UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549

FORM 10-Q

 

(Mark one)

[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended: September 30, 2004
OR
[  ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from  __________ to __________

Commission file number:  0-8641

SELECTIVE INSURANCE GROUP, INC.
(Exact name of registrant as specified in its charter)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such report), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X]            No [  ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act)

Yes [X]            No [  ]

Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date:

Common stock, par value $2 per share, outstanding as of September 30, 2004: 27,770,976

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NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

1.                      Basis of Presentation
The interim consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) are unaudited, but reflect all adjustments which, in the opinion of management, are necessary to provide a fair statement of the results of Selective Insurance Group, Inc. and its consolidated subsidiaries for the interim periods presented.  References herein to "Selective" or "Company" are to Selective Insurance Group, Inc. and its subsidiaries.  All such adjustments are of a normal recurring nature.  The results of operations for any interim period are not necessarily indicative of results for a full year.  These interim consolidated financial statements cover the third quarters ended September 30, 2004 (Third Quarter 2004) and September 30, 2003 (Third Quarter 2003) as well as the nine-month periods ended September 30, 2004 (Nine Months 2004) and September 30, 2003 (Nine Months 2003).  This document should be read in conjunction with the consolidated financial statements and notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2003.

2.                      Reclassifications
Certain amounts in the Company's prior year interim consolidated financial statements and related footnotes have been reclassified to conform to the 2004 presentation.  Such reclassification had no effect on the Company's net income or stockholders' equity.

3.                      Current and Pending Accounting Pronouncements
In December 2003, the Financial Accounting Standards Board (FASB) issued revised FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46R), which is a revised interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements". FIN 46R is required to be applied starting with fiscal years beginning after December 15, 2003. FIN 46R requires the consolidation of a variable interest entity (VIE) by an enterprise if that enterprise either absorbs a majority of the VIE's expected losses or receives a majority of the VIE's expected residual returns as a result of ownership, contractual or other financial interests in the VIE.  Prior to FIN 46R, entities were generally consolidated by an enterprise that had a controlling financial interest through ownership of a majority voting interest in the entity. FIN 46R defines a VIE as an entity in which equity investors do not have the characteristics of a controlling financial interest nor do they have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support.  The Company has no interests in VIEs or potential VIEs commonly referred to as special-purpose entities and as such, the adoption of this revised interpretation on January 1, 2004 has had no effect on the Company's results of operations or financial condition.

In March 2004, the Emerging Issues Task Force (EITF or Task Force) of the FASB reached a consensus on Issue No. 03-01, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments."   This consensus provides recognition and measurement guidance for determining when an investment is other-than-temporarily impaired, specifically when the investor has the ability and intent to hold an investment until recovery.  When originally issued, this guidance was to be effective for reporting periods beginning after June 15, 2004. In September 2004, the FASB decided to delay the effective date of the requirement to record impairment losses caused by the effect of increases in interest rates or sector spreads on debt securities subject to paragraph 16 of EITF 03-01 and to exclude minor impairments from the requirement as well. In addition, the scope of the Task Force's consensus, which was limited to certain debt securities, now includes all types of securities within the scope of EITF 03-01. The disclosure requirements as presently prescribed by EITF 03-01 and SEC Staff Accounting Bulletin No. 59, "Accounting for Noncurrent Marketable Equity Securities" remain in effect for public companies until new guidance is issued and becomes effective. Until such guidance is determined, the Company is unable to determine the impact any such guidance would have on its results of operations or financial condition.  The adoption of the proposed accounting literature could cause the Company: (i) to recognize impairment losses in the Consolidated Statements of Income that are not recognized currently; (ii) to recognize impairment losses, especially those due to increases in interest rates, in earlier periods; and (iii) alter its recognition of investment income on impaired securities.  Such an impact will likely increase earnings volatility in future periods.  However, since fluctuations in the fair value for available-for-sale-securities are already recorded in Accumulated Other Comprehensive Income, adoption of this standard in any form is not expected to have a significant impact on stockholders' equity. Further information on the Company's investments is provided in Item 2. "Management's Discussion and Analysis of Financial Condition and Results of Operations," in this report beginning on page 23.

 

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On October 13, 2004, the FASB concluded that the Proposed Statement 123R, "Share-Based Payment" (FAS 123R), which would require all companies to measure compensation expense on the income statement for all share-based payments (including employee stock options) at fair value, would be effective for public companies for interim or annual periods beginning after June 15, 2005. Retroactive application of the requirements of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (FAS 123) to the beginning of the fiscal year that includes the effective date would be permitted, but not required.  The Proposed Statement 123R is expected to be finalized either later this year or in early 2005. The pro forma results presented in Note 7 are in accordance with the required disclosures under Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure" (FAS 148), which should provide for a reasonable approximation of the impact the Proposed Statement 123R will have on the Company.

Also on October 13, 2004, the FASB ratified EITF Issue No. 04-8, "The Effect of Contingently Convertible Instruments on Diluted Earnings per Share."  As of September 30, 2004, the Company accounted for its Senior Convertible Notes in accordance with the FASB Statements of Financial Accounting Standards No. 128 "Earnings per share." Accordingly, the 3.9 million shares issuable upon conversion of the Convertible Notes are included in the diluted earnings per share calculation in the quarter when the contingency is met as well as the following quarter when the  convertible notes are actually convertible.  Therefore, the shares have been included in diluted earnings per share calculation for the Third Quarter 2004 as well as for the Nine Months 2004, but excluded from the calculation for periods prior to January 1, 2004, for which the contingency criteria was not met dating back to date of issuance in September 2002. EITF Issue No. 04-8, which will require that all shares issuable under a convertible security be included in the diluted earnings per share calculation upon issuance of the instrument, is expected to become effective for periods ending after December 15, 2004 and must be applied by restating all periods during which the instrument was outstanding regardless of whether the market price contingency was met or not. The implementation of this guidance is not anticipated to have any impact on our 2004 diluted earnings per share calculation, but it is likely to result in the restatement of our 2003 and 2002 diluted earnings per share calculations.

4.                      Acquisition of Wholly-Owned Subsidiary
On January 1, 2004, the Company purchased a property and casualty insurance company, domiciled in Maine, with approximately $5.0 million in surplus that was not then writing any business, for $5.3 million. The acquisition has been accounted for using the purchase method of accounting as prescribed by FASB Statement of Financial Accounting Standards No. 141, "Business Combinations."  The acquisition included assets of approximately $4.9 million in cash and cash equivalents, $0.1 million in bonds and $0.3 million of goodwill, which is being accounted for in accordance with FASB Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets." There were no liabilities acquired in connection with this acquisition.

5.                      Concentration of Credit Risk
The Company's concentration of credit risk includes accounts receivable due by clients to its human resource administration outsourcing operations, Selective HR Solutions (SHRS).  By law and/or by contract, SHRS assumes substantial employer rights, responsibilities, and risks related to certain employees of its clients and becomes a co-employer of the client's employees. Earned but unpaid wages related to SHRS's co-employees are recognized as an accrued payroll liability, as well as an account receivable, during the period in which such wages are earned.  Subsequent to the end of each period, such wages are paid and the related co-employer service fees are billed.  Accrued co-employer payroll and related service fees were $17.4 million as of September 30, 2004 and $15.5 million as of December 31, 2003.  Certain states limit a co-employer's liability for earned payroll to minimum wage and, accordingly, SHRS's potential liability for accrued co-employer payroll could be reduced.

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If a client does not pay its related payroll and service fees prior to the applicable payroll date, SHRS has the right to cancel the co-employer contract or, at its option, require letters of credit or other collateral. SHRS generally has not required such collateral.  As of September 30, 2004, the maximum exposure to any one account for earned payroll was approximately $0.6 million.  If the financial condition of a client were to deteriorate rapidly, resulting in nonpayment, SHRS's accounts receivable balances could grow and SHRS could be required to provide for allowances, which would decrease net income in the period that such determination was made.

The Company's Insurance Operations and SHRS segments are subject to geographic concentration.  Approximately 37% of net premiums written are related to insurance policies written in New Jersey, while 39% of HR outsourcing co-employer service fees are related to business in Florida.  Substantially all of the Company's remaining revenues come from the states of Connecticut, Delaware, Georgia, Illinois, Indiana, Iowa, Kentucky, Maryland, Michigan, Minnesota, Missouri, New York, North Carolina, Ohio Pennsylvania, Rhode Island, South Carolina, Virginia, and Wisconsin, Consequently, changes to economic or regulatory conditions in these states could adversely affect the Company.

For a discussion regarding reinsurance recoverables and related concentration of credit risk see Note 6, "Reinsurance" to the September 30, 2004 unaudited interim consolidated financial statements.

6.                      Reinsurance
The Company's consolidated financial statements reflect the effects of assumed and ceded reinsurance transactions.  Assumed reinsurance refers to the acceptance of certain insurance risks that other insurance entities have underwritten.  Ceded reinsurance involves transferring certain insurance risks (along with the related written and earned premiums) the Company has underwritten to other insurance companies who agree to share these risks.  The primary purpose of ceded reinsurance is to protect the Company from potential losses in excess of the amount it is prepared to accept.  The reinsurance recoverable from American Re-Insurance Company represents 8% and 7% of the Company's uncollateralized consolidated reinsurance recoverables as of September 30, 2004 and December 31, 2003, respectively. As of September 30, 2004, collateral in the amount of $37.7 million is held in a trust fund for the benefit of the Company related to the reinsurance contracts with American Re-Insurance Company.  In addition, just over 60% of the Company's uncollateralized net reinsurance recoverable balances are ceded to two state or federally sponsored pools (New Jersey Unsatisfied Claims Judgment Fund and the National Flood Insurance Program).

The Company evaluates and monitors the financial condition of its reinsurers under voluntary reinsurance arrangements to minimize its exposure to significant losses from reinsurer insolvencies.  On an ongoing basis, the Company reviews amounts outstanding, length of collection period, changes in reinsurance credit standing and other relevant factors to determine collectibility of reinsurance recoverables. During the Third Quarter 2004, there were rating downgrades and substantial reserve developments within the reinsurance industry that could affect our ability to collect under certain reinsurance contracts.  As a result, we increased our loss reserves by $2.5 million and exercised the special termination provision, which is effective in October 2004, on two of our reinsurance contracts due to rating agency downgrades of specific reinsurers that could adversely affect our ability to collect under certain reinsurance contracts.  We eliminated one carrier and added two highly rated carriers to our Property Catastrophe Excess of Loss and Terrorism Aggregate Excess of Loss treaties. We believe these actions will enhance and strengthen our reinsurance program.

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The following table is a listing of direct, assumed and ceded amounts by income statement caption:

		Unaudited,				Unaudited,
		Quarter ended				Nine months ended
		September 30,				September 30,
(in thousands)		2004		2003			2004		2003

Premiums written:
Direct	$	377,562		345,274		$	1,159,702		1,036,897
Assumed		19,448		13,469			32,789		24,313
Ceded		(40,559)		(41,230)			(111,528)		(113,431)
Net	$	356,451		317,513		$	1,080,963		947,779
		=======		=======			=======		=======
Premiums earned:
Direct	$	361,670		317,951		$	1,056,050		919,591
Assumed		9,440		7,374			26,016		18,865
Ceded		(34,036)		(35,644)			(103,700)		(105,589)
Net	$	337,074		289,681		$	978,366		832,867
		=======		=======			=======		=======
Losses and loss expenses incurred:
Direct	$	259,563		236,125		$	703,662		640,051
Assumed		8,398		6,022			22,654		15,949
Ceded		(43,119)		(37,963)			(82,007)		(62,973)
Net	$	224,842		204,184		$	644,309		593,027
		=======		=======			=======		======

 

Flood business, which we cede 100% to the National Flood Insurance Program, is included in the above amounts as follows:

		Unaudited,				Unaudited,
		Quarter ended				Nine months ended
		September 30,				September 30,
(in thousands)		2004		2003			2004		2003

Ceded premiums written	$	(22,816)		(19,302)		$	(59,972)		(50,177)
Ceded premiums earned		(18,062)		(15,240)			(51,906)		(43,051)
Ceded losses and loss expenses incurred		(32,442)		(27,416)			(43,234)		(31,044)

Assumed written and earned premiums increased primarily due to an increase in mandatory pool assumptions and an increase in writings of voluntary municipal pool business.  Offsetting the increases in our flood business, ceded written and earned premiums decreased primarily as a result of the termination of the New Jersey Unsatisfied Claims Judgment Fund (UCJF). The New Jersey UCJF was a mandatory reinsurance program, which provided for personal injury protection (PIP) coverage for New Jersey auto policies.  The UCJF assumed unlimited New Jersey PIP losses in excess of $75,000 up to $250,000 per person/ per occurrence from January 1, 1991 through December 31, 2003.  Effective January 1, 2004 the program was terminated for all new policies with carriers being responsible for 100% of the coverage, which remains capped at $250,000. A final adjustment to the prior treaty year UCJF premium resulted in a return of premium previously ceded of $2.4 million recorded by the Company in this quarter.

Increases in assumed losses were influenced primarily by increases in losses assumed from mandatory pools.  The increases in these assumptions are related to the Company's increased participations in the mandatory pools and general growth of the National Council on Compensation Insurance (NCCI) pool. Increases in ceded incurred losses were primarily attributable to increases in business ceded to the National Flood Insurance program and increased losses ceded to the casualty treaties.

