STATE AUTO FINANCIAL CORP - 10-K Annual Report

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UNITED STATES
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, 2002

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. _____

Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act).

Yes X No
--- ----

On June 28, 2002, 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 $208,937,312.

On March 21, 2003, the Registrant had 39,162,572 Common Shares
outstanding.

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 23, 2003, which Proxy Statement
will be filed within 120 days of December 31, 2002, are incorporated by
reference in Part III, Items 10, 11, 12 and 13 of this report.

Page 3

IMPORTANT INFORMATION REGARDING FORWARD-LOOKING STATEMENTS

All statements, other than statements of historical facts, included in
this Form 10-K of State Auto Financial or incorporated herein by reference,
including, without limitation, statements regarding State Auto Financial's
future financial position, business strategy, budgets, projected costs, goals
and plans and objectives of management for future operations, are
forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. Forward-looking statements generally can be
identified by the use of forward-looking terminology such as "may," "will,"
"expect," "intend," "estimate," "anticipate," "project," "believe" or "continue"
or the negative thereof or variations thereon or similar terminology.
Forward-looking statements speak only as the date the statements were made.
Although State Auto Financial believes that the expectations reflected in
forward-looking statements have a reasonable basis, it can give no assurance
that these expectations will prove to be correct. Forward-looking statements are
subject to risks and uncertainties that could cause actual events or results to
differ materially from those expressed in or implied by the statements. For a
discussion of the most significant risks and uncertainties that could cause
State Auto Financial's actual results to differ materially from those projected,
see Item 7 "Forward-Looking Statements; Certain Factors Affecting Future
Results." Except to the limited extent required by applicable law, State Auto
Financial undertakes no obligation to update or revise any forward-looking
statements, whether as a result of new information, future events, or otherwise.

PART I

ITEM 1. BUSINESS

(a) GENERAL DEVELOPMENT OF BUSINESS

State Auto Financial Corporation ("State Auto Financial" or "STFC") is an
insurance holding company formed in 1990 and headquartered in Columbus, Ohio.
STFC engages primarily in the property and casualty insurance business through
its wholly-owned subsidiaries, State Auto Property and Casualty Insurance
Company ("State Auto P&C"), Milbank Insurance Company ("Milbank"), Farmers
Casualty Insurance Company ("Farmers Casualty"), State Auto Insurance Company of
Ohio ("SA Ohio"), and State Auto National Insurance Company ("National").
Farmers Casualty owns 100% of the outstanding common shares of the
property-casualty insurer, Mid-Plains Insurance Company ("Mid-Plains").

Approximately 67% of State Auto Financial's outstanding common shares are
owned by State Automobile Mutual Insurance Company ("Mutual"), an Ohio mutual
property and casualty insurance company organized in 1921. Mutual owns 100% of
the outstanding common shares of property-casualty insurers, State Auto Florida
Insurance Company ("SA Florida") and State Auto Insurance Company of Wisconsin
("SA Wisconsin"), formerly named Midwest Security Insurance Company. Mutual is
also the sole owner of Meridian Insurance Group, Inc. ("MIGI"), an insurance
holding company with two wholly-owned property and casualty insurance
subsidiaries: Meridian Security Insurance Company ("Meridian Security") and
Meridian Citizens Security Insurance Company ("Meridian Citizens"). In 2001,
Mutual merged with Meridian Mutual Insurance Company ("Meridian Mutual"), with
Mutual continuing as the surviving corporation, and in a substantially
concurrent transaction Mutual acquired the outstanding shares of MIGI. Another
of MIGI's insurance subsidiaries, Insurance Company of Ohio ("ICO"), was
dissolved effective January 15, 2003. MIGI is also a party to an affiliation
agreement with the property-casualty insurer, Meridian Citizens Mutual Insurance
Company ("Meridian Citizens Mutual"). Meridian Security, Meridian Citizens, ICO
and Meridian Citizens Mutual are hereafter referred to collectively as the
"Meridian Insurers," and together with MIGI, they are hereafter referred to
collectively as the "Meridian Companies."

Another wholly-owned subsidiary of STFC is Stateco Financial
Services, Inc. ("Stateco"), which provides investment management services
to affiliated insurance companies. See "Investment Management Services" in
the "Narrative Description of Business." STFC also owns Strategic Insurance
Software, Inc. ("S.I.S."), a developer and seller of insurance-related
software. The limited liability company, 518 Property Management and
Leasing, LLC ("518 PML"), whose members are State Auto P&C and Stateco,
owns and leases real and personal property to affiliated companies. The
results of operations of S.I.S. and 518 PML are insignificant to the total
operations of STFC.

Page 4

State Auto Financial and its subsidiaries, State Auto P&C, Milbank,
Farmers Casualty, SA Ohio, National, Mid-Plains, Stateco, S.I.S., and 518 PML,
are collectively referred to as the "Company."

State Auto P&C has participated in a quota share reinsurance pooling
arrangement with Mutual since 1987 (the "Pooling Arrangement"). The participants
in the Pooling Arrangement currently are State Auto P&C, Mutual, Milbank, SA
Wisconsin, Farmers Casualty, SA Ohio, and SA Florida, collectively referred to
hereafter as the "Pooled Companies." State Auto P&C, Milbank, Farmers Casualty
and SA Ohio are collectively referred to hereafter as the "Pooled Subsidiaries."
Effective January 1, 2003, the pooling percentages were modified as follows:
Mutual (18.3%), State Auto P&C (59%), Milbank (17%), SA Wisconsin (1%), Farmers
Casualty (3%), SA Ohio (1%) and becoming party to the agreement on this same
date, SA Florida (0.7%). See "Pooling Arrangement" in the "Narrative Description
of Business." The Pooled Companies, National, Mid-Plains and the Meridian
Insurers are collectively referred to as the "State Auto Group."

The insurers in the State Auto Group write a broad line of property and
casualty insurance, including standard personal and commercial automobile;
nonstandard personal automobile; homeowners; commercial multi-peril; workers'
compensation; general liability and fire insurance through approximately 22,300
independent insurance agents associated with approximately 3,500 agencies in 26
states. The State Auto Group's insurance products are marketed primarily in the
central and eastern parts of the United States, excluding New York, New Jersey
and the New England States.

(b) FINANCIAL INFORMATION ABOUT SEGMENTS

The Company currently operates in four insurance segments. Prior to 2001,
it operated in two segments: the standard insurance segment, consisting of the
business operations of the Pooled Subsidiaries, and the nonstandard segment,
consisting of the business operations of National and Mid-Plains. With the
merger of Meridian Mutual into Mutual and the July 1, 2001, addition of the
former Meridian Mutual business to the Pooling Arrangement (see "Pooling
Arrangement" in "Narrative Description of Business"), the Company renamed the
two existing insurance segments as the "State Auto Standard Segment" and the
"State Auto Nonstandard Segment" and added two more insurance segments: the
"Meridian Standard Segment," for the standard insurance business of the former
Meridian Mutual, and the "Meridian Nonstandard Segment," for the nonstandard
insurance business of the former Meridian Mutual. Financial information about
all these segments is set forth in Note 15 to the Company's Consolidated
Financial Statements, included in Item 8 "Financial Statements and Supplementary
Data." Additional information regarding the Company's insurance and
non-insurance segments is provided in "Narrative Description of Business."

(c) NARRATIVE DESCRIPTION OF BUSINESS

PROPERTY AND CASUALTY INSURANCE

POOLING ARRANGEMENT

The Pooled Companies are parties to an intercompany Pooling Arrangement
under the Reinsurance Pooling Agreement Amended and Restated as of January 1,
2000, as amended by the First, Second, Third and Fourth Amendments (the "2000
Pooling Agreement"). The Pooling Arrangement covers all the property and
casualty insurance written by the parties, except voluntary assumed reinsurance
written by Mutual and catastrophe inter-company reinsurance written by State
Auto P&C. Under the terms of the Pooling Arrangement, each of the Pooled
Subsidiaries, SA Wisconsin and SA Florida cede premiums, losses and expenses on
all of their business to Mutual; in turn, Mutual cedes to each of the Pooled
Subsidiaries, SA Wisconsin and SA Florida a specified portion of premiums,
losses and expenses and Mutual retains the balance.

