Ohio Casualty Cp (OCAS) - Description of business

Company Description
Segment Description      Commercial Lines Segment The Group’s Commercial Lines segment accounted for 58.7%, 56.8% and 57.0% of net premiums written in 2006, 2005 and 2004, respectively, consisting of the following product lines:                           (in millions)   2006     2005     2004     Workers’ compensation   $ 137.5     $ 138.6     $ 132.9   Commercial automobile     223.4       227.7       233.5   General liability     101.1       95.7       89.5   CMP, fire and inland marine     367.7       361.5       372.3                       Total Commercial Lines   $ 829.7     $ 823.5     $ 828.2                       These product lines include: •   Workers’ compensation insurance — insures employers for their obligations to provide workers’ compensation benefits as required by applicable statutes, including medical payments, rehabilitation costs, lost wages, and disability and death benefits. These policies also provide coverage to employers for their liability exposures under the common law; •   Commercial automobile insurance — insures policyholders against first and third party liability related to the ownership and operation of motor vehicles used in the course of business and property damage to insured vehicles. These policies may provide uninsured motorist coverage, which provides coverage to insureds and their employees for bodily injury and property damage caused by an uninsured party; •   General liability insurance — insures policyholders against third party liability for bodily injury and property damage, including liability for products sold and covers the cost of the defense of claims alleging such damages; and •   Commercial multi-peril insurance (CMP) fire and inland marine — insures a business against risks from property, liability, crime and boiler and machinery explosion losses.       Specialty Lines Segment The Group’s Specialty Lines segment accounted for 10.3%, 10.4% and 9.3% of net premiums written in 2006, 2005 and 2004, respectively, consisting of the following product lines:                           (in millions)   2006     2005     2004     Commercial umbrella/other   $ 85.6     $ 97.2     $ 87.1   Fidelity and surety     59.7       53.2       48.4                       Total Specialty Lines   $ 145.3     $ 150.4     $ 135.5                       These product lines include: •   Commercial umbrella — indemnifies policyholders for liability and defense costs which exceed coverage provided by the underlying primary policies, typically commercial automobile and general liability policies, and provides coverage for some items not covered by underlying policies; •   Fidelity and surety — insures against dishonest acts of bonded employees and the non-performance of parties under contracts, respectively.       Personal Lines Segment The Group’s Personal Lines segment accounted for the remaining 31.0%, 32.8% and 33.7% of net premiums written in 2006, 2005 and 2004, respectively, consisting of the following product lines:Item 1. Continued                           (in millions)   2006     2005     2004     Personal auto including personal umbrella   $ 259.6     $ 283.7     $ 294.1   Personal property     177.6       191.8       196.1                       Total Personal Lines   $ 437.2     $ 475.5     $ 490.2                       These product lines include personal automobile and homeowners insurance sold to individuals and provide property and liability coverage.Marketing and DistributionThe Group is represented by approximately 3,350 independent insurance agencies (for this purpose considered the Group’s Agency Force) with approximately 5,700 agency locations, each containing at least one licensed agent of the Group. These agents also represent other unaffiliated companies which may compete with the Group. In addition to its home office facility, the Group operates in multiple claim, underwriting, bond and service offices to assist these independent agents in producing and servicing the Group’s business.Certain agencies that meet established profitability and production targets are eligible for “key producer” status. At December 31, 2006, these agencies represented 16.4% of the Group’s total Agency Force and wrote 48.5% of its book of business. The policies placed by key agents have consistently produced a lower loss ratio for the Group than policies placed by other agents.The Commercial Lines customer group, categorized by commercial liability coverage premium volume, included approximately 51% contractors/artisans, 18% mercantile, 19% service, 7% manufacturers and 5% other. The Group targets small and medium-sized commercial accounts that range in size, with average premium of $5 thousand — $7 thousand. The Group believes this small to medium size business customer group offers an opportunity to achieve superior underwriting results through development and maintenance of strong agent and customer relationships and application of the Group’s underwriting, loss control, pricing and claims expertise.The Group markets its Specialty Lines segment predominately to policyholders who have purchased commercial automobile and general liability policies and have a need for additional coverage under umbrella policies to cover costs which might exceed the underlying policies limits or are not covered under such policies. Specialty Lines also includes the marketing of the fidelity and surety products to employers and other parties in need of insurance against dishonest acts of bonded employees as well as the non-performance of parties under contractual agreements.The Group markets personal automobile insurance primarily to standard and preferred risk drivers. Standard and preferred