State Auto Financial's CEO Discusses Q4 2012 Results - Earnings Call Transcript

| About: State Auto (STFC)

State Auto Financial Corporation (NASDAQ:STFC)

Q4 2012 Earnings Call

February 19, 2013, 10:00 a.m. ET

Executives

Steve English – CFO

Bob Restrepo - President, Chairman & CEO

Scott Jones - VP & CIO

Matt Mrozek – Chief Actuarial Officer

Analysts

Chris Marone – Macquarie Research Equities

Larry Greenberg - Langen McAlenney

Brett Sherriffs (Steve) – KBW

Steven [Inaudible] – Philo Smith

Ron Bobman – Capital Returns

Operator

Good morning and thank you for standing by. All lines will be in listen only until the question-and-answer portion of the call. (Operator Instructions).Today’s call is being recorded. If you have any objections you may disconnect at this time.

Your speaker for today is Mr. Steve English, Chief Financial Officer. Sir, you may now begin.

Steve English

Thank you, Valerie. Good morning and welcome to our fourth quarter 2012 earnings conference call. Today, I'm joined by our Chairman, President, and CEO, Bob Restrepo, Chief Investment Officer, Scott Jones, and our Chief Actuarial Officer, Matt Mrozek.

Today's call will include prepared remarks by our CEO, Bob Restrepo and me, after which we will open the lines for questions.

Please note our comments today may include forward-looking statements, which by their nature involve a number of risk factors and uncertainties, which may affect future financial performance. Such risk factors may cause actual results to differ materially from those contained in our projections or forward-looking statements. These types of factors are discussed at the end of our press release as well as in our annual and quarterly filings with the Securities and Exchange Commission to which I refer you.

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

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

Bob Restrepo

Thank you, Steve, and good morning everyone.

State Auto Financial Corporation finished 2012 with a profitable quarter. We have improving ex-catastrophe loss ratios particularly for property offset somewhat by Superstorm Sandy catastrophe losses and strengthening to RED reserves.

We reported quarterly earnings per share of $0.51 and year-to-date, a profit of $0.27 a share.

Our fourth quarter combined ratio was 101.7%. RED added approximately 6.3 points. Without RED, our combined ratio would have been 95.4% comparable to our strong fourth quarter of last year.

For the full year 2012, we reported a combined ratio of 107.9%. RED was 5.6 points overall. Without RED, the result would have been 102.3%.

Most reserve strengthening in the quarter was for the second largest RED program covering restaurants. This program has been terminated. But we needed a quarter to assess ultimate loss costs. We reserve conservatively and now feel confident that we have the terminated programs adequately reserved.

For the year, RED increased our aggregate loss ratio by 5 percentage points and inflated our expense ratio by another .6 percentage points. Eliminating this business was an important step in our goal to achieve underwriting profitability and a 10% return on equity.

State Auto Financial Corporation's book value at the end of the year was $18.22 a share. Our current book value includes a reduction of $2.48 a share for the deferred tax asset valuation allowance we established at the end of the second quarter last year. The trailing fourth quarter return on equity result is 1.5%.

Now I'll give a brief overview of operating results and trends that we see in each of our three business segments.

In personal line, the all-important personal auto line showed modest improvement in the quarter and year-to-date primarily due to better weather and lower catastrophe losses. Our ex-catastrophe results for the quarter and the year remained flat. Bodily injury severity remains higher than expected. We filed for price increases consistent with these loss trends. In 2012, we increased personal auto prices 4.3%. We're not implementing price increases greater than loss cost trends.

Reduction for personal auto is slightly negative, a result of agency terminations and non-profitable property territories, flat new business, and the 3% reduction in policies in force.

We're pleased with homeowner results for the quarter and the year. After accounting for the homeowner's quota share reinsurance treaty, our ex-catastrophe loss ratio for the fourth quarter was 19.7%. For the year, we reported a result of 38.9, a 12 point improvement over 2011.

Large loss activity was flat with prior year. And we saw a better experience for non-catastrophe related claims and non-catastrophe non-weather losses. This is a direct result of aggressive actions we've been taking to achieve price adequacy, proper insurance to value, better spread of geographic risks, higher deductibles, and prudent use of reinsurance. I'm increasingly confident we'll achieve profit in this line barring a repeat of historic 2011 catastrophes.