 

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7.             Stock-Based Compensation
The FASB Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (FAS 123) establishes financial accounting and reporting standards for stock-based compensation plans. As permitted by FAS 123, the Company uses the accounting method prescribed by Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" (APB 25) to account for its stock-based compensation plans. Companies using APB 25 are required to make pro forma note disclosures of net income and earnings per share as if the fair value method of accounting, as defined in FAS 123, had been applied.

The FASB Statement of Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure" (FAS 148) amends FAS 123 to provide alternative methods of transition to FAS 123's fair value method of accounting for stock-based compensation.  The Company has adopted the pro forma footnote disclosure-only provisions of FAS 148. Based on the fair value method consistent with the provisions of FAS 148, the Company's net income and earnings per share would have been the following pro forma amounts indicated below:

		Unaudited,					Unaudited,
		Quarter ended					Nine months ended
		September 30,					September 30,
(in thousands, except per share amounts)		2004		2003			2004		2003

Net income, as reported	$	28,328		14,717			84,730		42,503
Add:  Stock-based employee compensation reported in net
income, net of related tax effect		971		1,078			3,409		2,400
Deduct:  Total stock-based employee compensation expense
determined under fair value-based method for all awards,
net of related tax effects		(1,125)		(771)			(4,214)		(3,136)
Pro forma net income	$	28,174		15,024			83,925		41,767
		======		======			======		======
Net income per share:
Basic - as reported	$	1.05		0.56			3.17		1.63
Basic - pro forma		1.05		0.57			3.14		1.60
Diluted - as reported		0.90		0.53			2.70		1.54
Diluted - pro forma		0.89		0.54			2.67		1.52

8.             Senior Convertible Notes
In 2002, the Company issued $305 million aggregate principal amount of 1.6155% senior convertible notes (Senior Convertible Notes), due September 24, 2032, at a discount of 61.988% resulting in an effective yield of 4.25%. The carrying value of these notes was $115.9 million at September 30, 2004 and December 31, 2003.  The Senior Convertible Notes are convertible at the option of the holders, if the conditions for conversion are satisfied, into 12.9783 shares of the Company's common stock per $1,000 principal amount of notes surrendered at a conversion price of $29.29.  The conditions for conversion are satisfied when the price of the Company's common stock has maintained a 20% premium to the conversion price of  $29.29, or $35.15, for 20 of 30 consecutive trading days ending on the last trading day of a calendar quarter. As previously reported, the conditions of conversion were met for the quarters ended March 31, 2004 (First Quarter 2004) and June 30, 2004 (Second Quarter 2004), and as such the holders were able to surrender the Senior Convertible Notes for conversion into shares of common stock, or cash at the Company's option, on any business day during the Second and Third quarters 2004, respectively. As of September 30, 2004, no such conversions had occurred.  On October 26, 2004, in accordance with the provisions of the Indenture, the Company's Board of Directors voted to permanently waive the stock price contingency provision.

In accordance with the FASB Statements of Financial Accounting Standards No. 128 "Earnings per share," the 3.9 million shares issuable upon conversion of the Senior Convertible Notes have been included in the diluted earnings per share calculation for Third Quarter and Nine Months 2004.  Additionally, as a result of the actions taken by the Board of Directors the shares issuable upon conversion of the Senior Convertible Notes will continue to be included in the diluted earnings per share calculation until the Senior Convertible Notes reach maturity or are otherwise extinguished. 

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On October 13, 2004, the FASB ratified EITF Issue No. 04-8, "The Effect of Contingently Convertible Instruments on Diluted Earnings per Share."  EITF 04-8 will require that convertible shares be included in the diluted earnings per share calculation upon issuance of the instrument. This guidance is expected to become effective for periods ending after December 15, 2004 and must be applied by restating all periods during which the instrument was outstanding regardless of whether the market price contingency was met or not. The implementation of this guidance is not anticipated to have any impact on our 2004 diluted earnings per share calculation, but it is likely to result in the restatement of our 2003 and 2002 diluted earnings per share calculations.

The Senior Convertible Notes are redeemable by the Company in whole or in part, at any time on or after September 24, 2007, at a price equal to the sum of the issue price, plus the call premium, if any, plus accrued original issue discount and accrued and unpaid cash interest, if any, on such Senior Convertible Notes to the applicable redemption date. The holders of the Senior Convertible Notes may require the Company to purchase all or a portion of their Senior Convertible Notes on either September 24, 2009, 2012, 2017, 2022, or 2027 at stated prices plus accrued cash interest, if any, to the purchase date. The Company may pay the purchase price in cash or shares of Company common stock or in a combination of cash and shares of Company common stock at the Company's option.

9.             Stockholders' Equity
On November 4, 2003, the Board of Directors authorized a 2.5 million-share common stock repurchase program scheduled to expire on November 30, 2005. The Company acquired approximately 141,000 shares for $4.9 million under that program during the Third Quarter and Nine Months 2004 leaving a remaining authorization of 2.4 million shares.

10.          Segment Information
The Company is primarily engaged in writing property and casualty insurance. The Company has classified its business into three segments, which is at the same level of disaggregation as that reviewed by senior management: Insurance Operations (commercial lines underwriting, personal lines underwriting), Investments, and Diversified Insurance Services (flood insurance, human resource administration outsourcing and managed care).  Insurance Operations are evaluated based on accounting principles generally accepted in the United States of America (GAAP) underwriting results, as well as statutory combined ratios.  Investments are evaluated based on after-tax investment returns, and the Diversified Insurance Services are evaluated based on several measures including, but not limited to, results of operations in accordance with GAAP.  The Company does not aggregate any of its operating segments.

The GAAP underwriting results of the Insurance Operations segment are determined taking into account net premiums earned, incurred losses and loss expenses, policyholders dividends, policy acquisition costs and other underwriting expenses. Management of the Investments segment is separate from the Insurance Operations segment and, therefore, has been classified as a separate segment. The operating results of the Investments segment takes into account net investment income and net realized gains and losses.  Also classified as a segment are the Diversified Insurance Services operations, which are managed separately from the other segments due to the fact that these businesses create a fee-based source of revenue that is not dependent on insurance underwriting cycles.  

These businesses fit into our business model in one of two ways: complementary (they share a common marketing or distribution system) or vertically (one company uses the other's products or services in its own product or supply output).  The flood and HR administration outsourcing products are sold through our independent agent distribution channel, while our managed care businesses provide a service used by our insurance claims operation, as well as by other insurance carriers. The segment results are determined taking into account the net revenues generated in each of the businesses, less the costs of operations.

Selective and its subsidiaries provide services to each other in the normal course of business.  These transactions totaled $7.8 million for Third Quarter 2004 and $21.3 million for Nine Months 2004, compared with $7.0 million for Third Quarter 2003 and $20.1 million for Nine Months 2003.  These transactions were eliminated in all consolidated statements.

In computing the results of each segment, no adjustment is made for interest expense, net general corporate expenses or federal income taxes. The Company does not maintain separate investment portfolios for the segments and, therefore, does not allocate assets to the segments.

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The following summaries present revenues (net investment income and net realized gains or losses in the case of the Investments segment) and pre-tax income (loss) for the individual segments:

		Unaudited,					Unaudited,
Revenue by segment		Quarter ended					Nine months ended
		September 30,					September 30,
(in thousands)		2004		2003			2004		2003

Insurance Operations:
Commercial automobile net premiums earned	$	78,456		65,258		$	225,323		186,987
Workers' compensation net premiums earned		67,003		55,181			195,872		162,293
General liability net premiums earned		79,125		66,579			227,648		188,898
Commercial property net premiums earned		38,970		34,048			113,139		94,584
Business owners' policy net premiums earned		12,534		11,318			37,249		32,223
Bonds net premiums earned		3,331		2,950			9,549		9,252
Other net premiums earned		233		230			681		674
Total commercial lines net premiums earned		279,652		235,564			809,461		674,911
Personal automobile net premiums earned		47,076		44,608			138,926		130,771
Homeowners' net premiums earned		8,700		8,025			25,468		23,059
Other net premiums earned		1,646		1,484			4,511		4,126
Total personal lines net premiums earned		57,422		54,117			168,905		157,956
Miscellaneous income		674		838			2,163		2,177
Total insurance operations revenues		337,748		290,519			980,529		835,044
Investments:
Net investment income		29,146		27,324			87,268		84,103
Net realized gain on investments		1,631		1,029			7,131		8,373
Total investment revenues		30,777		28,353			94,399		92,476
Diversified Insurance Services:
Human resource administration outsourcing		13,448		11,137			39,809		32,453
Flood insurance		8,992		7,386			21,952		17,917
Managed care		4,536		5,375			14,613		17,412
Other		672		555			1,900		1,490
Total diversified insurance services revenues		27,648		24,453			78,274		69,272
Total all segments		396,173		343,325			1,153,202		996,792
Other income		14		17			242		122
Total revenues	$	396,187		343,342		$	1,153,444		996,914
		======		======			=======		======

 

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		Unaudited,					Unaudited,
Income (loss), before federal income tax by segment		Quarter ended					Nine months ended
		September 30,					September 30,
(in thousands)		2004		2003			2004		2003

Insurance Operations:
Commercial lines underwriting	$	6,365		70		$	27,414		(15,394)
Personal lines underwriting		(77)		(6,350)			(267)		(11,392)
Underwriting gain (loss), before federal income tax		6,288		(6,280)			27,147		(26,786)
Investments:
Net investment income		29,146		27, 324			87,268		84,103
Net realized gain on investments		1,631		1,029			7,131		8,373
Total investment income, before federal income tax		30,777		28,353			94,399		92,476
Diversified Insurance Services:
Income before federal income tax		4,762		2,861			10,382		7,407
Total all segments		41,827		24,934			131,928		73,097
Interest expense		(3,611)		(4,145)			(11,534)		(13,135)
General corporate expenses		(1,977)		(1,908)			(6,600)		(4,722)
Income before federal income tax	$	36,239		18,881		$	113,794		55,240
		======		======			======		======

11.                    Retirement Plans
As of December 31, 2003, the Company adopted the revised FASB statement of Financial Accounting Standards No. 132R, "Employers' Disclosures about Pensions and Other Postretirement Benefits" (FAS 132R).  FAS 132R addresses disclosure items only and does not address measurement or recognition.  FAS 132R requires additional interim disclosures that were not required by the original statement, all of which are included for all periods presented.

		Retirement Income Plan		Postretirement Plan
		Unaudited,		Unaudited,
		Quarter ended September 30,		Quarter ended September 30,

($ in thousands)		2004		2003		2004		2003
Components of Net Periodic Benefit Cost:
Service cost	$	1,660		1,174		87		66
Interest cost		1,875		1,644		92		95
Expected return on plan assets		(1,672)		(1,281)		-		-
Amortization of unrecognized transition obligation		-		-		-		-
Amortization of unrecognized prior service cost		53		63		(8)		(8)
Amortization of unrecognized net (gain) loss		359		287		-		-
Net periodic cost	$	2,275		1,887		171		153
		=======		=======		=======		=======
Weighted-Average Expense Assumptions for the years ended December 31:
Discount rate		6.25	%	6.75		6.25		6.75
Expected return on plan assets		8.25	%	8.25		-		-
Rate of compensation increase		5.00	%	5.00		5.00		5.00

 

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		Retirement Income Plan		Postretirement Plan
		Unaudited,		Unaudited,
		Nine months ended		Nine months ended
		September 30,		September 30,

($ in thousands)		2004		2003		2004		2003
Components of Net Periodic Benefit Cost:
Service cost	$	4,464		3,780		253		210
Interest cost		5,491		4,892		284		297
Expected return on plan assets		(5,016)		(3,779)		-		-
Amortization of unrecognized transition obligation		-		-		-		-
Amortization of unrecognized prior service cost		159		187		(24)		(24)
Amortization of unrecognized net (gain) loss		931		825		-		-
Net periodic cost	$	6,029		5,905		513		483
		=======		=======		=======		=======
Weighted-Average Expense Assumptions for the years
ended December 31:
Discount rate		6.25	%	6.75		6.25		6.75
Expected return on plan assets		8.25	%	8.25		-		-
Rate of compensation increase		5.00	%	5.00		5.00		5.00

12.                   Federal Income Tax

During Third Quarter 2004, the Company received a favorable ruling from the Internal Revenue Service (IRS) regarding our ability to take interest deductions on debt at the holding company, while also holding municipal bonds at the insurance subsidiary level.  This favorable ruling allowed us to reverse our previously accrued $2.3 million in tax expense, which was slightly offset by an increase in tax expense in Third Quarter 2004 for $0.5 million for potential tax exposure items.  The result of this activity was that the effective tax rate remained flat for Third Quarter 2004 compared to the same period a year ago even though the Company experienced marked improvement in its underwriting results.  Although the IRS ruling in the Third Quarter 2004 also favorably impacted the effective tax rate for the Nine Months 2004, the improved underwriting results for the year more than offset this favorable impact as they resulted in an increase in the effective tax rate for Nine Months 2004 compared to the same period a year ago.

 

13.                   Commitments and Contingencies
Included in other investments is approximately $39.7 million of investments in limited partnerships as of September 30, 2004, and $35.6 million as of December 31, 2003. At September 30, 2004 the Company has an additional limited partnership investment commitment of up to $39.1 million.  There is no certainty that any additional investment will be required. The Company satisfied $0.9 million of our future commitments in the Third Quarter 2004 and $2.3 million for the Nine Months 2004.

14.                   Litigation
Like other companies in the insurance business, the Company is routinely party to litigation.  The Company does not believe that any pending litigation will have a material adverse effect on its financial condition, results of operations, or liquidity.

