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| SIGI > SEC Filings for SIGI > Form 10-Q on 26-Jul-2012 | All Recent SEC Filings |
26-Jul-2012
Quarterly Report
Introduction
We classify our business into two operating segments:
• Insurance Operations, which sells property and casualty insurance products
and services; and
• Investments, which invests the premiums collected by our insurance operations.
Our Insurance Operations offers standard Commercial Lines and Personal Lines
market insurance products and services through seven insurance subsidiaries and,
in 2011, we began offering commercial excess and surplus lines ("E&S") insurance
products through one insurance subsidiary as the result of the following
acquisition activity:
• The purchase of the renewal rights to an E&S book of business in August
2011; and
• The purchase of Montpelier U.S. Insurance Company (now known as Mesa Underwriters Specialty Insurance Company) ("MUSIC") in December 2011.
In the third quarter of 2012, we created two new insurance subsidiaries, Selective Casualty Insurance Company and Selective Fire and Casualty Insurance Company. These two new companies, which are expected to begin writing premium in 2013, have been included in our reinsurance pooling agreement as of July 1, 2012. See the "Reinsurance" section below for details regarding the pooling change. Our ten insurance subsidiaries are collectively referred to as the "Insurance Subsidiaries". For additional information regarding our recent acquisitions, refer to Note 13. "Business Combinations" in Item 8. "Financial Statements and Supplementary Data." of our Annual Report on Form 10-K for the year ended December 31, 2011 ("2011 Annual Report").
The purpose of the Management's Discussion and Analysis ("MD&A") is to provide an understanding of the consolidated results of operations and financial condition and known trends and uncertainties that may have a material impact in future periods. Consequently, investors should read the MD&A in conjunction with the consolidated financial statements in our 2011 Annual Report.
In the MD&A, we will discuss and analyze the following:
• Critical Accounting Policies and Estimates;
• Financial Highlights of Results for the second quarter ended June 30, 2012 ("Second Quarter 2012") and the six-month period ended June 30, 2012 ("Six Months 2012");
• Results of Operations and Related Information by Segment;
• Financial Condition, Liquidity, Short-term Borrowings, and Capital Resources;
• Ratings;
• Off-balance Sheet Arrangements; and
• Contractual Obligations, Contingent Liabilities, and Commitments.
Critical Accounting Policies and Estimates
These unaudited interim consolidated financial statements include amounts based
on our informed estimates and judgments for those transactions that are not yet
complete. Such estimates and judgments affect the reported amounts in the
consolidated financial statements. Those estimates and judgments most critical
to the preparation of the consolidated financial statements involve the
following: (i) reserves for losses and loss expenses; (ii) deferred policy
acquisition costs; (iii) premium audit; (iv) pension and post-retirement benefit
plan actuarial assumptions; (v) other-than-temporary investment impairments; and
(vi) reinsurance. These estimates and judgments require the use of assumptions
about matters that are highly uncertain and, therefore, are subject to change as
facts and circumstances develop. If different estimates and judgments had been
applied, materially different amounts might have been reported in the financial
statements. For additional information regarding our critical accounting
policies, refer to our 2011 Annual Report, pages 47 through 56.
Financial Highlights of Results for Second Quarter 2012 and Six Months 20121
Quarter ended June 30, Six Months ended June 30,
(Shares and $ in thousands, except per share Change Change
amounts) 2012 2011 % or Points 2012 2011 % or Points
GAAP measures:
Revenues $ 428,907 399,570 7 % 848,255 803,026 6 %
Pre-tax net investment income 34,006 39,345 (14 ) 66,634 82,818 (20 )
Pre-tax net income (692 ) (99 ) 599 22,499 26,059 (14 )
Net income 288 1,467 (80 ) 18,381 21,967 (16 )
Diluted net income per share 0.01 0.03 (67 ) 0.33 0.40 (18 )
Diluted weighted-average outstanding shares 55,681 55,135 1 55,642 55,092 1
GAAP combined ratio 106.9 % 109.6 (2.7 ) pts 103.7 % 106.6 (2.9 ) pts
Statutory combined ratio 106.2 % 109.5 (3.3 ) 102.7 % 106.1 (3.4 )
Return on average equity 0.1 % 0.6 (0.5 ) 3.4 % 4.3 (0.9 )
Non-GAAP measures:
Operating income2 $ 172 72 139 % 15,432 16,828 (8 ) %
Diluted operating income per share2 0.01 - NA 0.28 0.31 (10 )
Operating return on average equity2 0.1 % - 0.1 pts 2.9 % 3.3 % (0.4 ) pts
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1 Refer to the Glossary of Terms attached to our 2011 Annual Report as Exhibit 99.1 for definitions of terms used in this Form 10-Q.
