Common use of Stock Incentive Plans Clause in Contracts

Stock Incentive Plans. The Company follows Accounting Principles Board Option No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related interpretations in accounting for its employee stock incentive plans. For stock options granted to employees of Mutual in 1999, the Company also followed APB 25 and related interpretations, as the Company deemed such employees to be common law employees of the Company. Compensation cost charged against operations in 2000 and 1999 were $31,000 and $137,000, respectively, for those employee stock options granted where the exercise price was less than the market price of the underlying stock on the date of grant. Had compensation cost for the Company's plans been determined based on the fair values at the grant dates consistent with the method of SFAS No. 123, "Accounting for Stock-Based Compensation," SFAS No. 123), the Company's pro forma net earnings and net earnings per share information would have been as follows: 2000 1999 1998 ---- ---- ---- (in thousands, except per share figures) Pro forma net earnings .......................... $45,784 41,414 35,700 Pro forma net earnings per common share Basic ......................................... $ 1.19 1.02 0.85 Diluted ....................................... $ 1.17 1.00 0.83 The fair value of options granted in 2000, 1999 and 1998 were estimated at the date of grant using the Black-Scholes option-pricing model. The weighted average fair values and related assumptions for options granted were as follows: 2000 1999 1998 ---- ---- ---- Fair value ...................................... $4.66 $4.49 $6.10 Dividend yield .................................. .90% .90% .75% Risk free interest rate ......................... 6.51% 5.77% 5.31% Expected volatility factor ...................... .34 .32 .31 Expected life (years) ........................... 7.2 5.7 6.6 The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. The Company has stock option plans for certain directors and key employees. The nonemployee directors' plan provides each nonemployee director an option to purchase 1,500 shares of common stock following each annual meeting of the shareholders at an option price equal to the fair market value at the last business day prior to the annual meeting. The Company has reserved 300,000 shares of common stock under this plan. These options are exercisable at issuance to 10 years from date of grant. The key employee's plan provides that qualified stock options STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED may be granted at an option price not less than fair market value at date of grant and that nonqualified stock options may be granted at any price determined by the options committee of the Board of Directors. The Company has reserved 5,000,000 shares of common stock under this plan. These options are exercisable at such time or times as may be determined by a committee of the Company's Board of Directors. Normally, for certain employees these options are exercisable from 1 to 10 years from date of grant and 3 to 10 years for remaining employees. The Company has an employee stock purchase plan with a dividend reinvestment feature, under which employees of the Company may choose at two different specified time intervals each year to have up to 6% of their annual base earnings withheld to purchase the Company's common stock. The purchase price of the stock is 85% of the lower of its beginning-of-interval or end-of- interval market price. The Company has reserved 2,400,000 shares of common stock under this plan. At December 31, 2000, 1,699,000 shares have been purchased under this plan. The Company has a stock option incentive plan for certain designated independent insurance agencies that represent the Company and its affiliates. The Company has reserved 400,000 shares of common stock under this plan. The plan provides that the options become exercisable on the first day of the calendar year following the agency's achievement of specific production and profitability requirements over a period not greater than two calendar years from date of grant or a portion thereof in the first calendar year in which an agency commences participation under the plan. Options granted and vested under this plan have a 10-year term. The Company has accounted for the plan in its accompanying financial statements at fair value. The fair value of options granted was estimated at the reporting date or vesting