unreported losses) and loss expenses and all other underwriting and administrative expenses, but shall not include intercompany balances, liabilities for federal income taxes, liabilities incurred in connection with investment transactions, liabilities for dividends to stockholders declared and unpaid, other liabilities not incurred in connection with underwriting operations and liabilities arising out of the State Auto Mutual Reinsurance Book. (e) STATE AUTO IC: State Auto IC hereby reinsures and assumes and State Auto Mutual hereby cedes and transfers to State Auto IC its Respective Percentage of all Net Liabilities under all contracts and policies of insurance, (including those ceded by State Auto IC and reinsured by State Auto Mutual as provided in paragraph 2(e)), on which State Auto Mutual is subject to liability and which are outstanding and in force on or after the effective date hereof. Such liabilities shall include reserves for unearned premiums, outstanding losses (including unreported losses) and loss expenses and all other underwriting and administrative expenses, but shall not include intercompany balances, liabilities for federal income taxes, liabilities incurred in connection with investment transactions, liabilities for dividends to stockholders declared and unpaid, other liabilities not 10 Page 9 incurred in connection with underwriting operations and liabilities arising out of the State Auto Mutual Reinsurance Book. 5. ASSET TRANSFER BY STATE AUTO MUTUAL: (a) STATE AUTO P&C: In consideration of the agreements herein contained, State Auto Mutual hereby agrees that there has been or will be assigned and transferred to State Auto P&C an amount, in cash or other assets, equal to the aggregate of all liabilities of State Auto Mutual assumed by State Auto P&C under paragraph 4(a) hereof, less a ceding commission equal to the sum of the acquisition expenses associated with the unearned premium reserves which are transferred as provided herein. There shall be included among the assets assigned and transferred to State Auto P&C by State Auto Mutual all of the right, title and interest of State Auto Mutual in and to all assets relative to the underwriting operations of State Auto Mutual, due or that may become due, as evidenced by its books and records at the close of business on December 31, 1999, not including investments, accrued investment income, intercompany balances and bank deposits. (b) MILBANK: In consideration of the agreements herein contained, State Auto Mutual hereby agrees that there has been or will be assigned and transferred to Milbank an amount, in cash or other assets, equal to the aggregate of all liabilities of State Auto Mutual assumed by Milbank under paragraph 4(b) hereof, less a ceding commission equal to the sum of the acquisition expenses associated with the unearned premium reserves which are transferred as provided herein. There shall be included among the assets assigned and transferred to Milbank by State Auto Mutual all of the right, title and interest of State Auto Mutual in and to all assets relative to the underwriting operations of State Auto Mutual, due or that may become due, as evidenced by its books and records at the close of business on December 31, 1999, not including investments, accrued investment income, intercompany balances and bank deposits. (c) MIDWEST SECURITY: In consideration of the agreements herein contained, State Auto Mutual hereby agrees that there has been or will be assigned and transferred to Midwest Security an amount, in cash or other assets, equal to the aggregate of all liabilities of State Auto Mutual assumed by Midwest Security under paragraph 4(c) hereof, less a ceding commission equal to the sum of the acquisition expenses associated with the unearned premium reserves which are transferred as provided herein. There shall be included among the assets assigned and transferred to Midwest 11 Page 10 Security by State Auto Mutual all of the right, title and interest of State Auto Mutual in and to all assets relative to the underwriting operations of State Auto Mutual, due or that may become due, as evidenced by its books and records at the close of business on December 31, 1999, not including investments, accrued investment income, intercompany balances and bank deposits. (d) FARMERS CASUALTY: In consideration of the agreements herein contained, State Auto Mutual hereby agrees that there has been or will be assigned and transferred to Farmers Casualty an amount, in cash or other assets, equal to the aggregate of all liabilities of State Auto Mutual assumed by Farmers Casualty under paragraph 4(d) hereof, less a ceding commission equal to the sum of the acquisition expenses associated with the unearned premium reserves which are transferred as provided herein. There shall be included among the assets assigned and transferred to Farmers Casualty by State Auto Mutual all of the right, title and interest of State Auto Mutual in and to all assets relative to the underwriting operations of State Auto Mutual, due or that may become due, as evidenced by its books and records at the close of business on December 31, 1999, not including investments, accrued investment income, intercompany balances and bank deposits. (e) State Auto IC: In consideration of the agreements herein contained, State Auto Mutual hereby agrees that there has been or will be assigned and transferred to State Auto IC an amount, in cash or other assets, equal to the aggregate of all liabilities of State Auto Mutual assumed by State Auto IC under paragraph 4(e) hereof, less a ceding commission equal to the sum of the acquisition expenses associated with the unearned premium reserves which are transferred as provided herein. There shall be included among the assets assigned and transferred to State Auto IC by State Auto Mutual all of the right, title and interest of State Auto Mutual in and to all assets relative to the underwriting operations of State Auto Mutual, due or that may become due, as evidenced by its books and records at the close of business on December 31, 1999, not including investments, accrued investment income, intercompany balances and bank deposits. 6. PREMIUM COLLECTION AND PAYMENT OF LOSSES: As of the effective date of this Agreement and pursuant to the terms of the 2000 Management Agreement as amended from time to time, the 2000 Midwest Management Agreement, as amended from time to time, and the 2000 Farmers Casualty Management Agreement, as amended 12 Page 11 from time to time, State Auto P&C, Milbank, Midwest Security, Farmers Casualty, and State Auto IC hereby authorize and empower State Auto Mutual to collect and receive all premiums and to take charge of, adjust and administer the payment of all losses with respect to any and all contracts and policies of insurance previously or thereafter issued by State Auto P&C, Milbank, Midwest Security, Farmers Casualty and State Auto IC and to reinsure or terminate all such contracts and policies, and in all respects to act as though said contracts and policies were issued by State Auto Mutual. State Auto Mutual agrees to administer the payment of all losses and loss adjustment expenses in connection with such contracts and policies. None of the foregoing is intended to affect or impair the direct obligation of State Auto P&C, Milbank, Midwest Security, Farmers Casualty and State Auto IC to their insureds under policies issued by State Auto P&C, Milbank, Midwest Security, Farmers Casualty, and State Auto IC, respectively. 7. PREMIUM PAYABLE BY STATE AUTO MUTUAL: (a) STATE AUTO P&C: Commencing with the effective date of this Agreement, State Auto Mutual hereby agrees to pay to State Auto P&C its Respective Percentage of the Net Premiums written by the parties hereto. Similarly, commencing with the effective date of this Agreement, all losses, loss expenses, underwriting expenses, and administrative expenses chargeable to underwriting of the parties hereto (except for losses, loss expenses, underwriting expenses and administrative expenses chargeable to the State Auto Mutual Reinsurance Book), including the policyholder dividends, less all losses and expenses recovered and recoverable under reinsurance ceded to reinsurers other than the parties hereto, (except for catastrophe reinsurance ceded by State Auto Mutual, Farmers Casualty, Midwest Security, Milbank, and State Auto IC to State Auto P&C pursuant to a Property Catastrophe Overlying Excess of Loss Reinsurance Contract dated as of July 1, 1999 as amended January 1, 2000 in which State Auto P&C provides catastrophe coverage for the aforesaid companies for $135,000,000 of catastrophe losses and loss expenses in excess of $120,000,000 of such losses and loss expenses incurred by the Pooled Companies) (the "State Auto P&C Catastrophe Assumption Agreement") shall be prorated among the parties on the basis of the Respective Percentage of each. Accounts shall be rendered at quarterly intervals and shall be settled within sixty (60) days thereafter. (b) MILBANK: Commencing with the effective date of this Agreement, State Auto Mutual hereby agrees to pay Milbank its Respective Percentage of the Net Premiums written by the parties hereto. Similarly, commencing with the effective date 13 Page 12 of this Agreement, all losses, loss expenses, underwriting expenses, and administrative expenses chargeable to underwriting of the parties hereto (except for losses, loss expenses, underwriting expenses and administrative expenses chargeable to the State Auto Mutual Reinsurance Book), including policyholder dividends, less all losses and expenses recovered and recoverable under reinsurance ceded to reinsurers other than the parties hereto, (except for the State Auto P&C Catastrophe Assumption Agreement) shall be prorated among the parties on the basis of the Respective Percentage of each. Accounts shall be rendered at quarterly intervals and shall be settled within sixty (60) days thereafter. (c) MIDWEST SECURITY: Commencing with the effective date of this Agreement, State Auto Mutual hereby agrees to pay Midwest Security its Respective Percentage of the Net Premiums written by the parties hereto. Similarly, commencing with the effective date of this Agreement, all losses, loss expenses, underwriting expenses, and administrative expenses chargeable to underwriting of the parties hereto (except for losses, loss expenses, underwriting expenses and administrative expenses chargeable to the State Auto Mutual Reinsurance Book), including policyholder dividends, less all losses and expenses recovered and recoverable under reinsurance ceded to reinsurers other than the parties hereto, (except for the State Auto P&C Catastrophe Assumption Agreement) shall be prorated among the parties on the basis of the Respective Percentage of each. Accounts shall be rendered at quarterly intervals and shall be settled within sixty (60) days thereafter. (d) FARMERS CASUALTY: Commencing with the effective date of this Agreement, State Auto Mutual hereby agrees to pay Farmers Casualty its Respective Percentage of the Net Premiums written by the parties hereto. Similarly, commencing with the effective date of this Agreement, all losses, loss expenses, underwriting expenses, and administrative expenses chargeable to underwriting of the parties hereto (except for losses, loss expenses, underwriting expenses and administrative expenses chargeable to the State Auto Mutual Reinsurance Book), including policyholder dividends, less all losses and expenses recovered and recoverable under reinsurance ceded to reinsurers other than the parties hereto, (except for the State Auto P&C Catastrophe Assumption Agreement) shall be prorated among the parties on the basis of the Respective Percentage of each. Accounts shall be rendered at quarterly intervals and shall be settled within sixty (60) days thereafter. 14 Page 13 (e) STATE AUTO IC: Commencing with the effective date of this Agreement, State Auto Mutual hereby agrees to pay State Auto IC its Respective Percentage of the Net Premiums written by the parties hereto. Similarly, commencing with the effective date of this Agreement, all losses, loss expenses, underwriting expenses, and administrative expenses chargeable to underwriting of the parties hereto (except for losses, loss expenses, underwriting expenses and administrative expenses chargeable to the State Auto Mutual Reinsurance Book), including policyholder dividends, less all losses and expenses recovered and recoverable under reinsurance ceded to reinsurers other than the parties hereto, (except for the State Auto P&C Catastrophe Assumption Agreement) shall be prorated among the parties on the basis of the Respective Percentage of each. Accounts shall be rendered at quarterly intervals and shall be settled within sixty (60) days thereafter. 8. OFFSET: It is understood and agreed that, insofar as is practicable and consistent with the purposes and intentions of this Agreement, the obligations of each company under this Agreement to transfer assets to the other company may, in whole or in part, be offset against the reciprocal reinsurance obligations of each company to the other company so that each company shall deliver hereunder only a net amount of assets required under such offset. 