Three of the Company's subsidiaries, Consumer Health Network Plus, LLC (CHN), Alta Services, LLC (Alta) and Selective Insurance Company of America (SICA), were named as defendants, together with ten other unrelated parties, in Berlin Medical Associates PA, et al. v. CMI New Jersey Operating Corp., et al, a purported class action filed on May 21, 2003, by several non-hospital health care providers in the Superior Court of New Jersey, Law Division - Camden County.

The lawsuit alleges that the defendants breached the terms of their participating provider agreements and/or the terms of New Jersey automobile personal injury protection policies by reducing payments for plaintiffs' services pursuant to provider discount schedules when paying claims and were unjustly enriched.  The complaint does not specify monetary damages.  The defendants, including CHN, Alta, and SICA, are vigorously defending this lawsuit and, together with the other defendants, filed a motion to dismiss.  After a hearing on the motion, the court ordered the plaintiffs to amend their complaint.  In March 2004, the plaintiffs filed an amended complaint, which no longer named Alta as a defendant.  In May 2004, all remaining defendants, including CHN and SICA, moved to dismiss the amended complaint.  In July, they also filed a motion to dismiss the class action allegations.  The court has scheduled argument on both such motions in January 2005.

14

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Given the early stages of the litigation, it is extremely difficult to provide a meaningful estimate or range of any potential loss.  CHN and SICA will continue to vigorously defend the case.  At this time, however, the Company believes that, should the case ultimately be decided unfavorably, it would not have a material adverse effect on the Company's financial condition, results of operations, or liquidity.

 

One of the Company's insurance subsidiaries, Selective Insurance Company of the Southeast (SISE), is one of nine property and casualty insurance company defendants in Howell et all v. State Farm et al., a purported class action filed on May 18, 2004 in the United States District Court for the District of Maryland, Baltimore Division.  The court has not yet ruled on class certification.  The plaintiffs hold Standard Flood Insurance Policies (SFIP) issued by the defendant insurers, who are participants in the Write Your Own (WYO) Program of the Federal Insurance Administration's (FIA) National Flood Insurance Program (NFIP).  The FIA is an agency within the Federal Emergency Management Administration (FEMA).  All claims under SFIPs are 100% reinsured by FEMA.

The suit alleges that the insurers underpaid flood claims arising from Hurricane Isabel in breach of their contractual obligations, fiduciary duties, and the implied covenant of good faith and fair dealing and seeks damages.  The complaint does not specify monetary damages.  The insurers, including SISE, have denied the allegations, noting that they adjusted the claims as fiduciary agents of the U.S. Government in accordance with specific federal guidelines.  The insurers also have filed a motion to dismiss certain of the claims, which the court has not yet decided.

Given the early stages of the litigation, it is extremely difficult to provide a meaningful estimate or range of any potential loss.  FEMA's Office of the General Counsel, however, has advised the defendant carriers that, in its opinion, the claims were adjusted in accordance with the law and that FEMA will indemnify and reimburse the defense costs of the defendant insurers, including SISE.  Consequently, the Company believes that its exposure in the case is minimal.

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FORWARD-LOOKING STATEMENTS
In this Quarterly Report on Form 10-Q, Selective and its management discuss and make statements regarding their intentions, beliefs, current expectations, and projections regarding Selective'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. Selective and its management caution prospective investors that such forward-looking statements are not guarantees of future performance. Risks and uncertainties are inherent in Selective's 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 "Business Risks" in "Item 7 -- Management's Discussion and Analysis of Financial Condition and Results of Operations" in Selective's Annual Report on Form 10-K for 2003 ("Annual Report"). Those portions of the Annual Report are incorporated by reference into this report.  Selective and its management 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.

Factors that could cause our actual results to differ materially from those projected, forecasted or estimated by us in forward-looking statements, include, but are not limited to:

• the frequency and severity of catastrophic events, including, but not limited to, hurricanes, tornadoes, windstorms, earthquakes, hail, severe winter weather, fires, explosions and terrorism;

• adverse economic, market or regulatory conditions;

• the concentration of our business in a number of east coast and midwestern states;

• the adequacy of our loss reserves;

• the cost and availability of reinsurance;

• our ability to collect on reinsurance and the solvency of our reinsurers;

• uncertainties related to insurance premium rate increases and business retention;

• changes in insurance regulations that impact our ability to write and/or cease writing insurance policies in one or more states particularly changes in New Jersey automobile insurance laws and regulations;

• our ability to maintain favorable ratings from A.M. Best, Standard & Poor's, Moody's and Fitch;

• fluctuations in interest rates and the performance of the financial markets;

• our entry into new markets and businesses; and

• other risks and uncertainties we identify in this report and other filings with the Securities and Exchange Commission.

ITEM 2.  Management's Discussion and Analysis of Financial Condition and Results of Operations
The Company is primarily engaged in writing property and casualty insurance. The Company has classified its businesses into three segments, which is at the same level of disaggregation as that reviewed by senior management: Insurance Operations (commercial lines underwriting, personal lines underwriting), Investments, and Diversified Insurance Services (flood insurance, human resource administration outsourcing and managed care). Insurance Operations are evaluated based on underwriting results determined in accordance with Generally Accepted Accounting Principles (GAAP); Investments are evaluated based on after-tax investment returns; and the Diversified Insurance Services are evaluated based on several measures including, but not limited to, results of operations determined in accordance with GAAP. For an additional description of our critical accounting policies and estimates, refer to Item 8. "Financial Statements and Supplementary Data," Note 2 to our consolidated financial statements of our Annual Report on Form 10-K for the year-ended December 31, 2003 and the discussion beginning on page 31 of this report on Form 10-Q.  See Note 10 to the September 30, 2004 unaudited interim consolidated financial statements on pages 11 through 13 of this report on Form 10-Q for revenues and related income before federal income tax for each individual segment discussed below.

The following discussion relates to our results of operations, financial condition, liquidity and capital resources, off-balance sheet arrangements, contractual obligations and contingent liabilities and commitments and critical accounting policies for the interim periods indicated.

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Results of Operations
The following discussion is a comparison of the third quarter ended September 30, 2004 (Third Quarter 2004) and the nine-month period ended September 30, 2004 (Nine Months 2004) to the third quarter ended September 30, 2003 (Third Quarter 2003) and the nine-month period ended September 30, 2003 (Nine Months 2003), respectively.

Our net income increased 92% to $28.3 million, or $0.90 per diluted share, for Third Quarter 2004, compared to $14.7 million, or $0.53 per diluted share, for Third Quarter 2003. For the Nine Months 2004, our net income increased 99% to $84.7 million, or $2.70 per diluted share, compared to $42.5 million, or $1.54 per diluted share, for Nine Months 2003. Included in net income are net realized capital gains, after-tax, of $1.1 million for Third Quarter 2004 and $4.6 million for Nine Months 2004, compared to $0.7 million for Third Quarter 2003 and $5.4 million for Nine Months 2003. These results increased our annualized return on average equity (annualized net income divided by average equity) as of the Nine Months 2004 to 14.3%, which substantially exceeded our 9.5% return on average equity for the full year of 2003.

Insurance Operations

All Lines		Unaudited,					Unaudited,
		Quarter ended					Nine months ended
		September 30,					September 30,
($ in thousands)		2004		2003			2004		2003

GAAP Insurance Operations Results:
Net premiums written	$	356,451		317,513			1,080,963		947,779
		======		======			======		======
Net premiums earned	$	337,074		289,681			978,366		832,867
Less:
Losses and loss expenses incurred		224,842		204,184			644,309		593,027
Net underwriting expenses incurred		104,758		90,863			303,671		262,774
Dividends to policyholders		1,186		914			3,239		3,852
Underwriting profit (loss)	$	6,288		(6,280)			27,147		(26,786)
GAAP Ratios:
Loss and loss expense ratio		66.7	%	70.5			65.9	%	71.2
Underwriting expense ratio		31.0	%	31.4			31.0	%	31.5
Dividends to policyholders ratio		0.4	%	0.3			0.3	%	0.5
Combined ratio		98.1	%	102.2			97.2	%	103.2
		=======		=======			=======		=======

Net premiums written increased by approximately $38.9 million or 12%, to $356.5 million in Third Quarter 2004 and by $133.2 million, or 14%, to $1.1 billion in Nine Months 2004 when compared to the same periods in 2003. Net premiums earned increased by $47.4 million or 16%, to $337.1 million in Third Quarter 2004 and by $145.5 million, or 17%, to $1.0 billion in Nine Months 2004 when compared to the same periods in 2003. These increases were largely attributable to commercial lines renewal premium  price increases, including exposure, that averaged 9.4% in Third Quarter 2004 and 9.5% in the Nine Months 2004 compared to 12.0% in Third Quarter 2003 and 13.2% in the Nine Months 2003.  As expected, these price increases have decelerated over the nine months of 2004 and we expect this trend to continue over the remainder of the year; however, commercial lines earned price increases outpaced loss trends by 2.8 points for the Third Quarter 2004 and 3.9 points for the Nine Months 2004.  Combined ratios and ultimately net income would be unfavorably impacted if earned price increases cease to outpace loss costs trends in the future. However, underwriting improvements resulting in lower loss ratios could partially offset the unfavorable impact of increased loss trends.

Additional factors contributing to growth in net premiums written were: (i) net new business written of $68.9 million for the Third Quarter 2004 compared with $69.2 million in Third Quarter 2003 and $213.4 million in net new business written in the Nine Months 2004 compared with $206.0 million for Nine Months 2003 and (ii) commercial lines year-on-year retention improvement of 1 point to 81% in Third Quarter 2004 and 3 points to 83% in Nine Months 2004 compared with 80% for Third Quarter 2003 and Nine Months 2003.

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The loss and loss expense ratio decreased 3.8 points to 66.7% for Third Quarter 2004 and 5.3 points to 65.9% for Nine Months 2004 when compared with the same periods in 2003. The improvements were primarily due to increased premium rates coupled with underwriting improvements in both our commercial lines and personal lines businesses. Additionally, the loss and loss expense ratio declined due to lower catastrophe losses in the quarter and for the nine months. Weather-related catastrophe losses were  $12.2 million or 3.6 points in Third Quarter 2004 compared with $13.5 million or 4.7 points for Third Quarter 2003. Weather-related catastrophe losses accounted for $19.5 million in incurred losses and added 2.0 points to the loss and loss expense ratio for the Nine Months 2004, compared with $25.3 million and 3.0 points for Nine Months 2003.

The underwriting expense ratio decreased 0.4 points to 31.0% for Third Quarter 2004 and 0.5 points to 31.0% for Nine Months 2004 compared with the same periods last year.  Overall productivity, as measured by fiscal year net premiums written per insurance operations employee, increased approximately 18% to $781,000 compared to $662,000 for the same period a year ago. Contributing to the productivity gains are our strategic initiatives that are designed to either reduce costs and/or increase business, which include: (i) streamlined processing for small commercial lines accounts (One & Done) and (ii) web-based commercial lines and personal lines automated systems. These technology enhancements allow agents to initiate and self-service a portion of our business from their offices. At the end of the Third Quarter 2004, agents were processing approximately 50% of all endorsements through our commercial lines system, while underwriting templates automatically renewed over 30% of commercial lines policies. Additionally, agents are issuing 76% of new automobile policies directly on-line in the personal lines underwriting system.

The combined ratio decreased 4.1 points to 98.1% for Third Quarter 2004 and 6.0 points to 97.2% for Nine Months 2004 compared with the same periods last year.  The decrease in the combined ratio is attributable to the decreases in the loss and loss expense ratio and the underwriting expense ratio discussed above.

Commercial Lines Results

		Unaudited,					Unaudited,
Commercial Lines		Quarter ended					Nine months ended
		September 30,					September 30,
($ in thousands)		2004		2003			2004		2003

GAAP Insurance Operations Results:
Net premiums written	$	297,469		261,397		$	908,298		780,821
		=======		=======			=======		=======
Net premiums earned	$	279,652		235,564		$	809,461		674,911
Less:
Losses and loss expenses incurred		182,957		160,688			520,476		472,270
Net underwriting expenses incurred		89,144		73,892			258,332		214,183
Dividends to policyholders		1,186		914			3,239		3,852
Underwriting profit (loss)	$	6,365		70		$	27,414		(15,394)
GAAP Ratios:
Loss and loss expense ratio		65.4	%	68.2			64.3	%	70.0
Underwriting expense ratio		31.9	%	31.4			31.9	%	31.7
Dividends to policyholders ratio		0.4	%	0.4			0.4	%	0.6
Combined ratio		97.7	%	100.0			96.6	%	102.3
		=======		=======			=======		=======

 

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Commercial Lines underwriting accounted for approximately 84% of net premiums written in Nine Months 2004 compared to 82% in Nine Months 2003. Net premiums written increased $36.1 million, or 14%, to $297.5 million for Third Quarter 2004 and $127.5 million, or 16%, to $908.3 million for Nine Months 2004 compared with the same periods in 2003.  Net premiums earned increased by approximately $44.1 million or 19%, to $279.7 million in Third Quarter 2004 and by $134.6 million, or 20%, to $809.5 million in Nine Months 2004 when compared to the same periods in 2003. These increases were largely attributable to commercial lines renewal premium price increases, including exposure, that averaged 9.4% in Third Quarter 2004 and 9.5% in the Nine Months 2004 compared to 12.0% in Third Quarter 2003 and 13.2% in the Nine Months 2003.  As expected, these price increases have decelerated over the nine months of 2004 and we expect this trend to continue over the remainder of the year; however, commercial lines earned price increases outpaced loss trends by 2.8 points for the Third Quarter 2004 and 3.9 points for the Nine Months 2004.  Combined ratios and ultimately net income would be unfavorably impacted if earned price increases cease to outpace loss costs trends in the future. However, underwriting improvements resulting in lower loss ratios could partially offset the unfavorable impact of increased loss trends.

