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SIGI > SEC Filings for SIGI > Form 10-Q on 31-Jul-2014All Recent SEC Filings

Show all filings for SELECTIVE INSURANCE GROUP INC

Form 10-Q for SELECTIVE INSURANCE GROUP INC


31-Jul-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 Excess and Surplus ("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 Second Quarter and Six Months 2014 and Second Quarter and Six Months 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.


Table of Contents

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 ("OTTI"); 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 Second Quarter and Six Months 2014 and

Second Quarter and Six Months 20131
                                                Quarter ended June 30,                           Six Months ended June 30,
($ and
shares in thousands, except per share                                Change                                              Change
amounts)                                   2014         2013       % or Points                2014          2013       % or Points
Generally Accepted Accounting
Principles ("GAAP") measures:
Revenues                                $ 506,849     468,945             8       %      $  1,015,920     928,894             9       %
Pre-tax net investment income              36,774      34,003             8                    72,308      66,873             8
  Pre-tax net income                       39,521      36,201             9                    64,605      63,534             2
Net income                                 29,341      27,122             8                    47,315      48,430            (2 )
Diluted net income per share                 0.51        0.48             6                      0.83        0.86            (3 )
Diluted weighted-average outstanding
shares                                     57,260      56,616             1                    57,215      56,530             1
GAAP combined ratio                          97.8 %      98.9          (1.1 )     pts            99.4        98.0           1.4       pts
  Statutory combined ratio2                  97.5 %      97.7          (0.2 )                    99.2        97.3           1.9
Return on average equity                      9.7 %       9.7             -                       7.9         8.8          (0.9 )
Non-GAAP measures:
Operating income3                       $  26,390      23,773            11       %      $     39,673      43,897           (10 )     %
Diluted operating income per share3          0.46        0.42            10                      0.70        0.78           (10 )
Operating return on average equity3           8.7 %       8.5           0.2       pts             6.6         8.0          (1.4 )     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 Six Months 2013 included 0.7 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 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)                                   2014            2013           2014           2013
Operating income                      $      26,390        23,773          39,673        43,897
Net realized gains, net of tax                2,951         3,349           7,642         5,530
Loss on disposal of discontinued
operations, net of tax                            -             -               -          (997 )
Net income                            $      29,341        27,122          47,315        48,430

Diluted operating income per share    $        0.46          0.42            0.70          0.78
Diluted net realized gains per
share                                          0.05          0.06            0.13          0.10
Diluted net loss from disposal of
discontinued operations per share                 -             -               -         (0.02 )
Diluted net income per share          $        0.51          0.48            0.83          0.86


Table of Contents

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 and contribution by component for Second Quarter 2014 and Six Months 2014 and the comparable prior year periods are as follows:

Operating Return on
Average Equity                     Quarter ended June 30,                 Six Months ended June 30,
                                  2014                 2013                2014                2013
Standard Insurance
Operations                           2.2  %                 1.6  %           0.4  %              2.2  %
E&S Insurance Operations               -  %                (0.6 )%           0.1  %             (0.2 )%
Investments                          9.1  %                 9.2  %           9.0  %              9.2  %
Other                               (2.6 )%                (1.7 )%          (2.9 )%             (3.2 )%
Total                                8.7  %                 8.5  %           6.6  %              8.0  %

Our operating return on average equity in Second Quarter 2014 and Six Months 2014 reflects GAAP combined ratios of 97.8% and 99.4%, compared to 98.9% and 98.0% in the same periods a year ago. Increased favorable prior year casualty reserve development and the impact of renewal pure price increases drove the improvement in operating return on average equity in the quarter, despite increased levels of catastrophe and non-catastrophe property losses. On a year-to-date basis, the increase in property losses resulted in an increase in the combined ratio and a corresponding decline in operating return on average equity compared to Six Months 2013. Further descriptions of the variances for the quarter and year-to-date periods are as follows:

Catastrophe losses for Second Quarter 2014 and Six Months 2014 were $27.2 million, or 5.9 points, and $61.6 million, or 6.7 points, respectively, compared to $19.6 million, or 4.6 points, and $21.2 million, or 2.5 points, in the respective prior year periods. The majority of these catastrophe losses were attributed to extreme weather events in the first quarter of 2014, which brought freezing temperatures and snowstorms to our 22-state standard lines footprint, coupled with hail, tornadoes, and wind events in Second Quarter 2014.