9. GENERAL STATEMENT OF INTENT: It is the purpose and intent of this Agreement that: (a) State Auto Mutual shall be liable as a reinsurer to State Auto P&C, Milbank, Midwest Security, Farmers Casualty, and State Auto IC on the policies and contracts of insurance of State Auto P&C, Milbank, Midwest Security, Farmers Casualty and State Auto IC respectively, issued and in force at 12:01 a.m., EST, January 1, 2000, or on which there were, at that time, unsettled claims or losses, and on policies and contracts thereafter issued by State Auto P&C, Milbank, Midwest Security, Farmers Casualty and State Auto IC to the extent of State Auto Mutual's Respective Percentage. Premiums, losses, loss expenses, underwriting expenses and administrative expenses chargeable to the State Auto Mutual Reinsurance Book from and after 12:01 a.m. EST January 1, 2000 are excluded from the scope of the 2000 Pooling Agreement. (b) State Auto P&C shall be liable as a reinsurer to State Auto Mutual, Milbank, Midwest Security, Farmers Casualty and State Auto IC on the policies and contracts of insurance of State Auto Mutual, Milbank, Midwest Security, Farmers Casualty and State Auto IC, respectively, issued and in force 15 Page 14 at 12:01 a.m., EST, January 1, 2000, or on which there were, at that time, unsettled claims or losses, and on policies and contracts thereafter issued by State Auto Mutual, Milbank, Midwest Security, Farmers Casualty and State Auto IC to the extent of State Auto P&C's Respective Percentage. Premiums, losses, loss expenses, underwriting expenses and administrative expenses chargeable to the State Auto Mutual Reinsurance Book from and after 12:01 a.m. EST January 1, 2000 are excluded from the scope of the 2000 Pooling Agreement. (c) Milbank shall be liable as a reinsurer to State Auto Mutual, State Auto P&C, Midwest Security, Farmers Casualty and State Auto IC on the policies and contracts of State Auto Mutual, State Auto P&C, Midwest Security, Farmers Casualty and State Auto IC, respectively, issued and in force at 12:01 a.m., EST, on January 1, 2000 or on which there were, at that time, unsettled claims or losses and on policies thereafter issued by State Auto Mutual, State Auto P&C, Midwest Security, Farmers Casualty and State Auto IC to the extent of Milbank's Respective Percentage. Premiums, losses, loss expenses, underwriting expenses and administrative expenses chargeable to the State Auto Mutual Reinsurance Book from and after 12:01 a.m. EST January 1, 2000 are excluded from the scope of the 2000 Pooling Agreement. (d) Midwest Security shall be liable as a reinsurer to State Auto Mutual, State Auto P&C, Milbank, Farmers Casualty and State Auto IC on the policies and contracts of State Auto Mutual, State Auto P&C, Milbank, Farmers Casualty and State Auto IC, respectively, issued and in force at 12:01 a.m., EST, on January 1, 2000 or on which there were, at that time, unsettled claims or losses and on policies thereafter issued by State Auto Mutual, State Auto P&C, Milbank, Farmers Casualty and State Auto IC to the extent of Midwest Security's Respective Percentage. Premiums, losses, loss expenses, underwriting expenses and administrative expenses chargeable to the State Auto Mutual Reinsurance Book from and after 12:01 a.m. EST January 1, 2000 are excluded from the scope of the 2000 Pooling Agreement. (e) Farmers Casualty shall be liable as a reinsurer to State Auto Mutual, State Auto P&C, Milbank, Midwest Security and State Auto IC on the policies and contracts of State Auto Mutual, State Auto P&C, Milbank, Midwest Security and State Auto IC, respectively, issued and in force at 12:01 a.m., EST, January 1, 2000 or on which there were, at that time, unsettled claims or losses, and on policies and 16 Page 15 contracts thereafter issued by State Auto Mutual, State Auto P&C, Milbank, Midwest Security and State Auto IC to the extent of Farmers Casualty's Respective Percentage. Premiums, losses, loss expenses, underwriting expenses and administrative expenses chargeable to the State Auto Mutual Reinsurance Book from and after 12:01 a.m. EST January 1, 2000 are excluded from the scope of the 2000 Pooling Agreement. (f) State Auto IC shall be liable as a reinsurer to State Auto Mutual, State Auto P&C, Milbank, Midwest Security and Farmers Casualty on the policies and contracts of State Auto Mutual, State Auto P&C, Milbank, Midwest Security and Farmers Casualty, respectively, issued and in force at 12:01 a.m., EST, January 1, 2000 or on which there were, at that time, unsettled claims or losses, and on policies and contracts thereafter issued by State Auto Mutual, State Auto P&C, Milbank, Midwest Security and Farmers Casualty to the extent of State Auto IC's Respective Percentage. Premiums, losses, loss expenses, underwriting expenses and administrative expenses chargeable to the State Auto Mutual Reinsurance Book from and after 12:01 a.m. EST January 1, 2000 are excluded from the scope of the 2000 Pooling Agreement. (g) The parties hereto shall, on and after 12:01 a.m., EST, January 1, 2000, participate on the basis of 46% for State Auto Mutual, 39% for State Auto P&C, 10% for Milbank, 1% for Midwest Security, 3% for Farmers Casualty, and 1% for State Auto IC in all of the underwriting operations of each of the six parties hereto. Premiums, losses, loss expenses, underwriting expenses and administrative expenses chargeable to the State Auto Mutual Reinsurance Book from and after 12:01 a.m. EST January 1, 2000 are excluded from the scope of the 2000 Pooling Agreement. 10. LOSSES EXCLUDED: Notwithstanding any of the foregoing, the parties hereto understand and agree that this 2000 Pooling Agreement shall not apply to catastrophe losses and loss expenses for residential and commercial property to the extent such losses and loss expenses are covered by the State Auto P&C Catastrophe Assumption Agreement. Once the aforesaid $135,000,000 of coverage is exhausted by loss expenses and loss payments on behalf of any party hereto, under either the State Auto P&C Catastrophe Assumption Agreement or directly, all parties understand and agree that catastrophe losses and loss expenses in excess of $255,000,000 shall once again be ceded and assumed under the terms of the 2000 Pooling Agreement. All premiums attributable to the State Auto P&C Catastrophe Assumption Agreement are to be paid to State Auto P&C outside of the 2000 Pooling Agreement. All premiums, losses, loss expenses, underwriting expenses and administrative expenses attributable 17 Page 16 to the State Auto Mutual Reinsurance Book from and after 12:01 a.m. EST January 1, 2000 are outside the 2000 Pooling Agreement. In addition, this 2000 Pooling Agreement is subject to the Reserve Guaranty Agreement. 11. LIABILITIES EXCLUDED: In addition to the liabilities set forth in paragraphs 2(a), 2(b), 2(c), 2(d), 2(e) and 10 above, this Agreement shall not apply to the investment operation or liabilities for federal income tax or other liabilities excluded by this Agreement. 12. "FOLLOW THE FORTUNES": The reinsurance provided by the terms of this Agreement shall be subject to the same terms and conditions under which the original insurance was concluded, or which may be or may have been agreed to during the term of the original insurance contract. 13. METHODS AND PROCEDURES: The president of State Auto Mutual, State Auto P&C, Milbank, Midwest Security, Farmers Casualty and State Auto IC, or any officer of any of these companies designated by said president, shall determine the methods and procedures, including accounting transactions, by which the terms of this Agreement shall be performed by and on behalf of the parties hereto. 14. AMENDMENTS: This Agreement may be modified from time to time, so as to adapt its provisions to the varying conditions of the business of the Pooled Companies, by a mutual agreement in writing of the parties hereto, subject to ratification by the Board of Directors of each party and with the approval of the insurance regulatory officials from the State of Ohio, the State of South Carolina, the State of South Dakota, the State of Wisconsin, and the State of Iowa as required by law. 15. TERM: This Agreement shall remain in full force and effect until canceled by agreement of the parties or by the giving of ninety (90) days notice by one of the parties to the other parties and to the respective domiciliary insurance department of each of the parties. 16. INTERPRETATION: Wherever required to give the correct meaning throughout this Agreement, the singular shall be interpreted in the plural. Clerical errors or errors of involuntary or inadvertent omission or commission shall not be interpreted as a discharge of liability on behalf of any of the parties to this contract. Such errors shall be rectified at the time of discovery or as soon as practicable thereafter. Caption headings are for convenience only and are not intended to affect the construction of the terms hereof. 17. INSOLVENCY: The reinsurance made under this Agreement (which the parties understand and agree excludes the State Auto Mutual Reinsurance Book for such business assumed on and after January 1, 2000) shall be payable by the assuming reinsurer on the basis of the liability of the ceding insurer under the contract or contracts reinsured without diminution because of the insolvency of the ceding insurer. In the event of insolvency 18 Page 17 of the ceding insurer, the liquidator or receiver or statutory successor of such insurer shall give written notice to the assuming reinsurer of the pendency of a claim against the insolvent ceding insurer on the policy or bond reinsured within a reasonable time after such claim is filed in the insolvency proceeding; that during the pendency of such claim the assuming reinsurer may investigate such claim and interpose, at its own expense, in the proceeding where such claim is to be adjudicated any defense or defenses which it may deem available to the ceding insurer or its liquidator or receiver or statutory successors; that the expense thus incurred by the assuming reinsurer shall be chargeable, subject to court approval, against the insolvent ceding insurer as part of the expense of liquidation to the extent of a proportionate share of the benefit which may accrue to the ceding insurer solely as a result of the defense undertaken by the assuming reinsurer. The reinsurance made effective under this Agreement shall be payable by the assuming reinsurer to the ceding insurer or to the liquidator, receiver or statutory successor of the ceding insurer. 18. ARBITRATION: In the event of any dispute hereafter arising with respect to this Agreement, State Auto Mutual, State Auto P&C, Milbank, Midwest Security, Farmers Casualty and State Auto IC hereby agree that such dispute shall, upon the request of the one of the parties, be submitted to arbitration. One arbitrator shall be chosen by each party and those arbitrators shall then select an umpire who shall hear and decide the issues to be arbitrated. If one party fails to name an arbitrator within thirty (30) days after receipt of a written request to do so, the party initiating the arbitration may choose the arbitrators. The decision of the umpire shall be final and binding on the parties. Each party shall bear the expense of its arbitrator and the cost of the umpire shall be shared equally. The arbitration shall take place at Columbus, Ohio or such other location upon which the parties may mutually agree. 19. COUNTERPARTS: The 2000 Pooling Agreement may be executed in two or more counterparts, each of which shall be deemed an original and all of which shall constitute one and the same instrument. 19 Page 18 IN WITNESS WHEREOF, the parties have caused this Agreement to be duly executed as of the date and the year first above written. Attest State Automobile Mutual Insurance Company /s/ John R. Lowther By /s/ Robert H. Moone - -------------------------- --------------------------------- Secretary President State Auto Property and Casualty Insurance Company /s/ John R. Lowther By /s/ Robert H. Moone - -------------------------- --------------------------------- Secretary President Milbank Insurance Company /s/ John R. Lowther By /s/ Robert H. Moone - -------------------------- --------------------------------- Secretary President Midwest Security Insurance Company /s/ John R. Lowther By /s/ Robert H. Moone - -------------------------- --------------------------------- Secretary President Farmers Casualty Insurance Company /s/ John R. Lowther By /s/ Marion D. Houk - -------------------------- --------------------------------- Assistant Secretary President State Auto Insurance Company /s/ John R. Lowther By /s/ Robert H. Moone - -------------------------- --------------------------------- Secretary President EX-10.X 6 EXHIBIT 10(X) 1 Exhibit 10(X) Management and Operations Agreement As of January 1, 2000 Among State 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. 518 Property Management and Leasing, LLC 2 MANAGEMENT AND OPERATIONS AGREEMENT This Management Agreement (the "Agreement") is made as of January 1, 2000 among State Automobile Mutual Insurance Company, an Ohio corporation ("Mutual"), State Auto Financial Corporation, an Ohio corporation ("State Auto Financial"), State Auto Property and Casualty Insurance Company, a South Carolina corporation ("State Auto P&C"), State Auto National Insurance Company, an Ohio corporation ("National"), Milbank Insurance Company, a South Dakota corporation ("Milbank"), State Auto Insurance Company, an Ohio corporation ("State Auto IC"), Stateco Financial Services, Inc., an Ohio corporation ("Stateco"), Strategic Insurance Software, Inc., an Ohio corporation ("S.I.S."), and 518 Property Management and Leasing, LLC, an Ohio limited liability company ("518 PML"). BACKGROUND INFORMATION A. Mutual is a property and casualty insurance company. Its wholly owned subsidiary is Midwest Security Insurance Company ("Midwest Security"), a Wisconsin domiciled property and casualty insurance company which is a party to a separate Amended and Restated Management Agreement dated January 1, 2000 with State Auto P&C and Mutual (the "2000 Midwest Management Agreement"). Mutual also owns approximately 70% of the outstanding common shares, without par value, of State Auto Financial. B. State Auto P&C, Milbank, Stateco, National, and Farmers Casualty Insurance Company ("Farmers Casualty") are wholly owned subsidiaries of State Auto Financial. State Auto Financial also indirectly owns 100% of Mid-Plains Insurance Company ("Mid-Plains"), which is a wholly owned subsidiary of Farmers Casualty. Both Farmers Casualty and Mid-Plains are party to a separate Amended and Restated Management Agreement dated January 1, 2000 with State Auto P&C and Mutual (the "2000 Farmers Casualty Management Agreement"). State Auto Financial also owns all the issued and outstanding shares of State Auto IC, an Ohio corporation. State Auto Financial also indirectly owns 518 PML whose sole members are Stateco and State Auto P&C. State Auto Financial also controls S.I.S. through its ownership of S.I.S.' common shares. State Auto P&C, National, State Auto IC, Milbank, Farmers Casualty, and Mid-Plains are property and casualty insurance companies. Stateco provides investment management services to Mutual, State Auto P&C, National, Milbank, Midwest Security, Farmers Casualty and Mid-Plains and State Auto IC. 518 PML is engaged in the business of managing and leasing real and personal property whose present customers are affiliated companies. S.I.S. is engaged in the business of writing and servicing agency management software products, among other software products. It derives revenue from sales to insurer affiliates, as well as third-party insurers and agents. For purposes of this Agreement, State Auto Financial, State Auto