2 Operating income is used as an important financial measure by us, analysts, and investors, because the realization of investment gains and losses on sales in any given period is largely discretionary as to timing. In addition, these realized investment gains and losses, as well as other-than-temporary impairments ("OTTI") that are charged to earnings could distort the analysis of trends. See below for a reconciliation of operating income to net income in accordance with U.S. generally accepted accounting principles ("GAAP"). Operating return on average equity is calculated by dividing annualized operating income by average stockholders' equity.
Revenue increases in both the quarterly and year-to-date periods reflect higher premium from our Insurance Operations, partially offset by reductions in net investment income. Premium increases were attributable to our newly-acquired E&S business, as well as standard Commercial Lines and Personal Lines renewal pure price increases and higher retention. See the Insurance Operations discussion below for additional information.
Our pre-tax net income in both Second Quarter 2012 and 2011 was significantly impacted by catastrophe losses. These losses amounted to $30.2 million in Second Quarter 2012 and $38.1 million in the second quarter of 2011 ("Second Quarter 2011"). In addition, pre-tax net investment income was down $5.3 million, or 14% in Second Quarter 2012 compared to Second Quarter 2011, driven by lower returns on the alternative investment portion of our other investments portfolio. Our alternative investments, which are accounted for under the equity method, primarily consist of investments in limited partnerships, the majority of which report results to us on a one quarter lag. See Note 6. "Investments" in Item 1. "Financial Statements" of this Form 10-Q for additional information regarding our alternative investment portfolio.
Similar to the quarterly results, Six Months 2012 and 2011 were both significantly impacted by catastrophe losses of $37.1 million and $44.9 million, respectively. In addition, reductions in alternative investment returns, coupled with lower yields on our fixed maturity securities portfolio, drove the $16.2 million, or 20%, reduction in net investment income for Six Months 2012 versus Six Months 2011.
The net income fluctuation in both the quarterly and year-to-date periods reflect the pre-tax income changes discussed above.
The following table reconciles operating income and net income for the periods presented above:
Quarter ended Six Months ended
June 30, June 30,
($ in thousands, except per share amounts) 2012 2011 2012 2011
Operating income $ 172 72 15,432 16,828
Net realized gains, net of tax 116 1,395 2,949 5,139
Net income 288 1,467 18,381 21,967
Diluted operating income per share $ 0.01 - 0.28 0.31
Diluted net realized gains per share - 0.03 0.05 0.09
Diluted net income per share $ 0.01 0.03 0.33 0.40
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The variances in operating income are reflective of the results discussed above.
Results of Operations and Related Information by Segment
Insurance Operations
Our standard Commercial Lines and Personal Lines market insurance products and services are sold primarily in 22 states in the Eastern and Midwestern U.S. through approximately 1,000 independent insurance agencies. Our recent E&S acquisitions provide us the opportunity to write contract binding authority E&S business in all 50 states and the District of Columbia through approximately 100 wholesale agents across the entire country.
Our Insurance Operations segment consists of two components: (i) Commercial Lines, which markets primarily to businesses and represents approximately 82% of net premiums written ("NPW"); and (ii) Personal Lines, which markets primarily to individuals and represents approximately 18% of NPW. Our E&S operations write exclusively commercial lines of business, and for purposes of this MD&A, this business is included within Commercial Lines. The underwriting performance of these lines is generally measured by four different statutory ratios: (i) the loss and loss expense ratio; (ii) the underwriting expense ratio; (iii) the dividend ratio; and (iv) the combined ratio.