Premiums increased 5.1% for the quarter and 3.5% for the year all driven by price. We finished 2012 with almost a 15% increase in rate, another 2.9% from exposure upgrading, and 3.9% from insurance-to-value. All in, homeowner prices increased almost 23% for the year. And we plan for comparable increases in 2013.

Starting in 2009, we've doubled homeowner prices, managed concentrations, and mitigated losses using deductibles and reinsurance. Policy in fourth count is also down 4.3% for the year almost exclusively in the high catastrophe states. Retention is also down resulting from runoff from terminated agents.

We had another solid quarter in the business insurance segment. Results in commercial multi-peril, fire and allied, and general liability were quite good for the quarter and year. As with personal auto, our commercial auto results lagged expectations due to bodily injury loss trends.

We continue to apply price across the board.

Ex-catastrophe loss ratios for business insurance improved for the quarter and substantially for the year. 2012 was our best loss ratio since 2009 and is a substantial improvement over last year.

Production was strong for the quarter and year resulting in changes to our umbrella reinsurance program, improved retention, more new business, a slowly recovering economy, and price increases of 5% for the quarter and 3.5% for the year.

Since the end of the first quarter, we've achieved quarter-over-quarter price increases across all of our commercial lines, a trend we expect to continue in 2013.

Commercial auto results deteriorated in the quarter because of liability large losses. But for the year, loss ratio results were fairly flat to 2011.

Severity is up. And we'll continue to get more price to get ahead of this loss trend.

Ex-catastrophe physical damage losses were flat for the quarter and year. Physical damage losses were higher in the fourth quarter due to Superstorm Sandy, but are significantly lower year-to-date.

Price per exposure increased 3.6% for the quarter and almost 2% for the year. We plan for mid-single digit price increases in 2013.

Commercial multi-peril results did not compare favorably with an unusually good fourth quarter in 2011 and for the year. Property large losses in the quarter drove this increase compared to the same period in 2011. And our BOP line retention improved, new business increased, and prices were up 6% for the quarter and 3.5% for the year. We'll continue to push price increases for the BOP line.

Property improved for the quarter and year. Production is also good with a similar story, better retention, strong new business, price per exposure increases of 5.7 for the quarter, 3.1 for the year, and increased premium basis.

General liability had an excellent quarter and a solid year. Large losses have declined as case reserving processes stabilized. We expect this traditionally profitable line to continue producing good results benefitting from our claim process changes, underwriting discipline, and price increases.

Specialty insurance results were disproportionately hurt in both the quarter and year by RED reserve increases. Rockhill finished 2012 with exceptionally strong profit and production. Workers' compensation results improved in the quarter. And we anticipate solid underwriting profits from our targeted workers' compensation strategy, which focuses on accounts under $10,000 and our traditionally profitable debit MOD business written by RTW. Specialty production for the year and for 2013 will remain flat as continued growth in Rockhill offsets RED runoff.

With that, I'll turn you over to Steve before we open up the forum for your questions.

Steve English

Thanks, Bob.

Today, I will comment on a wide variety of items. Let's start with those that impacted operating results for 2012.

First, the homeowner quota share treaty. As you can see from schedule two of the investor packet, FGFC's GAAP underwriting loss for the year was reduced by $6 million due to the treaty. As we discussed throughout the year, the components of our combined ratio are impacted in varying ways as the treaty reduces our CAT loss ratio, but increased our non-CAT loss and expense ratios. Beyond the underwriting benefit received, the treaty provided statutory capital and improved our capital ratios. We ended the year well within the treaty features that could have triggered termination of the contract. And we are confident that over the next two treaty years, nothing will change in that regard. The treaty does contain caps for catastrophe losses with the cap for 2012 being set at 50 loss ratio points, reducing to 40 loss ratio points in 2013. We finished the year at 29.8 loss ratio points.

We continued to operate in the low interest rate environment as does the entire industry. Net investment income for the quarter benefitted from TIPS performance as our TIPS income was $1.3 million higher in 2012 despite holding lower overall levels of TIPS. Keep in mind that during the fourth quarter a year ago, we began repositioning the portfolio in anticipation of the pooling change, which occurred on the last day of the year and was funded early in 2013. This drove the high level of cash and cash equivalents on the balance sheet as of 12/31/2011. So we experienced some of the impact of having lower invested assets in the fourth quarter of 2011.

