State Auto Financial Corporation

estimates, primarily from the 2018 and 2019 accident years. Commercial lines development continues to be favorable across all product lines, and in particular, small and middle commercial, along with workers' compensation. The GAAP expense ratio is essentially flat with 2019 after nine months. No significant adjustments were recorded to the bad debt allowance directly as a result of COVID beyond what we booked in the first quarter of 2020. There were some note payable changes in the quarter. In early September, we retired SDFC's five-year note with the Federal Home Loan Bank, replacing it with a new 10-year note in the same amount of $21.5 million. The new interest rate is fixed at 1.37% versus the expiring rate of 1.73%. In addition, the $60 million Federal Home Loan Bank short-term loan entered into on March 19th, but turned and was repaid in full on September 22nd. And with that, I will turn the call over to Kim.

Thanks, Steve, and good morning, everyone. On October 29th, Workers' Comp Connect launched in Texas. This is our last product line to launch on the Connect platform. We are thrilled, and it's probably appropriate to look back at the impact that the Connect program has driven at State Auto since 2015. From the first day in 2015, the goals of the Connect program were the following. Increase scale. Reduce expense ratio. Reduce our non-CAT loss and ALAE ratio. Replace and upgrade our technology to give us a competitive advantage. Replace and upgrade our products and pricing models to compete with the best prices in the industry. Evolve our traditional retail independent agent distribution plan to expand to additional types of growing independent distributors that were emerging, driven by the significant innovation taking place in the world of independent agents. and significantly participate in the world of insurtech innovation at a moment in time when the insurance industry was entering a period of massive innovation and disruption. Our progress on scale. Direct new business written premium for the state auto group in the year 2015 for personal and commercial lines was $226 million. For 2019, it was $557.9 million. which equates to a 25.3% compound annual growth rate. For the 12 months ending September 30, 2020, it was $661.3 million. Connect has helped drive a 3x increase in our new business production since 2015, and this is without a full year of impact from Farm and Ranch, Middle Market, and Workers' Compensation Connect. This has driven our total written premium for personalized and commercialized to grow at double-digit rates over the last three years. This increase in the size of our new business engine has positioned us well for continued growth into the future. Progress on reducing expense ratio. Our strategy was to take a short-term expense ratio hit through the investment in Connect in exchange for longer-term expense ratio improvement through a more efficient platform and an increase in scale. Four of our product lines, personal auto, homeowners, commercial auto, and small commercial are far enough along to understand if this strategy is working or not. It has worked in three of our four product lines. Commercial auto is the best example of this, with a 2016 pre-Connect expense ratio of 38.5%. This increased to 46.5% in 2018 as we made our investment in Connect, but the year-to-date 2020 expense ratio is at 34.3%. a 4.2-point improvement than over PreConnect. Over the next two years, we believe the commercial auto expense ratio will get below 30%. This expense ratio reduction strategy has also worked in small commercial, whose pattern is very similar to commercial auto, and homeowners, where this pattern has been slower and more gradual. Personal auto is the product line where this strategy has not yet been effective, as the expense ratio has actually increased after the implementation of Connect. As I've told you on prior calls, we made missteps in personal auto with the primary one being our balance between preferred and non-standard business skewed too heavily towards non-standard, which has a very low retention. We were putting inefficient business on an efficient platform. This combination still produces overall inefficiency. The increase in the personal auto expense ratio is not from a bad strategy, but from poor execution of a good strategy. I will update you on our progress in personal auto later in this discussion. With the Connect product builds being completed, you should start to see two things. One, the same pattern of expense ratio reduction to show up in the remaining product lines over the next couple of years. And two, since there are no more new Connect builds to invest in, improvements in all the product lines should result in state autos total expense ratios starting to decline. Progress on our non-CAT loss and ALAE ratios. The non-CAT loss and ALAE ratios have been driven from the 57-58% range in 2015 down to the 49 to 51% range currently. Non-CAT loss and ALAE ratios in the 50 range with declining expense ratios should be sufficient to produce mid-90s combined ratios consistently over time. Progress on evolving our distribution plant. Insurers categorize agents in a variety of ways. We categorize them in the following way, retail agents, network agents, platform agents, and corporate agents. In 2015, we were heavily weighted in the world of retail agents, who we love, But we were underweighted in the network agent world, and we did zero business with platform agents, two IA categories that were rapidly innovating and growing. Over the last five years, we have seen a significant shift in the distribution of our business by agency category. Personalize is a good example of this phenomenon. In 2015, our Personalize new business was distributed in the following proportions. Retail, 63%. Network, 30%. Platform, zero. Corporate agent, 7%. Through nine