Summary of Insurance
Operations
All Lines Quarter ended June 30, Six months ended June 30,
Change Change
% or % or
($ in thousands) 2012 2011 Points 2012 2011 Points
GAAP Insurance Operations Results:
NPW $ 425,563 374,503 14 % 845,735 736,338 15 %
Net premiums earned
("NPE") 392,212 355,580 10 771,041 706,923 9
Less:
Losses and loss
expenses incurred 287,903 274,555 5 540,809 523,761 3
Net underwriting
expenses incurred 130,041 113,566 15 256,413 227,115 13
Dividends to
policyholders 1,230 1,461 (16 ) 2,144 2,747 (22 )
Underwriting loss $ (26,962 ) (34,002 ) 21 % (28,325 ) (46,700 ) 39 %
GAAP Ratios:
Loss and loss expense
ratio 73.4 % 77.2 (3.8 ) pts 70.1 74.1 (4.0 ) pts
Underwriting expense
ratio 33.2 32.0 1.2 33.3 32.1 1.2
Dividends to
policyholders ratio 0.3 0.4 (0.1 ) 0.3 0.4 (0.1 )
Combined ratio 106.9 109.6 (2.7 ) 103.7 106.6 (2.9 )
Statutory Ratios:
Loss and loss expense
ratio 73.4 77.2 (3.8 ) 70.1 74.1 (4.0 )
Underwriting expense
ratio 32.5 31.9 0.6 32.3 31.6 0.7
Dividends to
policyholders ratio 0.3 0.4 (0.1 ) 0.3 0.4 (0.1 )
Combined ratio 106.2 % 109.5 (3.3 ) pts 102.7 106.1 (3.4 ) pts
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NPW increases in both Second Quarter and Six Months 2012 compared to the prior
year periods were attributable to our newly acquired E&S business coupled with
higher renewal premiums in our standard Insurance Operations, reflecting
increases in renewal pure price. In addition, new business in our standard
Insurance Operations increased by 20%, or $25.1 million, in Six Months 2012
compared to Six Months 2011. The following provides quantitative information
regarding these premium fluctuations:
Quarter ended June 30, Six months ended June 30,
($ in millions) 2012 2011 2012 2011
E&S premiums $ 28.3 - 54.1 -
Standard Insurance Operations
retention 84 % 83 % 84 % 82 %
Standard Commercial Lines renewal
pure price increases 6.5 % 2.6 % 5.8 % 2.7 %
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NPE increases in Second Quarter and Six Months 2012 were consistent with the fluctuation in NPW for the twelve-month period ended June 30, 2012 as compared to the twelve-month period ended June 30, 2011.
Although the GAAP loss and loss expense ratio improved both in the quarterly and year-to-date periods, results were heavily impacted in both years by catastrophe losses. In 2012, the majority of these losses were incurred by two storms in the second quarter amounting to approximately $26 million of the $30.2 million total. The following tables provide quantitative information regarding catastrophe losses:
Quarter ended June 30, Six months ended June 30,
Catastrophe Catastrophe
Losses Impact to Losses Impact to
($ in millions) Incurred Loss Ratio Incurred Loss Ratio
2012 $ 30.2 7.7 pts $ 37.1 4.8 pts
2011 38.1 10.7 44.9 6.4
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In addition, non-catastrophe property losses decreased by $3.1 million, or 1.8 points, in Six Months 2012 compared to Six Months 2011.
The GAAP underwriting expense ratio in both Second Quarter and Six Months 2012 increased by 1.2 points compared to the prior year periods, primarily driven by expenses associated with our E&S business. As MUSIC unearned premiums as of the acquisition date were fully ceded, our underwriting expense ratio will be under pressure going forward until the premiums that we write subsequent to the purchase are earned to support the ongoing expenses of these operations.
Insurance Operations Outlook
The insurance industry has recently demonstrated, for both standard Commercial
Lines and Personal Lines, a moderate amount of renewal pricing and increased
underwriting discipline in part due to the extreme levels of catastrophe losses
and a very low interest rate environment. However, new business, particularly in
standard Commercial Lines, remains very competitive. The industry is expected to
remain unprofitable as evidenced by A.M. Best's industry combined ratio
projection of 102.0% for 2012, including approximately two points of favorable
prior year reserve development. Our Insurance Operations segment reported a
statutory combined ratio of 106.2% and 102.7% for Second Quarter and Six Months
2012, respectively, as compared to 109.5% and 106.1% in Second Quarter and Six
Months 2011, respectively. These combined ratios were significantly impacted by
the large amount of catastrophic events that occurred throughout 2012 and 2011.
A.M. Best continues to maintain its negative outlook on the commercial lines sector as widespread significant pricing improvements have not yet materialized. A recent report from the Commercial Lines Insurance Pricing Survey showed that industry pricing increased by 4.6% during the first quarter of 2012. While industry pricing continues to improve, we are on our 13th consecutive quarter of Commercial Lines renewal pure price increases with 6.5% in Second Quarter 2012, and retention continues to be strong at 82%, a two-point increase compared to the prior year period. The 5.8% Commercial Lines renewal pure price increase that we have obtained for Six Months 2012 demonstrates the overall strength of the relationships that we have with our independent agents, even in difficult economic times.
The personal lines market continues to be more receptive to price increases, and
A.M. Best has continued to maintain a stable outlook for the sector, citing that
capitalization will continue to be strong and rating actions will generally be
affirmations. Our Personal Lines operations continue to experience NPW growth
driven by ongoing rate increases that went into effect over the past several
years. Personal Lines filed rate increases that were effective for the quarter
averaged 6%, while retention remained relatively flat at 87%. As we achieve rate
increases in excess of loss trends, we expect Personal Lines profitability to
improve.