Dividend income was up in this year's fourth quarter as we increased levels of investment in equities, specifically dividend paying equities. On a year-to-date basis though, our net investment income was down $10 million. While TIPS income was up in the quarter, it was down for the entire year by $3.5 million. Some of that of course is due to changes in the CPI. But as I mentioned a moment ago, our overall levels of TIPS investments were down in 2012 caused by the pooling change. The balance of the decline in investment income is from the fixed income portfolio driven by lower levels of invested assets and interest rates.

As has been our practice in the past, I will comment on how our reserve development impacted the 2012 results. Obviously, the reserve adjustments we made on prior accident years for RED negatively impacted our calendar year results. But despite that, we did have overall favorable net development for the year of 1.6 points. That compares to a year ago, which was 2.3 points. Breaking net down between CAT and non-CAT, we had one point of favorable net CAT development and 0.6 of a point of favorable non-CAT. The amount of CAT favorable development is a bit higher than we normally experience. But that is due to the level of CAT losses we experienced in 2011. Assessing the development in relation to the amount of 2011 losses, the result was consistent with historic patterns.

Focusing on the favorable net development for non-CAT loss in ALAE reserves by segment, personal lines developed favorable by 1.2 points. Business insurance developed favorable by 1.5 points. But this was offset by adverse development within specialty of 2.7 points driven by RED. For the year, RED adverse development across all programs was $30.5 million. The balance of the favorable development of 0.6 points emerged from our loss adjustment expense reserves for internal costs or ULAE.

Tax expense for the quarter was zero and $100,000 for the year due to the existence of the tax valuation allowance. The $100,000 relates to an immaterial AMT adjustment treated as a permanent item. Given we finished the year with pre-tax income, we did not fall into the exception under ASC740 as we have previously discussed. My expectation is that the allowance will remain in place throughout 2013. But we will continue to assess this as we continue to improve our operating performance.

Let's move to the balance sheet for a couple of items. First, during the quarter, our book value per share dropped by $0.08 despite have $0.38 of operating earnings and $0.51 of net income, both on a diluted per share basis. Net unrealized losses drove this result partly due to investment valuations and partly due to the annual revaluation of our benefit plans. As a reminder, we terminated a year ago retiree health care benefits for most active employees and certain retirees. Also effective January 1, 2010, new employees were no longer eligible to join our pension plan. The impact of the revaluation was $7.4 million or $0.18 book value per share. And was primarily the result of lowering the discount rate from 4.4% to 4.05%.

Finally, I would like to comment about our plans to refinance the $100 million senior notes that are outstanding and due this coming November. In the latter part of 2012 and early in 2013, we have been working on a refinancing strategy. To that end, State Auto Property and Casualty Insurance Company, STFC's largest insurance subsidiary, has become a member of the Federal Home Loan Bank of Cincinnati. We intend to refinance the senior notes with the secured borrowing and very attractive rates with the FHLB. I hope to be able to provide greater details on our next call. Today, I can tell you, we are working with the FHLB to select the best terms and rates that make sense for STFC. We have been holding discussions with regulators, rating agencies, and our bank group as we work towards implementing this refinancing strategy.

And with that, we would like to open up the line for any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions). Ray Iadella from Macquarie, you may ask your question.

Chris Marone – Macquarie Research Equities

Hi. Good morning. This is actually Chris Marone calling for Ray. Thanks for taking the call. I was hoping perhaps to start you guys might be able to comment a little further on the development related to the restaurant program in this quarter? I got on the call a little bit late. I might have missed something in the prepared remarks, but just hoping to get a little bit more color on how comfortable you guys are with this being sort of a distinct and specific adjustment.

I know you commented that (NYSE:W) on the third quarter Trucking Associated Development hasn’t changed material. I was just hoping may be you could give a little more color on that business, as well, and how the reserves look there?

Bob Restrepo

Sure. Well, first off I’ll tell you that all of the programs in RED are now officially in runoff. So, we were able to use the back-half here of 2012 to take a good thorough look at our reserving positions. At the end of the third quarter, as we discussed, we looked at the Truck Program, and made a significant move on strengthening those reserves.

Here in the fourth quarter, the Restaurant Program, some of the developments we saw there were adverse to what our expectation was, so we took a hard look at it here at the end of this quarter. And we now believe that the reserves are adequate. Of course we’ll continue to monitor this on a go-forward basis, but now that the programs are officially in runoff, we feel that we have a much better sense of our reserving positions.