Page 5

The following table sets forth a chronology of the participant changes
that have occurred in the Pooling Arrangement since it became effective on
January 1, 1987:

- ------------------ -------- ----------- --------- --------------- ----------- -------- ----------
State Farmers SA
Year *** Mutual Auto P&C Milbank SA Wisconsin Casualty SA Ohio Florida
- ------------------ -------- ----------- --------- --------------- ----------- -------- ----------

1987-1991 80% 20% N/A N/A N/A N/A N/A
- ------------------ -------- ----------- --------- --------------- ----------- -------- ----------
1992-1994 70 30 N/A N/A N/A N/A N/A
- ------------------ -------- ----------- --------- --------------- ----------- -------- ----------
1995-1997 55 35 10* N/A N/A N/A N/A
- ------------------ -------- ----------- --------- --------------- ----------- -------- ----------
1998 52 37 10** 1 N/A N/A N/A
- ------------------ -------- ----------- --------- --------------- ----------- -------- ----------
1999 49 37 10 1 3 N/A N/A
- ------------------ -------- ----------- --------- --------------- ----------- -------- ----------
2000-9/30/2001 46 39 10 1 3 1 N/A
- ------------------ -------- ----------- --------- --------------- ----------- -------- ----------
10/1/2001-2002 19 59 17 1 3 1 N/A
- ------------------ -------- ----------- --------- --------------- ----------- -------- ----------
2003 18.3 59 17 1 3 1 0.7
- ------------------ -------- ----------- --------- --------------- ----------- -------- ----------

* At this time Milbank was a wholly owned subsidiary of Mutual

** In July, 1998 Milbank became a wholly owned subsidiary of STFC

*** Time period is for the year ended December 31, unless otherwise noted.

The following table sets forth a summary of the Pooling Arrangement
participant percentages of STFC and Mutual, aggregating their respective
wholly-owned subsidiaries:

- ---------------------------------------------------------------------------
Mutual (in the
Year*** Pooled Subsidiaries aggregate)
- ---------------------------------------------------------------------------

1987-1991 20% 80%
- ---------------------------------------------------------------------------
1992-1994 30 70
- ---------------------------------------------------------------------------
1995-1997 35 65
- ---------------------------------------------------------------------------
1/1/1998-6/30/1998 37 63
- ---------------------------------------------------------------------------
7/1/1998-12/31/1998 47 53
- ---------------------------------------------------------------------------
1999 50 50
- ---------------------------------------------------------------------------
2000 - 9/30/2001 53 47
- ---------------------------------------------------------------------------
10/1/2001-2003 80 20
- ---------------------------------------------------------------------------

*** Time period is for the year ended December 31, unless otherwise noted.

With the June 2001 merger of Meridian Mutual into Mutual, all insurance
business written by Meridian Mutual legally became the business of Mutual and
was included in the Pooling Arrangement effective July 1, 2001. Representing
approximately 20% of the Pooled Companies' business, the former Meridian Mutual
business is monitored as standard and nonstandard segments separate from the
State Auto standard and nonstandard business. Over time, it is anticipated that
the Meridian segments will decrease and eventually disappear as those segments
are fully integrated over to the State Auto systems platform. See "Standard
Insurance Segment" and "Nonstandard Insurance Segment" in "Narrative Description
of Business."

Prior to 2001, the pooling percentages were 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. As a result of the changes made to the pooling percentages in 2001, it is
not management's current intention to recommend an adjustment to the Pooled
Subsidiaries aggregate participation percentage in the foreseeable future. Under
revised procedures, management of each of the Pooled Companies would make
recommendations to an independent committee of the Board of each of Mutual and
STFC. These independent committees would review and evaluate such factors as
they deem relevant and recommend any appropriate pooling change to the Boards of
both Mutual and STFC. 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. None of the Pooled Companies
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 underwriting risk among each of the
participants. Under the terms of the Pooling Arrangement, all

Page 6

premiums, incurred losses, loss expenses and other underwriting expenses are
prorated among the companies on the basis of their participation in the pool.
One effect of the Pooling Arrangement is to provide each participant with an
identical mix of property and casualty insurance business on a net basis.

The 2000 Pooling Agreement contains a provision excluding catastrophic
loss claims and loss adjustment expenses incurred by the parties in the amount
of $100 million in excess of $120 million, as well as the premium for such
exposures. State Auto P&C reinsures each insurer in the State Auto Group for
this layer of reinsurance under a Catastrophe Assumption Agreement. See
"Reinsurance" in the "Narrative Description of Business."

The direct business of the Meridian Insurers is not included in the
Pooling Arrangement and to that extent is not included in the insurance
operations of the Company. If State Auto P&C were required to pay catastrophe
losses of the Meridian Insurers under the above referenced Catastrophe
Assumption Agreement, those losses would impact the Company's results.

MANAGEMENT AGREEMENT

State Auto P&C's employees provide all organizational, operational and
management functions for all insurance affiliates within the State Auto Group
through management and cost sharing agreements. For the performance of its
services under three of the management agreements, State Auto P&C is paid a
quarterly management and operations services fee based on formulas outlined in
the agreements, to the extent specified performance standards are achieved.
Under the 2000 Midwest Management Agreement among State Auto P&C, Mutual and SA
Wisconsin, SA Wisconsin pays 0.75% of direct written premium for management and
operation services performed by employees of State Auto P&C. Pursuant to the
2000 Farmers Casualty Management Agreement among Farmers Casualty, Mid-Plains,
State Auto P&C, and Mutual, Farmers Casualty and Mid-Plains pay 0.75% of direct
written premium for management and operation services performed by State Auto
P&C's employees. Under the Management Services Agreement among State Auto P&C,
MIGI and the Meridian Insurers (the "MIGI Management Agreement"), each of the
Meridian Companies (other than ICO) pays State Auto P&C 10% of all State Auto
P&C's employee-related costs in exchange for the services of those employees, in
addition to reimbursing State Auto P&C for the actual costs of such services.
Mutual provides facilities for all the insurance affiliates under management or
cost sharing agreements.

While there had been in place a fee under an agreement between State Auto
P&C and Mutual (the "2000 Management Agreement"), as a result of the resolution
of a disagreement with the Ohio Department of Insurance, the fee aspect of that
agreement was terminated, effective October 1, 2001, and that arrangement
continues as a pure cost sharing arrangement. As a result of the loss of the
service fee under the 2000 Management Agreement, substantially all of State Auto
P&C's insurance operations management fee was eliminated effective October 1,
2001. Consequently, beginning with the first quarter 2002, the management and
operations services segment is included in the "other" category for segment
reporting as the results of this segment no longer meet the quantitative
thresholds for separate presentation as a reportable segment.

Each of the affiliated management and cost sharing agreements, except the
MIGI Management Agreement, has a ten-year term and automatically renews for an
additional ten-year period unless sooner terminated in accordance with its
terms. If the 2000 Management Agreement is terminated for any reason, the
Company would have to locate facilities to continue its operations, although the
Company does not anticipate such termination.

Investment management services are provided by Stateco. See
"Investment Management Services" in the Narrative Description of Business."

STANDARD INSURANCE SEGMENTS

The Company's share of the business written by the Pooled Companies
constitutes the Company's State Auto and Meridian standard insurance segments as
well as the Meridian nonstandard segment. See "Nonstandard Insurance Segment" in
the "Narrative Description of Business." The standard segments include personal
and commercial property and casualty insurance lines, including

Page 7

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 segments and the
nonstandard segments. 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 the State Auto and Meridian standard
segments and nonstandard segments.

The following tables set forth the statutory loss and loss adjustment
expense ("LAE") ratios by line of insurance and the combined ratio for the
standard insurance segments of the Company's business. These tables were
prepared in accordance with accounting practices prescribed or permitted by
state insurance authorities, for the periods indicated. The loss & LAE ratio is
the ratio of incurred losses and loss adjustment expenses, without consideration
of salvage and subrogation recoverable, to net earned premiums ("loss & LAE
ratio"). The combined ratio is a traditional measure of underwriting
profitability. The combined ratio is the sum of (a) the loss & LAE 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 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, although management fee income is substantially reduced after
October 1, 2001. See "Management Agreement" in the "Narrative Description of
Business."

