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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934 (Fee required)
For the fiscal year ended...December 31, 2002
OR
| | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (No fee required)
For the transition period from ____________to____________.
Commission file number 0-8641
SELECTIVE INSURANCE GROUP, INC.
(Exact name of registrant as specified in its charter)
New Jersey 22-2168890
(State or Other Jurisdiction of Incorporation or Organization) (IRS Employer Identification No.)
40 Wantage Avenue, Branchville, New Jersey 07890
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (973) 948-3000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Title of Each Class:
1.6155% Senior Convertible Notes due September 24, 2032
8.75% Convertible Subordinated Debentures due January 1, 2008
(Title of class)
Common Stock, par value $2 per share
(Title of class)
Preferred Share Purchase Rights
(Title of class)
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 and (2) has been subject to such filing requirements for
the past 90 days.
|X| Yes | | No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
|X|
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act)
|X| Yes | | No
State the aggregate market value of the voting stock held by non-affiliates of
the registrant based on last sale price on the Nasdaq National Market on June
28, 2002.
Common Stock, par value $2 per share: $710,648,134
Indicate the number of shares outstanding of each of the registrant's
classes of common stock as of February 18, 2003.
Common Stock, par value $2 per share: 26,819,386
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement for the 2003 Annual
Meeting of Stockholders are incorporated by reference to Part III of this
report.
Portions of the registrant's 2002 Annual Report to Shareholders are incorporated
by reference in Parts I and II of this report.
FORWARD-LOOKING STATEMENTS
Some of the statements in this report, including information incorporated by
reference contain forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934. These statements relate to our intentions, beliefs, projections,
estimations or forecasts of future events or our future financial performance
and involve known and unknown risks, uncertainties and other factors that may
cause our or our industry's actual results, levels of activity, or performance
to be materially different from those expressed or implied by the
forward-looking statements. In some cases, you can identify forward-looking
statements by use of words such as "may," "will," "could," "would," "should,"
"expect," "plan," "anticipate," "target," "project," "intend," "believe,"
"estimate," "predict," "potential," "pro forma," "seek," "likely" or "continue"
or other comparable terminology. These statements are only predictions and we
can give no assurance that such expectations will prove to be correct.
Factors which 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
hurricanes, tornadoes, windstorms, earthquakes, hail, severe winter
weather, fires, explosions and terrorism;
- adverse economic, market or regulatory conditions;
- our concentration 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 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 filings with the
Securities and Exchange Commission, including but not limited to our
Annual Report on Form 10-K.
We undertake no obligation, other than as may be required under the federal
securities laws, to publicly update or revise any forward-looking statements,
whether as a result of new information, future events or otherwise. We do not
assume responsibility for the accuracy and completeness of the forward-looking
statements. All of the forward-looking statements in this report are qualified
by reference to the factors discussed under "Risk Factors" beginning on page 16
of this report. These risk factors may not be exhaustive. We operate in a
continually changing business environment, and new risk factors emerge from time
to time. We cannot predict such new risk factors, nor can we assess the impact,
if any, of such new risk factors on our businesses or the extent to which any
factor or combination of factors may cause actual results to differ materially
from those expressed or implied in any forward-looking statements in this
report. In light of these risks, uncertainties and assumptions, the
forward-looking events discussed in this report might not occur.
For these statements, we claim the protection of the safe harbor for
forward-looking statements contained in Section 27A of the Securities Act.
1
PART I
ITEM 1. BUSINESS.
GENERAL
Selective Insurance Group, Inc. (Parent) is a holding company that was
established in 1977. The Parent, through its subsidiaries, (collectively,
"Selective" or the "Company") offers property and casualty insurance products
and diversified insurance services products. The Company maintains a website at
www.selective.com. Our annual report on Form 10-K, quarterly reports on Form
10-Q and current reports on Form 8-K, and amendments to those reports, filed or
furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of
1934, are available free of charge on our website as soon as practicable after
electronic filing of such material with, or furnishing it to, the Securities and
Exchange Commission.
We offer commercial and personal insurance products through Selective Insurance
Company of America (SICA), Selective Way Insurance Company (SWIC), Selective
Insurance Company of the Southeast (SISE), Selective Insurance Company of South
Carolina (SISC) and Selective Insurance Company of New York (SINY)
(collectively, the Insurance Subsidiaries). Our Diversified Insurance Services'
products are sold by: Alta Services LLC (Alta), a managed care company that
provides medical claims handling services to Selective and other insurers,
Consumer Health Network Plus, LLC, (CHN) a New Jersey-based preferred provider
organization (PPO), Selective HR Solutions, Inc., a Florida-based human resource
administration outsourcing organization (HR outsourcing) and Flood Connect, a
provider of flood insurance and claim services to homeowners and commercial
customers.
Our insurance products are sold through approximately 800 independent agents in
20 northeastern, midatlantic, southeastern and midwestern states. We offer a
broad range of commercial insurance and alternative risk management products, to
small and medium sized businesses and government entities. Our commercial
insurance products represent over 80% of net premiums written. We also provide
personal insurance products to individuals and families which represent
approximately 20% of net premiums written. We write business in the following
states: Connecticut, Delaware, Georgia, Illinois, Indiana, Iowa, Kentucky,
Maryland, Michigan, Minnesota, Missouri, New Jersey, New York, North Carolina,
Ohio, Pennsylvania, Rhode Island, South Carolina, Virginia and Wisconsin.
In an effort to diversify our business and develop fee-based revenues, we also
offer diversified insurance services which include: flood business serviced by
us for the National Flood Insurance Program which is 100% ceded to the federal
government, managed care services and HR outsourcing products and services.
In March 2002, CHN acquired Northeast Health Direct, LLC (NHD), a
16,000-location network that operates in Connecticut and certain regions within
the states of Massachusetts, Vermont, and New Hampshire. We acquired NHD for
$3.2 million including certain acquisition and financial performance related
costs during 2002. We may be further required to pay additional consideration of
approximately $1 million over the next two years based on certain criteria
related to future financial performance of the business.
In May 2002, the Company sold its wholly-owned subsidiary, PDA Software, Inc.,
an insurance software development and program administration company.
The Company has classified its business into three segments: Insurance
Operations (commercial lines underwriting and personal lines underwriting),
Investments, and Diversified Insurance Services (managed care, flood insurance
and HR outsourcing). Prior year software development and program administration
amounts have been reclassified as discontinued operations. For a discussion of,
and information about, our segments and discontinued operations, see Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and Item 8. "Financial Statements and Supplementary Data", Note 9 to
the consolidated financial statements, "Segment Information", and Note 12 to the
consolidated financial statements, "Discontinued Operations".
INSURANCE OPERATIONS SEGMENT
The Insurance Operations segment focuses on the sale and servicing of property
and casualty insurance products. Our principal strategy is to generate
profitable premium growth based on superior customer service and on strong
franchise value with our independent agents. In addition, we strive to maintain
and build on Selective's position as a market leader among regional property and
casualty insurers.
The segment is managed by type of business: commercial lines underwriting and
personal lines underwriting. Lines of business covered by the commercial lines
underwriting segment include: fire/inland marine, workers' compensation, general
liability, automobile, business owners' policy and bonds. The personal lines
underwriting lines of business include homeowners' and automobile insurance
coverages. In addition to lines of business, we also analyze the results of this
segment by regional office, agent and strategic business unit.
2
For the ten years ended December 31, 2002, our average statutory loss and loss
expense ratio was 72.1%, which outperformed the property and casualty industry's
average ratio of 79.5%, as reported by A.M. Best Company (A.M. Best). (See
"glossary of terms" on page 20 of our 2002 Annual Report to Shareholders,
incorporated by reference herein.) We attribute our performance to the franchise
value we have created with our independent agency force, expertise in
underwriting property and casualty insurance risks, and our penetration of high
quality markets in the northeastern, southeastern, midatlantic and midwestern
states. For the ten years ended December 31, 2002, our average statutory
underwriting expense ratio was 31.5% compared with 26.8% for the property and
casualty industry. Our historical statutory underwriting expense ratio is higher
than the industry average primarily due to the following: (i) the industry
average underwriting expense ratio reflects the inclusion of direct writers of
insurance, companies that do not use independent agents, which generally have
lower distribution costs than we do, and (ii) over 80% of our net premiums
written are in the more expensive commercial lines business compared with the
industry at 50%, as reported by A.M. Best. Our underwriting expense ratio is
comparable with that of other commercial lines carriers. Our average statutory
combined ratio of 104.4% over the last ten year period outperformed the property
and casualty industry average statutory combined ratio over that period of
107.4%.
The table below sets forth a comparison of certain Company and industry
statutory ratios:
Simple
Average of
All Periods
Presented 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993
--------- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
CERTAIN COMPANY RATIOS: (1)
Loss 61.5% 61.4 64.1 66.4 65.0 59.9 56.8 60.6 60.4 60.6 60.3
Loss expense 10.6 10.9 10.2 9.3 9.4 10.3 11.4 10.8 10.8 11.1 11.5
Underwriting expense 31.5 30.3 31.5 31.7 30.5 32.2 31.2 30.8 29.4 31.6 35.5
Policyholders' dividends 0.8 0.6 0.9 0.9 0.8 0.7 0.7 0.7 1.0 1.0 1.2
Statutory combined ratio (2)(3) 104.4 103.2 106.7 108.2 105.7 103.2 100.1 102.9 101.6 104.3 108.5
Growth (decline) in net
premiums written
6.8 13.8 10.5 3.6 8.1 4.4 3.7 (8.6) 8.5 14.8 8.9
CERTAIN INDUSTRY RATIOS: (1)(4)
Loss 66.6 67.3 75.4 68.3 65.3 63.1 60.3 65.4 65.7 68.1 66.7
Loss expense 12.9 12.3 13.1 12.9 13.3 13.1 12.5 12.9 13.2 13.0 12.8
Underwriting expense 26.8 25.5 26.7 27.6 28.0 27.7 27.1 26.4 26.3 26.0 26.3
Policyholders' dividends 1.2 0.6 0.8 1.3 1.2 1.7 1.7 1.1 1.4 1.3 1.1
Statutory combined ratio (3) 107.4 105.7 116.0 110.1 107.8 105.6 101.6 105.8 106.4 108.5 106.9
Growth in net premiums written 5.0 14.2 8.1 4.4 1.9 1.8 2.9 3.4 3.6 3.8 6.2
COMPANY FAVORABLE
(UNFAVORABLE) TO INDUSTRY:
Statutory combined ratio 3.0 2.5 9.3 1.9 2.1 2.4 1.5 2.9 4.8 4.2 (1.6)
Growth (decline) in net
premiums written 1.8 (0.4) 2.4 (0.8) 6.2 2.6 0.8 (12.0) 4.9 11.0 2.7
Note: Some amounts may not foot due to rounding.
(1) The ratios and percentages are based upon Statutory Accounting Principles
(SAP) prescribed or permitted by state insurance departments in the states
in which each company is domiciled. Effective January 1, 2001, the Company
adopted a codified set of statutory accounting principles, as required by
the National Association of Insurance Commissioners. These principles were
not retroactively applied, but would not have had a material effect on the
ratios presented above. These principles may differ from accounting
principles generally accepted in the United States of America (GAAP). For
definitions of these ratios, please refer to the section entitled
"Glossary of Terms" on page 20 of our 2002 Annual Report to Shareholders
incorporated by reference herein.
(2) In 1993, this ratio includes a one-time restructuring charge of $9
million, which increased the ratio by 1.5 points.
(3) A statutory combined ratio under 100% generally indicates an underwriting
profit and a statutory combined ratio over 100% generally indicates an
underwriting loss. Because of investment income, a company may still be
profitable although its statutory combined ratio exceeds 100%.
(4) Source: A.M. Best. The industry ratios for 2002 have been estimated by
A.M. Best.
3
INSURANCE OPERATIONS RESULTS
Year Ended December 31,
(in thousands) 2002 2001 2000
----------- -------- --------
GAAP INSURANCE OPERATIONS RESULTS
Net premiums written $ 1,053,487 925,420 843,604
=========== ======== ========
Net premiums earned 988,268 883,048 821,265
Losses and loss expenses incurred 714,580 655,884 614,066
Net underwriting expenses incurred 306,669 279,527 264,651
Policyholders' dividends 5,762 8,275 7,670
----------- -------- --------
Underwriting loss $ (38,743) (60,638) (65,122)
=========== ======== ========
GAAP RATIOS:
Losses and loss expense ratio 72.3% 74.3% 74.8%
Underwriting expense ratio 31.0% 31.7% 32.2%
Policyholders' dividends ratio 0.6% 0.9% 0.9%
----------- -------- --------
Combined ratio 103.9% 106.9% 107.9%
=========== ======== ========
For the year ended December 31, 2002, we continued to outperform the industry
with a statutory combined ratio of 103.2%, compared with an A.M. Best estimate
for the industry of 105.7%. On a GAAP basis, the Company's combined ratio was
103.9% in 2002, compared with 106.9% in 2001 and 107.9% in 2000. The decrease
for 2002 when compared with 2001 was caused predominantly by increases in
commercial lines pricing which led to a decrease in the commercial lines
combined ratio to 102.7% in 2002 from 104.9% in 2001. The personal lines
combined ratio decreased to 108.8% in 2002 from 113.5% in 2001.
The primary difference between the statutory combined ratio and the combined
ratio (GAAP basis) is that policy acquisition costs and other underwriting
expenses are divided by net premiums written on a statutory basis, while on a
GAAP basis the expenses are divided by net premiums earned. In addition, on a
GAAP basis policy acquisition costs are deferred and amortized over the life of
the underlying policies.
The decrease in the 2001 overall combined ratio when compared with 2000 was
caused by a decrease in the commercial lines combined ratio to 104.9% from
107.4%, partially offset by an increase in the personal lines combined ratio to
113.5% from 109.7%.
The following table shows the distribution of total net premiums written, by
state, for the periods indicated:
Year Ended December 31,
NET PREMIUMS WRITTEN 2002 2001 2000
----- ----- -----
New Jersey 39.8% 40.3 41.8
Pennsylvania 13.8 13.5 13.4
New York 10.8 11.5 11.3
Maryland 6.6 7.0 6.9
Virginia 5.3 5.1 4.8
North Carolina 4.0 3.2 2.5
Illinois 2.9 3.0 3.4
Georgia 2.5 2.4 2.3
Indiana 2.4 2.6 2.2
South Carolina 2.1 2.5 3.0
Ohio 2.0 2.1 2.2
Wisconsin 1.5 1.6 1.7
Delaware 1.5 1.6 1.6
Michigan 1.5 1.3 1.1
Other states 3.3 2.3 1.8
----- ----- -----
Total 100.0% 100.0 100.0
AGENCY DISTRIBUTION FORCE
We sell our insurance products through independent insurance agents. Our strong
agency relationships start with providing a broad range of products, an ease of
doing business with us due to technology initiatives, superior underwriting and
claims service, stable markets, consistent underwriting standards, and
opportunity for growth and profitability. We have competitive
4
commission schedules and agents earn average commissions of approximately 15% of
their direct premiums written and can earn up to an additional 2% under our
agency profit sharing plan. We have six regional offices and a service center
office strategically placed throughout our geographic service area so staff can
maintain a high level of communication with agents. Senior management also
interacts frequently with agents through a variety of company sponsored events,
including: annual agency sales meetings in our operating territories; annual
agency incentive trip; annual agency customer service representative meetings;
annual Producer Council meetings where leading local agents discuss with
management how we can improve our product offerings, customer service and
overall efficiency; and, an annual agency strategy meeting where a group of
agents from our operating territories advise management as corporate strategies
and key initiatives are developed.
We continue to work with our independent insurance agents to generate profitable
premium growth. At this point, while the long-term effects of ongoing agency
consolidation and bank acquisitions of agencies cannot be fully anticipated, we
are taking steps to work even more closely with our best agents including those
purchased by a bank or other entity.
FIELD STRATEGY
In 1995, we began deploying field underwriters - agency management specialists
(AMS) and in 1997 field claim adjusters - claims management specialists (CMS)
into the territories serviced by our agents. At year-end 2002, there were
approximately 70 AMSs and 145 CMSs working in our operating territories. Working
and living near agents and customers enables AMSs to work side-by-side with
agents to evaluate new business opportunities and develop strong relationships
based on technical excellence and regular, personal interaction. The AMSs work
account-by-account to ensure we make fair, accurate underwriting decisions. CMSs
also work and live close to agents and customers so that they are able to be
on-site quickly after a loss occurs, as well as conduct on-site inspections and
obtain knowledge about potential exposures. We believe that personal, early
intervention by CMSs results in higher levels of customer satisfaction, quicker,
more accurate claim settlements, and better fraud detection.
AMSs and CMSs are supported by six regional field offices located throughout our
operating territories and underwriting and claim service centers in our
Richmond, Virginia location. In addition to supporting agency service and
relationship objectives, the regional offices and underwriting service center
are responsible for handling renewal business. The AMSs, regional office
underwriting teams, service center underwriters, and agents work together with
corporate management to maintain underwriting discipline and business quality.
The account-by-account and team strategy for underwriting supports our objective
of retaining established accounts with favorable underwriting results.
UNDERWRITING
The AMSs, regional offices and our agents all play an integral role in the
underwriting process, subject to our underwriting guidelines for particular
policies and types of customers. The regional offices work with our strategic
business units, which are organized by type of customer, to develop products and
underwriting guidelines as well as growth and profitability objectives. Our
actuarial department also works with the regions and the strategic business
units to determine pricing and to monitor profitability. These activities are
also based on AMS input regarding agents' needs for products and pricing. As our
competitors implement across-the-board rate increases, we are able to write the
type of business that fits our profile, at a sound price, through our one risk
at a time field-underwriting model.
Our Underwriting Service Center, located in Richmond, Virginia, helps our
independent insurance agents serve their small to mid-size business customers
throughout all of our operating territories. Through the Underwriting Service
Center, insurance licensed individuals utilize technology to respond by e-mail,
phone and/or fax to customer inquiries about insurance coverage, billing
transactions and more. In return for the services provided, the commission we
pay to the independent insurance agent is reduced by two points. The
Underwriting Service Center also creates opportunities for additional sales and
we believe positions us particularly well to compete for business from larger
agencies, including those owned by banks and agency aggregators.
One & Done, our Internet-enabled small business system allows agents to quote,
bind and process small business policies within minutes without any intervention
by the Company. Because building valuations and our underwriting criteria are
embedded in the system, agents using these templates can quickly provide
policies to owners of small businesses. This tool has been designed to support
agents' skills at selecting good accounts and allows them to have more time to
work on larger, more complex accounts. One & Done also allows us to produce new
business at a lower underwriting expense ratio and provides us the
infrastructure to significantly grow these historically profitable business
segments. Because of these features, we believe that this system is improving
our competitive position in the small commercial lines marketplace.
During 2002, we began the implementation of the web-based version of our
commercial lines automated system (CLAS). This version of CLAS has been
developed based on input from our agents and is designed to deliver real-time
transactions in a straight through processing environment for our larger
commercial lines accounts. We expect this implementation to be completed during
2003.
5
Loss control representatives (LCR) are responsible for surveying and assessing
accounts from a safety standpoint. Accounts with significant exposures in a
particular line of coverage may be placed on service by the LCR and receive
regular individualized attention.
The premium audit staff conducts audits of a commercial account's financial
records on an interim basis during the policy year, or at the end of a policy
term to adjust interim or final audit premium payments.
COMMERCIAL LINES UNDERWRITING GAAP
HIGHLIGHTS Net Net Underwriting GAAP
Premiums Premiums Income Combined
($ IN THOUSANDS) Written Earned (Loss) Ratio
Total Commercial Lines 2002 $849,215 788,454 (21,135) 102.7%
2001 723,842 678,321 (32,970) 104.9
2000 638,991 611,865 (45,186) 107.4
Fire/Inland Marine 2002 121,042 111,951 8,725 92.2
2001 99,501 92,489 (1,569) 101.7
2000 87,363 82,430 (13,367) 116.2
Workers' Compensation 2002 203,070 193,399 (20,488) 110.6
2001 180,322 170,129 (11,518) 106.8
2000 160,669 157,295 (13,927) 108.9
General Liability 2002 235,612 213,118 (5,756) 102.7
2001 191,885 179,287 374 99.8
2000 170,128 160,043 9,080 94.3
Automobile 2002 233,589 216,311 1,151 99.5
2001 199,016 186,674 (15,379) 108.2
2000 173,808 166,980 (23,253) 113.9
Business Owners' Policy (BOP) 2002 42,565 39,695 (3,611) 109.1
2001 36,468 34,004 (7,002) 120.6
2000 32,381 31,899 (4,783) 115.0
Bonds 2002 12,461 13,105 (1,237) 109.4
2001 15,780 14,994 1,992 86.7
2000 13,719 12,523 1,542 87.7
Other 2002 876 875 81 90.7
2001 870 744 132 82.3
2000 923 695 (478) 168.8
PERSONAL LINES UNDERWRITING GAAP
HIGHLIGHTS Net Net Underwriting GAAP
Premiums Premiums Income Combined
($ IN THOUSANDS) Written Earned (Loss) Ratio
Total Personal Lines 2002 $204,272 199,814 (17,608) 108.8%
2001 201,578 204,727 (27,668) 113.5
2000 204,613 209,400 (19,936) 109.5
Automobile 2002 169,090 166,442 (17,507) 110.5
2001 169,545 172,265 (29,705) 117.2
2000 171,405 176,558 (18,414) 110.4
Homeowners 2002 28,518 26,985 (423) 101.6
2001 26,118 26,414 851 96.8
2000 26,980 26,252 (2,709) 110.3
Other 2002 6,664 6,387 322 95.0
2001 5,915 6,048 1,186 80.4
2000 6,228 6,590 1,187 82.0
CLAIMS
Timely investigation and the fair settlement of meritorious claims is one of the
most important customer services we provide. In addition, we aggressively
investigate potentially suspicious or fraudulent claims so that appropriate
action can be taken
6
before payment is authorized. Company policy emphasizes the maintenance of
timely and adequate reserves for claims, and the cost-effective delivery of
claims services by controlling losses and loss expenses.
Our CMSs are primarily responsible for investigating and settling claims
directly with claimants. By promptly and personally investigating claims, the
CMS is able to provide personal service and quickly resolve claims. In
territories where there is insufficient claim volume to justify the placement of
a CMS, or when particular claim expertise is required, we use independent
adjusters to investigate and settle claims.
Our technology platform supports our field-claims staff and our mobile claim
system provides our CMSs and agents twenty-four hour electronic access to claim
information. We believe this system provides improved service to our agents,
insureds, claimants and attorneys, and enables us to settle claims with
efficiency and flexibility thereby benefiting our agents, insureds and
claimants.
Claim settlement authority levels are established for each CMS and supervisor
based on their experience and expertise, up to a regional branch office limit of
$100,000. Casualty claims with an exposure potential in excess of $100,000,
significant exposure to catastrophic injury or damage, property claims with an
exposure greater than $50,000, as well as claims involving suits against us
and/or questions of coverage are reported to the home office where senior claim
specialists review the claims and determine the appropriate reserve. They also
provide guidance on the handling of the claim until its final disposition. All
environmental and other latent exposure claims are referred to a centralized
environmental claims unit at the home office, which specializes in the
management and consistency of decisions regarding coverage application to these
varied exposures.
Our newest initiative is a Claim Service Center located in our existing
Richmond, Virginia location that services all of our operating territories. The
goal of this initiative is to enhance service with immediate claim triage on a
twenty-four hours, 7 days a week basis. The center is designed to reduce the
cycle time on first party automobile claims and raise usage of Selective's
discounts at body shops and car rental agencies. The center became operational
in the second quarter of 2002 and it is estimated that it will save
approximately $1 million each year.
For small policyholder claims, generally defined as less than $2,500, we have
implemented an "Agency Payment Program" enabling agents to pay property damage
claims on the spot without direct CMS involvement. Our claim staff reviews the
claims paid through this program and provide guidance to the agents on the
appropriate use of the checks. Agents paid approximately 18,900 claims through
this program in 2002, 24,400 in 2001 and 23,000 in 2000. The decrease in the
current year is due to the opening of the claim service center.
We have centralized, in the home office, a fraud unit to manage our field fraud
investigators and consistently adhere to uniform internal procedures to improve
detection and action on potentially fraudulent claims. Our automated claim
system tracks suspicious claims and determines the amount of the economic impact
when a claim is not paid because it is judged to have been fraudulent. It is our
policy to abide by state laws in notifying the proper authorities of our
findings. We feel this sends a clear message that we will not tolerate
fraudulent activity committed against our company and our customers. Also, we
provide anti-fraud training for employees who may be involved in claim handling
matters.
We also focus on, and have invested in, additional loss cost containment
initiatives. These initiatives include: (i) a comprehensive managed care
program, administered by Alta, which has reduced workers' compensation and
automobile loss costs; (ii) a voluntary automobile repair shop and rental
programs which have reduced costs in 2002 and 2001; and (iii) a small estimate
and property review program.
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) and limits (automatic 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.
We have a Reinsurance Security Committee that reviews and approves all
reinsurers who do business with us. The Reinsurance Security Committee reviews
the financial condition of the reinsurer as well as applicable company ratings
from: (i) A.M. Best; and (ii) Standard and Poor's Insurance Rating Services
(S&P). Further information is obtained from our reinsurance brokers, direct
reinsurers and market information sources. Company guidelines require a
reinsurer to have an "A-" or better rating by A.M. Best. However, the
Reinsurance Committee may approve reinsurers who have ratings below "A-" or who
have not been assigned a rating in certain circumstances. The committee may also
disapprove reinsurers with acceptable A.M. Best ratings after review of other
financial or operational data.
7
We continuously monitor the reinsurance program to determine that its protection
is not excessive, but adequate to ensure the availability of funds to provide
for losses while maintaining adequate funds for business growth. Our five
largest reinsurers based on 2002 ceded premiums are American Re-Insurance
Company, Partner Reinsurance Company of the US, Hannover Ruckversicherungs AG,
Axa Reassurances (Paris) and Motors Insurance Corp. Our flood book of business
is ceded 100% to the National Flood Insurance Program. In addition, we cede
no-fault claims for medical benefits in excess of $75,000 to the New Jersey
Unsatisfied Claim and Judgment Fund (UCJF).
We have both property and casualty excess of loss treaties as well as a property
catastrophe program. The property excess of loss treaty covers each property
risk in excess of $2 million up to $15 million. Our casualty excess of loss
treaty covers each casualty occurrence in excess of $2 million up to $50 million
in six layers, except for commercial umbrella, which is reinsured, up to $10
million. Effective July 1, 2002 we retain 25% of the first layer of the casualty
excess of loss treaty that covers $3 million in excess of $2 million.
The catastrophe program for the 2002 treaty year was in five layers and covered:
(i) 95% of losses in excess of $15 million up to $25 million; (ii) 95% of losses
in excess of $25 million up to $50 million; (iii) 95% of losses in excess of $50
million up to $85 million; (iv) 83.5% of losses in excess of $85 million up to
$120 million; (v) 83.5% of losses in excess of $120 million up to $165 million.
Total coverage under the program is $133.3 million. The structure for the
property catastrophe reinsurance program was unchanged for the 2003 renewal. The
catastrophe treaty excludes both losses insured under the Terrorism Risk
Insurance Act of 2002 (TRIA) and acts of terrorism not covered by TRIA resulting
from use of any biological, chemical or nuclear weapon. While the provisions of
TRIA will serve to mitigate our exposure in the event of a large-scale terrorist
attack, our deductible is substantial, approximating $60 million in 2003. See
the section entitled "Insurance Regulation" on page 12 in this report on Form
10-K, for additional discussion of TRIA. Effective February 1, 2003, Selective
has purchased a separate treaty that covers $45 million in the aggregate in
excess of a $15 million retention in the aggregate for TRIA, as well as,
nuclear, biological and chemical losses not covered by the act.
In addition, a homeowners' quota share program reinsures 75% of New Jersey
homeowners' property coverage up to a $1 million limit. The quota share includes
a $75 million per occurrence limit.
Our surety business is reinsured via a 17.5% quota share and an excess of loss
treaty in two layers. The net retention under the surety excess of loss treaty
for 2002 was $750,000 per loss/principal. The first layer of the treaty covered
losses up to $3.5 million at 100%. The second layer of the treaty covered
contract surety losses of $5 million and other surety/fidelity losses of $2
million in excess of $3.5 million at 90%. In 2003, our net retention for the
surety excess of loss treaty has been increased to $800,000 per loss and
principal and both layers of the treaty were placed at 90% with reinsurers,
while Selective retains 10% of the exposure.