P&C, Milbank, National, State Auto IC, Stateco, S.I.S. and 518 PML are hereinafter collectively referred to as the "State Auto Financial Group." The State Auto Financial Group and Mutual are hereinafter collectively referred to as the "State Auto Companies" and individually as a "State Auto Company." C. The insurance products offered by Mutual, State Auto P&C, National, Milbank, Midwest Security, Farmers Casualty, Mid-Plains and commencing on and after January 1, 2000, State Auto IC, are marketed together through independent agents and it is the intention of the parties to this Agreement to continue such arrangement. Mutual, State Auto P&C, Milbank, Midwest Security, Farmers Casualty and State Auto IC participate in a pooling arrangement pursuant to which each of State Auto P&C, Milbank, Midwest Security, Farmers Casualty, and State Auto IC cedes all of its insurance business to Mutual and in turn assumes a percentage of the combined 3 2 business of all those companies. Under the current pooling arrangement, effected through the Reinsurance Pooling Agreement Amended and Restated as of January 1, 2000 (the "2000 Pooling Agreement") the pool participants and their respective percentages are: Mutual - 46%, State Auto P&C - 39%, Milbank - 10%, Midwest Security - 1%, Farmers Casualty - 3%, and State Auto IC- 1%. D. Since April 1, 1994, there has been in place an Amended and Restated Management Agreement dated April 1, 1994 (the "94 Management Agreement") to which State Auto P&C, State Auto Financial, Mutual, Milbank and National are parties. State Auto P&C has provided executive management services to Mutual, Milbank and National under the '94 Management Agreement. It has provided the same services to Midwest Security since January 1, 1997 through a Management Agreement with Midwest Security and to Farmers Casualty and Mid-Plains since January 1, 1999 through a Management Agreement with Farmers Casualty and Mid-Plains. These services have been provided by individuals who are employees of State Auto P&C. Under these same Agreements, Mutual acted as common paymaster and provided all other employees and certain facilities these companies required to operate their businesses. E. Each of S.I.S., Stateco, and 518 PML (along with State Auto Financial, collectively the "Service Companies" and individually a "Service Company") was not a party to the `94 Management Agreement and each paid for the expenses attributable to its operations through payment of direct expenses and reasonable allocations for expenses that were other than direct expenses. F. As of January 1, 2000, all the individuals providing services to any of the State Auto Companies who heretofore were not employees of State Auto P&C have become employees of State Auto P&C. G. State Auto P&C and Mutual have entered into the 2000 Midwest Management Agreement and the 2000 Farmers Casualty Management Agreement as of January 1, 2000 which effect for Midwest Security, Farmers Casualty and Mid-Plains the operational changes described below. H. Mutual, State Auto Financial, National, Milbank, State Auto IC, and the Service Companies will require substantially all of the services of the employees of State Auto P&C including without limitation, executive, managerial, supervisory, administrative, technical, professional, and clerical services necessary or appropriate in the operation of their respective businesses (collectively referred to hereafter as "Management and Operations Services") and each of Mutual, State Auto Financial, National, Milbank, State Auto IC and the Service Companies will rely on Mutual to provide certain facilities needed to conduct their respective businesses. I. With this Agreement, the parties hereto desire to terminate the '94 Management Agreement, replace it with this Agreement, and formalize the operating relationship with those State Auto Companies that were not previously a party to any of the foregoing management agreements. STATEMENT OF AGREEMENT The parties hereby acknowledge the accuracy of the above Background Information and in consideration of the mutual covenants set forth herein and INTENDING TO BE LEGALLY BOUND HEREBY, hereby agree as follows: 4 3 1. TERMINATION: Upon this Agreement becoming effective, the '94 Management Agreement, is terminated and the relationship among the parties hereto shall be governed by this Agreement. 2. ENGAGEMENT AND TERM: On the terms and subject to the conditions described in this Agreement, Mutual, State Auto Financial, Milbank, National, State Auto IC, S.I.S., Stateco, and 518 PML (collectively, the "Managed Companies", individually, a "Managed Company") hereby engage State Auto P&C, and State Auto P&C hereby accepts such engagement, to provide Management and Operations Services to the Managed Companies as any of such Managed Companies require to operate its business. Any of State Auto P&C's employees may also serve as directors or officers of any of the State Auto Companies, notwithstanding that such persons may also be officers or directors of State Auto P&C. State Auto P&C shall also be entitled to continue using its employees to conduct all of its business operations, notwithstanding that such persons will be performing services for other State Auto Companies as well. To the extent reasonably possible, the parties shall jointly utilize State Auto P&C's employees in a cooperative manner and consistent with the business interests and needs of the State Auto Companies. State Auto P&C shall direct its employees performing such services for each of the Managed Companies to use their best efforts to promote the general interests and economic welfare of each of the Managed Companies to the same extent as such employees provide to State Auto P&C. The term of State Auto P&C's engagement under this Agreement shall begin on the date of this Agreement and shall end, unless sooner terminated in accordance with the provisions of Section 10 below, on the tenth anniversary of this Agreement. This Agreement shall be automatically renewed for successive ten-year periods upon the same terms and conditions contained in this Agreement, unless and until terminated as described in Section 10 below. 3. AUTHORITY AND DUTIES OF STATE AUTO P&C: In providing Management and Operations Services, State Auto P&C, acting through its employees, shall be responsible for performing all organizational, operational, and management functions of each of the Managed Companies. State Auto P&C shall use its reasonable efforts to operate each Managed Company's business efficiently and in accordance with the reasonable guidelines and policies which may be established from time to time by the board of directors of each of the Managed Companies. State Auto P&C shall have all authority necessary to carry out its duties under this Agreement and shall act as an agent of each of the Managed Companies. Without limiting the generality of the foregoing, State Auto P&C's duties under this Agreement shall include the following: (a) MANAGEMENT AND ADMINISTRATION OF INSURANCE OPERATIONS - State Auto P&C shall operate, administer, and manage the day-to-day insurance business operations of each of the Managed Companies engaged in the insurance business, in accordance with the underwriting, claims and any other reasonable guidelines of such companies which may be in effect or established from time to time by the board of directors of such companies. The management and administration of each such insurers' business operations by State Auto P&C shall include, without limitation, appointment and termination of agencies, underwriting of insurance risks, investigation and settlement of claims and arrangement of reinsurance. State Auto P&C shall use the same degree of care in acting on behalf of such insurers as the degree of care it uses in connection the conduct of its insurance business operations. 5 4 (b) MANAGEMENT AND ADMINISTRATION OF NON-INSURANCE OPERATIONS OF THE SERVICE COMPANIES - State Auto P&C through its employees, will perform Management and Operations Services for each of the other Managed Companies which are Service Companies in accordance with the policies and guidelines which each of such companies' board of directors may establish from time to time. State Auto P&C will use the same degree of care in acting on behalf of these companies as it uses in connection with the conduct of its own business operations. (c) EMPLOYEES - State Auto P&C shall provide each Managed Company with all executive, managerial, supervisory, administrative, technical, clerical, professional, and other personnel as may be necessary or desirable for the operation and administration of each Managed Company's business. State Auto P&C shall direct its employees, in performing such services for each Managed Company, to use their best efforts to promote the general interests and economic welfare of each Managed Company, in the same manner as such employees utilize when providing service to State Auto P&C. (d) EMPLOYEES AND PAYROLL - The employees provided by State Auto P&C to each Managed Company under this Agreement shall be employed as employees of State Auto P&C and not of any of the Managed Companies. Notwithstanding the foregoing, Mutual shall continue to act as the common agent or common paymaster of all such employees providing services to any State Auto Company. As common paymaster, Mutual shall be responsible for filing information and tax returns and issuing tax and other payroll forms and reports with respect to wages paid to the employees employed by State Auto P&C and provided to each Managed Company. 4. PROVISION OF FACILITIES AND EXPENSE PAYMENTS - During the term of this Agreement, Mutual shall provide State Auto P&C and each of the other Managed Companies with such data processing equipment, office supplies and equipment, furniture and fixtures, automobiles and such other items of tangible personal property as each of such Managed Companies may require or desire for the operation of its business. Utilizing the employees of State Auto P&C, Mutual shall act as agent for each of the Managed Companies and to the extent necessary for the purposes of its business, in collecting and disbursing funds due to any Managed Company, and in paying expenses and other operating costs of the facilities used by such parties except for those expenses paid directly by any such Managed Company from its own accounts. 5. BOARD OF DIRECTORS' CONTROL - Except as otherwise provided in this Agreement, the officers of State Auto P&C and of each of the Managed Companies shall be subject to the authority of their respective boards of directors. Each Managed Company and State Auto P&C may appoint or elect as its officers those persons who hold offices in any other State Auto Company, subject at all times to the power of each company's respective board of directors to appoint, elect, or remove its officers in accordance with its respective articles or certificate of incorporation, code of regulations or by-laws, and other governing documents, statutes, or rules of law applicable to each respective company. 6. ALLOCATION OF COSTS AND EXPENSES - Except to the extent otherwise allocated under any other provisions of this Agreement, all out-of-pocket expenses incurred for goods or services from third-party vendors or other unrelated parties which are identifiable to a particular State Auto Company, including without limitation, director's fees, legal fees, audit fees, stock transfer expenses, travel expenses, stationery, supplies and items of a similar nature, shall be charged to the State Auto Company for whose benefit such costs or expenses were incurred. All costs 6 5 and expenses incurred by State Auto P&C for the employees, equipment, facilities and other items shared by the parties pursuant to this Agreement shall be allocated among the parties to this Agreement as follows: (a) INSURANCE LOSSES, LOSS ADJUSTMENT EXPENSES AND UNDERWRITING EXPENSES OF MUTUAL, STATE AUTO P&C, MILBANK, AND STATE AUTO IC - All insurance losses, loss adjustment expenses and underwriting expenses of Mutual, State Auto P&C, Milbank, State Auto IC (hereafter the "Pooled Companies"), as computed under the statutory accounting principles used by State Auto P&C from time to time, including, but not limited to, all related claim adjustment services, commissions and brokerage expenses, salaries and employee relations and welfare expenses and all other loss adjustment and other underwriting expenses to be reflected in the annual statement to be filed with state insurance authorities, shall be shared by each of the Pooled Companies in accordance with the provisions of the pooling arrangement as in effect through the 2000 Pooling Agreement. It is understood and acknowledged that the percentages by which such losses and expenses are shared under the 2000 Pooling Agreement and other provisions of the 2000 Pooling Agreement may be changed from time to time under procedures outlined in the 2000 Pooling Agreement. (b) EXPENSES OF STATE AUTO FINANCIAL, STATECO, S.I.S., AND 518 PML, - The salary expenses attributable to State Auto P&C employees performing services for the Service Companies shall be reimbursed to State Auto P&C by each of these companies based on an allocation of the time these individuals spend on behalf of each of the Service Companies. In addition, each of the Service Companies shall reimburse State Auto P&C for the expense of services provided to it by State Auto P&C including, without limitation, payroll taxes, benefits, overhead, and rent based on a percentage of the aforesaid salary expenses to be determined annually by State Auto P&C in an amount that reasonably reflects the actual costs of the aforesaid items. (c) INSURANCE LOSSES, LOSS ADJUSTMENT EXPENSES AND UNDERWRITING EXPENSES OF NATIONAL - All insurance losses, loss adjustment expenses and underwriting expenses of National, as computed under the statutory accounting principles used by National from time to time shall be paid by National. Underwriting expenses include, without limitation, expenses for State Auto P&C employees providing services on behalf of National for only part of their time, which expenses shall be allocated to National in proportion to the amount of time those employees spend on National's behalf in accordance with statutory accounting principles used by National from time to time. (d) PENSION AND BENEFIT EXPENSES - Each of the members of State Auto Financial Group and Mutual, is designated as a participating company under the State Auto Insurance Companies Employees' Retirement Plan, and any other applicable benefit plans provided by any State Auto Company for the employees of State Auto P&C (the "Plans"). Each of the Pooled Companies share of pension and benefit expenses under the Plans for employees of State Auto P&C providing services to each of such insurers shall be allocated and paid pursuant to the 2000 Pooling Agreement and their percentage shares of all obligations of the Plans' sponsors under the Plans shall equal their percentage shares under the 2000 Pooling Agreement, as changed from time to time. State Auto Financial's, National's, S.I.S.'s, 518 PML's and Stateco's share of pension and benefit expenses under the Plans for employees of State Auto P&C shall be allocated to the respective company based on the percentage of payroll expenses attributable to each such company. 