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SIGI > SEC Filings for SIGI > Form 10-Q on 25-Oct-2012All Recent SEC Filings

Show all filings for SELECTIVE INSURANCE GROUP INC

Form 10-Q for SELECTIVE INSURANCE GROUP INC


25-Oct-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Forward-Looking Statements
In this Quarterly Report on Form 10-Q, we discuss and make statements regarding our intentions, beliefs, current expectations, and projections regarding our company's future operations and performance. Such statements are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are often identified by words such as "anticipates," "believes," "expects," "will," "should," and "intends" and their negatives. We caution prospective investors that such forward-looking statements are not guarantees of future performance. Risks and uncertainties are inherent in our future performance. Factors that could cause actual results to differ materially from those indicated by such forward-looking statements include, but are not limited to, those discussed under Item 1A. "Risk Factors" below in Part II "Other Information". These risk factors may not be exhaustive. We operate in a continually changing business environment and new risk factors emerge from time to time. We can neither predict such new risk factors nor can we assess the impact, if any, of such new risk factors on our businesses or the extent to which any factor or combination of factors may cause actual results to differ materially from those expressed or implied in any forward-looking statements in this report. In light of these risks, uncertainties, and assumptions, the forward-looking events discussed in this report might not occur. We make forward-looking statements based on currently available information and assume no obligation to update these statements due to changes in underlying factors, new information, future developments, or otherwise.

Introduction
We report our business in 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 Commercial Lines and Personal Lines market insurance products through our ten insurance subsidiaries, which include the following:
Nine subsidiaries that write standard Commercial Lines and Personal Lines business. Two of these subsidiaries, Selective Casualty Insurance Company and Selective Fire and Casualty Insurance Company, were created in the second quarter of 2012. These subsidiaries are expected to begin writing premium in 2013 and have been included in our reinsurance pooling agreement as of July 1, 2012. See the "Reinsurance" section below for details regarding the pooling change.

One subsidiary that writes excess and surplus lines ("E&S") business. We purchased this subsidiary, Mesa Underwriters Specialty Insurance Company ("MUSIC"), in December 2011. This acquisition complimented our August 2011 purchase of the renewal rights to an E&S book of business, as MUSIC is licensed to write E&S business in all 50 states and the District of Columbia.

Our ten insurance subsidiaries are collectively referred to as the "Insurance Subsidiaries". For additional information regarding our acquisition of MUSIC, 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.


Table of Contents

In the MD&A, we will discuss and analyze the following:
Critical Accounting Policies and Estimates;

Financial Highlights of Results for the third quarter ended September 30, 2012 ("Third Quarter 2012") and the nine-month period ended September 30, 2012 ("Nine Months 2012");

Results of Operations and Related Information by Segment;

Federal Income Taxes;

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.


Table of Contents

Financial Highlights of Results for Third Quarter 2012 and Nine Months 20121

                                                    Quarter ended
                                                    September 30,                                  Nine Months ended September 30,
(Shares and $ in thousands, except per share                                 Change                                                        Change
amounts)                                          2012          2011      % or Points                 2012                 2011         % or Points
GAAP measures:
Revenues                                       $ 436,872     394,069              11     %           1,285,127            1,197,095              7     %
Pre-tax net investment income                     30,650      35,786             (14 )                  97,284              118,604            (18 )
  Pre-tax net income (loss)                       20,314     (38,483 )           153                    42,813              (12,424 )          445
Net income (loss)                                 18,274     (17,968 )           202                    36,655                3,999            817
Diluted net income (loss) per share                 0.33       (0.33 )           200                      0.66                 0.07            843
Diluted weighted-average outstanding shares       55,862      54,183               3                    55,717               55,172              1
GAAP combined ratio                                 99.8 %     118.0  %        (18.2 )   pts             102.3 %              110.5           (8.2 )   pts
  Statutory combined ratio                          98.4 %     116.4  %        (18.0 )                   101.2 %              109.6           (8.4 )
Return on average equity                             6.6 %      (6.9 )%         13.5                       4.5 %                0.5            4.0
Non-GAAP measures:
Operating income (loss)2                       $  18,982     (15,989 )           219     %              34,414                  839          4,002     %
Diluted operating income (loss) per share2          0.34       (0.30 )           213                      0.62                 0.01          6,100
Operating return on average equity2                  6.9 %      (6.2 )%         13.1     pts               4.2 %                0.1 %          4.1     pts

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 and the results of discontinued operations 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 increased in both the quarter and year-to-date periods, reflecting 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.

