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State Auto Financial (NASDAQ:STFC)

Shareholder Analyst Conference Call

May 3, 2013 10:00 am ET

Executives

Robert P. Restrepo – Chairman and Chief Executive Officer

James A. Yano – Vice President, Secretary and General Counsel

Kyle Anderson – AVP Director of Corporate Communication

Robert P. Restrepo Jr.

Good morning and welcome to the 2013 Annual Meeting of Shareholders of State Auto Financial Corporation and I’ll call the meeting to order. My name is Bob Restrepo, Chairman, CEO and President of State Auto Financial Corporation. I’d like to welcome all of our shareholders, employees, agents and other guests as well as those joining us on the worldwide web. Those of you attending via the Internet have the ability to advance our slides that we’ll be using today. I’ll try to prompt you periodically as we go through the program, so you can stay with us.

First of all, I’d like to introduce the members of your Boards of Directors. I’ll introduce them to you by company and ask that you hold your recognition until they are all standing up. Beginning with State Auto Financial Corporation, STFC with Bob Baker, Dave D’Antoni, Eileen Mallesch, Tom Markert, David Meuse, Elaine Roberts, Sandy Trevor, and Paul Williams; and then turning with State Auto Mutual, Alison Coolbrith; Michael Fiorile, Jim Kunk; Paul Otte; Marsha Ryan; Ed Simcox; Dwight Smith; and Roger Sugarman. Thank you very much

The order of business at this morning’s meeting will be as follows. First, we’ll cover the procedural matter required to conduct the meeting, next we’ll consider and act upon matters set forth in the company’s proxy solicitation material distributed to shareholder in connection with the Annual Meeting, and finally we’ll present a report on the company’s operations in 2012 and in the first quarter of 2013. I like to ask our Secretary and General Counsel, Jay Yano to report on the procedural requirements for the meeting.

James A. Yano

A complete list of our shareholders of record for State Auto Financial Corporation who are entitled to vote at this meeting arranged in alphabetical order and noting the address and number and class of shares held by each such shareholder is available and subject to inspection by any shareholder during this meeting. The list is maintained by Joseph Boeckman and Kyle Anderson sitting over to my right.

Mailing of the notice of the Annual Meeting of Shareholders, our proxy statement and the former proxy was commenced on April 2, 2013 to shareholders of record as of March 8, 2013. I received an affidavit with mailing from Broadridge Financial Solutions confirming the mailing. The Directors in the company have appointed Kyle Anderson and Joseph Boeckman, Joe is an attorney with the law firm of Baker & Hostetler, as our Inspectors of Election.

Joe and Kyle are responsible for determining the number of shares outstanding, voting rights with respect to those shares, the number of shares represented at this meeting, the existence of a quorum, and the authenticity, validity and effect of the proxies. We also receive votes, ballots, consents and waivers, and they will hear and determine all challenges and questions arising in connection with any vote. They count and tabulate all votes, consents, waivers and releases, they determine and announce the results, and they do such other acts which are proper and necessary to conduct the election of vote at this meeting.

I received the report from Joe and Kyle, which states that the Inspectors have determined that as of March 8, 2013, the record date for this meeting, the company had issued an outstanding 40,515,134 common shares, of which 39,265,917 shares or 96.91% of the outstanding shares are represented at this meeting in person and by proxy. As a consequence, we have a valid quorum and we can conduct business at this meeting.

Robert P. Restrepo Jr.

Thank you. Thank you very much, Jay. This morning we’ll be voting by ballot on the matters described in detail in the Proxy Statement. The proxies will vote in accordance with instructions on the proxy forms. All shareholders should file their proxy forms with the Inspectors of Election to facilitate the tabulation of votes, unless they wish to vote separately by ballot.

If any shareholder wishes to vote in person on any of the four proposals to be presented at this meeting, please raise your hand at this time and one of the Inspectors of Election will provide you with ballots, which will be collected while the polls are opened for the voting on each proposal. Is there anybody that wishes to vote in person? Seeing none.

The first order of business is the election of Directors of the company. We’ll be voting on the election of three Class I Directors, and now I declare the meeting open to receive nominations, now and I’ll ask Jay Yano to present the formal resolution nominating the individuals recommended by the Nominating and Governance Committee of the company’s Board of Directors.

James A. Yano

Thanks, Bob. Result, that the following individuals are hereby nominated for election as Class I Directors of the company, each to hold office for a three-year term and until a successor is elected and qualified. Robert E. Baker, Thomas E. Markert, and Alexander B. Trevor.

Robert P. Restrepo Jr.