7 6 (f) REAL ESTATE EXPENSES - State Auto P&C, State Auto Financial, National, Stateco, and 518 PML, currently are provided office space by Mutual in the office located at 518 East Broad Street, Columbus, OH. The amount of rent Mutual charges State Auto Financial, National, Stateco, and 518 PML shall be based upon the percentage that the total salaries (including a benefits factor) paid to individuals performing services for any of such entities bears to the aggregate of all salaries for State Auto P&C times the total rent expenses for the State Auto Companies for the location at 518 East Broad Street, Columbus, OH in accordance with statutory accounting principles. The rent expense incurred by each of the Pooled Companies for other office locations owned by Mutual (Cincinnati, OH and Cleveland, OH) is an underwriting expense subject to the 2000 Pooling Agreement. Notwithstanding the foregoing allocations to the contrary, if a State Auto Company which is not currently participating the 2000 Pooling Agreement, hereafter begins participating in such 2000 Pooling Agreement as amended from time to time, then expenses subject to the 2000 Pooling Agreement shall be allocated among that company and the other pooling arrangement participants in the same manner as expenses are allocated between the Pooled Companies as set forth above. 7. SERVICES FEE - The Services Fee shall be determined as follows: (a) For the services provided by State Auto P&C hereunder, each Managed Company that is an insurance company shall pay to State Auto P&C an annual service fee equal to four percent (4%) times the most recent three-year average of statutory surplus (or the average of such lesser period that such Managed Company has filed an annual statutory statement as a subsidiary of Mutual or State Auto Financial) (statutorily admitted assets less liabilities), less the carrying value of its subsidiaries as reflected on its annual statutory financial statement for consolidated subsidiaries which are also Managed Companies. Such fee shall be payable in not less often than quarterly installments during the term of this Agreement. (b) For the services provided by State Auto P&C, each Managed Company that is a Service Company shall pay to State Auto P&C an annual service fee equal to four per cent (4 %) of the three year average (or such shorter period of such company's existence) of shareholders equity of such company or its equivalent less the carrying value of any subsidiary reflected on the books of such Service Company, which subsidiary is also a Managed Company. (c) Upon request of either Mutual or State Auto Financial, on behalf of the State Auto Financial Group, not more often than annually, the amount of the management fee shall be reviewed to determine whether an adjustment in the management fee is necessary. Any change to the management fee, other than changes automatically occurring pursuant to the terms of this Agreement, must be presented to the Coordinating Committee (defined in 9(b) below), which must review and evaluate the proposed change and make a recommendation to the boards of directors of Mutual and State Auto Financial. Any such change presented to the Coordinating Committee must be approved by the boards of directors of Mutual, which shall make a determination for Mutual, and State Auto Financial, which shall make a determination for all members of the State Auto Financial Group. (d) If any Managed Company that is an insurance company (a "Managed Insurer") does not meet the performance standard (as described below) for any calendar quarter, then the quarterly service fee payment shall be withheld, unless such performance standard had been met for the trailing four quarters as a whole, in which case the quarterly service fee shall 8 7 not be withheld. If any portion of the service fee is withheld pursuant to this section, it shall be released to State Auto P&C if, based on such Managed Company's performance for the entire calendar year, the Managed Company's performance meets the performance standard. The performance standard may be changed from time to time, provided that any such change shall be approved by the board of directors of such Managed Company and State Auto P&C after review and approval by the Coordinating Committee. At the commencement of this Agreement the performance standard shall be as follows: Payment would be withheld if, for the calendar quarter immediately preceding the then current calendar quarter, a Managed Insurer's statutory combined ratio is equal to or greater than the statutory combined ratio for the property casualty insurance industry for the same period, as published by A. M. Best and Co., excluding the effect of losses arising out of catastrophes numbered by the Insurance Services Office and other extraordinary loss events arising out of circumstances that bear no relation to the performance by employees provided by State Auto P&C and for the calendar quarter for which the management fee is due such Managed Insurer's surplus as regards policyholders shall have decreased by more than 10% from the amount of surplus as regards policyholders as of the end of the previous calendar year. 8. PAYMENTS FOR SERVICES - All amounts due under this Agreement shall be due and payable by the respective company within fifteen days after request for payment from the party to be paid. 9. CONFLICTS OF INTEREST - The parties hereby acknowledge that, due to the common management of Mutual and the State Auto Financial Group, conflicts of interest may arise with respect to business opportunities available to such companies. In order to deal with such conflicts of interest on an equitable basis, the following guidelines shall be used to determine which company may avail itself of a business opportunity: (a) A business opportunity shall not be required to be presented to the Coordinating Committee, as described in 9(b) below, if: (i) such business opportunity involves the purchase or sale on the open market of marketable securities at the market price for that issue or comparable issues; (ii) such business opportunity involves the new issue of stocks or bonds in a public offering registered or exempt from registration under the Securities Act of 1933, as amended; (iii) such business opportunity does not fit within the investment criteria and guidelines, including without limitation debt to equity mix, of either Mutual or State Auto P&C, or any other party to this Agreement, established by their respective investment committees; (iv) such business opportunity involves the underwriting of policies of insurance; (v) State Auto Financial proposes to purchase securities issued by it; or (vi) in the good faith judgment of the common officers of Mutual and State Auto Financial on behalf of the State Auto Financial Group, such business opportunity does not meet the investment policies or objectives, the underwriting or claims guidelines, or is inconsistent with the cash flow or tax situation of Mutual or any member of the State Auto Financial Group. (b) All other business opportunities shall be presented to a Coordinating Committee consisting of two eligible directors of Mutual and two eligible directors of State Auto Financial (the "Coordinating Committee"), with the State Auto Financial committee members also representing the interests of all subsidiaries of State Auto Financial and the Mutual members also representing the interests of wholly owned subsidiaries of Mutual. In order to be eligible to serve on the Coordinating Committee, Mutual directors shall not, during the time of service on 9 8 such committee, also be directors or officers of the companies in the State Auto Financial Group, and State Auto Financial directors shall not, during the time of service on such committee, also be directors or officers of Mutual or any wholly owned subsidiary of Mutual. The Coordinating Committee shall review and evaluate such business opportunities using such factors as it considers relevant. Based upon such review and evaluation, such committee shall make a recommendation to each respective board of directors as to whether or not such business opportunities should be pursued and if so, by which company. If the Coordinating Committee is unable to agree upon a recommendation by at least a majority vote of all of its members, the two directors serving on such committee from either of Mutual or State Auto Financial shall report that result to the board of such company on which they serve, along with their recommendation, if any. The boards of directors of Mutual and of State Auto Financial must then act on the recommendation of the committee or the committee members after considering all other factors deemed relevant to them. (c) A State Auto Company shall not sell any property or security to, or purchase any property or security from, any other State Auto Company, if, in the good faith judgment of the common officers of Mutual and State Auto Financial such sale or purchase is a material transaction to any State Auto Company which is a party to the sale or purchase, unless such sale or purchase is presented to the Coordinating Committee for review and evaluation and approved by the boards of directors of Mutual and State Auto Financial in the manner provided in the preceding paragraph (b). Notwithstanding the foregoing, State Auto P&C and Mutual may sell marketable securities to one another at the market price of such securities or an approximation thereof. 10. TERMINATION - This Agreement may be terminated prior to the end of the initial term, or any renewal thereof, as follows: (a) By any of the Managed Companies, at its option, at any time after a "Change in Control" or "Potential Change in Control" (as defined below) of State Auto Financial. (b) At the end of the term then in effect by any of the parties upon advance written notice to the other parties at least two years prior to the end of the term then in effect (provided that such termination shall only relate to the Company giving notice and shall not terminate the Agreement with respect to any of the other parties unless they also give notice of termination of at least two years prior to the end of the term then in effect). (c) Automatically, with respect to a party, if that party files a voluntary petition in bankruptcy, applies for or consents to the appointment of a receiver, makes a general assignment for the benefit of creditors, admits in writing its inability to pay debts as they mature, files a petition or answer seeking a reorganization or arrangement with creditors under any insolvency law, files an answer admitting the material allegations of a petition filed in any bankruptcy or reorganization proceeding, or if a decree of any court is entered adjudging the party to be bankrupt or approving a reorganization or arrangement under any insolvency law (which decree is not set aside within ninety days after it is entered), (provided that such termination shall only relate to the Company subject to the foregoing event or action and shall not terminate the Agreement with respect to any of the other parties unless they also give notice of termination either within thirty days of the event that causes the automatic termination for another party). For purposes of this section, a "Change in Control" means the happening of any of the following: 10 9 (i) When any "person" as defined in Section 3 (a)(9) of the Securities Exchange Act of 1934 (the "Exchange Act") and as used in Sections 13(d) and 14(d) thereof, including a "group" as defined in Section 13(d) of the Exchange Act, but excluding State Auto Financial and any subsidiary and any employee benefit plan sponsored or maintained by State Auto Financial or any subsidiary (including any trustee or such plan acting as trustee) and excluding Mutual, directly or indirectly, becomes the "beneficial owner" (as defined in Rule 13(d)(3) under the Exchange Act, as amended from time to time), of securities of State Auto Financial representing 20% or more of the combined voting power of the then outstanding securities; (ii) When, during any period of twenty-four consecutive months during the effectiveness of this Agreement, the individuals who, at the beginning of such period, constitute the board of directors of State Auto Financial (the "Incumbent Directors") cease for any reason other than death to constitute at least a majority thereof; provided, however, that a director who was not a director at the beginning of such twenty-four month period shall be deemed to have satisfied such twenty-four month requirement (and be an Incumbent Director) if such director was elected by, or on the recommendation of or with the approval of, at least two-thirds of the directors who then qualified as Incumbent Directors either actually (because they were directors at the beginning of such twenty-four month period) or by prior operation of this paragraph; or (iii) The occurrence of a transaction requiring shareholder approval for the acquisition of State Auto Financial by an entity other than Mutual or a subsidiary of State Auto Financial through purchase of assets, by merger or otherwise. For purposes of this section, a "Potential Change in Control" means the happening of any one of the following: (i) The approval by shareholders of an Agreement by State Auto Financial, the consummation of which would result in a Change in Control of State Auto Financial as defined above; or (ii) The acquisition of beneficial ownership, directly or indirectly, by any entity, person or group other than State Auto Financial or a subsidiary or any employee benefit plan sponsored or maintained by State Auto Financial or any subsidiary (including any trustee of such plan acting as such trustee) of securities of State Auto Financial representing 5% or more of the combined voting power of State Auto Financial's outstanding securities and the adoption by the board of directors of State Auto Financial of a resolution to the effect that a Potential Change in Control of State Auto Financial has occurred for purposes of this Agreement. 