In regards to the Truck Program, it – as I mentioned, we took a hard look at that at the end of the third quarter, we took another hard look at it here at the end of the fourth quarter, and we were encouraged that our assessment that we had come to at the end of the third quarter was essentially the assessment we came to at the end of the fourth quarter.

Chris Marone - Macquarie

Okay, got you, thank you. And could you, if it’s possible, could you indicate what the timeline on – I know that you clarified that RED is officially in runoff, but what’s the timeline expected before, you know, the books are essentially closed on these lines?

Bob Restrepo

Into next year, we will have something – sorry end of ’13, I’m still in ’12. In ’13 we will have some earned premium run into our numbers as the programs terminate that won’t be a significant amount of earn earned premium. We are reserving that with loss picks that are pretty conservative, pretty high to protect the balance sheet.

So, I would say that in 2012, our (with) without RED results won’t be materially different. It shouldn’t have a material impact on 2013.

Chris Marone - Macquarie

Understood. Okay. Thank you for that. And then, my next question related to homeowners. You guys commented on the aggressive price increases that you’re getting there. I was just wondering what the retentions have been doing as you’ve been raising price?

Bob Restrepo

Yes, our retentions have been affected by the terminated – the runoff from terminated agencies, and primarily in what we call Class C states, which is our most CAT prone states. If you adjust for the impact of terminated agents, our retention levels are actually pretty much identical to what our historical patterns are.

Chris Marone - Macquarie

Got you.

Bob Restrepo

And the net conclusion from that is the prices are sticking.

Chris Marone - Macquarie

And is that across the board, or is that better in certain markets than others?

Bob Restrepo

It all depending upon – largely dependent upon the terminated agents. So, if we have some states particular in the Midwest or the Southeast, where we’ve been more aggressive with agency terminations, and trying to reduce our property exposure there, that’s where we’ve seen the big impact on retentions.


In states that have more favorable weather patterns, the retention is by-in-large consistent with what we’ve traditionally experienced.

Chris Marone - Macquarie

Okay, thanks for that. And then my last question for now; I was hoping maybe you could help us how to think about the tax rate in 2013? I know your commentary sort of suggested, you know, that there might be a possibility that as you evaluate the DTA. You know, to me it sounded that maybe there’s even a chance that you guys might run through it this year depending on how improved results are. Could you help us just think about how to model what the tax rate would be in a non-deferred tax asset environment, or how we should think about modeling your results in 2013 as results continue– assuming results do continue to improve?

Steve English

Sure. Let’s start with what I think my expectation is for what I think will happen. Which is, I believe the allowance most likely will stay in place for the entirety of 2013, we’ll continue to assess that. But my expectation is then for 2013, on the income statement, pretax income will have zero tax expense in 2013 due to the existence of the allowance.

The only way we would have a provision running through the income statement in 2013, would be if we fell into the exception or the trap that we’ve discussed on prior calls, which would result if I have other comprehensive income, but have an operating loss. But my expectation is that I will not be in that trap.


Now, in terms of viewing the company without regards to the allowance, if you’re – you know, if I didn’t have the allowance today, what do I believe an effective cash rate would be on a GAAP basis, and I would say that would be somewhere in about the 25% range given our current mix of tax exempt versus taxable investment income.

Chris Marone – Macquarie

That’s helpful. Thanks very much. Okay, great, thanks for your help.

Operator

Larry Greenberg from Langen McAlenney, you may ask your question.

Larry Greenberg – Langen McAlenney

Good morning. Thank you. Hey Steve, just following-up on the premium question for RED. I mean, it seems like the difference between what the underlying specialty book is running at, and what you’re putting RED up at is very significant. So, can you be more specific on how much premium, earned premium will flow-through in 2013 from RED?

Steve English

Sure, Larry. I think you’ll see about 20 million or so of earned premium flow-through for the year.

Larry Greenberg – Langen McAlenney

Okay. And that, I mean, how many quarters will we be seeing?

Steve English

It will front-end-loaded, so it will be – I don’t have with me an exact emergence pattern, but I can tell you it would be front-end-loaded and declining. And by the time we get to the fourth quarter there should be little if any earned premium coming through.

Larry Greenberg – Langen McAlenney

Okay, great. That’s helpful. And then, on the deferred tax allowance, what is 2012 kind of represent in the considerations you go through for recognizing or deciding a point at which you’ll no longer recognize that allowance?