risk drivers are those who have met certain criteria, including a driving record which reflects a low historical incidence of at-fault accidents and moving violations of traffic laws. The Group also markets the homeowners insurance product to individuals to provide coverage for damage to their home and/or personal property.CompetitionThe property and casualty insurance industry is highly competitive. The Group competes on the basis of service, price and coverage. According to A.M. Best, based on net insurance premiums written in 2005, the latest year for which industry-wide comparison statistics are available: •   more than $437 billion of net premiums were written by property and casualty insurance companies in the United States and no one company or company group had a market share greater than approximately 10.9%; and •   the Group ranked as the fiftieth largest property and casualty insurance group in the United States. Item 1. ContinuedRegulation      State Regulation The Corporation’s insurance subsidiaries are subject to regulation and supervision in the states in which they are domiciled and in which they are licensed to transact business. The Company, American Fire, Ohio Security and OCNJ are all domiciled in Ohio. West American and Avomark are domiciled in Indiana. Collectively, the Corporation’s subsidiaries are licensed to transact business in 49 states and the District of Columbia, actively writing in approximately 40 states. Although the federal government does not directly regulate the insurance industry, federal initiatives can impact the industry.The authority of state insurance departments extends to various matters, including: •   the establishment of standards of solvency, which must be met and maintained by insurers; •   the licensing of insurers and agents; •   the imposition of restrictions on investments; •   approval and regulation of premium rates and policy forms for property and casualty insurance; •   the payment of dividends and distributions; •   the provisions which insurers must make for current losses and future liabilities; and •   the deposit of securities for the benefit of policyholders. State insurance departments also conduct periodic examinations of the financial and business affairs of insurance companies and require the filing of annual and other reports relating to the financial condition of insurance companies. Regulatory agencies require that premium rates not be excessive, inadequate or unfairly discriminatory. In general, the Corporation’s insurance subsidiaries must file all rates for personal and commercial insurance with the insurance department of each state in which they operate.State laws also regulate insurance holding company systems. Each insurance holding company in a 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. Pursuant to these laws, the respective departments may examine the parent and the insurance subsidiaries at any time and require prior approval or notice of various transactions including dividends or distributions to the parent from the subsidiary domiciled in that state.These state laws also require prior notice or regulatory agency approval of changes in control of an insurer or its holding company and of other material transfers of assets within the holding company structure. Under applicable provisions of Indiana and Ohio insurance statutes, the states in which the members of the Group are domiciled, a person would not be permitted to acquire direct or indirect control of the Corporation or any of its insurance subsidiaries, unless that person had obtained prior approval of the Indiana Insurance Commissioner and the Ohio Superintendent of Insurance. For the purposes of Indiana and Ohio insurance laws, any person acquiring more than 10% of the voting securities of a company is presumed to have acquired “control” of that company.      National Association of Insurance Commissioners (NAIC) The Corporation’s insurance subsidiaries are subject to the general statutory accounting practices and reporting formats established by the NAIC. The NAIC also promulgates model insurance laws and regulations relating to the financial condition and operations of insurance companies, including the Insurance Regulating Information System.NAIC model laws and rules are not usually applicable unless enacted into law or promulgated into regulation by the individual states. The adoption of NAIC model laws and regulations is a key aspect of the NAIC Financial Regulations Standards and Accreditation Program, which also sets forth minimum staffing and resource levels for all state insurance departments. Ohio and Indiana are accredited.Item 1. ContinuedThe NAIC has developed a “Risk-Based Capital” model for property and casualty insurers. The model is used to establish standards, which relate insurance company statutory surplus to risks of operations and assist regulators in determining solvency requirements. The standards are designed to assess capital adequacy and to raise the level of protection that statutory surplus provides for policyholders. The Risk-Based Capital model measures the following four major areas of risk to which property and casualty insurers are exposed: •   asset and liability risk; •   credit risk; •   underwriting risk; and •   off-balance sheet risk. The Risk-Based Capital model law requires the calculation of a ratio of total adjusted capital to Authorized Control Level (ACL) risk-based capital. Based upon the unaudited 2006 statutory financial statements, all insurance companies in the Group significantly exceeded 200% of the ACL, which represents the level below which there could be regulatory intervention and corrective action.      