11. ARBITRATION - Any and all disagreements or controversies arising with respect to this Agreement, whether during or after the term of State Auto P&C's engagement under this Agreement, shall be settled by binding arbitration by a panel of three arbitrators, one selected by Mutual on behalf of any member of the Mutual Group, one selected by State Auto Financial on behalf of any member of the State Auto Financial Group, and the third to be selected by the mutual agreement of the first two arbitrators. The arbitration shall be held, and the award made, in Franklin County, Ohio, pursuant to the Ohio Arbitration Law (Ohio Revised Code Chapter 2711 or any law of similar tenor or effect that hereafter is enacted). All fees of the arbitrators shall be borne equally by the parties to the arbitration. 11 10 12. COMPLETE AGREEMENT - This document contains the entire agreement between the parties and supersedes all prior or contemporaneous discussions, negotiations, representations, or agreements relating to the subject matter, including without limitation, the 94 Management Agreement and all previous amendments thereto. No changes to this Agreement shall be made or be binding on any party unless made in writing and signed by each party to this Agreement. 13. NO THIRD PARTY BENEFIT - This Agreement is intended for the exclusive benefit of the parties to this Agreement and their respective successors and assigns, and nothing contained in this Agreement shall be construed as creating any rights or benefits in or to any third party. 14. CAPTIONS - The captions of the various sections of this Agreement are not part of the content or context of this Agreement, but are only labels to assist in locating those sections, and shall be ignored in construing this Agreement. 15. FORCE MAJEURE - Notwithstanding any provision of this Agreement to the contrary, any party's obligations under this Agreement shall be excused if and to the extent that any delay or failure to perform such obligations is due to fire or other casualty, material shortages, strikes or labor disputes, acts of God, or other causes beyond the reasonable control of such party. 16. AMENDMENTS - This Agreement may be amended by the parties, upon authority of their officers without specific director approval, if such amendment is solely for the purpose of clarification and does not change the substance of this Agreement and the parties have obtained an opinion of legal counsel to that effect. Additionally, any present or future subsidiary or affiliate of Mutual or State Auto Financial may be added as a party to this Agreement by an amendment entered into by Mutual, State Auto Financial and the new party, after approval of the Coordinating Committee and the directors of each such Company. Except as otherwise specifically provided in this Agreement, all other amendments to this Agreement must be presented to the Coordinating Committee and be approved by the directors of each company pursuant to the procedures set forth in Section 9. 17. SUCCESSORS - No party may assign any of its rights or obligations under this Agreement without the written consent of all other parties to this Agreement, which consent may be arbitrarily withheld by any such party. Except as otherwise provided in this Agreement, this Agreement shall be binding upon, inure to the benefit of, and be enforceable by and against the respective successors and assigns of each party to this Agreement. In Witness whereof, each of the parties hereto has subscribed its name below. Date: December 30, 1999 STATE AUTOMOBILE MUTUAL INSURANCE COMPANY By: /s/ Robert H. Moone -------------------------------------- Robert H. Moone, President 12 11 STATE AUTO FINANCIAL CORPORATION By: /s/ Robert H. Moone ---------------------------------------- Robert H. Moone, President STATE AUTO PROPERTY AND CASUALTY INSURANCE COMPANY By: /s/ Robert H. Moone ---------------------------------------- Robert H. Moone, President STATE AUTO NATIONAL INSURANCE COMPANY By: /s/ Robert H. Moone ---------------------------------------- Robert H. Moone, President STATE AUTO INSURANCE COMPANY By: /s/ Robert H. Moone ---------------------------------------- Robert H. Moone, President STATECO FINANCIAL SERVICES, INC. By: /s/ Robert H. Moone ---------------------------------------- Robert H. Moone, President MILBANK INSURANCE COMPANY By: /s/ Robert H. Moone ---------------------------------------- Robert H. Moone, President STRATEGIC INSURANCE SOFTWARE, INC. By: /s/ Robert H. Moone ---------------------------------------- Robert H. Moone, Vice Chairman 518 PROPERTY AND MANAGEMENT LEASING, LLC By: /s/ Robert H. Moone ---------------------------------------- Robert H. Moone, President EX-10.Y 7 EXHIBIT 10(Y) 1 Exhibit 10(Y) Property Catastrophe Overlying Excess of Loss Reinsurance Contract Issued to 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 By State Auto Property and Casualty Insurance Company 2 PROPERTY CATASTROPHE OVERLYING EXCESS OF LOSS REINSURANCE CONTRACT ISSUED TO 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 BY STATE AUTO PROPERTY AND CASUALTY INSURANCE COMPANY 3 STATE AUTOMOBILE MUTUAL INSURANCE COMPANY MILBANK INSURANCE COMPANY STATE AUTO NATIONAL INSURANCE COMPANY MIDWEST SECURITY INSURANCE COMPANY FARMERS CASUALTY INSURANCE COMPANY MID-PLAINS INSURANCE COMPANY PROPERTY CATASTROPHE OVERLYING EXCESS OF LOSS REINSURANCE CONTRACT TABLE OF CONTENTS ----------------- ARTICLE NO. TITLE PAGE - ----------- ----- ---- ARTICLE I BUSINESS COVERED 1 ARTICLE II EXCLUSIONS 1 - 2 ARTICLE III TERM 3 ARTICLE IV TERRITORY 3 ARTICLE V AMOUNT OF LIMIT AND RETENTION 3 ARTICLE VI ULTIMATE NET LOSS 3 - 4 ARTICLE VII NET RETAINED LINES 4 ARTICLE VIII UNDERLYING EXCESS 4 ARTICLE IX DEFINITION OF LOSS OCCURRENCE 4 - 5 ARTICLE X NOTICE OF LOSS AND LOSS SETTLEMENT 6 ARTICLE XI PREMIUM 6 ARTICLE XII CURRENCY 6 ARTICLE XIII OFFSET 6 - 7 ARTICLE XIV ACCESS TO RECORDS 7 ARTICLE XV ERRORS AND OMISSIONS 7 ARTICLE XVI TAXES 7 ARTICLE XVII INSOLVENCY 7 - 8 ARTICLE XVIII ARBITRATION 8 - 9 4 PROPERTY CATASTROPHE OVERLYING EXCESS OF LOSS --------------------------------------------- REINSURANCE CONTRACT -------------------- BETWEEN STATE AUTOMOBILE MUTUAL INSURANCE COMPANY MILBANK INSURANCE COMPANY STATE AUTO NATIONAL INSURANCE COMPANY MIDWEST SECURITY INSURANCE COMPANY FARMERS CASUALTY INSURANCE COMPANY MID-PLAINS INSURANCE COMPANY (HEREINAFTER COLLECTIVELY REFERRED TO AS THE "COMPANY") AND STATE AUTO PROPERTY AND CASUALTY INSURANCE COMPANY (HEREINAFTER REFERRED TO AS THE SUBSCRIBING "REINSURER") ARTICLE I --------- BUSINESS COVERED: - ----------------- The Reinsurer shall indemnify the Company for the net excess liability as hereinafter provided and specified, which may accrue to the Company as a result of any loss or losses which may occur during the currency of the Contract under any and all policies, contracts, binders and other evidence of insurance and reinsurance, oral or written (hereinafter referred to as "Policies") heretofore or hereafter issued or entered into by or on behalf of the Company and classified by the Company as Fire, Allied Lines, Homeowners (property coverages), Farmowners (property coverages), Commercial Multiple Peril policies (property coverages), Ocean Marine, Inland Marine and Automobile Physical Damage. ARTICLE II ---------- EXCLUSIONS: - ----------- The following shall be excluded from the scope of this Contract: 1. Business written and classified by the Company as: a) Aviation Insurance; b) Casualty Insurance (i.e. Accident, Health, Third Party Liability, Workers Compensation and Employers Liability, Fidelity, Plate Glass and Burglary and Theft when written as such); c) Credit Insurance; d) Financial Guarantee Insurance; e) Insolvency Insurance; 5 f) Life Insurance; g) Mortgage Impairment Insurance; h) Title Insurance; i) Surety; j) Flood Insurance when written as such; k) Earthquake Insurance when written as such; l) Difference in Conditions Insurance; m) Ocean Marine Insurance, except yachts; n) Boiler and Machinery; o) Multiple Peril policies other than the Property coverages as included in the Business Covered Section, hereof; p) Reinsurance, but not to exclude so-called agency reinsurance, reinsurance of an individual risk or policy, or any intercompany pooling arrangements. 2. Wind and Hail on growing and standing crops. 3. Manufacture, processing, storage, filling or breaking down of explosives. 4. Oil and petrochemical refineries and pipelines and oil or gas drilling rigs. 5. Excess of Loss insurance or reinsurance where the deductible exceeds $99,999. 6. Bridges and Tunnels where the Total Insured Value over all interests exceeds $250,000,000. 7. Extra Contractual Obligations and Losses in Excess of Policy Limits as per attached Exclusion Clause. 8. Loss/or Damage/or Costs/or Expenses arising from seepage and/or Pollution and/or Contamination, other than Contamination from Smoke Damage. Nevertheless, this exclusion does not preclude payment of the cost of removal of debris of property damaged by a loss otherwise covered hereunder, but subject always to a limit of 25% of the Company's property loss under the original policy. 9. Loss in respect of overhead transmission and distribution lines and their supporting structure other than those on or within 150 meters (or 500 feet) of the insured premises. It is understood and agreed that public utilities extension and/or suppliers extension and/or contingent business interruption coverages are not subject to this exclusion, provided that these are not part of a transmitters' or distributors' policy. 10. Insolvency Fund Exclusion Clause. 11. War Risk Exclusion Clause. 12. Pools and Associations Exclusion Clause. 13. Nuclear Incident Exclusion Clauses - Physical Damage - Reinsurance - U.S.A. and Canada. 6 ARTICLE III ----------- TERM: - ----- The term of this Contract shall be from 12:01 A.M. Standard Time, July 1, 1999 to 12:01 A.M. Standard Time, July 1, 2000. If the liability of the Reinsurer under this Contract terminates while a loss occurrence giving rise to a claim hereunder is in progress, then the Reinsurer shall be liable as if the whole loss occurrence had occurred during the term of this Contract, provided that no part of that loss occurrence is claimed against any renewal or replacement of this Contract. ARTICLE IV ---------- TERRITORY: - ---------- This Contract shall cover wherever the Company's Policies cover. ARTICLE V --------- AMOUNT OF LIMIT AND RETENTION: - ------------------------------ No claim shall be made hereunder unless and until the Company and other members of the State Auto Insurance Companies Group, being State Automobile Mutual Insurance Company, State Auto Property and Casualty Insurance Company, Milbank Insurance Company, Midwest Security Insurance Company, State Auto National Insurance Company, Farmers Casualty Insurance Company, and Mid-Plains Insurance Company, hereinafter referred to as the "Group", on a pooled basis where applicable, shall first have sustained an Ultimate Net Loss in excess of $120,000,000, regardless of the number of Policies under which such loss is payable or the number of interests insured. The Reinsurer shall then be liable for the amount of Ultimate Net Loss for the Company in excess of $120,000,000 Ultimate Net Loss each occurrence, but the sum recoverable from the Reinsurer in respect of each loss occurrence shall not exceed $100,000,000, nor more than $100,000,000 in respect of all loss occurrences during the term of this contract. The amount of coverage is subject to at least two risks being involved in the same loss occurrence. ARTICLE VI ---------- ULTIMATE NET LOSS: - ------------------ The term "ultimate net loss" shall mean the amount that the Company pays, such loss to include all expenses incurred by the Company in connection with the settlement of losses or resistance to or negotiations concerning a loss, including salaries and expenses of employees of the Company while diverted from their normal duties to the service of field adjustment but shall not include any office expenses of the Company. However, nothing in this Article shall be construed to prevent 7 the Company from including all such amounts defined as ultimate net loss attributable to the Group on a pooled basis for the first $120,000,000 of ultimate net loss. All salvages and recoveries and payments (net of the cost of obtaining any salvage, recovery or payment), whether recovered or received prior or subsequent to loss settlement under this Contract, including amounts recoverable under all Reinsurances whether collected or not, shall be applied as if recovered or received prior to the aforesaid settlement and shall be deducted from the actual loss incurred to arrive at the amount of ultimate net loss. Nothing in this Article shall be construed to mean losses are not recoverable until the ultimate net loss to the Company has been ascertained. ARTICLE VII ----------- NET RETAINED LINES: - ------------------- This Contract applies to only that portion of any policy which the Company and the other member of the Group, on a pooled basis where applicable, retains net for its own account. The amount of the Reinsurer's liability hereunder in respect of any loss shall not be increased by reason of the inability of the Company to collect from any other Reinsurer, whether specific or general, any amounts which may have become due whether such inability arises from the insolvency of such other Reinsurer or otherwise. ARTICLE VIII ------------ UNDERLYING EXCESS: - ------------------ The Company has in force underlying catastrophe excess of loss reinsurance and recoveries thereunder shall be disregarded for all purposes of this Contract and shall inure to the sole benefit of the Company. ARTICLE IX ---------- DEFINITION OF LOSS OCCURRENCE: - ------------------------------ The term "loss occurrence" shall mean the sum of all individual losses directly occasioned by any one disaster, accident or loss or series of disasters, accidents or losses arising out of one event which occurs within the area of one state of the United States or province of Canada and states or provinces contiguous thereto and to one another. However, the duration and extent of any one "loss occurrence" shall be limited