See the section entitled "Reinsurance Renewals" beginning on page 29 of Item 7.
"Management's Discussion and Analysis of Financial Condition and Results of
Operations", in this report on Form 10-K, for additional discussion about our
reinsurance programs.
POOLING ARRANGEMENTS
The Insurance Subsidiaries participate in an inter-company pooling and expense
sharing arrangement ("pool" or "pooling agreement"). The pool permits each
Insurance Subsidiary to rely on the capacity of the entire pool, rather than
only its own capital and surplus and it prevents any one Insurance Subsidiary
from suffering any undue losses, as all Insurance Subsidiaries share
underwriting profits and losses in proportion to their pool participation
percentages. The pool permits all Insurance Subsidiaries to obtain a uniform
rating from A.M. Best.
The pool participation percentage of each Insurance Subsidiary reflects the
ratio of that subsidiary's policyholders' surplus to our aggregate
policyholders' surplus. The percentages are as follows:
Selective Insurance Company of America 55.5%
Selective Way Insurance Company 21.5%
Selective Insurance Company of South Carolina 9.0%
Selective Insurance Company of the Southeast 7.0%
Selective Insurance Company of New York 7.0%
Through the pooling agreement, SICA assumes from the other Insurance
Subsidiaries, net of applicable reinsurance, all of their combined premiums,
losses, loss expenses and underwriting expenses and SICA cedes to the other
Insurance Subsidiaries 44.5% of the Insurance Subsidiaries' combined premiums,
losses, loss expenses and underwriting expenses. Through the pool, the Insurance
Subsidiaries also share underwriting and administration expenses. Accounts are
rendered within forty-five days after the end of the calendar quarter and are
settled within sixty days after the end of the calendar
8
quarter. The pool may be terminated at the end of any calendar month by any
Insurance Subsidiary giving ninety days prior notice of termination.
NET LOSSES AND LOSS EXPENSE RESERVES
The table on page 10 provides information about reserves for net losses and loss
expenses. Also see Note 5 and Note 17(a) to the consolidated financial
statements in Item 8. "Financial Statements and Supplementary Data".
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 at each
reporting date. The difference between; (i) projected ultimate loss and loss
expense reserves and (ii) case loss reserves and loss expense reserves thereon
is 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 liability for losses and loss expenses. 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.
Reserves are reviewed by both internal and independent actuaries for adequacy on
a periodic basis. 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.
The anticipated effect of inflation is implicitly considered when estimating
reserves for net losses and loss expenses. While anticipated increases due to
inflation are considered in estimating ultimate claim costs, the increase in the
average severity of claims is caused by a number of factors that vary with the
individual type of policy written. Future average severity is projected based on
historical and anticipated trends and also are adjusted for anticipated changes
in general economic trends.
After taking into account all relevant factors, we believe that the reserve for
net losses and loss expenses at December 31, 2002, is adequate to provide for
the ultimate net costs of claims incurred as of that date. Establishment of
appropriate reserves is an inherently uncertain process and there can be no
certainty that currently established reserves will prove adequate in light of
subsequent actual experience.
The table on page 10 represents the development of balance sheet net reserves
for 1992 through 2002. The top three lines of the table reconcile gross reserves
to net reserves for unpaid losses and loss expenses recorded at the balance
sheet date for each of the indicated years. The upper portion of the table shows
the re-estimated amount of the previously recorded gross and net reserves with
related reinsurance recoverable, based on experience as of the end of each
succeeding year. The estimate is either increased or decreased as more
information becomes known about the frequency and severity of claims for
individual years.
The lower section of the table shows the cumulative amount paid with respect to
the previously recorded reserves as of the end of each succeeding year. For
example, as of December 31, 2002, we paid $687.9 million of the currently
estimated $770.0 million of losses and loss expenses that were incurred through
the end of 1993; thus, the difference, an estimated $82.1 million of losses and
loss expenses incurred through 1993, remained unpaid as of December 31, 2002.
The "cumulative redundancy (deficiency)" represents the aggregate change in the
estimates over all prior years. For example, the 1993 reserve developed a $33.7
million net redundancy over the course of the succeeding ten years while on a
gross basis, the 1993 reserve developed a $35.1 million deficiency over the same
period. The net amount has been included in income over the past ten years. The
cumulative net deficiencies in 2001, 2000 and 1999 are the result of normal
reserve development inherent in the uncertainty in establishing reserves,
anticipated loss trends, growth in business, as well as
9
increased reinsurance retentions. Approximately half of the cumulative gross
deficiency is related to unlimited medical payments ceded to the Unsatisfied
Claim and Judgment fund in the state of New Jersey.
In evaluating this information, it should be noted that each amount includes the
total of all changes in amounts for prior periods. For example, the amount of
redundancy to losses settled in 2002, but incurred in 1999, will be included in
the cumulative redundancy (deficiency) amounts in 1999, 2000, and 2001. This
table does not present accident or policy year development data, which certain
readers may be more accustomed to analyzing. Conditions and trends that have
affected development of the reserves in the past may not necessarily occur in
the future. Accordingly, it may not be appropriate to extrapolate redundancies
or deficiencies based on this table.
ANALYSIS OF NET LOSSES AND LOSS EXPENSE DEVELOPMENT
(in millions) 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Gross reserves for
unpaid losses and
loss expenses at
December 31 $ 870.2 917.7 999.4 1,120.1 1,189.8 1,161.2 1,193.3 1,273.8 1,272.7 1,298.3 1,403.4
Reinsurance
recoverable on
unpaid losses and
loss expenses at
December 31 $(132.6) (114.0) (111.5) (121.4) (150.2) (124.2) (140.5) (192.0) (160.9) (166.5) (160.4)
Net reserves for
unpaid losses and
loss expenses at
December 31 $ 737.6 803.7 887.9 998.7 1,039.6 1,037.0 1,052.8 1,081.8 1,111.8 1,131.8 1,243.1
Net reserves
estimated as of:
One year later $ 734.8 801.0 900.6 989.5 1,029.5 1,034.5 1,044.2 1,080.7 1,125.5 1,151.7
Two years later 732.5 790.0 899.5 977.6 1,028.1 1,024.8 1,035.9 1,088.2 1,152.7
Three years later 718.7 788.5 894.9 974.4 1,020.5 1,014.0 1,033.3 1,115.6
Four years later 716.5 782.9 894.7 965.2 1,014.4 998.1 1,040.3
Five years later 717.3 780.3 892.2 960.8 1,000.9 997.9
Six years later 716.4 778.9 888.9 955.2 1,002.1
Seven years later 714.0 772.1 890.2 956.7
Eight years later 706.0 770.1 891.3
Nine years later 702.9 770.0
Ten years later 701.9
Cumulative net
redundancy
(deficiency) $ 35.7 33.7 (3.4) 42.0 37.5 39.1 12.5 (33.8) (40.9) (19.8)
======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Cumulative amount
of net reserves
paid
through:
One year later $ 219.5 224.6 259.4 280.4 303.6 313.7 328.1 348.2 399.2 377.1
Two years later 352.3 382.3 443.4 481.6 519.6 531.1 537.5 600.3 649.1
Three years later 451.4 497.7 573.7 628.0 674.7 665.5 703.8 767.5
Four years later 517.2 567.4 661.3 722.2 760.8 760.8 797.1
Five years later 556.3 611.1 716.0 773.3 820.0 812.2
Six years later 580.6 642.8 748.4 811.9 850.9
Seven years later 600.4 662.6 774.6 832.9
Eight years later 613.6 677.5 790.2
Nine years later 624.2 687.9
Ten years later 632.0
Re-estimated gross
liability $ 952.8 1,079.7 1,158.8 1,213.9 1,191.2 1,236.2 1,325.1 1,328.9 1,335.2
Re-estimated
reinsurance
recoverable (182.8) (188.4) (202.1) (211.8) (193.3) (195.9) (209.6) (176.2) (183.6)
------- ------- ------- ------- ------- ------- ------- ------- -------
Re-estimated net
liability $ 770.0 891.3 956.7 1,002.1 997.9 1,040.3 1,115.6 1,152.7 1,151.7
======= ======= ======= ======= ======= ======= ======= ======= =======
Cumulative gross
(deficiency) $ (35.1) (80.3) (38.7) (24.1) (30.0) (42.9) (51.3) (56.3) (18.9)
======= ======= ======= ======= ======= ======= ======= ======= =======
Cumulative net
redundancy
(deficiency) $ 33.7 (3.4) 42.0 37.5 39.1 12.5 (33.8) (36.9) (19.8)
======= ======= ======= ======= ======= ======= ======= ======= =======
Note: Some amounts may not foot due to rounding.
10
RECONCILIATION OF STATUTORY TO GAAP LOSSES AND LOSS EXPENSE RESERVES
(in thousands) 2002 2001
----------- ----------
Statutory losses and loss expense reserves (1) $ 1,244,575 1,135,536
Provision for uncollectible reinsurance 1,450 654
Elimination of inter-company profit in loss expense reserves (2) (2,757) (4,363)
Other (217) --
----------- ----------
GAAP losses and loss expense reserve - net 1,243,051 1,131,827
Reinsurance recoverable on unpaid losses and loss expenses 160,374 166,511
----------- ----------
GAAP losses and loss expense reserves - gross $ 1,403,425 1,298,338
=========== ==========
(1) Statutory losses and loss expense reserves, net of reinsurance recoverable
on unpaid losses and loss expenses.
(2) Alta Services LLC, an affiliate of the insurance companies, charges a fee
for managed care services which is included in loss expense.
ENVIRONMENTAL RESERVES
Reserves established for liability insurance include exposure to 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.
"Asbestos claims" means those claims presented to us in which bodily injury is
alleged to have occurred as a result of exposure to asbestos and/or
asbestos-containing products. During the past two decades, the insurance
industry has experienced the emergence and development of an increasing number
of asbestos claims. At December 31, 2002, asbestos claims constituted 90% of our
2,593 environmental claims compared with 89% of our 2,278 outstanding
environmental claims at December 31, 2001.
"Non-asbestos claims" means pollution and environmental claims alleging bodily
injury or property damage presented, or expected to be presented, to us other
than asbestos. These claims include landfills, leaking underground storage tanks
and mold. In past years, landfill claims have accounted for a significant
portion of our environmental claim unit's litigation costs.
Although we have had limited mold claims activity in the past, and do not write
business in states that have historically been most exposed to these claims, in
order to support and affirm the exclusion we added the Insurance Services Office
(ISO) mold coverage limitation endorsement to all homeowner renewals beginning
in the fourth quarter of 2002 in New Jersey and seven of our other personal
lines states.
We refer all environmental claims to our centralized environmental claim unit,
which specializes in the claim management of these exposures. Environmental
reserves are evaluated on a case-by-case basis. As cases progress, the ability
to assess potential liability often improves. Reserves are then adjusted
accordingly. In addition, each case is reviewed in light of other factors
affecting liability, including judicial interpretation of coverage issues.
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. 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.
11
The table below summarizes the number of asbestos and non-asbestos claims
outstanding at December 31, 2002, 2001 and 2000. For additional information
about our environmental reserves, see Note 17 (a) to the consolidated financial
statements in Item 8. "Financial Statements and Supplementary Data".
ENVIRONMENTAL CLAIMS ACTIVITY 2002 2001 2000
-------- ------- -------
ASBESTOS RELATED CLAIMS (1)
Claims at beginning of year 2,038 1,868 1,700
Claims received during year 725 606 320
Claims closed during year (2) (417) (436) (152)
-------- ------- -------
Claims at end of year 2,346 2,038 1,868
======== ======= =======
Average net loss settlement on closed claims $ 344 449 1,934
Amount paid to administer claims $ 230 123 206
NON-ASBESTOS RELATED CLAIMS (1)
Claims at beginning of year 240 212 179
Claims received during year 105 138 134
Claims closed during year (2) (98) (110) (101)
-------- ------- -------
Claims at end of year 247 240 212
======== ======= =======
Average net loss settlement on closed claims $ 16,609 14,827 15,495
Amount paid to administer claims $ 851 907 759
(1) The number of environmental claims presented in the tables includes all
multiple claimants who are associated with the same site or incident.
(2) Includes claims dismissed, settled, or otherwise resolved.
INSURANCE REGULATION
GENERAL
Insurance companies are subject to supervision and regulation in the states in
which they are domiciled and transact business. Such supervision and regulation
relate to numerous aspects of an insurance company's business and financial
condition. The primary purpose of such supervision and regulation is the
protection of policyholders. The extent of regulation varies, but generally is
derived from state statutes which delegate regulatory, supervisory and
administrative authority to state insurance departments. We believe that we are
in compliance with applicable regulatory requirements in all material respects
as of the date of this report. Although the U.S. federal government does not
directly regulate the insurance industry, federal initiatives from time to time
can have an impact on the industry.
On November 26, 2002 TRIA legislation was signed into law. The program
terminates on December 31, 2005. TRIA requires sharing the risk of future losses
from terrorism between private insurers and the federal government, and is
applicable to almost all commercial lines of insurance. Insurance companies with
direct commercial insurance exposure in the United Sates are required to
participate in the program. With the signing of this legislation, all previously
approved exclusions for terrorism are rescinded. Over the three months December
2002 to February 2003, we notified existing commercial policyholders of the
existence of the federal backstop, offered comparable terrorism coverage and
specified the cost of that coverage in accordance with the requirements of TRIA.
Policyholders have the option to accept or decline the coverage, or negotiate
other terms. These provisions apply to new policies written after enactment. An
event has to cause $5 million in losses to be certified as an act of terrorism.
Each participating insurance company will be responsible for paying out a
certain amount in claims - a deductible - before Federal assistance becomes
available. This deductible is based on a percentage of direct earned premiums
from calendar year 2002. The deductible is as follows: 2002 - 1 percent (from
enactment through the end of the year) ; 2003 - 7 percent; 2004 - 10 percent;
and 2005 - 15 percent. For losses above a company's deductible, the Federal
government will cover 90%, while the company contributes 10%. While the
provisions of TRIA will serve to mitigate our exposure in the event of a
large-scale terrorist attack, our deductible is substantial, approximating $60
million in 2003. Therefore, we continue to monitor concentrations of risk.
Effective February 1, 2003, Selective has purchased a separate treaty that
covers $45 million in the aggregate in excess of a $15 million retention in the
aggregate for TRIA, nuclear, biological and chemical losses not covered by the
act.
Effective January 1, 2001, we adopted a codified set of statutory accounting
principles as required by the National Association of Insurance Commissioners
(NAIC). The changes to the statutory accounting principles reduced the
differences within statutory accounting permitted practices between states. The
adoption of the codified statutory accounting principles had minimal impact to
the Risk Based Capital ratios for the Insurance Subsidiaries and did not
significantly impact the dividend paying capabilities of the Insurance
Subsidiaries. Our adoption of these principles led to an increase in 2001
combined statutory surplus of $43.0 million.
12
On June 1, 2000, federal regulators issued final regulations implementing the
provisions of the Financial Services Modernization Act of 1999, also known as
the Gramm-Leach-Bliley Act (the Act), governing the privacy of consumer
financial information. The regulations became effective on November 13, 2000,
and the date for compliance with the regulations was July 1, 2001. The
regulations limit disclosure by financial institutions of "nonpublic personal
information" about individuals who obtain financial products or services for
personal, family, or household purposes. The Act and the regulations generally
apply to disclosures to non-affiliated third parties, subject to specified
exceptions, but not to disclosures to affiliates. Many states in which we
operate have adopted laws that are at least as restrictive as the Act and the
regulations. This is an evolving area of regulation requiring our continued
monitoring to ensure continued compliance with the Act.
While we believe we are in compliance with all currently effective and
applicable laws affecting our operations, we cannot currently quantify the
financial impact we would incur to satisfy revised or additional regulatory
requirements that may be imposed in the future.
STATE REGULATION
The authority of the state insurance departments extends to such matters as the
establishment of standards of solvency, which must be met and maintained by
insurers, the licensing of insurers and agents, the imposition of restrictions
on investments, premium rates for property and casualty insurance, the payment
of dividends and distributions, the provisions which insurers must make for
current losses and future liabilities, the deposit of securities for the benefit
of policyholders and the approval of policy forms. State insurance departments
also conduct periodic examinations of the financial and business affairs of
insurance companies and require the filing of annual and other reports relating
to the financial condition of insurance companies. Regulatory agencies require
that premium rates not be excessive, inadequate or unfairly discriminatory. In
general, the Insurance Subsidiaries must file all rates for commercial and
personal insurance with the insurance department of each state in which they
operate.
All states have enacted legislation that regulates insurance holding company
systems. Each insurance company in a holding company system is required to
register with the insurance supervisory agency of its state of domicile and
furnish information concerning the operations of companies within the holding
company system that may materially affect the operations, management or
financial condition of the insurers. Pursuant to these laws, the respective
departments may examine the Parent and the Insurance Subsidiaries at any time,
require disclosure or prior approval of material transactions of the Insurance
Subsidiaries with any affiliate and require prior approval or notice of certain
transactions, such as dividends or distributions to the Parent from the
Insurance Subsidiary domiciled in that state.
NAIC GUIDELINES
The Insurance Subsidiaries are subject to the general statutory accounting
principles and reporting formats established by the NAIC. The NAIC also
promulgates model insurance laws and regulations relating to the financial and
operational regulations of insurance companies, which includes the Insurance
Regulatory Information System (IRIS). IRIS identifies eleven industry ratios and
specifies "usual values" for each ratio. Departure from the usual values on four
or more of the ratios can lead to inquiries from individual state commissioners
about certain aspects of the insurer's business. The Insurance Subsidiaries have
consistently met all of the IRIS ratio tests.
NAIC model laws and rules are not usually applicable unless enacted into law or
promulgated into regulation by the individual states. The adoption of certain
NAIC model laws and regulations is a key aspect of the NAIC Financial
Regulations Standards and Accreditation Program, which also sets forth minimum
staffing, and resource levels for all states. All of the domiciliary states of
the Insurance Subsidiaries are accredited, with the exception of New York.
Examinations conducted by accredited states can be accepted by other states. The
NAIC intends to create an eventual nationwide regulatory network of accredited
states.
The NAIC Model Act is also intended to enhance the regulation of insurer
solvency. This act contains certain risk-based capital (RBC) requirements for
property and casualty insurance companies. The requirements are designed to
assess capital adequacy and to raise the level of protection that statutory
surplus provides for policyholders. RBC measures the four major areas of risk to
which property and casualty insurers are exposed: (i) asset risk; (ii) credit
risk; (iii) underwriting risk; and (iv) off-balance sheet risk. Insurers with a
ratio below 200% of their total adjusted capital to their Authorized Control
Level, as calculated in the Model Act, are subject to different levels of
regulatory intervention and action. Based upon the unaudited 2002 statutory
financial statements for the Insurance Subsidiaries, each Insurance Subsidiary's
total adjusted capital exceeded the Authorized Control Level.
13
INVESTMENTS SEGMENT
The long-term objective of our investment policy is to maximize after-tax yield
while providing liquidity and preserving assets and stockholders' equity. The
current investment mix is 89% debt securities, 9% equity securities, 1%
short-term investments, and 1% other investments. High credit quality has always
been a cornerstone of our investment strategy, as evidenced by the fact that 99%
of our debt securities are investment grade. The average rating of our debt
securities is "AA", S&P's second highest credit quality rating.
We emphasize liquidity requirements in response to an unpredictable underwriting
environment and the need to minimize the exposure to catastrophic events. To
provide liquidity while maintaining consistent performance, maturities of debt
securities are "laddered" so that some issues are always approaching maturity,
thereby providing a source of predictable cash flow. To reduce sensitivity to
interest rate fluctuations, we invest our debt portfolio primarily in
intermediate-term securities. The average maturity of the portfolio was 5.3
years at December 31, 2002 compared with 4.9 years at December 31, 2001.
We will continue to follow the investment philosophy that has historically
proven successful for us. The strategy is to continue to purchase debt
securities in sectors that represent the most attractive relative value and
maintain a moderate equity exposure. Managing investment risk by adhering to
these strategies is intended to protect the interests of our stockholders as
well as those of our policyholders and, at the same time, enhance our financial
strength and underwriting capacity.
For additional information about our investment policy, see section titled
"Investments" beginning on page 30.
DIVERSIFIED INSURANCE SERVICES SEGMENT
Our Diversified Insurance Services segment provides synergies with our agency
force and creates new opportunities for agents to bring added value services and
products to their customers. Our Diversified Insurance Services operation has
three core functions: human resource administration outsourcing (HR
Outsourcing), managed care and flood insurance. The 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 production or supply output). The flood and HR outsourcing
products are currently sold through our independent agent distribution channel,
while our managed care businesses provide an integral service used by our claims
operation, as well as by other insurance carriers. In December 2001 the
Company's management adopted a plan to divest itself of its 100% ownership
interest in PDA Software Services, Inc. (PDA), which had historically been
reported as part of the Diversified Insurance Services segment. This divestiture
plan was realized in May 2002 when the Company sold all of the issued and
outstanding shares of capital stock of PDA as well as certain software
applications developed by PDA at a net gain of $0.5 million.
The results for this segment's continuing operations are as follows:
FOR THE YEAR ENDED DECEMBER 31,
($ in thousands) 2002 2001 2000
-------- ------- ------
HR OUTSOURCING
Net revenue $ 38,127 34,352 29,155
Pre-tax profit (loss) (1,397) (6,599) 110
MANAGED CARE
Net revenue 22,525 19,088 15,014
Pre-tax profit 3,010 3,686 3,509
FLOOD INSURANCE
Net revenue 18,317 14,571 11,991
Pre-tax profit 3,863 2,093 1,609
OTHER
Net revenue 1,827 1,615 1,367
Pre-tax profit 438 393 281
TOTAL
Net revenue 80,796 69,626 57,527
Pre-tax profit (loss) 5,914 (427) 5,509
After-tax profit (loss) 4,051 (201) 3,605
After-tax return on net revenue 5.0% (0.3)% 6.3%
HUMAN RESOURCE ADMINISTRATION OUTSOURCING
Selective HR Solutions, Inc. (Selective HR) provides human resource
administration outsourcing services, including benefits, payroll and employee
management services, and risk and compliance management products and services,
including workers'
14
compensation. HR outsourcing by the nature of its product package, provides a
very high level of day-to-day services to its customers, which we believe will
be attractive to small business owners, who can be accessed through existing
relationships with our independent agents.
We continue to focus on further educating the Company's agency distribution
force in order to better leverage their existing business owner relationships in
an effort to improve upon the approximately 60 agents that are selling this
product. Since the acquisition of Selective HR in 1999, the number of worksite
employees has increased to just fewer than 22,000 from the approximately 12,000
we had at acquisition. However, worksite lives were about 19,000 at the end of
January, 2003, which we expected, given our aggressive pricing and underwriting
strategy, and the planned loss of a large client.
MANAGED CARE
The goal of our managed care program is to return patients to their normal
routine, at work and at home, and ensure medical costs are delivered in the most
cost effective manner possible. Our managed care program provides workers'
compensation and automobile medical claim services, health network services,
third party administrative services and discounted access to the number one
membership based medical provider network in New Jersey, while bearing no
underwriting risk. Our medical claim services include first report of injury,
referrals to medical providers, comprehensive medical case management, as well
as medical bill audits and re-pricing. Our managed care program also provides
medical claim management services under New Jersey's Automobile Insurance Cost
Reduction Act. As part of our managed care program there are also two preferred
provider organizations, which are networks of physicians, hospitals and other
medical providers that have agreed, by contract, to discount their rates to
members.
For the fifth consecutive year, NJBIZ (formerly Business News New Jersey)
recognized Consumer Health Network Plus, LLC (CHN) as the number one preferred
provider organization in New Jersey based on membership. Network expansion
continues to be a major initiative for our managed care program. During 2002,
our medical provider network expanded to 83,000 locations from 60,000 locations
in 2001. This expansion was primarily the result of the acquisition of Northeast
Health Direct, LLC (NHD), a 16,000-location network that operates in Connecticut
and certain regions within the states of Massachusetts, Vermont, and New
Hampshire. CHN acquired NHD for $3.2 million including certain acquisition and
financial performance related costs during 2002. CHN may be further required to
pay additional consideration of approximately $1 million over the next two years
based on certain criteria related to future financial performance.
FLOOD INSURANCE
Selective is a servicing carrier for the National Flood Insurance Program
(NFIP). We provide a market for flood insurance to our agents and also have
flood-only appointments with over 5,700 agents across the country. As a
servicing carrier, not an underwriter, Selective bears no risk of policyholder
loss, since the premiums we collect are ceded 100% to the federal government. We
receive a servicing fee from which we pay agency commissions and other related
expenses. In addition to the servicing fees, we receive fees for handling
claims. Currently, Selective is servicing more than 135,000 flood policies under
this program as compared with 115,000 at this time last year. During 2002 the
NFIP recognized Selective for its growth during fiscal 2001 by presenting
Selective with its "Administrators Club" award.
DIVERSIFIED INSURANCE SERVICES REGULATION
The companies of our Diversified Insurance Services segment are subject to
certain laws and regulations.
Selective HR is an HR outsourcing company, which includes, but is not limited
to, co-employee services. As a co-employer for some of its clients, federal,
state and local laws and regulations relating to labor, tax and employment
matters affect Selective HR. By contracting with its clients and creating a
co-employer relationship with employees assigned to work at client company
locations, Selective HR assumes certain contractual obligations, legal
obligations and responsibilities of an employer under these laws and
regulations. Many of these laws and regulations do not specifically address the
obligations and responsibilities of co-employers. If these laws and regulations,
such as the Employee Retirement Income Security Act, and federal and state
employment laws and tax laws, are ultimately applied to a co-employer's
relationship with their worksite employees, they could have a material adverse
effect on Selective HR's results of operations or financial condition.
Some states in which Selective HR operates have passed licensing or registration
requirements for co-employers. These regulatory laws vary from state to state
but generally provide for monitoring the fiscal responsibility of co-employers.
Alta, CHN and NHD, operate as a managed care organization (MCO) and/or a
preferred provider organization (PPO) and are subject to laws and/or regulations
in some states where they do business, which require them to be licensed to
operate as an MCO or a PPO.
In New Jersey, a state from which both Alta and CHN derive substantial revenue,
regulations implementing the Healthcare Quality Act may deem insured health
benefit plans who contract with PPOs to be Managed Care Plans. Managed Care
Plans may be required, through PPO contracts, to provide enrollees with
information regarding the plan and the network and also to afford providers with
certain protections. We are not currently subject to these regulations. If this
changes in the future, it
15
may require additional expenditure to achieve compliance, which would not be
material to our consolidated results of operations or financial condition.
Both federal and state laws regarding privacy of medical records and patient
privacy also affect Alta, CHN and NHD. Alta, CHN and NHD are not "covered
entities" under the federal HIPAA statute or regulations. This is an evolving
area of regulation requiring us to continually monitor and review our
operations.
While Selective HR, Alta, CHN and NHD believe they are currently in compliance
with all laws and regulations affecting their operations, there can be no
assurance that, in the future, they will be able to satisfy new or revised
licensing and regulatory requirements.
SelecTech is overseen by Alta and provides third-party administrative services
to self-insured accounts. SelecTech also works closely with SRM Insurance
Brokerage, LLC to assist businesses and government entities looking for
customized insurance products and services. When operating as an insurance
adjuster, SelecTech is subject to the laws and/or regulations in some of the
states in which it does business, which require it to be licensed as an
adjuster.
COMPETITION
We face significant competition in both the Insurance Operations and Diversified
Insurance Services segments.
Our Insurance Operations compete with regional and national insurance companies,
including direct writers of insurance coverage. Many of these competitors have
greater financial, technical and operating resources. In addition, we face
competition within each insurance agency which sells our insurance, because most
of our agencies represent more than one insurance company. Based on net premiums
written for 2001 (latest publicly available information), the Company is the
60th largest property and casualty group in the United States of America.
During 2002, our managed care unit was ranked as the number one PPO in New
Jersey and the 19th largest nationwide based on membership, and includes over
83,000 medical provider locations. Currently, our HR Outsourcing unit's
co-employer component is the 13th largest in the nation.
The property and casualty insurance industry is highly competitive on the basis
of both price and service. There are many companies competing for the same
insurance customers in the geographic areas in which we operate.
Please refer to the "Risk Factors" section below, and Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
SEASONALITY
The Company's insurance business experiences a modest seasonality with regard to
premiums written, which are usually highest in January and July of each year due
to certain commercial lines renewals. Although the written premium experiences
modest seasonality, premiums are earned ratably over the period of coverage.