The following table sets forth the aggregate statutory loss & LAE ratios
by line of insurance and the combined ratio for the Company's two standard
insurance segments, the State Auto standard insurance segment and beginning July
1, 2001, the Meridian standard insurance segment:

- ------------------------------------ --------------- ---------------------- --------------------
Standard Insurance Segments
Year Ended December 31(1)
- ------------------------------------ --------------- ---------------------- --------------------
2002 2001 2000
---- ---- ----
- ------------------------------------ --------------- ---------------------- --------------------

Loss & LAE ratios:
- ------------------------------------ --------------- ---------------------- --------------------
Automobile - Personal......... 68.8% 69.7% 63.9%
- ------------------------------------ --------------- ---------------------- --------------------
Automobile - Commercial....... 66.5% 90.1% 81.7%
- ------------------------------------ --------------- ---------------------- --------------------
Homeowners and Farmowners..... 85.1% 85.8% 78.8%
- ------------------------------------ --------------- ---------------------- --------------------
Commercial multi-peril........ 89.9% 100.4% 63.0%
- ------------------------------------ --------------- ---------------------- --------------------
Workers' compensation......... 83.7% 105.2% 65.2%
- ------------------------------------ --------------- ---------------------- --------------------
Fire and allied lines......... 58.9% 62.9% 58.8%
- ------------------------------------ --------------- ---------------------- --------------------
Other commercial liability.... 77.7% 58.2% 80.7%
- ------------------------------------ --------------- ---------------------- --------------------
Other personal lines.......... 37.4% 42.5% 34.6%
- ------------------------------------ --------------- ---------------------- --------------------
Other commercial lines........ 19.3% 27.1% 9.7%
----- ----- ----
- ------------------------------------ --------------- ---------------------- --------------------
Total loss & LAE ratio.............. 72.5% 76.2% 67.6%
- ------------------------------------ --------------- ---------------------- --------------------
Expense ratio....................... 30.2% 28.3% 27.1%
----- ----- -----
- ------------------------------------ --------------- ---------------------- --------------------
Combined ratio...................... 102.7% 104.5% 94.7%
====== ====== =====
- ------------------------------------ --------------- ---------------------- --------------------

(1) Reflects a combination of the loss experience of the Pooled Subsidiaries
after giving effect to reinsurance and the 2000 Pooling Agreement.

- -----------------------------------------

Page 8

The following tables provide the statutory loss and LAE ratios by line of
insurance and the combined ratio for the State Auto and Meridian standard
insurance segments, respectively.

- ------------------------------------ --------------------------------------------------------------
State Auto Standard Segment
Year Ended December 31(1)
- ------------------------------------ --------------------------------------------------------------
2002 2001 2000
---- ---- ----
- ------------------------------------ ------------------ ---------------------- --------------------

Loss & LAE ratios:
- ------------------------------------ ------------------ ---------------------- --------------------
Automobile - Personal ........ 67.5% 62.5% 63.9%
- ------------------------------------ ------------------ ---------------------- --------------------
Automobile - Commercial....... 63.5% 75.9% 81.7%
- ------------------------------------ ------------------ ---------------------- --------------------
Homeowners and Farmowners..... 81.1% 79.5% 78.8%
- ------------------------------------ ------------------ ---------------------- --------------------
Commercial multi-peril........ 80.8% 74.4% 63.0%
- ------------------------------------ ------------------ ---------------------- --------------------
Workers' compensation......... 84.4% 69.9% 65.2%
- ------------------------------------ ------------------ ---------------------- --------------------
Fire and allied lines......... 58.8% 62.8% 58.8%
- ------------------------------------ ------------------ ---------------------- --------------------
Other commercial liability.... 78.8% 54.5% 80.7%
- ------------------------------------ ------------------ ---------------------- --------------------
Other personal lines.......... 30.5% 44.1% 34.6%
- ------------------------------------ ------------------ ---------------------- --------------------
Other commercial lines........ 26.2% 27.8% 9.7%
----- ----- -----
- ------------------------------------ ------------------ ---------------------- --------------------
Total loss & LAE ratio............. 69.6% 66.3% 67.6%
- ------------------------------------ ------------------ ---------------------- --------------------
Expense ratio....................... 30.0% 28.4% 27.1%
----- ----- -----
- ------------------------------------ ------------------ ---------------------- --------------------
Combined ratio...................... 99.6% 94.7% 94.7%
===== ===== =====
- ------------------------------------ ------------------ ---------------------- --------------------

(1) Reflects a combination of the loss experience of the Pooled Subsidiaries
after giving effect to reinsurance and the 2000 Pooling Agreement.

- -----------------------------------------

- ----------------------------------------------- -----------------------------------------------------
Meridian Standard Segment Year Ended December 31(1)
- ----------------------------------------------- -------------------------- --------------------------
2002 2001
---- ----
- ----------------------------------------------- -------------------------- --------------------------

Loss & LAE ratios:
- ----------------------------------------------- -------------------------- --------------------------
Automobile - Personal ................... 75.1% 122.5%
- ----------------------------------------------- -------------------------- --------------------------
Automobile - Commercial.................. 76.5% 153.7%
- ----------------------------------------------- -------------------------- --------------------------
Homeowners and Farmowners................ 106.5% 136.3%
- ----------------------------------------------- -------------------------- --------------------------
Commercial multi-peril................... 107.5% 171.6%
- ----------------------------------------------- -------------------------- --------------------------
Workers' compensation.................... 82.7% 165.4%
- ----------------------------------------------- -------------------------- --------------------------
Fire and allied lines.................... 60.8% 66.9%
- ----------------------------------------------- -------------------------- --------------------------
Other commercial liability............... 50.0% 214.5%
- ----------------------------------------------- -------------------------- --------------------------
Other personal lines..................... 70.1% 27.1%
----- -----
- ----------------------------------------------- -------------------------- --------------------------
Total loss & LAE ratio......................... 85.5% 139.6%
- ----------------------------------------------- -------------------------- --------------------------
Expense ratio.................................. 31.3% 27.8%
----- -----
- ----------------------------------------------- -------------------------- --------------------------
Combined ratio................................. 116.8% 167.4%
====== ======
- ----------------------------------------------- -------------------------- --------------------------

(1) Reflects the loss experience of the Meridian standard segment assumed by the
Pooled Subsidiaries through the 2000 Pooling Agreement, beginning July 1, 2001.

- -----------------------------------------

NONSTANDARD INSURANCE SEGMENTS

The Company writes personal automobile insurance for nonstandard risks
through National and Mid-Plains. National is licensed in 24 states and active in
19 of those states. Mid-Plains operates in Kansas and Iowa.

Existing nonstandard auto risks in the Meridian nonstandard segment will
continue to be written by Mutual until such policies terminate. During the
fourth quarter of 2001, National's product and system platform began to be
introduced on a state by state basis to former Meridian agents, and by the end
of 2002 had been rolled out to all Meridian nonstandard states of operations. As
a result of the Company's integration efforts that occurred within the Meridian
nonstandard segment during 2001 and 2002, the Meridian nonstandard segment will
be included in the State Auto nonstandard segment beginning with the first
quarter of 2003.

Page 9

It is envisioned that National will eventually be the principal writer for
all nonstandard auto risks within the State Auto Group. Nonstandard automobile
products provide insurance for private passenger automobile risks that are
typically not acceptable to standard market companies for various reasons, such
as an insured's poor loss experience, poor driving record, or 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 provides the statutory loss & LAE ratios by line of
insurance for the Company's nonstandard insurance segments, which includes
National and Mid-Plains, and beginning July 1, 2001, the Meridian nonstandard
insurance segment:

- ------------------------------------------------ ----------------------------------------------------------
Nonstandard Insurance Segments
Year Ended December 31(1)
- ------------------------------------------------ -------------------- ------------------- -----------------
2002 2001 2000
---- ---- ----
- ------------------------------------------------ -------------------- ------------------- -----------------

Loss & LAE ratio:
- ------------------------------------------------ -------------------- ------------------- -----------------
Automobile................................. 79.0% 92.0% 81.4%
- ------------------------------------------------ -------------------- ------------------- -----------------
Expense ratio................................... 19.2% 21.7% 25.2%
----- ----- -----
- ------------------------------------------------ -------------------- ------------------- -----------------
Combined ratio.................................. 98.2% 113.7% 106.6%
===== ====== ======
- ------------------------------------------------ -------------------- ------------------- -----------------

(1) Reflects the combination of the loss experience of National and Mid-Plains
as well as the Meridian nonstandard segment assumed by the Pooled Subsidiaries
through the 2000 Pooling Agreement, beginning July 1, 2001.

- ----------------------------------------

The following tables set forth the statutory loss and LAE ratios and
combined ratios of National and Mid-Plains, which are engaged in the State Auto
nonstandard segment of the business, and beginning July 1, 2001, the Meridian
nonstandard segment, respectively:

- ------------------------------------------------ ----------------------------------------------------------
State Auto Nonstandard Segment
Year Ended December 31(1)
- ------------------------------------------------ ----------------------------------------------------------
2002 2001 2000
---- ---- ----
- ------------------------------------------------ -------------------- ------------------- -----------------

Loss & LAE ratio:
- ------------------------------------------------ -------------------- ------------------- -----------------
Automobile................................. 83.0% 77.9% 81.4%
- ------------------------------------------------ -------------------- ------------------- -----------------
Expense ratio................................... 18.3% 21.9% 25.2%
----- ----- -----
- ------------------------------------------------ -------------------- ------------------- -----------------
Combined ratio.................................. 101.3% 99.8% 106.6%
====== ===== ======
- ------------------------------------------------ -------------------- ------------------- -----------------

(1) Reflects the combination of the loss experience of National and
Mid-Plains.