Are there any other nominations? I daeclare the nomination is closed and the poll is open for voting. Is there anyone who has not voted, if so please raise your hand, if your ballot needs to be collected. Hereby, I declare the poll closed. Will the Inspectors of Election please announce the results?

Kyle Anderson

Directors; Baker, Markert, and Trevor have each been reelected as Class I Directors by more than 99.3% of the votes submitted by the company’s shareholders. The final tabulation will be available after the meeting.

Robert P. Restrepo Jr.

Great. Thank you, Kyle. The next order of business is to vote on Proposal Two, which is a proposal to approve Amendment No. 2 of the company’s 2009 Equity Incentive Compensation Plan and to reaffirm the material terms of such plan as modified and described in the Proxy Statement, and Jay will present the formal resolution.

James A. Yano

Result for Amendment No. 2 to the 2009 Equity Incentive Compensation Plan as described in the Proxy Statement for this Annual Meeting, be and hereby is approved and that the material terms of the Plan, be and hereby, are reaffirmed as modified as described in the Proxy Statement for this Annual Meeting.

Robert P. Restrepo Jr.

Is there any discussion here the resolution? The discussion is closed and I declare the polls are open for voting on the resolution. Again, please raise your hand if your ballot needs to be collected. I hereby declare the poll closed, and will the Inspectors of Election report the results of the voting please?

Kyle Anderson

The preliminary results of balloting show that more than 97.6% of the outstanding shares represented in person or by proxy at this meeting has been voted in favor of the approval of the resolution. Final tabulation will be available after this meeting.

Robert P. Restrepo Jr.

Thank you, again, Kyle. The next order of business is the vote on proposal 3, which is a proposal to ratify the selection of Ernst & Young LLP as the company’s independent registered public accounting firm for 2013, and again, Jay will present the formal resolution.

James A. Yano

Results of the selection of Ernst & Young LLP as the company’s independent registered public accounting firm, be and hereby is ratified and approved.

Robert P. Restrepo Jr.

Is there any discussion on the resolution? The discussion is closed and I declare the polls open for voting on the resolution, please raise your hand again if you need a ballot or hand of ballot that needs to be collected. I would like to declare the poll closed and with the Inspectors of Election report the results of the voting on Proposal 3.

Kyle Anderson

The preliminary results of the balloting show that more than 98% of the outstanding shares represented in person or by proxy at this meeting has been voted in favor of the approval of the resolution. Final tabulation will be available after this meeting. Thank you.

Robert P. Restrepo Jr.

Thank you. The last proposal we’ll vote on today at this meeting is Proposal 4, which concerns the advisory vote on executive compensation required by the Dodd–Frank Act. The Proposal 4 is an advisory vote on compensation paid to our named executive officers as disclosed in our Proxy Statement for this meeting. And again, Jay will present the last formal resolution on Proposal 4.

James A. Yano

Results of the shareholders in the company approved on an advisory basis, the compensation of the company’s named executive officers as disclosed in the proxy statement for the company’s 2013 Annual Meeting of Shareholders under the compensation, discussion and analysis section and the tables note generative disclosure relating to compensation are named executive officers of the company.

Robert P. Restrepo Jr.

Thank you, Jay. Is there any discussion on the resolution? The discussion is closed and I declare the polls open for voting on the resolution. Please raise your hand if your ballot needs to be collected. I hereby declare the poll closed and with the Inspectors of Election report the results of the voting.

Kyle Anderson

The preliminary results of the balloting show that more than 98% of the outstanding shares represented in person or by proxy at this meeting has been voted in favor of the approval of the compensation of the company’s named executive officers as disclosed in the proxy statement for this meeting. Final tabulation will be available after this meeting. Thank you.

Robert P. Restrepo Jr.

There’s no other business. I would like to motion, I’ll entertain a motion and close the business part of the meeting, so that we may proceed with the informational session. Now for a second speak English. All those in favor say I and the approached motion carries.

The business session of the 2013 Analyst Shareholders Meeting is now closed. But I would like before I get into my overview of the business results, I’d like to introduce Eric Schreiber, Craig Marshall, Andrea Hecht, Richard Lipovich who were from the firm Ernst & Young, our auditors for 2013, as they could stand and be represented, be presented. Anybody have any questions? Thank you and thanks for joining us today.

I’ll now move forward with my comments on 2012 and the first quarter of 2013. 2012 State Auto made substantial progress in improving results. Our goal remains to produce sustained underwriting profitability and returns on shareholder equity exceeding 10%. Progress accelerated 2013 this year as demonstrated in our first quarter results.