Losses and loss expenses incurred tend to remain consistent throughout the year,
unless a catastrophe occurs. Catastrophes predominantly occur in the winter
months due to cold and snow, in the spring and summer due to hail and tornadoes
and in early fall, due to hurricanes. HR outsourcing products peak in terms of
new customers in the first quarter when clients traditionally begin their fiscal
year.
EMPLOYEES
We currently employ approximately 2,200 employees of which 1,725 work in our
Insurance Operations and Investments segment and 475 work in our Diversified
Insurance Services segment. The largest single concentration of employees is the
850 that work at our offices in Branchville, New Jersey.
RISK FACTORS
The following are certain risk factors that can affect our business and our
results of operations and financial condition. There may be other risk factors,
and this list is not exhaustive. We operate in a continually changing business
environment, and new risk factors emerge from time to time. We cannot predict
such new risk factors, nor can we assess the impact, if any, of such new risk
factors on our business.
CATASTROPHIC EVENTS CAN HAVE A SIGNIFICANT IMPACT ON OUR FINANCIAL AND
OPERATIONAL CONDITION.
Results of property and casualty insurers are subject to weather and other
conditions prevailing in an accident year. While one year may be relatively free
of major weather or other disasters, another year may have numerous such events
causing results for such a year to be materially worse than for other years.
16
Our Insurance Subsidiaries have experienced, and are expected in the future to
experience, catastrophe losses. It is possible that a catastrophic event or a
series of multiple catastrophic events could have a material adverse effect on
the operating results and financial condition of the Insurance Subsidiaries,
thereby limiting the ability of the Insurance Subsidiaries to pay dividends.
Various events can cause catastrophes, including hurricanes, tornadoes,
windstorms, earthquakes, hail, terrorism, explosions, severe winter weather and
fires. The frequency and severity of these catastrophes are inherently
unpredictable. The extent of losses from a catastrophe is a function of both the
total amount of insured exposures in the area affected by the event and the
severity of the event. Although catastrophes can cause losses in a variety of
property and casualty lines, most of the catastrophe-related claims of our
Insurance Subsidiaries historically have been related to commercial property and
homeowners' coverages.
Our Insurance Subsidiaries seek to reduce their exposure to catastrophe losses
through the purchase of catastrophe reinsurance. Nevertheless, reinsurance may
prove inadequate if
- a major catastrophic loss exceeds the reinsurance limit, or
- an insurance subsidiary pays a number of smaller catastrophic loss
claims, which individually fall below the subsidiary's retention
level.
In the past ten years the single largest catastrophe event generated claims of
$14.1 million net of reinsurance. In that same period, total catastrophe losses
in any one-year ranged from $2.2 million to $19.6 million net of reinsurance.
OUR GEOGRAPHIC CONCENTRATION TIES OUR PERFORMANCE TO THE ECONOMIC AND REGULATORY
CONDITIONS AND WEATHER-RELATED EVENTS IN THE EAST COAST AND MIDWESTERN STATES.
Our property and casualty insurance business is concentrated geographically.
Approximately 40% of our net premiums written are for insurance policies written
in New Jersey. Other East Coast states, including Connecticut, Delaware,
Georgia, Maryland, New York, North Carolina, Pennsylvania, Rhode Island, South
Carolina, Virginia and several Midwestern states, including Illinois, Indiana,
Iowa, Kentucky, Michigan, Minnesota, Missouri, Ohio and Wisconsin, account for
substantially all of our other business. Consequently, unusually severe storms
or other natural or man-made disasters which destroy property in the states in
which we write insurance could adversely affect our operations. Our revenues and
profitability are also subject to prevailing economic and regulatory conditions
in those states in which we write insurance. Because our business is
concentrated in a limited number of markets, we may be exposed to risks of
adverse developments that are greater than the risks of having business in a
greater number of markets.
WE FACE SIGNIFICANT COMPETITION FROM OTHER REGIONAL AND NATIONAL INSURANCE
COMPANIES, AGENTS AND FROM SELF-INSURANCE.
We compete with regional and national insurance companies, including direct
writers of insurance coverage. Many of these competitors are larger than we are
and have greater financial, technical and operating resources. In addition, we
face competition within each insurance agency which sells our insurance, because
most of our agencies represent more than one insurance company.
The property and casualty insurance industry is highly competitive on the basis
of both price and service. If our competitors price their products more
aggressively, our ability to grow or renew our business may be adversely
impacted. There are many companies competing for the same insurance customers in
the geographic areas in which we operate. The Internet may also emerge as a
significant source of new competition, both from existing competitors using
their brand name and resources to write business through this distribution
channel and from new competitors.
We also face competition because of entities which self-insure, primarily in the
commercial insurance market. Many of our customers and potential customers are
examining the benefits and risks of self-insuring as an alternative to
traditional insurance.
A number of new, proposed or potential legislative or industry developments
could further increase competition in the property and casualty insurance
industry. These developments include:
- the enactment of the Gramm-Leach-Bliley Act of 1999, which could
result in increased competition from new entrants to the insurance
market, including banks and other financial service companies;
- programs in which state-sponsored entities provide property
insurance in catastrophe-prone areas or other alternative market
types of coverage; and
- changing practices caused by the Internet, which has led to greater
competition in the insurance business and, in some cases, greater
expectations for customer service.
New competition from these developments could cause the supply or demand for
insurance to change, which could adversely affect our results of operations and
financial condition.
17
WE ARE HEAVILY REGULATED IN THE STATES IN WHICH WE OPERATE.
We are subject to extensive supervision and regulation in the states in which we
transact business. The primary purpose of supervision and regulation is to
protect individual policyholders and not shareholders or other investors. Our
business can be adversely affected by private passenger automobile insurance
regulations and any other regulations affecting property and casualty insurance
companies. For example, laws and regulations can reduce or set rates at levels
which we do not believe are adequate for the risks we insure. Other laws and
regulations can limit our ability to cancel or refuse to renew policies and
require us to offer coverage to all consumers. Changes in laws and regulations,
or their interpretations, pertaining to insurance, including workers'
compensation, healthcare or managed care, preferred provider organizations and
human resource outsourcing administration organizations, may also have an
adverse effect on our business. Although the federal government does not
directly regulate the insurance industry, federal initiatives, from time to
time, can also impact the insurance industry.
In addition, proposals intended to control the cost and availability of
healthcare services have been debated in the U.S. Congress and state
legislatures. Although we do not write health insurance in our managed care
business, nor assume any healthcare risk, rules affecting healthcare services
can affect workers' compensation, commercial and personal automobile, liability
and other insurance which we do write. We cannot determine whether or in what
form healthcare reform legislation may be adopted by the U.S. Congress or any
state legislature. We also cannot determine the nature and effect, if any, that
the adoption of healthcare legislation or regulations, or changing
interpretations, at the federal or state level would have on us.
Examples of regulatory risks include:
Automobile Insurance Regulation
In March 1999, we began to implement a state-mandated 15% rate reduction for all
personal automobile policies in New Jersey. As a result of this roll-back, our
annual premiums in this line have been reduced. The effect of this rollback
continued through 2001 decreasing premium collected and adversely impacting
profitability. In addition, the New Jersey Urban Enterprise Zone Program
requires New Jersey auto insurers, including us, to write involuntary urban auto
insurance proportionate to our voluntary market share.
In October 2001, the Company withdrew a filing, originated in July 2000, seeking
an overall 18.9% rate increase and reached an agreement with the New Jersey
Department of Banking and Insurance. The agreement exhibited signs of more
regulatory flexibility in the rate-setting process and involved rate increases
for some coverages, decreases for others, tier changes for each change in risk,
as well as discounts for certain customers. Additional rate changes for New
Jersey personal automobile business were approved in January 2002, effective
March 1, 2002 and February 2003, effective March 1, 2003 by the New Jersey
Department of Banking and Insurance. In spite of these improvements, this
business currently remains unprofitable.
South Carolina law established a joint underwriting association for automobile
insurance. We are required to be a member along with other automobile insurers
in South Carolina. As a member of this association, we have to write automobile
insurance for some involuntary risks, and we share in the profit or loss of the
association. On March 1, 2003, the association was replaced by an assigned risk
plan. This plan will assign risks which are unable to obtain coverage
voluntarily to insurers based on their market share. We are unable at this time
to assess the impact of these changes on our results of operations.
Workers' Compensation Insurance Regulation
Because we voluntarily write workers' compensation insurance, we are required by
state law to write involuntary coverage. Insurance companies that underwrite
voluntary workers' compensation insurance can either write involuntary coverage
assigned by state regulatory authorities or participate in a sharing
arrangement. We currently write involuntary coverage assigned to us in a sharing
arrangement. We currently write involuntary coverage assigned to us directly
from the State of New Jersey, and this business is unprofitable.
Homeowners Insurance Regulation
New Jersey regulations prohibit us from canceling or non-renewing homeowners
insurance policies for any arbitrary, capricious or unfairly discriminatory
reason or without adequate notice to the insured. We are subject to regulatory
provisions that are designed to address problems in the homeowners property
insurance marketplace. These provisions regulate matters relating to the
availability and affordability of such insurance and take two forms: voluntary
and involuntary. Involuntary provisions, such as the New Jersey Fair Access to
Insurance Requirements (FAIR), generally result in assessments to us. The New
Jersey FAIR writes fire and extended coverage on homeowners for those
individuals unable to secure insurance elsewhere. Insurance companies who
voluntarily write homeowners insurance in New Jersey are assessed a portion of
any deficit from the New Jersey FAIR based on their share of the voluntary
market. Similar involuntary plans exist in most other states where we operate.
18
A CHANGE IN OUR MARKET SHARE IN NEW JERSEY COULD ADVERSELY IMPACT THE RESULTS IN
OUR PRIVATE PASSENGER AUTOMOBILE BUSINESS.
New Jersey insurance regulations require New Jersey auto insurers to
involuntarily write private passenger automobile insurance for individuals who
are unable to obtain insurance in the voluntary market at the same premium rates
that are applicable to policies which the insurers voluntarily write. The amount
of involuntary insurance which an insurer must write in New Jersey depends on
the insurer's market share in New Jersey -- the greater the market share the
more involuntary coverage the insurer is required to write. The underwriting of
involuntary personal automobile insurance in New Jersey is unprofitable.
During 2002, the New Jersey Department of Banking and Insurance issued an order
allowing State Farm Indemnity Company, which had approximately 17% of the market
share for New Jersey private passenger automobile insurance, to non-renew a
limited portion of its existing New Jersey voluntary private passenger
automobile insurance. On September 13, 2002, the Department issued an order that
establishes a method to distribute State Farm's insured vehicles among the
remaining private passenger automobile insurers in the state. The implementation
of this order could increase the number of private passenger vehicles we insure
in New Jersey by as much as 3,300 vehicles, which in turn could increase our
involuntary allotment.
THE PROPERTY AND CASUALTY INSURANCE INDUSTRY IS CYCLICAL.
Historically, the results of the property and casualty insurance industry have
been subject to significant fluctuations due to competition, economic
conditions, interest rates and other factors. For example, in 2000 and 2001,
commercial pricing increased, but had decreased for several years preceding
2000. Furthermore, the industry's profitability is affected by unpredictable
developments, including:
- natural and man-made disasters;
- fluctuations in interest rates and other changes in the investment
environment that affect returns on our investments;
- inflationary pressures that affect the size of losses; and
- judicial decisions that affect insurers' liabilities.
The demand for property and casualty insurance, particularly commercial lines,
can also vary with the overall level of economic activity.
WE ARE A HOLDING COMPANY, AND WE MAY BE RESTRICTED IN DECLARING DIVIDENDS, AND
THUS MAY NOT HAVE ACCESS TO THE CASH THAT IS NEEDED TO MEET OUR CASH NEEDS.
Although substantially all of our operations are conducted through our
subsidiaries, none of our subsidiaries is obligated to make funds available to
us for payment of dividends or other cash distributions that we are required to
make. Restrictions on our subsidiaries' ability to pay dividends or to make
other cash payments to us may materially affect our ability to pay principal and
interest on our indebtedness and dividends on our common stock.
Our subsidiaries are permitted under the terms of our indebtedness to incur
additional indebtedness that may restrict or prohibit the making of
distributions, the payment of dividends or the making of loans by our
subsidiaries to us. We cannot assure you that the agreements governing the
current and future indebtedness of our subsidiaries will permit our subsidiaries
to provide us with sufficient dividends, distributions or loans to fund our cash
needs.
The Insurance Subsidiaries may declare and pay dividends to us only if they are
permitted to do so under the insurance regulations of their respective
domiciliary state. All of the states in which our Insurance Subsidiaries are
domiciled regulate the payment of dividends. Some states, including New Jersey,
North Carolina and South Carolina, require that we give notice to the relevant
state insurance commissioner prior to our Insurance Subsidiaries declaring any
dividends and distributions payable to us. During the notice period, the state
insurance commissioner may disallow all or part of the proposed dividend if it
determines that the insurer's surplus as regards policyholders is not reasonable
in relation to the insurer's liabilities and adequate to its financial needs, or
in the case of New Jersey, if the regulatory authority determines that the
insurer is otherwise in a hazardous financial condition.
Notwithstanding the foregoing, if insurance regulators otherwise determine that
payment of a dividend or any other payment to an affiliate would be detrimental
to an insurance subsidiary's policyholders or creditors, because of the
financial condition of the insurance subsidiary or otherwise, the regulators may
block dividends or other payments to affiliates that would otherwise be
permitted without prior approval.
The Insurance Subsidiaries' sources of funds consist primarily of premiums,
investment income and proceeds from sales and redemption of investments. Such
funds are applied primarily to payment of claims, insurance operating expenses,
income taxes and the purchase of investments, as well as dividends and other
payments.
19
The Diversified Insurance Services subsidiaries may also declare and pay
dividends. The potential dividends are restricted only by the operating needs of
the subsidiaries. The Diversified Insurance Services subsidiaries' sources of
funds consist primarily of fees for services rendered. Such funds are applied
primarily to payment of operating expenses as well as dividends and other
payments.
OUR RESERVES MAY NOT BE ADEQUATE TO COVER ESTIMATED LOSSES AND EXPENSES.
We are required to maintain loss reserves for our estimated liability for losses
and loss expenses associated with reported and unreported claims for each
accounting period. From time to time we have to increase reserves, and if our
reserves are inadequate, we will be required to further increase reserves. An
increase in reserves results in an increase in losses and a reduction in our net
income and stockholders' equity for the period in which the deficiency in
reserves is identified and could have a material adverse effect on our results
of operations, liquidity and financial condition. Our reserve amounts are
estimated based on what we expect the ultimate settlement and claim
administration expenses to be. These estimates are based on facts and
circumstances of which we are aware, predictions of future events, and trends in
claims severity and frequency and other subjective factors. There is no method
for precisely estimating our ultimate liability for settlement and claims.
We regularly review our reserving techniques and our overall amount of reserves.
We also review:
- information regarding each claim for losses;
- our loss history and the industry's loss history;
- legislative enactments, judicial decisions and legal developments
regarding damages;
- changes in political attitudes; and
- trends in general economic conditions, including inflation.
We cannot be certain that the reserves we establish are adequate or will be
adequate in the future.
OUR ABILITY TO REDUCE OUR EXPOSURE TO RISKS DEPENDS ON THE AVAILABILITY AND COST
OF REINSURANCE.
We transfer our exposure to some risks to others through reinsurance
arrangements with other insurance and reinsurance companies. Under our
reinsurance arrangements, another insurer assumes a specified portion of our
losses and loss adjustment expenses in exchange for a specified portion of
policy premiums. The availability, amount and cost of reinsurance depend on
market conditions and may vary significantly. Any decrease in the amount of our
reinsurance will increase our risk of loss. Furthermore, we face a credit risk
with respect to reinsurance. When we obtain reinsurance, we are still liable for
those transferred risks if the reinsurer cannot meet those obligations.
Therefore, the inability of any of our reinsurers to meet its financial
obligations could materially and adversely affect our operations.
Reinsurers experienced significant losses related to the terrorist events of
September 11, 2001. As a result, we may incur significantly higher reinsurance
costs and more restrictive terms and conditions. Also, there may be reduced
availability of reinsurance for some types of commercial exposures.
WE DEPEND ON OUR INVESTMENTS TO SUPPORT OUR OPERATIONS AND TO PROVIDE A
SIGNIFICANT PORTION OF OUR REVENUES AND EARNINGS.
We, like many other property and casualty insurance companies, depend on income
from our investment portfolio for a significant portion of our revenues and
earnings. Any significant decline in our investment income as a result of
falling interest rates, decreased dividend payment rates or general market
conditions would have an adverse effect on our results. Fluctuations in interest
rates cause inverse fluctuations in the market value of our debt portfolio. Any
significant decline in the market value of our investments would reduce our
shareholders' equity and our policyholders' surplus which could impact our
ability to write additional premiums. In addition our notes payable are subject
to certain debt-to-capitalization restrictions which could also be impacted by a
significant decline in investment values.
WE DEPEND ON OUR INDEPENDENT INSURANCE AGENTS.
We market and sell our insurance products through independent, non-exclusive
insurance agencies and brokers. Agencies and brokers are not obligated to
promote our insurance products, and they may also sell our competitors'
insurance products. As a result, our business depends in part on the marketing
and sales efforts of these agencies and brokers. As we diversify and expand our
business geographically, we may need to expand our network of agencies and
brokers to successfully market our products. If these agencies and brokers fail
to market our products successfully, our business may be adversely impacted.
Also, independent agents may decide to sell their businesses to banks, other
insurance agencies, or other businesses. Agents with a Selective appointment may
decide to buy other agents. Changes in ownership or agencies, or expansion of
agencies through acquisition could adversely affect an agency's ability to
control growth and profitability, thereby adversely affecting our business.
20
WE MAY BE ADVERSELY IMPACTED BY A CHANGE IN OUR RATINGS.
Insurance companies are subject to financial strength ratings produced by
external rating agencies. Higher ratings generally indicate financial stability
and a strong ability to pay claims. Ratings are assigned by rating agencies to
insurers based upon factors relevant to policyholders. Ratings are not
recommendations to buy, hold or sell our common stock.
The principal agencies that cover the property and casualty industry are A.M.
Best Company, Standard & Poor's Rating Services (S&P), Moody's Investor Service
(Moody's) and Fitch Rating Service (Fitch). We believe our ability to write
business is most influenced by our rating from A.M. Best. We are currently rated
"A+" (Superior) by A.M. Best, which is their second highest of fifteen ratings.
A rating below "A" from A.M. Best could materially adversely affect the business
we write. We believe that ratings from S&P, Moody's or Fitch, although
important, have less of an impact on our business. We are currently rated "A" by
S&P, "A2" by Moody's and "A" by Fitch. An unfavorable change in either of these
ratings could make it more expensive for us to access capital markets and would
increase the interest rate charged to us under our current lines of credit. We
cannot be sure that we will maintain our current lines of credit. We cannot be
sure that we will maintain our current A.M. Best, S&P's, Moody's or Fitch's
ratings.
WE EMPLOY ANTI-TAKEOVER MEASURES THAT MAY DISCOURAGE POTENTIAL ACQUIRORS OF OUR
COMPANY, WHICH COULD ADVERSELY AFFECT THE VALUE OF OUR COMMON STOCK.
We own, directly or indirectly, all of the shares of stock of Insurance
Subsidiaries domiciled in the states of New Jersey, New York, North Carolina and
South Carolina. State insurance laws require prior approval by state insurance
departments of any acquisition or control of a domestic insurance company or of
any company which controls a domestic insurance company. Any purchase of 10% or
more of our outstanding common stock would require prior action by all or some
of the insurance commissioners of the above-referenced states.
In addition, other factors may discourage, delay or prevent a change of control
of Selective. These include, among others, provisions in our certificate of
incorporation, as amended, relating to:
- supermajority voting and fair price to our business combinations;
- staggered terms for our directors;
- supermajority voting requirements to amend the foregoing provisions;
- our stockholder rights plan;
- guaranteed payments which must be made to our officers upon a change
of control; and
- the ability of our board of directors to issue "blank check"
preferred stock.
The New Jersey Shareholders Protection Act provides, among other things, that a
New Jersey corporation, such as Selective, may not engage in business
combinations specified in the statute with a shareholder having indirect or
direct beneficial ownership of 10% or more of the voting power of our
outstanding stock (an interested shareholder) for a period of five years
following the date on which the shareholder became an interested shareholder,
unless the business combination is approved by the board of directors of the
corporation before the date the shareholder became an interested shareholder.
These provisions also could have the effect of depriving shareholders of an
opportunity to receive a premium over the prevailing market price if a hostile
takeover were attempted and may adversely affect the value of our common stock.
WE DEPEND ON KEY PERSONNEL.
The success of our business is dependent, to a large extent, on our ability to
attract and retain key employees, in particular our senior officers, key
management, sales, information systems, underwriting, claims, managed care, HR
outsourcing and corporate personnel. Competition to attract and retain key
personnel is intense. While we have employment agreements with a number of key
managers, in general, we do not have employment contracts or non-compete
arrangements with our employees.
WE FACE RISKS FROM TECHNOLOGY-RELATED FAILURES.
Increasingly, our businesses are dependent on computer and Internet-enabled
technology. Our inability to anticipate or manage problems with technology
associated with scalability, security, functionality or reliability could
adversely impact our businesses.
WE FACE RISKS IN THE HUMAN RESOURCE ADMINISTRATION OUTSOURCING BUSINESS.
Regulatory
The operations of Selective HR are affected by numerous federal and state laws
and regulations relating to employment matters, benefits plans and taxes. In
performing services for its clients, Selective HR assumes some obligations of an
21
employer under these laws and regulations. If these federal or state laws are
ultimately applied in a manner unfavorable to Selective HR, it could have a
material adverse effect on our operations and financial condition.
Liability for worksite employee payroll
When providing co-employment services, Selective HR assumes the obligations to
pay the salaries, wages and related benefit costs and payroll taxes of its
clients' worksite employees. Clients are required to fund these obligations for
us. If clients failed to fund these obligations, and if these obligations were
to be significant, it could have a material adverse effect on our results of
operations or financial condition.
Liabilities for Client and Employee Actions
Selective HR establishes, by contract, division of responsibility with the
client for various personnel management matters, including compliance with and
liability under various governmental regulations. Because of this relationship,
however, Selective HR may be subject to liability for the clients' violations of
laws and regulations. Although the agreements with clients generally obligate
them to indemnify Selective HR for any liability attributable to the conduct of
the clients, Selective HR may not be able to collect on the contractual
indemnification claim. In addition, worksite employees may be deemed to be
agents of Selective HR subjecting Selective HR to liability for the actions of
those worksite employees which could have a material adverse effect on our
results of operations or financial condition.
CLASS ACTION LITIGATION COULD AFFECT OUR BUSINESS PRACTICES AND FINANCIAL
RESULTS.
The insurance industry has been the target of class action litigation in areas
including the following:
- after-market crash parts;
- urban homeowner underwriting practices;
- health maintenance organization practices; and
- personal injury protection payments.
It is possible that future class action litigation could adversely affect our
insurance and diversified insurance services businesses.
UNIONIZATION OF MEDICAL PROVIDERS COULD IMPACT OUR OPERATIONS.
Our subsidiary, CHN, builds medical provider networks and leases networks to
insurers, medical management companies, third party administrators and other
medical claim payors. The lessors receive medical fee discounts from network
providers in exchange for potential patient volume commitments from CHN client
and payor base. If medical providers, such as physicians, decided to unionize,
that might impair CHN's ability to maintain and grow networks, negotiate fee
discount arrangements and lease networks to their customers. These events would
have an adverse impact not only on CHN, but also on Alta Services, our managed
care subsidiary, which leases CHN networks, and Selective as a whole because we
rely, in part, on provider networks and discounts to manage our claim medical
expenses. Those events could also have an adverse effect of the results of
operations of our Diversified Insurance Services business and Selective.
22
ITEM 2. PROPERTIES.
Situated on approximately 125 acres in Branchville, New Jersey, is our 315,000
square foot facility owned by Wantage Avenue Holding Company, Inc., a subsidiary
of Selective. This office complex and the information technology office below
are used by all segments of the business. All regional, field underwriting,
information technology office, service centers, and subsidiary office locations,
as indicated below, are leased. The regional offices are used by the Insurance
Operations segment. The subsidiary offices are used by the Diversified Insurance
Services segment. Our facilities are substantially fully utilized and are
adequate for the conduct of our business.
REGIONAL INSURANCE OFFICES SERVICE OFFICES DIVERSIFIED INSURANCE SERVICES OFFICES
CHESAPEAKE REGION UNDERWRITING SERVICE CENTER ALTA SERVICES LLC
HUNT VALLEY, MARYLAND RICHMOND, VIRGINIA HAMILTON, NEW JERSEY
6 North Park Drive, Suite 200 1100 Boulders Parkway, Suite 601 IBIS Plaza
Scott A. Hewitt, Vice President Craig G. Borens, Vice President 3525 Quakerbridge Road
James W. Coleman, Jr.
MID-AMERICA REGION CLAIMS SERVICE CENTER Executive Vice President
COLUMBUS, OHIO RICHMOND, VIRGINIA
8800 Lyra Drive, Suite 200 1100 Boulders Parkway, Suite 601 CONSUMER HEALTH NETWORK PLUS, LLC
Timothy J. Violand, Vice President Craig G. Borens, Vice President SOUTH PLAINFIELD, NEW JERSEY
One Cragwood Road
NEW JERSEY REGION INFORMATION TECHNOLOGY OFFICE James W. Coleman, Jr.
HAMILTON, NEW JERSEY GLASTONBURY, CONNECTICUT Executive Vice President
1395 Yardville-Hamilton Square Road 500 Winding Brook Drive
Edward F. Drag, II, Vice President Bradford S. Allen, Senior Vice President FLOODCONNECT, LLC
BRANCHVILLE, NEW JERSEY
NORTHEAST REGION 40 Wantage Avenue
BRANCHVILLE, NEW JERSEY Robert J. Butler, Assistant Vice President
40 Wantage Avenue
Gregory J. Massey, Vice President SELECTIVE HR SOLUTIONS, INC.
SARASOTA, FLORIDA
PENNSYLVANIA REGION 6920 Professional Parkway East
ALLENTOWN, PENNSYLVANIA James W. Coleman, Jr.
1275 Glenlivet Drive, Suite 200 Executive Vice President
Charles C. Adams, Vice President
SOUTHERN REGION
CHARLOTTE, NORTH CAROLINA
3420 Toringdon Way, Suite 300
Ronald C. Leibel, Vice President
ITEM 3. LEGAL PROCEEDINGS.
Information required under this item is included in Note 17 to the consolidated
financial statements appearing under Item 8. "Financial Statements and
Supplementary Data," and is incorporated by reference herein.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. - NONE
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Information required under this item regarding the price range of our common
stock for each quarter of the two most recent fiscal years and the frequency and
amount of dividends is included in the section entitled "Quarterly Financial
Information", on page 67 under Item 8. Financial Statements and Supplementary
Data of this report on Form 10-K and is incorporated by reference herein.
Additional information required under this item regarding the frequency, amount
and any restrictions on cash dividends for the two most recent fiscal years, and
any information regarding restrictions and limitations on the payment of cash
dividends is found in the section entitled "Financial Condition, Liquidity and
Capital Resources" beginning on page 35 up through the second paragraph on page
37, under Item 7. Management's Discussion and Analysis of Financial Condition
and Results of Operations and in Note 7 to the consolidated financial statements
of this report on Form 10-K and is incorporated by reference herein.
The Company's common stock trades on The Nasdaq National Market under the
symbol: SIGI. As of December 31, 2002, there were approximately 4,445
stockholders of record.
23
ITEM 6. SELECTED FINANCIAL DATA.
