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SIGI > SEC Filings for SIGI > Form 10-Q on 1-Aug-2013All Recent SEC Filings

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Form 10-Q for SELECTIVE INSURANCE GROUP INC


1-Aug-2013

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 classify our business into three operating segments:
Standard Insurance Operations - comprised of both commercial lines ("Commercial Lines") and personal lines ("Personal Lines") insurance products and services that are sold in the standard marketplace;

Excess and Surplus ("E&S") Insurance Operations - comprised of Commercial Lines insurance products and services that are unavailable in the standard market due to market conditions or characteristics of the insured that are caused by the insured's claim history or the characteristics of their business; and

Investments - invests the premiums collected by our Standard and E&S Insurance Operations, as well as amounts generated through our capital management strategies, which may include the issuance of debt and equity securities.

Our Standard Insurance Operations products and services are sold through nine subsidiaries that write Commercial Lines and Personal Lines business, some of which write flood business through the National Flood Insurance Program's ("NFIP") write-your-own ("WYO") program. Two of these subsidiaries, Selective Casualty Insurance Company ("SCIC") and Selective Fire and Casualty Insurance Company ("SFCIC"), were created in 2012. These subsidiaries began writing direct premium in 2013 and have been included in our reinsurance pooling agreement as of July 1, 2012.
Our E&S Insurance Operations products and services are sold through a subsidiary that was acquired in December 2011. This subsidiary, Mesa Underwriters Specialty Insurance Company ("MUSIC"), provides us with a nationally-authorized non-admitted platform to write commercial and personal E&S lines business. For additional information regarding our E&S acquisitions, refer to Note 12. "Business Combinations" in Item 8. "Financial Statements and Supplementary Data." contained in our Annual Report on Form 10-K for the year ended December 31, 2012 ("2012 Annual Report").
Our ten insurance subsidiaries are collectively referred to as the "Insurance Subsidiaries".
The purpose of 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 2012 Annual Report. In the MD&A, we will discuss and analyze the following:
Critical Accounting Policies and Estimates;

Financial Highlights of Results for second quarters ended June 30, 2013 ("Second Quarter 2013") and June 30, 2012 ("Second Quarter 2012") and the six-month periods ended June 30, 2013 ("Six Months 2013") and June 30, 2012 ("Six 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.


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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 loss and loss expenses; (ii) deferred policy acquisition costs; (iii) pension and post-retirement benefit plan actuarial assumptions; (iv) other-than-temporary investment impairments; and (v) 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 2012 Annual Report, pages 44 through 53. However, for changes related to actuarial assumptions used in the measurement of the Retirement Income Plan for Selective Insurance Company of America and The Selective Insurance Supplemental Pension Plan (jointly referred to as the "Retirement Income Plan"), see Note 10. "Retirement Plans" of this Form 10-Q.

Financial Highlights of Results for Second Quarter 2013 and Six Months 20131

                                                Quarter ended June 30,                           Six Months ended June 30,
($ and
shares in thousands, except per share                                Change                                               Change
amounts)                                   2013         2012      % or Points                 2013           2012       % or Points
Generally Accepted Accounting
Principles ("GAAP") measures:
Revenues                                $ 468,945     428,907              9     %          928,894        848,255            10       %
Pre-tax net investment income              34,003      34,006              -                 66,873         66,634             -
  Pre-tax net income (loss)                36,201        (692 )        5,331                 63,534         22,499           182
Net income                                 27,122         288          9,317                 48,430         18,381           163
Diluted net income per share                 0.48        0.01          4,700                   0.86           0.33           161
Diluted weighted-average outstanding
shares                                     56,616      55,681              2                 56,530         55,642             2
GAAP combined ratio                          98.9 %     106.9           (8.0 )   pts           98.0          103.7          (5.7 )     pts
  Statutory combined ratio2                  97.7 %     106.2           (8.5 )                 97.3          102.7          (5.4 )
Return on average equity                      9.7 %       0.1            9.6                    8.8            3.4           5.4
Non-GAAP measures:
Operating income3                       $  23,773         172         13,722     %      $    43,897         15,432           184       %
Diluted operating income per share3          0.42        0.01          4,100                   0.78           0.28           179
Operating return on average equity3           8.5 %       0.1            8.4     pts            8.0            2.9           5.1       pts

1 Refer to the Glossary of Terms attached to our 2012 Annual Report as Exhibit 99.1 for definitions of terms used in this Form 10-Q.

2 Six Months 2013 includes 0.7 points related to the Retirement Income Plan amendments that curtail the accrual of additional benefits for all eligible employees participating in the plans after March 31, 2016.

3 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 GAAP. Operating return on average equity is calculated by dividing annualized operating income by average stockholders' equity.

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

                                          Quarter ended June 30,          Six Months ended June 30,
($ in thousands, except per share
amounts)                                    2013            2012            2013             2012
Operating income                      $       23,773           172          43,897            15,432
Net realized gains, net of tax                 3,349           116           5,530             2,949
Loss on disposal of discontinued
operations, net of tax                             -             -            (997 )               -
Net income                            $       27,122           288          48,430            18,381

Diluted operating income per share    $         0.42          0.01            0.78              0.28
Diluted net realized gains per
share                                           0.06             -            0.10              0.05
Diluted net loss from disposal of
discontinued operations per share                  -             -           (0.02 )               -
Diluted net income per share          $         0.48          0.01            0.86              0.33


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Over the long term, we target a return on average equity that is three points higher than our historic cost of capital of approximately 9%, excluding the impact of realized gains and losses, which is referred to as operating return on equity. Our operating return on average equity was 8.5% in Second Quarter 2013 compared to 0.1% in Second Quarter 2012. For Six Months 2013 and Six Months 2012, our operating return on average equity was 8.0% and 2.9%, respectively. Our operating return on average equity contribution by component is as follows:

Operating Return on
Average Equity                     Quarter ended June 30,              Six Months ended June 30,
                                   2013               2012              2013                2012
Insurance Operations                 1.0  %              (6.5 )            2.0                 (3.4 )
Investments                          9.2                  9.5              9.2                  9.4
Other                               (1.7 )               (2.9 )           (3.2 )               (3.1 )
Total                                8.5                  0.1              8.0                  2.9

Improvements in the operating return on average equity generated from our Insurance Subsidiaries reflect increases in underwriting profitability of $31.4 million in the quarter and $45.0 million in the year-to-date periods. These fluctuations were driven primarily by: (i) higher underwriting profitability in our Standard Insurance Operations of $28.6 million and $37.2 million, respectively, reflecting the impact of earning renewal pure price increases that have been exceeding loss costs trends over the past year along with decreases in catastrophe and non-catastrophe property losses quarter over quarter and significantly lower catastrophe losses year over year; and (ii) improvements in our E&S Insurance Operations of $2.8 million and $7.8 million, respectively. E&S operations were primarily affected by: (i) earned premiums that now reflect the full operations of this business; (ii) renewal pure price increases; and (iii) a decrease in initial start-up expenditures.

Our investment segment's contribution to operating return on equity was relatively consistent both in Second Quarter 2013 compared to Second Quarter 2012 and Six Months 2013 compared to Six Months 2012. Net investment income continues to be negatively impacted by the interest rate environment, which has lowered reinvestment yields within our fixed maturity securities portfolio when comparing periods. However, higher returns in our other investments portfolio, which were driven by higher returns from the alternative investments within that portfolio along with increased dividend income from our equity portfolio, have partially offset the impact of lower returns from our fixed maturity securities portfolio.

The Second Quarter 2013 improvement in our operating return on average equity attributable to our "Other" results of 1.2 points was driven by the impact of a lower effective tax rate adjustment in Second Quarter 2013 as compared to Second Quarter 2012. We are required, through accounting rules, to record each quarter's taxes at the expected annual marginal tax rate regardless of the relative magnitude of the individual components within any one quarter. As net income in Second Quarter 2012 was disproportionate compared to expected full year net income, a more significant effective tax rate adjustment was required compared to Second Quarter 2013 in which net income is more in line with full year expected results. While the year-to-date period was also impacted by a lower effective tax rate adjustment, for the six-month period, this improvement was offset by the write-off of debt costs associated with the redemption of our 7.50% Junior Notes due 2066 in the first quarter of 2013, coupled with higher stock compensation expense due to the increase in our stock price.


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The following table provides a quantitative foundation for analyzing our overall Insurance Subsidiaries underwriting results:
All Lines Quarter ended June 30, Six Months ended June 30, Change % or Change % or ($ in thousands) 2013 2012 Points 2013 2012 Points GAAP Insurance Operations Results:

Net premiums written
("NPW")                      $ 462,177      425,563          9        %      912,301     845,735          8        %
Net premiums earned
("NPE")                        426,252      392,212          9               847,192     771,041         10
Less:
Loss and loss expense
incurred                       279,594      287,903         (3 )             549,443     540,809          2
Net underwriting expenses
incurred                       141,194      130,041          9               279,038     256,413          9
Dividends to policyholders         981        1,230        (20 )               2,067       2,144         (4 )
Underwriting gain (loss)     $   4,483      (26,962 )      117        %       16,644     (28,325 )      159        %
GAAP Ratios:
Loss and loss expense
ratio                             65.6   %     73.4       (7.8 )      pts       64.9        70.1       (5.2 )      pts
Underwriting expense ratio        33.1         33.2       (0.1 )                32.9        33.3       (0.4 )
Dividends to policyholders
ratio                              0.2          0.3       (0.1 )                 0.2         0.3       (0.1 )
Combined ratio                    98.9        106.9       (8.0 )                98.0       103.7       (5.7 )
Statutory Ratios:
Loss and loss expense
ratio                             65.6         73.4       (7.8 )                64.9        70.1       (5.2 )
Underwriting expense ratio        31.9         32.5       (0.6 )                32.2        32.3       (0.1 )
Dividends to policyholders
ratio                              0.2          0.3       (0.1 )                 0.2         0.3       (0.1 )
Combined ratio                    97.7   %    106.2       (8.5 )      pts       97.3       102.7       (5.4 )      pts

The growth in NPW for our Insurance Subsidiaries in Second Quarter 2013 and Six Months 2013 compared to prior year periods reflects the following in our Standard Insurance Operations: (i) renewal pure price increases that we have achieved; (ii) strong retention; and (iii) new business.

NPE increases in Second Quarter 2013 and Six Months 2013 were consistent with the fluctuations in NPW for the twelve-month period ended June 30, 2013 compared to the twelve-month period ended June 30, 2012.

The combined ratio improved for both the quarterly and year-to-date periods. This improvement reflects overall improvements in pricing, as well as significantly lower catastrophe losses and non-catastrophe property losses quarter over quarter and significantly lower catastrophe losses year over year. Renewal pure price increases averaged 7.4% for the quarterly period and 7.5% for the year-to-date period in our Standard Insurance Operations in 2013. These price increases exceeded loss trends by approximately 4 points.

Outlook
In their 2012 year-end review, A.M. Best and Company ("A.M. Best") projected an industry combined ratio of 101.2% for 2013. This projection reflects a more normal level of catastrophe losses as well as the impact of pricing improvements that were achieved in 2012 and are expected to continue in 2013. However, A.M. Best expects that the industry's performance will remain challenged by the continuing sluggish macroeconomic environment, which includes persisting low investment yields, the lingering effects of the soft market conditions that have prevailed in recent years, and a reduced level of loss reserve redundancies. These challenges are expected to lead to more negative rating actions than positive rating actions in 2013.

For 2013, we expect to achieve a statutory combined ratio of 96% excluding catastrophes and any favorable or unfavorable prior year casualty reserve development. Our estimate for catastrophe losses in 2013 is three points. In addition, we expect our E&S Insurance Operations to produce a combined ratio between 100% and 102% for 2013, and be at profitability levels similar to our Standard Insurance Operations in 2014. We also expect to achieve an overall statutory combined ratio of 92% by year-end 2014 excluding three points of expected catastrophe losses. Our Insurance Subsidiaries reported a statutory combined ratio of 93.1%, excluding catastrophe losses, for Second Quarter 2013 and 94.8% for Six Months 2013, which included favorable prior year casualty reserve development of $2 million in Second Quarter 2013 and $3 million in Six Months 2013 compared to $5 million in Second Quarter 2012 and $8 million in Six Months 2012.

A key component of meeting our combined ratio targets is our ability to generate Commercial Lines renewal pure price increases in excess of our predicted loss trends. Although A.M. Best is maintaining its negative outlook for the commercial lines market, it does anticipate that sustained pricing momentum will continue in 2013. We achieved renewal pure price


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increases of 7.3% for standard Commercial Lines and 8.4% for standard Personal Lines in Six Months 2013. While these increases demonstrate our ability to generate price at a granular level, we anticipate that 2014 standard renewal rates will be modestly below the current year 7.5% rate that we achieved.

Although interest rates rose during the quarter, they are still low by historical standards. The continued low interest rate environment has several significant impacts on our business, some of which are beneficial and some of which present a challenge to us. The benefits include lower inflation rates that suppress loss trends, as well as reduce our cost of capital. However, the low interest rate environment presents a significant challenge in generating after-tax returns on our investment portfolio as fixed income securities mature and money is re-invested at lower rates. Even if current interest rate levels were to increase by 50 basis points per year for the next few years, book yields on our overall portfolio would continue to underperform 2012 book yield levels until we reach 2018. As a result, for 2013, we anticipate after-tax investment income of approximately $95 million, lower than the $100 million we earned on an after-tax basis in 2012.


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Results of Operations and Related Information by Segment

Insurance Operations

Standard Insurance Operations
Our Standard Insurance Operations segment, which represents 93% of our combined insurance operations NPW, sells insurance products and services primarily in 22 states in the Eastern and Midwestern U.S. and the District of Columbia, through approximately 1,100 independent retail insurance agencies. This segment consists of two components: (i) Commercial Lines, which markets primarily to businesses and represents approximately 82% of the segment's NPW; and (ii) Personal Lines, including our flood business, which markets primarily to individuals and represents approximately 18% of the segment's NPW.

Quarter ended June 30, Six Months ended June 30,
Change % or Change % or
($ in thousands) 2013 2012 Points 2013 2012 Points GAAP Insurance Operations Results:
NPW                        $     429,511          397,224          8        %          851,255     791,601          8        %
NPE                              396,205          376,245          5                   787,086     745,351          6
Less:
Loss and loss expense
incurred                         258,520          275,297         (6 )                 509,251     520,736         (2 )
Net underwriting
expenses incurred                129,936          121,580          7                   256,925     240,803          7
Dividends to
policyholders                        981            1,230        (20 )                   2,067       2,144         (4 )
Underwriting gain (loss)   $       6,768          (21,862 )      131        %           18,843     (18,332 )      203        %
GAAP Ratios:
Loss and loss expense
ratio                               65.2        %    73.2       (8.0 )      pts           64.7        69.9       (5.2 )      pts
Underwriting expense
ratio                               32.9             32.3        0.6                      32.6        32.3        0.3
Dividends to
policyholders ratio                  0.2              0.3       (0.1 )                     0.3         0.3          -
Combined ratio                      98.3            105.8       (7.5 )                    97.6       102.5       (4.9 )
Statutory Ratios:
Loss and loss expense
ratio1                              65.3             73.3       (8.0 )                    64.7        69.9       (5.2 )
Underwriting expense
ratio1                              31.5             31.9       (0.4 )                    31.9        31.6        0.3
Dividends to
policyholders ratio                  0.2              0.3       (0.1 )                     0.3         0.3          -
Combined ratio1                     97.0        %   105.5       (8.5 )      pts           96.9       101.8       (4.9 )      pts

1 Six Months 2013 includes 0.2 points in the loss and loss expense ratio, 0.5 points in the underwriting ratio, and 0.7 points in the combined ratio related to the Retirement Income Plan amendments recorded in the first quarter of 2013 that curtail the accrual of additional benefits for all eligible employees participating in the plans after March 31, 2016.

The improvements in NPW in Second Quarter and Six Months 2013 compared to Second Quarter and Six Months 2012 are primarily the result of the following:

                                 Quarter ended June 30,        Quarter ended June 30,
                                          2013                 2012
                                  Renewal                        Renewal
                                Pure Price                     Pure Price
($ in millions)                  Increase      Retention        Increase      Retention

Standard Commercial Lines 7.2 % 83 % 6.4 82 Standard Personal Lines 8.3 87 5.6 87

                                Six Months ended June 30,      Six Months ended June 30,
                                          2013                           2012
                                  Renewal                        Renewal
                                Pure Price                     Pure Price
($ in millions)                  Increase      Retention        Increase      Retention
Standard Commercial Lines               7.3 %          82 %            5.8            82
Standard Personal Lines                 8.4            86              5.7            86

NPE increases in Second Quarter and Six Months 2013 were consistent with the fluctuations in NPW for the twelve-month period ended June 30, 2013 as compared to the twelve-month period ended June 30, 2012.


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The GAAP loss and loss expense ratio improved 8.0 points in Second Quarter 2013 and 5.2 points in Six Months 2013 compared to the same periods a year ago. The improvement in the ratios reflect the earning of renewal pure price increases that averaged 6.3% in our Standard Insurance Operations in 2012 and exceeded loss trends by approximately 3 points. The following variances are included in the GAAP loss and loss expense ratio:

                                                                    Quarter ended June 30,
                                 Quarter ended June 30, 2013                 2012
                                                 Impact on                    Impact on
                                                  Loss and         Loss and    Loss and
. . .
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