Notwithstanding our improving results, I’m personally disappointed in our 2012 performance. Despite the best efforts of our talent team with associates, State Auto suffered the third worst catastrophe year in the last 15 years producing catastrophe losses well in excess of what we expected. In addition, our performance was hurt by the shutdown and reserves strengthening of our former business unit RED. RED represented a brief and very disappointing business relationship.

It implied our 2012 combined ratio by over 5.5 points and left the significant improvements we made in our operating performance last year. After strengthening reserves and dissolving the business, we are very optimistic about our ability to further improve results and generate the kinds of returns our investors expect and deserve.

Slide 12, shows substantially improved results in 2012 relative to 2011 in an income statement format. Premiums declined resulting from the change in the quota share pooling arrangement we have with State Auto Mutual. STFC now retains 55% of State Auto group results. In the recent past, the pooling percentage was 80%.

We produced positive net income and a positive return on equity following the catastrophic year of 2011. And we increased book value per share to $18.22. The result is net of $2.48 a share for a evaluation allowance on deferred tax assets.

Our goal remains to produce the profits necessary to remove the valuation allowance over the next 18 months or so and significantly enhance book value. Slide 13 shows the improvement we’ve made in our combined ratio results despite the above average catastrophe losses and a significant impact of the RED reserve strengthening.

In 2012, ex-catastrophe loss ratio results benefited from continued underwriting discipline, increasing prices, and superior claim handling. We expect to see continued improvements in our loss ratio performance and we are targeting ex-catastrophe loss ratios at a high 50% range. Improving our loss ratio results and our risk management capability is political. We’ve seen a fundamental and dramatic change in the weather.

As you can see from Slide 14, industry losses from what we call thunderstorm activity remain at historically high levels. Thunderstorm losses do not include Hurricanes, but they do include losses from Tornados, Wind and Hail. As a result, the slide does not include Hurricane Ike which affected our results in 2008, but it does include Superstorm Sandy in 2012.

However, you define it, the weather has clearly changed and we’ve changed our view in the future accordingly. We underwrite price and manage our risk portfolio assuming that the last five years is more predictive of the future than the previous 40 years. That’s why we’ve been so aggressive in fixing our homeowners business and managing our portfolio of property risks and our efforts are paying off.

Slide 15 shows a substantial improvement we’ve made in our underwriting performance. In the first quarter this year, we produced a combined ratio result of a 100.2%. Expenses typically run higher in the first quarter and we expect to achieve expense ratio results roughly comparable with the last two years by year end.

In addition the impact of the runoff from RED programs disproportionately affected first quarter results. Our largest terminated program completed its runoff in the first quarter and we expect the impact from RED to diminish throughout the rest of the year.

On the other hand, we benefited from normal first quarter capacity experience. Although, our first quarter result was much better than the five-year average, it is comparable to what we would have typically expected to see prior to 2008. Catastrophe losses were also reduced because of the homeowners quota share treaty that we put in place at the end of 2010.

Although, the homeowners quota share treaty does protect our capital and provide us time to complete, our homeowners remediation plan, it does come at a cost. We see premiums and losses to our reinsurance partners, but we’ve retained the loss adjustment expenses. The combination exceeded premiums and retained claim expenses increases both our expense ratio and our ex-catastrophe loss ratio.

So you can see on Slide 16, removing the impact of red and the homeowners quota share treaty, better illustrates the quality of our underlying, underwriting performance. Our expense ratio is reasonably competitive, our ex-catastrophe loss ratio is quite good, and our catastrophe losses are more normal.

Continuing to improve our underwriting performance remains our highest priority and we’re pleased with the progress we’ve made, but we won’t be satisfied until we can consistently achieve underwriting profitability and double-digit returns on equity. Our most important driver to improving results will be achieving price increases and each segment and for every line of business as shown on Slide 17.

in the first quarter, personal lines prices increased close to 10%. Prices continued to increase in the business insurance segment and our result for the first quarter exceeded 7% with healthy increases in all lines. By the end of the year, we expect prices in the business insurance segment to increase in the 8% to 10% range.

The specialty segment workers’ compensation prices are up close to 10% and we’re getting a healthy increases and our excess in surplus and program business written by Rock Health. Homeowners continued to benefit from price increases, geographic diversification, and loss mitigation.

In 2012, the combined impact rate increases, insurance to value, and property value upgrading increased to our homeowner prices by over 20%. We expect to see a comparable result this year in 2013. As these actions earn-out, we’re seeing a significant reduction in on our ex-catastrophe loss ratio result and expect to see over time reduced catastrophe loss ratios as well. Our geographic diversification and loss mitigation actions are also having the desired impact.

We’re reducing our presence in catastrophe pronged states and rolling out deductible programs to mitigate the impact of bad weather on our results. We continue to be very pleased with our claim performance. Service is never been better, our cost structure continues to shrink, and we’re doing an excellent job managing and then the repay out.