Steve English

As you might recall from some of our previous discussions about the allowance, what triggered the establishment of the allowance, of course were the large losses in the second quarter of ’11. Where we were looking at where we were going to finish 2011, at the time, on a running three year basis. We were going to be in a three year loss position, which is sort of an unofficial starting point of the discussion as to the need of an allowance.


Of course you look for other sources of income that can – whereas you can recover the deferred taxes such as your ability to carry back or take specific actions to create taxable income. And then finally you look at your go-forward ability to produce taxable income. So, that’s what led to the allowance.

So, now we come into 2012, and while we have pretax income, when you think about the three year test, the magnitude of those ’11 losses still overshadow our three position. We’re still in the three year loss position.

Additionally, while we had pretax book income for the year, our taxable income is a small tax loss. So, the next thing we’ll be looking at as we improve profitability, is when we’re actually generating taxable income for the tax return, which is dependent upon obviously the underwriting results in our mix of taxable, non-taxable investment income.

Larry Greenberg – Langen McAlenney

Okay. I guess the question is; you know, was 2012 a positive data point?

Steve English

Oh, yes.

Larry Greenberg – Langen McAlenney

It was?

Steve English

Yes.

Larry Greenberg – Langen McAlenney

Okay. And you would leave open some chance that 2014, you know you could potentially remove that allowance?

Steve English

I have already had some preliminary conversations with my auditors just trying to look down the road, and that is – so I would answer your question “yes”, that that is a possibility. But obviously it will depend on to what extent, what progress we make, and what the current trends are at that time. But if you recall, when we get to ’14, ’11 falls out of the numbers in terms of assessing the rolling three year position.

Larry Greenberg – Langen McAlenney

At the end of ’14?

Steve English

Right, but that’s where the judgments and the discussions start I think.

Larry Greenberg – Langen McAlenney

Okay, fair enough. Do you have statuary capital and surplus for both the Mutual and the Stock Companies?

Steve English

Yes. The Group, statuary capital, finished the year at 1.057 billion. And the public company subsidiaries finished the year at 630 million.

Larry Greenberg – Langen McAlenney

Thank you. And, Bob, have you changed your expectation for when you’ll reach that 10% ROE goal?

Bob Restrepo

We’re still targeting over the next two years. We expect substantial progress this year in 2013, and, you know, we’re targeting it for ’14. And driven by several things, but the most important this is the price increases in every line, personal business, as well as specialty.


We continue to evaluate our underwriting quality, and actually think with the help of predictive modeling, it’s improved. And our personal insurance and our business insurance segment is a big contributor to our plan as you know. As the claim process changes that we put in place eighteen months, two years ago, we actually began almost three years ago. Those have stabilized and we’re starting to see the benefit, not only in our dimity payoff, but also in the expenses related to adjudicating the claims, which are [inaudible] allocated or un-allocated loss adjustment expenses.

And, you know, setting aside RED, we think we have a real good handle on our risk/management profile. So – and we have an improving cost structure. But the big thing is driving the loss ration improvement, and beginning to experience the benefits of your diversification probably by shrinking in some areas, probably by laying of risk through the reinsurance program, and growing in areas that aren’t so CAT prone.


But our focus is really on the loss ratio. Next year pricing, underwriting discipline and reaping the – [inaudible] benefits of the claim process change, that are now well in place.

Larry Greenberg – Langen McAlenney

Okay. So it’s for the year 2014?

Steven English

Yes.

Larry Greenberg - Langen McAlenney

Okay, great. Thank you.

Operator

Brett Sherriffs from KBW, you may ask your question.

Brett Sherriffs – KBW

Hey, good morning, Bob and Steve.

Bob Restrepo

Good morning.

Brett Sherriffs – KBW

I just wanted to jump back to the reserve piece real quick. I was wondering if you could just tell me what the remaining reserves are on the RED runoff business?

Bob Restrepo

We have group-wide – it would be about $150 million.

Steve English

Yes, more or less.

Bob Restrepo

Approximately 140, 150 million.

Brett Sherriffs – KBW

Okay, thank you.

Bob Restrepo

All in. I mean, that’s Case, IBNR.

Brett Sherriffs – KBW

Okay. Actually, I just want to jump back to the dividend reduction back in 2012. I was just curious if you could kind of elaborate on the timing of that and what caused you to do it at this point in time?