Additional factors contributing to growth in premiums written were: (i) net new business written of $60.1 million for the Third Quarter 2004 compared with $60.2 million in Third Quarter 2003 and $190.1 million in net new business written in the Nine Months 2004 compared with $180.1 million for Nine Months 2003 and (ii) commercial lines year-on-year retention improvement of 1 point to 81% in Third Quarter 2004 and 3 points to 83% in Nine Months 2004 compared with 80% for Third Quarter 2003 and Nine Months 2003.

The Commercial Lines loss and loss expense ratio decreased 2.8 points to 65.4% for Third Quarter 2004 and 5.7 points to 64.3% for Nine Months 2004 when compared with the same periods in 2003. This improvement reflects fewer large losses that amounted to $3.3 million during the quarter compared to $7.7 million for the same period a year ago in our property line of business as well as the success of our long-term strategy that incorporates higher pricing, continued underwriting enhancements, and heightened loss control efforts - all of which led to a better overall mix of business. The Third Quarter 2004 loss and loss expense ratio included an impact of 3.9 points or $11.1 million of weather-related catastrophe losses compared with 3.7 points in Third Quarter 2003. The Nine Months 2004 loss and loss expense ratio included an impact of 2.1 points or $17.2 million as the result of weather-related catastrophes compared with an impact of 2.8 points or $18.7 million for Nine Months 2003. Partially offsetting improvements in the Commercial Lines loss and loss expense ratio was an increase to our loss reserves of $2.5 million adding 0.9 points to the ratio for Third Quarter 2004 and 0.3 points for Nine Months 2004.  This was due to rating agency downgrades of specific reinsurers, which could adversely affect our ability to collect under reinsurance contracts.

The Commercial Lines underwriting expense ratio increased by 0.5 points to 31.9% for Third Quarter 2004 and 0.2 points to 31.9% for the Nine Months 2004 compared to the same period a year ago. Improvements in productivity were more than offset by increases in profit-based compensation for agents and employees of 2.4 points for Third Quarter 2004 and 0.8 points for Nine Months 2004 compared with the same periods a year ago.

The Commercial Lines combined ratio decreased 2.3 points, to 97.7%, for Third Quarter 2004 and 5.7 points, to 96.6%, for Nine Months 2004 when compared to a combined ratio of 100.0% in Third Quarter 2003 and 102.3% for Nine Months 2003. These favorable results were driven primarily by improvements in the loss and loss expense ratio as discussed above.

                          Commercial Automobile Business
Commercial automobile, which accounted for 28% of commercial lines statutory net premiums earned in Third Quarter 2004 and Nine Months 2004 compared to 28% in Third Quarter and Nine Months 2003 registered another strong quarter, with a statutory loss and loss expense ratio that improved 11.4 points to 52.1% in Third Quarter 2004 and 7.9 points to 55.4% for Nine Months 2004 compared to 63.5% in Third Quarter 2003 and 63.3% for Nine Months 2003. This line has been favorably impacted by price increases, stricter underwriting standards, and the removal of certain classes of business that we determined to be unprofitable.

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                          Workers' Compensation Business
Our workers' compensation business accounted for 24% of commercial lines statutory net premiums earned in Third Quarter and Nine Months 2004 compared to 23% in Third Quarter 2003 and 24% in Nine Months 2003.  Our workers' compensation business posted a statutory loss and loss expense ratio of 85.1% for Third Quarter 2004 and 83.4% for Nine Months 2004, compared with 82.5% for Third Quarter 2003 and 84.9% for Nine Months 2003. Rating agency downgrades of certain reinsurers caused us to reevaluate our ability to collect under certain reinsurance contracts, which resulted in an increase to our loss reserves of $1.3 million to this line of business adding 1.9 points to the statutory loss and loss expense ratio for the Third Quarter 2004 and 0.7 points for the Nine Months 2004.  This line of business also continues to be impacted by unfavorable external factors, including: a regulatory climate that makes it difficult to obtain rate increases in some states; rising medical costs; increasing indemnity benefits; and a decreasing number of workers' compensation-only providers who can provide our agents with alternative markets for this line of business.  Although results for this line of business are not at an acceptable level, the Company continues to maintain an underwriting position for the workers' compensation business that focuses on low-to-medium hazard business.  In addition, our underwriting measures also include requiring job site inspections and increasing the number of our trained loss control representatives from 61 as of Third Quarter 2003 to 65 as of Third Quarter 2004.  Our workers' compensation pricing has increased by 40% since 2000 through a combination of rate increases, credit and dividend reductions, and moving business to higher-priced tiers. However, the rate increases that we have been able to get approved have just kept pace with loss trends.  Since 2000, commercial lines policy counts have risen almost 13% while workers' compensation policy counts have risen  less than 1%.  Given the Company's broad desire for business, it is essential that we write this business, where appropriate, to meet the overall account needs of agents and their clients.  However, when it is appropriate, we encourage our agents to place this line elsewhere.  Currently, less than 5% of the business is unsupported by another commercial line. Our underwriting and pricing actions are ongoing, including a focus on low-to-medium hazard business, limiting growth in policy counts, and a forecasted 11.6% overall price increase in 2004.

                          General Liability Business
Our general liability business, which accounted for 28% of commercial lines statutory net premiums earned in Third Quarter and Nine Months 2004 and 28% in Third Quarter and Nine Months 2003, posted a statutory loss and loss expense ratio of 68.5% for Third Quarter 2004 and 64.2% for Nine Months 2004, compared to 65.3% for Third Quarter 2003 and 66.8% for Nine Months 2003. Rating agency downgrades of certain reinsurers caused us to reevaluate our ability to collect under certain reinsurance contracts, which resulted in an increase to our loss reserves of $1.2 million to this line of business adding 1.5 points to the statutory loss and loss expense ratio for the Third Quarter 2004 and 0.5 points for the Nine Months 2004. Our favorable performance in this line through the Nine Months 2004 reflects our long-term improvement strategy that incorporates higher pricing, heightened loss control efforts and continued underwriting enhancements, which includes contractual underwriting procedures. 

                          Commercial Property Business
Our commercial property business, which accounted for 14% of commercial lines statutory net premiums earned in Third Quarter and Nine Months 2004 as well as Third Quarter and Nine Months 2003, posted a statutory loss and loss expense ratio of 50.8% for Third Quarter 2004 and 48.4% for Nine Months 2004, compared with 61.5% for Third Quarter 2003 and 64.4% for Nine Months 2003. The Third Quarter 2004 loss and loss expense ratio included 26.2 points or $10.2 million of weather-related catastrophe losses compared with 19.6 points or $6.7 million in Third Quarter 2003. The Nine Months 2004 loss and loss expense ratio included 13.0 points or $14.7 million as the result of weather-related catastrophes compared with 16.3 points or $15.4 million for Nine Months 2003.  Improvements in the Third Quarter 2004 were largely due to substantially lower frequency and severity of claims when compared to the same period a year ago.  Additionally, we continue to implement ongoing pricing and underwriting actions to improve results in this line of business, which include: better insurance to value estimates across our book of business; a shift to risks of better construction quality and newer buildings; and an overall focus on low-to-medium hazard property exposures.

 

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Personal Lines Results

		Unaudited,					Unaudited,
Personal Lines		Quarter ended					Nine months ended
		September 30,					September 30,
($ in thousands)		2004		2003			2004		2003

GAAP Insurance Operations Results:
Net premiums written	$	58,982		56,116		$	172,665		166,958
		=======		=======			=======		=======
Net premiums earned	$	57,422		54,117		$	168,905		157,956
Less:
Losses and loss expenses incurred		41,885		43,496			123,833		120,757
Net underwriting expenses incurred		15,614		16,971			45,339		48,591
Underwriting profit (loss)	$	(77)		(6,350)		$	(267)		(11,392)
GAAP Ratios:
Loss and loss expense ratio		72.9	%	80.4			73.3	%	76.4
Underwriting expense ratio		27.2	%	31.3			26.8	%	30.8
Combined ratio		100.1	%	111.7			100.1	%	107.2
		=======		=======			=======		=======

Personal Lines underwriting accounted for approximately 16% of net premiums written for Nine Months 2004 compared to 18% for Nine Months 2003. Personal Lines Underwriting net premiums written increased $2.9 million, or 5%, to $59.0 million for Third Quarter 2004 and $5.7 million, or 3%, to $172.7 million for Nine Months 2004 when compared to the same periods in 2003.  The principal factors contributing to this growth were: (i) personal lines renewal premium price increases averaging 5.6% in Third Quarter 2004 and 5.4% in the Nine Months 2004 compared to 4.7% in Third Quarter 2003 and 4.6% in the Nine Months 2003 and (ii) net new business written of $8.8 million in Third Quarter 2004 compared to $8.9 million in Third Quarter 2003.  Net new business written in Nine Months 2004 was $23.3 million compared with $25.8 million written in Nine Months 2003.

The Personal Lines loss and loss expense ratio decreased 7.5 points, to 72.9%, for Third Quarter 2004 and 3.1 points, to 73.3%, for Nine Months 2004 when compared to the same periods in 2003. The Third Quarter 2004 included 2.0 points of weather-related catastrophe losses compared with 9.0 points in Third Quarter 2003, while the Nine Months 2004 included 1.4 points of weather-related catastrophes compared with 4.2 points for the Nine Months 2003. Additionally, we added $2.0 million to our homeowners' reserves, which partially offset the improvements in the Personal Lines loss and loss expense ratio for the Third Quarter 2004 and Nine Months 2004.  This action resulted from unfavorable trends in claims for groundwater contamination caused by leakage of certain underground heating oil storage tanks in New Jersey.  Increased frequency was triggered, in part, by the state's robust real estate market, leading to an increase in home tank inspections.  Overall claim severity has been low, with average claim payments of $22,000, and there has been almost no similar claim activity in our other operating states.  To address this issue, we began restricting writings of policies with coverage for underground heating oil storage tanks, company-wide, more than 18 months ago, and are reviewing possible coverage changes for existing business.  Further improvements in the Personal Lines loss and loss expense ratio were attributable to price increases. During Third Quarter 2004, we implemented a new rate filing that allows us to use credit scoring for New Jersey auto business, as well as tier changes, which reduce rates by an average of approximately 2.5%.  These enhancements will lead to greater savings for our best risks, while improving the overall book of business.

The Personal Lines underwriting expense ratio showed improvement of 4.1 points, to 27.2%, for Third Quarter 2004 and 4.0 points, to 26.8%, for the Nine Months 2004 compared to the same periods a year ago. These improvements are attributable to increased pricing and a change in deferred acquisition cost amortization estimates, which were revised last year to better match acquisition expenses and earned premiums.

The Personal Lines Underwriting combined ratio decreased 11.6 points, to 100.1%, for Third Quarter 2004 and 7.1 points, to 100.1%, for Nine Months 2004 compared with the same periods last year. The decrease in the combined ratio was primarily attributable to the decreases in the loss and loss expense ratio as well as the underwriting expense ratio discussed above.

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                          Personal Automobile Business
Our personal automobile line of business represented 82% of our personal lines statutory net premiums earned for Third Quarter 2004 and Nine Months 2004, compared with 82% for Third Quarter 2003 and 83% for Nine Months 2003. New Jersey accounted for 75% of our overall personal automobile net premiums written for Third Quarter 2004 and 74% for Nine Months 2004 compared to 72% for Third Quarter 2003, and 73% for Nine Months 2003.The personal automobile statutory loss and loss expense ratio decreased 4.2 points to 69.0% for Third Quarter 2004 and 3.7 points to 70.3% for Nine Months 2004 when compared with the same periods in 2003. This improvement reflects continued progress in our New Jersey personal automobile business resulting from significant actions taken over the last four years, including aggressive pricing initiatives; a redesign of our rating tiers; and an improving political and regulatory climate.   Most recently, to remain competitive for the best risks, we have implemented a new rate filing that allows us to use credit scoring for New Jersey auto business, as well as tier changes to reduce rates by an average of approximately 2.5%. These enhancements will lead to greater savings for our best risks.  Additionally, further improvements in our loss costs can also be attributed to benefits derived as a result of the verbal tort threshold, which has reduced the number and severity of litigated claims, as modified by the New Jersey Automobile Insurance Cost Reduction Act (AICRA).

                          Homeowners Business
Our homeowners line of business, which accounted for 15% of personal lines statutory net premiums earned for Third Quarter 2004 and Nine Months 2004, compared with 15% for Third Quarter 2003 and Nine Months 2003,had a statutory loss and loss expense ratio of 101.6% for Third Quarter 2004 and 86.4% for the Nine Months 2004 compared to 127.6% for Third Quarter 2003 and 97.1% for the Nine Months 2003.Weather-related catastrophes added 10.3 points in the Third Quarter 2004 and 8.1 points for the Nine Months 2004 compared to 54.7 points in the Third Quarter 2003 and 26.1 points for the Nine Months 2003.  In addition, we added $2.0 million to our homeowners' reserves.  This action resulted from unfavorable trends in claims related to groundwater contamination caused by leakage of certain underground heating oil storage tanks in New Jersey, which added 23.0 points to the statutory loss and loss expense ratio for Third Quarter 2004 and 7.9 points for Nine Months 2004. Increased frequency of claims was triggered, in part, by the state's robust real estate market, leading to an increase in home tank inspections.  Overall claim severity has been low, with average claim payments of $22,000, and there has been almost no similar claim activity in our other operating states.  We began restricting writings of policies with coverage for underground heating oil storage tanks, company-wide, more than 18 months ago, and are reviewing possible coverage changes for existing business. Further improvements in this line have been driven by the results of the plan initiated three years ago, which included: (i) double-digit rate increases in six states; (ii) expanding the use of credit history to apply discounts and surcharges for new and renewal business; (iii) continuing the rollout of higher wind and hail deductibles in coastal and selected inland territories; and (iv) expanding the account credit, where appropriate, to encourage agents to write entire accounts.