The improvement in pre-tax and after-tax net income in both Third Quarter and Nine Months 2012 compared to last year was driven primarily by an improvement in catastrophe losses. These pre-tax losses decreased by $57.9 million, to $9.6 million, in Third Quarter 2012 and by $65.7 million, to $46.7 million, in Nine Months 2012, compared to the prior year periods. Partially offsetting these underwriting improvements were lower returns on the alternative investment portion of our other investments portfolio.

The following table reconciles operating income and net income for the periods presented above:

                                                Quarter ended             Nine Months ended
                                                September 30,               September 30,
($ in thousands, except per share
amounts)                                      2012          2011          2012           2011
Operating income (loss)                    $  18,982      (15,989 )   $    34,414          839
Net realized (losses) gains, net of tax         (708 )     (1,329 )         2,241        3,810
Loss on disposal of discontinued
operations, net of tax                             -         (650 )             -         (650 )
Net income (loss)                          $  18,274      (17,968 )   $    36,655        3,999

Diluted operating income (loss) per
share                                      $    0.34        (0.30 )   $      0.62         0.01
Diluted net realized (losses) gains per
share                                          (0.01 )      (0.02 )          0.04         0.07
Diluted net loss from disposal of
discontinued operations per share                  -        (0.01 )             -        (0.01 )
Diluted net income (loss) per share        $    0.33        (0.33 )   $      0.66         0.07

The variances in operating income are reflective of the results discussed above.


Table of Contents

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 1,100 independent insurance agencies. Our recent E&S business 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.

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

                              Quarter ended
All Lines                     September 30,                              Nine months ended September 30,
                                                    Change                                                      Change
                                                     % or                                                        % or
($ in thousands)            2012         2011       Points                  2012                 2011           Points
GAAP Insurance Operations Results:
NPW                      $ 450,518     396,832        14       %           1,296,253            1,133,170        14        %
Net premiums earned
("NPE")                    406,225     358,963        13                   1,177,266            1,065,886        10
Less:
Losses and loss
expenses incurred          272,251     305,958       (11 )                   813,060              829,719        (2 )
Net underwriting
expenses incurred          132,428     116,728        13                     388,841              343,843        13
Dividends to
policyholders                  685       1,056       (35 )                     2,829                3,803       (26 )
Underwriting gain
(loss)                   $     861     (64,779 )     101       %             (27,464 )           (111,479 )      75        %
GAAP Ratios:
Loss and loss expense
ratio                         67.0 %      85.2     (18.2 )     pts              69.1                 77.8      (8.7 )      pts
Underwriting expense
ratio                         32.6        32.5       0.1                        33.0                 32.3       0.7
Dividends to
policyholders ratio            0.2         0.3      (0.1 )                       0.2                  0.4      (0.2 )
Combined ratio                99.8       118.0     (18.2 )                     102.3                110.5      (8.2 )
Statutory Ratios:
Loss and loss expense
ratio                         66.9        85.1     (18.2 )                      69.0                 77.8      (8.8 )
Underwriting expense
ratio                         31.3        31.0       0.3                        32.0                 31.4       0.6
Dividends to
policyholders ratio            0.2         0.3      (0.1 )                       0.2                  0.4      (0.2 )
Combined ratio                98.4 %     116.4     (18.0 )     pts             101.2                109.6      (8.4 )      pts

NPW increases in both Third Quarter and Nine 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 and strong retention. In addition, new business contributed to the NPW increase in Nine Months 2012 compared to Nine Months 2011. The following provides quantitative information regarding these premium fluctuations:

                                                                            Nine months ended
                                        Quarter ended September 30,           September 30,
($ in millions)                            2012               2011          2012          2011
E&S premiums                         $        29.8               8.4       83.9            8.4
Standard Insurance Operations new
business                             $        69.2              70.3      222.9          198.8
Standard Insurance Operations
retention                                       85 %              84 %       84 %           83 %
Standard Commercial Lines renewal
pure price increases                           6.6 %             2.7 %      6.0 %          2.7 %
Standard Personal Lines renewal
pure price increases                           6.9 %             5.9 %      6.1 %          6.3 %


Table of Contents

NPE increases in Third Quarter and Nine Months 2012 were consistent with the fluctuation in NPW for the twelve-month period ended September 30, 2012 as compared to the twelve-month period ended September 30, 2011.

The GAAP loss and loss expense ratio improved in the quarter and year-to-date periods as catastrophe losses were lower than the historic level we experienced last year, which included significant storms, such as Hurricane Irene and Tropical Storm Lee. The following tables provide quantitative information regarding catastrophe losses:

                                                          Nine months ended September
                    Quarter ended September 30,                       30,
                   Catastrophe                            Catastrophe
                      Losses         Impact to               Losses        Impact to
($ in millions)      Incurred       Loss Ratio              Incurred       Loss Ratio
2012             $          9.6            2.4   pts    $         46.7             4.0 pts
2011                       67.5           18.8                   112.4            10.5

In addition, favorable prior year development on our casualty lines was $7 million, or 1.7 points, in Third Quarter 2012 compared to $10 million, or 2.7 points, in Third Quarter 2011. Favorable prior year casualty development was $16 million, or 1.3 points, in Nine Months 2012 compared to $19 million, or 1.8 points, in Nine Months 2011.

Insurance Operations Outlook
A.M. Best Company ("A.M. Best") noted in their October financial review that the industry's underwriting and operating performance improved substantially in the first half of 2012 as a result of lower catastrophe losses, which accounted for 6.0 pointsof the industry's combined ratio of 101.0%, compared to 12.7 points of catastrophe losses in the first half of 2011. In addition, rate increases and exposure growth drove increases in NPW and NPE. This improvement in the industry's results is expected to continue through 2012, particularly in light of the reduction in catastrophe-related losses through September. The industry still faces obstacles associated with prolonged challenging market conditions, the persistently slow economic recovery, expectations for sustained low investment yields, and investment market volatility. Our Insurance Operations segment reported statutory combined ratios of 98.4% and 101.2% for Third Quarter and Nine Months 2012, respectively, as compared to 116.4% and 109.6% in Third Quarter and Nine Months 2011, respectively. Similar to the industry, we experienced lower catastrophe losses this year compared to the historic level of catastrophe losses that we experienced last year.

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 6.0% during the second quarter of 2012. While industry pricing continues to improve, we completed our 14th consecutive quarter of Commercial Lines renewal pure price increases with 6.6% in Third Quarter 2012. Our Commercial Lines retention continues to be strong at 83%, which is a one-point increase compared to the prior year period. For Nine Months 2012, Commercial Lines renewal pure price increases were 6%, coupled with strong policy retention, demonstrating the overall strength of the relationships that we have with our independent agents in very competitive market conditions and slow economic times.

The personal lines market continues to provide more pricing power 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 renewal pure price increases for Third Quarter and Nine Months 2012 averaged 6.9% and 6.1%, respectively, while retention remained strong at 87% and 86%. Strong property results and favorable prior year development, as well as the ongoing pure price increases that we have achieved contributed to a Personal Lines statutory combined ratio of 88.8% in Third Quarter 2012 and 98.4% for Nine Months 2012.

Given our results through Nine Months 2012, we expect to generate a full-year statutory combined ratio of approximately 101.5% and a full-year combined ratio of approximately 102.5% under U.S. generally accepted accounting principles ("GAAP"), both of 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. Investment income is expected to be approximately $100 million, after tax, given the alternative investment portfolio performance and the low interest rate environment. Weighted average shares at year-end 2012 are expected to be approximately 55.6 million.