Bob Restrepo

Yeah, we have – I’ll let Steve finish this up, but we have internal guidelines that the Boards use, the FTFC Board uses to determine an appropriate dividend, and of course, that’s paid out – that’s determined primarily by what the yield is and what the payout is. And we were running higher than our internal standards for both yield as well as payout and we’ve been running higher than that for at least two years, ever since – well, obviously, since 2011 but even before then.

So we looked out over the next couple of years and said, are we going to produce the kind of earnings. And by two years, I mean, 2013 when we made the decision and we felt that the likelihood of operating within those guidelines was less than 50/50, so we made a dividend change that put is in those – put us in the proper parameters regarding what we felt was an attractive yield but also an appropriate portion of our profits.

Steve English

And the other factors balanced against that, Brett, is the – from a capital perspective, discussions with rating agencies and taking into account discussions also with regulators. And putting that all together it made sense to make that adjustment.

The other factor that was going through our minds was the fact that when we changed the pooling agreement, we effectively downsized the company, you know, we lowered the leverage, we lowered the premium base and while we’re working hard to improve the margin on that base, the fact remains we downsized the company. So that was another factor we considered in making that decision.

Brett Sherriffs – KBW

Okay, that makes sense. Bob or Steve, would you care to elaborate on what, you know, some of the target payout ratios you think are appropriate?

Bob Restrepo

No, we’ve never shared those publically.

Brett Sherriffs – KBW

Okay. And just lastly, I know we’re only about half way through the quarter, is there any notable large losses or cash that you could discuss so far in 2013?

Bob Restrepo

It’s still moving. You’re right, we’re only half way through and March tends to be both ours as well as the industry, the most troublesome month, particularly over the past couple of years. So far, last time I looked, the industry’s only experienced one DCF number catastrophe, the one that came through in, I think it was January the 30th, and the storms that hit Hattiesburg, Mississippi and prior to that the storms that swept through the Midwest and the East Coast which results in the big snowfall in the Northeast still have not been numbered by Property Claims Services as a catastrophe. That could change as we get more thawing, but it’s been a pretty mild year so far, pretty normal for both the industry as well as StateAuto, nothing material.

Brett Sherriffs – KBW

All right, great. Thanks for your answer.

Operator

Steven [Inaudible] from Philo Smith, you may ask your question

Steven [Inaudible] – Philo Smith

Hi. Thanks for taking my question here. You guys have stated previously that since the end of 2008, you know, Homeowners has been the company’s biggest issue and to your credit, you’ve moved aggressively to improve the line through rate increases and posing deductibles, terminating unprofitable agents, et cetera. You know, obviously the Homeowner’s results in 2012 are improved, so it appears those efforts are definitely paying off. I guess my question is, you know, how close are you to really feeling good about Homeowners? It appears Homeowners is on the rise. Do you think you’re kind of 60% of the way to feeling really good about that line? Is it 80%? I guess any commentary there would be appreciated. Thanks.

Bob Restrepo

That’s a good question. It’s really a multi-step process in terms of us feeling good about it. I’m not sure if in my lifetime I’ll ever feel good about it because it’s so volatile. And the weather, I mean, as I’ve said in the past, what we’ve assumed with the weather that we’ve seen over the last five years is going to continue for the foreseeable future and we’ve baked that into our underwriting, our risk management and our pricing actions, very volatile. So when I look at the future of Homeowner’s the first step is to make an underwriting profit and we’re darn close to that. As I implied in my comments, barring a return of 2011, I’m increasingly confident we’ll make an underwriting profit in Homeowner’s this year in 2013.

But that still doesn’t mean we’re making an acceptable risk adjusted return in the line and we’ll need at least another year of the kind of price increases that we’ve been getting over the past couple of years to kind of put us in hollering distance of what I think is an appropriate risk-adjusted return for the line. But we’ve really got to target combined ratios in the low-90s to high-80s to have an appropriated risk-adjusted return given the short-tail nature of the line and given the volatility of the line and we’re probably at least 10 points from there. So we’ve been – we’re finally ahead of the loss curve and we’ve been chasing that for four years now. So what we’re looking for going forward over the next two years as these price increases earn out and everything else we’ve been doing earns out margin improvements.

Steven [Inaudible] – Philo Smith

Okay, thanks.