Non-catastrophe property losses in Second Quarter 2014 and Six Months 2014 were at some 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 Second Quarter 2014 and Six Months 2014 were approximately $73.0 million, or 15.7 points, and $164.4 million, or 17.9 points, respectively. Non-catastrophe losses for the quarter and year-to-date periods were both about 4 points higher than the same periods last year. These non-catastrophe property losses were primarily the result of fires, roof collapses, and water damage, which were often related to the weather events experienced throughout our footprint states in both Second Quarter 2014 and Six Months 2014.

Renewal pure price increases of 7.6% were achieved in full-year 2013, which are currently earning in at 6.9% in Second Quarter 2014 and 7.1% in Six Months 2014. 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 approximately 2.5 points for both periods.

Favorable prior year casualty development in Second Quarter 2014 and Six Months 2014 was $17.5 million, or 3.8 points, and $31.5 million, or 3.5 points, respectively, compared to favorable prior year casualty development of $2 million, or 0.5 points, and $4 million, or 0.4 points, in Second Quarter 2013 and Six Months 2013, respectively. We experienced stable workers compensation trends in the quarter and year-to-date periods, with no development either favorable or unfavorable. The level of releases in Second Quarter and Six Months 2014 were driven by improving claim trends within our general liability line of business for the 2012 and prior accident years.

Also contributing to Six Months 2014 Insurance Operations results, was the March 2014 sale of the renewal rights to our self-insured group, or "SIG," book of pooled public entity business, which contributed $8 million to other income, reducing the combined ratio by 0.9 points. 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 Second Quarter 2014 operating return on average equity compared to Second Quarter 2013 was driven by higher long-term employee compensation expense associated with our performance relative to our peer group and fluctuations in our stock price. This item is captured within the "Other" component in the table above.


Table of Contents

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                                        Change
                                                     % or                                          % or
($ in thousands)          2014          2013        Points               2014         2013        Points
GAAP Insurance Operations Results:
Net premiums written
("NPW")                $ 479,823      462,177         4        %      $ 956,573     912,301         5        %
Net premiums earned
("NPE")                  463,625      426,252         9                 920,120     847,192         9
Less:
Loss and loss
expense incurred         297,795      279,594         7                 618,341     549,443        13
Net underwriting
expenses incurred        154,197      141,194         9                 293,923     279,038         5
Dividends to
policyholders              1,549          981        58                   2,787       2,067        35
Underwriting gain      $  10,084        4,483       125        %      $   5,069      16,644       (70 )      %
GAAP Ratios:
Loss and loss
expense ratio               64.2   %     65.6      (1.4 )      pts         67.2   %    64.9       2.3        pts
Underwriting expense
ratio                       33.3         33.1       0.2                    31.9        32.9      (1.0 )
Dividends to
policyholders ratio          0.3          0.2       0.1                     0.3         0.2       0.1
Combined ratio              97.8         98.9      (1.1 )                  99.4        98.0       1.4
Statutory Ratios:
Loss and loss
expense ratio1              64.2         65.6      (1.4 )                  67.2        64.9       2.3
Underwriting expense
ratio1                      33.0         31.9       1.1                    31.7        32.2      (0.5 )
Dividends to
policyholders ratio          0.3          0.2       0.1                     0.3         0.2       0.1
Combined ratio1             97.5   %     97.7      (0.2 )      pts         99.2   %    97.3       1.9        pts

1 Statutory ratios for Six Months 2013 included 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 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 Second Quarter and Six Months 2014 compared to Second Quarter and Six Months 2013 was primarily driven by renewal pure price increases and strong retention in our Standard Commercial Lines Insurance Operations.

NPE increases in Second Quarter 2014 and Six Months 2014 were consistent with the fluctuations in NPW for the twelve-month period ended June 30, 2014 compared to the twelve-month period ended June 30, 2013.

The combined ratios for both Second Quarter 2014 and Six Months 2014 were primarily driven by property results, renewal pure price increases, and favorable prior year casualty development, as discussed 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." They expect that 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 for 2014, 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.