- -----------------------------------------

- ------------------------------------------------- ----------------- ---------------------------
Meridian Nonstandard Segment
Year Ended December 31(1)
- ------------------------------------------------- ---------------------------------------------
2002 2001
---- ----
- ------------------------------------------------- ----------------- ---------------------------

Loss & LAE ratio:
- ------------------------------------------------- ----------------- ---------------------------
Automobile.................................. 48.7% 168.2%
- ------------------------------------------------- ----------------- ---------------------------
Expense ratio.................................... 31.9% 20.8%
----- -----
- ------------------------------------------------- ----------------- ---------------------------
Combined ratio................................... 80.6% 189.0%
===== ======
- ------------------------------------------------- ----------------- ---------------------------

(1) Reflects the loss experience of the Meridian nonstandard segment assumed by
the Pooled Subsidiaries through the 2000 Pooling Agreement, beginning July 1,
2001.

MARKETING

In its 26 states of operation, the State Auto Group markets its products
through approximately 22,300 insurance agents associated with approximately
3,500 independent insurance agencies. None of the companies in the State Auto
Group has any contracts with managing general agencies.

Page 10

National markets nonstandard products in 19 states exclusively through the
Company's network of independent agents. Mid-Plains writes nonstandard auto
insurance in Iowa and Kansas through the agency network of Farmers Casualty in
those states, and the Mid-Plains business is processed on National's system. The
former Meridian Mutual nonstandard products were also marketed through the
Meridian independent agency force, as well as agents specializing in nonstandard
coverage only. As noted, National's product has been introduced to these "former
Meridian agents." See "Nonstandard 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, including the following: regular travel by senior management and
branch office staff to meet with agents, in person, in their home states;
training opportunities; and an agent stock purchase 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)). The Company believes that, since agents and their customers
realize better service and efficiencies through automation, they value their
relationship with the Company. Automation can make it easier for the agent to do
business with the Company, which attracts prospective agents and enhances the
existing agencies' relationship with the Company.

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 Agencies. Inner Circle Agencies
are rewarded with additional trip and financial incentives, including additional
profit sharing bonus and additional contributions to their Inner Circle Agent
Stock Purchase Plan, a 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.

The Company receives premiums on products marketed in Alabama, Arkansas,
District of Columbia, Florida, Georgia, Idaho, Illinois, Indiana, Iowa, Kansas,
Kentucky, Maryland, Michigan, Minnesota, Mississippi, Missouri, North Carolina,
North Dakota, Ohio, Oklahoma, Pennsylvania, South Carolina, South Dakota,
Tennessee, Utah, Virginia, Washington, West Virginia and Wisconsin. During 2002,
the seven states that contributed the greatest percentage of direct premiums
written by the State Auto Group were: Ohio (18.3%), Kentucky (12.0%), Indiana
(8.5%), Tennessee (6.8%), Minnesota (6.1%), Pennsylvania (5.3%), and South
Carolina (4.1%).

Page 11

CLAIMS

Insurance claims on policies written by the Company are usually
investigated and settled by staff claims adjusters. The Company's claims
division 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. Achievement of these goals
supports the Company's marketing efforts by providing agents and policyholders
with prompt and effective service.

Claim settlement authority levels are established for each adjuster,
supervisor and manager based on his or her level of expertise and experience.
The claims division is responsible for reviewing the claim, obtaining necessary
documentation and establishing loss and expense reserves of certain claims.
Generally, property or casualty claims estimated to reach $100,000 or above are
sent to the home office to be supervised by claims division specialists.
Branches with small volumes of large claims report claims to the home office at
a lower dollar threshold. 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
division 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 third party, proprietary bodily injury evaluation software which
claims representatives use to help them value bodily injury claims, except for
the most severe injury cases, continues to be a valuable tool for the Company.
The Central Claims Department allows the Company to improve claims efficiency
and economy by concentrating the handling of smaller, less complex claims in a
centralized environment. The claims division also provides 24 hour, 7 days a
week claim service through associates in its Contact Center.

RESERVES

Loss reserves are management's best estimates at a given point in time of
what the Company expects to pay to claimants, based on facts, circumstances and
historical trends then known. During the loss settlement period, additional
facts regarding individual claims may become known, and consequently it often
becomes necessary to refine and adjust the estimates of liability. The Company's
results of operations and financial condition could be impacted, perhaps
significantly, in the future if the ultimate payments required to settle claims
vary from the liability currently recorded.

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, litigation and in house claims
processing costs from such losses.

Reserves for reported losses are initially 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. Case and formula
basis loss reserves are reviewed on a regular basis. As new data becomes
available, estimates are updated resulting in adjustments to loss reserves.
Generally, reported losses initially reserved on a formula basis which have not
settled after six months, are case reserved at that time. 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. Additional information regarding the Company's
reserves is included in

Page 12

Item 7 "Management's Discussion and Analysis" in the Losses and Loss Expenses
Payable section included therein.

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, 2002, 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, 2002:

- --------------------------------------------------------------- -----------------------------------------------------
Year Ended December 31
- --------------------------------------------------------------- -----------------------------------------------------
2002 2001 2000
---- ---- ----
- --------------------------------------------------------------- -----------------------------------------------------
(in thousands)
- --------------------------------------------------------------- ----------------- ---------------- ------------------

Beginning of Year:
- --------------------------------------------------------------- ----------------- ---------------- ------------------
Loss and loss expenses payable $523,860 $244,583 $232,489
- --------------------------------------------------------------- ----------------- ---------------- ------------------
Less: Reinsurance recoverable on losses and loss
expenses payable(1) 13,919 7,930 10,807
------ ----- ------
- --------------------------------------------------------------- ----------------- ---------------- ------------------
Net losses and loss expenses payable(2) $509,941 $236,653 $221,682
- --------------------------------------------------------------- ----------------- ---------------- ------------------
Provision for losses and loss
- --------------------------------------------------------------- ----------------- ---------------- ------------------
expenses occurring:
- --------------------------------------------------------------- ----------------- ---------------- ------------------
Current year 641,060 366,348 277,805
- --------------------------------------------------------------- ----------------- ---------------- ------------------
Prior years(3) 12,414 60,726 (5,638)
------ ------ ------
- --------------------------------------------------------------- ----------------- ---------------- ------------------
Total 653,474 427,074 272,167
- --------------------------------------------------------------- ----------------- ---------------- ------------------
Loss and loss expense payments
- --------------------------------------------------------------- ----------------- ---------------- ------------------
for claims occurring during:
- --------------------------------------------------------------- ----------------- ---------------- ------------------
Current year 349,733 240,508 164,620
- --------------------------------------------------------------- ----------------- ---------------- ------------------
Prior years 221,549 144,862 104,871
------- ------- -------
- --------------------------------------------------------------- ----------------- ---------------- ------------------
Total 572,282 385,370 269,491
- --------------------------------------------------------------- ----------------- ---------------- ------------------
Impact of the addition of the former Meridian Mutual
- --------------------------------------------------------------- ----------------- ---------------- ------------------
business to the Pooling Arrangement, effective
- --------------------------------------------------------------- ----------------- ---------------- ------------------
7/1/01 - 75,575 -
- --------------------------------------------------------------- ----------------- ---------------- ------------------
Impact of pooling change effective 10/1/01 and 1/1/00 (4) - 156,009 12,295
------- ------- ------
- --------------------------------------------------------------- ----------------- ---------------- ------------------
End of Year:
- --------------------------------------------------------------- ----------------- ---------------- ------------------
Net losses and loss expenses payable(1) 592,133 509,941 236,653
- --------------------------------------------------------------- ----------------- ---------------- ------------------
Add: Reinsurance recoverable on losses and loss
expenses payable(2) 8,825 13,919 7,930
----- ------ -----
- --------------------------------------------------------------- ----------------- ---------------- ------------------
Losses and loss expenses payable $600,958 $523,860 $244,583
======== ======== ========
- --------------------------------------------------------------- ----------------- ---------------- ------------------

(1) Includes amounts due from affiliates of $4,286, $8,867 and $2,111,
respectively.

(2) Includes net amounts assumed from affiliates of $303,959, $280,011 and
$10,126, respectively.