Operator

Ron Bobman from Capital Returns, you may ask your question.

Ron Bobman – Capital Returns

Hi. Thanks a lot. Good morning and congrats on the results as well. There was a question, the last caller asked about the RED reserve balance and you answered, I think, 140, 150. And I think you said group. So just so that I understand, would that be a gross reserve balance for the mutual as well as the stock company?

Bob Restrepo

No, yeah, I added to that confusion, so I apologize. The number I was quoting would be just a public company so you would divide that by 0.65 if you wanted to get the group number.

Ron Bobman – Capital Returns

Okay, I just wanted to – okay, thanks. And then I had a question about the canceled agents. When you speak of canceled agents, do you mean canceled for all StateAuto lines of business, canceled for personal lines only or canceled for homeowners?

Bob Restrepo

It varies. For the most part – it varies. Our focus is really on personal lines. A lot of our agents are traditional agents that have been with us a long time. We’re primarily, if not almost exclusively personals line agencies. So for those agencies where we never had had much of a commercial lines presence or don’t see much of a future, we terminate the entire relationship. But as you can see within our production results, we’re getting some good traction and production in commercial lines, partly because we’re providing somewhat larger accounts than we’ve traditionally written, somewhat because of the recovering economy, somewhat because the price increases. So we’re getting a good response from the larger, more sophisticated commercial agencies and if they’re in unprofitable properties for those agencies we terminated the personals lines relationship but our continuing with the commercial lines relationship.

Ron Bobman – Capital Returns

So when you speak of canceled – how many – what’s the number – if I missed it, I apologize.

Bob Restrepo

I think all in, it’s about 120 agencies. I’ve primarily focused in states where I’ve had the worse experience, like Kentucky, Tennessee, Alabama, Georgia and somewhat in Indiana and Ohio, but it’s more where I’m sitting here in Columbus, it’s a little bit more south and east of where I’m sitting.

Ron Bobman – Capital Returns

And what’s the company’s obligation, even though you’ve told the agent, you know, no more personal lines production, homeowners in particular, you’ve canceled them, what’s your obligation to actually provide a renewal quote to a homeowner’s insurer?

Bob Restrepo

It varies by state. Some states, like Minnesota were we got a lot smaller three or four years ago, you had to offer at least one renewal offer and then the business runs off so it takes two years basically for the business to run off. Most of the states that I just talked about – in fact, all of the states I think I just discussed don’t have that one renewal requirement. They’ll only terminate an agent if it’s effective immediately for new business in these states and then as the policies come up for renewal, they’re run off. We usually give at least either 90 to 180 days advanced notice so there’s about a year and a half lag. But this process has been underway for a year now.

Ron Bobman – Capital Returns

And just sort of what all this ties back to, so if we focus on the homeowner’s book that is continuing, you know, it’s the book ex the cancelations and the rates that you cite as far as the renewal rate increases and I want to say it was in the 20s I thought I heard you say, that’s – that was sort of speaking to, I think, to the whole book. Is that 20-plus number a good number for, on average, the homeowners book that is with continuing agents.

Bob Restrepo

Yes.

Ron Bobman – Capital Returns

Okay, thanks a lot, guys. Best of luck and I hope it continues.

Bob Restrepo

Thank you.

Operator

(Operator Instructions). Mr. Greenberg, your line is open again.

Larry Greenberg - Langen McAlenney

[Inaudible] CAT weather impact did that. And would you characterize your non-CAT weather as better than average in…

Bob Restrepo

No, I wouldn’t, Larry. ’11 was worse than average on both, obviously CATs but also non-CAT weather was much worse. I think the experience we had in 2012 was closer to historic patterns. Frankly, if you factor in the impact of earn premium from a dollar standpoint, it’s probably a little worse than what we’ve experienced, let’s say over the last 10 years or so, but as a percentage of premium, it was much closer to what we would ordinarily expect.

Larry Greenberg - Langen McAlenney

Okay. Great, thanks.

Bob Restrepo

No help, no hurt.

Operator

There are no further questions at this time.

Steve English

Well, thank you, Valerie and we want to thank all of you for participating in our conference call and for your continued interest in and support of StateAuto Financial Corporation. We look forward to speaking with you again on our first quarter earnings call which is currently scheduled for April 30, 2013. Thank you and have a good day.

Operator

This concludes your conference call. You may now disconnect.

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