months of 2020, our personalized new business is distributed in the following proportions. Retail, 35%, networks, 54%, platforms, 8%, and corporate agents, 3%. This major change in how our business is distributed is a sign that we are now effectively competing in all the methods of distribution in the independent agency channel. Progress on our technology, products, and pricing models for what we call the Connect platform. The historical model for insurance technology products and pricing models was that a carrier would do a big build and then wait an extended period of time, two to five years, to do another big build. Our technology, product design, and pricing models for every single product line have converted from the periodic big build model to a continuous improvement model. For pricing models, you hear us talk about versions, personal auto version 2.1, homeowners version 3.0, commercial auto version 2.0. small commercial version 2.2. In this approach, our pricing models are continually improving. Every quarter, enhancements are made, and this has a very different impact than the approach where one's pricing models improve only once every couple of years. And for our technology, we're converting from the big build teams for Connect to small product teams that are continually enhancing different parts of Connect. In 2015, we started from a place where we had fallen behind the industry in a number of areas. Our conversion to this operational model of continuous improvement is to help ensure that this never happens again, that we never fall behind and have to dig ourselves out of a hole. Progress on the participation in the world of insurtech and being prepared for this era of innovation and disruption in the insurance industry. In 2015, State Auto did not participate in the world of insurtech. State Auto Labs, State Auto's corporate venture capital fund, was created in 2016 And since that time, 24 InsurTech startups have been implemented into State Auto's insurance operations, and six investments have been made. Without Connect, we would not have been able to integrate this number of InsurTechs into our insurance operations. It would have been impossible on our legacy system. In the first quarter of 2020, Coverager, a news source and researcher of the InsurTech world, surveyed the participants of the InsurTech world and released their list of the top 11 insurance corporate venture capital funds and InsurTech partners in the industry. State Auto Labs was on that list of the top 11. We believe that the insurance industry is still at the beginning of a period of massive innovation and disruption, and it is critical to be connected into the InsurTech world. As we reflect on the impact of Connect and all of the efforts surrounding Connect, we believe it has accomplished all of the goals that we established back in 2015 when we started. and that it has positioned us well to be an extremely successful insurer over the next decade, it is impossible for us to adequately thank all of the state auto associates for what they did to implement the Connect program. We have posted to the investor section of our website in greater detail the data I have referenced this morning. Now on to third quarter results. Overall personalized and commercialized statutory results are the following. Third quarter 20 combined ratio is 102.2 compared to 98.7 for third quarter 19. Third quarter 20 year-to-date combined ratio is 106.9 compared to the 102.7 through 3Q 19 year-to-date. Written premium growth was 9.2% third quarter 20 versus third quarter 19. 11.4% year-to-date 2020 compared to 2019 year-to-date. For the quarter, commercial lines had a combined ratio of 88.9 and written premium growth of 8.3%, and personal lines had a combined ratio of 111.5 and written premium growth of 9.7. To appropriately understand our results, there are quite a few things to unwind. For our quarterly results, catastrophes are again the story of the quarter. The catastrophe impact on our third quarter 2020 results were the following. Personal lines and commercial lines CAT loss ratios were 9.9 points higher than 3Q19, with personal lines 11.6 points higher, commercial lines 7.6 points higher. Non-CAT loss and ALAE ratios are at our plan for 3Q20. The personal lines and commercial lines non-CAT loss ratio was 6.3 points lower than 3Q19, with personal lines being 2.3 points lower and commercial lines being 12.2 points lower. Non-CAT loss in the ALAE prior accident year loss ratio impact. The personalized and commercialized non-CAT loss ratio accident year impact was 0.4 points lower than third quarter 19. The personalized non-CAT loss ratio prior accident year impact was five points higher than 3Q19, while the commercialized non-CAT loss ratio prior accident year impact was 7.9 points lower than 3Q19. The overall impact of prior accident years was roughly the same as last year, but there was a meaningful shift between personal lines and commercial lines. Non-CAT loss and ALA current accident year loss ratios. The personal lines and commercial lines non-CAT current accident year loss ratios were 5.9 points lower than 3Q19, with personal lines being 7.3 points lower and commercial lines being 4.3 points lower. This improvement in the current action year is driven by two factors, COVID and the actions that we have taken and personalized to address the issues that we discussed on the first quarter earnings call. We feel very good about where we are positioned. Catastrophes happen, and 2020 is a horrible catastrophe year. But when we look back at the total of the past six years, our actual CAT loss ratio is virtually identical to our planned CAT loss ratio. Catastrophes have to be managed over an extended period of time, understanding there will be individual horrible catastrophe years along the way. We feel good about our catastrophe management. The adverse prior year reserve