(3) This line item shows increases (decreases) in the current calendar year in
the provision for losses and loss expenses attributable to claims occurring in
prior years. The increase of $12,414 in 2002 for claims occurring in prior years
is well within normal expectations for reserve development and claim settlement
uncertainty. The increase of $60,726 in 2001 for claims occurring in prior years
is primarily the result of reserve strengthening on the former Meridian Mutual
business in order to bring these claim reserves in line with historic State Auto
adequacy levels as well as ongoing analysis of recent loss development trends.
The decrease in calendar year losses from prior years in 2000 of $5,638 is
within a normal expectation of reserve variation.

Page 13

(4) This line item represents the increase in loss and loss expense reserves due
to the Company's change in pooling participation percentages effective October
1, 2001 and January 1, 2000, respectively. See "Pooling Arrangement" in
"Narrative Description of Business."

- -----------------------------------------

The following table sets forth the development of reserves for losses and
loss expenses from 1992 through 2002 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, 2002, the Company had paid 72.7% of the
currently estimated losses and loss expenses that had been incurred, but not
paid, as of December 31, 1992.

The amounts on the "cumulative redundancy (deficiency)" line represent the
aggregate change in the estimates over all prior years. For example, the 1992
reserve has developed a $17,765 million redundancy through December 31, 2002.
That amount has been included in operations over the ten years and did not have
a significant effect on income of any one year. The effects on income caused by
changes in estimates of the reserves for losses and loss expenses for the most
recent three years are shown in the foregoing three-year loss development table.

In evaluating the information in the table, it should be noted that each
amount includes the effects of all changes in amounts for prior periods. For
example, the amount of the redundancy related to losses settled in 1996, but
incurred in 1993, will be included in the cumulative redundancy amount for years
1993, 1994 and 1995. 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.

In 1992, 1995, 1998, 1999, 2000 and 2001, the Pooling Arrangement was
amended to increase the Company's share of premiums, losses and expenses. An
amount of assets equal to the increase in net liabilities was transferred to the
Company from Mutual in 1992, 1995, 1998, 1999, 2000 and 2001 in conjunction with
each year's respective pooling change. The amount of the assets transferred from
Mutual in 1992, 1995, 1998, 1999, 2000 and 2001 has been netted against and has
reduced the cumulative amounts paid for years prior to 1992, 1995, 1998, 1999,
2000 and 2001, respectively.

[See table on following page.]

Page 14

State Auto Financial Corp.
Years Ended December 31
------------------------------------------------------------------------------
1992 1993 1994 1995 1996

(Dollars in Thousands)

Net liability for losses
and loss expenses payable $119,044 $123,337 $126,743 $206,327 $199,480

Paid (cumulative)
as of:
One year later 41.3% 42.2% 1.5% 38.2% 39.4%
Two years later 60.9% 41.3% 29.1% 55.4% 54.1%
Three years later 60.6% 55.6% 44.5% 63.3% 65.0%
Four years later 68.0% 64.5% 51.0% 67.7% 73.2%
Five years later 71.9% 67.2% 54.6% 71.9% 69.8%
Six years later 72.5% 69.0% 58.8% 67.1% 74.6%
Seven years later 73.7% 72.1% 52.3% 69.3%
Eight years later 75.2% 67.0% 54.4%
Nine years later 71.5% 68.4%
Ten years later 72.7%

Net liability re-estimate
as of:
One year later 92.7% 93.7% 87.4% 87.0% 91.3%
Two years later 90.5% 90.0% 77.1% 86.4% 87.3%
Three years later 87.6% 85.0% 77.0% 83.2% 86.7%
Four years later 85.6% 86.3% 72.9% 81.6% 87.0%
Five years later 87.3% 82.8% 70.9% 81.3% 92.6%
Six years later 84.5% 81.6% 70.0% 83.6% 92.9%
Seven years later 83.0% 80.8% 72.6% 83.7%
Eight years later 82.0% 83.6% 72.8%
Nine years later 84.7% 83.8%
Ten years later 85.1%

Cumulative redundancy (deficiency) $17,765 $19,933 $34,440 $33,689 $14,196

Cumulative redundancy (deficiency) 14.9% 16.2% 27.2% 16.3% 7.1%

Gross* liability - end of year $224,771 $245,929 $277,783 $412,553 $410,658
Reinsurance recoverable $105,727 $122,591 $151,040 $206,226 $211,178
Net liability - end of year $119,044 $123,337 $126,743 $206,327 $199,480

Gross liability re-estimated - latest 96.4% 100.8% 93.2% 84.9% 93.3%
Reinsurance recoverable re-estimated - latest 109.1% 117.9% 110.3% 86.2% 93.7%
Net liability re-estimated - latest 85.1% 83.8% 72.8% 83.7% 92.9%

* Gross liability includes: Direct & assumed losses & loss expenses payable.

As the Pooling Arrangement provides for the right of offset, the Company has reported losses and loss expenses payable ceded to
Mutual as assets only in situations when when net amounts ceded to Mutual exceed that assumed. The following table provides a
reconciliation of the reinsurance recoverable to the amount reported in the Company's consolidated financial statements at each
balance sheet date:

Reinsurance recoverable $105,727 $122,591 $151,040 $206,226 $211,178
Amount netted against assumed from Mutual $99,096 $115,945 $142,680 $193,367 $194,839
Net reinsurance recoverable $6,631 $6,646 $8,360 $12,859 $16,339

State Auto Financial Corp.
Years Ended December 31
--------------------------------------------------------------------------------
1997 1998 1999 2000 2001 2002

(Dollars in Thousands)

Net liability for losses
and loss expenses payable $194,155 $205,034 $221,682 $236,653 $509,941 $592,133

Paid (cumulative)
as of:
One year later 32.7% 35.4% 41.8% 5.9% 43.4% ---
Two years later 54.6% 61.6% 43.0% 52.7%
Three years later 70.1% 62.1% 71.9%
Four years later 69.2% 78.8%
Five years later 77.1%
Six years later
Seven years later
Eight years later
Nine years later
Ten years later

Net liability re-estimate
as of:
One year later 93.0% 96.6% 97.5% 125.7% 102.4% ---
Two years later 92.0% 96.7% 119.1% 129.1%
Three years later 91.9% 111.9% 120.3%
Four years later 102.0% 111.5%
Five years later 101.4%
Six years later
Seven years later
Eight years later
Nine years later
Ten years later

Cumulative redundancy (deficiency) -$2,784 -$23,629 -$44,947 -$68,903 -$12,414 ---

Cumulative redundancy (deficiency) -1.4% -11.5% -20.3% -29.1% -2.4% ---

Gross* liability - end of year $402,718 $414,268 $438,748 $457,202 $743,710 $862,428
Reinsurance recoverable $208,563 $209,234 $217,065 $220,544 $233,769 $270,295
Net liability - end of year $194,155 $205,034 $221,682 $236,657 $509,941 $592,133

Gross liability re-estimated - latest 98.3% 107.2% 109.9% 114.6% 101.2%
Reinsurance recoverable re-estimated - latest 95.3% 102.9% 99.3% 99.0% 98.5%
Net liability re-estimated - latest 101.4% 111.5% 120.3% 129.1% 102.4%

Reinsurance recoverable $208,563 $209,234 $217,065 $220,544 $233,770 $270,295
Amount netted against assumed from Mutual $187,506 $196,818 $206,258 $212,614 $219,851 $261,470
Net reinsurance recoverable $21,057 $12,416 $10,807 $7,930 $13,919 $8,825

Page 15

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

- --------------------------------------------------------------------- ----------------- ------------------- ---------------------
2002 2001 2000
---- ---- ----
- --------------------------------------------------------------------- ----------------- ------------------- ---------------------
(in thousands)
- --------------------------------------------------------------------- -----------------------------------------------------------

GAAP losses and loss
expenses payable $600,958 $523,860 $244,583
- --------------------------------------------------------------------- ----------------- ------------------- ---------------------
Less: ceded reinsurance recoverable
on losses and loss expenses payable 8,825 13,919 7,930
----- ------ -----
- --------------------------------------------------------------------- ----------------- ------------------- ---------------------
Net losses and loss expenses payable 592,133 509,941 236,653
- --------------------------------------------------------------------- ----------------- ------------------- ---------------------
Add: salvage and subrogation
recoverable 27,093 26,216 13,402
------ ------ ------
- --------------------------------------------------------------------- ----------------- ------------------- ---------------------
STAT losses and loss
Expenses $619,226 $536,157 $250,055
======== ======== ========
- --------------------------------------------------------------------- ----------------- ------------------- ---------------------

REINSURANCE

Members of the State Auto Group follow the customary industry practice of
reinsuring a portion of their exposures and paying to the reinsurers a portion
of the premiums received. Insurance is ceded principally to reduce net liability
on individual risks or for individual loss occurrences, including catastrophic
losses. Although reinsurance does not legally discharge the individual members
of the State Auto Group 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 is party to working reinsurance
treaties for property, casualty and workers compensation lines with several
reinsurers arranged through a reinsurance broker. Under the property per risk
excess of loss treaty, each member 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 million of 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 excess over $2.0 million up
to $5.0 million of covered loss. Also, certain unusual claim situations
involving bodily injury liability, property damage, uninsured motorists and
personal injury protection are covered by an arrangement that provides for $10.0
million of coverage in excess of 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. The rates for this reinsurance are negotiated annually.