Reinsurance
The Insurance Subsidiaries follow the customary practice of ceding a portion of their risks and paying to reinsurers a portion of the premiums received under the policies.  This reinsurance program permits greater diversification of business and the ability to offer increased coverage while limiting maximum net losses.  The Insurance Subsidiaries are parties to reinsurance contracts under which certain types of policies are automatically reinsured without the need for approval by the reinsurer of individual risks covered (treaty reinsurance), reinsurance contracts handled on an individual policy or per-risk basis requiring the agreement of the reinsurer as to each risk insured (facultative reinsurance).  Reinsurance does not legally discharge an insurer from its liability for the full face amount of its policies, but does make the reinsurer liable to the insurer to the extent of the reinsurance ceded.

Our Property and Casualty Excess of Loss treaties were successfully renewed effective July 1, 2004, with a modest reduction to the prior year's cession rates.  The ceded premium for the renewed treaties is expected to decrease by approximately $300,000 as compared to the prior treaty year.  However, we are expecting to retain approximately $3.0 million more in losses due to an increase in our co-participation in the first layer of the Casualty Excess of Loss treaty.

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Our Casualty Excess of Loss treaty provides per occurrence coverage of $48.0 million in excess of $2.0 million retention of any casualty loss.  Selective retains 50%, or $1.5 million, of the first $3.0 million excess of $2.0 million layer.  Our co-participation in this layer was 25% in the prior year.  The casualty treaty distinguishes between certified (Terrorism Risk Insurance Act of 2002 (TRIA) events or foreign acts) and non-certified (all other or domestic) terrorism losses. Non-certified terrorism losses are treated like any other losses.  The annual aggregate limit for certified terrorism losses is capped at two times each layer's occurrence limit, or $96.0 million.  Consistent with the 2003 treaty: nuclear, biological and chemical losses are excluded from the casualty excess of loss treaty; however, our Terrorism Excess of Loss treaty covers these exposures once our $15.0 million annual aggregate deductible is met. There are no exclusions for mold or cyber risks in this treaty.

Our Property Excess of Loss treaty provides coverage on each property risk of $18 million in excess of $2.0 million retention.  Under the 2004 treaty, the Company cedes 100% of $18.0 million per risk in excess of the $2.0 million retention.  This is a change from the prior year treaty where the Company retained 25% of the $5.0 million excess of the $5.0 million second layer for a total coverage of $16.7 million per risk in excess of the $2.0 million retention.  As with the casualty treaty, the property treaty distinguishes between certified (TRIA) and non-certified terrorism losses. The treaty provides annual aggregate certified terrorism limits for all risks of $9.0 million for the first layer, $15.0 million for the second layer and $20.0 million for the third layer.  The provision in last year's treaty that limited coverage for TRIA losses for all risks up to $75.0 million in total insured value per location was eliminated with the July 1, 2004 renewal.  Claims arising from non-certified terrorist acts are treated like any other losses.  Consistent with the 2003 contract: nuclear, biological and chemical losses are excluded from the Property Excess of Loss treaty; however, our Terrorism Excess of Loss Treaty covers these exposures once our $15.0 million annual aggregate deductible is met. There are no exclusions for mold or cyber risks in this contract.

Effective January 1, 2004 the New Jersey Unsatisfied Claims Judgment Fund (UCJF) was terminated for all new policies with carriers being responsible for 100% of the coverage, which is capped at $250,000. The New Jersey UCJF was a mandatory reinsurance program, which provided for personal injury protection (PIP) coverage for New Jersey auto policies.  The UCJF assumed unlimited New Jersey PIP losses in excess of $75,000 up to $250,000 per person/per occurrence from January 1, 1991 through December 31, 2003.  A final adjustment to the prior treaty year UCJF premium resulted in a return of premium previously ceded of $2.4 million, which was recorded by the Company in the Third Quarter 2004.

Additionally, during Third Quarter 2004, we exercised the special termination provision, which is effective in October 2004, on two of our reinsurance contracts due to rating agency downgrades of specific reinsurers that could adversely affect our ability to collect under certain reinsurance contracts. We eliminated one carrier and added two highly rated carriers to our Property Catastrophe Excess of Loss and Terrorism Aggregate Excess of Loss treaties. We believe these actions will enhance and strengthen our reinsurance program.

Investments
After-tax investment income increased  9% , to $22.0 million, for Third Quarter 2004, up from $20.2 million for Third Quarter 2003.  The increase reflects an increased asset base as our overall investment portfolio reached $2.7 billion at September 30, 2004, compared with $2.4 billion at September 30, 2003.  The increased asset base was driven by improved underwriting results generating $266.2 million of net operating cash flow and an increase in net securities payable of $56.9 million for Nine Months 2004 compared with $207.5 million of net operating cash flow and an increase in net securities payable of $16.3 million for Nine Months 2003.  Also contributing to the increase on a year-to-date basis were our limited partnership investments.  These investments, which are subject to market fluctuations, added $2.7 million, after-tax, to investment income for Nine Months 2004 compared with $1.7 million for Nine Months 2003.  The overall after-tax portfolio yield was 3.4%, compared with 3.7% for the same period last year, reflecting downward pressure from maturing bonds that are being replaced by bonds with lower interest rates.

We continue to maintain a conservative, diversified investment portfolio, with our debt securities representing 85% of invested assets. Approximately 63% of our debt securities portfolio is rated "AAA." Our portfolio has an average rating of "AA," with less than 1% of the portfolio rated below investment grade.

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At September 30, 2004 our investment portfolio included non-investment grade securities, all of which were in unrealized gain positions, with an amortized cost of $7.2 million, or less than 1% of the portfolio, and a fair value of $7.3 million.  At December 31, 2003, non-investment grade securities in our investment portfolio represented 1% of the portfolio, with an amortized cost of $25.2 million and a fair value of $27.2 million. The non-investment grade securities in unrealized loss positions represented 5% of our total gross unrealized loss at December 31, 2003.  The fair value of these securities was determined by independent pricing services or bid prices provided by various broker dealers.  The Company did not have a material investment in non-traded securities at September 30, 2004, or at December 31, 2003. The Company also regularly reviews the diversification of the investment portfolio compared with an investment grade corporate index.

The Company regularly reviews its entire investment portfolio for declines in value.  If we believe a decline in the value of a particular investment is temporary, we record the decline as an unrealized loss in accumulated other comprehensive income. If we believe the decline is "other than temporary," we write down the carrying value of the investment and record a realized loss in our consolidated statements of income.  Our assessment of a decline in value includes our current judgment as to the financial position and future prospects of the entity that issued the investment security.  Broad changes in the overall market or interest rate environment generally will not lead to a write-down.  If our judgment about an individual security changes in the future we may ultimately record a realized loss after having originally concluded that the decline in value was temporary, which could have a material impact on our net income and financial position of future periods.

In evaluating potential impairment of debt securities, we evaluate certain factors, including but not limited to the following:

• Whether the decline appears to be issuer or industry specific;

• The degree to which an issuer is current or in arrears in making principal and interest payments on the debt securities in question;

• The issuer's current financial condition and its ability to make future scheduled principal and interest payments on a timely basis;

• Buy/hold/sell recommendations published by outside investment advisors and analysts; and

• Relevant rating history, analysis and guidance provided by rating agencies and analysts.

In evaluating potential impairment of equity securities, we evaluate certain factors, including but not limited to the following:

• Whether the decline appears to be issuer or industry specific;

• The relationship of market prices per share to book value per share at the date of acquisition and date of evaluation;

• The price-earnings ratio at the time of acquisition and date of evaluation;

• The financial condition and near-term prospects of the issuer, including any specific events that may influence the issuer's operations;

• The recent income or loss of the issuer;

• The independent auditors' report on the issuer's recent financial statements;

• The dividend policy of the issuer at the date of acquisition and the date of evaluation;

• Any buy/hold/sell recommendations or price projections published by outside investment advisors; and

• Any rating agency announcements.

Realized Gains and Losses
Realized gains and losses are determined on the basis of the amortized cost of specific investments sold or written-down, and are credited or charged to income. Management's decision to sell securities is based on portfolio management considerations, which include security valuations, credit concerns and certain underlying  financial indicators. We also consider sector weightings, tax management, and general economic factors. Decisions to sell securities are made to benefit the overall investment portfolio. We sell securities to enhance portfolio risk/reward and to maximize future investment returns. Liquidity is a consideration when buying or selling securities, but because of the high quality of our investment portfolio, the securities sold have not diminished the overall liquidity of our portfolio.

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The following table presents the Company's net realized gains (losses) during Third Quarter 2004 and Third Quarter 2003 as well as Nine Months 2004 and Nine Months 2003:

	Unaudited,				Unaudited,
	Quarter ended				Nine months ended
	September 30,				September 30,
(in millions)		2004		2003		2004		2003

Held-to-maturity debt securities
Gains	$	0.1		-		0.2		-
Losses		-		-		-		-
Available-for-sale debt securities
Gains		1.0		0.9		4.3		7.6
Losses		(0.4)		(1.8)		(4.9)		(1.8)
Available-for-sale equity securities
Gains		1.8		2.0		9.2		2.7
Losses		(0.9)		(0.1)		(1.7)		(0.1)
Total net realized gains		1.6		1.0		7.1		8.4
Income tax expense		0.5		0.3		2.5		3.0
Net realized gains, net of income tax		1.1		0.7		4.6		5.4
		=======		=======		=======		=======

Realized losses include impairment charges from investment write-downs for other than temporary declines, if any, in the period such determination is made.  There were no impairment charges recorded during Third Quarter 2004, compared with $1.2 million during Third Quarter 2003, nor were there any for Nine Months 2004, compared with $1.2 million for Nine Months 2003. The following tables present the period of time that securities, sold at a loss during these periods, were continuously in an unrealized loss position prior to sale:

		Unaudited,			Unaudited,
Period of time in an unrealized loss position		Quarter ended			Quarter ended
		September 30,			September 30,
(in millions)		2004			2003

		Fair					Fair
		Value on		Realized			Value on		Realized
		Sale Date		Loss			Sale Date		Loss
Debt securities:
0 - 6 months	$	5.0		0.1			17.5		0.3
7 - 12 months		17.5		0.2			-		-
Greater than 12 months		-		-			-		-
Total debt securities		22.5		0.3			17.5		0.3
Equities:
0 - 6 months		3.2		1.0			1.0		0.1
7 - 12 months		-		-			-		-
Greater than 12 months		-		-			-		-
Total equities		3.2		1.0			1.0		0.1
Total	$	25.7		1.3			18.5		0.4
		=======		=======			=======		=======

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		Unaudited,			Unaudited,
Period of time in an unrealized loss position		Nine months ended			Nine months ended
		September 30,			September 30,
(in millions)		2004			2003

		Fair					Fair
		Value on		Realized			Value on		Realized
		Sale Date		Loss			Sale Date		Loss
Debt securities:
0 - 6 months	$	104.7		4.6			22.5		0.3
7 - 12 months		17.5		0.2			-		-
Greater than 12 months		-		-			-		-
Total debt securities		122.2		4.8
							22.5		0.3
Equities:
0 - 6 months		10.0		1.6			1.0		0.1
7 - 12 months		-		-			-		-
Greater than 12 months		-		-			-		-
Total equities		10.0		1.6			1.0		0.1
Total	$	132.2		6.4			23.5		0.4
		=======		=======			=======		=======

These securities were sold despite the fact that they were in a loss position due to a tax management shift from taxable to tax-advantaged securities, which included offsetting some of our realized capital gains, heightened credit risk of the individual security sold, or the need to reduce our exposure to certain issuers, industries or sectors in light of changing economic conditions.

Unrealized losses
The following table summarizes, for all available-for-sale securities in an unrealized loss position at September 30, 2004 and December 31, 2003, the aggregate fair value and gross pre-tax unrealized loss recorded in our accumulated other comprehensive income, by asset class and by length of time those securities have continuously been in an unrealized loss position:

Period of time in unrealized loss position	Unaudited		Unaudited
(in millions)	September 30, 2004		December 31, 2003

				Gross				Gross
		Fair		Unrealized		Fair		Unrealized
		Value		Loss		Value		Loss
Debt securities:
0 - 6 months	$	229.1		1.5		143.2		2.3
7 - 12 months		69.7		1.1		57.3		1.3
Greater than 12 months		16.0		0.2		5.5		0.1
Total debt securities		314.8		2.8		206.0		3.7
Equities:
0 - 6 months		10.6		0.9		1.5		-
7 - 12 months		-		-		-		-
Greater than 12 months		-		-		17.4		0.3
Total equities		10.6		0.9		18.9		0.3
Total	$	325.4		3.7		224.9		4.0
		========		========		========		========

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At September 30, 2004, the Company had four debt securities in an unrealized loss position for more than 12 months, with a fair value of $16.0 million and an unrealized loss of $0.2 million compared to one debt security at December 31, 2003 with a fair value of $5.5 million and an unrealized loss of $0.1 million.  The increase in the number of securities with unrealized losses was mainly due to changes in the interest rate environment. As interest rates rise, the market value of debt securities with fixed interest rates falls. At present, the Company believes these declines to be temporary.

At September 30, 2004, there were no equity securities that have been in an unrealized loss position for more than 12 months.  At December 31, 2003, there were two equity securities in an unrealized loss position for more than 12 months with a fair value of $17.4 million and an unrealized loss of $0.3 million, which have both moved into an unrealized gain position as of September 30, 2004.  Both of these securities had fair values not less than 98% of cost, and these declines were deemed to be temporary.

The following table presents information regarding our available-for-sale debt securities that were in an unrealized loss position at September 30, 2004 by maturity. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

Contractual Maturities:		Amortized		Fair
(in millions)		Cost		Value
One year or less	$	6.5		6.4
Due after one year through five years		156.4		155.2
Due after five years through ten years		146.4		144.9
Due after ten years through fifteen years		8.3		8.3
Total	$	317.6		314.8
		========		========

 

Diversified Insurance Services Segment

	Unaudited,				Unaudited,
	Quarter ended				Nine months ended
	September 30,				September 30,
($ in thousands)		2004		2003		2004		2003

Human resource administration outsourcing
Net revenue	$	13,448		11,137	$	39,809		32,453
Pre-tax profit (loss)		624		(520)		1,335		(408)
Flood Insurance
Net revenue		8,992		7,386		21,952		17,917
Pre-tax profit		3,134		2,400		6,242		4,590
Managed Care
Net revenue		4,536		5,375		14,613		17,412
Pre-tax profit		758		953		2,186		3,015
Other
Net revenue		672		555		1,900		1,490
Pre-tax profit		246		28		619		210
Total
Net revenue		27,648		24,453		78,274		69,272
Pre-tax profit		4,762		2,861		10,382		7,407
Net income		3,115		1,892		6,833		4,972
Return on net revenue		11.3	%	7.7		8.7	%	7.2

The Diversified Insurance Services segment's operations generated $27.6 million of net revenue and $3.1 million of net income for Third Quarter 2004 compared to $24.5 million of net revenue and $1.9 million of net income for Third Quarter 2003. These same businesses generated $78.3 million of net revenue and $6.8 million of net income for Nine Months 2004 compared to $69.3 million of net revenue and $5.0 million of net income for the same period in 2003.  The segment generated a return on net revenue of 11.3% for the Third Quarter 2004 and 8.7% for the Nine Months 2004, compared to 7.7% for the Third Quarter 2003 and 7.2% for the Nine Months 2003.

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Human Resource Administration Outsourcing (HR Outsourcing)
Net revenue for Selective HR Solutions Inc., provider of our human resource administration outsourcing product, was $13.4 million for Third Quarter 2004, up 21% compared with $11.1 million in Third Quarter 2003.  Net revenue for Nine Months 2004 increased 23% to $39.8 million compared to $32.5 million for Nine Months 2003. Pre-tax profit was $0.6 million for Third Quarter 2004, compared to a pre-tax loss of $0.5 million for Third Quarter 2003. For Nine Months 2004, pre-tax profit was $1.3 million compared to a pre-tax loss of $0.4 million for Nine Months 2003. For Nine Months 2004, we added 5,463 new worksite lives, which increased our total worksite lives to 22,759 and led to better economies of scale. The improved results are also reflective of price increases that have been implemented over the past couple of years, which have led to an increase in our HR Outsourcing's average administration fee per worksite employee to $584 for the Nine Months 2004 compared to $550 for the same period a year ago.

Flood Insurance
Premium growth of 18% for Third Quarter 2004 and 20% for Nine Months 2004 compared to the same periods a year ago were driven by enhanced marketing efforts with the personal lines underwriting operation. These efforts resulted in new business of $6.4 million for Third Quarter 2004 compared to $5.6 million for the comparable period last year, and $15.6 million for Nine Months 2004 compared to $14.6 million for the same period last year.  This growth brought our total in-force premium served to approximately $76 million as of September 30, 2004 compared to approximately $63 million as of September 30, 2003. Premium growth has resulted in increased servicing fees of $7.9 million for Third Quarter 2004 compared to $6.5 million for Third Quarter 2003 and $20.6 million for Nine Months 2004 compared to $16.9 million for Nine Months 2003.  Claim administration servicing fees, which are included in net revenues, amounted to $1.1 million for servicing approximately 2,200 claims in Third Quarter 2004 and $1.4 million for servicing approximately 3,100 claims in Nine Months 2004 compared to $0.9 million for servicing approximately 1,600 claims in Third Quarter 2003 and $1.0 million for servicing approximately 1,800 claims in Nine Months 2003. The increase in claim administration servicing fees is primarily attributable to an active hurricane season and its impact on the east coast of the United States. Pre-tax profit increased to $3.1 million for Third Quarter 2004 and $6.2 million for Nine Months 2004 due to the aforementioned growth in servicing fees and claim administration fees for Third Quarter 2004 compared to $2.4 million for Third Quarter 2003 and $4.6 million for Nine Months 2003.

Managed Care
Net revenues decreased 16%, to $4.5 million, for Third Quarter 2004 compared to $5.4 million for Third Quarter 2003, and 16%, to $14.6 million, for Nine Months 2004 compared to $17.4 million for Nine Months 2003.  This reduction reflected the loss of business that occurred primarily as a result of industry consolidation, the elimination of unprofitable accounts, and the loss of one large client to a competitor. Decreased net revenues, partially offset by expense reductions that included a 10% reduction in the managed care workforce, resulted in a corresponding decrease in pre-tax profit by 20% to $0.8 million for Third Quarter 2004 compared to $1.0 million for Third Quarter 2003, and 27% to $2.2 million for Nine Months 2004 compared to $3.0 million for Nine Months 2003.

Federal Income Taxes
Total federal income tax expense increased $3.7 million for Third Quarter 2004, to $7.9 million, and $16.3 million for Nine Months 2004, to $29.1 million, compared with the same periods last year.  Our effective tax rate differs from the federal corporate rate of 35% primarily as a result of tax-advantaged investment income.  The effective tax rate for the Third Quarter 2004 was 22%, flat compared with the same period last year and 26% for Nine Months 2004, compared with 23% for the same period last year.  During Third Quarter 2004, the Company received a favorable ruling from the Internal Revenue Service (IRS) regarding our ability to take interest deductions on debt at the holding company, while also holding municipal bonds at the insurance subsidiary level. This favorable ruling allowed us to reverse our previously accrued $2.3 million in tax expense, which was slightly offset by an increase in tax expense in Third Quarter 2004 of $0.5 million for potential tax exposure items. The result of this activity was that the effective tax rate remained flat for the Third Quarter 2004 compared to the same period a year ago even though the Company experienced marked improvement in its underwriting results. Although the IRS ruling in the Third Quarter 2004 also favorably impacted the effective tax rate for the Nine Months 2004, the improved underwriting results for the year more than offset this favorable impact as they resulted in an increase in the effective tax rate for Nine Months 2004 compared to the same period a year ago.
 

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Financial Condition, Liquidity and Capital Resources
Selective Insurance Group, Inc. (Parent) is an insurance holding company whose principal assets are investments in its subsidiaries. The Parent's primary means of meeting its liquidity requirements is through dividends from these subsidiaries. The payment of dividends from the Insurance Subsidiaries is governed by state regulatory requirements, and these dividends are generally payable only from earned surplus as reported in our statutory Annual Statements as of the preceding December 31. Based upon the 2003 combined statutory financial statements, the Insurance Subsidiaries are permitted to pay the Parent in 2004 ordinary dividends in the aggregate amount of approximately $64.0 million.  Through the Nine Months 2004 and the Nine Months 2003, the Insurance Subsidiaries provided $15.0 million in ordinary dividends of which $5.0 million was provided in Third Quarter 2004 and in Third Quarter 2003. There can be no assurance that the Insurance Subsidiaries will be able to pay additional dividends to the Parent in the future in an amount sufficient to enable the Parent to meet its liquidity requirements.   For additional information regarding regulatory limitations on the payment of dividends by the insurance subsidiaries to the Parent and amounts available for the payment of such dividends, refer to Item 8. "Financial Statements and Supplementary Data", Note 8 to the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2003.  The payment of dividends from Diversified Insurance Services subsidiaries are restricted only by the available operating cash flows of those subsidiaries. Growth in the Diversified Insurance Services segment has increased consolidated cash flows from operations to $7.3 million for Nine Months 2004, compared with $5.8 million for Nine Months 2003 and resulted in dividends to the Parent of $8.4 million for Nine Months 2004 of which $1.3 million was provided in the Third Quarter 2004 compared to $7.9 million for Nine Months 2003 of which $2.0 million was provided in the Third Quarter 2003.

The Parent also generates cash from the sale of its common stock under various stock plans, the dividend reinvestment program, and from investment income, all of which totaled $1.7 million in the Third Quarter 2004 and $7.8 million for the Nine Months 2004, further reducing the Parent's cash requirements. The Parent also currently has available revolving lines of credit amounting to $45.0 million, under which no balances were outstanding as of either September 30, 2004 or December 31, 2003 as well as $24.4 million remaining in an irrevocable trust to provide for the repayment of notes that have maturities over the next 15 months.

The Parent's cash requirements were  $31.4 million in Third Quarter 2004 and $53.7 million for the Nine Months 2004. These cash requirements include principal and interest payments on the Senior Convertible Notes and various notes payable, dividends to stockholders and general operating expenses.  The Company has contractual principal obligations pursuant to various notes payable of $24.0 million in 2004, all of which have been paid as of September 30, 2004.  The 2002 convertible note issuance has a contingent conversion feature that permits the holders of the notes to convert the notes when the price of the Company's common stock has maintained a 20% premium to the conversion price of $29.29, or $35.15, for 20 of 30 consecutive trading days ending on the last trading day of the previous calendar quarter.  On October 26, 2004, in accordance with the available provisions of the Indenture, the Company's Board of Directors voted to permanently waive the stock price contingency provision.  As a result, the Senior Convertible Notes will continue to be convertible into shares of common stock until their maturity, although no such conversions had occurred as of the end of Third Quarter 2004.  As a result of the notes being convertible, 3.9 million shares of common stock were added to our diluted earnings per share calculation in Third Quarter 2004 and Nine Months 2004. See Note 8 to our unaudited interim consolidated financial statements for more information on our senior convertible notes.

Dividends to stockholders are declared and paid at the discretion of the Board of Directors based upon the Company's operating results, financial condition, capital requirements, contractual restrictions and other relevant factors.  The Parent has paid regular quarterly cash dividends to its stockholders for 75 consecutive years.  On October 26, 2004, the Board of Directors approved a 12% increase in the cash dividend on the Company's common stock, to $0.19 per share, payable on December 1, 2004 to stockholders of record on November 15, 2004.   The Parent currently plans to continue to pay quarterly cash dividends. For information regarding restrictions on the Parent's ability to pay dividends to its stockholders, refer to Item 8. "Financial Statements and Supplementary Data", Note 7(b) to the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2003.

On November 4, 2003, the Board of Directors authorized a 2.5 million-share stock repurchase program scheduled to expire on November 30, 2005. The Company acquired approximately 141,000 shares for $4.9 million under that program during the Third Quarter and Nine Months 2004 leaving a remaining authorization of 2.4 million shares.

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In addition to the cash requirements of the Parent, our operating obligations and cash outflows include: claim settlements; commissions; labor costs; premium taxes; general and administrative expenses; investment purchases; and capital expenditures. The Insurance Subsidiaries satisfy their obligations and cash outflows through premium collections, interest and dividend income and maturities or calls of its debt securities.  Generally, the Insurance Subsidiaries do not match securities held to liabilities as part of ongoing asset/liability duration management. The duration of the asset portfolio of 4.3 years is longer than its liabilities of approximately 2.5 years. The current duration of our debt securities, which is within the Company's historical range and a component of our investment philosophy, utilizes a laddered maturity structure so that liquidation of available-for-sale debt securities should not be necessary in the ordinary course of business.  Liquidity is always a consideration when buying or selling securities, but because of the high quality of our investment portfolio, the securities sold have not diminished the overall liquidity of our portfolio. Since cash inflow from premiums is received in advance of cash outflow required to settle claims, we accumulate funds that we invest. At September 30, 2004, we had $2.7 billion in investments compared with $2.4 billion at December 31, 2003.   Additionally, the Insurance Subsidiaries have additional investment commitments for their limited partnership investments of up to $39.1 million; however, there is no certainty that any additional investment will be required.

Net Cash provided by operating activities amounted to $140.2 million in Third Quarter 2004 and $266.2 million in Nine Months 2004 compared to $107.2 million in Third Quarter 2003 and $207.5 million in Nine Months 2003. Included in net cash provided by operating activities were paid loss and loss expenses of $153.0 million in Third Quarter 2004 and $479.9 million in Nine Months 2004 compared to $154.5 million in Third Quarter 2003 and $472.3 million in Nine Months 2003. The increase in net cash from provided by operating activities in 2004 is a result of: (i) price increases, premium growth, and lower loss and loss expense ratios; and (ii) increased investment income from a larger investment portfolio.