to all individual losses sustained by the Company occurring during any period of one hundred sixty-eight (168) consecutive hours arising out of and directly occasioned by the same event except that the term "loss occurrence" shall be further defined as follows: A. As regards windstorm, hail, tornado, hurricane, cyclone, including ensuing collapse and water damage, all individual losses sustained by the Company 8 occurring during any period of seventy-two (72) consecutive hours arising out of and directly occasioned by the same event. However, the event need not be limited to one state or province or states or provinces contiguous thereto. B. As regards riot, riot attending a strike, civil commotion, vandalism and malicious mischief, all individual losses sustained by the Company occurring during any period of seventy-two (72) consecutive hours within the area of one municipality or county and the municipalities or counties contiguous thereto arising out of and directly occasioned by the same event. The maximum duration of seventy-two (72) consecutive hours may be extended in respect of individual losses which occur beyond such seventy-two (72) consecutive hours during the continued occupation of an insured's premises by strikers, provided such occupation commenced during the aforesaid period. C. As regards earthquake (the epicentre of which need not necessarily be within the territorial confines referred to in the opening paragraph of this Article) and fire following directly occasioned by the earthquake, only those individual fire losses which commence during the period of one hundred and sixty-eight (168) consecutive hours may be included in the Company's "loss occurrence". D. As regards "freeze", only individual losses directly occasioned by collapse, breakage of glass and water damage (caused by bursting of frozen pipes and tanks) may be included in the Company's "loss occurrence". For all "loss occurrences" except as referred to under sub-paragraph B, the Company may choose the date and time when any such period of consecutive hours commences, provided that it is not earlier than the date and time of the occurrence of the first recorded individual loss sustained by the Company arising out of that disaster, accident, or loss and provided that only one such period of one hundred and sixty-eight (168) consecutive hours shall apply with respect to one event, except for those "loss occurrences" referred to in sub-paragraph A above, where only one such period of seventy-two (72) consecutive hours shall apply with respect to one event, regardless of the duration of the event. As respect those "loss occurrences" referred to in sub-paragraph B above, if the disaster, accident or loss occasioned by the event is of greater duration than seventy-two (72) consecutive hours, then the Company may divide that disaster, accident or loss into two or more "loss occurrences" provided no two periods overlap and no individual loss is included in more than one such period and provided that no period commences earlier than the date and time of the occurrence of the first recorded individual loss sustained by the Company arising out of that disaster, accident or loss. No individual losses occasioned by an event that would be covered by seventy-two (72) hours clauses may be included in any "loss occurrence" claimed under the one hundred and sixty-eight (168) hours provision. 9 ARTICLE X --------- NOTICE OF LOSS AND LOSS SETTLEMENT: - ----------------------------------- The Company shall adjust, settle, or compromise all claims and losses hereunder. All loss settlements by the Company which comply with the terms hereof shall be unconditionally binding upon the Reinsurer. The Company shall advise the Reinsurer promptly of all claims and any subsequent developments pertaining thereto, which may, in the Company's opinion, develop into losses involving Reinsurance hereunder. Inadvertent omission or oversight in dispatching such advices shall in no way affect the liability of the Reinsurer under this Contract provided the Company informs the Reinsurer of such omission or oversight promptly upon its discovery. The Reinsurer shall tender all loss payments as soon as practicable after receipt of any proof of loss. ARTICLE XI ---------- PREMIUM: - -------- The premium to be paid to the Reinsurer shall be $3,000,000, payable in four equal quarterly installments. Each company shall pay a percentage of the premium based on its share of written premiums of the subject lines of businesss as estimated in Exhibit A. ARTICLE XII ----------- CURRENCY: - --------- All retentions, limits and premiums referenced in this Contract are expressed in United States Dollars and all payments made by either party shall be made in United States Dollars. Amounts paid or received by the Company in any other currency shall be converted to United States Dollars at the rate of exchange at the date such transaction is entered on the books of the Company. ARTICLE XIII ------------ OFFSET: - ------- The Company and the Reinsurer, each at its option, may offset any balance or balances, whether on account of premiums, claims and losses, loss expenses or salvages due from one party to the other under this Contract; provided, however, that in the event of the insolvency of a party hereto, offsets shall only be allowed in accordance with applicable statutes and regulations. 10 ARTICLE XIV ----------- ACCESS TO RECORDS: - ------------------ The Company shall place at the disposal of the Reinsurer at all reasonable times, and the Reinsurer shall have the right to inspect through its designated representatives, during the term of this Contract and thereafter, all books, records and papers of the Company in connection with any reinsurance hereunder, or the subject matter hereof. ARTICLE XV ---------- ERRORS AND OMISSIONS: - --------------------- Any inadvertent delay, omission or error shall not be held to relieve either party hereto from any liability which would attach to either party if such delay, omission or error had not been made, provided such delay, omission or error is rectified as soon as practicable after discovery. ARTICLE XVI ----------- TAXES: - ------ In consideration of the terms under which this Contract is issued, the Company undertakes not to claim any deduction of the premium hereon when making Canadian tax returns, or when making tax returns, other than income or profits tax returns, to any state or territory of the United States of America or to the District of Columbia. ARTICLE XVII ------------ INSOLVENCY: - ----------- The reinsurance under this Contract shall be payable by the Reinsurer on the basis of the liability of one or more of the Companies under the Policy or Policies reinsured without diminution because of the insolvency of one or more of the Companies reinsured or because the liquidator, receiver, conservator or statutory successor of the Company(ies) has failed to pay all or a portion of any claim. In the event of the insolvency of one or more of the Companies reinsured, the liquidator, receiver, conservator or statutory successor of the Company(ies) shall give written notice to the Reinsurer of the pendency of a claim against the insolvent Company(ies) on the Policy or Policies reinsured within a reasonable time after such claim is filed in the insolvency proceeding and during the pendency of such claim the Reinsurer may investigate such claim and interpose, at its own expense, in the proceeding where such claim is to be adjudicated any defense or defenses which it may deem available to the Company(ies) or its liquidator, receiver, conservator or statutory successor. The expense thus incurred by the Reinsurer shall be chargeable subject to court approval against the insolvent Company(ies) as part of the expense of liquidation to the extent of 11 a proportionate share of the benefit which may accrue to the Company(ies) solely as a result of the defense undertaken by the Reinsurer. Where two or more Reinsurers are involved in the same claim and a majority in interest elect to interpose defense to such claim, the expense shall be apportioned in accordance with the terms of this Contract as though such expense had been incurred by the Company(ies). In the event of the insolvency of one or more of the Companies reinsured, the reinsurance under this Contract shall be payable by the Reinsurer directly to the Company(ies) or to the liquidator, receiver, conservator or statutory successor, except as provided by subsection (A) of section 4118 of the Insurance Law of New York or except where (I) the Contract specifies another payee of such Reinsurance in the event of the insolvency of the Company(ies) and (II) the Reinsurer with the consent of the direct insureds and, with the prior approval of the Superintendent of Insurance of New York to the certificate of assumption issued to New York direct insureds, has assumed such policy obligations of the Company(ies) as its direct obligations to the payees under such policies, in substitution for the obligations of the Company(ies) to such payees. ARTICLE XVIII ------------- ARBITRATION: - ------------ If any dispute shall arise between the parties to this Contract, either before or after its termination, with reference to the interpretation of this Contract or the rights of either party with respect to any transactions under this Contract, including the formation or validity thereof, the dispute shall be referred to three (3) arbitrators as a condition precedent to any right of action arising under this Contract. The arbitrators shall be active or retired disinterested officers of insurance or reinsurance companies or Lloyd's Underwriters other than the parties or their affiliates. One arbitrator shall be chosen by each party and the third by the two so chosen. If either party refuses or neglects to appoint an arbitrator within thirty (30) days after the receipt of written notice from the other party requesting it to do so, the requesting party may nominate two (2) arbitrators who shall choose the third. In the event the arbitrators do not agree on the selection of the third arbitrator within thirty (30) days after both arbitrators have been named, the Company shall petition the American Arbitration Association to appoint the third arbitrator. If the American Arbitration Association fails to appoint the third arbitrator within thirty (30) days after it has been requested to do so, either party may request a justice of a court of general jurisdiction of the state in which the arbitration is to be held, to appoint an officer or retired officer of an insurance or reinsurance company or Lloyd's Underwriter as the third arbitrator. In the event both parties request the appointment of the third arbitrator, the third arbitrator shall be the soonest named in writing by the justice of the court. Each party shall submit its case to the arbitrators within thirty (30) days of the appointment of the arbitrators. The arbitrators shall consider this Contract an honorable engagement rather than merely a legal obligation; they are relieved of all judicial formalities and may abstain from following the strict rules of law. The decision of a majority of the arbitrators shall be final and binding on both the Company and the Reinsurer. Judgment may be entered upon the award of the arbitrators in any court having jurisdiction. 12 Each party shall bear the fee and expenses of its own arbitrator, one half of the fee and the expenses of the third arbitrator and one half of the other expenses of the arbitration. In the event both arbitrators are chosen by one party, the fees of the arbitrators shall be equally divided between the parties. Any such arbitration shall take place in Columbus, Ohio unless some other location is mutually agreed upon by the parties. 13 EXHIBIT A STATE AUTOMOBILE MUTUAL INSURANCE COMPANY STATE AUTO NATIONAL MILBANK INSURANCE COMPANY MIDWEST SECURITY INSURANCE COMPANY FARMERS CASUALTY INSURANCE COMPANY MID-PLAINS INSURANCE COMPANY PROPERTY CATASTROPHE OVERLYING EXCESS OF LOSS REINSURANCE CONTRACT ------------------------------------------------------------------ FOR THE PERIOD 12:01 A.M. STANDARD TIME JULY 1, 1999 THROUGH 12:01 A.M. STANDARD TIME JULY 1, 2000 Calculation of Premium Percentage for Each Company
Written Premium July 1, 1998 through June 30, 1999 Annual State Automobile State Auto Farmers Statement Line Mutual Milbank Midwest National Casualty Mid-Plains Total - ------------------------------------------------------------------------------------------------------------------------------------ 1.0 21,858,073 742,377 53,077 22,653,527 2.0 12,958,492 616,452 30,033 13,604,977 65% of 3.0 0 3,131,479 0 3,131,479 65% of 4.0 28,698,456 7,017,580 1,724,386 452,373 37,892,795 50% of 5.0 9,946,161 1,099,410 0 11,045,571 90% of 8.0 1,928,889 5,933 0 1,934,822 9.0 8,331,051 1,178,978 178,003 9,688,032 12.0 1,689,108 10,906 355 1,700,369 50% of 21.1 25,044,475 7,707,316 3,374,757 4,675,777 5,604,110 1,260,420 47,666,855 50% of 21.2 5,317,616 337,952 0 5,655,568 Total 115,772,321 21,848,383 5,360,611 4,675,777 6,056,483 1,260,420 154,973,995 Premiums Ceded (364,090) (37,875) (4,192) 0 (991) 0 (407,148) Net Total 115,408,231 21,810,508 5,356,419 4,675,777 6,055,492 1,260,420 154,566,847 % of Total 74.67% 14.11% 3.47% 3.03% 3.92% 0.82% 100.0% Item 1: Selected Estimates 75.0% 14.0% 3.0% 3.0% 4.0% 1.0% 100.0% Item 2: Premium (rounded to 000) 2,250,000 420,000 90,000 90,000 120,000 30,000 3,000,000 Item 3: Quarterly Installment 562,500 105,000 22,500 22,500 30,000 7,500 750,000