The terms of the workers compensation excess of loss program provide that
each company in the State Auto Group is responsible for the first $2.0 million
of covered loss. The reinsurers are responsible for 100% of the excess over $2.0
million up to $5.0 million of covered loss, and 95% of the excess over $5.0
million up to $10 million of covered loss. Net retentions under this contract
may be submitted to the casualty excess of loss program, subject to a limit of
$2 million per loss occurrence.

In addition, the State Auto Group has secured other reinsurance to limit
the net cost of large loss events for certain types of coverage. Included are
umbrella liability losses which are reinsured up to a limit of $10.0 million
above a maximum $600,000 retention. The State Auto Group also makes use of
facultative reinsurance for unique risk situations and participates in
involuntary pools and associations in certain states.

The members of the State Auto Group combined retain the first $40 million
of each property catastrophe occurrence that affects more than two individual
risks. Eighty ($80) million dollars of traditional reinsurance is available
above the $40 million retention with a co-participation of 5%.

Page 16

In the event of a catastrophe loss in excess of $120.0 million for the
State Auto Group, STFC has implemented a structured contingent financing
agreement (the "Credit Agreement") with Bank One and other lenders (the
"Lenders") to provide up to $100.0 million. Under the Credit Agreement, in the
event of such a loss, STFC 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 the Lenders. STFC 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, SA Wisconsin,
National, Farmers Casualty, Mid-Plains, SA Ohio, Meridian Citizens Mutual and
Meridian Security pursuant to a Catastrophe Assumption Agreement in the amount
of $100.0 million excess $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. STFC is obligated to redeem the preferred
shares by making periodic payments to the SPC. The SPC would use these payments
to repay the Lenders over a five year period. This layer of $100.0 million
excess of $120.0 million is excluded from the Pooling Arrangement. In addition,
STFC's obligation to repay the SPC has been secured by a Put Agreement among
STFC, Mutual and the Lenders; under which, in the event of a default by STFC as
described in the Credit Agreement or in the Put Agreement, Mutual would be
obligated to either purchase the preferred shares from the SPC or repay the SPC
for the loan(s) outstanding.

National has a reinsurance agreement with Mutual pursuant to which Mutual
assumes up to $4,950,000 of each liability loss occurrence in excess of
National's $50,000 of retention; and up to $450,000 of each catastrophe loss
occurrence in excess of National's $50,000 of retention. Mutual further provides
National with an 8.5% quota share within the $50,000 retention on liability
coverages, and a 20% quota share on physical damage coverages. Mid-Plains also
has a reinsurance agreement with Mutual pursuant to which Mutual assumes up to
$450,000 of each liability loss occurrence in excess of Mid-Plains' $50,000 of
retention.

For the period October 1, 2001 through December 31, 2003, Mutual entered
into a Stop Loss Reinsurance Arrangement (the "Stop Loss") with certain of the
Pooled Companies. Under the Stop Loss, Mutual has agreed to participate in the
Pooling Arrangement's quarterly underwriting losses and gains, in the manner
described. If the Pooling Arrangement loss and LAE ratio(the "Pool loss and LAE
ratio") is between 70.75% and 80.00%, Mutual will reinsure certain of the Pooled
Companies 27% of the Pooling Arrangement's losses in excess of a Pool loss and
LAE ratio of 70.75% up to 80.00%. Certain of the Pooled Companies would be
responsible for its share of the Pooling Arrangement's losses over the 80.00%
threshold. Also, Mutual will have the right to participate in the profits of the
Pooling Arrangement; Mutual will assume 27% of the Pooling Arrangement's
underwriting profits attributable to a Pool loss and LAE ratio less than 69.25%,
but more than 59.99%. This Stop Loss Reinsurance Arrangement will cease at the
end of the fourth quarter, 2003.

See discussion regarding the federal Terrorism Risk Insurance Act of 2002
("Terrorism Act") at Regulation section and Item 7 "Management's Discussion and
Analysis" in the Other External Factors section included therein.

REGULATION

Most states, including all the domiciliary states of the State Auto Group,
have enacted legislation that regulates insurance holding company systems. 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 any members of the State Auto Group, 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 to shareholders. Pursuant to these laws, all
transactions within the holding company system affecting any members of the
State Auto Group 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. The insurance laws of all the
domiciliary states of the State Auto Group provide that no person may

Page 17

acquire direct or indirect control of a domestic insurer without obtaining the
prior written approval of the state insurance commissioner for such acquisition.

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. 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. STFC's insurance subsidiaries generally are restricted by the
insurance laws of their respective states of domicile as to the amount of
dividends they may pay to STFC without the prior approval of the respective
state regulatory authorities. Generally, the maximum dividend that may be paid
by an insurance subsidiary during any year without prior regulatory approval is
limited to the greater of a stated percentage of that subsidiary's statutory
surplus as of a certain date, or adjusted net income of the subsidiary, for the
preceding year. Pursuant to these rules, a total of $35.3 million is available
for payment to State Auto Financial as a dividend from State Auto P&C, Milbank,
Farmers Casualty, SA Ohio and National during 2003 without prior approval from
their domiciliary state insurance departments, under current law.

Rate and Related Regulation. In general, the Company is not aware of the
adoption of any adverse legislation or regulation by any state where the Company
did business during 2002 which would present material obstacles to the Company's
overall business. However, several states where the Company does business have
passed or are considering more strict regulation of the use of credit scoring in
rating and/or risk selection in personal lines of business. Regulations or laws
restricting the use of this information have an adverse impact on the Company
because these laws impede the ability of the Company to make optimum use of
credit scoring information. Such regulations would limit the ability of the
Company, as well as the ability of all other insurance carriers operating in
that jurisdiction, to take advantage of this tool.

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, 2002, each
insurer affiliated with the Company surpassed all standards tested by the
formula applying risk-based capital requirements.

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,
expanding the terms of the contract, multiplying limits of coverage, creating
rights for policyholders not intended to be included in the

Page 18

contract and interpreting applicable statutes expansively to create obligations
on insurers not originally considered when the statute was passed. Courts have
also undone legal reforms passed by legislatures, which reforms were intended to
reduce a litigant's rights of action or amounts recoverable and so reduce the
costs borne by the insurance mechanism. These court decisions can adversely
affect an insurer's profitability. They also create pressure on rates charged
for coverages adversely affected, and this can cause a legislative response
resulting in rate suppression that can adversely affect an insurer.

The newly enacted Terrorism Act requires the federal government and the
insurance industry to share in insured losses up to $100 billion per year
resulting from future terrorist attacks within the United States. Under the
Terrorism Act, commercial property and casualty insurers must offer their
commercial policyholders coverage against certified acts of terrorism, but the
policyholders may choose to reject this coverage. If the policyholder rejects
coverage for certified acts of terrorism, the Company intends, subject to the
approval of the state regulators, to cover only such acts of terrorism that are
not certified acts under the Terrorism Act and that do not arise out of nuclear,
biological or chemical agents.

Probably the most significant piece of legislation to affect the Company
was not a state insurance law, but rather the federal Sarbanes-Oxley Act of 2002
("Sarbanes Oxley"), which took effect in July 2002. While this law does not
affect the Company's insurance operations, it has and will continue to have an
effect on the Company. Sarbanes Oxley was the response of the Congress to the
corporate scandals of the last two years. Sarbanes Oxley imposes significant new
rules on the Company's corporate governance, its financial and reporting
processes and its relationship with its independent auditor. Sarbanes Oxley will
require the Company to increase the internal staff functions to ensure that it
can demonstrate it is complying with these new legal requirements, which can be
expected to have an adverse effect on the Company's expense ratio.

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. Stateco performs investment
management services for the Company and Mutual and its subsidiaries, although
investment policies implemented by Stateco continue to be set for each company
through the Investment Committee of its Board of Directors. See "Investment
Management Services" in the "Narrative Description of Business."

