Basis of Presentation

3 Months Ended

Mar. 31, 2020

Accounting Policies [Abstract]

Basis of Presentation

Basis of Presentation

The accompanying unaudited condensed consolidated financial statements of State Auto Financial Corporation and Subsidiaries (“State Auto Financial” or the “Company”) have been prepared in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for complete financial statements. In the opinion of the Company, all adjustments (consisting of normal, recurring accruals) considered necessary for a fair statement have been included. Operating results for the three months ended March 31, 2020, are not necessarily indicative of the results that may be expected for the year ending December 31, 2020. The balance sheet at December 31, 2019, has been derived from the audited financial statements at that date, but does not include all of the information and footnotes required by GAAP for complete financial statements.

For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 (the “2019 Form 10-K”). Capitalized terms used herein and not otherwise defined shall have the meaning ascribed to them in the 2019 Form 10-K.

The COVID-19 pandemic has caused an economic downturn on a global scale, including temporary closures of many businesses and reduced consumer spending due to shelter-in-place and other governmental regulations, as well as significant market disruption and volatility. The scope, duration and magnitude of the effects of COVID-19 are evolving rapidly and in ways that are difficult or impossible to anticipate. The Company cannot, at this time, predict the impact the pandemic will have on its future consolidated financial position, cash flows or results of operations, however, the impact could be material. The Company's future financial results and operations depend in part on the duration and severity of the pandemic and what actions are taken to mitigate the outbreak.

Adoption of Recent Accounting Pronouncements

Measurement of Credit Losses on Financial Instruments

On January 1, 2020, the Company adopted ASU 2016-13 Financial Instruments - Credit Losses (ASC 326): Measurement of Credit Losses on Financial Instruments, which replaces the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss (CECL) methodology. The measurement of expected credit losses under the CECL methodology is applicable to financial assets measured at amortized cost. This includes the Company's direct third party reinsurance recoverables, and the Company's share of the State Auto Group's third party reinsurance recoverables assumed via the Pooling Arrangement. In addition, ASC 326 made changes to the accounting for available-for-sale fixed maturities. One such change is to require credit losses to be presented as an allowance rather than as a write-down on available-for-sale fixed maturities management does not intend to sell or believes that it is more likely than not they will not be required to sell.

The adoption of this guidance reduced retained earnings by $0.5 million, net of tax, and established an allowance for estimated uncollectible reinsurance as of January 1, 2020. Adoption of ASC 326 for available-for-sale fixed maturities was prospective, and therefore there was no adjustment to retained earnings as of January 1, 2020. Changes to the Company's accounting policy resulting from the adoption of the guidance are discussed below.

Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement

In August 2018, the FASB issued ASU 2018-13 which changes the fair value measurement disclosure requirements of ASC 820 by adding, eliminating and modifying disclosures. The new guidance eliminates (i) the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, (ii) the entity's policy for the timing of transfers between levels, and (iii) the entity's valuation process for Level 3 fair value measurements. Additionally, the guidance now requires to disclose (i) the changes in unrealized gains and losses in other comprehensive income for recurring Level 3 fair value measurements, and (ii) the range and weighted average used to develop significant unobservable inputs and how the weighted average was calculated for Level 3 fair value measurements. Finally, the guidance requires entities to provide information about the measurement uncertainty of Level 3 fair value measurements as of the reporting date rather than a point in the future. The guidance became effective for annual reporting periods after December 15, 2019 and it did not have a material impact on the Company's results of operations, consolidated financial position or cash flows.

Pending Adoption of Recent Accounting Pronouncements

For information regarding other accounting pronouncements that the Company has not yet adopted, see the “Pending Adoption of Recent Accounting Pronouncements” section of Note 1 of the Notes to Consolidated Financial Statements in the 2019 Form 10-K.

Significant Accounting Policy Updates

The following accounting policies have been updated to reflect the Company's adoption of ASU 2016-13 Financial Instruments - Credit Losses (ASC 326): Measurement of Credit Losses on Financial Instruments as described above.

