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SIGI > SEC Filings for SIGI > Form 10-Q on 24-Apr-2014All Recent SEC Filings

Show all filings for SELECTIVE INSURANCE GROUP INC

Form 10-Q for SELECTIVE INSURANCE GROUP INC


24-Apr-2014

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:
Our Standard Insurance Operations segment, which is comprised of both commercial lines ("Commercial Lines") and personal lines ("Personal Lines") business, sells property and casualty insurance products and services in the standard market, including flood insurance through the National Flood Insurance Program's ("NFIPs") write-your-own ("WYO") program;

Our E&S Insurance Operations segment sells Commercial Lines property and casualty insurance products and services to insureds who have not obtained coverage in the standard market; and

Our Investments segment, which 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 NFIP's WYO program.
Our E&S Insurance Operations products and services are sold through one subsidiary. 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.
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 2013 Annual Report filed with the U.S. Securities and Exchange Commission ("SEC"). In the MD&A, we will discuss and analyze the following:
Critical Accounting Policies and Estimates;

Financial Highlights of Results for First Quarter 2014 and First Quarter 2013;

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) pension and post-retirement benefit plan actuarial assumptions; (iii) other-than-temporary investment impairments; and (iv) 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 2013 Annual Report, pages 44 through 52.

Financial Highlights of Results for First Quarter 2014 and First Quarter 20131

                                                       Quarter ended March 31,
($ and
shares in thousands, except per share                                          Change
amounts)                                         2014           2013        % or Points
Generally Accepted Accounting Principles
("GAAP") measures:
Revenues                                     $  509,071        459,949             11       %
Pre-tax net investment income                    35,534         32,870              8
  Pre-tax net income                             25,084         27,333             (8 )
Net income                                       17,974         21,308            (16 )
Diluted net income per share                       0.31           0.38            (18 )
Diluted weighted-average outstanding
shares                                           57,172         56,455              1
GAAP combined ratio                               101.1 %         97.1            4.0       pts
  Statutory combined ratio2                       100.8 %         96.8            4.0
Return on average equity                            6.1 %          7.7           (1.6 )
Non-GAAP measures:
Operating income3                            $   13,283         20,124            (34 )     %
Diluted operating income per share3                0.23           0.36            (36 )
Operating return on average equity3                 4.5 %          7.2           (2.7 )     pts

1 Refer to the Glossary of Terms attached to our 2013 Annual Report as Exhibit 99.1 for definitions of terms used in this Form 10-Q.

2 The statutory combined ratio for First Quarter 2013 included 1.3 points related to the Retirement Income Plan amendments that curtailed 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 March 31,
($ in thousands, except per share amounts)                2014               2013
Operating income                                    $        13,283            20,124
Net realized gains, net of tax                                4,691             2,181
Loss on disposal of discontinued operations, net
of tax                                                            -              (997 )
Net income                                          $        17,974            21,308

Diluted operating income per share                  $          0.23              0.36
Diluted net realized gains per share                           0.08              0.04
Diluted net loss from disposal of discontinued
operations per share                                              -             (0.02 )
Diluted net income per share                        $          0.31              0.38


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Over the long term, we target a return on average equity that is three points higher than our cost of capital, or 12%, excluding the impact of realized gains and losses, which is referred to as operating return on average equity. Our operating return on average equity was 4.5% in First Quarter 2014 compared to 7.2% in First Quarter 2013. Our operating return on average equity contribution by component is as follows:

Operating Return on Average Equity     Quarter ended March 31,
                                         2014            2013
Standard Insurance Operations            (1.3 )%           2.8  %
E&S Insurance Operations                  0.2  %             -
Investments                               9.1  %           8.9  %
Other                                    (3.5 )%          (4.5 )%
Total                                     4.5  %           7.2  %

Our operating return on average equity in First Quarter 2014 reflects a higher GAAP combined ratio of 101.1% compared to 97.1% in First Quarter 2013. Extreme winter weather was a significant driver of our First Quarter 2014 results. Information concerning these property losses, as well as other variances are as follows:
Catastrophe losses for First Quarter 2014 were $34 million, or 7.5 points, compared to $1.6 million, or 0.4 points, in First Quarter 2013. The majority of these catastrophe losses were attributed to weather events defined by Insurance Services Office property claims service ("PCS") as CATs 31 and 32 in January, which brought freezing temperatures and snowstorms to our 22-state standard lines footprint.

