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SIGI > SEC Filings for SIGI > Form 10-K on 28-Feb-2014All Recent SEC Filings

Show all filings for SELECTIVE INSURANCE GROUP INC

Form 10-K for SELECTIVE INSURANCE GROUP INC


28-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.

Forward-looking Statements
Certain statements in this report, including information incorporated by reference, are "forward-looking statements" as that term is defined in the Private Securities Litigation Reform Act of 1995 ("PSLRA"). The PSLRA provides a safe harbor under the Securities Act of 1933 and the Exchange Act for forward-looking statements. These statements relate to our intentions, beliefs, projections, estimations or forecasts of future events or future financial performance and involve known and unknown risks, uncertainties and other factors that may cause us or the industry's actual results, levels of activity, or performance to be materially different from those expressed or implied by the forward-looking statements. In some cases, forward-looking statements may be identified by use of the words such as "may," "will," "could," "would," "should," "expect," "plan," "anticipate," "target," "project," "intend," "believe," "estimate," "predict," "potential," "pro forma," "seek," "likely," or "continue" or other comparable terminology. These statements are only predictions, and we can give no assurance that such expectations will prove to be correct. We undertake no obligation, other than as may be required under the federal securities laws, to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Factors that could cause our actual results to differ materially from those we have projected, forecasted or estimated in forward-looking statements are discussed in further detail in Item 1A. "Risk Factors." of this Form 10-K. 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.

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 sold to insureds who have not obtained coverage in the standard market; and

Investments - invests the premiums collected by our Standard and E&S Insurance Operations, and 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 a nationally-authorized non-admitted platform to write commercial and personal E&S lines business.
Our ten insurance subsidiaries are collectively referred to as the "Insurance Subsidiaries".
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.
In the MD&A, we will discuss and analyze the following:
Critical Accounting Policies and Estimates;

Financial Highlights of Results for Years Ended December 31, 2013, 2012, and 2011;

Results of Operations and Related Information by Segment;

Federal Income Taxes;

Financial Condition, Liquidity, Short-term Borrowings, and Capital Resources;

Off-Balance Sheet Arrangements;

Contractual Obligations, Contingent Liabilities, and Commitments; and

Ratings.


Critical Accounting Policies and Estimates We have identified the policies and estimates described below as critical to our business operations and the understanding of the results of our operations. Our preparation of the Financial Statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our Financial Statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurance that actual results will not differ from those estimates. Those estimates that were most critical to the preparation of the Financial Statements involved the following: (i) reserves for losses and loss expenses; (ii) pension and post-retirement benefit plan actuarial assumptions; (iii) other-than-temporary-impairment ("OTTI"); and (iv) reinsurance.

Reserves for Losses and Loss Expenses
Significant periods of time can elapse between the occurrence of an insured loss, the reporting of the loss to the insurer, and the insurer's payment of that loss. To recognize liabilities for unpaid losses and loss expenses, insurers establish reserves as balance sheet liabilities representing an estimate of amounts needed to pay reported and unreported net losses and loss expenses. As of December 31, 2013, we had accrued $3.3 billion of gross loss and loss expense reserves compared to $4.1 billion at December 31, 2012, the decrease of which is largely attributable to the loss and loss expense reserves associated with Hurricane Sandy that were 100% reinsured by the Federal government under the NFIP. The gross loss and loss expense reserves under this program were $51.2 million as of December 31, 2013 compared to $909.9 million as of December 31, 2012.

The following tables provide case and incurred but not reported ("IBNR") reserves for losses and loss expenses, and reinsurance recoverable on unpaid losses and loss expenses as of December 31, 2013 and 2012:

As of December 31, 2013
                                Losses and Loss Expense Reserves
                                                                           Reinsurance
                                                                           Recoverable
                                                                            on Unpaid
                               Case             IBNR                       Losses and
($ in thousands)             Reserves         Reserves        Total       Loss Expenses    Net Reserves
Commercial automobile     $     136,543        225,387        361,930          18,847          343,083
Workers compensation            532,087        637,738      1,169,825         197,934          971,891
General liability               227,307        965,095      1,192,402         137,854        1,054,548
Commercial property              43,831          6,143         49,974           9,702           40,272
Businessowners'
policies                         32,225         57,636         89,861           7,915           81,946
Bonds                             4,885          5,054          9,939             911            9,028
Other                             2,095          1,061          3,156           2,064            1,092
Total standard
Commercial Lines                978,973      1,898,114      2,877,087         375,227        2,501,860