Table of Contents

Review of Underwriting Results by Line of Business

Commercial Lines
                              Quarter ended                            Nine months ended September
Commercial Lines              September 30,                                        30,
                                                   Change %                                             Change %
($ in thousands)            2012         2011      or Points              2012             2011        or Points
GAAP Insurance
Operations Results:
NPW                      $ 371,082     323,696        15       %      1,074,466            927,335        16        %
NPE                        334,420     292,363        14                966,896            869,421        11
Less:
Losses and loss
expenses incurred          227,531     229,119        (1 )              662,732            641,504         3
Net underwriting
expenses incurred          112,563      98,700        14                331,702            290,264        14
Dividends to
policyholders                  685       1,056       (35 )                2,829              3,803       (26 )
Underwriting loss        $  (6,359 )   (36,512 )      83       %        (30,367 )          (66,150 )      54        %
GAAP Ratios:
Loss and loss expense
ratio                         68.0 %      78.4     (10.4 )     pts         68.5 %             73.8      (5.3 )      pts
Underwriting expense
ratio                         33.7        33.7         -                   34.3               33.4       0.9
Dividends to
policyholders ratio            0.2         0.4      (0.2 )                  0.3                0.4      (0.1 )
Combined ratio               101.9       112.5     (10.6 )                103.1              107.6      (4.5 )
Statutory Ratios:
Loss and loss expense
ratio                         67.9        78.2     (10.3 )                 68.5               73.8      (5.3 )
Underwriting expense
ratio                         32.4        32.1       0.3                   33.0               32.4       0.6
Dividends to
policyholders ratio            0.2         0.4      (0.2 )                  0.3                0.4      (0.1 )
Combined ratio               100.5       110.7     (10.2 )     pts        101.8              106.6      (4.8 )      pts

Commercial Lines NPW increases in both Third Quarter and Nine 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 Commercial Lines increased by 15%, or $24.5 million, in Nine Months 2012 compared to Nine Months 2011. The following provides quantitative information regarding these premium fluctuations:

                                        Quarter ended           Nine months ended
                                        September 30,             September 30,
($ in millions)                        2012         2011        2012          2011
  E&S premiums                      $    29.8        8.4       83.9            8.4
Standard Commercial Lines direct
new business                             56.1       57.5      184.6          160.1
Standard Commercial Lines
retention                                  83 %       82 %       82 %           80 %
Standard Commercial Lines renewal
pure price increases                      6.6 %      2.7 %      6.0 %          2.7 %

NPE increases in Third Quarter and Nine Months 2012 compared to Third Quarter and Nine Months 2011 are consistent with the fluctuation in NPW for the twelve-month period ended September 30, 2012 as compared to the twelve-month period ended September 30, 2011.

The GAAP loss and loss expense ratio improved in the quarter and year-to-date periods, as catastrophe losses were lower than the historic level we experienced last year, which included significant storms such as Hurricane Irene and Tropical Storm Lee. The following table provides quantitative information regarding catastrophe losses:

                           Third Quarter                         Nine Months Ended
                                                                           Impact to
                    Catastrophe      Impact to             Catastrophe      Loss and
                      Losses       Loss and Loss             Losses       Loss Expense
($ in millions)      Incurred      Expense Ratio            Incurred         Ratio
           2012  $         7.7               2.3 pts    $        30.3              3.1 pts
           2011           39.6              13.5                 70.4              8.1


Table of Contents

The following is a discussion of our most significant standard market commercial lines of business:

General Liability

                             Quarter ended                               Nine months ended
                             September 30,                                 September 30,
                                                                                                Change
                                                 Change % or                                     % or
($ in thousands)           2012        2011        Points                2012         2011      Points
Statutory NPW            106,020      95,187        11         %      305,870       274,422         11   %
  Direct new business     16,737      16,907        (1 )               53,050        45,036         18
  Retention                   83 %        81 %       2         pts         81 %          79 %        2   pts
  Renewal pure price
increases                    7.2 %       3.3 %     3.9                    6.8 %         3.7 %      3.1
. . .
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