The Company's decision to make a specific investment is influenced
primarily by the following factors: (a) investment risks; (b) general market
conditions; (c) relative valuations of investment vehicles; (d) general market
interest rates; (e) the Company's liquidity requirements at any given time; and
(f) the Company's current federal income tax position and relative spread
between after tax yields on tax-exempt and taxable fixed income investments. The
Company has investment policy guidelines with respect to purchasing fixed income
investments which preclude investments in bonds that are rated below investment
grade by a recognized rating service. The maximum investment in any single note
or bond is limited to 5.0% of assets, other than obligations of the U.S.
government or government agencies, for which there is no limit. Investments in
equity securities are selected based on their potential for 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. Prior to year-end 2002, the fixed maturity investments were
classified as available for sale and carried at fair market value, or as
held-to-maturity and carried at amortized cost according to the Statement of
Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." As of December 31, 2002, all fixed
maturity investments have been classified as available for sale. Fixed
maturities classified as available for sale totaled $1,216.7 million and
$1,051.4 million at December 31, 2002 and December

Page 19

31, 2001, respectively. Fixed maturities categorized as hold-to-maturity totaled
$-0- and $27.4 million at December 31, 2002 and December 31, 2001, respectively.

At December 31, 2002 and 2001, respectively, the Company's equity
portfolio totaled $53.7 million and $59.8 million.

The table below provides information about the quality and the scope of
the Company's fixed maturity portfolio as of December 31, 2002:

- -------------------------------- ------------------------ ------------- -------------------------- ---------------------------
Fair Market Value % of Quality* Amortized Cost Fair Market Value
Portfolio
- -------------------------------- ------------------------ ------------- -------------------------- ---------------------------

Investment Grade -
Corporates and Municipals 72.0% AA+ $824,856 $876,333
- -------------------------------- ------------------------ ------------- -------------------------- ---------------------------

U.S. Governments 2.8% AAA $31,207 $33,684
- -------------------------------- ------------------------ ------------- -------------------------- ---------------------------

U.S. Government Agencies 25.2% AAA $293,271 $306,681
- -------------------------------- ------------------------ ------------- -------------------------- ---------------------------
100.0% $1,149,334 $1,216,698
- -------------------------------- ------------------------ ------------- -------------------------- ---------------------------

*As rated by Moody's Investors Service

- -----------------------------------------

The following table sets forth the Company's investment results for the
periods indicated:

- ---------------------------------- --------------------------------------- ----------------------------- -------------------------
Year ended December 31
- ---------------------------------- -----------------------------------------------------------------------------------------------
2002 2001 2000
---- ---- ----
- ---------------------------------- --------------------------------------- ----------------------------- -------------------------

Average Invested Assets (1) $1,210,641 $870,864 $712,627
- ---------------------------------- --------------------------------------- ----------------------------- -------------------------

Net Investment Income (2) $59,691 $47,375 $38,915
- ---------------------------------- --------------------------------------- ----------------------------- -------------------------

Average Yield 4.9% 5.4% 5.5%
- ---------------------------------- --------------------------------------- ----------------------------- -------------------------

(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.

- -----------------------------------------

For additional discussion regarding the Company's investments, see Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations.

INVESTMENT MANAGEMENT SERVICES

Stateco has been providing investment management services since 1993.
These services are provided to all insurance companies affiliated with the
Company or Mutual. 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. The
Investment Committee of each insurer's Board of Directors sets investment
policies to be followed by Stateco.

COMPETITION

The property and casualty insurance industry is highly competitive. 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

Page 20

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, quality service to the policyholder and the
agent, and a fully developed agency relations program.

Another underwriting and claims issue the Company is confronting is "toxic
mold." This source of loss has received significant publicity in recent months,
and indications are that mold claims will increase in the future. The Company
believes that, under its insurance policies, the Company is not obligated to
cover this kind of commonly occurring condition, particularly when remediation
costs are extreme. Hence, to protect its current rate structure, the Company has
filed mold limitations and exclusions on homeowner policies and certain
commercial policies in all states that will accept such filings.

EMPLOYEES

As of March 13, 2003, the Company had 2,097 employees. This includes 565
employees who had been employees of MIGI until January 1, 2002. 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.

AVAILABLE INFORMATION

STFC's internet website address is www.stfc.com. Through this internet
website (found under the "SEC Filings" link), STFC makes available, free of
charge, its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current
Reports on Form 8-K, and all amendments to those reports filed or furnished
pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as
soon as reasonably practicable after STFC electronically files such material
with the Securities and Exchange Commission.

EXECUTIVE OFFICERS OF THE REGISTRANT

Name of Executive Officer Principal Occupation(s) An Executive Officer
and Position(s) with Company Age During the Past Five Years of the Company Since (1)
---------------------------- --- -------------------------- ------------------------

Robert H. Moone, 59 Chairman of the Board of STFC and Mutual, 1/1/01 to 1991
Chairman, President and present; Chief Executive Officer of STFC and Mutual, 5/99
Chief Executive Officer to present; President of STFC and Mutual, 5/96 to
present; Executive Vice President, 11/93 to 5/96 and
prior thereto Vice President of STFC and Mutual

Mark A. Blackburn, 51 Senior Vice President of STFC and Mutual, 3/01 to 1999
Senior Vice President present; Vice President of STFC and Mutual, 8/99 to 3/01;
Executive Vice President of Grange Mutual Casualty
Insurance Company 4/96 to 4/99; and for more than five
years prior thereto, Vice President of General
Reinsurance Corporation

Steven J. Johnston, 43 Senior Vice President of STFC and Mutual, 8/99 to 1994
Senior Vice President, present; Treasurer and Chief Financial Officer of STFC
Treasurer and Chief and Mutual, 4/97 to present; Vice President of STFC and
Financial Officer Mutual, 5/95 to 8/99

John R. Lowther, 52 Senior Vice President of STFC and Mutual, 3/01 to 1991
Senior Vice President, present; Secretary and General Counsel of STFC, 5/91 to
Secretary and present and of Mutual 8/89 to present; Vice President of
General Counsel STFC, 5/91 to 3/01 and of Mutual 8/89 to 3/01

James E. Duemey, 56 Vice President and Investment Officer of STFC and Mutual, 1991
Vice President 5/91 to present
and Investment Officer

Page 21

Name of Executive Officer Principal Occupation(s) An Executive Officer
and Position(s) with Company Age During the Past Five Years of the Company Since (1)
---------------------------- --- -------------------------- ------------------------

William D. Hansen, 37 Vice President of Mutual, 3/00 to present; Vice President 2000
Vice President of STFC, 5/00 to present; Assistant Vice President of
Mutual 5/95 to 3/00

Steven R. Hazelbaker 47 Vice President of Mutual 6/01 to present; Vice President 2001
Vice President of STFC 6/01 to present; CFO and Treasurer of MIGI and
Meridian Mutual 1994 to 6/01; Vice President of MIGI and
Meridian Mutual 1995 to 6/01

Noreen W. Johnson, 54 Vice President of STFC and Mutual, 3/98 to present; 1998
Vice President Assistant Vice President of Mutual, 3/97 to 3/98;
employee of Mutual since 9/92

Robert A. Lett, 63 Vice President of STFC, 3/98 to present; Vice President 1994
Vice President of Mutual, 2/88 to present

John B. Melvin, 53 Vice President of STFC, 3/98 to present; Vice President 1994
Vice President of Mutual, 11/93 to present; and prior thereto an officer
of Mutual

Cathy B. Miley, (2) 53 Vice President of STFC, 3/98 to present; Vice President 1995
Vice President of Mutual, 3/95 to present; Assistant Secretary of
Mutual, 8/92 to 3/95

Richard L. Miley, (2) 49 Vice President of STFC, 3/98 to present; Vice President 1995
Vice President of Mutual, 5/95 to present; Assistant Vice President of
Mutual, 8/87 to 5/95

John M. Petrucci, 44 Vice President of Mutual, 3/00 to present; Vice President 2000
Vice President of STFC, 5/00 to present; employee of Mutual since 9/96

Cynthia A. Powell, 42 Vice President of Mutual, 3/00 to present; Assistant Vice 2000
Vice President President, 8/96 to 3/00; Vice President of STFC 5/00 to
present; Assistant Vice President of STFC, 4/97 to 5/00;
employee of Mutual since 6/90

(1) Each of the foregoing officers has been designated by the Company's Board of
Directors as an executive officer for purposes of Section 16 of the Securities
Exchange Act of 1934.

(2) Richard L. Miley and Cathy B. Miley are husband and wife.