Given the elevated level of catastrophe losses incurred through Six Months 2012, we expect to generate overall full year statutory and GAAP combined ratios of between 102% and 103%, which include a full-year catastrophe loss assumption of approximately 3.5 points. These combined ratios do not include any assumptions for additional reserve development, favorable or unfavorable. Weighted average shares at year-end 2012 are expected to be approximately 55.6 million. Investment income at year-end 2012 is expected to be $100 to $105 million, after-tax.
Review of Underwriting Results by Line of Business
Commercial Lines
Commercial Lines Quarter ended June 30, Six months ended June 30,
Change % Change %
($ in thousands) 2012 2011 or Points 2012 2011 or Points
GAAP Insurance
Operations Results:
NPW $ 348,758 303,305 15 % 703,384 603,639 17 %
NPE 322,256 290,295 11 632,476 577,058 10
Less:
Losses and loss
expenses incurred 229,928 216,363 6 435,201 412,385 6
Net underwriting
expenses incurred 110,622 95,917 15 219,139 191,564 14
Dividends to
policyholders 1,230 1,461 (16 ) 2,144 2,747 (22 )
Underwriting loss $ (19,524 ) (23,446 ) 17 % (24,008 ) (29,638 ) 19 %
GAAP Ratios:
Loss and loss expense
ratio 71.3 % 74.5 (3.2 ) pts 68.8 71.5 (2.7 ) pts
Underwriting expense
ratio 34.4 33.1 1.3 34.7 33.1 1.6
Dividends to
policyholders ratio 0.4 0.5 (0.1 ) 0.3 0.5 (0.2 )
Combined ratio 106.1 108.1 (2.0 ) 103.8 105.1 (1.3 )
Statutory Ratios:
Loss and loss expense
ratio 71.3 74.5 (3.2 ) 68.8 71.5 (2.7 )
Underwriting expense
ratio 33.9 33.2 0.7 33.3 32.4 0.9
Dividends to
policyholders ratio 0.4 0.5 (0.1 ) 0.3 0.5 (0.2 )
Combined ratio 105.6 % 108.2 (2.6 ) pts 102.4 % 104.4 (2.0 ) pts
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• NPW increases in both Second Quarter and Six Months 2012 were attributable to our newly acquired E&S business coupled with higher renewal premiums in our standard Insurance Operations. In addition, new business in our standard Insurance Operations increased by 25%, or $25.9 million, in Six Months 2012 compared to Six Months 2011. The following provides quantitative information regarding these premium fluctuations:
Quarter ended June 30, Six months ended June 30,
($ in millions) 2012 2011 2012 2011
E&S premiums $ 28.3 - 54.1 -
Standard Insurance Operations
retention 82 % 80 % 82 % 80 %
Standard Commercial Lines renewal
pure price increases 6.5 % 2.6 % 5.8 % 2.7 %
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• NPE increases in Second Quarter and Six Months 2012 compared to Second Quarter and Six Months 2011 are consistent with the fluctuation in NPW for the twelve-month period ended June 30, 2012 as compared to the twelve-month period ended June 30, 2011.
• Although the GAAP loss and loss expense ratio improved both in the quarterly and year-to-date periods, results were heavily impacted in both years by catastrophe losses. The following tables provide quantitative information regarding catastrophe losses:
Second Quarter Six Months
Impact to
Catastrophe Impact to Loss Catastrophe Loss and
Losses and Loss Losses Loss Expense
($ in millions) Incurred Expense Ratio Incurred Ratio
2012 $ 18.6 5.8 pts $ 22.5 3.6 pts
2011 25.8 8.9 30.8 5.3
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• The increases in the GAAP underwriting expense ratios in both periods was driven by underwriting expenses associated with our E&S business. These expenses, which amounted to $8.5 million in Second Quarter 2012 and $15.6 million in Six Months 2012, added approximately 2.5 points to the expense ratio in both periods. As MUSIC unearned premiums as of the acquisition date were fully ceded, our underwriting expense ratio will be under pressure going forward until the premiums that we write subsequent to the purchase are earned to support the ongoing expenses of these operations. This was partially offset by growth in NPE that has outpaced overhead costs.
The following is a discussion of our most significant standard market commercial lines of business:
General Liability
Quarter ended June 30, Six months ended June 30,
Change % Change %
($ in thousands) 2012 2011 or Points 2012 2011 or Points
Statutory NPW $ 99,222 90,463 10 % 199,850 179,235 12 %
Statutory NPE 92,632 85,672 8 182,775 168,238 9
Statutory combined
ratio 102.3 % 103.0 (0.7 ) pts 101.3 % 101.7 (0.4 ) pts
% of total statutory
commercial NPW 28 % 30 28 % 30
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