14 INTERESTS AND LIABILITIES AGREEMENT ----------------------------------- BETWEEN STATE AUTOMOBILE MUTUAL INSURANCE COMPANY MILBANK INSURANCE COMPANY STATE AUTO NATIONAL INSURANCE COMPANY MIDWEST SECURITY INSURANCE COMPANY FARMERS CASUALTY INSURANCE COMPANY MID-PLAINS INSURANCE COMPANY (THE "COMPANY") AND STATE AUTO PROPERTY AND CASUALTY INSURANCE COMPANY (THE SUBSCRIBING "REINSURER") It is hereby mutually agreed by and between the Company on the one part, and the Subscribing Reinsurer on the other part that effective July 1, 1999, the Subscribing Reinsurer's share of the Interests and Liabilities of the PROPERTY CATASTROPHE OVERLYING EXCESS OF LOSS REINSURANCE CONTRACT attached hereto and forming part of this Agreement, shall be for ONE HUNDRED PERCENT (100%). IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be signed in duplicate by their authorized representatives. Signed in Columbus, Ohio this 8th day of December, 1999. STATE AUTO PROPERTY AND CASUALTY INSURANCE COMPANY By /s/ Steven J. Johnston ------------------------------------- Title Senior Vice President ---------------------------------- Signed in Columbus, Ohio this 8th day of December, 1999. STATE AUTOMOBILE MUTUAL INSURANCE COMPANY MILBANK INSURANCE COMPANY STATE AUTO NATIONAL INSURANCE COMPANY MIDWEST INSURANCE COMPANY FARMERS CASUALTY INSURANCE COMPANY MID-PLAINS INSURANCE COMPANY By /s/ Steven J. Johnston ------------------------------------- Title Senior Vice President ---------------------------------- 15 ENDORSEMENT NO. 1 ----------------- TO THE PROPERTY CATASTROPHE OVERLYING EXCESS OF LOSS REINSURANCE CONTRACT BETWEEN 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 (THE "COMPANY") AND STATE AUTO PROPERTY AND CASUALTY INSURANCE COMPANY (THE SUBSCRIBING "REINSURER") It is hereby understood and agreed that effective January 1, 2000, this Contract is amended as follows: I. Company shall read: 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 State Auto Insurance Company II. ARTICLE V, AMOUNT OF LIMIT AND RETENTION shall read: No claim shall be made hereunder unless and until the Company and other members of the State Auto Insurance Companies Group, being State Automobile Mutual Insurance Company, State Auto Property and Casualty Insurance Company, Milbank Insurance Company, Midwest Security Insurance Company, State Auto National Insurance Company, Farmers Casualty Insurance Company, and Mid-Plains Insurance Company, hereinafter referred to as the "Group", on a pooled basis where applicable, shall first have sustained an Ultimate Net Loss in excess of $120,000,000, regardless of the number of Policies under which such loss is payable or the number of interests insured. The Reinsurer shall then be liable for the amount of Ultimate Net Loss for the Company in excess of $120,000,000 Ultimate Net Loss each occurrence, but the sum recoverable from the Reinsurer in respect of each loss occurrence shall not exceed $135,000,000, nor more than $135,000,000 in respect of all loss occurrences during the term of this contract. 16 ENDORSEMENT NO. 1 ----------------- The amount of coverage is subject to at least two risks being involved in the same loss occurrence. III. ARTICLE XI, PREMIUM, shall read: The premium to be paid to the Reinsurer shall be $4,050,000, payable in four equal quarterly installments. Each company shall pay a percentage of the premium based on its share of written premiums of the subject lines of business as estimated in Exhibit A. IV. EXHIBIT A is modified as attached and replaces the original Exhibit A. All other terms and conditions remain unchanged. IN WITNESS WHEREOF, the parties hereto have caused this endorsement to be signed in duplicate by their authorized representatives. Signed in Columbus, Ohio this 21st day of February, 2000. STATE AUTO PROPERTY AND CASUALTY INSURANCE COMPANY By /s/ Steven J. Johnston ------------------------------------- Title Senior Vice President ---------------------------------- Signed in Columbus, Ohio this 21st day of February, 2000. STATE AUTOMOBILE MUTUAL INSURANCE COMPANY MILBANK INSURANCE COMPANY STATE AUTO NATIONAL INSURANCE COMPANY MIDWEST SECURITY INSURANCE COMPANY FARMERS CASUALTY INSURANCE COMPANY MID-PLAINS INSURANCE COMPANY STATE AUTO INSURANCE COMPANY By /s/ Steven J. Johnston ------------------------------------- Title Senior Vice President ---------------------------------- 17 ENDORSEMENT NO. 1 ----------------- EXHIBIT A STATE AUTOMOBILE MUTUAL INSURANCE COMPANY STATE AUTO NATIONAL MILBANK INSURANCE COMPANY MIDWEST SECURITY INSURANCE COMPANY FARMERS CASUALTY INSURANCE COMPANY MID-PLAINS INSURANCE COMPANY PROPERTY CATASTROPHE OVERLYING EXCESS OF LOSS REINSURANCE CONTRACT ------------------------------------------------------------------ FOR THE PERIOD 12:01 A.M. STANDARD TIME JULY 1, 1999 THROUGH 12:01 A.M. STANDARD TIME JULY 1, 2000 Calculation of Premium Percentage for Each Company
Written Premium July 1, 1998 through June 30, 1999 Annual State Automobile State Auto Farmers Statement Line Mutual Milbank Midwest National Casualty Mid-Plains Total - ---------------------------------------------------------------------------------------------------------------------------------- 1.0 21,858,073 742,377 53,077 22,653,527 2.0 12,958,492 616,452 30,033 13,604,977 65% of 3.0 0 3,131,479 0 3,131,479 65% of 4.0 28,698,456 7,017,580 1,724,386 452,373 37,892,795 50% of 5.0 9,946,161 1,099,410 0 11,045,571 90% of 8.0 1,928,889 5,933 0 1,934,822 9.0 8,331,051 1,178,978 178,003 9,688,032 12.0 1,689,108 10,906 355 1,700,369 50% of 21.1 25,044,475 7,707,316 3,374,757 4,675,777 5,604,110 1,260,420 47,666,855 50% of 21.2 5,317,616 337,952 0 5,655,568 Total 115,772,321 21,848,383 5,360,611 4,675,777 6,056,483 1,260,420 154,973,995 Premiums Ceded (364,090) (37,875) (4,192) 0 (991) 0 (407,148) Net Total 115,408,231 21,810,508 5,356,419 4,675,777 6,055,492 1,260,420 154,566,847 % of Total 74.67% 14.11% 3.47% 3.03% 3.92% 0.82% 100.0% Item 1: Selected Estimates 75.0% 14.0% 3.0% 3.0% 4.0% 1.0% 100.0% Item 2: Annual Premium (rounded to 000) 3,037,500 567,000 121,500 121,500 162,000 40,500 4,050,000 Item 3: Quarterly Installment 759,375 141,750 30,375 30,375 40,500 10,125 1,012,500
18 INSOLVENCY FUNDS EXCLUSIONS CLAUSE This Agreement excludes: All liability of the Company arising, by contract, operation of law, or otherwise, from its participation or membership, whether voluntary or involuntary, in any insolvency fund. "Insolvency Fund" includes any guaranty fund, insolvency fund, plan, pool, association, fund or other arrangement, howsoever denominated, established or governed, which provides for any assessment of or payment or assumption by the Company of part or all of any claim, debt, charge, fee or other obligation of an insurer, or its successors or assigns, which has been declared by any competent authority to be insolvent, or which is otherwise deemed unable to meet any claim, debt, charge, fee, or other obligation in whole or in part. 19 NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE - U.S.A. -------------------- 1. This Reinsurance does not cover any loss or liability accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer, from any Pool of Insurers or Reinsurers formed for the purpose of covering Atomic or Nuclear Energy risks. 2. Without in any way restricting the operation of paragraph (1) of this Clause, this Reinsurance does not cover any loss or liability accruing to the Reassured, directly or indirectly and whether as Insurer or Reinsurer, from any insurance against Physical Damage (including business interruption or consequential loss arising out of such Physical Damage) to: I. Nuclear reactor power plants including all auxiliary property on the site, or II. Any other nuclear reactor installation including laboratories handling radioactive materials in connection with reactor installations, and "critical facilities" as such, or III. Installations for fabricating complete fuel elements or for processing substantial quantities of "special nuclear material," and for reprocessing, salvaging, chemically separating, storing or disposing of "spent" nuclear fuel or waste materials, or IV. Installations other than those listed in paragraph (2) III above using substantial quantities of radioactive isotopes or other products of nuclear fission. 3. Without in any way restricting the operations of paragraphs (1) and (2) hereof, this Reinsurance does not cover any loss or liability by radioactive contamination accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer, from any insurance on property which is on the same site as a nuclear reactor power plant or other nuclear installation and which normally would be insured therewith except that this paragraph (3) shall not operate: (A) Where the Reassured does not have knowledge of such nuclear reactor power plant or nuclear installation, or (B) Where said insurance contains a provision excluding coverage for damage to property caused by or resulting from radioactive contamination, however caused. However on and after 1st January 1960 this sub-paragraph (B) shall only apply provided the said radioactive contamination exclusion provision has been approved by the Governmental Authority having jurisdiction thereof. 4. Without in any way restricting the operations of paragraphs (1), (2) and (3) hereof, this Reinsurance does not cover any loss or liability by radioactive contamination accruing to the Reassured, directly or indirectly, and whether as Insurer or Reinsurer, when such radioactive contamination is a named hazard specifically insured against. 20 5. It is understood and agreed that this Clause shall not extend to risks using radioactive isotopes in any form where the nuclear exposure is not considered by the Reassured to be the primary hazard. 6. The term "special nuclear material" shall have the meaning given it in the Atomic Energy Act of 1954, or by any law amendatory thereof. 7. The Reassured to be sole judge of what constitutes: (A) substantial quantities, and (B) the extent of installation, plant or site. NOTE: Without in any way restricting the operation of paragraph (1) hereof, it is understood and agreed that: (A) all policies issued by the Reassured on or before 31st December 1957 shall be free from the application of the other provision of this Clause until expiry date or 31st December 1960, whichever first occurs whereupon all the provisions of this Clause shall apply, (B) with respect to any risk located in Canada policies issued by the Reassured on or before 31st December 1958 shall be free from the application of the other provisions of this Clause until expiry date or 31st December 1960, whichever first occurs whereupon all the provisions of this Clause shall apply. 21 NUCLEAR INCIDENT EXCLUSION CLAUSE - PHYSICAL DAMAGE - REINSURANCE - CANADA -------------------- APPLICABLE TO POLICIES BECOMING EFFECTIVE ON AND AFTER JANUARY 1, 1985 (SEE NOTE) 1. This Agreement does not cover any loss or liability accruing to the Reinsured, directly or indirectly, and whether as Insurer or Reinsurer, from any Pool of Insurers or Reinsurers formed for the purpose of covering Atomic or Nuclear Energy risks. 2. Without in any way restricting the operation of paragraph 1 of this Clause, this Agreement does not cover any loss or liability accruing to the Reinsured, directly or indirectly, and whether as Insurer or Reinsurer, from any insurance against Physical Damage (including business interruption or consequential loss arising out of such Physical Damage) to: (A) Nuclear reactor power plants including all auxiliary property on the site, or (B) Any other nuclear reactor installation, including laboratories handling radioactive materials in connection with reactor installations, and critical facilities as such, or (C) Installations for fabricating complete fuel elements or for processing substantial quantities of prescribed substances, and for reprocessing, salvaging, chemically separating, storing or disposing of spent nuclear fuel or waste materials, or (D) Installations other than those listed in (C) above using substantial quantities of radioactive isotopes or other products of nuclear fission. 3. Without in any way restricting the operations of paragraphs 1 and 2 of this Clause, this Agreement does not cover any loss or liability by radioactive contamination accruing to the Reinsured, directly or indirectly, and whether as Insurer or Reinsurer from any insurance on property which is on the same site as a nuclear reactor power plant or other nuclear installations and which normally would be insured therewith, except that this paragraph 3 shall not operate (A) Where the Reinsured does not have knowledge of such nuclear reactor power plant or nuclear installation, or (B) Where the said insurance contains a provision excluding coverage for damage to property caused by or resulting from radioactive contamination, however caused. 22 4. Without in any way restricting the operation of paragraphs 1, 2, and 3 of this Clause, this Agreement does not cover any loss or liability by radioactive contamination accruing to the Reinsured, directly or indirectly, and whether as Insurer or Reinsurer, when such radioactive contamination is a named hazard specifically insured against. 5. This Clause shall not extend to risks using radioactive isotopes in any form where the nuclear exposure is not considered by the Reinsured to be the primary hazard. 6. The term "prescribed substances" shall have the meaning given it by the Atomic Energy Control Act R.S.C. 1974, or by any law amendatory thereof. 7. The Reinsured to be sole judge of what constitutes: (A) substantial quantities, and (B) the extent of installation, plant or site. 8. Without in any way restricting the operation of paragraphs 1, 2, 3 and 4 of this Clause, this Agreement does not cover any loss or liability accruing to the Reinsured, directly or indirectly, and whether as Insurer or Reinsurer caused by any nuclear incident as defined in the Nuclear Liability Act, nuclear explosion or contamination by radioactive material. NOTE: In addition, this Clause is applicable to all original contracts of the Reinsured in effect prior to January 1, 1985 whether new, renewal or replacement which incorporate a Nuclear Incident/Radioactive Contamination Exclusion as contained in form IBC 1105 1-82. 