Total assets increased by 13%, or $430.7 million, at September 30, 2004 compared to December 31, 2003.  Invested assets increased by $292.3 million due to: (i) net purchases in the amount of $285.3 million primarily funded by $266.2 million of operating cash flow as well as an increase in net securities payable of $56.9 million and (ii) an increase in unrealized gains of $7.1 million.  Increased premium written drove increases in premium receivables of $74.0 million and deferred policy acquisition costs of $22.9 million.  Reinsurance recoverable on unpaid losses and loss expenses increased $28.9 million due to a $14.5 million increase in Flood losses, which are ceded to the Federal Government's National Flood Insurance Program, and a $14.0 million increase in casualty losses. Current federal tax recoverable increased $10.8 million primarily due to a combination of 2003 and 2004 tax payments offset by tax expense associated with improved profitability.

Total liabilities increased 13%, or $346.3 million, at September 30, 2004 compared to December 31, 2003.  Loss and loss expense reserves increased $192.8 million as a result of increased exposure on new and existing policies as well as normal loss trends, which include inflation and rising medical costs. Increased premium writings are primarily responsible for the increase in unearned premium reserves of $110.4 million.  Notes payable decreased $24.0 million due to scheduled payments made in May and August 2004. Deferred federal income tax liability increased $5.8 million from $12.7 million at December 31, 2003 to $18.4 million at September 30, 2004 primarily due to increased unrealized gains in our investment portfolio; the deferred impact of improved underwriting results from the insurance operations; and tax depreciation and amortization.  Other liabilities increased $60.8 million compared to December 31, 2004 primarily due to an increase in securities payable of  $57.7 million for investment trades that had not yet been settled in cash as of September 30, 2004.

Total stockholders' equity increased 11%, or $84.4 million at September 30, 2004 compared to December 31, 2003. Additional paid in capital increased $22.1 million primarily due to activity involving various stock award and purchase plans. Retained earnings increased $70.7 million due to net income of $84.7 million offset by shareholder dividends of $14.0 million. After-tax unrealized gains on our investment portfolio increased as of September 30, 2004 compared to December 31, 2003 accounting for the $4.6 million increase in accumulated other comprehensive income.  As an offset to stockholders' equity, unearned stock compensation and notes receivable from stock sales increased $6.2 million, or 66%, compared to December 31, 2003 due to the issuance of 2004 restricted stock grants. Treasury stock increased $8.1 million due to the repurchase of approximately 141,000 shares for $4.9 million under the Company's common stock repurchase program and the repurchase of 89,000 shares for $3.2 million in relation to various stock plan awards.

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Critical Accounting Policies and Estimates
We have identified the policies below as critical to our business operations and the understanding of our results of operations. For a detailed discussion of the application of these and other accounting policies, see Item 8. "Financial Statements and Supplementary Data," Note 2 to our consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2003.  Our preparation of the unaudited interim consolidated 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.

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 estimates of amounts needed to pay reported and unreported net losses and loss expenses.

When a claim is reported to an insurance subsidiary, its claims personnel establish a "case reserve" for the estimated amount of the ultimate payment.  The amount of the reserve is primarily based upon 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 general insurance reserving practices, as well as the experience and knowledge of the claims person.  Until the claim is resolved, these estimates are revised as deemed necessary by the responsible claims personnel based on subsequent developments and periodic reviews of the cases.

In accordance with industry practice, we maintain, in addition to case reserves, estimates of reserves for losses and loss expenses incurred but not yet reported (IBNR).  We project our estimate of ultimate losses and loss expenses on a quarterly basis.  The difference between: (i) projected ultimate loss and loss expense reserves and (ii) case loss reserves and loss expense reserves thereon are carried as the IBNR reserve.  By using both estimates of reported claims and IBNR determined using generally accepted actuarial reserving techniques, we estimate the ultimate net reserve for losses and loss expenses.  Reserves are reviewed by both internal and independent actuaries for adequacy on a periodic basis.  Beginning in 2003, we began using independent actuaries to certify the adequacy of our reserves. When reviewing reserves, we analyze historical data and estimate the impact of various 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.  This process assumes that past experience, adjusted for the effects of current developments and anticipated trends, is an appropriate basis for predicting future events.  There is no precise method, however, 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.

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The following tables provide case and IBNR reserves for losses, reserves for loss expenses, and reinsurance recoverable on unpaid losses and loss expenses as of September 30, 2004 and December 31, 2003:

As of September 30, 2004

Reinsurance

Loss Reserves

recoverable

on unpaid

Case

IBNR

Loss expense

losses and

($ in thousands)

reserves

reserves

Total

reserves

loss expenses

Net reserves

Commercial automobile	$	90,999		172,905		263,904	$	28,757		5,955		286,706
Workers' compensation		297,624		224,786		522,410		49,738		67,092		505,056
General liability		138,906		276,724		415,630		82,683		25,897		472,416
Commercial property		20,406		5,545		25,951		1,625		797		26,779
Business owners' policy		21,228		20,820		42,048		6,047		4,947		43,148
Bonds		2,041		2,693		4,734		1,666		1,301		5,099
Other		764		2,649		3,413		5		364		3,054
Total commercial lines		571,968		706,122		1,278,090		170,521		106,353		1,342,258
Personal automobile		133,115		99,107		232,222		37,179		69,600		199,801
Homeowners		12,592		5,720		18,312		2,506		3,091		17,727
Other		29,551		8,869		38,420		3,319		34,483		7,256
Total personal lines		175,258		113,696		288,954		43,004		107,174		224,784
Total	$	747,226		819,818		1,567,044	$	213,525		213,527		1,567,042
		=======		=======		=======		=======		=======		=======

 

As of December 31, 2003

Reinsurance

Loss Reserves

recoverable

on unpaid

Case

IBNR

Loss expense

losses and

($ in thousands)

reserves

reserves

Total

reserves

loss expenses

Net reserves

Commercial automobile	$	87,332		150,797		238,129	$	26,673		5,746		259,056
Workers compensation		285,999		182,075		468,074		44,330		64,589		447,815
General liability		120,697		237,821		358,518		72,249		15,516		415,251
Commercial property*		20,080		(857)		19,223		1,590		907		19,906
Business owners' policy		19,703		19,251		38,954		5,543		4,936		39,561
Bonds		1,020		2,881		3,901		1,676		1,357		4,220
Other		1,198		2,168		3,366		6		790		2,582
Total Commercial		536,029		594,136		1,130,165		152,067		93,841		1,188,391
Personal automobile		138,710		95,411		234,121		30,191		69,440		194,872
Homeowners		10,213		5,858		16,071		2,376		3,336		15,111
Other		13,112		7,301		20,413		2,409		17,994		4,828
Total personal lines		162,035		108,570		270,605		34,976		90,770		214,811
Total	$	698,064		702,706		1,400,770	$	187,043		184,611		1,403,202
		=======		=======		=======		=======		=======		=======

*Negative IBNR reserves are due to the inclusion of reserves for recoveries from salvage and subrogation.

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In light of the many uncertainties associated with establishing the estimates and making the assumptions necessary to establish reserve levels, the Company reviews its reserve estimates on a regular basis as described above and makes adjustments in the period that the need for such adjustment is determined. These reviews, from time to time, result in the Company identifying information and trends that cause the Company to increase some reserves and decrease other reserves for prior periods and could lead to the identification of a need for additional increases in loss and loss adjustment expense reserves, which could materially adversely affect the Company's results of operations, equity, business, insurer financial strength and debt ratings. As of September 30, 2004, the Company had accrued $1,567.0 million of net loss and loss expense reserves compared to $1,403.2 million as of December 31, 2003. During the Nine Months 2004, the Company experienced negligible adverse development in its loss and loss expense reserves totaling $3.6 million.  This development was driven by an increase to our loss reserves for doubtful reinsurance recoveries of $2.5 million attributable to the general liability and workers compensation lines of business and reductions in expected bond subrogation recoveries in our bond line of business of $2.0 million. In addition, we had net favorable emergence of $0.9 million from our other lines of business.  For the full year 2003, our general liability line of business, specifically products/completed operations business, demonstrated significant prior year development.  The estimates for prior year losses increased $17.9 million, with $14.0 million in accident years 2000 and prior.  Prior to 2002 we had more exposure to faulty workmanship and materials for both the general contractor and subcontractors and inadequate limits on subcontractors.

As of December 31, 2003, we had established a range of reasonably possible reserves for net claims of approximately $1,331.0 million to $1,487.8 million.  A low and high reasonable IBNR selection was derived primarily by considering the range of indications calculated using standard 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 this range reflects the most likely scenarios, it is possible that the final outcomes may fall above or below these amounts.  This range does not include any provision for potential increases or decreases associated with environmental reserves, as management believes it is not meaningful to calculate a range given the uncertainties associated with environmental claims.  Included in our net carried loss and loss expense reserves were net reserves for environmental claims of $38.5 million at September 30, 2004 and $36.5 million at December 31, 2003.  The ultimate actual liability may be higher or lower than reserves established.  We do not discount to present value that portion of our loss and loss expense reserves expected to be paid in future periods. However, the loss reserves include anticipated recoveries from salvage and subrogation.

As noted above, included in the loss and loss expense reserves on the consolidated balance sheets are amounts for environmental claims, both asbestos and non‑asbestos.  These claims have arisen primarily under older policies containing exclusions for environmental liability which certain courts, in interpreting such exclusions, have determined do not bar such claims.  The emergence of these claims is slow and highly unpredictable.  Since 1986, policies issued by the Insurance Subsidiaries have contained a more expansive exclusion for losses related to environmental claims. Our asbestos and non‑asbestos environmental claims have arisen primarily from exposures in municipal government, small commercial risks and homeowners policies.

IBNR reserve estimation for environmental claims is often difficult because, in addition to other factors, there are significant uncertainties associated with critical assumptions in the estimation process such as average clean-up costs, third-party costs, potentially responsible party shares, allocation of damages, insurer litigation costs, insurer coverage defenses and potential changes to state and federal statutes.  However, management is not aware of any emerging trends that could result in future reserve adjustments except for the unfavorable trends in groundwater contamination claims, resulting in an increase in loss reserves in our homeowners line of business during Third Quarter 2004 caused by certain underground heating oil storage tanks in New Jersey.  Increased frequency of claims has been triggered, in part, by the state's robust real estate market, leading to an increase in home tank inspections.  Overall claim severity has been low, with average claim payments of $22,000, and there has been almost no similar claim activity in our other operating states.  We began restricting writings of policies with coverage for underground heating oil storage tanks, company-wide, more than 18 months ago, and are reviewing possible coverage changes for existing business.    Moreover, normal historically-based actuarial approaches are difficult to apply because relevant history is not available. In addition, while models can be applied, such models can produce significantly different results with small changes in assumptions. As a result, management does not calculate a specific environmental loss range, as it believes it would not be meaningful.

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Premium Revenue
Net premiums written equal direct premiums written, plus assumed premiums less ceded premiums. All three components of net premiums written are recognized in revenue over the period that coverage is provided. The Company had net premiums written of $356.5 million for Third Quarter 2004 and $1.1 billion for Nine Months 2004 compared with $317.5 million for Third Quarter 2003 and $947.8 million for Nine Months 2003. The vast majority of our net premiums written have a coverage period of twelve months. This means we record 1/12 of the net premiums written as earned premium each month, until the full amount is recognized.  When premium rates increase, the effect of those increases would not immediately affect earned premium. Rather, those increases will be recognized ratably over the period of coverage. The Company earned net premiums of  $337.1 million for Third Quarter 2004 and $978.4 million for Nine Months 2004 compared with $289.7 million for Third Quarter 2003 and $832.9 million for Nine Months 2003. Unearned premiums and prepaid reinsurance premiums, which are recorded on the consolidated balance sheets, represent that portion of premiums written that are applicable to the unexpired terms of policies in force. As of September 30, 2004 the Company had unearned premiums of $760.3 million and prepaid reinsurance premiums of $60.6 million compared with unearned premiums of $649.9 million and prepaid reinsurance premiums of $52.8 million as of December 31, 2004.

Deferred Policy Acquisition Costs
Policy acquisition costs, which include commissions, premium taxes, fees, and certain other costs of underwriting policies, are deferred and amortized over the same period in which the related premiums are earned.  Deferred policy acquisition costs are limited to the estimated amounts recoverable after providing for losses and loss expenses that are expected to be incurred, based upon historical and current experience.  Anticipated investment income is considered in determining whether a premium deficiency exists. The Company continually reviews the methods of making such estimates and establishing the deferred costs, and any adjustments therefrom are made in the accounting period in which the adjustment arose. As of September 30, 2004 the Company had deferred policy acquisition costs of $195.3 million compared with $172.4 million as of December 31, 2003.

Adoption of Accounting Pronouncements
In December 2003, the Financial Accounting Standards Board (FASB) issued revised FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46R), which is a revised interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements". FIN 46R is required to be applied starting with fiscal years beginning after December 15, 2003.  FIN 46R requires the consolidation of a variable interest entity (VIE) by an enterprise if that enterprise either absorbs a majority of the VIE's expected losses or receives a majority of the VIE's expected residual returns as a result of ownership, contractual or other financial interests in the VIE.  Prior to FIN 46R, entities were generally consolidated by an enterprise that had a controlling financial interest through ownership of a majority voting interest in the entity. FIN 46R defines a VIE as an entity in which equity investors do not have the characteristics of a controlling financial interest nor do they have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support.  The Company has no interests in VIEs or potential VIEs commonly referred to as special-purpose entities and as such, the adoption of this revised interpretation on January 1, 2004 has had no effect on the Company's results of operations or financial condition.