development in personal auto is part of the price that you're paying for the personal auto missteps we made in 2018 and 2019. The improvement in current accident-year loss ratios get them to where they need to be to consistently produce mid-90s combined ratios. And as I explained earlier, being at the end of the Connect program means that expense ratio improvement should start to flow into our total results. Some updates on our individual product lines. Personal auto. The personal auto combined ratio for third quarter 20 was 104.7. This was driven by 7.8 loss ratio points from prior accident years. This is nine points higher impact from prior accident years than in third quarter 19. And as I said before, this adverse prior year reserve development in personal auto is part of the price we are paying for personal auto missteps we made in 2018 and 2019. The third quarter 20 current accident year loss in ALAE ratio of 56.4 is 11 points better than a year ago. And third quarter 20 year to date is 11.3 points better than a year ago. Our shift to less non-standard and more preferred is progressing as expected. Connect version 2.1 has been approved in 20 states, and we are seeing the changes in competitiveness across the preferred through non-standard risk spectrum that we expected. Connect ultra-preferred and preferred policies and force growth is 42% as of 9-30-20 versus prior year, while Connect non-standard PIF growth is minus 13% as of 9-30-20 versus a prior year. As of 9-30-20, for the first time in Connect's history, ultra-preferred and preferred Connect PIF is larger than non-standard PIF. This shift is driving an increase in personal auto retention, as personal auto retention is up 1.7 points to 68.4 since December 31, 2019. In another sign of this shift, personal umbrella new business sales were up 123% in third quarter 20 versus third quarter 19. We are pleased with our progress through 2020 in personal auto, but there's still work to do in this product line. Homeowners, catastrophes are again the story of the quarter for homeowners with a CAT loss and ALAE ratio of 30.4 compared to 9.2 in third quarter 19. Growth continues to be strong in homeowners with written premium growth rate of plus 21.7%, policies enforced growth rate of plus 16.1%, new business account growth rate of 16.2% and a retention level of 76.7, which is up 1.2 points since December 31st, 2019. The improved personal auto rate competitiveness from Personal Auto Connect version 2.1 is helping homeowners retention. Commercial auto. Our commercial auto results continue to be just terrific, with third quarter 20 results of a combined ratio of 94.3, total written premium growth of 44.4, a new business premium growth rate of 46.7, and a premium retention level of 84.1. Middle market, small commercial, and workers' compensation results in third quarter 20 were all impacted by prior accident-year loss ratios that were much more favorable than a year ago, while middle market and small commercial results in third quarter 20 were also impacted by much higher CAT loss ratios than a year ago. The workers' comp third quarter 20 current action year loss ratio of 82.2 was 18 points higher than a year ago, driven by five large losses in the quarter. Middle market growth. We are seeing a slowdown in middle market submissions. Agents are telling us that middle market policyholders are more hesitant to move carriers at this moment in time. Our third quarter 20 middle market new business written premium declined 39.8% from a year ago, and our total middle market new business written premium was flat from a year ago. We rolled out eight additional states for Middle Market Connect in September, bringing the total states on Middle Market Connect to 16. Workers' compensation growth. Our workers' compensation business has shrunk for several years due to four reasons. One, we exited monoline small workers' compensation business sold through wholesalers, which had consistently been unprofitable. Two, we have maintained rate discipline while the market has been significantly decreasing rates over the last several years, and this puts significant downward pressure on retention. Three, we are currently non-renewing our nursing home workers' comp policies. And fourth, and the last reason, is that our workers' compensation business was sold on a separate system from the rest of State Auto's products, making it significantly harder to package workers' comp with the rest of our commercial products. This changed on October 29th with the launch of our first workers' comps, Connect State, Texas. Workers' compensation will now be on the same platform as the rest of our products, and we anticipate this significantly accelerating our growth of our workers' compensation business, reversing several years of premium decline. The last few years of work have now positioned our workers' comp business for significant future success. Farm and ranch results continue to be terrific. Farm and Ranch Connect is now launched in 27 states. Third quarter 20 results versus a year ago are the following. New business written premium growth rate of 202%, total written premium growth rate of 31.6%, A combined ratio of 101.4, which includes a catastrophe loss ratio of 22.1, which is 18.9 points higher than third quarter 19. An elevated expense ratio of 45.1% as Farm and Ranch is at the height of its Connect investment. And a non-CAT loss and ALAE ratio of 30.8%, which is 13.5 points lower than third quarter 19. Our Farm and Ranch business is positioned incredibly well for future profitable growth. We are excited about how our product lineup is currently positioned for future success, and with that, we'll open the line for questions.

As a reminder, to ask a question, you will need to press star one in your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Your first question will come from Paul Newsom. Please proceed.