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SIGI > SEC Filings for SIGI > Form 10-Q on 31-Oct-2013All Recent SEC Filings

Show all filings for SELECTIVE INSURANCE GROUP INC

Form 10-Q for SELECTIVE INSURANCE GROUP INC


31-Oct-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 the third quarters ended September 30, 2013 ("Third Quarter 2013") and September 30, 2012 ("Third Quarter 2012") and the nine-month periods ended September 30, 2013 ("Nine Months 2013") and 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.


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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 Supplemental Excess Retirement Plan (jointly referred to as the "Retirement Income Plan"), see Note 10. "Retirement Plans" of this Form 10-Q.

Financial Highlights of Results for Third Quarter 2013 and Nine Months 20131

                                                Quarter ended September 30,                        Nine Months ended September 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                                $    486,813      436,872            11       %         1,415,707     1,285,127            10       %
Pre-tax net investment income                 32,457       30,650             6                    99,330        97,284             2
  Pre-tax net income                          44,485       20,314           119                   108,019        42,813           152
Net income                                    32,653       18,274            79                    81,083        36,655           121
Diluted net income per share                    0.57         0.33            73                      1.43          0.66           117
Diluted weighted-average outstanding
shares                                        56,900       55,862             2                    56,719        55,717             2
GAAP combined ratio                             97.7 %       99.8          (2.1 )     pts            97.9         102.3          (4.4 )     pts
  Statutory combined ratio2                     96.3 %       98.4          (2.1 )                    96.9         101.2          (4.3 )
Return on average equity                        11.7 %        6.6           5.1                       9.8           4.5           5.3
Non-GAAP measures:
Operating income3                       $     23,922       18,982            26       %      $     67,819        34,414            97       %
Diluted operating income per share3             0.42         0.34            24                      1.20          0.62            94
Operating return on average equity3              8.6 %        6.9           1.7       pts             8.2           4.2           4.0       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 Nine Months 2013 includes 0.4 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 September 30,         Nine Months ended September 30,
($ in thousands, except per share
amounts)                                    2013            2012              2013                  2012
Operating income                      $       23,922        18,982             67,819                 34,414
Net realized gains (losses), net of
tax                                            8,731          (708 )           14,261                  2,241
Loss on disposal of discontinued
operations, net of tax                             -             -               (997 )                    -
Net income                            $       32,653        18,274             81,083                 36,655

Diluted operating income per share    $         0.42          0.34               1.20                   0.62
Diluted net realized gains (losses)
per share                                       0.15         (0.01 )             0.25                   0.04
Diluted net loss from disposal of
discontinued operations per share                  -             -              (0.02 )                    -
Diluted net income per share          $         0.57          0.33               1.43                   0.66


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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 8.6% in Third Quarter 2013 compared to 6.9% in Third Quarter 2012. For Nine Months 2013 and Nine Months 2012, our operating return on average equity was 8.2% and 4.2%, respectively. Our operating return on average equity contribution by component is as follows:

Operating Return on
Average Equity                   Quarter ended September 30,          Nine Months ended September 30,
                                   2013                 2012              2013                2012
Insurance Operations                 2.4  %                 0.2              2.1                 (2.2 )
Investments                          8.8                    8.5              9.0                  9.0
Other                               (2.6 )                 (1.8 )           (2.9 )               (2.6 )
Total                                8.6                    6.9              8.2                  4.2

Improvements in our operating return on average equity generated from our Insurance Subsidiaries reflect increases in underwriting profitability of $9.3 million in the quarter and $54.3 million in the year-to-date period. These fluctuations were driven primarily by: (i) higher underwriting profitability in our Standard Insurance Operations of $3.6 million and $40.7 million, respectively, reflecting the impact of earning renewal pure price increases, which exceeded loss costs trends over the past year; and (ii) improvements in our E&S Insurance Operations of $5.7 million and $13.5 million, respectively. E&S operations were primarily affected by: (i) earned premiums that now reflect the full operations of this business following the acquisition in 2011; (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 Third Quarter and Nine Months 2013 compared to the same periods last year. Higher income from our alternative investments was partially offset by lower income on our fixed maturity securities portfolio. This portfolio has been negatively impacted by the interest rate environment, which has lowered reinvestment yields when comparing periods.

The operating return on average equity generated by our Insurance Subsidiaries and our Investments segment was partially offset by: (i) long-term compensation to our employees, which increases as our stock price improves; (ii) interest expense on our issued debt; and (iii) the first quarter of 2013 write-off of unamortized debt costs related to the redemption of our 7.5% Junior Subordinated Notes.


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The following table provides a quantitative foundation for analyzing our overall Insurance Subsidiaries underwriting results:

All Lines                            Quarter ended September 30,                   Nine Months ended September 30,
                                                          Change
                                                           % or                                         Change % or
($ in thousands)                2013          2012        Points               2013          2012         Points
GAAP Insurance Operations Results:
Net premiums written
("NPW")                      $ 492,748      450,518          9       %      1,405,049     1,296,253          8        %
Net premiums earned
("NPE")                        437,568      406,225          8              1,284,760     1,177,266          9
Less:
Loss and loss expense
incurred                       283,317      272,251          4                832,760       813,060          2
Net underwriting expenses
incurred                       142,774      132,428          8                421,812       388,841          8
Dividends to policyholders       1,326          685         94                  3,393         2,829         20
Underwriting gain (loss)     $  10,151          861      1,079       %         26,795       (27,464 )      198        %
GAAP Ratios:
Loss and loss expense
ratio                             64.7   %     67.0       (2.3 )     pts         64.8          69.1       (4.3 )      pts
Underwriting expense ratio        32.7         32.6        0.1                   32.8          33.0       (0.2 )
Dividends to policyholders
ratio                              0.3          0.2        0.1                    0.3           0.2        0.1
Combined ratio                    97.7         99.8       (2.1 )                 97.9         102.3       (4.4 )
Statutory Ratios:
Loss and loss expense
ratio                             64.7         66.9       (2.2 )                 64.8          69.0       (4.2 )
Underwriting expense ratio        31.3         31.3          -                   31.8          32.0       (0.2 )
Dividends to policyholders
ratio                              0.3          0.2        0.1                    0.3           0.2        0.1
Combined ratio                    96.3   %     98.4       (2.1 )     pts         96.9         101.2       (4.3 )      pts

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

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

The combined ratio improved for both the quarterly and year-to-date periods. This improvement was driven by renewal pure price increases that are exceeding loss trends in our Standard Insurance Operations. In addition, the improvement in the combined ratios in Third Quarter 2013 and Nine Months 2013 was also driven by the following in our E&S Insurance Operations: (i) earned premiums that now reflect the full operations of this business; (ii) underwriting improvements, including renewal pure price increases; and (iii) a decrease in initial start-up expenditures and acquisition costs.

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. However, continued improvements in the pricing environment, coupled with modest exposure growth from the slowly improving economy, and underwriting actions taken to insulate balance sheets against further impact from the challenging investment environment, produced an underwriting profit for the industry through the first six months of 2013 with a combined ratio of 96.5%.

Reflecting the improved results, Selective now expects to generate a 2013 full year statutory combined ratio of approximately 95.5%, excluding 2.5 points of catastrophe losses, a net improvement of one point from previously issued guidance. This assumes no prior year casualty reserve development in the fourth quarter. In addition, investment income will be approximately $95 - $100 million, after tax, and weighted average shares at year end 2013 are anticipated to be approximately 57 million.
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, excluding catastrophe losses, of 93.6% for Third Quarter 2013 and 94.3% for Nine Months 2013.

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 7.6% for standard Commercial Lines and 8.0% for standard Personal Lines in Nine Months 2013. While these increases demonstrate the overall strength of the relationships that we have with our independent retail agents, even in difficult economic and competitive times, we are expecting overall price increases in 2014 will be between 6% and 7.5%.

Although interest rates on the 10-year U.S. Treasury Note rose by 85 basis points during Nine Months 2013, 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 maturity 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 approximately 2017.


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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.
                                                                        Nine Months ended September
                      Quarter ended September 30,                                   30,
                                                      Change                                            Change
                                                       % or                                              % or
($ in thousands)          2013              2012      Points                 2013            2012       Points
GAAP Insurance
Operations
Results:
NPW                 $       457,173       420,754         9     %           1,308,428     1,212,355         8     %
NPE                         405,676       381,498         6                 1,192,762     1,126,849         6
Less:
Loss and loss
expense incurred            262,697       251,694         4                   771,948       772,430         -
Net underwriting
expenses incurred           131,515       122,550         7                   388,440       363,353         7
Dividends to
policyholders                 1,326           685        94                     3,393         2,829        20
Underwriting gain
(loss)              $        10,138         6,569        54     %              28,981       (11,763 )     346     %
GAAP Ratios:
Loss and loss
expense ratio                  64.8    %     66.0      (1.2 )   pts              64.7          68.5      (3.8 )   pts
Underwriting
expense ratio                  32.4          32.1       0.3                      32.6          32.2       0.4
Dividends to
policyholders
ratio                           0.3           0.2       0.1                       0.3           0.3         -
Combined ratio                 97.5          98.3      (0.8 )                    97.6         101.0      (3.4 )
Statutory Ratios:
Loss and loss
expense ratio1                 64.7          65.9      (1.2 )                    64.7          68.6      (3.9 )
Underwriting
expense ratio1                 31.0          30.8       0.2                      31.6          31.2       0.4
Dividends to
policyholders
ratio                           0.3           0.2       0.1                       0.3           0.3         -
Combined ratio1                96.0    %     96.9      (0.9 )   pts              96.6         100.1      (3.5 )   pts

1 Nine Months 2013 includes 0.2 points in the loss and loss expense ratio, 0.3 points in the underwriting expense ratio, and 0.5 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 Third Quarter and Nine Months 2013 compared to Third Quarter and Nine Months 2012 are primarily the result of the following:

                                 Quarter ended September        Quarter ended September
                                        30, 2013                       30, 2012
                                  Renewal                        Renewal
                                Pure Price                     Pure Price
($ in millions)                  Increase      Retention        Increase      Retention
Standard Commercial Lines               7.9 %          83 %            6.6            83
Standard Personal Lines                 7.5            86              6.9            87



                                    Nine Months ended              Nine Months ended
                                   September 30, 2013             September 30, 2012
                                  Renewal                        Renewal
                                Pure Price                     Pure Price
($ in millions)                  Increase      Retention        Increase      Retention
Standard Commercial Lines               7.6 %          82 %            6.0            82
Standard Personal Lines                 8.0            86              6.1            86

In addition, new business was up $15.8 million, or 23%, in Third Quarter 2013 and $25.3 million, or 11%, in Nine Months 2013 mainly driven by our standard Commercial Lines operations.


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

The GAAP loss and loss expense ratio improved 1.2 points in Third Quarter 2013 and 3.8 points in Nine Months 2013 compared to the same periods a year ago. The improvement in the ratio reflects the earning of Standard Insurance Operations renewal pure price increases that averaged 6.3% in 2012 and 7.7% in Nine Months 2013, both of which exceed our projected loss trend of 3%. In addition, the following variances are included in the GAAP loss and loss expense ratio:

                            Quarter ended September 30,          Quarter ended September
                                       2013                             30, 2012
                                               Impact on                       Impact on
                                               Loss and                        Loss and
                                                 Loss           Loss and Loss    Loss
                             Loss and Loss      Expense            Expense      Expense       Change in
($ in millions)            Expense Incurred      Ratio            Incurred       Ratio          Ratio
Catastrophe losses        $            10.9           2.7 pts           8.6           2.3 pts   0.4
Non-catastrophe property
losses                                 54.8          13.5              53.3          14.0      (0.5 )
Favorable prior year
casualty reserve
development                             3.5           0.8               7.0           1.8       1.0



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