Regulations on Dividends The Corporation is dependent on dividend payments from its insurance subsidiaries in order to meet or fund operating expenses, debt obligations, common stock repurchases and shareholder dividend payments. Insurance regulatory authorities impose various restrictions and prior approval requirements on the payment of dividends by insurance companies and holding companies. This regulation allows dividends to equal the greater of (1) 10% of policyholders’ surplus or (2) 100% of the insurer’s net income, each determined as of the preceding year end, without prior approval of the insurance department.Dividend payments to the Corporation from the Company are limited to approximately $206.0 million during 2007 without prior approval of the Ohio insurance department based on 100% of the Company’s net income for the year ending December 31, 2006. Additional restrictions limiting the amount of dividends paid by the Company to the Corporation may result from the minimum risk-based capital requirements in the Corporation’s revolving credit agreement as disclosed in Item 15, Note 15 - Debt, in the Notes to the Consolidated Financial Statements on pages 87 and 88 of this Annual Report on Form 10-K.Pooling AgreementAll of the Company’s insurance subsidiaries, except OCNJ, have entered into an intercompany reinsurance pooling agreement with the Company. As of January 1, 2005, the Company, the lead company of the pool, assumes and retains 100% of the pool’s underwriting experience. There are no retrocessions to the Company’s insurance subsidiaries.Prior to January 1, 2005, under the terms of the previous intercompany reinsurance pooling agreement, all of the participants’ outstanding underwriting liabilities as of January 1, 1984, and all subsequent insurance transactions were pooled. The participating insurance subsidiaries shared in underwriting activity in 2004 based on the following percentages:           Insurance Subsidiary   Percentage of Losses The Company     46.75 % West American     46.75   American Fire     5.00   Ohio Security     1.00   Avomark     0.50   Item 1. ContinuedInvestmentsThe distribution of the Consolidated Corporation’s invested assets is determined by a number of factors, including: •   rates of return; •   investment risks; •   insurance law requirements; •   diversification; •   liquidity needs; •   tax planning; •   general market conditions; and •   business mix and liability payout patterns. Periodically, the investment portfolios are reallocated subject to the parameters set by management, under the direction of the Finance Committee of the Board of Directors. Management evaluates the investment portfolio on a regular basis to determine the optimal investment strategy based upon the factors mentioned above.Assets relating to property and casualty insurance operations are invested to maximize after-tax returns with appropriate diversification of risk. As a result of improved underwriting profitability, the Consolidated Corporation began to increase funds invested in tax-exempt securities which resulted in enhanced after-tax investment income yields due to the tax-exempt status of the securities.Equity and available-for-sale fixed income securities are marked to fair value on the consolidated balance sheets. As a result, shareholders’ equity fluctuates with changes in the value of these portfolios. The effect of future market volatility is managed through investment diversification, credit and asset duration management and by maintaining an appropriate ratio of equity securities to shareholders’ equity and statutory surplus.See further detailed information and discussion on the results of operations and liquidity of the Consolidated Corporation’s investment portfolio in the “Investment Results” section on pages 41-45 and the “Investment Portfolio” section on pages 60-62 of Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operation, of this Annual Report on Form 10-K.Liabilities for Unpaid Losses and Loss Adjustment ExpensesLiabilities for losses and loss adjustment expenses (LAE) are established for the estimated ultimate cost of settling claims for an insured event, both reported claims and incurred but not reported claims, based on information known as of the evaluation date. The estimated liabilities include the direct cost of the loss under terms of insurance policies, as well as legal fees and general expenses of administering the claims adjustment process. Because of the inherent future uncertainties in estimating ultimate costs of settling claims, actual losses and LAE may deviate substantially from the amounts recorded in the Consolidated Corporation’s financial statements. Furthermore, the timing, frequency and extent of adjustments to the estimated liabilities cannot be accurately predicted since conditions, events and trends which led to historical loss and LAE development and which serve as the basis for estimating ultimate claims cost may not occur in the future in exactly the same manner, if at all. As more information becomes available and claims are settled, the estimated liabilities are adjusted upward or downward with the effect of increasing or decreasing net income at the time of the adjustments. The effect of these adjustments may have a material adverse impact on the results of operations of the Group.Item 1. ContinuedThe following tables present an analysis of losses and LAE and related liabilities for the periods indicated. The first table represents the impact of loss and LAE activity for current and prior accident year claims on calendar year incurred and paid losses and LAE. The second table displays the development of losses and LAE liabilities as of successive year-end evaluations for each of the past ten years.Reconciliation of Liabilities