Non-catastrophe property losses in First Quarter 2014 that were at one of the highest levels that we have experienced in recent years. The impact varied by line but, for both standard lines and E&S, non-catastrophe property losses for First Quarter 2014 were approximately $91 million, or 20 points, on our total combined ratio. This was about 5 points higher than First Quarter 2013 and 6 points higher than the non-catastrophe property loss quarterly average over the last three-year period. These non-catastrophe property losses were primarily the result of roof collapses, frozen pipes, and fires which were often related to the extreme weather experienced throughout our footprint states.

Partially offsetting these losses were:
Renewal pure price increases of 7.6% that we achieved in full-year 2013, which are currently earning in at about 7.3%. This earned rate is above the loss cost trend of approximately 3%. After taking into account the incremental expenses associated with the additional premium, the net benefit to the combined ratio is about 2.5 points.

Favorable prior year casualty development in First Quarter 2014 that was $14 million, or 3.1 points, compared to favorable prior year casualty development of $2 million, or 0.4 points, in First Quarter 2013. We experienced stable workers compensation trends in the quarter with no development either favorable or unfavorable. The level of releases in First Quarter 2014 was driven by improving claim trends within our general liability line of business for the 2009 through 2012 accident years.

$8 million, or 1.8 points, in other income for the March 2014 sale of the renewal rights to our self-insured group, or "SIG," book of pooled public entity business. Although we did not solicit buyers, we decided to sell this very small and specialized book of business when the opportunity presented itself because it had significant production outside of our standard lines footprint, and proved difficult to grow. We, however, have retained our substantial individual risk public entity book of business and we will continue to look for opportunities to grow it.

The remaining fluctuation in our operating return on average equity was driven by reduced corporate expenses that included the following: (i) the First Quarter 2013 redemption of our previously outstanding 7.50% Junior Subordinated Notes due 2066, that resulted in capitalized debt issue costs of $3.3 million, pre-tax, being charged to expense; and (ii) reduced long-term employee compensation expense associated with changes in our stock price. These items are captured within the "Other" component in the table above.


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

All Lines                                          Quarter ended March 31,
($ in thousands)                        2014         2013      Change % or Points
GAAP Insurance Operations Results:
Net premiums written ("NPW")         $ 476,750     450,124                  6        %
Net premiums earned ("NPE")            456,495     420,940                  8
Less:
Loss and loss expense incurred         320,546     269,849                 19
Net underwriting expenses incurred     139,726     137,844                  1
Dividends to policyholders               1,238       1,086                 14
Underwriting (loss) gain             $  (5,015 )    12,161               (141 )      %
GAAP Ratios:
Loss and loss expense ratio               70.2   %    64.1                6.1        pts
Underwriting expense ratio                30.6        32.7               (2.1 )
Dividends to policyholders ratio           0.3         0.3                  -
Combined ratio                           101.1        97.1                4.0
Statutory Ratios:
Loss and loss expense ratio1              70.2        64.1                6.1
Underwriting expense ratio1               30.3        32.4               (2.1 )
Dividends to policyholders ratio           0.3         0.3                  -
Combined ratio1                          100.8   %    96.8                4.0        pts

1 Statutory ratios for First Quarter 2013 included 0.3 points in the loss and loss expense ratio, 1.0 points in the underwriting ratio, and 1.3 points in the combined ratio related to the Retirement Income Plan amendments that curtailed the accrual of additional benefits for all eligible employees participating in the plans after March 31, 2016.

The growth in NPW for our Insurance Subsidiaries in First Quarter 2014 compared to First Quarter 2013 was primarily driven by renewal pure price increases and strong retention in our Standard Commercial Lines Insurance Operations.

NPE increases in First Quarter 2014 were consistent with the fluctuations in NPW for the twelve-month period ended March 31, 2014 compared to the twelve-month period ended March 31, 2013.