date using the Black-Scholes option-pricing model. The weighted average fair value and related assumptions for 2000 and 1999, respectively, were as follows: fair value of $10.91 and $4.02; dividend yield of .90% for both years; expected volatility factor of .32 and .30; risk-free interest rate of 5.19% and 6.80%; and expected life of the option of 9.0 and 9.7 years. Expense of $493,000 and $105,000 associated with this plan was recognized in 2000 and 1999, respectively. A summary of the Company's stock option activity and related information for these plans for the years ended December 31, 2000, 1999 and 1998, follows: 2000 1999 1998 ------------------------ ------------------------ ------------------------ WEIGHTED-AVERAGE WEIGHTED-AVERAGE WEIGHTED-AVERAGE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE ------- -------------- ------- -------------- ------- -------------- (numbers in thousands, except per share figures) Outstanding, beginning of year 2,546 $ 7.76 2,272 $ 6.76 2,019 $ 5.04 Granted 492 10.29 453 11.24 339 16.31 Exercised (129) 4.32 (165) 3.34 (86) 4.02 Canceled (57) 11.15 (14) 10.52 -- -- ----- ----- ----- Outstanding, end of year 2,852 8.28 2,546 7.76 2,272 6.76 ===== ===== ===== A summary of information pertaining to options outstanding and exercisable as of December 31, 2000 follows: OPTIONS OUTSTANDING OPTIONS EXERCISABLE --------------------------------------------- ------------------------- WEIGHTED-AVERAGE REMAINING WEIGHTED-AVERAGE WEIGHTED-AVERAGE RANGE OF EXERCISE PRICES NUMBER CONTRACTUAL LIFE EXERCISE PRICE NUMBER EXERCISE PRICE ------------------------- ------ ---------------- ---------------- ------ ---------------- (numbers in thousands, except per share figures) Less than $5.00 734 2.0 $ 3.98 734 $ 3.98 $5.01 - $10.00 1,004 4.9 6.66 961 6.56 Greater than $10.01 1,114 8.5 12.58 537 13.89 ----- ----- 2,852 5.5 8.28 2,232 7.47 ===== ===== STANDBY PURCHASE AGREEMENT SCHEDULE 1 PART B During 2001, the common shares of STFC became a permitted investment in the State Auto 401(k) Capital Accumulation Plan (the "CAP") plan and in non-qualified deferred compensation plans for key employees and directors. The CAP and Employee Non-Qualified Deferred Compensation Plan were registered with the SEC. The Directors' Non-Qualified Deferred Compensation Plan was not registered with the SEC, since it is within the scope of an exception to registration. The participants in the non-qualified deferred compensation plans are unsecured creditors of State Auto and part of the obligations under those plans will reflect the value of STFC common shares to the extent any participants investments are so directed. Fidelity Investments is the Trustee of the CAP. State Auto Financial has an active program of share repurchases ongoing as authorized by its board of directors. Agreemen/Standby Purchase Agreement part B 11-05-01 EXHIBIT A to the Standby Purchase Agreement [Form Class A Preferred Stock Certificate] [Front of Class A Preferred Stock Certificate] CERTIFICATE NUMBER SHARES ------ ------ _________________ ________________ STATE AUTO FINANCIAL CORPORATION Incorporated under the laws of the State of Ohio CUSIP __________ SEE REVERSE SIDE FOR CERTAIN TRANSFER RESTRICTIONS AND OTHER IMPORTANT INFORMATION This is to Certify that ______________________________ is the owner of ______________________________________________________________________ FULLY PAID AND NON-ASSESSABLE SHARES OF CLASS A PREFERRED STOCK NO PAR VALUE OF State Auto Financial Corporation transferable on the books of the Corporation by the holder hereof in person or by duly authorized Attorney upon surrender of this Certificate properly endorsed. WITNESS the seal of the Corporation and the signatures of its duly authorized officers. ______________________________ __________________________________ Secretary Chief Executive Officer __________________________________ President [Reverse of Class A Preferred Stock Certificate] STATE AUTO FINANCIAL CORPORATION The Corporation will furnish upon request and without charge to each shareholder the powers, designations, preferences and relative, participating, optional or other special rights of each class of stock series within a class of stock of the Corporation, as well as the qualifications, limitations and restrictions relating to those preferences and/or rights. THE SHARES EVIDENCED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, AND MAY BE REOFFERED AND SOLD ONLY IF REGISTERED PURSUANT TO THE PROVISIONS OF SAID SECURITIES ACT OR IF AN EXEMPTION FROM REGISTRATION IS AVAILABLE. In addition, the shares evidenced by this certificate are subject to the restrictions on transfer set forth in the Terms and Conditions attached hereto. TERMS AND CONDITIONS of CLASS A PREFERRED STOCK of STATE AUTO FINANCIAL CORPORATION _______________________________________________________________________________ Pursuant to Section 1701.14 of the Ohio General Corporation Law _______________________________________________________________________________