for Losses and Loss Adjustment Expenses (in millions)                               2006     2005     2004   Net liabilities, balance as of January 1   $ 2,262.2     $ 2,186.1     $ 2,131.3   Incurred related to:                         Current year     945.7       927.4       958.1   Prior years     (52.2 )     (20.1 )     (21.8 )                     Total incurred     893.5       907.3       936.3                             Paid related to:                         Current year     339.8       327.9       354.1   Prior years     489.3       503.3       527.4                       Total paid     829.1       831.2       881.5                             Net liabilities, balance as of December 31     2,326.6       2,262.2       2,186.1   Reinsurance recoverable     585.7       684.6       570.3                       Gross liabilities, balance as of December 31   $ 2,912.3     $ 2,946.8     $ 2,756.4                       The accounting policies used to estimate liabilities for losses and LAE are considered critical accounting policies and are further discussed in the “Reserves for Losses and LAE Adjustment Expenses” sub-section in the “Critical Accounting Policies” section of Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operation, on pages 48-56 in this Annual Report on Form 10-K. In addition loss and LAE liabilities are further discussed in Note 1J - Summary of Significant Accounting Policies and Note 8 — Losses and Loss Reserves, in the Notes to the Consolidated Financial Statements on page 72 and pages 84 and 85 of this Annual Report on Form 10-K.Item 1. ContinuedAnalysis of Development of Loss and Loss Adjustment Expense Liabilities (In millions)                                                                                           Year Ended December 31   1996   1997   1998   1999   2000   2001   2002   2003   2004   2005   2006 Net liability as originally estimated:   $ 1,486.6     $ 1,421.8     $ 1,865.6     $ 1,823.3     $ 1,907.3     $ 1,982.0     $ 2,079.3     $ 2,131.3     $ 2,186.1     $ 2,262.2     $ 2,326.6                                                                                             Life Operations Liability     3.7       0.1       0.1       —       —       —       —       —       —       —       —                                                                                             P&C Operations Liability   $ 1,482.9     $ 1,421.7     $ 1,865.5     $ 1,823.3     $ 1,907.3     $ 1,982.0     $ 2,079.3     $ 2,131.3     $ 2,186.1     $ 2,262.2     $ 2,326.6                                                                                             Net cumulative payments as of:                                                                                         One year later     483.6       449.8       640.2       614.0       609.1       608.9       586.7       527.4       503.3       489.3           Two years later     747.4       751.2       999.1       960.5       1,002.7       1,015.2       951.5       865.8       837.0                   Three years later     950.1       919.3       1,223.3       1,226.2       1,290.4       1,281.9       1,212.9       1,111.3                           Four years later     1,058.3       1,016.9       1,385.2       1,399.5       1,465.9       1,457.6       1,382.7                                   Five years later     1,121.3       1,088.8       1,485.7       1,504.1       1,584.1       1,576.0                                           Six years later     1,171.2       1,137.6       1,548.2       1,578.6       1,669.1                                                   Seven years later     1,207.0       1,171.3       1,601.1       1,641.1                                                           Eight years later     1,233.5       1,205.2       1,646.9                                                                   Nine years later     1,263.1       1,228.9                                                                           Ten years later     1,284.1                                                                                                                                                                             Gross cumulative payments as of:                                                                                         One year later     498.3       469.9       654.2       636.5       647.1       636.8       674.9       609.9       578.4       576.3           Two years later     781.9       775.4       1,022.2       1,007.1       1,060.6       1,122.7       1,111.6       1,012.1       994.4                   Three years later     983.4       950.4       1,261.1       1,281.4       1,404.5       1,455.5       1,427.0       1,325.7                           Four years later     1,098.7       1,057.5       1,426.5       1,492.0       1,620.5       1,659.0       1,637.0                                   Five years later     1,171.2       1,131.5       1,532.4       1,616.7       1,763.7       1,806.8                                           Six years later     1,223.2       1,187.0       1,601.0       1,706.8       1,874.3                                                   Seven years later     1,265.3       1,226.7       1,666.6       1,787.7                                                           Eight years later     1,297.2       1,272.0       1,725.0                                                                   Nine years later     1,338.3       1,307.2                                                                           Ten years later     1,370.8                                                                                   Item 1. ContinuedAnalysis of Development of Loss and Loss Adjustment Expense Liabilities (continued) (In millions)