The increase in the combined ratio for First Quarter 2014 was primarily driven by property results that were impacted by extreme winter weather. For a discussion on these property losses as well as other variances, see the discussion above.

Outlook
In their 2013 year-end review, dated February 4, 2014, A.M. Best and Company ("A.M. Best") projected an industry combined ratio of 99.4% for 2014. Their report cited: "In looking ahead to 2014, A.M. Best expects premiums to continue growing through price increases, but the pace of these rate changes are expected to slow and temper growth in premium." Underwriting results should improve slightly on the rate level achieved in recent years, although less favorable development of prior years' loss reserves is anticipated. In addition, a more normal level of catastrophe losses could increase combined ratios by almost 200 basis points, and the industry will continue to be challenged by the relatively low investment yields that are expected to persist through 2014, as well as the slow recovery from the recession of 2007 through 2009.

Although A.M. Best is continuing to maintain its negative outlook for the commercial lines market reflecting "the uncertainty around loss-reserve development and continued low profit margins driven by low investment yields," it anticipates a 99.9% statutory combined ratio driven by: (i) a more normal level of catastrophe losses; (ii) less favorable loss-reserve development; and
(iii) loss trends that are partially offset by lower pricing. For personal lines, A.M. Best maintains a stable outlook in the coming year reflecting ongoing stability of the auto line and successful carriers continuing to enhance the granularity of their home pricing models. Standard & Poor's ("S&P"), while maintaining a stable outlook on the property and casualty industry, believes that "rate increases will lose steam and fail to outpace loss cost trends" in 2014.

In early 2012, we laid out a three-year plan to achieve overall annual renewal pure price increases of 5% to 8%. Our expectation for full-year 2014 is 6% to 7%, and we achieved 6.4% in First Quarter 2014. In addition, we are revising our previously disclosed expectations for our Standard Personal Lines and our E&S Lines as we are currently expecting this business, as well as our Standard Commercial Lines business, to each achieve renewal pure price increases of 6% to 7% for


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full-year 2014. In our Standard Commercial Lines, we have achieved renewal pure price increases for 20 consecutive quarters, including 6.4% for First Quarter 2014, 7.6% for full-year 2013, and 6.3% for full-year 2012. The 7.6% renewal pure price increase in 2013 translated into earned price increases of 7.3% in First Quarter 2014 which is above loss cost trends of approximately 3%. The 6% to 7% overall renewal pure price increases that we expect to achieve in 2014 are also above loss cost trends, and will continue to add to profitability in 2015. Furthermore in First Quarter 2014, we achieved renewal pure price increases of 6.8% in our Standard Personal Lines, and 4.1% in our E&S Lines.

Our First Quarter 2014 statutory combined ratio, excluding catastrophes, was 93.3%, which is in line with our stated full-year 2014 goal of 92%. The catastrophe losses in First Quarter 2014 of $34 million added 7.5 points to our statutory combined ratio, compared to our full-year catastrophe loss expectation of four points. This increased level of catastrophe losses was related to extreme winter weather, primarily driven by weather events defined by PCS as CATs 31 and 32 in January.

The yield on the 10-year U.S. Treasury Notes fell by 31 basis points in First Quarter 2014. 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 interest rate environment presents a significant challenge in generating after-tax return on our investment portfolio as fixed income securities mature and money is re-invested at lower rates. Because maturing and called bonds generally carry a higher book yield than is available in the current market, we expect the yield on the overall investment portfolio to continue to decline, albeit at a less significant pace than we have been experiencing.

In 2014, we expect to generate:
A full-year combined ratio of 92% excluding catastrophe losses and assuming no additional prior year casualty reserve development;

Four points of catastrophe losses for the year;

After-tax investment income of approximately $100 million; and

Weighted-average shares of approximately 57.4 million.


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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 83% of the segment's NPW; and (ii) Personal Lines,
including our flood business, which markets primarily to individuals and
represents approximately 17% of the segment's NPW.
                                       Quarter ended March 31,
                                                                    Change
                                                                     % or
($ in thousands)                           2014            2013     Points
GAAP Insurance Operations Results:
NPW                                  $     446,688       421,744        6     %
NPE                                        424,259       390,881        9
Less:
Loss and loss expense incurred             300,666       250,731       20
Net underwriting expenses incurred         128,345       126,989        1
Dividends to policyholders                   1,238         1,086       14
Underwriting (loss) gain             $      (5,990 )      12,075     (150 )   %
GAAP Ratios:
Loss and loss expense ratio                   70.9     %    64.1      6.8     pts
Underwriting expense ratio                    30.2          32.5     (2.3 )
Dividends to policyholders ratio               0.3           0.3        -
Combined ratio                               101.4          96.9      4.5
Statutory Ratios:
Loss and loss expense ratio1                  70.9          64.2      6.7
Underwriting expense ratio1                   29.9          32.3     (2.4 )
Dividends to policyholders ratio               0.3           0.3        -
Combined ratio1                              101.1     %    96.8      4.3     pts

1 Statutory ratios for First Quarter 2013 included 0.3 points in the loss and loss expense ratio, 1.1 points in the underwriting ratio, and 1.4 points in the combined ratio related to the Retirement Income Plan amendments that curtailed the accrual of additional benefits for all eligible employees participating in the plans after March 31, 2016.

The improvements in NPW in First Quarter 2014 compared to First Quarter 2013 include the following:

                               Quarter ended March 31,         Quarter ended March 31,
                                         2014                            2013
                                Renewal                         Renewal
                              Pure Price                      Pure Price
($ in millions)                Increase       Retention        Increase       Retention
Standard Commercial Lines             6.4 %           84 %            7.5 %           83 %
Standard Personal Lines               6.8             82              8.5             87

The decrease in the Standard Personal Lines retention was driven by targeted actions that we have taken to reduce our exposure to certain coverages that have historically been less profitable for us. Excluding the impact of these targeted actions, retention remains strong and comparable to last year.

NPE increases in First Quarter 2014 were consistent with the fluctuations in NPW for the twelve-month period ended March 31, 2014 as compared to the twelve-month period ended March 31, 2013.


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The GAAP loss and loss expense ratio increased 6.8 points in First Quarter 2014 compared to First Quarter 2013. The increase in this ratio was primarily driven by extreme winter weather, including: (i) an increased level of catastrophe losses; and (ii) higher non-catastrophe property losses. These losses were partially offset by: (i) Standard Insurance Operations renewal pure price increases that amounted to 6.5% in First Quarter 2014 and 7.6% in full year 2013, the earning of which exceeds our 3% projected loss trend; and (ii) favorable prior year casualty reserve development. Quantitative information regarding the property losses and the reserve development is as follows:

                                   First Quarter 2014                         First Quarter 2013
                                                    Impact on                              Impact on
                          Loss and Loss Expense   Loss and Loss          Loss and Loss   Loss and Loss      Change in
($ in millions)                 Incurred          Expense Ratio        Expense Incurred  Expense Ratio        Ratio
Catastrophe losses       $           34.2               8.1      pts          1.3               0.3     pts   7.8
Non-catastrophe property
losses                               86.2              20.3                  60.7              15.5           4.8
Favorable prior year
casualty reserve
development                         (14.0 )            (3.3 )                (2.5 )            (0.6 )        (2.7 )

The breakdown of favorable prior year casualty reserve development in our Standard Insurance Operations by line of business is as follows:

Favorable/(Unfavorable) Prior Year Casualty
Reserve Development                                     Quarter ended March 31,
($ in millions)                                          2014               2013
General liability                                  $         11.0               4.0
Commercial automobile                                           -                 -
Workers compensation                                            -              (7.5 )
Businessowners' policies                                      1.0               3.0
Homeowners                                                      -               1.5
Personal automobile                                           2.0               1.0
Other                                              $            -               0.5
Total favorable prior year casualty reserve
development                                        $         14.0               2.5

Favorable impact on loss ratio                                3.3   pts         0.6   pts

Favorable prior year casualty reserve development of $14 million in First Quarter 2014 was driven by improving claim trends for the 2009 through 2012 accident years on our general liability line of business. Excluding the impact of the workers compensation line of business prior year development in First Quarter 2013, the remainder of the casualty lines experienced a level of . . .

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