In March 2004, the Emerging Issues Task Force (EITF or Task Force) of the FASB reached a consensus on Issue No. 03-01, "The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments."   This consensus provides recognition and measurement guidance for determining when an investment is other-than-temporarily impaired, specifically when the investor has the ability and intent to hold an investment until recovery.  When originally issued this guidance was to be effective for reporting periods beginning after June 15, 2004. In September 2004, the FASB decided to delay the effective date of the requirement to record impairment losses caused by the effect of increases in interest rates or sector spreads on debt securities subject to paragraph 16 of EITF 03-01 and to exclude minor impairments from the requirement as well. Along with the delay, the scope of the Task Force's consensus, which was limited to certain debt securities, now includes all types of securities within the scope of EITF 03-01. The disclosure requirements as presently prescribed by EITF 03-01 and SEC Staff Accounting Bulletin No. 59, "Accounting for Noncurrent Marketable Equity Securities" remain in effect for public companies until new guidance is issued and becomes effective. Until such guidance is determined, the Company is unable to determine the impact any such guidance would have on its results of operations or financial condition.  The adoption of the proposed accounting literature could cause the Company: (i) to recognize impairment losses in the Consolidated Statements of Income that are not recognized currently; (ii) to recognize impairment losses, especially those due to increases in interest rates, in earlier periods; and (iii) alter its recognition of investment income on impaired securities.  Such an impact will likely increase earnings volatility in future periods.  However, since fluctuations in the fair value for available-for-sale-securities are already recorded in Accumulated Other Comprehensive Income, adoption of this standard in any form is not expected to have a significant impact on stockholders' equity.

 

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Further information on the Company's investments is provided in Item 2. "Management's Discussion and Analysis of Financial Condition and Results of Operations," on this Form 10-Q beginning on page 28 of this Form 10-Q.

On October 13, 2004, the FASB concluded that the Proposed Statement 123R, "Share-Based Payment" (FAS 123R), which would require all companies to measure compensation expense in the income statement for all share-based payments (including employee stock options) at fair value, would be effective for public companies for interim or annual periods beginning after June 15, 2005. Retroactive application of the requirements of FAS 123 (not FAS 123R) to the beginning of the fiscal year that includes the effective date would be permitted, but not required.  The Proposed Statement 123R is expected to be finalized either later this year or in early 2005.  The pro forma results presented in Note 7 to the Consolidated Financial Statements on this Form 10Q, page 10, are in accordance with the required disclosures under FAS 148, and should provide for a reasonable approximation of the impact the Proposed Statement 123R will have on the Company.

Also on October 13, 2004, the FASB ratified EITF Issue No. 04-8, "The Effect of Contingently Convertible Instruments on Diluted Earnings per Share."  As of September 30, 2004, the Company treated its Senior Convertible Notes in accordance with the FASB Statements of Financial Accounting Standards No. 128 "Earnings per share." Accordingly, the potentially convertible 3.9 million shares have been included in diluted earnings per share calculation for Third Quarter and Nine Months 2004 based on the fact that the conditions of conversion were met for the quarters ending March 31, 2004 (First Quarter 2004) and June 30, 2004 (Second Quarter 2004), but excluded from the calculation for all previous periods for which the contingency criteria was not met dating back to the date of issuance in September 2002.  However, on October 26, 2004, in accordance with the available provisions of the Indenture, the Company's Board of Directors voted to permanently waive the stock price contingency provision and as a result the potentially convertible shares will continue to be included in the diluted earnings per share calculation until the bonds reach maturity.  EITF Issue No. 04-8, which will require that convertible shares be included in the diluted earnings per share calculation upon issuance of the instrument, is expected to become effective for periods ending after December 15, 2004 and must be applied by restating all periods during which the instrument was outstanding regardless of whether the market price contingency was met or not. The implementation of this guidance is not anticipated to have any impact on our 2004 diluted earnings per share calculation, but it is likely to result in the restatement of our 2003 and 2002 diluted earnings per share calculations for the inclusion of the aforementioned shares as well as the addition of related interest expense to the calculation.

Off-Balance Sheet Arrangements, Contractual Obligations and Contingent Liabilities and Commitments
At September 30, 2004 and December 31, 2003, the Company did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or for other contractually narrow or limited purposes.  As such, the Company is not exposed to any financing, liquidity, market or credit risk that could arise if the Company had engaged in such relationships.

Our future cash payments associated with contractual obligations pursuant to operating leases for office space and equipment, senior convertible notes, convertible subordinated debentures and notes payable have not materially changed since December 31, 2003.  We expect to have the capacity to repay and/or refinance these obligations as they come due.

The senior convertible notes have a contingent conversion feature that allows conversion of the notes when the stock price has maintained a 20% premium to the conversion price of $29.29, or $35.15, for 20 of 30 consecutive trading days ending on the last trading day of such calendar quarter.  As was previously reported this contingency had been met as of the first and second quarters of 2004 and as such the holders were able to surrender notes for conversion into shares of common stock, or cash, at the Company's option on any business day in second and third quarters of 2004. As of the end of the Third Quarter 2004, no such conversions had occurred. The conditions of conversion were not met at the end of the Third Quarter 2004.  However, on October 26, 2004, in accordance with the available provisions of the Indenture, the Company's Board of Directors voted to permanently waive the stock price contingency provision. As a result, the Convertible Notes will continue to be convertible into shares of common stock until their maturity. As a result of the notes being convertible during the third quarter, 3.9 million shares have been added to our diluted earnings per share calculation for Third Quarter 2004 and the Nine Months 2004. We expect to have the capacity to repay and/or refinance all of these obligations as they come due.

 

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We currently have available revolving lines of credit amounting to $45.0 million, under which no balances are outstanding as of either September 30, 2004 or December 31, 2003. We have issued no guarantees on behalf of others and have no trading activities involving non-exchange traded contracts accounted for at fair value. We have no material transactions with related parties other than those disclosed in Item 8. "Financial Statements and Supplementary Data", Note 17 to our consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2003.

ITEM 3.  Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes in the information about market risk set forth in our Annual Report on Form 10-K for the year-ended December 31, 2003.

ITEM 4.  Control and Procedures
The Company, under the supervision and with the participation of Company's management, including its Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act) as of the end of the period covered by this report.  Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective as of the end of the period covered by this report.

No change in the Company's internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act) occurred during the Third Quarter 2004 that materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

PART II  Other Information

Item 1.             Legal Proceedings
Like other companies in the insurance business, the Company is routinely party to litigation.  The Company does not believe that any pending litigation will have a material adverse effect on its financial condition, results of operations, or liquidity.

Three of the Company's subsidiaries, Consumer Health Network Plus, LLC (CHN), Alta Services, LLC (Alta) and Selective Insurance Company of America (SICA), were named as defendants, together with ten other unrelated parties, in Berlin Medical Associates PA, et al. v. CMI New Jersey Operating Corp., et al, a purported class action filed on May 21, 2003, by several non-hospital health care providers in the Superior Court of New Jersey, Law Division - Camden County.

The lawsuit alleges that the defendants breached the terms of their participating provider agreements and/or the terms of New Jersey automobile personal injury protection policies by reducing payments for plaintiffs' services pursuant to provider discount schedules when paying claims and were unjustly enriched.  The complaint does not specify monetary damages.  The defendants, including CHN, Alta, and SICA, are vigorously defending this lawsuit and, together with the other defendants, filed a motion to dismiss.  After a hearing on the motion, the court ordered the plaintiffs to amend their complaint.  In March 2004, the plaintiffs filed an amended complaint, which no longer named Alta as a defendant.  In May 2004, all remaining defendants, including CHN and SICA, moved to dismiss the amended complaint.  In July, they also filed a motion to dismiss the class action allegations.  The court has scheduled arguments on both such motions in January 2005.

Given the early stages of the litigation, it is extremely difficult to provide a meaningful estimate or range of any potential loss.  CHN and SICA will continue to vigorously defend the case.  At this time, however, the Company believes that, should the case ultimately be decided unfavorably, it would not have a material adverse effect on the Company's financial condition, results of operations, or liquidity.

One of the Company's insurance subsidiaries, Selective Insurance Company of the Southeast (SISE), is one of nine property and casualty insurance company defendants in Howell et all v. State Farm et al., a purported class action filed on May 18, 2004 in the United States District Court for the District of Maryland, Baltimore Division.  The court has not yet ruled on class certification.  The plaintiffs hold Standard Flood Insurance Policies (SFIP) issued by the defendant insurers, who are participants in the Write Your Own (WYO) Program of the Federal Insurance Administration's (FIA) National Flood Insurance Program ("NFIP").  The FIA is an agency within the Federal Emergency Management Administration (FEMA).  All claims under SFIPs are 100% reinsured by FEMA.

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The suit alleges that the insurers underpaid flood claims arising from Hurricane Isabel in breach of their contractual obligations, fiduciary duties, and the implied covenant of good faith and fair dealing and seeks damages.  The complaint does not specify monetary damages.  The insurers, including SISE, have denied the allegations, noting that they adjusted the claims as fiduciary agents of the U.S. Government in accordance with specific federal guidelines.  The insurers also have filed a motion to dismiss certain of the claims, which the court has not yet decided.

Given the early stages of the litigation, it is extremely difficult to provide a meaningful estimate or range of any potential loss.  FEMA's Office of the General Counsel, however, has advised the defendant carriers that, in its opinion, the claims were adjusted in accordance with the law and that FEMA will indemnify and reimburse the defense costs of the defendant insurers, including SISE.  Consequently, the Company believes that its exposure in the case is minimal. 

Item 2.        Unregistered Sales of Equity Securities and Use of Proceeds

(a)               Recent Sales of Unregistered Securities: None

(b)               Use of Proceeds: None

(c)               Purchases of Equity Securities by Issuer and Affiliated Purchases:

 

The table below sets forth information regarding the purchase by the Company of our common stock during the periods indicated:

						Total Number of		Maximum Number
						Shares Purchased		of  Shares that May Yet
		Total Number of		Average Price Paid		as Part of Publicly		Be Purchased Under the
Period		Shares Purchased1		Per Share		Announced Plans		Announced Plans
						or Programs		or Programs2
July 1-31, 2004		-		-		-		2,500,000
August 1-31, 2004		147,557		35.04		141,199		2,358,801
September 1-30, 2004		1,063		36.29		-		2,358,801
Total		148,620	$	35.05		141,199

1    The Third Quarter included 3,161 shares purchased from employees in connection with the vesting of restricted stock.  The Company also purchased 4,260 shares from employees in connection with stock option exercises.    These shares were not purchased as part of the publicly announced program.  The shares were purchased at the closing price of the Company's common stock on the dates of the purchases.

2    On November 4, 2003 the Board of Directors authorized a 2.5 million-share repurchase program scheduled to expire on November 30, 2005, which was publicly announced on November 5, 2003. In August of 2004, the Company repurchased 141,199 shares.

Item 3.             Defaults Upon Senior Securities - None

Item 4.             Submission of Matters to a Vote of Security Holders - None

Item 5.             Other Information -

Following the end of the Third Quarter 2004, the New York Attorney General ("NYAG") filed a civil complaint against Marsh, Inc., an insurance brokerage firm, and its parent, Marsh & McLennan Companies, Inc. (collectively, "Marsh"), for alleged bid rigging and price fixing.  The NYAG has also questioned the business practices of several of our national competitors and is investigating these issues further.  The NYAG has challenged Marsh for advising clients and receiving fees as an insurance broker while simultaneously receiving compensation from insurance companies for the placement of the clients' business under marketing services agreements that were undisclosed to the clients.  Regulators in other states subsequently announced investigations and other reviews of the insurance industry.  These reviews are ongoing and the Company cannot estimate the scope or breadth of the issues that may be investigated, their results, or timeframe in which the reviews might be completed.  The Company also cannot predict the impact, if any, that these investigations and reviews may have on its business or the property and casualty insurance industry generally. 

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Since its inception in 1926, the Company has distributed almost 100% of its insurance products through non-exclusive independent insurance agents.  The Company has agency agreements with the independent insurance agents it appoints.  By law and Company practice, the independent insurance agents must be licensed by the states in which they do business.  Independent agents are not obligated to promote the Company's insurance products and they also may and do sell our competitors' insurance products.  The Company does not distribute its products through insurance brokerages, such as Marsh, nor does it use marketing services agreements.  Through its agency agreements, the Company also restricts the ability of its appointed independent agents to receive compensation from other sources for writing business with the Company. 

The Company, pursuant to its agency agreements, pays independent agents commissions for the business they write with the Company.  The general commission structure paid on each policy is disclosed as part of the Company's public rate filings made in the states where we write insurance business.  The Company also pays additional commission based on the annual underwriting results and growth of an agent's entire book of business -not specific individual accounts - with the Company.

Item 6.             Exhibits and Reports on Form 8-K

(a)               Exhibits:

The exhibits required by Item 601 of Regulation S-K are listed in the Exhibit Index, which immediately precedes the exhibits filed with this Form 10-Q.

(b)               Reports on Form 8-K:

On July 27, 2004, the Company furnished a report on Form 8-K under Item 12 thereof with respect to the issuance of a press release announcing its financial results for the quarter and year ended June 30, 2004.  The Company's press release dated July 27, 2004 was attached as Exhibit 99.1.

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.


SELECTIVE INSURANCE GROUP, INC.
Registrant

Date: November 5, 2004	By:  /s/ Gregory E. Murphy
	Gregory E. Murphy
	Chairman, President and Chief Executive Officer
Date: November 5, 2004	By:  /s/ Dale A. Thatcher
	Dale A. Thatcher
	Executive Vice President of Finance, Chief Financial Officer and Treasurer