Investments

Investments in fixed maturities are classified as available-for-sale and are carried at fair value. For fixed maturities in an unrealized loss position, the Company first assesses whether it intends to sell, or it is more likely than not that it will be required to sell the security before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the security's amortized cost basis is written down to fair value through income. For fixed maturities that do not meet the aforementioned criteria, management considers the extent to which fair value is less than amortized cost, any changes to the rating of the security by a rating agency, and adverse conditions specifically related to the security, among other factors. If this assessment indicates that a credit loss exists, the present value of cash flows expected to be collected from the security are compared to the amortized cost basis of the security. If the present value of cash flows expected to be collected is less than the amortized cost basis, a credit loss exists and an allowance for credit losses is recorded for the credit loss, limited by the amount that the fair value is less than the amortized cost basis. Any impairment that has not been recorded through an allowance for credit losses is recognized in other comprehensive income.

Changes in the allowance for credit losses are recorded in the "net investment gain (loss)" line item on the condensed consolidated statement of income. Losses are charged against the allowance when management believes the uncollectibility of a fixed maturity is confirmed or when either of the criteria regarding intent or requirement to sell is met. Description and disclosure of credit losses on fixed maturities are disclosed in Note 2 of the Notes to Condensed Consolidated Financial Statements.

The Company excludes accrued interest receivable from both the estimated fair value and the amortized cost basis of available-for-sale fixed maturities and includes such amounts within "accrued investment income and other assets" on the Company's condensed consolidated balance sheets. Any uncollectible accrued interest receivable is written off in the period it is deemed uncollectible.

Reinsurance Recoverables

Management assesses expected credit losses on third party reinsurance recoverables for the entire State Auto Pool as pursuant to the Pooling Arrangement (as defined in Note 6) and the Company is responsible for its share of the estimated uncollectible reinsurance for the entire pool. Management uses A.M. Best’s Financial Strength ratings or equivalent such as S&P, Moody’s, or Fitch when an A.M. Best Financial Strength rating is not available to assess the credit risk of the reinsurance recoverables. The estimate of expected credit losses considers historical credit loss information as well as current conditions and reasonable and supportable forecasts. Description and disclosure of credit losses on reinsurance recoverables are disclosed in Note 6 of the Notes to Condensed Consolidated Financial Statements.

Premiums

Premiums are recognized as earned pro rata over the policy period. Unearned premiums represent the portion of premiums written relative to the unexpired terms of coverage.

Under the terms of the Pooling Arrangement, State Auto Mutual receives all premiums and pays all losses and expenses associated with the insurance business produced by the STFC Pooled Companies and the other pool participants, and then it settles the intercompany balances generated by these transactions with the pool participants within 60 days following each quarter end. When settling the intercompany balances, State Auto Mutual provides the pool participants with full credit for their share of the Pooled Companies net premiums written during the quarter, retaining all premium receivable amounts from insureds and agents.

Management utilizes an aging schedule to estimate an allowance for uncollectible amounts relating to the State Auto Group’s premiums receivable balance. Current and historical collection experiences along with reasonable and supportable forecasts are used to estimate a percentage of the premiums receivable balance that will be uncollectible. Credit risk is partially mitigated by the State Auto Group's ability to cancel the policy if the policyholder does not pay the premium. Pursuant to the Pooling Arrangement, bad debt expense for uncollectible premiums receivable is allocated to pool members on the basis of pool participation and is included in the quarterly settlement of intercompany balances. This is included in "other expenses" on the condensed consolidated statements of income and reflected in “due to/from affiliates” on the Company's condensed consolidated balance sheets. The Company’s share of the premium balances due to State Auto Mutual from agents and insureds at March 31, 2020 and December 31, 2019 is approximately $386.6 million and $371.0 million, respectively, net of the allowance for uncollectible premiums receivable of $7.0 million and $4.3 million, respectively.