Table of Contents

In its financial review issued on July 14, 2014, A.M. Best noted that increased catastrophe and weather-related claims led to an increase in losses for the U.S. property and casualty industry in the first quarter of 2014, causing underwriting and net income to decline compared with last year's results. Losses related to the polar vortex account for much of this increase. Overall, catastrophe losses accounted for 3.4 points on the combined ratio, a substantial increase over the 2.1-point impact in the first quarter of last year. Despite these increased losses, the industry posted another quarter of profitable underwriting, producing a combined ratio of 96.4% for the first quarter of 2014, up from 92.7% for the first quarter of 2013.

In early 2012, we laid out a three-year plan to achieve overall annual renewal pure price increases of 5% to 8%. We achieved 6.0% in Six Months 2014, including 6.1% in our Standard Commercial Lines, 6.2% in our Standard Personal Lines, and 3.7% in our E&S Lines. The 7.6% overall renewal pure price increase in 2013 translated into earned price increases of 7.1% in Six Months 2014, which is above loss cost trends of approximately 3%. The 6% overall renewal pure price increase that we expect to achieve in 2014 is also above loss cost trends, and will continue to add to profitability in 2015.

Our Insurance Subsidiaries reported statutory combined ratios, excluding catastrophes, of 91.6% for Second Quarter 2014 and 92.5% for Six Months 2014, which are in line with our stated full-year 2014 goal of 92%. The catastrophe losses in Second Quarter 2014 of $27 million added 5.9 points to our statutory combined ratio, and the catastrophe losses in Six Months 2014 of $61.6 million added 6.7 points to our statutory combined ratio. This increased level of catastrophe losses was related to extreme winter weather in the first quarter of 2014 and Midwest storms in Second Quarter 2014.

The yield on the 10-year U.S. Treasury Notes fell by 50 basis points in Six Months 2014, but as the overall portfolio yield approaches the yield of new purchases, we have begun to see a declining rate of pressure on the yield of the existing portfolio. 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.

Given the results we have achieved in Six Months 2014, including the level of catastrophe losses we have incurred and the overall renewal pure price increases we have achieved, we currently expect to generate:
A full-year combined ratio of 92% excluding catastrophe losses and assuming no additional prior year casualty reserve development;

Five points of catastrophe losses for the year, which is one point higher than our previous guidance;

Renewal pure price increases of approximately 6% on an overall company basis, at the low end of our previous estimate of 6%-7%;

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

Weighted-average shares of approximately 57.4 million.


Table of Contents

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 June 30,                            Six Months ended June 30,
                                                           Change                                            Change
                                                            % or                                              % or
($ in thousands)              2014               2013      Points                 2014             2013      Points
GAAP Insurance
Operations Results:
NPW                   $     442,041            429,511         3     %      $      888,729       851,255         4     %
NPE                         429,051            396,205         8                   853,310       787,086         8
Less:
Loss and loss
expense incurred            275,395            258,520         7                   576,061       509,251        13
Net underwriting
expenses incurred           141,986            129,936         9                   270,331       256,925         5
Dividends to
policyholders                 1,549                981        58                     2,787         2,067        35
Underwriting gain     $      10,121              6,768        50     %      $        4,131        18,843       (78 )   %
GAAP Ratios:
Loss and loss
expense ratio                  64.2         %     65.2      (1.0 )   pts              67.5    %     64.7       2.8     pts
Underwriting
expense ratio                  33.0               32.9       0.1                      31.7          32.6      (0.9 )
Dividends to
policyholders ratio             0.4                0.2       0.2                       0.3           0.3         -
Combined ratio                 97.6               98.3      (0.7 )                    99.5          97.6       1.9
Statutory Ratios:
Loss and loss
expense ratio1                 64.2               65.3      (1.1 )                    67.5          64.7       2.8
Underwriting
expense ratio1                 32.7               31.5       1.2                      31.4          31.9      (0.5 )
Dividends to
policyholders ratio             0.4                0.2       0.2                       0.3           0.3         -
Combined ratio1                97.3         %     97.0       0.3     pts              99.2    %     96.9       2.3     pts

1 Statutory ratios for Six Months 2013 included 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 that curtailed 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 2014 compared to Second Quarter and Six Months 2013 include the following:

                                Quarter ended June 30,          Quarter ended June 30,
                                         2014                            2013
                                Renewal                         Renewal
                              Pure Price                      Pure Price
($ in millions)                Increase       Retention        Increase       Retention
Standard Commercial Lines             5.9 %           82 %            7.2 %           83 %
Standard Personal Lines               6.5             82              8.3             87



                               Six Months ended June         Six Months ended June
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