Eleven-Year Financial Highlights
(All presentations are in
accordance with GAAP
unless noted otherwise,
number of weighted average
shares and dollars in
thousands, except per share
amounts) 2002 2001 2000 1999 1998
----------- --------- --------- --------- ---------
Net premiums written .......................... $ 1,053,487 925,420 843,604 811,677 748,873
Net premiums earned ........................... 988,268 883,048 821,265 799,065 722,992
Net investment income earned .................. 103,067 96,767 99,495 96,531 99,196
Net realized gains (losses) ................... 3,294 6,816 4,191 29,377 (2,139)
Diversified insurance services revenue (1),(3) 80,796 69,626 57,527 29,764 14,100
Total revenues ................................ 1,178,950 1,059,020 986,217 957,879 837,329
Underwriting loss (2) ......................... (38,743) (60,638) (65,122) (54,147) (24,986)
Diversified insurance services income
(loss) from continuing operations (1),(3) . 5,914 (427) 5,509 4,772 2,217
Net income from continuing operations (3) ..... 42,138 26,318 26,686 54,241 53,570
(Loss) from discontinued operations (3) ....... (169) (625) (151) (524) --
Net income (4) ................................ 41,969 25,693 26,535 53,717 53,570
Comprehensive income .......................... 59,366 24,405 49,166 16,088 78,842
Total assets .................................. 3,029,847 2,684,344 2,590,903 2,507,545 2,432,168
Notes payable and debentures (7) .............. 262,768 156,433 163,634 81,585 88,791
Stockholders' equity .......................... 652,102 591,160 577,797 569,964 607,583
Statutory premiums to surplus ratio (2),(5) ... 1.9:1 1.8:1 1.7:1 1.6:1 1.5:1
Statutory combined ratio (1),(2),(6) .......... 103.2% 106.7 108.2 105.7 103.2
Combined ratio (1),(2),(6) .................... 103.9% 106.9 107.9 106.8 103.6
Yield on investment, before-tax ............... 5.4% 5.4 5.8 5.6 5.7
Debt to capitalization ........................ 28.7% 21.0 22.1 12.5 13.2
Return on average equity ...................... 6.8% 4.4 4.6 9.1 9.1
Per share data:
Net income from continuing operations:
Basic ......................................... 1.67 1.07 1.07 2.00 1.88
Diluted ....................................... 1.57 1.00 1.01 1.88 1.74
Net income:
Basic ......................................... 1.66 1.05 1.07 1.98 1.88
Diluted ....................................... 1.56 0.98 1.01 1.87 1.74
Dividends to stockholders ..................... 0.60 0.60 0.60 0.59 0.56
Stockholders' equity .......................... 24.52 23.15 22.92 21.46 21.30
Price range of common stock:
High .......................................... 31.48 28.21 25.88 22.50 29.25
Low ........................................... 19.36 19.94 14.63 16.50 16.69
Close ......................................... 25.18 21.73 24.25 17.19 20.13
Number of weighted average shares:
Basic ......................................... 25,301 24,583 24,907 27,081 28,480
Diluted ....................................... 26,922 26,424 26,572 28,877 30,412
24
1997 1996 1995 1994 1993 1992
--------- --------- --------- --------- --------- ---------
717,618 692,239 757,021 697,941 607,462 560,360
676,268 694,947 742,817 680,270 594,919 539,792
100,530 96,952 91,640 80,657 77,326 73,516
6,021 2,786 900 4,230 4,528 3,943
8,236 7,061 4,529 3,482 2,912 2,519
794,183 804,780 843,100 771,682 682,510 622,084
(3,022) (21,982) (17,468) (35,119) (54,530) (42,127)
765 1,950 856 591 545 453
69,608 55,551 53,042 38,276 22,678 53,915
-- -- -- -- -- --
69,608 55,551 53,042 38,276 22,678 53,915
105,931 51,539 105,035 1,078 21,380 53,520
2,306,191 2,189,737 2,119,804 1,870,718 1,725,736 1,639,033
96,559 103,769 111,292 111,378 61,291 63,681
565,316 474,299 436,749 329,164 322,807 311,705
1.5:1 1.7:1 2.1:1 2.4:1 2.6:1 2.5:1
100.1 102.9 101.6 104.3 108.5 107.9
100.3 102.9 102.3 105.1 109.1 107.7
6.0 6.1 6.4 6.5 6.8 7.2
14.6 18.0 20.3 25.3 16.0 17.0
13.4 12.2 13.9 11.7 7.1 18.5
2.41 1.92 1.86 1.38 0.83 2.02
2.27 1.83 1.81 1.29 0.81 1.93
2.41 1.92 1.86 1.38 0.83 2.02
2.27 1.83 1.81 1.29 0.81 1.93
0.56 0.56 0.56 0.56 0.56 0.55
19.32 16.31 15.17 11.62 11.74 11.60
28.38 19.38 19.19 15.38 15.50 11.75
18.31 15.50 12.25 11.50 10.25 8.00
27.00 19.00 17.75 12.63 15.25 11.00
28,909 28,860 28,481 27,759 27,271 26,690
30,925 30,360 29,846 29,356 29,133 28,869
(1) Flood business is included in statutory underwriting results in accordance
with prescribed statutory accounting practices. On a GAAP basis only,
flood servicing revenue and expense has been reclassified from
underwriting results to Diversified Insurance Services. Prior years have
been restated to reflect this reclassification as well as the exclusion of
results from discontinued operations.
(2) See the Glossary of Terms on page 20 of the 2002 Annual Report to
Shareholders for definitions of terms and specific measures, which
glossary is incorporated by reference herein.
(3) See Note 12 to the consolidated financial statements and the section
entitled Results of Operations for a discussion of discontinued operations
and Note 9 for components of income (loss), which are incorporated by
reference herein.
(4) Net income for 1992 increased by $26 million due to the adoption of two
accounting policies, Financial Accounting Standards No. 109, "Accounting
for Income Taxes" (FASB 109), and a change in the method of deferring
policy acquisition costs. FASB 109 increased net income by $20 million
($0.76 per basic share and $0.70 per diluted share) and the change in
deferred policy acquisition costs increased net income by $6 million
($0.23 per basic share and $0.21 per diluted share).
(5) Regulatory and rating agencies use the statutory premiums to surplus ratio
as a measure of solvency, viewing an increase in the ratio as a possible
increase in solvency risk. Management and analysts also view this ratio as
a measure of the effective use of capital since, as the ratio increases,
revenue per dollar of invested capital increases, indicating the possible
opportunity for an increased return.
(6) Changes in both the GAAP and statutory combined ratios are viewed by
management and analysts as indicative of changes in the profitability of
underwriting operations. A ratio over 100% is indicative of an
underwriting loss, and a ratio below 100% is indicative of an underwriting
profit.
(7) See Note 6 to the consolidated financial statements for a discussion of
senior convertible notes issued during 2002, which discussion is
incorporated by reference herein.
25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
RESULTS OF OPERATIONS(1)
2002 COMPARED WITH 2001 AND 2000
Financial Highlights
(dollars in thousands) 2002 2001 2000
---------- ------- -------
Net premiums written $1,053,487 925,420 843,604
Diversified insurance services revenue (2) 80,796 69,626 57,527
Net investment income earned 103,067 96,767 99,495
Operating income (1), (2) 39,997 21,888 23,962
Net realized gains, after-tax 2,141 4,430 2,724
Net income 41,969 25,693 26,535
Statutory combined ratio 103.2% 106.7 108.2
Combined ratio 103.9% 106.9 107.9
Return on average equity 6.8% 4.4 4.6
(1) - Refer to the Glossary of Terms on page 20 of the 2002 Annual Report to
Shareholders for definitions of terms used in this financial review,
incorporated by reference herein.
(2) - From continuing operations, refer to Note 12 to the consolidated
financial statements and this section for further discussion.
2002 was a year characterized by serious challenges for the entire property and
casualty insurance industry and the U.S. economy. However, our competitive
positioning and growth strategies enabled us to reach the goals we set for 2002
and reinforce our capacity for continued improvement. We surpassed our 2001
record revenue of $1 billion and net premiums written of $925 million with
revenue from continuing operations of $1.2 billion and net premiums written over
the billion-dollar threshold to $1.1 billion.
These results increased 2002 net income to $42.0 million, or $1.56 per diluted
share on 26,922,000 weighted average shares, compared with $25.7 million or
$0.98 per diluted share in 2001 on 26,424,000 weighted average shares and $26.5
million or $1.01 per diluted share in 2000 on 26,572,000 weighted average
shares. The 63% increase for 2002 compared with 2001 was attributable to our
core commercial lines operation, where we achieved our 11th straight quarter of
double digit price increases. These increases averaged 19% for 2002, compared
with 16% in 2001 and 13% in 2000.
Net investment income earned for the year was $103.1 million compared with $96.8
million in 2001 and $99.5 million in 2000. The Company generated operating cash
flows of $180.1 million in 2002, compared with $52.7 million in 2001 and $64.3
million in 2000. The 2002 operating cash flows coupled with the $112.8 million
net proceeds from the senior convertible notes, increased our overall investment
portfolio to $2.1 billion. This higher asset base drove our increased investment
income, even though interest rates continue to trend downward. The decrease in
2001 compared with 2000 was due to: (i) lower interest rates, (ii) lower return
on our investments in limited partnerships that are subject to market
fluctuations (see Note 2 (j) to the consolidated financial statements for
additional discussion), and (iii) lower year-end distributions from mutual
funds. Net pre-tax realized gains for 2002 decreased to $3.3 million from $6.8
million in 2001 and $4.2 million in 2000. Realized investment gains and losses
fluctuate based on investment decisions regarding individual securities as well
as tax planning strategies.
For the year, we reported operating income from continuing operations of $40.0
million, compared with $21.9 million in 2001 and $24.0 million in 2000.
Operating income from continuing operations differs from net income by the
exclusion of after-tax realized gains or losses on investment sales, as well as
net income from discontinued operations. It is used as an important financial
measure by management, analysts and investors, but is not intended as a
substitute for net income prepared in accordance with accounting principles
generally accepted in the United States of America (GAAP). This financial
measure may not be comparable to similar measures reported by other companies.
We manage our business in three segments: Insurance Operations (commercial lines
underwriting and personal lines underwriting); Investments; and Diversified
Insurance Services. The summaries below provide further insight into these
segments.
INSURANCE OPERATIONS
For 2002, net premiums written were $1.1 billion, an increase of 14%, over 2001
net premiums written of $925.4 million which were 10% higher than 2000 net
premiums written of $843.6 million. The 2002 increase included approximately
26
$224.2 million in new business, up 19% over last year's $188.3 million, while
2000 included $171.7 million. Net premiums written for commercial lines grew 17%
in 2002, while personal lines were up 1%. This growth reflects our ongoing
strategy to primarily focus on our core commercial lines operation, while
building a smaller, but profitable personal lines segment. For 2002, our overall
statutory combined ratio was 103.2% down from 106.7% in 2001 and 108.2% in 2000.
This ratio was better than the A.M. Best estimated industry-wide statutory
combined ratio of 105.7% for 2002.
Historically in the insurance industry, the ratio of statutory premiums to
surplus has been used as a measure of solvency. An increase in the ratio can
indicate a possible increase in solvency risk. Management and certain analysts
also view this ratio as a measure of the effective use of capital since, as the
ratio increases, revenue per dollar of invested capital increases, indicating
the possible opportunity for an increased return. Our statutory premiums to
surplus ratio has increased to 1.9x in 2002 from 1.8x in 2001, but this increase
is mainly due to the effect of price increases and not to increased exposure.
COMMERCIAL LINES RESULTS
Commercial lines net premiums written were $849.2 million for 2002, or
approximately 81% of our total net premiums written, $723.8 million for 2001 and
$639.0 million for 2000. Growth in our core commercial lines operation was led
by a 19% increase in renewal price increases for the year, compared with 16% for
2001 and 13% for 2000. Commercial lines policies in force were 302,672 at
December 31, 2002 compared with 295,860 in 2001 and 296,986 in 2000. Even with
these price increases, retention at point of renewal was 83% for 2002, versus
81% in 2001. Included in the net premiums written totals are new business of
$196.7 million in 2002, compared with $163.6 million in 2001 and $133.6 million
in 2000. We believe that the increase in new business was primarily attributable
to our field strategy, which puts underwriting and claims specialists in direct
contact with our agencies. This new business growth also reflects continued
agency integration of our small business and technology initiatives through
systems such as One & Done, our Internet-based business system that allows
agents to issue small business policies from their offices. In 2002, our agents
processed $18.8 million of new small commercial business through One & Done,
compared with $7.0 million in 2001, the initial year this system was in use.
Policies entered through One & Done accounted for more than 30% of our new
commercial policies in 2002.
The Company's commercial lines combined ratio finished the year at 102.7%,
compared with 104.9% in 2001 and 107.4% in 2000. Price increases, combined with
underwriting improvements, are driving these profitability improvements. Our
commercial lines statutory combined ratios showed similar improvements, as 2002
finished at 102.2% compared with 104.5% in 2001 and 108.2% in 2000.
Our commercial lines loss and loss expense ratio was 70.4% in 2002, compared
with 70.9% in 2001 and 72.5% in 2000. The 0.5% decrease in the ratio in 2002
from 2001 was attributable to the 19% renewal price increase which had an effect
of 7.4 points on the loss and loss expense ratio. This was offset by 4.7 points
of loss trends, 1.0 point of catastrophes losses and 1.2 points of reinsurance
costs. The 1.6% decrease in the ratio in 2001 from 2000 was attributable to the
16% renewal price increase which had an effect of 5.7 points on the loss and
loss expense ratio and 0.9 points of favorable catastrophe losses. This was
offset by 4.0 points of loss trends and 1.0 point of reinsurance costs.
We yielded solid improvements in underwriting results across most commercial
lines segments. The statutory combined ratio for commercial property dropped to
90.2%, compared with 101.4% in 2001 and 113.5% in 2000.
The commercial automobile statutory combined ratio improved to 99.2%, for the
year, compared with 108.0% in 2001 and 113.8% in 2000, while the business owners
policy statutory combined ratio improved to 108.3%, compared with 120.0% in 2001
and 116.8% in 2000. Improvements in these lines reflect higher pricing, as well
as continued underwriting improvement and heightened loss control efforts, all
of which lead to a better overall mix of business.
Our workers' compensation line requires further improvement, however, as the
statutory combined ratio increased to 110.9%, compared with 106.6% in 2001 and
110.5% in 2000. We saw an increase in claim severity during 2002, primarily from
contracting and manufacturing risks. These risks accounted for 65% of our losses
greater than $100,000. In response to this, we are writing less business in
certain contracting classes, along with eliminating new business policies
written for one to three person operations. To increase earned premium we have
reduced our average schedule credit, to an average of 3.1% in 2002 compared with
5.5% in 2001 and 8.2% in 2000. Since these credits reduce net premiums written,
by reducing the credits we are increasing our net premiums written. Where
obtainable, we are also seeking aggressive pricing, which includes an 11.5%
average increase effective January 1, 2003 in New Jersey, one of our larger
workers' compensation markets. It is also important to keep in mind our use of
account-based underwriting. In New Jersey, for example, our workers'
compensation statutory combined ratio was 120.7% for 2002 compared with 100.2%
in 2001 and 112.3% in 2000. However, the state's overall commercial lines
statutory combined ratio came in at 93.7% for 2002 compared with 97.0% in 2001
and 100.4% in 2000, demonstrating our ability to manage the workers'
compensation product as just one component of the overall commercial account.
We experienced higher than expected loss emergence in 2002 for past accident
years in our Other Liability line of business. This led to a statutory combined
ratio of 101.0% in 2002, compared with 99.1% in 2001 and 95.2% in 2000.
27
The liability line of business is inherently volatile, which makes it more
difficult to reserve. To bring our statutory combined ratio back to levels seen
in prior years we have tightened underwriting guidelines. As a result, we are
restricting the amount of work a contractor is able to subcontract, requiring
written contracts with Hold Harmless and Indemnification agreements in place and
setting minimum limits of liability coverage. In addition, we have revised
underwriting guidelines in our restaurant business, to allow less liquor sales,
disallow playground or recreational activities, and require more stringent life
safety measures in each restaurant.
The commercial lines underwriting expense ratio decreased to 31.6% in 2002 down
from 32.7% in 2001 and 33.6% in 2000. These improvements reflect the higher
prices as well as the "high-tech, high-touch" approach that makes it easy and
cost-effective for our agents to do business with us. One & Done is part of our
small business strategy: to eliminate redundancies in the independent agency
distribution model by delivering easy and efficient systems. This system allows
us to write business at a marginal underwriting expense ratio of about 23%. This
will have a positive impact on our underwriting expense ratio as we use One &
Done to process more business. We have begun to roll out our web-based
commercial lines system that delivers real-time rating to our agencies, while
enabling them to seamlessly exchange information with the Company. Having our
agents perform tasks that in the past would have been performed by a Selective
employee has allowed us to reduce staff, which has also contributed to the
reduced underwriting expense ratio. Overall, Selective agencies utilized these
systems to enter more than 65% of commercial policies directly from their
offices.
In addition, two years ago we established our Underwriting Service Center. The
Underwriting Service Center services smaller accounts for a 2% reduction in
commission, so agents can focus their attention on larger, more complex
accounts. The Underwriting Service Center was servicing more than $25 million of
premiums as of the end of 2002. Agents are beginning to realize that it is not
efficient to handle small business, and that our Underwriting Service Center is
a better option.
PERSONAL LINES RESULTS
Personal lines net premiums written were $204.3 million in 2002, $201.6 million
in 2001, and $204.6 million in 2000. The increase in net premiums written is
attributable to renewal price increases reaching an average of 9.0% in 2002,
compared with 2.1% in 2001 and a decrease of 2.9% in 2000 due to the rate
roll-back imposed by New Jersey's Automobile Insurance Cost Reduction Act
(AICRA).
The personal lines combined ratio for the year was 108.8%, compared with 113.5%
last year and 109.5% in 2000. This decrease was caused primarily by a decrease
in the New Jersey personal automobile loss and loss expense ratio for the year
to 79.7% from 90.8% in 2001 and 81.4% in 2000. This decrease reflects an $8.0
million pre-tax reserve charge taken during 2001 due to the shortfall in
estimated savings for the Company's New Jersey private passenger automobile
liability coverage from AICRA. The charge added 4.0 points to the overall and
6.3 points to the New Jersey personal automobile combined ratio for 2001.
The personal lines ratio of losses and loss expenses incurred decreased 5.4
points, to 80.1% in 2002, compared with 85.5%, in 2001 and 81.4% in 2000 due to
two years of favorable pricing and tier changes and the reserve charge taken
during 2001. This book of business, however, remains unprofitable.
As we continue to earn higher premiums from price and tier changes, we expect
ongoing improvements in our New Jersey personal automobile results. In 2002, we
continued to see reductions in new business submissions for New Jersey personal
automobile, with our market share now down to approximately 2.3% compared with
2.5% in 2001 and 2.7% in 2000. New Jersey insured vehicles declined to 111,000
over the course of 2002 from approximately 121,000 in 2001. New Jersey personal
automobile net premiums written now represents about 12% of our overall net
premiums written down from 13% in 2001 and 15% in 2000. In addition, we were
recently granted a 2.8% increase, effective in March 2003 that will continue the
upward trend of higher premiums per vehicle. Our average premium per vehicle in
New Jersey increased 9.3% for 2002, compared with an increase of 4.6% in 2001;
while it remained flat in 2000. During 2002, we also realized commission savings
of $3.5 million over 2001, as we reduced our commission schedule to be more in
line with competitors.
In our nine other personal lines states, net premiums written were up 6% for the
year to $65.4 million, compared with $61.9 million in 2001 and $62.0 million in
2000, reflecting the ongoing implementation of price increases, tier changes and
other underwriting actions to improve results. We also continue efforts to
control our exposure in New York due to the high cost of required participation
in the involuntary automobile insurance market. In 2002, we decreased the number
of vehicles written in New York by more than 17%, to under 11,000 compared with
12,900 in 2001 and 11,900 in 2000.
Our personal lines statutory combined ratio for these nine states was 120.5%,
compared with 115.4% in 2001 and 119.6% in 2000, reflecting the negative impact
of charges relating to the New York assigned risk automobile business. Excluding
New York, the full year ratio was 116.1%, compared with 113.4% in 2001 and
119.1% in 2000, and in line with our full year 2002 revised estimate of 118.0%.
Obviously, these results are not acceptable, and we have extensive plans, by
state, to establish an appropriate level of profitability.
28
Price and tier changes for these nine states, totaling more than 22% for
automobile and about 12% for homeowners over the last two years, continue to
favorably impact net premiums earned. We are aggressively pursuing additional
double-digit rate increases and tier changes in 2003, as personal lines prices
continue to push upward industry-wide.
REINSURANCE RENEWALS
We recently completed the renewals for our 2003 calendar reinsurance treaties.
All three treaties remained substantially unchanged from 2002.
Our New Jersey Homeowners' 75% Quota Share treaty renewed at the expiring $75.0
million per occurrence limit with form following coverage. Premiums ceded under
this treaty remained flat compared with the prior year at approximately $19.7
million. Terms and conditions remained relatively the same.
Our Property Catastrophe treaty renewed at existing limits of $150.0 million and
retention of $15.0 million. Terrorism coverage is excluded as per definition of
the Terrorism Risk Insurance Act (TRIA) as well as nuclear, biological and
chemical losses. The overall program cost for this treaty was $7.8 million, an
increase of 4.0% over last year's $7.5 million. The $15.0 million retention
would be reduced to a minimum retention of $1.0 million for a New Jersey region
catastrophe, due to a provision under the treaty that provides Selective up to
$14.0 million of benefit from the New Jersey Homeowners 75% quota share treaty.
Our bond treaty included a slight increase in retention, to $800,000 in 2003
from $750,000 in 2002 and a small co-participation feature, but the rate
remained stable at 11.3% of subject premium.
On November 26, 2002 TRIA legislation was signed into law. The program
terminates on December 31, 2005. TRIA requires sharing the risk of future losses
from terrorism between private insurers and the federal government, and is
applicable to almost all commercial lines of insurance. Insurance companies with
direct commercial insurance exposure in the United Sates are required to
participate in the program. With the signing of this legislation, all previously
approved exclusions for terrorism are rescinded. Over the three months December
2002 to February 2003, we notified existing commercial policyholders of the
existence of the federal backstop, offered comparable terrorism coverage and
specified the cost of that coverage in accordance with the requirements of TRIA.
Policyholders have the option to accept or decline the coverage, or negotiate
other terms. These provisions apply to new policies written after enactment. An
event has to cause $5 million in losses to be certified as an act of terrorism.
Each participating insurance company will be responsible for paying out a
certain amount in claims - a deductible - before Federal assistance becomes
available. This deductible is based on a percentage of direct earned premiums
from calendar year 2002. The deductible is as follows: 2002 - 1 percent (from
enactment through the end of the year) ; 2003 - 7 percent; 2004 - 10 percent;
and 2005 - 15 percent. For losses above a company's deductible, the Federal
government will cover 90%, while the company contributes 10%. While the
provisions of TRIA will serve to mitigate our exposure in the event of a
large-scale terrorist attack, our deductible is substantial, approximating $60
million in 2003. Therefore, we continue to monitor concentrations of risk.
Effective February 1, 2003, Selective has purchased a separate treaty that
covers $45 million in the aggregate in excess of a $15 million retention in the
aggregate for TRIA, as well as, nuclear, biological and chemical losses not
covered by the act.
Our property and casualty excess of loss treaties were renewed effective July 1,
2002. Under our casualty treaty, the Company retains the first $2.0 million of
any casualty loss as well as 25% of the next $3.0 million in losses in excess of
the $2.0 million retention. For contract year 2001, the Company retained 15% of
this layer. The casualty program provides coverage of $48.0 million in excess of
the Company's $2.0 million retention in six layers, except commercial umbrella,
which is reinsured up to $10.0 million. The casualty contract includes one
annual aggregate limit by coverage layer for a terrorism loss. Nuclear,
biological and chemical losses are excluded, but there is no exclusion for mold
losses or cyber risks. The underlying Selective policies exclude nuclear losses,
however, biological and chemical losses are covered to some extent on most
policies.
The property excess of loss structure remained unchanged with coverage of up to
$13.0 million per risk in excess of the Company's retention of $2.0 million.
This treaty includes terrorism coverage for all risks that are under $50.0
million in total insured value, with annual aggregate limits of $9.0 million for
the first layer, $15.0 million for the second layer and $10.0 million for the
third layer. Nuclear, biological and chemical losses are excluded, but there is
no exclusion for mold losses or cyber risks. The underlying policies exclude
nuclear losses, however, biological and chemical losses are covered to some
extent on most policies.
The estimated reinsurance cost for the property and casualty excess of loss
treaties is projected to be approximately $27.6 million for the contract year
ending June 2003, compared with $18.5 million for contract year ending June 2002
and $11.5 million for contract year ending June 2001. Reinsurance costs over the
past three years have trended upward reflecting poor industry-wide reinsurance
results, including the September 11th terrorist attacks, as well as concerns
about industry-wide asbestos and other environmental claims. Our costs reflect
these factors despite our relatively good results and significantly lower
exposure to these industry-wide issues.
29
INVESTMENTS
Although lower interest rates have put pressure on investment returns, we still
generated an increase in before-tax investment income to $103.1 million for the
year, compared with $96.8 million for 2001 and $99.5 million in 2000. The
increase reflects an increased asset base as our overall investment portfolio
reached $2.1 billion. This was due to strong operating cash flows of $180.1
million in 2002, compared with $52.7 million in 2001 and $64.3 in 2000 coupled
with the net proceeds of $112.8 million from the senior convertible notes
offered in September. Our before-tax portfolio yield was 5.4% in 2002 consistent
with 2001 but lower than the 5.8% in 2000.
We continue to maintain a conservative, diversified investment portfolio, with
our debt security holdings representing 89% of invested assets. 59% of our debt
securities portfolio is rated "AAA" while the portfolio has an average rating of
"AA", Standard & Poor's second highest credit quality rating. High credit
quality continues to be a cornerstone of our investment strategy, as evidenced
by the fact that 99% of the debt securities are investment grade.
The following table presents the Moody's and Standard & Poor's ratings of our
debt securities portfolio:
Rating 2002 2001
- ------- ---- ----
Aaa/AAA 59% 44%
Aa/AA 19% 28%
A/A 16% 21%
Baa/BBB 5% 6%
Other 1% 1%
--- ---
Total 100% 100%
=== ===
We emphasize liquidity requirements in response to an unpredictable underwriting
environment and the need to minimize the exposure to catastrophic events. To
provide liquidity while maintaining consistent performance, debt security
maturities are "laddered" so that some issues are always approaching maturity,
thereby providing a source of predictable cash flow. To reduce sensitivity to
interest rate fluctuations, we invest our debt securities portfolio primarily in
intermediate-term securities. The average maturity of the portfolio at December
31, 2002 was 5.3 years compared with 4.9 years at December 31, 2001.
We will continue to follow our investment philosophy that has historically
proven successful. The strategy is to continue to purchase debt securities in
sectors that represent the most attractive relative value and maintain a
moderate equity exposure. Managing investment risk by adhering to these
strategies is intended to protect the interests of our stockholders as well as
those of our policyholders and, at the same time, enhance our financial strength
and underwriting capacity.
The Company regularly reviews its investment portfolio for declines in value,
focusing attention on securities whose market value is less than 85% of their
cost/amortized cost at the time of review. 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. Factors
considered, but not limited to, in evaluating potential impairment of debt
securities include 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.
Factors considered, but not limited to, in evaluating potential impairment of
equity securities include 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;
30
- 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 are determined on the basis of the cost of specific
investments sold or written-down, and are credited or charged to income.
Realized losses include impairment charges from investment write-downs for other
than temporary declines of $7.1 million for 2002, $1.4 million for 2001 and $1.0
million for 2000. These securities were written down due to heightened credit
risk that was security specific and would not impact other securities held.