Stock Incentive Plans. The Company follows Accounting Principles Principals Board Option Opinion No. 25, "Accounting for Stock Issued issued to Employees" (APB 25) and related interpretations Interpretations in accounting for its employee stock incentive plans. For stock options granted to employees of Mutual in 1999, the Company also followed APB 25 and related interpretationsInterpretations, as the Company deemed such employees to be common law employees of the Company. , Compensation cost charged against operations in 2000 and 1999 were $31,000 and $137,000, respectively, for those employee stock options granted where the exercise price was less than the market price of the underlying stock on the date of grant. Had compensation cost for the Company's plans been determined based on the fair values at the grant dates consistent with the method of SFAS No. 123, "Accounting for Stock-Based Compensation," (SFAS No. 123), the Company's pro forma net earnings and net earnings per share information would have been as follows: 2000 1999 1998 ---- ---- ---- (in thousands, except per share figures) Pro forma net earnings .......................... earnings....................... $45,784 41,414 35,700 Pro forma net earnings per common share Basic ......................................... Basic................................... $ 1.19 1.02 0.85 Diluted ....................................... Diluted................................. $ 1.17 1.00 0.83 The fair value of options granted in 2000, 1999 and 1998 were estimated at the date of grant using the Black-Scholes option-pricing model. The weighted average fair values and related assumptions for options granted were as follows: 2000 1999 1998 ---- ---- ---- Fair value ...................................... value......................... $4.66 $4.49 $6.10 Dividend yield .................................. .90yield..................... 90% .90% .75% Risk free interest rate ......................... ........... 6.51% 5.77% 5.31% Expected volatility factor ...................... factor......... .34 .32 .31 Expected life (years) ........................... ).............. 7.2 5.7 6.6 The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options. The Company has stock option plans for certain directors and key employees. The nonemployee directors' plan provides each nonemployee director an option to purchase 1,500 shares of common stock following each annual meeting of the shareholders at an option price equal to the fair market value at the last business day prior to the annual meeting. The Company has reserved 300,000 shares of common stock under this plan. These options are exercisable at issuance to 10 years from date of grant. The key employee's plan provides that qualified stock options STATE AUTO FINANCIAL CORPORATION AND SUBSIDIARIES (a majority-owned subsidiary of State Automobile Mutual Insurance Company) NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, CONTINUED may be granted at an option price not less than fair market value at date of grant and that nonqualified stock options may be granted at any price determined by the options committee of the Board of Directors. The Company has reserved 5,000,000 shares of common stock under this plan. These options are exercisable at such time or times as may be determined by a committee of the Company's Board of Directors. Normally, for certain employees these options are exercisable from 1 to 10 years from date of grant and 3 to 10 years for remaining employees. The Company has an employee stock purchase plan with a dividend reinvestment feature, under which employees of the Company may choose at two different specified time intervals each year to have up to 6% of their annual base earnings withheld to purchase the Company's common stock. The purchase price of the stock is 85% of the lower of its beginning-of-interval or end-of- interval market price. The Company has reserved 2,400,000 shares of common stock under