Personal automobile             106,377         89,596        195,973          62,663          133,310
Homeowners                       26,201         27,520         53,721           7,254           46,467
Other                            39,155         23,561         62,716          52,157           10,559
Total standard Personal
Lines                           171,733        140,677        312,410         122,074          190,336

E&S Insurance
Operations                       25,575        134,698        160,273          43,538          116,735

Total                     $   1,176,281      2,173,489      3,349,770         540,839        2,808,931


December 31, 2012
                                       Losses and Loss Expense Reserves
                                                                                 Reinsurance
                                                                                 Recoverable
                                                                                  on Unpaid
                                       Case            IBNR                      Losses and
($ in thousands)                     Reserves        Reserves        Total      Loss Expenses    Net Reserves
Commercial automobile             $     127,270       221,452       348,722          15,474          333,248
Workers compensation                    494,467       586,141     1,080,608         158,035          922,573
General liability                       214,216       902,087     1,116,303         116,791          999,512
Commercial property                      71,903        12,925        84,828          35,639           49,189
Businessowners' policies                 44,620        66,783       111,403          20,410           90,993
Bonds                                     2,441         6,915         9,356             425            8,931
Other                                     1,265         1,071         2,336           1,200            1,136
Total standard Commercial Lines         956,182     1,797,374     2,753,556         347,974        2,405,582

Personal automobile                     107,670        92,759       200,429          67,615          132,814
Homeowners                               37,652        35,495        73,147          28,950           44,197
Other                                   865,469        56,037       921,506         911,928            9,578
Total standard Personal Lines         1,010,791       184,291     1,195,082       1,008,493          186,589

E&S Insurance Operations                 18,738       101,565       120,303          53,288           67,015

Total                             $   1,985,711     2,083,230     4,068,941       1,409,755        2,659,186

How reserves are established
When a claim is reported to an Insurance Subsidiary, claims personnel establish a "case reserve" for the estimated amount of the ultimate payment. The amount of the reserve is primarily based on a case-by-case evaluation of the type of claim involved, the circumstances surrounding each claim, and the policy provisions relating to the type of losses. The estimate reflects the informed judgment of such personnel based on their knowledge, experience, and general insurance reserving practices. Until the claim is resolved, these estimates are revised as deemed appropriate by the responsible claims personnel based on subsequent developments and periodic reviews of the case.

Using generally accepted actuarial reserving techniques, we project our estimate of ultimate losses and loss expenses at each reporting date. The difference between: (i) the projected ultimate loss and loss expense reserves; and (ii) the case loss reserves and the loss and loss expenses reserved thereon are carried as the IBNR reserve. The actuarial techniques used are part of a comprehensive reserving process that includes two primary components. The first component is a detailed quarterly reserve analysis performed by our internal actuarial staff. In completing this analysis, the actuaries must gather substantially similar data in sufficient volume to ensure statistical credibility of the data, while maintaining appropriate differentiation. This process defines the reserving segments, to which various actuarial projection methods are applied. When applying these methods, the actuaries are required to make numerous assumptions including, for example, the selection of loss and loss expense development factors and the weight to be applied to each individual projection method. These methods include paid and incurred versions for the following: loss and loss expense development, Bornhuetter-Ferguson, Berquist-Sherman, and frequency/severity modeling (chain-ladder approach). The second component of the analysis is the projection of the expected ultimate loss and loss expense ratio for each line of business for the current accident year. This projection is part of our planning process wherein we review and update expected loss and loss expense ratios each quarter. This review includes actual versus expected pricing changes, loss and loss expense trend assumptions, and updated prior period loss and loss expense ratios from the most recent quarterly reserve analysis.


In addition to the quarterly reserve analysis, a range of possible IBNR reserves is estimated annually and continually considered, among other factors, in establishing IBNR for each reporting period. Loss and loss expense trends are also considered, which include, but are not limited to, large loss activity, asbestos and environmental claim activity, large case reserve additions or reductions for prior accident years, and reinsurance recoverable issues. We also consider factors such as: (i) per claim information; (ii) company and industry historical loss experience; (iii) legislative enactments, judicial decisions, legal developments in the imposition of damages, and changes in political attitudes; and (iv) trends in general economic conditions, including the effects of inflation. Based on the consideration of the range of possible IBNR reserves, recent loss and loss expense trends, uncertainty associated with actuarial assumptions and other factors, IBNR is established and the ultimate net liability for losses and loss expenses is determined. Such an assessment requires considerable judgment given that it is frequently not possible to determine whether a change in the data is an anomaly until sometime after the event. Even if a change is determined to be permanent, it is not always possible to reliably determine the extent of the change until sometime later. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of reserves because the eventual deficiency or redundancy is affected by many factors. The changes in these estimates, resulting from the continuous review process and the differences between estimates and ultimate payments, are reflected in the Consolidated Statements of Income for the period in which such estimates are changed. Any changes in the liability estimate may be material to the results of operations in future periods.

Range of reasonable reserves
We have estimated a range of reasonably possible reserves for net loss and loss expense claims to be $2,574 million to $2,966 million at December 31, 2013, which compares to $2,456 million to $2,805 million at December 31, 2012. These ranges reflect low and high reasonable reserve estimates which were selected primarily by considering the range of indications calculated using generally accepted actuarial techniques. Such techniques assume that past experience, adjusted for the effects of current developments and anticipated trends, are an appropriate basis for predicting future events. Although these ranges reflect likely scenarios, it is possible that the final outcomes may fall above or below these amounts. The ranges do not include a provision for potential increases or decreases associated with asbestos, environmental, and other continuous exposure claims, as traditional actuarial techniques cannot be effectively applied to these exposures.

Major trends by line of business creating additional loss and loss expense reserve uncertainty
The Insurance Subsidiaries are multi-state, multi-line property and casualty insurance companies and, as such, are subject to reserve uncertainty stemming from a variety of sources. These uncertainties are considered at each step in the process of establishing loss and loss expense reserves. However, as market conditions change, certain trends are identified that management believes create an additional amount of uncertainty. A discussion of recent trends, by line of business, that have been recognized by management follows.

Standard Market General Liability Line of Business At December 31, 2013, our general liability line of business had recorded reserves, net of reinsurance, of $1.1 billion, which represented 38% of our total net reserves. In calendar year 2013, this line experienced favorable development of $20.0 million, which was driven by lower severities in the 2010 and prior accident years. This favorable development was partially offset by unfavorable development in accident years 2011 and 2012, which showed higher average severities in the premises and operations coverage. During the 2012 calendar year, this line of business showed modestly unfavorable development due to increased severities in the 2010 and 2011 accident years. During the 2011 calendar year, this line of business experienced overall favorable reserve development that was largely attributable to accident years 2006 through 2009, which showed generally lower frequencies. The broad nature of this line of business, and the longer average time for the claims settlement process, makes it more susceptible to changes in litigation and the tort environment. This line of business also includes excess policies that provide additional limits above underlying automobile and general liability coverages, which is subject to catastrophic losses, and therefore influenced by the factors noted above to a greater degree.

Standard Market Workers Compensation Line of Business At December 31, 2013, our workers compensation line of business recorded reserves, net of reinsurance, of $972 million or 35% of our total net reserves. During the past three years, this line has experienced unfavorable reserve development. The 2013 unfavorable development was $23.5 million driven by accident years 2008 and prior. This development reflects increases in the ultimate severities for medical costs, driven largely by case reserve adjustments to long-term care claims, and our review of medical cost development over many years. We continue our efforts to mitigate these impacts through various medical cost containment initiatives.


In addition to the uncertainties associated with actuarial assumptions and methodologies described above, the workers compensation line of business can be impacted by a variety of issues, such as the following:

Unexpected changes in medical cost inflation - Variability in our historical workers compensation medical costs, along with uncertainty regarding future medical inflation, creates the potential for additional volatility in our reserves;

Changes in statutory workers compensation benefits - Benefit changes may be enacted such that they affect all outstanding claims, regardless of having occurred in the past. Depending upon the social and political climate, these changes may be such that they either increase or decrease associated claim costs;

Changes in overall economic conditions - Higher levels of unemployment could ultimately impact both the severity and frequency of workers compensation claims. There is also potential for an increase in severity if the longevity of workers compensation claims increases. Injured workers could have less incentive to return to work when their company is in financial distress or injured workers could be laid off while on workers compensation. Conversely, there is potential for a decrease in frequency if workers are reluctant to file claims or have less work and less exposure to injury.

In addition, changes in the economy could impact reserves in other ways. For example, in 2012, audit and endorsement activity resulted in additional premium of $14.3 million, and in 2013, audit and endorsement activity resulted in additional premium of $7.4 million. Since premiums earned are used as a basis for setting initial reserves on the current accident year, our reserves could be impacted. While audit and endorsement premiums are modeled within our annual budgeting process, they remain uncertain and therefore provide additional variability to the resulting loss and loss expense ratio estimates.

Standard Market Commercial Automobile Line of Business At December 31, 2013, our commercial automobile line of business had recorded reserves, net of reinsurance, of $343 million, which represented 12% of our total net reserves. During the past three years this line experienced favorable reserve development. In 2013 the favorable development was $4.5 million, driven by accident years 2006 through 2010, which represents a continued trend of better than expected reported emergence in these years. This favorable development was partially offset by unfavorable development in the 2012 accident year, due to increased severity.