The Company realized gains and losses from the sale of available-for-sale debt
and equity securities during 2002, 2001 and 2000. The following table presents
the period of time that securities, sold at a loss during these years, were
continuously in an unrealized loss position prior to sale:
(in millions) 2002 2001 2000
--------------------- -------------------- --------------------
Fair Fair Fair
Period of time in an Value on Realized Value on Realized Value on Realized
unrealized loss position Sale Date Loss Sale Date Loss Sale Date Loss
--------- -------- --------- -------- --------- --------
Debt securities:
0 - 6 months $28.4 5.0 4.7 0.3 -- --
7 - 12 months 4.9 0.1 -- -- 4.7 0.1
Greater than 12 months 3.7 1.3 13.6 1.2 1.8 1.1
----- ----- ----- ----- ----- -----
Total debt securities 37.0 6.4 18.3 1.5 6.5 1.2
----- ----- ----- ----- ----- -----
Equity Securities:
0 - 6 months -- -- 3.3 0.7 4.3 1.8
7 - 12 months -- -- 9.9 3.0 1.4 1.7
Greater than 12 months -- -- 1.2 0.8 1.9 1.1
----- ----- ----- ----- ----- -----
Total equities -- -- 14.4 4.5 7.6 4.6
----- ----- ----- ----- ----- -----
Total $37.0 6.4 32.7 6.0 14.1 5.8
===== ===== ===== ===== ===== =====
These securities were sold despite the fact that they were in a loss position
due to 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 December 31, 2002 and 2001, 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:
(in millions) 2002 2001
--------------------- --------------------
Gross Gross
Period of time in Fair Unrealized Fair Unrealized
unrealized loss position Value Loss Value Loss
----- ---------- ----- ----------
Debt securities:
0 - 6 months $110.8 3.3 253.1 9.2
7 - 12 months 12.9 0.3 2.4 0.6
Greater than 12 months 19.8 3.0 12.8 1.5
------ ---- ----- ----
Total debt securities 143.5 6.6 268.3 11.3
------ ---- ----- ----
Equities:
0 - 6 months 15.6 2.3 20.2 1.2
7 - 12 months 15.9 3.2 0.5 0.1
Greater than 12 months 8.3 2.4 0.2 --
------ ---- ----- ----
Total equities 39.8 7.9 20.9 1.3
------ ---- ----- ----
Total $183.3 14.5 289.2 12.6
====== ==== ===== ====
31
The following table presents information regarding our available-for-sale debt
securities that were in an unrealized loss position at December 31, 2002 by
contractual maturity:
Amortized Fair
(in millions) Cost Value
--------- -----
One year or less $ 23.2 22.2
Due after one year through five years 25.5 24.6
Due after five years through ten years 71.6 68.5
Due after ten years through fifteen years 19.9 18.4
Due after fifteen years 10.0 9.8
------ -----
Total $150.2 143.5
====== =====
At December 31, 2002 our investment portfolio included non-investment grade
securities with an amortized cost of $14.7 million, or 0.6% of the portfolio,
and a fair value of $13.3 million. At December 31, 2001, non-investment grade
securities in our investment portfolio represented 0.8%, with an amortized cost
of $16.2 million and a fair value of $14.8 million. The unrealized loss on these
securities represented 9.8% of our total unrealized loss at December 31, 2002,
and 11.3% at December 31, 2001. The fair value of these securities was
determined by independent pricing services or bid prices provided by various
broker dealers. The Company does not have a material investment in non-traded
securities in 2002 or 2001.
The Company regularly reviews the diversification of the investment portfolio
compared with an investment grade corporate index. At December 31, 2002, 19.8%
of the market value of our corporate bond and preferred stock portfolios were
represented by investments in banks, some of which were in an unrealized loss
position, compared with 11.2% in the benchmark corporate index. The average
Moody's rating for the banking portfolio is "A1" with the lowest rated security
at "Baa2" and the average Standard and Poor's rating is "A+", with the lowest
rated security at "BB"-.
DIVERSIFIED INSURANCE SERVICES
The Diversified Insurance Services businesses create a fee-based source of
revenue that is not dependent on insurance underwriting cycles. These businesses
are not capital intensive and strengthen our ability to develop new revenue
streams in fast-growing markets. During 2002, our Diversified Insurance Services
strategy further evolved, which led to a more refined focus on businesses that
provide synergy with our agency force and create new opportunities for agents to
bring added value services and products to their customers. This focus has led
us to consolidate our Diversified Insurance Services operations into three core
functions: Human Resource Administration Outsourcing (HR outsourcing), managed
care and flood insurance. The 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 outsourcing products are sold
through our independent agent distribution channel, while our managed care
businesses provide an integral service used by our claims operation, as well as
by other insurance carriers. We measure the performance of these companies in
terms of revenue growth, results of operations, and returns on revenue.
The continuing operations of Diversified Insurance Services generated $80.8
million of revenue and $4.1 million of net income for 2002, compared with $69.6
million of revenue and $0.2 million of net loss for 2001 and $57.5 million of
revenue and $3.6 million of net income for 2000. The segment's return on net
revenue increased to 5.0% for 2002, compared with (0.3)% for 2001 and 6.3% for
2000.
Our HR outsourcing company, Selective HR Solutions, Inc., provides human
resource administration, including benefits, payroll and employee management
services, and risk and compliance management products and services, including
workers' compensation insurance. HR outsourcing, by the nature of its product
package, provides a very high level of day-to-day services to its customers,
which we believe will be attractive to small business owners, who can be
accessed through existing relationships with our independent agents. HR
outsourcing revenues increased 11% to $38.1 million for 2002, compared with
$34.4 million for 2001 and $29.2 million for 2000. Net loss decreased to $0.7
million, compared with $4.2 million for 2001 and net income of $0.1 million for
2000. Due to market pricing pressures, revenue increases have not kept pace with
increasing product costs and as a result we continue to implement new pricing
and cost reduction initiatives. During 2002, labor related expenses were down
about 14% over 2001 as a direct result of such initiatives. In 2001 revenue
increases were more than offset by a $4.0 million workers' compensation reserve
increase combined with increased variable and infrastructure costs thus
resulting in a net loss compared with 2000.
Our managed care companies [Alta Services LLC (Alta), SelecTech, LLC
(Selectech), Consumer Health Network Plus, LLC (CHN) and Northeast Health
Direct, LLC (NHD)] provide workers' compensation and automobile medical claim
services, third party administrative services and discounted access to the
number one membership based medical provider network in New Jersey while bearing
no underwriting risks. Network expansion has been, and will continue to be a
major initiative for our managed care program. During 2002 our medical provider
network expanded to just over 83,000 locations from 60,000
32
locations in 2001. This expansion was primarily the result of the acquisition of
NHD, a 16,000-location network that operates in Connecticut and certain regions
within the states of Massachusetts, Vermont, and New Hampshire. CHN acquired NHD
for $3.2 million including certain acquisition and financial performance related
costs during 2002. CHN may be further required to pay additional consideration
of approximately $1 million over the next two years based on certain criteria
related to future financial performance. Managed care revenues increased 18% to
$22.5 million for 2002, compared with $19.1 million for 2001 and $15.0 million
for 2000. Net income decreased to $2.0 million in 2002, compared with $2.4
million for 2001 and $2.3 million for 2000. The increase in revenue during 2002
was attributable to network growth and expansion, but was more than offset by
increased legal expenses and benefit costs. In an effort to reduce operating
expenses, initiatives are currently underway to consolidate offices and reduce
staff counts as duplicate functions are eliminated. Increases in both revenues
and net income during 2001 were the result of network and client expansion.
Selective is a servicing carrier for the National Flood Insurance Program.
Through this program, Selective is able to provide a market for flood insurance
to over 5,700 agents across the country. As a servicing carrier, Selective bears
no risk of policyholder loss since the program is fully reinsured by the federal
government. Currently, Selective is servicing more than 135,000 flood policies
under this program, compared with 115,000 in 2001 and 85,000 in 2000. This
growth resulted in an increase in servicing fees in 2002 of 26% to $18.3
million, compared with $14.6 million for 2001 and $12.0 million for 2000. This
increase in servicing revenues resulted in a corresponding increase in net
income to $2.5 million for 2002, compared with $1.4 million for 2001 and $1.1
million for 2000.
In December 2001 the Company's management adopted a plan to divest itself of its
100% ownership interest in PDA Software Services, Inc. (PDA), which had
historically been reported as part of the Diversified Insurance Services
segment. This divestiture plan was realized in May 2002 when the Company sold
all of the issued and outstanding shares of capital stock of PDA as well as
certain software applications developed by PDA at a net gain of $0.5 million. In
addition, the Company recovered $5.0 million of capitalized software development
costs.
FEDERAL INCOME TAXES
Our total federal income tax expense increased $13.4 million in 2002 to an
expense of $10.8 million, compared with a benefit of $2.6 million in 2001 and
$1.9 million in 2000. These amounts reflect an effective tax rate of 20.4% for
2002, compared with (11.1)% in 2001 and (7.5)% in 2000. The expense in 2002
reflects improved underwriting results as well as an increase in net investment
income, which was comprised of a higher percentage of taxable securities as
compared with prior years. The benefit in 2001 and 2000 reflects lower taxable
income for those years due mainly to increased underwriting losses. Our
effective tax rate differs from the federal corporate rate of 35% primarily as a
result of tax-exempt investment income and the dividends received deduction.
The total deferred tax asset declined slightly at December 31, 2002 to $8.7
million, compared with $9.4 million at December 31, 2001. Increases in current
year deferred policy acquisition costs and unrealized gains on the
available-for-sale investment portfolio were offset by increases in loss reserve
discounting, unearned premium reserves and additional alternative minimum tax
credits generated by regular tax net operating loss carrybacks for 2001 and
2000. The following table presents the Company's taxable income (loss), pre-tax
financial statement income and net deferred tax asset:
(in millions) 2002 2001 2000
------- ----- -----
Current taxable income (loss),
from continuing operations $ 42.9 (17.5) (11.4)
Pretax financial statement income 52.9 23.7 24.8
Net deferred tax asset 8.7 9.4 9.0
CRITICAL ACCOUNTING POLICIES
We have identified the policies described below as critical to our business
operations and the understanding of our results of operations. For a detailed
discussion on the application of these and other accounting policies, see Note 1
to the consolidated financial statements. Note that our preparation of the
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 consolidated 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
33
expenses. As of December 31, 2002, the Company had accrued $1.4 billion of loss
and loss expense reserves compared with $1.3 billion at December 31, 2001.
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 at each
reporting date. The difference between: (i) projected ultimate loss and loss
expense reserves and (ii) case loss reserves and loss expense reserves thereon
is 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 liability for losses and loss expenses. We have
established a range of reasonably possible IBNR losses for non-environmental net
claims of approximately $523.5 million to $666.5 million at December 31, 2002
and of approximately $460.4 million to $573.9 million at December 31, 2001. 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. Our net carried IBNR reserves for non-environmental claims,
including loss expense reserves, were $588.5 million at December 31, 2002 and
$496.2 million at December 31, 2001. 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.
Reserves are reviewed by both internal and independent actuaries for adequacy on
a periodic basis. 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.
Included in the reserves above 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. 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.
34
The table below summarizes the number of asbestos and non-asbestos claims
outstanding at December 31, 2002, 2001 and 2000. For additional information
about our environmental reserves, see page 11 and Note 17(a) to the consolidated
financial statements.
Environmental Claims Activity 2002 2001 2000
-------- ------- -------
ASBESTOS RELATED CLAIMS (1)
Claims at beginning of year 2,038 1,868 1,700
Claims received during year 725 606 320
Claims closed during year(2) (417) (436) (152)
-------- ------- -------
Claims at end of year 2,346 2,038 1,868
======== ======= =======
Average net loss settlement on closed claims $ 344 449 1,934
Amount paid to administer claims $ 230 123 206
NON-ASBESTOS RELATED CLAIMS (1)
Claims at beginning of year 240 212 179
Claims received during year 105 138 134
Claims closed during year(2) (98) (110) (101)
-------- ------- -------
Claims at end of year 247 240 212
======== ======= =======
Average net loss settlement on closed claims $ 16,609 14,827 15,495
Amount paid to administer claims $ 851 907 759
(1) The number of environmental claims presented in the tables includes all
multiple claimants who are associated with the same site or incident.
(2) Includes claims dismissed, settled, or otherwise resolved.
Of the 2,346 asbestos related claims, 1,296 involve only three insureds. The
case reserves associated with these three insureds amounted to $3.0 million on a
net and gross basis. About 90 of the total environmental claims involve
approximately 20 landfill sites. The landfill sites account for case reserves of
$17.9 million on a gross basis and $17.7 million on a net basis. The remaining
claims, which account for $5.7 million of case reserves on a gross basis and
$4.9 million on a net basis, involve leaking underground storage tanks and other
latent environmental exposures.
After taking into account all relevant factors, we believe that the reserve for
net losses and loss expenses at December 31, 2002, is adequate to provide for
the ultimate net costs of claims incurred as of that date. Establishment of
appropriate reserves is an inherently uncertain process and there can be no
certainty that currently established reserves will prove adequate in light of
subsequent actual experience.
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 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. It should be noted that when premium rates increase, the
effect of those increases will not immediately affect earned premium. Rather,
those increases will be recognized ratably over the period of coverage. 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.
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 methods of
making such estimates and establishing the deferred costs are continually
reviewed by the Company, and any adjustments therefrom are made in the
accounting period in which the adjustment arose.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Selective Insurance Group, Inc. (Parent) is an insurance holding company whose
principal assets are its investments in its insurance and Diversified Insurance
Services 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.
See Note 7 to the consolidated financial statements for additional
35
discussion. Dividends from Diversified Insurance Services subsidiaries are
restricted only by the operating needs of those subsidiaries. The Parent's cash
requirements include principal and interest payments on the senior convertible
notes, various notes payable and convertible subordinated debentures, dividends
to stockholders and general operating expenses.
The Parent generates cash from the sale of its common stock under various stock
plans, the dividend reinvestment program, and from investment income, all of
which approximated $9.9 million and reduced the Parent's annual cash
requirements from $36.5 million to $26.6 million. As indicated in the table on
the next page, the Company has contractual obligations pursuant to convertible
subordinated debentures and various notes payable of $24.0 million in 2003. As
part of our senior convertible note issuance, the Company has established an
irrevocable trust in the amount of $72.0 million, to provide funds for the notes
payable maturities scheduled in the next three years.
Based upon the 2002 unaudited statutory financial statements, the Insurance
Subsidiaries are permitted to pay the Parent in 2003 ordinary dividends in the
aggregate amount of approximately $51 million. There can be no assurance that
the Insurance Subsidiaries will be able to pay 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, see Note 7 to the consolidated
financial statements. Growth in the Diversified Insurance Services segment has
augmented consolidated cash flows from operations by generating $16.3 million in
2002, compared with $3.6 million in 2001 and $10.3 million in 2000. Dividends to
stockholders are declared and paid at the discretion of the Board 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 74 consecutive years and
currently plans to continue to pay quarterly cash dividends. For information
regarding restrictions on the Parent's ability to pay dividends to its
stockholders, see Note 6(b) to the consolidated financial statements.
In addition to the cash requirements of the Parent, our operating obligations
and cash outflow 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
outflow through premium collections, interest and dividend income and maturities
of investments.
On May 7, 2002, the Board of Directors extended the expiration date of the stock
repurchase program to May 31, 2003. There are approximately 700,000 shares
remaining under the current repurchase authorization of 8 million shares. The
Company also has additional investment commitments for its limited partnership
investments of up to $16.4 million, however there is no certainty that any
additional investment will be required.
Financial instruments that could potentially subject the Company to
concentration of credit risk include accounts receivable associated with our HR
Outsourcing subsidiary, which acts as a co-employer with certain clients. As a
co-employer, we contractually assume substantial employer rights,
responsibilities and risks of its clients' employees, who are considered
co-employees. Co-employer payroll and related service fees that were earned, but
unpaid, were $12.2 million as of December 31, 2002 and $15.4 million as of
December 31, 2001. Certain states in which we conduct this business, limit a
co-employer's liability for earned payroll to minimum wage. This would reduce
the Company's potential liability for accrued co-employer payroll. In the event
that a client does not pay their related payroll and service fees prior to the
applicable payroll date, the Company has the right to cancel the co-employer
contract or at its option, require letters of credit or other collateral. As of
December 31, 2002 the maximum exposure to any one account for earned payroll is
approximately $1.1 million. HR outsourcing is also subject to geographic
concentration. Approximately 32% of co-employer client payroll is within the
state of Florida. Other east coast states, including Georgia, Maryland, New
Jersey, Virginia, North Carolina, South Carolina, Pennsylvania, New York, and
Delaware account for substantially all of our other business. Consequently,
changes to economic or regulatory conditions in these states could adversely
affect the HR outsourcing operations.
Cash provided by operating activities amounted to $180.1 million in 2002, $52.7
million in 2001, and $64.3 million in 2000. This increase in 2002 is a result
of: i) a 13.8% increase in net premiums written and improved underwriting
profitability, driven by rate increases in renewal premiums; ii) increased
investment income from a larger investment portfolio; and iii) approximately
$13.0 million more operating cash generated by our Diversified Insurance
Services companies due to 16% revenue growth and a $4.3 million increase in
their net income.
Since cash inflow from premiums is received in advance of cash outflow required
to settle claims, we accumulate funds that we invest. At December 31, 2002 we
had $2.1 billion in investments compared with $1.8 billion in 2001 as a result
of increased operating cash flow combined with the net proceeds from the
issuance of senior convertible notes. Our investment program is structured with
staggered maturities so that liquidation of available-for-sale debt securities
should not be necessary in the ordinary course of business.
Total assets increased 13%, or $345.5 million, from December 31, 2001 to
December 31, 2002. This increase was primarily due to: (i) an increase in total
investments of $313.2 million resulting from the $180.1 million operating cash
flow, $112.8 million net proceeds from our senior convertible notes and an
increase of $26.8 million in pre-tax unrealized gains in the
36
available-for-sale investment portfolio, as well as additional purchases of
available-for-sale debt securities from cash received from increased net
premiums written; (ii) a 10% increase in premium receivables of $33.2 million
and a 13% increase in deferred policy acquisition costs of $16.5 million, both
corresponding with the net premiums written growth for the year.
The rise in total liabilities of $284.6 million, or 14%, from December 31, 2001
to December 31, 2002, was attributable to: (i) the senior convertible notes
offering of $115.9 million; (ii) an increase in unearned premium reserve of 15%,
or $71.4 million, due to growth in net premiums written over the year 2001, and
our loss and loss expense reserves of 8%, or $105.1 million, due to normal
reserve development and growth in net premiums written over the year 2001.
We are subject to financial strength ratings produced by external rating
agencies. The principal agencies that cover the property and casualty industry
are: A.M. Best Company (A.M. Best), Standard & Poor's Rating Services (S&P),
Moody's Investor Service (Moody's) and Fitch Ratings Service (Fitch). We believe
our ability to write business is most influenced by our rating from A.M. Best.
We are currently rated "A+" (Superior) by A.M. Best, which is their second
highest of fifteen ratings. A rating below "A" from A.M. Best, could materially
adversely affect the business we write. We believe that ratings from S&P,
Moody's or Fitch, although important, have less of an impact on our business.
The Company continually reviews its financial agreements for any potential
rating triggers that could dictate a significant change in terms of the
agreements if the Company's credit rating were to suddenly and drastically
change. A rating downgrade to below "A-" in its A.M. Best or S&P rating would be
considered an event of default under the terms of the Company's line of credit
agreements. The Company had no outstanding borrowings on these lines at December
31, 2002 or 2001. Holders of the senior convertible notes due 2032 may surrender
their note for conversion during any period in which the credit rating assigned
to the notes is "Ba2" or lower by Moody's or "BB" or lower by S&P. While these
triggers would not materially affect our results of operations or financial
condition, they may impact certain financial ratios.
OFF-BALANCE SHEET ARRANGEMENTS, CONTRACTUAL OBLIGATIONS AND CONTINGENT
LIABILITIES AND COMMITMENTS
At December 31, 2002 and 2001, 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 as of December 31, 2002
are summarized below:
Contractual obligations
------------------------------------------------------
Less than 1-3 3-5 After 5
(in millions) Total 1 year years years years
------ --------- ------ ------ ------
Operating leases $ 24.2 6.3 10.3 5.6 2.0
Senior convertible notes 305.0 -- -- -- 305.0
Convertible subordinated debentures 1.3 -- -- -- 1.3
Notes payable 145.5 24.0 48.0 36.6 36.9
------ ------ ------ ------ ------
Total $476.0 30.3 58.3 42.2 345.2
====== ====== ====== ====== ======
We fully expect to have the capacity to repay and/or refinance these obligations
as they come due.
We currently have available revolving lines of credit amounting to $50.0
million, under which no balances are outstanding as of either December 31, 2002
or 2001. See Note 6(d) to the consolidated financial statements for more
information. 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 Note 16 to the consolidated financial statements.
AUDIT COMMITTEE APPROVAL OF NON-AUDIT SERVICES
In accordance with Section 10A(i)(2) of the Securities Exchange Act of 1934, as
amended, as added by Section 202 of the Sarbanes-Oxley Act of 2002, we are
required to disclose non-audit services approved by our Audit Committee to be
performed by KPMG, LLP, our independent auditors. Non-audit services are
services other than those provided in connection with an audit or a review of
our financial statements and the financial statements of our subsidiaries.
During 2002, KPMG, LLP did not provide any non-audit services to us.
37
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of potential loss in fair value arising from adverse
fluctuations in interest rates, market rates and prices, foreign currency
exchange rates, and other relevant market rate or price changes. The following
is a discussion of the Company's primary market risk exposures and how they were
being managed as of December 31, 2002. Our market risk sensitive instruments are
for other than trading purposes.
Our investment policy is conservative with the long-term objective of maximizing
after-tax yield while providing liquidity and preserving assets and
stockholders' equity. The current investment mix is 89% debt securities, 9%
equity securities, 1% short-term investments and 1% other investments. We have
no direct exposure to commodity risk and minimal exposure to foreign exchange
risk.
To reduce the sensitivity of interest rate fluctuations, we invest our debt
securities portfolio primarily in intermediate-term securities. At December 31,
2002, 92% of the portfolio was ten years or less to maturity, with the average
maturity of 5.3 years.
Our portfolio of marketable equity securities is exposed to equity price risk
arising from potential volatility in equity market prices. We attempt to
minimize the exposure to equity price risk by maintaining a diversified
portfolio limiting concentrations in any one company or industry.
For our overall investment portfolio, there were no significant changes in our
primary market risk exposures or in how those exposures are managed compared
with the year ended December 31, 2001. We do not currently anticipate
significant changes in our primary market risk exposures or in how those
exposures are managed in future reporting periods based upon what is known or
expected to be in effect in future reporting periods.
We utilize sensitivity analysis to measure the potential loss in future
earnings, fair values or cash flows of market sensitive instruments. The
sensitivity analysis hypothetically assumes: (i) a parallel 200 basis point
shift in interest rates up and down in 100 basis point increments; and (ii) a
20% change in equity prices up and down in 10% increments at December 31, 2002
and 2001.
In the analysis, we include investments in debt securities and investments in
equity securities. The primary market risk to the Company's market sensitive
instruments is interest rate risk and equity price risk.
This analysis is not intended to provide a precise forecast of the effect of
changes in market interest rates and equity prices on our income or
stockholders' equity. Further, the calculations do not take into account any
actions we may take in response to market fluctuations.
The following table presents the sensitivity analysis of each component of
market risk as of December 31, 2002 and 2001.
-----------------------------------------------------------------
2002
INTEREST RATE SHIFT IN BASIS POINTS
-----------------------------------------------------------------
($ IN MILLIONS) -200 -100 0 100 200
-------- -------- -------- -------- --------
MARKET VALUE OF DEBT
SECURITY PORTFOLIO $2,057.7 $1,968.6 $1,886.8 $1,806.5 $1,724.2
MARKET VALUE CHANGE FROM BASE (%) 9.1% 4.3% 0.0% (4.3)% (8.6)%
-----------------------------------------------------------------
2001
Interest Rate Shift in Basis Points
-----------------------------------------------------------------
-200 -100 0 100 200
-------- -------- -------- -------- --------
Market value of debt
security portfolio $1,682.6 $1,615.9 $1,552.5 $1,491.9 $1,433.8
Market value change from base (%) 8.4% 4.1% 0.0% (3.9)% (7.7)%
-----------------------------------------------------------------
2002
CHANGE IN EQUITY VALUES IN PERCENT
-----------------------------------------------------------------
-20% -10% 0% 10% 20%
-------- -------- -------- -------- --------
MARKET VALUE OF EQUITY PORTFOLIO $ 157.5 $ 177.2 $ 196.9 $ 216.6 $ 236.3
-----------------------------------------------------------------
2001
Change in Equity Values in Percent
-----------------------------------------------------------------
-20% -10% 0% 10% 20%
-------- -------- -------- -------- --------
Market value of equity portfolio $ 187.0 $ 210.3 $ 233.7 $ 257.1 $ 280.4
38
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Consolidated Balance Sheets
December 31,
(in thousands, except share amounts) 2002 2001
----------- ----------
ASSETS
INVESTMENTS:
Debt securities, held-to-maturity - at amortized cost
(fair value: $114,785-2002; $182,554-2001) $ 109,318 175,453
Debt securities, available-for-sale - at fair value
(amortized cost: $1,671,347-2002; $1,335,656-2001) 1,772,061 1,369,965
Equity securities, available-for-sale - at fair value
(cost of: $120,036-2002; $117,186-2001) 196,913 233,703
Short-term investments - (at cost which approximates fair value) 24,700 19,155
Other investments 23,559 15,033
----------- ----------
Total investments (Note 2) 2,126,551 1,813,309
Cash 2,228 7,295
Interest and dividends due or accrued 22,689 23,073
Premiums receivable, net of allowance for uncollectible
accounts of: $2,814-2002; $3,633-2001 353,935 320,741
Other trade receivables, net of allowance for uncollectible
accounts of: $867-2002; $666-2001 19,769 29,491
Reinsurance recoverable on paid losses and loss expenses 7,272 14,405
Reinsurance recoverable on unpaid losses and loss expenses (Note 4) 160,374 166,511
Prepaid reinsurance premiums (Note 4) 46,141 39,932
Current federal income tax -- 5,945
Deferred federal income tax (Note 11) 8,707 9,416
Real estate, furniture, equipment, and software development - at cost,
net of accumulated depreciation and amortization of:
$70,628-2002; $68,926-2001 52,424 55,802
Deferred policy acquisition costs (Note 1j) 148,158 131,651
Goodwill (Note 1k) 42,808 46,495
Other assets 38,791 20,278
----------- ----------
Total assets $ 3,029,847 2,684,344
=========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Reserve for losses (Note 5) $ 1,232,322 1,133,673
Reserve for loss expenses (Note 5) 171,103 164,665
Unearned premiums 557,141 485,713
Senior convertible notes (Note 6) 115,937 --
Notes payable (Note 6) 145,500 152,643
Current federal income tax 2,565 --
Other liabilities 153,177 156,490
----------- ----------
Total liabilities 2,377,745 2,093,184
----------- ----------
STOCKHOLDERS' EQUITY:
Preferred stock of $0 par value per share:
Authorized shares: 5,000,000; no shares issued or outstanding
Common stock of $2 par value per share:
Authorized shares: 180,000,000
Issued: 40,780,950-2002; 39,588,746-2001 81,562 79,177
Additional paid-in capital 95,435 77,126
Retained earnings 562,553 536,188
Accumulated other comprehensive income 115,434 98,037
Treasury stock - at cost (shares: 14,185,020-2002; 14,056,403-2001) (195,295) (192,284)
Unearned stock compensation and notes receivable from stock sales (7,587) (7,084)
----------- ----------
Total stockholders' equity (Notes 7 and 8) 652,102 591,160
----------- ----------
Commitments and contingencies (Notes 4 and 17)
Total liabilities and stockholders' equity $ 3,029,847 2,684,344
=========== ==========
See accompanying notes to consolidated financial statements.
39
Consolidated Statements of Income
Years ended December 31,
(in thousands, except per share amounts) 2002 2001 2000
----------- ---------- --------
Revenues:
Net premiums written $ 1,053,487 925,420 843,604
Net (increase) in unearned premiums and prepaid
reinsurance premiums (65,219) (42,372) (22,339)
----------- ---------- --------
Net premiums earned 988,268 883,048 821,265
Net investment income earned 103,067 96,767 99,495
Net realized gains 3,294 6,816 4,191
Diversified insurance services revenue 80,796 69,626 57,527
Other income 3,525 2,763 3,739
----------- ---------- --------
Total revenues 1,178,950 1,059,020 986,217
----------- ---------- --------
Expenses:
Losses incurred 609,048 567,778 541,487
Loss expenses incurred 105,532 88,106 72,579
Policy acquisition costs 307,505 277,897 261,540
Dividends to policyholders 5,762 8,275 7,670
Interest expense 15,093 14,526 13,745
Diversified insurance services expenses 74,882 70,053 52,018
Other expenses 8,221 8,687 12,352
----------- ---------- --------
Total expenses 1,126,043 1,035,322 961,391
----------- ---------- --------
Income from continuing operations,
before federal income tax 52,907 23,698 24,826
----------- ---------- --------
Federal income tax expense (benefit)
Current 19,841 (1,874) 3,233
Deferred (9,072) (746) (5,093)
----------- ---------- --------
Total federal income tax expense (benefit) 10,769 (2,620) (1,860)
----------- ---------- --------
Loss from discontinued operations, net of tax:
$(377)-2002; $(234)-2001; $(131)-2000 (708) (625) (151)
Gain on disposition of discontinued operations,
net of tax: $290-2002 539 -- --
----------- ---------- --------
Total discontinued operations, net of tax (169) (625) (151)
----------- ---------- --------
Net income $ 41,969 25,693 26,535
=========== ========== ========
Earnings per share:
Basic net income from continuing operations $ 1.67 1.07 1.07
Basic net (loss) from discontinued operations (0.01) (0.02) --
----------- ---------- --------
Basic net income $ 1.66 1.05 1.07
=========== ========== ========
Diluted net income from continuing operations $ 1.57 1.00 1.01
Diluted net (loss) from discontinued operations (0.01) (0.02) --
----------- ---------- --------
Diluted net income $ 1.56 0.98 1.01
=========== ========== ========
Dividends to stockholders $ 0.60 0.60 0.60
See accompanying notes to consolidated financial statements.
40
Consolidated Statements of Stockholders' Equity
Years ended December 31,
(in thousands, except per share amounts) 2002 2001 2000
---- ---- ----
Common stock:
Beginning of year $ 79,177 77,568 75,929
Dividend reinvestment plan
(shares: 46,353-2002; 47,672-2001;
63,928-2000) 93 95 128
Convertible subordinated debentures
(shares: 347,312-2002; 8,190-2001;
326,122-2000) 695 16 652
Stock purchase and compensation plans
(shares: 798,539-2002; 749,142-2001;
429,287-2000) 1,597 1,498 859
--------- -------- --------
End of year 81,562 79,177 77,568
--------- -------- --------
Additional paid-in capital:
Beginning of year 77,126 63,074 53,470
Dividend reinvestment plan 1,049 1,043 1,017
Convertible subordinated debentures 1,747 41 1,629
Stock purchase and compensation plans 15,513 12,968 6,958
--------- -------- --------
End of year 95,435 77,126 63,074
--------- -------- --------
Retained earnings:
Beginning of year 536,188 525,669 514,477
Net income 41,969 41,969 25,693 25,693 26,535 26,535
Cash dividends to stockholders
($0.60 per share-2002; $0.60 per share
2001; $0.60 per share-2000) (15,604) (15,174) (15,343)
--------- -------- --------
End of year 562,553 536,188 525,669
--------- -------- --------
Accumulated other comprehensive income:
Beginning of year 98,037 99,325 76,694
Other comprehensive income (loss),
increase (decrease) in net unrealized
gains on available-for-sale securities,
net of deferred income tax effect 17,397 17,397 (1,288) (1,288) 22,631 22,631
--------- ------ -------- ------ -------- ------
End of year 115,434 98,037 99,325
--------- -------- --------
Comprehensive income 59,366 24,405 49,166
====== ====== ======
Treasury stock:
Beginning of year (192,284) (181,552) (143,875)
Acquisition of treasury stock
(shares: 128,617-2002; 479,137-2001;
2,170,544-2000) (3,011) (10,732) (37,677)
--------- -------- --------
End of year (195,295) (192,284) (181,552)
--------- -------- --------
Unearned stock compensation and notes
receivable from stock sales:
Beginning of year (7,084) (6,287) (6,731)
Unearned stock compensation (4,480) (3,845) (3,156)
Amortization of deferred compensation
expense and amounts received on notes 3,977 3,048 3,600
--------- -------- --------
End of year (7,587) (7,084) (6,287)
--------- -------- --------
Total stockholders' equity $ 652,102 591,160 577,797
========= ======== ========
The Company also has authorized, but not issued, 5,000,000 shares of preferred
stock without par value of which 300,000 shares have been designated Series A
junior preferred stock without par value.
See accompanying notes to consolidated financial statements.
41
Consolidated Statements of Cash Flows
Years ended December 31,
(in thousands) 2002 2001 2000
--------- -------- --------
OPERATING ACTIVITIES
Net income $ 41,969 25,693 26,535
--------- -------- --------
Adjustments to reconcile net income to net cash provided by operating activities:
Increase in reserves for losses and loss expenses, net of
reinsurance recoverable on unpaid losses and loss expenses 101,927 20,040 30,023
Increase in unearned premiums, net of prepaid reinsurance premiums 65,218 42,372 22,339
Increase in net federal income tax recoverable (290) (4,016) (2,292)
Depreciation and amortization 8,103 12,245 11,785
Amortization of deferred compensation 3,848 3,006 3,462
Increase in premiums receivables (33,194) (28,809) (43,022)
Decrease (increase) in other trade receivables 5,870 (4,576) (9,427)
Increase in deferred policy acquisition costs (16,507) (13,238) (9,318)
Decrease (increase) in interest and dividends due or accrued 384 (265) 737
Decrease (increase) in reinsurance recoverable on paid losses and loss expenses 7,133 (5,073) 465
Net realized (gains) (3,294) (6,816) (4,191)
Gain on disposition of discontinued operations (829) -- --
Other-net (281) 12,120 37,172
--------- -------- --------
Net adjustments 138,088 26,990 37,733
--------- -------- --------
Net cash provided by operating activities 180,057 52,683 64,268
--------- -------- --------
INVESTING ACTIVITIES
Purchase of debt securities, available-for-sale (656,542) (326,099) (157,685)
Purchase of equity securities, available-for-sale (11,586) (62,619) (25,384)
Purchase of other investments (9,324) (1,462) (4,406)
Purchase and adjustments of subsidiaries acquired (net of cash acquired of $48 in 2002) (3,139) (97) (5,996)
Sale of subsidiary (net of cash of $385) 15,349 -- --
Sale of debt securities, available-for-sale 223,821 45,221 21,629
Redemption and maturities of debt securities, held-to-maturity 66,411 49,807 46,183
Redemption and maturities of debt securities, available-for-sale 92,866 131,174 90,818
Sale of equity securities, available-for-sale 16,430 56,376 42,506
Proceeds from other investments 798 71 6,727
(Decrease) increase in net payable for security transactions (3,781) 4,800 (2,304)
Net additions to real estate, furniture, equipment and software development (11,775) (6,824) (12,003)
--------- -------- --------
Net cash (used in) provided by investing activities (280,472) (109,652) 85
--------- -------- --------
FINANCING ACTIVITIES
Dividends to stockholders (15,604) (15,174) (15,343)
Acquisition of treasury stock (3,011) (10,732) (37,677)
Net proceeds from issuance of senior convertible notes 112,750 -- --
Net proceeds from notes payable -- -- 88,440
Principal payment of notes payable (7,143) (7,143) (7,143)
Proceeds from short-term debt -- -- 40,200
Paydown of short-term debt -- -- (91,502)
Net proceeds from dividend reinvestment plan 1,142 1,138 1,145
Net proceeds from stock purchase and compensation plans 12,630 10,621 4,661
Proceeds received on notes receivable from stock sales 129 42 138
--------- -------- --------
Net cash provided by (used in) financing activities 100,893 (21,248) (17,081)
--------- -------- --------
Net increase (decrease) in short-term investments and cash 478 (78,217) 47,272
Short-term investments and cash at beginning of year 26,450 104,667 57,395
--------- -------- --------
Short-term investments and cash at end of year $ 26,928 26,450 104,667
========= ======== ========
See accompanying notes to consolidated financial statements
42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2002, 2001, and 2000
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Consolidation Policy
The consolidated financial statements include the accounts of Selective
Insurance Group, Inc. (Selective) and its subsidiaries (collectively, the
"Company") and have been prepared in accordance with accounting principles
generally accepted in the United States of America (GAAP). All material
intercompany accounts and transactions have been eliminated.
(b) Use of Estimates
The preparation of the consolidated financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the reported
financial statement balances, as well as the disclosure of contingent assets and
liabilities. Actual results could differ from those estimates.
(c) Reclassifications
Certain amounts in the Company's prior years' consolidated financial statements
and related footnotes have been reclassified to conform with the 2002
presentation. Such reclassification had no effect on the Company's net income or
stockholders' equity.
(d) Investments
Held-to-maturity debt securities are carried at amortized cost, which is
calculated using the scientific method, because management has the ability and
intent to hold such securities until maturity. Available-for-sale debt and
equity securities are carried at fair value. Limited partnerships are carried
using the equity method, which approximates fair value. Net unrealized gains and
losses on held-to-maturity debt securities are not reflected in accumulated
other comprehensive income. Net unrealized gains and losses on
available-for-sale debt and equity securities, net of deferred income tax
effect, are included as a separate component of accumulated other comprehensive
income. No material investments of the Company were non-income producing for the
years ended December 31, 2002 and 2001.
Realized gains and losses are determined on the basis of the cost of specific
investments sold and are credited or charged to income. In the event that a
decline in fair value of an investment is considered to be other than temporary,
such investments are written down to their fair value at the date the impairment
was determined and the amount of the write-down is included in realized losses.
Realized losses from investment write-downs were $7.1 million for 2002, $1.4
million for 2001 and $1.0 million for 2000.
(e) Fair Values of Financial Instruments
The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:
(1) Investment Securities: Fair values for held-to-maturity debt
securities are based on quoted market prices where available, or from
independent pricing services. The fair values of available-for-sale debt and
equity securities, which also represent their carrying amounts, are based on
quoted market prices. Other investments are carried at either cost or the equity
method, which approximates fair value.
(2) Indebtedness: The fair value of the convertible subordinated
debentures and the 1.6155% Senior Convertible Notes due September 24, 2032, are
based on quoted market prices. The fair values of the 8.77% Senior Notes due
August 1, 2005, the 8.63% Senior Notes due May 4, 2007, and the 8.87% Senior
Notes due May 4, 2010 were estimated using a cash flow analysis based upon the
Company's current incremental borrowing rate for the remaining term of the loan.
See Note 3 for a summary table of the fair value and related carrying
amounts of financial instruments.
(f) Allowance for Doubtful Accounts
The Company estimates an allowance for doubtful accounts on its premiums, other
trade receivables, and reinsurance recoverables. This allowance is based on
historical write-off percentages adjusted for the effects of current and
anticipated trends. The allowance for premium receivables was $2.8 million at
December 31, 2002 and $3.6 million at December 31, 2001. The allowance for trade
receivables was $0.9 million at December 31, 2002 and $0.7 million at December
31, 2001. The allowance for reinsurance recoverables was $1.5 million at
December 31, 2002 and $0.7 million at December 31, 2001.
(g) Concentration of Credit Risk
Financial instruments that could potentially subject the Company to
concentration of credit risk include accounts receivable associated with our
human resource administration outsourcing subsidiary, which acts as a
co-employer with certain clients. As a co-employer, we contractually assume
substantial employer rights, responsibilities and risks of our clients'
employees,
43
who are considered co-employees. These accounts receivable, which are included
in other trade receivables on the consolidated balance sheets, consist of
service fees to be paid by our clients. Under the accrual method, earned but
unpaid wages at the end of each period related to the Company's worksite
employees are recognized as an accrued payroll liability as well as an account
receivable during the period in which wages are earned by the worksite employee.
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 $12.2 million as of December 31, 2002 and $15.4 million as of
December 31, 2001. Certain states limit a co-employer's liability for earned
payroll to minimum wage. This would reduce the Company's potential liability for
accrued co-employer payroll. In the event that a client does not pay their
related payroll and service fees prior to the applicable payroll date, the
Company has the right to cancel the co-employer contract or at its option,
require letters of credit or other collateral. The Company has generally not
required such collateral. As of December 31, 2002 the maximum exposure to any
one account for earned payroll is approximately $1.1 million. If the financial
condition of a client were to deteriorate rapidly, resulting in nonpayment, the
Company's accounts receivable balances could grow and the Company could be
required to provide for allowances, which would decrease net income in the
period that such determination was made.
HR outsourcing is also subject to geographic concentration. Approximately 32% of
co-employer client payroll is within the state of Florida. Other east coast
states, including Georgia, Maryland, New Jersey, Virginia, North Carolina, South
Carolina, Pennsylvania, New York, and Delaware, account for substantially all of
our other business. Consequently, changes to economic or regulatory conditions
in these states could adversely affect the HR outsourcing operations.
(h) Reinsurance
The Company records its ceded reinsurance transactions on a gross basis which
results in reinsurance recoverables on losses and loss expenses and ceded
unearned premiums (prepaid reinsurance premiums). The Company also discloses
reinsurance amounts for ceded premiums written and earned and ceded losses and
loss expenses incurred. See Note 4 for more information on reinsurance.
(i) Real Estate, Furniture, Equipment and Software Development
The value of real estate, furniture and equipment is stated at cost less
accumulated depreciation. Provisions for depreciation are computed using the
straight-line method over the estimated useful lives of the assets, which range
from three to forty years for financial statement purposes and the straight-line
method and various accelerated methods for federal income tax purposes. The
Company capitalizes the costs of computer software developed or obtained for
internal use and amortizes the cost using the straight-line method over
estimated useful lives of the systems being developed that range from three to
ten years.
(j) Deferred Policy Acquisition Costs
Policy acquisition costs are directly related to the writing of an insurance
policy and are deferred and amortized over the life of the policies in order to
facilitate a matching of revenues and expenses. These costs include labor costs,
commissions, premium taxes and assessments, boards, bureaus and dues, travel,
and other underwriting expenses incurred in the acquisition of premium. The
deferred policy acquisition costs are limited to the sum of unearned premiums
and anticipated investment income less anticipated losses and loss expenses,
policyholder dividends and other expenses for maintenance of policies in force.
The Company regularly conducts reviews for potential premium deficiencies. There
were no premium deficiencies for any of the reported years as the sum of the
anticipated losses and loss expenses, policyholder dividends and other expenses
did not exceed the related unearned premium and anticipated investment income.
Deferred policy acquisition costs amortized to expense were $280.6 million for
2002, $257.2 million for 2001 and $235.4 million for 2000. The investment yields
assumed for each reporting period, which are based upon the Company's actual
average investment yield, before-tax, were 5.4% for 2002, 5.4% for 2001 and 5.8%
for 2000.
(k) Goodwill
Goodwill results from business acquisitions where the cost of assets acquired
exceeds the fair value of those assets. The Company's goodwill balance by
operating segment is as follows:
(in thousands) 2002 2001
------- ------
Diversified insurance services goodwill $35,249 38,936
Insurance operations goodwill 7,559 7,559
------- ------
Total goodwill $42,808 46,495
======= ======
The decrease in goodwill in our Diversified Insurance Services segment is the
net effect of the sale of PDA Software Services, Inc. (PDA), $4.2 million,
offset by the acquisition of Northeast Health Direct, LLC (NHD), $0.5 million.
See Notes 12 and 1(r) for additional information regarding discontinued
operations and acquisitions, respectively.
44
As of January 1, 2002 the Company adopted the Financial Accounting Standards
Board (FASB) Statement of Financial Accounting Standards No. 142, "Goodwill and
Other Intangible Assets" (FAS 142). FAS 142 addresses the initial recognition
and measurement of goodwill and other intangible assets. FAS 142 changes the
accounting for goodwill and intangible assets that have indefinite useful lives
from an amortization approach to an impairment-only approach that requires those
assets to be tested at least annually for impairment. The statement is applied
to all goodwill and other intangible assets recognized in an entity's financial
statements at that date. Impairment losses that arise due to the initial
application of FAS 142 (resulting from an impairment test) are to be reported as
a change in accounting principle. No such impairments were recorded during 2002.
Goodwill amortization expense, which is included in other expenses on the
consolidated statements of income and mainly in the Diversified Insurance
Services segment, was $3.3 million for 2001 and $3.1 million for 2000.
The following table shows net income and earnings per share as if FAS 142 had
been adopted during those periods presented:
(in thousands, except per share amounts) 2002 2001 2000
---------- ---------- ----------
Income from continuing operations, as reported $ 42,138 26,318 26,686
Add back: Goodwill amortization, net of tax -- 2,178 2,155
---------- ---------- ----------
Adjusted income from continuing operations 42,138 28,496 28,841
Loss from discontinued operations, net of tax (169) (625) (151)
---------- ---------- ----------
Adjusted net income $ 41,969 27,871 28,690
========== ========== ==========
Basic earnings per share:
Income from continuing operations, as reported $ 1.67 1.07 1.07
Add back: Goodwill amortization, net of tax -- 0.09 0.09
---------- ---------- ----------
Adjusted income from continuing operations 1.67 1.16 1.16
Loss from discontinued operations, net of tax (0.01) (0.02) --
---------- ---------- ----------
Adjusted net income $ 1.66 1.14 1.16
========== ========== ==========
Diluted earnings per share:
Income from continuing operations, as reported $ 1.57 1.00 1.01
Add back: Goodwill amortization, net of tax -- 0.08 0.08
---------- ---------- ----------
Adjusted income from continuing operations 1.57 1.08 1.09
Loss from discontinued operations, net of tax (0.01) (0.02) --
---------- ---------- ----------
Adjusted net income $ 1.56 1.06 1.09
========== ========== ==========
(l) Reserves for Losses and Loss Expenses
In accordance with industry practice, the Company maintains reserves for losses
and loss expenses. These reserves are made up of both case reserves and reserves
for claims incurred but not yet reported (IBNR). Case reserves result from a
claim that has been reported to an insurance subsidiary and are estimated at the
amount of ultimate payment. Additional IBNR reserves are established based on
generally accepted actuarial techniques. Such techniques assume that past
experience, adjusted for the effects of current developments and anticipated
trends, are an appropriate basis for predicting future events.
The internal assumptions considered by the Company in the estimation of the IBNR
amounts for both environmental and non-environmental reserves at the Company's
reporting dates are based on: (i) an analysis of both paid and incurred loss and
loss expense development trends; (ii) an analysis of both paid and incurred
claim count development trends; (iii) the exposure estimates for reported
claims; (iv) recent development on exposure estimates with respect to individual
large claims and the aggregate of all claims; (v) the rate at which new
environmental claims are being reported; and (vi) patterns of events observed by
claims personnel or reported to them by defense counsel. External factors
identified by the Company in the estimation of IBNR for both environmental and
non-environmental IBNR reserves include: legislative enactments, judicial
decisions, legal developments in the determination of liability and the
imposition of damages, and trends in general economic conditions, including the
effects of inflation. Adjustments to IBNR are made periodically to take into
account changes in the volume of business written, claims frequency and
severity, the mix of business, claims processing and other items as described
that are expected by management to affect the Company's reserves for losses and
loss expenses over time.
By using both individual estimates of reported claims and generally accepted
actuarial reserving techniques, the Company estimates the ultimate net liability
for losses and loss expenses. While the ultimate actual liability may be higher
or lower than reserves established, the Company believes the reserves to be
adequate. Any changes in the liability estimate may be material to the results
of operations in future periods. The Company does not discount to present value
that portion of its loss reserves expected to be paid in future periods;
however, the loss reserves include anticipated recoveries for salvage and
subrogation claims. Such salvage and subrogation amounted to $40.5 million for
2002 and $37.6 million for 2001.
Reserves are reviewed for adequacy on a periodic basis. When reviewing reserves,
the Company analyzes historical data and estimates 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
45
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. Based upon such reviews, the Company believes that the estimated
reserves for losses and loss expenses are adequate to cover the ultimate cost of
claims. The changes in these estimates, resulting from the continuous review
process and the differences between estimates and ultimate payments, are
reflected in the consolidated statements of income for the period in which such
estimates are changed.
(m) Premium Revenue
Net premiums written include direct writings plus reinsurance assumed and
estimates of premiums earned but unbilled on the workers' compensation and
general liability lines of insurance, less reinsurance ceded. Premiums written
are recognized as revenue over the period that coverage is provided using the
semi-monthly pro rata method. Unearned premiums and prepaid reinsurance premiums
represent that portion of premiums written that are applicable to the unexpired
terms of policies in force.
(n) 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 footnote disclosures of net income and earnings per share as if
the fair value method of accounting, as defined in FAS 123, had been applied.
See Note 15 for more information.
As of December 31, 2002 the Company adopted the FASB Statement of Financial
Accounting Standards No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure" (FAS 148). FAS 148 amends FAS 123 to provide
alternative methods of transition to FAS 123's fair value method of accounting
for stock-based compensation. FAS 148 also amends the disclosure provisions of
FAS 123 to require disclosure in the Summary of Significant Accounting Policies
footnote the effects of an entity's accounting policy with respect to
stock-based employee compensation on reported net income and earnings per share.
The Company has adopted the pro forma footnote disclosure-only provisions of FAS
123. Based on the fair value method consistent with the provisions of FAS 123,
the Company's net income and earnings per share would have been reduced to the
following pro forma amounts indicated below:
(in thousands, except per share amounts) 2002 2001 2000
---------- ---------- ----------
Net income, as reported $ 41,969 25,693 26,535
Add: Stock-based employee compensation reported in net income,
net of related tax effect 2,502 1,955 2,498
Deduct: Total stock-based employee compensation expense determined
under fair value-based method for all awards, net of related tax effects (3,705) (3,693) (3,094)
---------- ---------- ----------
Pro forma net income $ 40,766 23,955 25,939
========== ========== ==========
Net income per share:
Basic - as reported $ 1.66 1.05 1.07
Basic - pro forma 1.61 0.97 1.04
Diluted - as reported 1.56 0.98 1.01
Diluted - pro forma 1.52 0.91 0.99
(o) Dividends to Policyholders
The Company establishes reserves for dividends to policyholders on certain
workers' compensation policies. These dividends are based on the policyholders'
loss experience. The dividend reserves are established based on past experience,
adjusted for the effects of current developments and anticipated trends. The
expense for these dividends is recognized over a period that begins at policy
inception and ends with the payment of the dividend. The expense recognized for
these dividends was $5.8 million in 2002, $8.3 million in 2001, and $7.7 million
in 2000. The Company issues no policies that entitle the policyholder to
participate in the earnings or surplus of the Insurance Subsidiaries.
(p) Federal Income Tax
The Company uses the asset and liability method of accounting for income taxes.
Deferred federal income taxes arise from the recognition of temporary
differences between financial statement carrying amounts and the tax basis of
the Company's assets and liabilities, as well as tax on net unrealized gains or
losses on available-for-sale securities. A valuation allowance is
46
established when it is more likely than not that some portion of the deferred
tax asset will not be realized. The effect of a change in tax rates is
recognized in the period of enactment.
(q) Statement of Cash Flows
Short-term investments are comprised of highly liquid investments that are
readily convertible into known amounts of cash. Such investments have maturities
of 90 days or less from the date of purchase.
The Company's cash paid during the year for interest and federal income taxes
and non-cash financing activities were as follows:
(in thousands) 2002 2001 2000
------- ------ ------
Cash paid during the year for:
Interest $13,724 14,236 12,536
Federal income tax 10,012 -- 304
Non-cash financing activity:
Conversion of convertible
subordinated debentures 2,459 58 2,309
Unearned stock compensation 4,480 3,845 3,156
(r) Acquisitions
During 2002, the Company completed the acquisition of NHD, a 16,000-location
network that operates in Connecticut and certain regions within the states of
Massachusetts, Vermont, and New Hampshire. Consumer Health Network Plus, LLC
(CHN), which is included in our Diversified Insurance Services segment, acquired
NHD for $3.2 million, including certain acquisition and financial performance
related costs, during 2002. CHN may be further required to pay additional
consideration of approximately $1.0 million over the next two years based on
certain criteria related to future financial performance. In connection with the
acquisition, the Company recorded intangible assets of $1.7 million for network
physician contracts and $0.7 million for existing client contracts. The network
physician contracts have an indefinite life and will be reviewed annually for
potential impairment. The client contracts are being amortized over their useful
lives, 3 years, with $0.2 million amortized to expense in 2002. These amounts
are included in other assets on the consolidated balance sheets.
Separate pro forma information of this acquisition has not been presented, as
management has determined that such information is not material.
NOTE 2 INVESTMENTS
(a) The components of net investment income earned are as follows:
(in thousands) 2002 2001 2000
--------- -------- --------
Debt securities $ 98,661 91,140 88,559
Equity securities 3,820 3,495 4,979
Short-term investments 620 1,996 2,773
Other investments 1,403 1,880 4,750
--------- -------- --------
104,504 98,511 101,061
Investment expenses (1,437) (1,744) (1,566)
--------- -------- --------
Net investment income earned $ 103,067 96,767 99,495
========= ======== ========
(b) Net unrealized gains on held-to-maturity debt securities are as follows:
(in thousands) 2002 2001 2000
--------- -------- --------
Net unrealized gains $ 5,467 7,101 5,880
========= ======== ========
Increase (decrease) in net
unrealized gains $ (1,634) 1,221 5,660
========= ======== ========
47
(c) Net unrealized gains (losses) on available-for-sale securities are as
follows:
(in thousands) 2002 2001 2000
--------- -------- --------
Debt securities $ 100,714 34,309 18,060
Equity securities 76,877 116,517 134,748
--------- -------- --------
Total net unrealized gains 177,591 150,826 152,808
Deferred income tax
expense (62,157) (52,789) (53,483)
--------- -------- --------
Net unrealized gains,
net of deferred income tax $ 115,434 98,037 99,325
========= ======== ========
Increase (decrease) in net
unrealized gains, net
of deferred income tax $ 17,397 (1,288) 22,631
========= ======== ========
(d) The amortized cost, estimated fair values and unrealized gains (losses) of
held-to-maturity debt securities at December 31, 2002 and 2001, respectively,
are as follows:
(in thousands) Amortized Cost Unrealized Gains Unrealized Losses Fair Value
2002 2001 2002 2001 2002 2001 2002 2001
---------- --------- ------- -------- ------- ---------- --------- ---------
U.S. government and
government agencies $ 2,102 2,120 10 73 -- -- 2,112 2,193
Obligations of states and
political subdivisions 103,215 164,029 5,385 6,793 (17) (50) 108,583 170,772
Mortgage-backed securities 4,001 9,304 89 285 -- -- 4,090 9,589
---------- --------- ------- -------- ------- ---------- --------- ---------
Total held-to-maturity
debt securities $ 109,318 175,453 5,484 7,151 (17) (50) 114,785 182,554
========== ========= ======= ======== ======= ========== ========= =========
(e) The cost/amortized cost, estimated fair values and unrealized gains (losses)
of available-for-sale securities at December 31, 2002 and 2001, respectively,
are as follows:
(in thousands) Cost/Amortized Cost Unrealized Gains Unrealized Losses Fair Value
2002 2001 2002 2001 2002 2001 2002 2001
---------- --------- ------- -------- ------- ---------- --------- ---------
U.S. government and
government agencies $ 203,540 124,046 14,408 4,509 (374) (996) 217,574 127,559
Obligations of states and
political subdivisions 435,188 489,241 25,292 17,454 (349) (1,072) 460,131 505,623
Corporate securities 507,275 576,626 37,555 19,169 (5,357) (8,908) 539,473 586,887
Asset-backed securities 21,857 6,827 700 20 (15) (313) 22,542 6,534
Mortgage-backed
securities 503,487 138,916 29,401 4,497 (547) (51) 532,341 143,362
---------- --------- ------- -------- ------- ---------- --------- ---------
Available-for-sale
debt securities 1,671,347 1,335,656 107,356 45,649 (6,642) (11,340) 1,772,061 1,369,965
Available-for-sale
equity securities 120,036 117,186 84,776 117,801 (7,899) (1,284) 196,913 233,703
---------- --------- ------- -------- ------- ---------- --------- ---------
Total available-for-
sale securities $1,791,383 1,452,842 192,132 163,450 (14,541) (12,624) 1,968,974 1,603,668
========== ========= ======= ======== ======= ========== ========= =========
(f) Realized gains (losses) are as follows:
(in thousands) 2002 2001 2000
-------- ------- -------
Held-to-maturity debt securities
Gains $ 248 74 8
Available-for-sale debt securities
Gains 8,846 2,727 197
Losses (13,494) (2,098) (2,340)
Available-for-sale equity securities
Gains 7,694 12,231 11,039
Losses -- (6,118) (4,713)
-------- ------- -------
Net realized gains $ 3,294 6,816 4,191
======== ======= =======
48
Proceeds from sale of available-for-sale securities were $240.3 million during
2002, $101.6 million during 2001, and $64.1 million during 2000.
(g) The amortized cost and estimated fair value of debt securities at December
31, 2002, by contractual maturity are shown below. Mortgage-backed securities
are included in the maturity tables using the estimated average life of each
security.
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.
Listed below are held-to-maturity debt securities:
Amortized Fair
(in thousands) Cost Value
---------- ---------
Due in one year or less $ 31,600 32,171
Due after one year through
five years 72,635 77,076
Due after five years through
ten years 4,319 4,617
Due after ten years through
fifteen years 764 921
---------- ---------
Total held-to-maturity
debt securities $ 109,318 114,785
========== =========
Listed below are available-for-sale debt securities:
Amortized Fair
(in thousands) Cost Value
---------- ---------
Due in one year or less $ 179,204 183,594
Due after one year through
five years 587,914 624,062
Due after five years through
ten years 756,217 808,235
Due after ten years through
fifteen years 138,012 146,356
Due after fifteen years 10,000 9,814
---------- ---------
Total available-for-sale
debt securities $1,671,347 1,772,061
========== =========
(h) Certain investments were on deposit with various state regulatory agencies
to comply with insurance laws with carrying values of $26.1 million as of
December 31, 2002 and $18.4 million at December 31, 2001.
(i) The Company is not exposed to significant concentrations of credit risk
within its investment portfolio.
(j) Included in other investments is $23.5 million of investments in limited
partnerships in 2002 and $14.7 million in 2001. These investments are purchased
and sold through an investment advisor and are carried at the equity method,
which approximates fair value. Any change in fair value of these investments is
recognized in net investment income earned in the period of change. At December
31, 2002 the Company has additional investment commitments of up to $16.4
million. There is no certainty that any additional investment will be required.
49
(k) The components of comprehensive income, both gross and net of tax, for 2002,
2001 and 2000 are as follows:
2002
(in thousands) Gross Tax Net
-------- ------- -------
Income $ 52,651 10,682 41,969
-------- ------- -------
Components of other
comprehensive income:
Unrealized holding gains
during the period 28,107 9,838 18,269
Reclassification adjustment (1,342) (470) (872)
-------- ------- -------
Other comprehensive income 26,765 9,368 17,397
-------- ------- -------
Comprehensive income $ 79,416 20,050 59,366
======== ======= =======
2001
(in thousands) Gross Tax Net
-------- ------- -------
Income $ 22,839 (2,854) 25,693
-------- ------- -------
Components of other
comprehensive loss:
Unrealized holding gains
during the period 3,229 1,130 2,099
Reclassification adjustment (5,211) (1,824) (3,387)
-------- ------- -------
Other comprehensive loss (1,982) (694) (1,288)
-------- ------- -------
Comprehensive income $ 20,857 (3,548) 24,405
======== ======= =======
2000
(in thousands) Gross Tax Net
-------- ------- -------
Income $ 24,544 (1,991) 26,535
-------- ------- -------
Components of other
comprehensive income:
Unrealized holding gains
during the period 39,249 13,737 25,512
Reclassification adjustment (4,432) (1,551) (2,881)
-------- ------- -------
Other comprehensive income 34,817 12,186 22,631
-------- ------- -------
Comprehensive income $ 59,361 10,195 49,166
======== ======= =======
50
NOTE 3 FAIR VALUES OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and estimated fair values of
the Company's financial instruments as of December 31, 2002 and 2001:
2002 2001
-------------------------- -------------------------
CARRYING FAIR Carrying Fair
(in thousands) AMOUNT VALUE Amount Value
---------- --------- --------- ---------
FINANCIAL ASSETS
Debt securities:
Held-to-maturity $ 109,318 114,785 175,453 182,554
Available-for-sale 1,772,061 1,772,061 1,369,965 1,369,965
Equity securities 196,913 196,913 233,703 233,703
Other investments 48,259 48,259 34,188 34,188
FINANCIAL LIABILITIES
Notes payable:
8.77% Senior Notes 54,000 58,059 54,000 57,698
7.84% Senior Notes -- -- 7,143 7,405
8.63% Senior Notes Series A 30,000 32,185 30,000 31,380
8.87% Senior Notes Series B 61,500 66,525 61,500 63,848
---------- --------- --------- ---------
Total notes payable 145,500 156,769 152,643 160,331
Senior convertible notes 115,937 128,863 -- --
Convertible subordinated debentures 1,331 4,737 3,790 11,607
The Company's carrying amounts shown in the table are included in the
consolidated balance sheets. The convertible subordinated debentures are
included in "other liabilities" on the consolidated balance sheets. See Note 1
(e) for the methods and assumptions used by the Company in estimating the fair
values of its financial instruments.
NOTE 4 REINSURANCE
In the ordinary course of business, the Insurance Subsidiaries assume and cede
premiums with other reinsurance and insurance companies and various pools and
associations of which they are members. A large portion of the reinsurance is
effected under reinsurance contracts known as treaties and, in some instances,
by negotiation on each individual risk. The Insurance Subsidiaries have in place
excess of loss and catastrophe reinsurance treaties which protect against losses
over stipulated amounts arising from any one occurrence or event and quota share
reinsurance treaties where the Company and the reinsurer share the amount of
premium and covered losses based on a stated percentage. The reinsurance
arrangements enable greater diversification of business and can serve to limit
the maximum net loss on catastrophes and large and unusually hazardous risks.
The Insurance Subsidiaries are contingently liable to the extent that any
reinsurer becomes unable to meet its contractual obligations. The Company
reviews the financial condition of its existing reinsurers for any potential
write-offs of uncollectible amounts as well as suitability to remain on the
reinsurance program. The Company had prepaid reinsurance premiums and net
reinsurance recoverables with American Re-Insurance Company (American Re) (rated
"A+ Superior" by A.M. Best Company, Inc.) that amounted to $62.0 million at
December 31, 2002 and $71.0 million at December 31, 2001, and a state insurance
fund for $64.9 million in 2002 and $76.5 million in 2001. The Company has a
$39.6 million trust fund agreement with American Re that secures a portion of
their recoverable amounts.
Under the Company's reinsurance arrangements, which are all prospective in
nature, reinsurance premiums ceded are recorded as prepaid reinsurance and
amortized over the remaining contract period in proportion to the reinsurance
protection provided, or recorded periodically, as per terms of the contract, in
a direct relationship to the direct premium recording.
51
Recoveries are recognized as direct losses are recorded.
(in thousands) 2002 2001 2000
----------- ---------- --------
Premiums written:
Direct $ 1,161,536 1,012,735 924,431
Assumed 25,274 21,789 14,192
Ceded (133,323) (109,104) (95,019)
----------- ---------- --------
Net $ 1,053,487 925,420 843,604
----------- ---------- --------
Premiums earned:
Direct $ 1,092,672 964,762 901,189
Assumed 22,711 20,555 14,529
Ceded (127,115) (102,269) (94,453)
----------- ---------- --------
Net $ 988,268 883,048 821,265
----------- ---------- --------
Losses and loss expenses incurred:
Direct $ 732,944 706,785 652,860
Assumed 21,055 22,255 11,007
Ceded (39,419) (73,156) (49,801)
----------- ---------- --------
Net $ 714,580 655,884 614,066
----------- ---------- --------
Flood business, which we cede 100% to the National Flood Insurance Program, is
included in the above amounts as follows:
(in thousands) 2002 2001 2000
-------- ------- -------
Ceded premiums written $(53,266) (42,433) (35,085)
Ceded premiums earned (48,012) (37,191) (34,472)
Ceded losses and loss expenses incurred (4,865) (11,930) (7,712)
In addition to our flood business, ceded premiums written increased
approximately $13.0 million in 2002 compared with 2001, due to increased direct
premiums written and reinsurance rates.
Ceded losses and loss expenses incurred decreased in 2002 compared with 2001,
beyond our flood business included in the above table, due to: i) a decrease in
losses ceded to a state insurance fund of $ 9.1 million, ii) a decrease in
casualty losses of $7.8 million and iii) a decrease in property losses of $11.2
million.
NOTE 5 RESERVES FOR LOSSES AND LOSS EXPENSES
The table below provides a roll-forward of reserves for losses and loss expenses
for beginning and ending reserve balances:
(in thousands) 2002 2001 2000
---------- --------- ----------
Gross reserves for losses and loss expenses at beginning of year $1,298,338 1,272,656 1,273,808
Less reinsurance recoverable on unpaid loss and loss
expenses at beginning of year 166,511 160,869 192,044
---------- --------- ----------
Net reserves for losses and loss expenses at beginning of year 1,131,827 1,111,787 1,081,764
---------- --------- ----------
Incurred losses and loss expenses for claims occurring in the:
Current year 694,744 642,173 615,095
Prior years 19,836 13,711 (1,029)
---------- --------- ----------
Total incurred losses and loss expenses 714,580 655,884 614,066
---------- --------- ----------
Paid losses and loss expenses occurring in the:
Current year 226,286 236,620 235,879
Prior years 377,070 399,224 348,164
---------- --------- ----------
Total paid losses and loss expenses 603,356 635,844 584,043
---------- --------- ----------
Net reserves for losses and loss expenses at end of year 1,243,051 1,131,827 1,111,787
Reinsurance recoverable on unpaid loss and loss
expenses at end of year 160,374 166,511 160,869
---------- --------- ----------
Gross reserves for losses and loss expenses at end of year $1,403,425 1,298,338 1,272,656
========== ========= ==========
52
Incurred loss and loss expense development related to prior years was $19.8
million in 2002, $13.7 million in 2001 and ($1.0) million in 2000, while net
loss and loss expense reserves increased by $111.2 million in 2002 and by $20.0
million in 2001. These changes were the result of normal reserve development
inherent in the uncertainty in establishing reserves for losses and loss
expenses, anticipated loss trends, growth in business, as well as increased
reinsurance retentions.
During 2002, the only line of business that demonstrated significant prior year
development was the Other Liability line of business. In this line, estimates
for prior year losses increased by $21.1 million, primarily in accident years
1998 and 1999. The Other Liability line of business is inherently volatile which
makes it more difficult to reserve.
In addition, changes in our claims operation including senior management changes
and the development of a field claims model over the past four years have
impacted claim settlement patterns and average case reserves. During 2002, these
changes were minimal relative to the previous three years. This, combined with
higher than expected loss emergence in 2002 for past accident years, has led us
to recognize an increase in our estimates for these older periods.
As additional information is collected in the loss settlement process, reserves
are adjusted accordingly. These adjustments are reflected in the consolidated
statements of income in the period in which such adjustments are recognized.
These adjustments could have a material impact on the results of operations of
future periods when the adjustments are made.
NOTE 6 INDEBTEDNESS
(a) Senior Convertible Notes
In 2002 the Company issued $305 million aggregate principal amount of 1.6155%
senior convertible notes (Convertible Notes), due September 24, 2032, at a
discount of 61.988% resulting in an effective yield of 4.25%. The Company
recorded gross proceeds of $116.0 million along with $3.2 million of deferred
charges, which are amortized over the life of the note, in connection with debt
issuance costs. $72.0 million of the net proceeds have been used to fund an
irrevocable trust to provide for certain payment obligations in respect of the
Company's outstanding debt obligations. The Company paid as a capital
contribution $40.0 million to the Company's insurance operating subsidiaries.
Interest on the Convertible Notes is payable semi-annually at a rate of 1.6155%
beginning March 24, 2003 until September 24, 2009, to holders of record at the
close of business on the preceding March 9 or September 9, respectively. After
that date, cash interest will not be paid on the Convertible Notes prior to
maturity unless contingent cash interest becomes payable. Contingent cash
interest becomes payable if the average market price of a Convertible Note for
the applicable five trading day period equals 120% or more of the sum of the
Convertible Note's issue price, accrued original issue discount and accrued cash
interest, if any, for a Convertible Note to the day immediately preceding the
relevant six-month period. The contingent cash interest payable per Convertible
Note in respect of any quarterly period within any six-month period will equal
the greater of (a) any regular cash dividends per share paid by the Company on
our common stock during that quarterly period multiplied by the then applicable
conversion rate or (b) $0.15 multiplied by 12.9783. The Convertible Notes will
be convertible at the option of the holders, if the conditions for conversion
are satisfied, into shares of the Company's common stock at a conversion price
of $29.29. Holders may also surrender Convertible Notes for conversion only
during any period in which the credit rating assigned to the Convertible Notes
is Ba2 or lower by Moody's Investors Service, Inc. (Moody's) or BB+ or lower by
Standard and Poor's Credit Market Services (S&P), the Convertible Notes are no
longer rated by either Moody's or S&P, or the credit rating assigned to the
Convertible Notes has been suspended or withdrawn by either Moody's or S&P. The
Convertible Notes will cease to be convertible pursuant to this credit rating
criteria during any period or periods in which all of the credit ratings are
increased above such levels. The 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, or such
Convertible Notes to the applicable redemption date. The holders of the
Convertible Notes may require the Company to purchase all or a portion of their
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.
The Company has various covenants under the Indenture dated September 24, 2002,
which include, but are not limited to, timely payment of securities, timely
filing of Securities and Exchange Commission and other reports, and compliance
with securities laws upon purchase of securities.
(b) Notes Payable
(1) On May 4, 2000, the Company entered into a $30.0 million and a $61.5 million
note purchase agreement with various lenders covering the 8.63% and 8.87% Senior
Notes, respectively.
For the 8.63% Senior Notes, the Company is required to pay $6.0 million
principal amount in each year commencing on May 4, 2003 and ending on May 4,
2007, inclusive, together with accrued interest thereon. The unpaid principal
amount of these Senior Notes accrues interest and is payable semiannually on May
4 and November 4 of each year, until the principal is paid in full.
53
For the 8.87% Senior Notes, the Company is required to pay $12.3 million
principal amount in each year commencing on May 4, 2006 and ending on May 4,
2010, inclusive, together with accrued interest thereon. The unpaid principal
amount of these Senior Notes accrues interest and is payable semiannually on May
4 and November 4 of each year, until the principal is paid in full.
(2) On August 12, 1994, the Company entered into a $54.0 million note purchase
agreement with various lenders covering the 8.77% Senior Notes. The Company is
required to pay $18.0 million principal amount in each year commencing on August
1, 2003 and ending on August 1, 2005, inclusive, together with accrued interest
thereon. The unpaid principal amount of the 8.77% Senior Notes accrues interest
and is payable semiannually on February 1 and August 1 of each year, until the
principal is paid in full.
(3) On November 24, 1992, the Company entered into a $50.0 million note purchase
agreement with various lenders covering the 7.84% Senior Notes. The Company made
its final required principal payment of $7.1 million on November 15, 2002
together with accrued interest thereon.
Each note purchase agreement contains restrictive business covenants that are
reviewed quarterly. They include, but are not limited to, a limitation on
indebtedness, restricted ability to declare dividends and net worth maintenance.
At December 31, 2002 the amount available for dividends to stockholders under
said restrictions was $176.4 million for the 1994 Senior Notes and $138.6
million for the 2000 Senior Notes.
(c) Convertible Subordinated Debentures
The Debentures were issued under an Indenture dated December 29, 1982,
("Indenture") in the principal amount of $25.0 million, bearing interest at a
rate of 8.75% per annum, which is payable on the unpaid principal semiannually
on January 1 and July 1 in each year to holders of record at the close of
business on the preceding December 15 and June 15, respectively. The Debentures
are convertible into common stock at an effective conversion price of $7.08 per
share. The principal amount of the Debentures, $1.3 million at 2002 and $3.8
million at 2001, including any accrued interest, is due on January 1, 2008 and
is included in other liabilities on the consolidated balance sheets.
The Indenture requires the Company to retire, through the operation of a
mandatory sinking fund, 5% of the original $25.0 million aggregate principal
amount of the debentures on, or before December 31 of each of the years from
1993, to and including, 2006. Voluntary conversions have satisfied this
obligation in its entirety.
(d) Short-Term Debt The Company has revolving lines of credit with State Street
Corporation, $25.0 million, and Wachovia Bank (formerly First Union National
Bank), $25.0 million, totaling $50.0 million at December 31, 2002 and 2001. At
December 31, 2002 and 2001, there were no balances outstanding. Interest is
determined on a LIBOR, prime rate or money market rate basis at the Company's
option. The weighted average interest rate on these borrowings was 5.3% in 2001.
No borrowings were made during 2002.
NOTE 7 STOCKHOLDERS' EQUITY
Under a common stock repurchase program authorized by the Board of Directors on
July 29, 1996 and extended on July 28, 1998, May 7, 1999, November 2, 1999,
February 3, 2000, May 31, 2001 and May 31, 2002, the Company can repurchase up
to 8,000,000 shares. The Company acquired 11,000 shares for $0.2 million in
2002, 0.3 million shares for $7.5 million in 2001 and 2.1 million shares for
$36.5 million in 2000. The total amount of stock repurchased under this program
since July 29, 1996 through December 31, 2002 is 7.3 million shares at a total
cost of $140.5 million.
The Company maintains a dividend reinvestment plan, under which 60,598 shares of
common stock are available for issuance. Shares purchased under this plan are
issued at fair value. As of December 31, 2002, the Company had an additional 6.4
million shares reserved for various stock compensation plans, retirement plans
and debt offerings.
Shares repurchased in conjunction with restricted stock vestings and option
exercises were 117,000 shares at a cost of $2.8 million in 2002, 133,000 shares
at a cost of $3.2 million in 2001 and 69,000 shares at a cost of $1.1 million in
2000.
Selective's ability to declare and pay dividends on common stock is affected by
the ability of its subsidiaries to declare and pay dividends to the holding
company. The dividends from Diversified Insurance Services subsidiaries are
restricted only by the operating needs of those subsidiaries. The dividends from
Insurance Subsidiaries are under the regulatory limitations of the states in
which the Insurance Subsidiaries are domiciled: New Jersey, New York, North
Carolina and South Carolina.
In all such jurisdictions, domestic insurers are prohibited from paying
"extraordinary dividends" without approval of the insurance commissioner of the
respective state. Additionally, New Jersey and South Carolina require notice of
the declaration of any ordinary or extraordinary dividend distribution. During
the notice period, the relevant state regulatory authority may disallow all or
part of the proposed dividend if it determines that the insurer's surplus, with
regard to policyholders, is not reasonable in relation to the insurer's
outstanding liabilities and adequate for its financial needs.
54
Based on the unaudited 2002 statutory financial statements, the maximum ordinary
dividends that can be paid to Selective in 2003 are:
(in millions)
Selective Insurance Company of America $30.4
Selective Way Insurance Company 11.4
Selective Insurance Company of the Southeast 2.7
Selective Insurance Company of South Carolina 2.5
Selective Insurance Company of New York 4.1
-----
Total $51.1
=====
The statutory capital and surplus of the Insurance Subsidiaries in excess of
these ordinary dividend amounts must remain with the Insurance Subsidiaries in
the absence of the approval of a request for an extraordinary dividend.
NOTE 8 PREFERRED SHARE PURCHASE RIGHTS PLAN
On February 2, 1999, Selective's Board of Directors approved the amended and
restated stockholder rights plan. The rights to purchase one two-hundredth of a
share of Selective Series A Junior Preferred Stock at an exercise price of $80
are attached to all shares of Selective common stock and are exercisable ten
days after an announcement that a person or group has acquired 15% or more of
the common stock (Acquiring Person) or ten business days after a person
commences or announces its intent to make a tender offer which would result in
their acquiring 15% or more of the common stock (Acquiring Person). If a person
or group becomes an Acquiring Person, each right will entitle the holder, other
than the Acquiring Person, to purchase the number of Selective common shares
having a market value of two times the exercise price of $80.
If Selective is acquired in a merger, or 50% or more of its assets are sold,
each right other than the rights of an Acquiring Person, will be exercisable to
purchase shares of the acquiring company having twice the market value of the
$80 exercise price.
Before an Acquiring Person acquires 50% or more of the common shares,
Selective's Board may exchange rights, other than the rights of an Acquiring
Person, at an exchange ratio of one share of common stock per right. The rights
expire February 2, 2009, unless Selective's Board redeems them at $0.01 per
right before a person or group triggers the plan or unless Selective's Board
exchanges them for common stock.
NOTE 9 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. Insurance Operations are
evaluated based on GAAP underwriting results, 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. The Diversified Insurance
Services segment is managed independently from the other segments and,
therefore, has been classified separately. The Diversified Insurance Services
segment consists of managed care, flood operations and human resource
administration outsourcing (HR Outsourcing). The segment results are determined
taking into account the net revenues generated in each of the businesses, less
the costs of operations. Prior years have been restated to exclude software
development and administration, which are accounted for as discontinued
operations in 2002 and 2001.
Selective and its subsidiaries provide services to each other in the normal
course of business. These transactions totaled $12.4 million in 2002, $14.1
million in 2001 and $14.5 million in 2000. These transactions were eliminated in
all consolidated financial 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.
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 for
the individual segments:
55
REVENUE BY SEGMENT
(in thousands) 2002 2001 2000
----------- ---------- --------
INSURANCE OPERATIONS:
Commercial lines net premiums earned $ 788,454 678,321 611,865
Personal lines net premiums earned 199,814 204,727 209,400
----------- ---------- --------
Total insurance operations revenues 988,268 883,048 821,265
----------- ---------- --------
INVESTMENTS:
Net investment income 103,067 96,767 99,495
Net realized gains on investments 3,294 6,816 4,191
----------- ---------- --------
Total investment revenues 106,361 103,583 103,686
----------- ---------- --------
DIVERSIFIED INSURANCE SERVICES:
Diversified insurance services revenues,
from continuing operations 80,796 69,626 57,527
----------- ---------- --------
Other income 3,525 2,763 3,739
----------- ---------- --------
TOTAL REVENUES FROM CONTINUING
OPERATIONS $ 1,178,950 1,059,020 986,217
=========== ========== ========
Income or (loss) from continuing operations before federal income tax by
segment:
(in thousands) 2002 2001 2000
----------- ---------- --------
INSURANCE OPERATIONS:
Commercial lines underwriting $ (21,135) (32,970) (45,186)
Personal lines underwriting (17,608) (27,668) (19,936)
----------- ---------- --------
Underwriting loss, before federal
income tax (38,743) (60,638) (65,122)
----------- ---------- --------
INVESTMENTS:
Net investment income 103,067 96,767 99,495
Net realized gains on investments 3,294 6,816 4,191
----------- ---------- --------
Total investment income, before federal income tax 106,361 103,583 103,686
----------- ---------- --------
DIVERSIFIED INSURANCE SERVICES:
Income (loss) from continuing operations,
before federal income tax 5,914 (427) 5,509
----------- ---------- --------
TOTAL ALL SEGMENTS 73,532 42,518 44,073
Interest expense (15,093) (14,526) (13,745)
General corporate expenses (5,532) (4,294) (5,502)
----------- ---------- --------
INCOME FROM CONTINUING OPERATIONS,
BEFORE FEDERAL INCOME TAX $ 52,907 23,698 24,826
=========== ========== ========
56
NOTE 10 EARNINGS PER SHARE
The following table provides a reconciliation of the numerators and denominators
of the basic and diluted earning per share (EPS) computations of net income for
the year ended:
2002
INCOME (LOSS) SHARES PER SHARE
(in thousands, except per share amounts) (NUMERATOR) (DENOMINATOR) AMOUNT
------------- ------------- ---------
Basic EPS:
Net income from continuing operations $ 42,138 25,301 $ 1.67
Net (loss) from discontinued operations (169) 25,301 (0.01)
-------- --------
Net income available to common stockholders $ 41,969 25,301 $ 1.66
======== ====== ========
Effect of dilutive securities:
Restricted stock -- 796
8.75% convertible subordinated debentures 143 363
Stock options -- 359
Deferred shares -- 103
-------- ------
Diluted EPS:
Income from continuing operations $ 42,281 26,922 $ 1.57
Net (loss) from discontinued operations (169) 26,922 (0.01)
-------- --------
Income available to common stockholders
and assumed conversions $ 42,112 26,922 $ 1.56
======== ====== ========
2001
Income (Loss) Shares Per Share
(in thousands, except per share amounts) (Numerator) (Denominator) Amount
------------- ------------- ---------
Basic EPS:
Net income from continuing operations $ 26,318 24,583 $ 1.07
Net (loss) from discontinued operations (625) 24,583 (0.02)
-------- --------
Net income available to common stockholders $ 25,693 24,583 $ 1.05
======== ====== ========
Effect of dilutive securities:
Restricted stock -- 769
8.75% convertible subordinated debentures 220 540
Stock options (141) 469
Deferred shares -- 63
-------- ------
Diluted EPS:
Income from continuing operations $ 26,397 26,424 $ 1.00
Net (loss) from discontinued operations (625) 26,424 (0.02)
-------- --------
Income available to common stockholders
and assumed conversions $ 25,772 26,424 $ 0.98
======== ====== ========
57
2000
Income (Loss) Shares Per Share
(in thousands, except per share amounts) (Numerator) (Denominator) Amount
------------- ------------- ---------
Basic EPS:
Net income from continuing operations $ 26,686 24,907 $ 1.07
Net (loss) from discontinued operations (151) 24,907 --
-------- --------
Net income available to common stockholders $ 26,535 24,907 $ 1.07
======== ====== ========
Effect of dilutive securities:
Restricted stock -- 752
8.75% convertible subordinated debentures 250 649
Stock options (18) 210
Deferred shares -- 54
-------- ------
Diluted EPS:
Income from continuing operations $ 26,918 26,572 $ 1.01
Net (loss) from discontinued operations (151) 26,572 --
-------- --------
Income available to common stockholders
and assumed conversions $ 26,767 26,572 $ 1.01
======== ====== ========
NOTE 11 FEDERAL INCOME TAX
(a) A reconciliation of federal income tax on pretax earnings at the corporate
rate to the effective tax rate is as follows:
(in thousands) 2002 2001 2000
-------- ------ ------
Tax at statutory rate of 35% $ 18,517 8,294 8,689
Tax-exempt interest (7,138) (8,764) (9,495)
Dividends received deduction (2,222) (2,333) (1,997)
Other 1,612 183 943
-------- ------ ------
Federal income tax expense (benefit) $ 10,769 (2,620) (1,860)
======== ====== ======
(b) The tax effects of the significant temporary differences that give rise to
deferred tax liabilities and assets are as follows:
(in thousands) 2002 2001
-------- -------
Deferred tax liabilities:
Deferred policy acquisition costs $ 51,852 46,075
Unrealized gains on available-for-sale securities 62,359 52,789
Accelerated depreciation 4,301 3,735
Premium audit accrual 2,802 4,140
Amortization of discount on bonds 2,301 2,572
Other 2,085 2,348
-------- -------
Total deferred tax liabilities 125,700 111,659
Deferred tax assets:
Net loss reserve discounting 70,864 65,419
Net unearned premiums 35,812 31,205
Self-insured employee benefit reserves 3,043 2,434
Pension 2,304 3,556
Deferred compensation 2,948 2,756
Alternative minimum tax 14,415 11,225
Allowance for doubtful accounts 994 1,272
Other 4,027 3,758
-------- -------
Total deferred tax assets 134,407 121,625
Valuation allowance recognized for
deferred tax assets -- 550
-------- -------
Deferred federal income tax $ 8,707 9,416
======== =======
58
Based on our tax loss carryback availability, and the historic levels of current
taxable income and pretax financial statement income, we believe that more
likely than not, the existing deductible temporary differences will reverse
during periods in which we will generate net taxable income or have adequate
carryback availability. As a result, the Company has taken down the valuation
allowance recognized for deferred tax assets.
Stockholders' equity reflects tax benefits related to compensation expense
deductions for stock options exercised of $2.4 million at December 31, 2002, and
$1.3 million at December 31, 2001. There was no tax benefit recognized in 2000.
NOTE 12 DISCONTINUED OPERATIONS
In December 2001, the Company's management adopted a plan to divest itself of
its 100% ownership interest in PDA. During May 2002, the Company sold all of the
issued and outstanding shares of capital stock and certain software applications
developed by PDA for proceeds of $16.3 million at a net gain of $0.5 million.
This gain is included in discontinued operations, on the consolidated statements
of income. The tax benefit included in the loss from discontinued operations was
$0.4 million for 2002, $0.2 million for 2001 and $0.1 million for 2000. The
amount of tax expense in 2002 for the gain on disposition of discontinued
operations is $0.3 million. As a result of the sale, $5.0 million of capitalized
software development cost were recovered. We have reclassified all prior period
amounts to present the operating results of PDA as a discontinued operation.
Operating results from discontinued operations are as follows:
(in thousands) 2002 2001 2000
------- ------- -------
Net revenue $ 8,186 18,001 18,536
Pre-tax loss (1,085) (859) (281)
Net loss (708) (625) (151)
Gain on disposition, net of tax 539 -- --
NOTE 13 RETIREMENT PLANS
(a) Retirement Plan for Nonemployee Directors
The Company terminated, effective December 31, 1997, a nonqualified defined
benefit retirement income plan for nonemployee Directors. The estimated accrued
costs for this plan were not material. As part of the termination, the present
value of each Director's future benefits, as of that date, was converted into
units based on the fair value of Selective common stock. The original
termination called for the cash value of these units based upon the fair value
of Selective common stock on retirement date to be distributed to each Director,
or at each Director's election, over a period of fifteen years after such
retirement. On May 8, 2002, the shareholders approved the conversion of the
units issued under the termination plan into shares of Selective stock. All of
the shares issued under this conversion have been deferred by the participants
for receipt upon retirement, or at each Director's election, over a period of no
more than 5 years after such retirement. These deferred shares, which are
currently being held in accounts on behalf of each Director, are credited with
cash dividends along with interest on those dividends. The accrued liability of
these deferred shares of stock and the related dividend and interest earnings at
December 31, 2002 was $1.5 million compared with the accrued liability for the
units outstanding at December 31, 2001 of $1.4 million.