this plan. At December 31, 2000, 1,699,000 shares have been purchased under this plan. The Company has a stock option incentive plan for certain designated independent insurance agencies that represent the Company and its affiliates. The Company has reserved 400,000 shares of common stock under this plan. The plan provides that the options become exercisable on the first day of the calendar year following the agency's achievement of specific production and profitability requirements over a period not greater than two calendar years from date of grant or a portion thereof in the first calendar year in which an agency commences participation under the plan. Options granted and vested under this plan have a 10-year term. The Company has accounted for the plan in its accompanying financial statements at fair value. The fair value of options granted was estimated at the reporting date or vesting date using the Black-Scholes option-pricing model. The weighted average fair value and related assumptions for 2000 and 1999, respectively, were as follows: fair value of $10.91 and $4.02; dividend yield of .90% for both years; expected volatility factor of .32 and .30; risk-free interest rate of 5.19% and 6.80%; and expected life of the option of 9.0 and 9.7 years. Expense of $493,000 and $105,000 associated with this plan was recognized in 2000 and 1999, respectively. A summary of the Company's stock option activity and related information for these plans for the years ended December 31, 2000, 1999 and 1998, follows: 2000 1999 1998 ------------------------ ------------------------ ------------------------ WEIGHTED-AVERAGE WEIGHTED-AVERAGE WEIGHTED-AVERAGE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE OPTIONS EXERCISE PRICE ------- -------------- ------- -------------- ------- -------------- (numbers in thousands, except per share figures) Outstanding, beginning of year 2,546 $ 7.76 2,272 $ 6.76 2,019 $ 5.04 Granted 492 10.29 453 11.24 339 16.31 Exercised (129) 4.32 (165) 3.34 (86) 4.02 Canceled (57) 11.15 (14) 10.52 -- -- ----- ----- ----- Outstanding, end of year 2,852 8.28 2,546 7.76 2,272 6.76 ===== ===== ===== A summary of information pertaining to options outstanding and exercisable as of December 31, 2000 follows: OPTIONS OUTSTANDING OPTIONS EXERCISABLE --------------------------------------------- ------------------------- WEIGHTED-AVERAGE REMAINING WEIGHTED-AVERAGE WEIGHTED-AVERAGE RANGE OF EXERCISE PRICES NUMBER CONTRACTUAL LIFE EXERCISE PRICE NUMBER EXERCISE PRICE ------------------------- ------------------------ ------ ---------------- ---------------- ------ ---------------- (numbers in thousands, except per share figures) Less than $5.00 734 2.0 $ 3.98 734 $ 3.98 $5.01 - $10.00 1,004 4.9 6.66 961 6.56 Greater than $10.01 1,114 8.5 12.58 537 13.89 ----- ----- 2,852 5.5 8.28 2,232 7.47 ===== ===== STANDBY PURCHASE AGREEMENT SCHEDULE 1 PART Put Agreement Schedule III Part B During 2001, the common shares of STFC became a permitted investment in the State Auto 401(k) Capital Accumulation Plan (the "CAP") plan and in non-qualified deferred compensation plans for key employees and directors. The CAP and the Employee Non-Qualified Deferred Compensation Plan were registered with the SEC. The Directors' Non-Qualified Deferred Compensation Plan was not registered with the SEC, since it is within the scope of an exception to registration. The participants in the non-qualified deferred compensation plans are unsecured creditors of State Auto and part of the obligations under those plans will reflect the value of STFC common shares to the extent any participants investments are so directed. Fidelity Investments is the Trustee of the CAP. State Auto Financial has an active program of share repurchases ongoing as authorized by its board of directors. Agreemen/Standby Purchase Agreement part B put agreement schedule III 11-056-01 EXHIBIT A to the Standby Purchase Put Agreement [Form Class A Preferred Stock Certificateof Put Notice] [Front Date] State Automobile Mutual Insurance Company State Auto Financial Corporation [Address] Re: Put Agreement dated as of Class A Preferred Stock Certificate] CERTIFICATE NUMBER SHARES ------ ------ November 16, 2001, between State Automobile Mutual Insurance Company, State Auto Financial Corporation and Bank One, NA, as Agent. Dear Ladies and Gentlemen: Reference is made to the Amended and Restated Put Agreement dated as of November 16, 2001 (as modified and supplemented and in effect from time to time, the "PUT AGREEMENT"), among State Automobile Mutual Insurance Company ("STATE AUTO MUTUAL"), State Auto Financial Corporation and Bank One, NA, as Agent. Capitalized terms used but not defined herein shall have the respective meanings assigned to such terms in the Put Agreement. [Pursuant to Section 2.2 of the Put Agreement, the undersigned hereby requires that State Auto Mutual purchase all of each Lender's Loans, Note and Commitment. The aggregate purchase price payable by State Auto Mutual for all such Loans, Notes and Commitments shall be $_______________ representing the sum of (a) principal of such Loans in the amount of $_______________, PLUS (b) accrued and unpaid interest thereon in the amount of $__ _____________, PLUS (c) other amounts payable under the Basic Documents in respect thereof in the amount of $________________ STATE AUTO FINANCIAL CORPORATION Incorporated under the laws .] [Pursuant to Section 2.3 of the Put Agreement, the undersigned hereby requires that State Auto Mutual purchase all of Ohio CUSIP the Pledged Stock for an aggregate purchase price equal to $_______________ SEE REVERSE SIDE FOR CERTAIN TRANSFER RESTRICTIONS AND OTHER IMPORTANT INFORMATION This is to Certify that representing the sum of (a) the aggregate Redemption Value of such Pledged Stock in the amount of $_____________, PLUS (b) accrued and unpaid dividends thereon in the amount of $______________________________ is the owner of .] The Put Purchase Date for such purchase shall be _______________, _______________________________________________________ FULLY PAID AND NON-ASSESSABLE SHARES . BANK ONE, NA, as Agent By ------------------------------------- Title: A-1 EXHIBIT B OPINION OF CLASS A PREFERRED STOCK NO PAR VALUE GENERAL COUNSEL OF THE STATE AUTO OBLIGORS [STATE AUTO INSURANCE COMPANIES LETTERHEAD] November 16, 2001 To each of the Lenders party to the Credit Agreement referred to below and Bank One, NA, as Agent Ladies and Gentlemen: I am the general counsel of State Automobile Mutual Insurance Company ("STATE AUTO MUTUAL") and State Auto Financial Corporation transferable ("STATE AUTO FINANCIAL" and, together with State Auto Mutual, the "STATE AUTO OBLIGORS") and have acted as counsel to the State Auto Obligors in connection with (i) the Amended and Restated Put Agreement dated as of November 16, 2001 (the "PUT AGREEMENT") among the State Auto Obligors and Bank One, NA, in its capacity as Agent (the "AGENT") on the books behalf of the Corporation by lenders party to an Amended and Restated Credit Agreement dated as of November 16, 2001, among SAF Funding Corporation, the holder hereof Agent and (ii) the agreements, instruments and other documents referred to in person or by duly authorized Attorney upon surrender of this Certificate properly endorsedthe next paragraph. WITNESS All capitalized terms used but not defined herein have the seal respective meanings given to such terms in the Put Agreement. This opinion letter is delivered to you pursuant to Section 4.18(c) of the Corporation and the signatures of its duly authorized officers. ______________________________ __________________________________ Secretary Chief Executive Officer __________________________________ President [Reverse of Class A Preferred Stock Certificate] STATE AUTO FINANCIAL CORPORATION The Corporation will furnish upon request and without charge to each shareholder the powers, designations, preferences and relative, participating, optional or other special rights of each class of stock series within a class of stock of the Corporation, as well as the qualifications, limitations and restrictions relating to those preferences and/or rights. THE SHARES EVIDENCED BY THIS CERTIFICATE HAVE NOT BEEN REGISTERED UNDER THE SECURITIES ACT OF 1933, AS AMENDED, AND MAY BE REOFFERED AND SOLD ONLY IF REGISTERED PURSUANT TO THE PROVISIONS OF SAID SECURITIES ACT OR IF AN EXEMPTION FROM REGISTRATION IS AVAILABLEPut Agreement. In additionrendering the opinions expressed below, I have examined the shares evidenced by this certificate are subject to the restrictions on transfer set forth in the Terms following agreements, instruments and Conditions attached hereto. TERMS AND CONDITIONS of CLASS A PREFERRED STOCK of STATE AUTO FINANCIAL CORPORATION _______________________________________________________________________________ Pursuant to Section 1701.14 of the Ohio General Corporation Law _______________________________________________________________________________other documents: