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State Auto Financial announces third quarter earnings, resolution of service fee disagreement


COLUMBUS, Ohio -- October 25, 2001 -- State Auto Financial Corporation (Nasdaq:STFC) reported third quarter net earnings of $7,276,000.

Third quarter reported earnings per share were $0.19 ($0.18 diluted) compared with $0.21 ($0.20 diluted) for the third quarter 2000. Net operating earnings per share for the third quarter ending September 30, 2001 were $0.18 ($0.17 diluted) equal to the same period last year.

For the first nine months of 2001, net reported earnings were $31,249,000 or $0.80 ($0.78 diluted) compared with $34,183,000 or $0.89 ($0.87 diluted) for the same 2000 period. Net operating earnings per share for the nine months ended September 30, 2001 were $0.76 ($0.74 diluted) compared with $0.81 ($0.79 diluted) for the same period last year. Third quarter revenue was $156,671,000, up 34.7% from $116,328,000. Revenue for the first nine months of 2001 was $397,705,000, up 14.7% from $346,742,000. STFC's combined ratio for the third quarter was 105.2.

The business formerly written by Meridian Mutual Insurance Company (Meridian), which was merged into State Auto Mutual (Mutual), became part of the State Auto Pool effective July 1, 2001, and represented 29.4% of STFC's third quarter net written premium. The third quarter GAAP combined ratio for this business was 130.4. Meridian case reserves were and are now being reviewed with the intent of reserving the previous Meridian claims in a manner consistent with State Auto practices. The result was an increase in the third quarter of $5,700,000 in case reserves on claims occurring in accident periods prior to the third quarter 2001. This reserve strengthening represents 4.1 points of STFC's 105.2 combined ratio and reduced basic earnings per share by $0.095 for the quarter.

"While the third quarter fell somewhat short of our expectations we believe there is positive news and reason for optimism," noted STFC Chairman and CEO Robert Moone. "It appears the strengthening of Meridian prior period case reserves that so impacted our results was largely completed during the quarter. This fact, coupled with a number of underwriting and pricing initiatives, is designed to improve our position going forward. Likewise, the resolution of the disagreement (explained below) with the Ohio Department of Insurance (O.D.I.) erases the sense of uncertainty that surrounded the fee income portion of STFC's earnings. Most importantly, the results of the State Auto book of business remain exceptionally strong."

Resolution of Service Fee Disagreement

STFC announced today that on October 24, 2001, its board and Mutual's board and special committees thereof approved a resolution of the disagreement between the company and the O.D.I. as to the service fee payable by Mutual to State Auto Property and Casualty Insurance Company (State Auto P&C), a subsidiary of STFC, under the 2000 management agreement among members of the State Auto Group.

Effective October 1, 2001, the management agreement will be modified to eliminate the service fee. It will allocate costs and apportion those costs among the parties to the agreement in accordance with the pooling percentages under the State Auto reinsurance pooling arrangement (the State Auto Pool). For those companies not party to the State Auto Pool, costs will be allocated under statutory accounting principles. Under the revised pooling agreement effective October 1, 2001, STFC will assume a larger percentage of income and expense of the State Auto Pool.

An O.D.I. letter confirming the resolution permits recognition of the service fee income, which amounted to $12.5 million for the nine-month period through September 30, 2001, and approves regulatory filings that implement the revised management agreement and pooling changes. Under the revised formula, 80% of the State Auto Pool income and expenses will be allocated to STFC's insurance company affiliates, which compares with their allocation of 53% under the prior pooling agreement.

In addition, effective October 1, 2001, Mutual entered into a stop loss reinsurance arrangement with State Auto P&C and its affiliates that participate in the State Auto Pool. Under the stop loss, Mutual has agreed to participate in the State Auto Pool's quarterly underwriting losses and gains. If the State Auto Pool's loss ratio is between 70.75% and 80%, Mutual will reinsure State Auto P&C and its affiliates for 27% of the pool's underwriting loss in excess of a loss ratio of 70.75%. STFC would be responsible for its share of the pool's losses over the 80% threshold. Also, Mutual will have the right to participate in the profits of the State Auto Pool. Mutual will be paid 27% of the pool's underwriting profits attributable to loss ratios less than 69.25%, but more than 60%. The change in pool percentage coupled with the stop loss reinsurance are expected to result in a minimum annual pre-tax benefit of $9 million during the period through December 31, 2003, which is the term of the stop loss arrangement. This should partially offset the above-described loss of the service fee income going forward. Implementation of this resolution remains subject to approval by other state insurance regulatory authorities.

State Auto Financial Corporation is a regional property and casualty insurance holding company engaged primarily in writing personal and commercial automobile, homeowners, commercial multi-peril, workers' compensation and fire insurance. The company currently markets its products through more than 21,500 agents associated with approximately 3,400 agencies in 26 states. Products are marketed primarily in the Midwest and Eastern United States, excluding New York, New Jersey and the New England states.

Except for historical information, all other information in this news release consists of forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from those projected, anticipated or implied. The most significant of these uncertainties are described in State Auto Financial's Form 10-K and Form 10-Q reports and exhibits to those reports, and include (but are not limited to) legislative changes at both the state and federal level, state and federal regulatory rule making promulgations and adjudications, class action litigation involving the insurance industry and judicial decisions affecting claims, policy coverages and the general costs of doing business, the impact of competition on products and pricing, inflation in the costs of the products and services insurance pays for, product development, geographic spread of risk, weather and weather-related events, and other types of catastrophic events. State Auto Financial undertakes no obligation to update or revise any forward-looking statements.

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