23 POOLS, ASSOCIATIONS & SYNDICATES EXCLUSION CLAUSE SECTION A: - ---------- EXCLUDING: (1) All Business derived directly or indirectly from any Pool, Association or Syndicate which maintains its own reinsurance facilities. (2) Any Pool or Scheme (whether voluntary or mandatory) formed after March 1, l968 for the purpose of insuring Property whether on a country-wide basis or in respect of designated areas. This exclusion shall not apply to so-called Automobile Insurance Plans or other Pools formed to provide coverage for Automobile Physical Damage. SECTION B: - ---------- It is agreed that business written by the Company for the same perils, which is known at the time to be insured by, or in excess of underlying amounts placed in the following Pools, Associations, or Syndicates, whether by way of insurance or reinsurance, is excluded hereunder: Industrial Risk Insurers; Associated Factory Mutuals; Improved Risk Mutuals. Any Pool, Association or Syndicate formed for the purpose of writing Oil, Gas or Petro-Chemical Plants and/or Oil or Gas Drilling Rigs. United States Aircraft Insurance Group, Canadian Aircraft Insurance Group, Associated Aviation Underwriters, American Aviation Underwriters. SECTION B does not apply: (1) Where the Total Insured Value over all interests of the risk in question is less than $250,000,000. (2) To interests traditionally underwritten as Inland Marine or Stock and/or Contents written on a Blanket basis. (3) To Contingent Business Interruption, except when the Company is aware that the key location is known at the time to be insured in any Pool, Association or Syndicate named above, other than as provided for under Section B (1). (4) To risks as follows: Offices, Hotels, Apartments, Hospitals, Educational Establishments, Public Utilities (other than Railroad Schedules) and Builder's Risks on the classes of risks specified in this subsection (4) only. 24 SECTION C: - ---------- Where this Clause attaches to catastrophe excesses, the following Section C is added: NEVERTHELESS the Reinsurer specifically agree that liability accruing to the Company from its participation in: (l) The following so-called "Coastal Pools": ALABAMA INSURANCE UNDERWRITING ASSOCIATION FLORIDA WINDSTORM UNDERWRITING ASSOCIATION LOUISIANA INSURANCE UNDERWRITING ASSOCIATION MISSISSIPPI WINDSTORM UNDERWRITING ASSOCIATION NORTH CAROLINA INSURANCE UNDERWRITING ASSOCIATION SOUTH CAROLINA WINDSTORM AND HAIL UNDERWRITING ASSOCIATION TEXAS CATASTROPHE PROPERTY INSURANCE ASSOCIATION and (2) All "FAIR Plan" and "Rural Risk Plan" business, including the Florida Residential Property and Casualty Joint Underwriting Association and the Florida Property and Casualty Joint Underwriting Association ("JUA"). For all perils otherwise protected hereunder shall not be excluded, except, however, that this reinsurance does not include any increase in such liability resulting from: (1) the inability of any other participant in such "Coastal Pool" and/or "FAIR Plan" and/or "Rural Risk Plan" and/or Residual Market Mechanisms to meet its liability. (2) any claim against such "Coastal Pool" and/or "FAIR Plan" and/or "Rural Risk Plan" and/or Residual Market Mechanisms or any participant therein, including the Company, whether by way of subrogation or otherwise, brought by or on behalf of any Insolvency Fund (as defined in the Insolvency Fund Exclusion Clause incorporated in this Contract). 25 SECTION D: - --------- Notwithstanding Section C above, in respect of the FWUA, FPCJUA and RPCJUA, where an assessment is made against the Company by the FWUA, the FPCJUA, the RPCJUA, or any combination thereof, the maximum loss that the Company may include in the Ultimate Net Loss in respect of any loss occurrence hereunder shall not exceed the lesser of: (1) The Company's assessment from the relevant entity (FWUA, FPCJUA and/or RPCJUA) for the accounting year in which the loss occurrence commenced, or (2) The product of the following: a) The Company's percentage participation in the relevant entity for the accounting year in which the loss occurrence commenced; and b) The relevant entity's total losses in such loss occurrence. Any assessments for accounting years subsequent to that in which the loss occurrence commenced may not be included in the Ultimate Net Loss hereunder. Moreover, notwithstanding Section C above, in respect of the FWUA, the FPCJUA and/or the RPCJUA, the Ultimate Net Loss hereunder shall not include any monies expended to purchase or retire bonds as a consequence of being a member of the FWUA, the FPCJUA and/or the RPCJUA. For the purposes of this Contract, the Company may not include in the Ultimate Net Loss any assessment or any percentage assessment levied by the FWUA, the FPCJUA and/or the RPCJUA to meet the obligations of an insolvent insurer member or other party, or to meet any obligations arising from the deferment by the FWUA, FPCJUA and/or RPCJUA of the collection of monies. 26 NORTH AMERICAN WAR EXCLUSION CLAUSE (REINSURANCE) Approved by Lloyd's Underwriters' Fire and Non-Marine Association "As regards interests which at time of loss or damage are on shore, no liability shall attach hereto in respect of any loss or damage which is occasioned by war, invasion, hostilities, acts of foreign enemies, civil war, rebellion, insurrection, military or usurped power, or martial law or confiscation by order of any government or public authority. This War Exclusion Clause shall not, however, apply to interests which at time of loss or damage are within the territorial limits of the United States of America (comprising the fifty States of the Union and the District of Columbia, its territories and possessions including Panama Canal Zone and the Commonwealth of Puerto Rico and including Bridges between the U.S.A. and Mexico provided they are under United States ownership), Canada, St. Pierre and Miquelon, provided such interests are insured under policies, endorsements or binders containing a standard war or hostilities or warlike operations exclusion clause." Nevertheless, this Clause shall not be construed to apply to riots, strikes, civil commotion, vandalism, malicious damage including acts committed by the agent of any government, party or faction engaged in war, hostilities, or other warlike operation, providing such agent is acting secretly and not in connection with any operations of military or naval armed forces in the country where the interest insured is situated. EX-10.Z 8 EXHIBIT 10(Z) 1 Exhibit 10(Z) First Amendment To the Management and Operations Agreement Effective January 1, 2000 Among State 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. 518 Property Management and Leasing, LLC 2 FIRST AMENDMENT TO MANAGEMENT AND OPERATIONS AGREEMENT This First Amendment (the "Amendment") to the Management and Operations Agreement dated January 1, 2000 is attached to and hereby expressly made a part of said Management and Operations Agreement (the "2000 Management Agreement") by and among State Automobile Mutual Insurance Company, an Ohio corporation ("Mutual"), State Auto Financial Corporation, an Ohio corporation ("State Auto Financial"), State Auto Property and Casualty Insurance Company, a South Carolina corporation ("State Auto P&C"), State Auto National Insurance Company, an Ohio corporation ("National"), Milbank Insurance Company, a South Dakota corporation ("Milbank"), State Auto Insurance Company, an Ohio corporation ("State Auto IC"), Stateco Financial Services, Inc., an Ohio corporation ("Stateco"), Strategic Insurance Software, Inc., an Ohio corporation ("S.I.S."), and 518 Property Management and Leasing, LLC, an Ohio limited liability company ("518 PML"). BACKGROUND INFORMATION ---------------------- The parties hereto desire to make clarifying changes to the 2000 Management Agreement in order to address certain concerns of the Ohio Insurance Department relating to the accounting processes to be used by the insurers party to the 2000 Management Agreement. While this Amendment is executed on March 21, 2000, it is understood to be effective from and after January 1, 2000. STATEMENT OF AGREEMENT ---------------------- In consideration of the mutual covenants set forth herein and intending to be legally bound hereby, the parties hereto hereby agree as follows. 1. Capitalized terms used herein that are not otherwise defined herein shall have the meaning ascribed to such term in the 2000 Management Agreement, as amended by this Amendment. 2. Section 7 Services Fee is amended by the addition of the following sentences at the end of subsection (a): The service fee shall be allocated in accordance with applicable statutory accounting principles by each Managed Company that is an insurance company. State Auto P&C shall record this service fee as other income in accordance with applicable statutory accounting principles. 3. In Section 7, subsection (c), any reference to the phrase "management fee" shall be amended to read "service fee." 4. In all other respects the 2000 Management Agreement is hereby reaffirmed. 3 In Witness Whereof, the parties to the 2000 Management Agreement have caused this First Amendment to be executed as of March 21, 2000. STATE AUTOMOBILE MUTUAL INSURANCE COMPANY By: /s/ Robert H. Moone --------------------------------------------- Robert H. Moone, President STATE AUTO FINANCIAL CORPORATION By: /s/ Robert H. Moone --------------------------------------------- Robert H. Moone, President STATE AUTO PROPERTY AND CASUALTY INSURANCE COMPANY By: /s/ Robert H. Moone --------------------------------------------- Robert H. Moone, President STATE AUTO NATIONAL INSURANCE COMPANY By: /s/ Robert H. Moone --------------------------------------------- Robert H. Moone, President STATE AUTO INSURANCE COMPANY By: /s/ Robert H. Moone --------------------------------------------- Robert H. Moone, President STATECO FINANCIAL SERVICES, INC. By: /s/ Robert H. Moone --------------------------------------------- Robert H. Moone, President MILBANK INSURANCE COMPANY By: /s/ Robert H. Moone --------------------------------------------- Robert H. Moone, President STRATEGIC INSURANCE SOFTWARE, INC. By: /s/ Robert H. Moone --------------------------------------------- Robert H. Moone, Vice Chairman 518 PROPERTY AND MANAGEMENT LEASING, LLC By: /s/ Robert H. Moone --------------------------------------------- Robert H. Moone, President EX-10.AA 9 EXHIBIT 10(AA) 1 Exhibit 10(AA) First Amendment to the June 1, 1999 Credit Agreement Dated November 1, 1999 Between State Auto Financial Corporation and State Automobile Mutual Insurance Company 2 FIRST AMENDMENT TO THE CREDIT AGREEMENT This First Amendment to the Credit Agreement dated effective as of November 11, 1999 (the "First Amendment") is attached to and hereby expressly made a part of the Credit Agreement dated as of June 1, 1999 (the "Credit Agreement") by and between State Auto Financial Corporation (the "Company") and State Automobile Mutual Insurance Company (the "Lender"). In consideration of the mutual covenants set forth herein and INTENDING TO BE LEGALLY BOUND HEREBY, the Company and the Lender hereby agree to amend the Credit Agreement in the following particulars as set forth in this First Amendment. Section 1. Definitions and Accounting Matters: The definition of Commitment is deleted and replaced by the following: Commitment shall mean, as to the Lender, the obligation of the Lender to make Loans in an aggregate principal amount up to but not exceeding $50,000,000. Section 2. Commitment, Loans, Notes and Prepayments: Section 2.01 Loans is deleted and replaced by the following: 2.01. Loans: The Lender agrees, on the terms and conditions of this Agreement, to make one or more term loans to the Company in dollars on or before the Commitment Termination Date in an aggregate principal amount up to but not exceeding $50,000,000. Loans paid or prepaid may not be re-borrowed. In addition, the Company hereby restates and brings forward each representation and warranty set forth in Section 6 of the Credit Agreement as though each were made as of the date of this First Amendment. The Company also specifically agrees that the covenants set forth in Section 7 of the Credit Agreement shall continue to be applicable to the Credit Agreement as amended by this First Amendment. By their signatures hereon, the parties expressly agree to the changes to the Credit Agreement as set forth in this First Amendment and each does further hereby reaffirm each and every other provision of the Credit Agreement. For the Company By: /s/ John R. Lowther Title: Vice President 3 For the Lender Commitment $50,000,000 State Automobile Mutual Insurance Company By: /s/ Steven J. Johnston Title: Senior Vice President EX-21 10 EXHIBIT 21 1 Exhibit 21 List of subsidiaries of State Auto Financial Corporation State Auto Property and Casualty Insurance Company, a South Carolina corporation State Auto National Insurance Company, an Ohio corporation Stateco Financial Services, Inc., an Ohio corporation Strategic Insurance Software, Inc., an Ohio corporation Milbank Insurance Company, a South Dakota corporation Farmers Casualty Insurance Company, an Iowa corporation Mid-Plains Insurance Company, an Iowa corporation State Auto Insurance Company, an Ohio corporation 518 Property Management and Leasing, LLC, an Ohio limited liability company EX-23 11 EXHIBIT 23 1 Exhibit 23 Consent of Independent Auditors We consent to the incorporation by reference in the Registration Statement on Forms S-8 pertaining to the 1991 Stock Option Plan, the 1991 Directors' Stock Option Plan and the 1991 Employee Stock Purchase and Dividend Reinvestment Plan, and on Form S-3 pertaining to the Monthly Stock Purchase Plan for Independent Agents of our report dated February 18, 2000, with respect to the consolidated financial statements and schedules of State Auto Financial Corporation and subsidiaries included in this Annual Report (Form 10-K) for the year ended December 31, 1999. /s/Ernst & Young LLP Columbus, Ohio March 23, 2000 2 Exhibit 23 (Continued) STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) 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, 1999 and 1998, and the related consolidated statements of earnings, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1999. Our audits also included the financial statement schedules listed in the Index at Item 14(a)(2). These consolidated financial statements and schedules are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedules 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, 1999 and 1998, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedules, when considered in relation to the basic financial statements taken as a whole, present fairly in all material respects the information set forth therein. /s/Ernst & Young LLP Columbus, Ohio February 18, 2000 EX-27 12 EXHIBIT 27
7 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM STATE AUTO FINANCIAL COPORATION'S AUDITED FINANCIAL STATEMENTS ON FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1999 AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS. YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 527,806,000 43,981,000 0 55,518,000 0 0 627,305,000 24,560,000 0 28,936,000 759,945,000 232,489,000 153,570,000 0 0 45,500,000 0 0 105,888,000 211,799,000 759,945,000 392,058,000 34,262,000 2,555,000 11,996,000 264,628,000 92,441,000 19,331,000 56,985,000 14,169,000 42,816,000 0 0 0 42,816,000 1.05 1.03 225,914,000 271,507,000 (6,878,000) 168,512,000 100,349,000 221,682,000 (6,878,000) Beginning reserves have been increased $13,247,000 due to the January 1,1999 acquisition of Farmers Casualty Insurance Co. and its wholly-owned subsidiary and also $7,633,000 due to the January 1, 1999 increase in pooling participation percentage.
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