ITEM 2. PROPERTIES

Because the operations of the Company and Mutual are integrated with one
another pursuant to the terms of the 2000 Management Agreement, the Company and
Mutual share their operating facilities. See Item 1, "Management Agreement" in
the "Narrative Description of Business." The Company's and Mutual's corporate
headquarters are located in Columbus, Ohio in buildings owned by Mutual that
contain approximately 270,000 square feet of office space. The Company and
Mutual also have regional underwriting and claims office facilities that are
owned by Mutual, including a 6,600 square foot branch office in Cleveland, Ohio;
a 29,000 square foot branch office in Cincinnati, Ohio; and a 205,000 square
foot regional office in Indianapolis, Indiana. In addition, 518 PML owns and
leases to Mutual regional office facilities in Nashville, Tennessee; Greer,
South Carolina; and Des Moines, Iowa. Milbank owns an office facility in
Milbank, South Dakota, where Company employees provide services to Milbank
agents and policyholders. SA Wisconsin leases an office facility in Onalaska,
Wisconsin, where Company employees service SA Wisconsin's agents and
policyholders. Mutual also leases space in Columbus, Ohio for a regional office
and leases a number of small offices throughout its operating area for the
claims operations of Mutual and the Company.

Page 22

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, 2003, there were 937 shareholders of record of the
Company's common shares.

MARKET PRICE RANGE, COMMON STOCK(1)

Initial Public Offering -- June 28, 1991, $2.25(1). The high and low sale
prices for each quarterly period for the past two years as reported by Nasdaq
are:

------------------------------ ---------------------- ---------------------- -------------------
2001 HIGH LOW DIVIDEND
---- ---- --- --------

------------------------------ ---------------------- ---------------------- -------------------

First Quarter $17.688 $13.313 $0.0300
------------------------------ ---------------------- ---------------------- -------------------
Second Quarter $17.340 $12.833 $0.0300
------------------------------ ---------------------- ---------------------- -------------------
Third Quarter $17.800 $12.300 $0.0325
------------------------------ ---------------------- ---------------------- -------------------
Fourth Quarter $17.500 $13.100 $0.0325
------------------------------ ---------------------- ---------------------- -------------------

------------------------------ ---------------------- ---------------------- -------------------
2002
------------------------------ ---------------------- ---------------------- -------------------
First Quarter $17.250 $13.700 $0.0325
------------------------------ ---------------------- ---------------------- -------------------
Second Quarter $17.019 $14.330 $0.0325
------------------------------ ---------------------- ---------------------- -------------------
Third Quarter $16.820 $14.500 $0.0350
------------------------------ ---------------------- ---------------------- -------------------
Fourth Quarter $16.780 $12.670 $0.0350
------------------------------ ---------------------- ---------------------- -------------------

(1) Adjusted for stock splits.

Additionally, see Liquidity and Capital Resources section of "Management's
Discussion and Analysis of Financial Condition and Results of Operations"
included in Item 7 of this Form 10-K Annual Report for a discussion of
regulatory restrictions on the payment of dividends by the Company's insurance
subsidiaries.

ITEM 6. SELECTED FINANCIAL DATA

"Selected Consolidated Financial Data" is as follows:

Page 23

STATE AUTO FINANCIAL CORPORATION AND
SUBSIDIARIES (a majority-owned subsidiary of State
Automobile Mutual Insurance Company)

SELECTED CONSOLIDATED FINANCIAL DATA

YEAR ENDED DECEMBER 31
----------------------
2002 2001* 2000* 1999* 1998* 1997 1996 1995* 1994
---- ----- ----- ----- ----- ---- ---- ----- ----
STATEMENTS OF (Dollars in thousands, except per share data)
INCOME DATA:

Earned premiums $ 896,595 555,207 397,967 392,058 356,210 320,050 304,472 296,364 225,297
Net investment income $ 59,691 47,375 38,915 34,262 32,506 31,107 29,863 28,461 22,189
Management services
income $ 2,638 15,586 17,594 8,727 7,945 7,367 6,774 6,377 5,170
Net realized gains on
investments $ 5,909 1,962 5,255 2,555 2,925 3,043 2,788 1,758 1,595
Other income $ 2,646 3,142 3,043 3,269 2,473 1,409 1,200 525 147
---------------------------------------------------------------------------------------------------
Total revenues $ 967,479 623,272 462,774 440,871 402,059 362,976 345,097 333,485 254,398
---------------------------------------------------------------------------------------------------

Income before federal
income taxes $ 37,790 17,976 61,444 56,985 49,605 56,638 34,792 40,953 20,294
---------------------------------------------------------------------------------------------------
Net income $ 36,995 20,615 47,714 42,816 37,497 40,998 26,407 29,894 15,835
---------------------------------------------------------------------------------------------------
Earnings per common
share(1)(2):
Basic $ 0.95 0.53 1.24 1.05 0.89 0.99 0.64 0.73 0.39
---------------------------------------------------------------------------------------------------
Diluted $ 0.93 0.52 1.21 1.03 0.87 0.97 0.63 0.72 0.39
---------------------------------------------------------------------------------------------------
Cash dividends per
common share(1) $ 0.14 0.13 0.12 0.11 0.10 0.09 0.08 0.07 0.06
---------------------------------------------------------------------------------------------------

BALANCE SHEET DATA AT YEAR END:
Total investments $ 1,272,316 1,138,656 750,870 627,305 579,966 526,363 499,277 479,908 350,639
Total assets $ 1,592,995 1,367,496 898,106 759,945 717,520 664,384 605,385 579,194 487,282
Total notes payable $ 75,500 45,500 45,500 45,500 - - - - -
Total stockholders'
equity $ 463,769 400,193 386,059 317,687 340,824 297,258 247,619 225,763 175,852
Book value per
common share(1) $ 11.89 10.28 10.01 8.29 8.11 7.11 5.98 5.48 4.29

STATUTORY RATIOS:
Loss ratio 73.1 77.4 68.5 67.4 68.4 65.2 72.7 68.6 75.4
Expense ratio 29.2 27.8 27.0 29.5 29.4 28.9 27.3 31.0 28.2
Combined ratio 102.3 105.7 95.5 96.9 97.8 94.1 100.0 99.6 103.6
Industry combined ratio(3) 105.7 115.9 110.1 107.8 105.6 101.6 105.8 106.5 108.5
Ratio of net premiums
written to statutory
capital and surplus 2.62 1.81 1.32 1.47 1.63 1.71 1.91 2.12 1.77

(1) Adjusted for a July 1998 2-for-1 common stock split as well as a July 1996
3-for-2 common stock split effected in the form of a stock dividend.
(2) The earnings per share amounts prior to 1997 have been restated as required
to comply with SFAS No. 128.
(3) Preliminary industry information for 2002 from A.M. Best.

* Reflects change in Pooling Arrangement, effective October 1, 2001, January 1,
2000, 1999, 1998 and 1995.

Page 24

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
of Ohio, formerly State Auto Insurance Company ("SA Ohio"), provides personal
and commercial insurance for the standard insurance market. State Auto National
Insurance Company ("National") and Mid-Plains Insurance Company ("Mid-Plains")
write personal automobile insurance for risks in the nonstandard insurance
market. These insurance products are marketed through the independent agency
system. State Auto Financial is a majority-owned subsidiary of State Automobile
Mutual Insurance Company ("Mutual"), an Ohio domiciled property and casualty
insurer. State Auto Financial and its subsidiaries are referred to collectively
herein as the "Company."

Mutual's wholly-owned subsidiaries are State Auto Insurance Company of
Wisconsin, formerly Midwest Security Insurance Company ("SA Wisconsin"), State
Auto Florida Insurance Company ("SA Florida") and Meridian Insurance Group, Inc.
("MIGI"). MIGI's subsidiaries are Meridian Security Insurance Company ("Meridian
Security"), Meridian Citizens Security Insurance Company ("Meridian Citizens")
and Insurance Company of Ohio ("ICO"). ICO ceased insurance operations on
October 1, 2002 and was dissolved on January 15, 2003. MIGI is also party to an
affiliation agreement with Meridian Citizens Mutual Insurance Company ("Meridian
Citizens Mutual"). Meridian Security, Meridian Citizens, ICO and Meridian
Citizens Mutual are collectively referred herein as the "MIGI Insurers."

State Auto P&C provides employees to all insurance affiliates, including
Mutual and each of its affiliates. This is contractually provided for under the
following management and/or cost sharing agreements: 1) the "2000 Management
Agreement", to which State Auto P&C, Mutual, National, Milbank, and SA Ohio are
parties. After October 1, 2001, the 2000 Management Agreement became a pure cost
sharing agreement, but prior thereto, this agreement provided for a management
fee based on surplus which was paid by each managed company to State Auto P&C;
2) the "Midwes