Standard Market Personal Automobile Line of Business At December 31, 2013, our personal automobile line of business had recorded reserves, net of reinsurance, of $133 million, which represented 5% of our total net reserves. In calendar year 2013, this line experienced favorable development of $3.0 million, which was driven by accident years 2010 and 2011 in states other than New Jersey. Over the past several years, the New Jersey personal automobile marketplace has continued to be extremely competitive, while at the same time we have been growing our market share in our other personal lines footprint states, the result of which has been a gradually changing overall mix of business. We review the reserves for states other than New Jersey on a combined basis so that there is a sufficient volume of data to ensure statistical credibility. However, the state mix of business changes over time may increase the uncertainty surrounding our personal automobile reserves.

E&S Lines
At December 31, 2013, our E&S line of business had recorded reserves, net of reinsurance, of $117 million, which represented 4% of our total net reserves. In calendar year 2013 this line experienced favorable development of $2.0 million. Since we have limited historical loss experience in these lines of business, our reserve estimates are based largely on development patterns of companies that have similar operations. Therefore, these estimates are subject to somewhat greater uncertainty than the comparable traditional lines of business.

Other Lines of Business
At December 31, 2013, no other individual line of business had recorded reserves of more than $82 million, net of reinsurance. We have not identified any recent trends that would create additional significant reserve uncertainty for these other lines of business.


Other impacts creating additional loss and loss expense reserve uncertainty

Claims Initiative Impacts
In addition to the line of business specific issues mentioned above, these lines of business have been impacted by a number of initiatives undertaken by our claims department that have resulted in volatility in the average level of case reserves. Some of these initiatives have also impacted changes in claims settlement rates. These changes impact the data upon which the ultimate loss and loss expense projections are made. While these changes in case reserve levels and settlement rates increase the uncertainty in the short run, we expect the longer-term benefit will be a more refined management of the claims process.

Some of the specific actions implemented are as follows:
Increased focus on reducing workers compensation medical costs through more favorable Preferred Provider Organizations ("PPO") contracts and greater PPO penetration.

The introduction of a Complex Claims Unit to which all significant and complex liability claims are assigned. This unit has been staffed with personnel that have significant experience in handling and settling these types of claims.

Increased activity in the areas of fraud investigation and salvage/subrogation recoveries. These efforts have been supported by the introduction of predictive models that allow us to better focus our efforts.

The establishment of a workers compensation strategic case management unit, which specializes in the investigation and medical management of lost-time claims with high exposure and/or escalation risk.

Our internal reserve analyses incorporate actuarial projection methods which make adjustments for changes in case reserve adequacy and claims settlement rates. These methods adjust our historical loss experience to the current level of case adequacy or settlement rate, which provides a more consistent basis for projecting future development patterns. These methods have their own assumptions and judgments associated with them, so as with any projection method, they are not definitive in and of themselves. Furthermore, given that the expected benefits from our claims initiatives take time to fully manifest, we do not take full credit for the anticipated benefit in establishing our loss and loss expense reserves. Therefore, these initiatives may prove more or less beneficial than currently reflected, which will affect development in future years. Our various projection methods provide an indication of these potential future impacts. These impacts would be greatest within our larger reserve lines of workers compensation, general liability, and commercial automobile liability, within the more recent accident years.

Economic Inflationary Impacts
Although inflationary volatility is expected to be low in the near term, current United States monetary policy and global economic conditions bring additional uncertainty in the long-term given the length of time required for claim settlement in these lines of business. Uncertainty regarding future inflation or deflation creates the potential for additional volatility in our reserves for these lines of business.

Sensitivity analysis: Potential impact on reserve uncertainty due to changes in key assumptions
Our process to establish reserves includes a variety of key assumptions, including, but not limited to, the following:
The selection of loss and loss expense development factors;

The weight to be applied to each individual actuarial projection method;

Projected future loss trends; and

Expected ultimate loss and loss expense ratios for the current accident year.

The importance of any single assumption depends on several considerations, such as the line of business and the accident year. If the actual experience emerges differently than the assumptions used in the process to establish reserves, changes in our reserve estimate are possible and may be material to the results of operations in future periods. Set forth below are sensitivity tests which highlight potential impacts to loss and loss expense reserves under different scenarios, for the major casualty lines of business. It is important to note that these tests consider each assumption and line of business individually, without any consideration of correlation between lines of business and accident . . .

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