The improvement in our property, auto physical damage, and liability underwriting results is largely driven by claim performance. Looking to the future, we expect to see improvements in our automobile bodily injury and personal injury protection results as well. We’re continuing runoff from RED programs, will also improve results. We expect the year-end impact from RED to be de minimis.

As we improved our underwriting performance, we’re also mindful of stringent cost control. As you’ve seen our expense ratio performance has improved, setting aside the impact of the homeowner quota share treaty, which will continue through 2014.

And lastly, and most importantly, we won’t succeed as our employees aren’t engaged. Our ability to fix homeowners, well commercialize, integrate specialty, reduce superior claim performance and maintain high levels of customer service is all dependent on an engaged and committed workforce.

We set metrics, we monitor results, and we respond to the feedback that we’ve received. We won’t succeed as our employees aren’t committed to our success, and the improved results we’ve reported are direct results of improving associative engagement.

As we’ve restructured our business processes and implemented plans to improve results, we continue to grow group premiums as illustrated on Slide 18. We finished 2012. we’re slightly over $1.9 billion in direct written premium. In 2013, we expect to see similar trends of flat Personal Insurance reduction as we complete the homeowners’ remediation. Double digit increases in business insurance and mixed production results in the Specialty segment with strong Rockhill growth offset by run off from RED.

Slide 19 shows the impact of the homeowner quota share treaty, which we put in place at the end of 2010. This is a three-year program, I’m sorry, at the end of 2011. This is a three-year program and will continue to affect the production results of State Auto Financial Corporation through 2014. Looking at the segments briefly, we are very pleased with the progress we made in Personal Insurance as shown on slide 20, and we look forward to achieving an underwriting profit in 2013 borrowing unusually bad catastrophes like what we saw in 2011. Expense ratios are seasonally high in the first quarter and unless catastrophe loss ratio, results will improve as we earn out price increases in personal automobile and homeowners.

To concede on Slide 21, it’s Personal Insurance segment that’s affected by the homeowner quota share reinsurance treaty. Setting aside the impact of the treaty, we’ve made substantial progress and had an outstanding quarter in the Personal Insurance segment. Slide 22 shows the price increases we’re achieving, the healthy premium growth we’ve reported and the net decline in policy count as we shrink our presence in catastrophe-prone states.

Slide 23 shows business insurance results and this is where we need more work and more improvement. Although, expense ratio results will settle down a bit as the year progresses, they remain higher than industry norms. Continued premium growth, improving productivity and riding a larger mix of larger accounts will improve results. In addition to the price increases we’re achieving robust improved loss ratio and expense ratio results. We expect to see substantial improvement in the business insurance segments beginning this year.

Slide 24 shows price improvements we’re getting relative to the industry. As I said earlier, we expect to see a continued lift in pricing and plan for an 8% to 10% increase by year-end. Slide 25 shows a significant improvement we made with our Specialty results driven by very strong performance in Rockhill and substantially improved results in workers’ compensation offset by the impact of RED, which is illustrated on slide 26. We have exceptionally strong results without RED in our excess and surplus property, excess and surplus casualty, and we had industry leading results in workers’ compensation resulting from marketing discipline and our state-of-the-art claims process.

Results in our program line will improve as we build scale, increase prices and complete the runoff from RED. We are off to an excellent start in 2013, and we’ve made substantial progress on all our key priorities as shown on Slide 27. Prices are up in each segment and for each line. Homeowner share produced an underwriting profit this year resulting from higher prices, geographic diversification, and the loss mitigation initiatives we’ve been putting in place since the end of 2008. We’ll continue to build out a substantial and profitable Specialty business and complete the RED run-off.

We think we have a top quartile claim organization and we’ll continue to focus on improving performance for service, cost and indemnity management. We look to improve service and productivity in our business insurance segment and ultimately improve both loss ratio and expense ratio performance.

We now have the processes, the operating platform and most importantly, the people, to achieve success. Our strategy is sound, our execution results are improving, I’m very confident that we are well positioned to return State Auto Financial Corporation to a sustained underwriting profitability and superior returns for our shareholders.

And with that, I’d be happy to take any questions.

I know most of you here asked you questions when we reviewed first quarter results and we really are off to a terrific start. And we’re already, it’s hard to believe, we’re already entered through the year. So April is looking pretty good so far. So I’m very hopeful that we are going to have a – the kind of year that you all deserved here and a kind of year that our shareholders definitely deserve.

With that, I’ll call the meeting to a close and we are adjourned. Thank You.

Question-and-Answer Session

[No Q&A session for this event]

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