(b) Retirement Savings Plan
The Company offers a voluntary defined contribution 401(k) retirement savings
plan to employees who meet eligibility requirements. The plan allows employees
to make voluntary contributions to a number of diversified investment options
including the Company's common stock, on a before and/or after-tax basis. Shares
of the Company's common stock issued under this plan were 23,496 during 2002 and
23,095 during 2001.
The number of shares of the Company's common stock available to be purchased
under the plan was 824,587 at December 31, 2002. During the first six months of
2002 and all of 2001, employees could contribute up to a maximum of 12% of their
defined compensation and these contributions, up to a maximum of 6%, were
matched 50% by the Company. Effective July 1, 2002 employees can contribute 50%
of their defined compensation and these contributions, up to a maximum of 7%,
are matched 65% by the Company.
An additional defined contribution plan is maintained by Selective HR Solutions,
a subsidiary of the Diversified Insurance Services segment, which does not
participate in the Company's defined contribution plan. The plan allows
employees to contribute a maximum of 15% of defined compensation and up to 3% of
contributions are matched 200% by the employer.
Employer contributions for all the plans amounted to $3.1 million in 2002, $2.6
million in 2001 and $2.2 million in 2000.
59
(c) Deferred Compensation Plan
Effective July 1, 2002, the Company began offering a nonqualifed deferred
compensation plan (deferred compensation plan) to a group of management or
highly compensated employees (the Participants). The plan provides the
Participants the opportunity to elect to defer receipt of specified portions of
compensation and to have such deferred amounts treated as if invested in
specified investment options as a method of rewarding and retaining such
employees. A Participant in the plan may elect to defer compensation or awards
to be received from the Company or an affiliated entity, including up to: (i)
50% annual base salary; (ii) 100% of incentive compensation, and/or (iii) a
percentage of other compensation as otherwise designated by the Administrator of
the plan.
In addition to the deferrals elected by the Participants, the Company may choose
at any time to make discretionary Company contributions on a consistent basis to
the deferral accounts of all Participants in its sole discretion. No
discretionary contributions were made. The Company may also choose to make
matching contributions to the deferral accounts of some or all Participants to
the extent a Participant did not receive the maximum matching contribution
permissible under the Selective Insurance Retirement Savings Plan due to
limitations under the Internal Revenue Code or such plan.
During 2002, the Company contributed $0.1 million to the deferred compensation
plan.
(d) Retirement Income and Postretirement Plans
The Company has a noncontributory defined benefit retirement income plan
covering substantially all employees who meet eligibility requirements. The
Company's funding policy provides that payments to the pension trust shall be
equal to the minimum funding requirements of the Employee Retirement Income
Security Act, plus additional amounts that may be approved by the Company from
time to time. Effective July 1, 2002, two new amendments to the plan were
adopted. For new entrants into the plan the monthly retirement benefits
beginning at normal retirement were decreased to 1.2% from 2.0% of the average
monthly compensation as defined. Also, for all plan participants the early
retirement age was changed to include a formula, whereby age plus years of
service must sum to at least 70.
The plan's assets are generally invested in debt and equity securities. The debt
securities are invested 100% in investment grade quality securities.
The Company also provides life insurance benefits ("postretirement benefits")
for retired employees. Substantially all the Company's employees may become
eligible for these benefits if they reach retirement age while working for the
Company and meet a minimum of ten years of eligibility service. Those who
retired prior to January 1, 1991 receive life insurance coverage which decreases
over ten years to a current ultimate value of $5,000 per retiree. Those retiring
on or after January 1, 1991 receive life insurance coverage in an amount equal
to 50% of their annual salary amount in effect at the end of their active career
to a maximum benefit of $100,000. Those retiring on or after January 1, 2002
receive life insurance coverage in an amount equal to 50% of their annual salary
amount in effect at the end of their active career to a maximum benefit of
$35,000.
The estimated cost of these benefits is accrued over the working lives of those
employees expected to qualify for such benefits as a level percentage of their
payroll costs.
Retirement Income Plan Postretirement Plan
---------------------- -------------------
(in thousands) 2002 2001 2002 2001
-------- ------- ------ ------
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation, beginning of year $ 82,147 69,614 6,198 5,406
Service cost 4,487 4,723 276 273
Interest cost 5,902 5,225 400 403
Amendments 1,134 -- (844) --
Actuarial losses 5,768 4,602 264 319
Benefits paid (2,273) (2,017) (187) (203)
-------- ------- ------ ------
Benefit obligation, end of year $ 97,165 82,147 6,107 6,198
======== ======= ====== ======
CHANGE IN FAIR VALUE OF ASSETS:
Fair value of assets, beginning of year $ 55,455 51,845 -- --
Actual return on plan assets (net of
expenses) 165 632 -- --
Contributions by the employer 7,407 4,978 -- --
Benefits paid (2,236) (2,000) -- --
-------- ------- ------ ------
Fair value of assets, end of year $ 60,791 55,455 -- --
======== ======= ====== ======
RECONCILIATION OF FUNDED STATUS:
Funded status $(36,374) (26,692) (6,107) (6,198)
Unrecognized prior service cost 1,688 759 (395) 456
Unrecognized net (gain) loss 22,762 12,507 57 (212)
-------- ------- ------ ------
Net amount recognized $(11,924) (13,426) (6,445) (5,954)
======== ======= ====== ======
60
Retirement Income Plan Postretirement Plan
-------------------------------- -----------------------
(in thousands) 2002 2001 2000 2002 2001 2000
------- ------ ------ ---- ---- ----
COMPONENTS OF NET PERIODIC
BENEFIT COST:
Service cost $ 4,487 4,723 4,047 276 273 216
Interest cost 5,902 5,225 4,638 400 403 374
Expected return on plan assets (4,904) (4,610) (4,222) -- -- --
Amortization of unrecognized
prior service cost 205 172 172 7 46 46
Amortization of unrecognized
net loss 252 11 12 (5) (2) --
------- ------ ------ ---- ---- ---
Net periodic cost $ 5,942 5,521 4,647 678 720 636
======= ====== ====== ==== ==== ===
WEIGHTED-AVERAGE ASSUMPTIONS
AS OF DECEMBER 31:
Discount rate 6.75% 7.25 7.50 6.75 7.25 7.50
Expected return on plan assets 8.25% 8.50 8.50 -- -- --
Rate of compensation increase 5.00% 5.00 5.00 5.00 5.00 5.00
All amounts in the reconciliations of funded status were recognized in the
consolidated balance sheets for 2002 and 2001. There were no amounts to be
included in other comprehensive income for the periods shown resulting from a
change in the minimum pension liability.
NOTE 14 INCENTIVE COMPENSATION PLANS
The Company has incentive compensation plans in which employees are eligible to
participate based on corporate and individual performance goals. The total
compensation costs charged to expense in connection with the plans were $6.9
million in 2002, $4.5 million in 2001, and $1.3 million in 2000.
NOTE 15 STOCK COMPENSATION PLANS
The Company has adopted the pro forma footnote disclosure-only provisions of FAS
123. See Note 1(n) for the pro-forma effect on net income and earnings per share
if the Company had adopted FAS 123. The fair value of each option grant is
estimated on the date of grant using the Black Scholes option-pricing model with
the following weighted average assumptions for 2002, 2001 and 2000:
All Other Option Plans Employee Stock Purchase Plan
--------------------------------- ---------------------------------
2002 2001 2000 2002 2001 2000
------- ------- ------- ------- ------- -------
Risk free interest rate 4.71% 5.07% 6.56% 1.50% 2.70% 6.00%
Expected life 7 YEARS 7 years 7 years 6 MONTHS 6 months 6 months
Dividend yield 2.4% 2.5% 3.4% 2.4% 2.5% 3.4%
Expected volatility 24% 24% 23% 35% 37% 31%
The weighted-average fair value of options and stocks granted per share, during
the year for 2002, 2001 and 2000, is as follows:
2002 2001 2000
-------- -------- --------
Stock option plans $ 5.60 6.07 4.01
Restricted stock 21.19 22.86 15.60
Employee stock purchase plan:
Six month option 2.16 2.06 1.55
15% of grant date market value 3.74 2.86 2.67
-------- -------- --------
Total $ 5.90 4.92 4.22
======== ======== ========
Agents stock purchase plan:
Discount* of grant date market value $ 2.41 2.40 1.00
*See Note 15(g)
61
A summary of the option transactions under the stock option plans is as follows:
Weighted
Stock average
Number appreciation exercise
of shares rights price
---------- ------------ --------
Outstanding at December 31, 1999 1,873,282 36,000 $17.11
Granted 2000 163,950 -- 15.49
Exercised 2000 (103,430) (7,610) 13.11
Forfeited 2000 (98,210) (14,390) 18.97
---------- ------- ------
Outstanding at December 31, 2000 1,835,592 14,000 17.12
Granted 2001 194,350 -- 22.43
Exercised 2001 (410,725) (4,000) 14.25
Forfeited 2001 (23,973) (10,000) 19.09
---------- ------- ------
OUTSTANDING AT DECEMBER 31, 2001 1,595,244 -- 18.44
GRANTED 2002 184,750 -- 21.16
EXERCISED 2002 (438,963) -- 16.84
FORFEITED 2002 (20,827) -- 21.27
---------- ------- ------
OUTSTANDING AT DECEMBER 31, 2002 1,320,204 -- $19.31
========== ======= ======
Options exercisable and their weighted average exercise price at year end are
1,287,204 and $19.22 for 2002, 1,562,244 and $18.38 for 2001 and 1,773,915 and
$17.02 for 2000.
The following table summarizes information about stock options outstanding and
exercisable under the stock option plans at December 31, 2002:
Options Outstanding Options Exercisable
------------------------------------------ --------------------------
Weighted
average Weighted Weighted
Range of remaining average average
exercise Number of contractual exercise Number of exercise
prices shares life in years price shares price
- --------- --------- ------------- -------- --------- --------
$10 to 14 72,928 1.6 $13.01 72,928 $13.01
14 to 18 367,476 3.5 16.07 367,476 16.07
18 to 20 337,350 4.3 18.50 337,350 18.50
20 to 28 542,450 6.9 22.86 509,450 22.87
--------- --- ------ --------- ------
1,320,204 5.0 $19.31 1,287,204 $19.22
========= =========
(a) Stock Option Plan II
Under the Company's Stock Option Plan II, 1,069,921 shares of the Company's
common stock are available for issuance at December 31, 2002. The plan permits
the granting of qualified and nonqualified stock options to employees, which may
or may not have SARs attached. Options and related SARs may be granted at not
less than fair value on the date of the grant and may be subject to certain
vesting periods as determined by the Company's Salary and Employee Benefits
Committee (Committee). Each grant must be exercised within ten years from the
date of the grant. Under this plan, the Company granted options of 146,750 for
2002, 161,350 for 2001 and 130,950 for 2000.
Under the Company's Stock Option Plan II, the Committee may, at its discretion,
make restricted or unrestricted grants of common stock, or grant rights to
receive common stock, to employees in addition to or in substitution for options
and/or SARs granted. The Company granted total restricted shares of 208,588 for
2002, 235,342 for 2001 and 211,309 for 2000, and forfeited shares of 39,415 in
2002, 52,969 in 2001 and 69,718 in 2000. Each such grant must be expressly
subject to the attainment of one or more performance-related objectives for
certain executive officers, and may be subject to the attainment of one or more
performance-related objectives for other employees, as determined by the
Committee and set forth in an award agreement. Each such grant also is subject
to a vesting period or other terms, conditions, restrictions and limitations as
determined by the Committee at its discretion and set forth in an award
agreement.
During the vesting period, dividends are earned and held in escrow on the
restricted shares subject to the same vesting period and conditions as set forth
in the award agreement. Effective September 3, 1996, dividends earned on the
restricted shares are reinvested in the Company's common stock at fair value.
The Company issued through the dividend reinvestment feature (net
62
of forfeitures), restricted shares of 16,817 in 2002, 16,929 in 2001 and 9,908
in 2000, from the dividend reinvestment plan reserves.
Unearned stock compensation is recognized for the fair value of the restricted
shares when granted and is accounted for as a reduction of stockholders' equity.
This balance is amortized into compensation expense along with the adjustment
for the increases or decreases in the fair value of the Company's common stock
for share awards subject to performance-related objectives. Unearned stock
compensation of $7.2 million in 2002, $6.8 million in 2001 and $5.9 million in
2000 was recorded as a reduction of stockholders' equity and the amounts
amortized to compensation expense were $3.8 million in 2002, $3.0 million in
2001 and $3.5 million in 2000. This plan expired on September 1, 2002 and was
replaced with the Company's Stock Option Plan III.
(b) Stock Option Plan III
In May 2002, the shareholders approved the Company's Stock Option Plan III,
which has 1,989,000 shares of the Company's common stock available for issuance
at December 31, 2002. The plan permits the granting of qualified and
nonqualified stock options to employees, which may or may not have stock
appreciation rights (SARs) attached. Options and related SARs may be granted at
not less than fair value on the date of the grant and may be subject to certain
vesting periods as determined by the Company's Salary and Employee Benefits
Committee (Committee). Each grant must be exercised within ten years from the
date of the grant. Under this plan, the Company granted options for 5,000 shares
in 2002.
Under the Company's Stock Option Plan III, the Committee may, at its discretion,
make restricted or unrestricted grants of common stock, or grant rights to
receive common stock, to employees in addition to or in substitution for options
and/or SARs granted. The Company granted total restricted shares of 11,000 for
2002 with no related forfeitures. Each such grant must be expressly subject to
the attainment of one or more performance-related objectives for certain
executive officers, and may be subject to the attainment of one or more
performance-related objectives for other employees, as determined by the
Committee and set forth in an award agreement. Each such grant also is subject
to a vesting period or other terms, conditions, restrictions and limitations as
determined by the Committee at its discretion as set forth in an award
agreement. Dividends earned on the restricted shares are reinvested in the
Company's common stock at fair value. The Company issued through the dividend
reinvestment feature (net of forfeitures), 75 restricted shares in 2002.
Unearned stock compensation of $0.2 million was recorded in 2002 as a reduction
of stockholders' equity and the amount amortized to compensation expense was
$14,000.
(c) Employee Stock Purchase Plan
Under the terms of the employee stock purchase plan, the number of shares of
common stock available to be purchased is 384,525. This plan is available to all
employees who meet the eligibility requirements and provides for the issuance of
options to purchase shares of common stock. The purchase price is the lower of:
(i) 85% of the closing market price at the time the option is granted or (ii)
85% of the closing price at the time the option is exercised. The Company issued
shares to employees in the amount of 64,869 in 2002, 72,460 in 2001 and 92,886
in 2000.
(d) Stock Unit Awards
Beginning in 1998, certain officers of the Company were granted phantom stock
units in lieu of grants of restricted stock. There were no phantom stock units
awarded in 2002, 2001 and 2000. The value of all outstanding phantom stock units
was paid in cash during 2002. The value of the phantom stock units was charged
to compensation expense over the employment period.
(e) Stock Option Plan for Directors
Under the Company's stock option plan for directors, 724,000 shares of the
Company's common stock are available for issuance. Each director who is not a
full-time employee of the Company participates in the plan and automatically
receives a nonqualified option to purchase 3,000 shares of common stock at not
less than fair value on March 1 of each year. Each option becomes exercisable
one year after the option was granted and expires no more than ten years from
the date the option is granted. Under this plan, the Company granted 33,000
options in 2002, 2001 and 2000.
(f) Stock Compensation Plan for Nonemployee Directors
In May 1996, the shareholders approved the stock compensation plan for
nonemployee directors, effective January 1, 1997. The purpose of this plan is to
provide for the payment of the annual compensation for the directors' services
in shares of the Company's common stock. The amount of common shares available
for issuance under the plan is 346,735. The Company issued 6,479 shares during
2002, 6,120 shares during 2001 and 11,435 shares during 2000, and charged to
expense $0.4 million in 2002, 2001 and 2000. The plan was amended, effective
January 1, 2001, to permit the directors to elect to receive up to 50% of their
compensation under the plan in cash for each calendar year. Each non-employee
director must elect on or before December 20 of each year how compensation for
the following year will be paid.
63
(g) Agent Stock Purchase Plan
Under the terms of the agents' stock purchase plan, the number of shares of
common stock available to be purchased is 801,283. This plan provides for
quarterly offerings in which independent insurance agents can purchase the
Company's common stock at a 10% discount with a one year restricted period
during which the shares purchased cannot be sold or transferred. Purchases made
prior to the December 1, 2001 quarterly offering were discounted at 5% with no
holding restrictions applied. The Company issued shares to agents in the amount
of 69,341 in 2002, 40,883 in 2001 and 33,082 in 2000.
NOTE 16 RELATED PARTY TRANSACTIONS
In 1994, certain officers of Selective exercised stock options by signing
promissory notes in payment for the stock, totaling $1.0 million. The Company's
noninterest bearing promissory notes are secured by the common stock shares
issued upon exercise, which are held by the Company as collateral. The
promissory notes are full recourse and subject to certain employment
requirements. The outstanding principal amount was $0.2 million at December 31,
2002 and $0.3 million at December 31, 2001.
In August 1998, certain officers of Selective purchased stock on the open market
with proceeds advanced by the Company. These officers gave Selective promissory
notes totaling $1.8 million. The notes bear interest at 2.5% and are secured by
the purchased shares of Selective's common stock. The promissory notes are full
recourse and subject to certain employment requirements. The principal amount
outstanding was $0.7 million at December 31, 2002 and $1.0 million at December
31, 2001.
The Company has utilized the services of Chas. E. Rue & Sons, Inc., a general
insurance agency, of which William M. Rue, a director of Selective Insurance
Group, Inc., is the President and owner of more than a 5% equity interest. The
Company's Insurance Subsidiaries purchased insurance coverages from Chas. E. Rue
& Sons, Inc. with premiums of $1.1 million in 2002, $1.0 million in 2001, and
$0.9 million in 2000. As an independent agent for Selective, Chas. E. Rue &
Sons, Inc. received $1.3 million in commissions for insurance policies placed
with the Company's Insurance Subsidiaries in 2002 and $1.2 million in both 2001
and 2000. Additionally, Chas E. Rue & Son, Inc., owns 20% of PL, LLC, which is
an insurance fund administrator that places reinsurance through the Company. PL,
LLC received reinsurance commissions of $0.4 million in 2002, $0.1 million in
2001 and $0.3 million in 2000. The Company believes that the related party
transactions with Chas. E. Rue & Sons, Inc. and PL, LLC were on terms as fair to
the Company as could have been obtained from unaffiliated third parties.
NOTE 17 COMMITMENTS AND CONTINGENCIES
(a) Reserves established for liability insurance, written primarily in the
general liability line of business, continue to reflect exposure to
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. There are
significant uncertainties in estimating our exposure to environmental claims
(for both case and IBNR reserves) resulting from lack of historical data, long
reporting delays, uncertainty as to the number and identity of claimants and
complex legal and coverage issues. Legal issues which arise in environmental
cases include the determination of whether a case is one for a federal or state
forum, choice of law, causation, admissibility of evidence, allocation of
damages and contribution among joint defendants, successor and predecessor
liability and whether direct action against insurers can be maintained. Coverage
issues which arise in environmental cases include the interpretation and
application of policy exclusions, the determination and calculation of policy
limits, the determination of the ultimate amount of a loss, the extent to which
a loss is covered by a policy, if at all, the obligation of an insurer to defend
a claim and the extent to which a party can prove the existence of coverage.
Courts have reached different and sometimes inconsistent conclusions on these
legal and coverage issues. We do not discount to present value that portion of
our loss reserves expected to be paid in future periods.
At December 31, 2002, our reserves for environmental claims amounted to $40.1
million on a gross basis (including case reserves of $29.5 million and IBNR
reserves of $10.6 million) and $34.3 million on a net basis (including case
reserves of $27.5 million and IBNR reserves of $6.8 million). There are a total
of 2,593 environmental claims, including multiple claimants who are associated
with the same site or incident. Of these 2,346 are asbestos related, of which
1,296 involve only three insureds. The total case reserves associated with these
three insureds amounted to $3.0 million on a net and gross basis. The total case
reserves for asbestos related claims amounted to $5.9 million on a gross basis
and $4.9 million on a net basis. About 90 of the total environmental claims
involve approximately 20 landfill sites. The landfill sites account for case
reserves of $17.9 million on a gross basis and $17.7 million on a net basis. The
remaining claims, which account for $5.7 million of case reserves on a gross
basis and $4.9 million on a net basis, involve leaking underground storage tanks
and other latent environmental exposures.
64
The following table details our exposures to various environmental claims.
(in millions) 2002
---------------
GROSS NET
----- -----
Asbestos $ 8.4 6.1
Landfill sites 18.4 18.2
Other* 13.3 10.0
----- -----
Total $40.1 34.3
===== =====
*Consists of leaking underground storage tanks, and other latent environmental
exposures.
IBNR reserve estimation 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. 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.
We have established a range of reasonably possible IBNR losses for
non-environmental net claims of approximately $523.5 million to $666.5 million
at December 31, 2002 and of approximately $460.4 million to $573.9 million at
December 31, 2001. A low and high reasonable IBNR selection was derived
primarily by considering the range of indications calculated using standard
actuarial techniques. Our net IBNR reserves for non-environmental claims,
including loss expense reserves, were $588.5 million at December 31, 2002 and
$496.2 million at December 31, 2001.
The following table provides a roll-forward of gross and net environmental
incurred losses and loss expenses and related reserves thereon:
2002 2001 2000
-------------------- ------------------- -------------------
(in thousands) GROSS NET Gross Net Gross Net
-------- ------- ------- ------- ------- -------
ASBESTOS
Reserves for losses and loss expenses
at the beginning of year $ 8,052 5,752 6,650 4,338 8,100 4,257
Incurred losses and loss expenses 761 761 1,665 1,677 (887) 644
Less losses and loss expenses paid (375) (375) (263) (263) (563) (563)
-------- ------- ------- ------- ------- -------
Reserves for losses and loss expenses
at the end of year $ 8,438 6,138 8,052 5,752 6,650 4,338
======== ======= ======= ======= ======= =======
NON-ASBESTOS
Reserves for losses and loss expenses
at the beginning of year $ 32,234 28,734 33,844 30,616 34,105 32,148
Incurred losses and loss expenses 2,168 2,130 1,748 1,471 2,316 785
Less losses and loss expenses paid (2,726) (2,688) (3,358) (3,353) (2,577) (2,317)
-------- ------- ------- ------- ------- -------
Reserves for losses and loss expenses
at the end of year $ 31,676 28,176 32,234 28,734 33,844 30,616
======== ======= ======= ======= ======= =======
TOTAL ENVIRONMENTAL CLAIMS
Reserves for losses and loss expenses
at the beginning of year $ 40,286 34,486 40,494 34,954 42,205 36,405
Incurred losses and loss expenses 2,929 2,891 3,413 3,148 1,429 1,429
Less losses and loss expenses paid (3,101) (3,063) (3,621) (3,616) (3,140) (2,880)
-------- ------- ------- ------- ------- -------
Reserves for losses and loss expenses
at the end of year $ 40,114 34,314 40,286 34,486 40,494 34,954
======== ======= ======= ======= ======= =======
Based on our aggregate reserve for net losses and loss expenses at December 31,
2002, we do not expect that liabilities associated with environmental and
non-environmental claims will have a materially adverse impact on our future
liquidity, financial position and results of operations. However, given the
complexity of coverage and other legal issues, and the significant assumptions
used in estimating such exposures, actual results could significantly differ
from our current estimates.
(b) The Company purchases annuities from life insurance companies to fulfill
obligations under claim settlements which provide for periodic future payments
to claimants. As of December 31, 2002, the Company had purchased such annuities
in the amount of $10.7 million for settlement of claims on a structured basis
for which the Company is contingently liable. To the Company's knowledge, none
of the issuers of such annuities have defaulted in their obligations thereunder.
65
(c) The Company has various operating leases for office space and equipment.
Such lease agreements, which expire at various times, are generally renewed or
replaced by similar leases. Rental expense under these leases amounted to $8.2
million in 2002, $9.1 million in 2001, and $8.4 million in 2000.
In addition, certain leases for rented premises and equipment are noncancelable,
and liability for payment will continue even though the space or equipment may
no longer be in use.
At December 31, 2002, the total future minimum rental commitments under
noncancelable leases was $24.2 million and such yearly amounts are as follows:
(in thousands)
2003 $ 6,261
2004 5,714
2005 4,584
2006 3,358
2007 2,192
After 2007 2,044
-------
Total minimum payment required $24,153
=======
(d) The Company has additional investment commitments for its limited
partnership investments of up to $16.4 million. There is no certainty that any
additional investment will be required. See Note 2(j) for additional discussion
of our investments in limited partnerships.
NOTE 18 STATUTORY FINANCIAL INFORMATION
The Insurance Subsidiaries prepare their statutory financial statements in
accordance with accounting practices prescribed or permitted by the various
state insurance departments of domicile. Prescribed statutory accounting
practices include state laws, regulations and general administrative rules, as
well as a variety of publications of the National Association of Insurance
Commissioners (NAIC). Permitted statutory accounting practices encompass all
accounting practices that are not prescribed; such practices differ from state
to state, may differ from company to company within a state and may change in
the future. The Insurance Subsidiaries do not utilize any permitted statutory
accounting practices that materially affect the determination of statutory
surplus, statutory net income or risk-based capital. As of December 31, 2002 the
various state insurance departments of domicile have adopted the NAIC Accounting
Practices and Procedures manual, version effective January 1, 2001, (NAIC SAP)
in its entirety, as a component of prescribed or permitted practices.
The Company's combined statutory capital and surplus was $549.4 million
(unaudited) in 2002 and $525.9 million in 2001. The Company's combined statutory
net income was $29.4 million (unaudited) in 2002, $21.4 million in 2001 and
$26.4 million in 2000.
The Company is required to maintain certain minimum amounts of statutory surplus
to satisfy their various state insurance departments of domicile. These
risk-based capital (RBC) requirements for property and casualty insurance
companies are designed to assess capital adequacy and to raise the level of
protection that statutory surplus provides for policyholders. Based upon the
Insurance Subsidiaries 2002 unaudited statutory financial statements, their
combined total adjusted capital exceeded the authorized control level RBC by
4.7:1, as defined by the NAIC.
66
Quarterly Financial Information (1)
First Quarter Second Quarter Third Quarter Fourth Quarter
(unaudited, in thousands, --------------------- ------------------- -------------------- --------------------
except per share data) 2002 2001 2002 2001 2002 2001 2002 2001
--------- -------- -------- ------- -------- -------- -------- --------
Net premiums written $ 281,445 239,916 268,287 235,697 267,439 235,956 236,316 213,851
Net premiums earned 234,295 213,017 244,498 216,266 251,991 222,247 257,484 231,518
Net investment income earned 24,504 23,808 25,100 23,920 24,493 23,655 28,970 25,384
Net realized gains (losses) 109 840 (411) 1,564 1,521 2,829 2,075 1,583
Diversified insurance services
revenue from continuing
operations 18,833 17,032 20,720 17,174 21,321 18,287 19,923 17,133
Diversified insurance services
net income (loss) from
continuing operations (2),(3) 943 1,056 1,068 766 1,256 (2,059) 785 36
Income (loss) from
continuing operations (3) 11,678 9,522 10,080 9,955 13,839 (708) 17,311 4,927
Income (loss) from discontinued
operations, net of tax 2 (53) (126) 4 -- (209) (47) (366)
Net income (3) 10,301 8,299 8,245 8,890 11,112 2,066 12,312 6,436
Other comprehensive
income (loss) (6,021) (2,066) 8,444 1,239 15,315 (604) (341) 144
--------- -------- -------- ------- -------- -------- -------- --------
Comprehensive income 4,280 6,233 16,689 10,129 26,427 1,462 11,971 6,580
NET INCOME PER SHARE:
Basic (3) 0.41 0.34 0.33 0.36 0.43 0.08 0.48 0.26
Diluted (3) 0.39 0.32 0.31 0.34 0.41 0.08 0.46 0.25
Dividends to stockholders (4) 0.15 0.15 0.15 0.15 0.15 0.15 0.15 0.15
PRICE RANGE OF COMMON STOCK: (5)
High 27.74 26.94 31.48 28.21 28.07 27.90 26.34 26.10
Low 19.36 15.94 25.66 22.25 20.35 20.08 19.97 20.50
The addition of all quarters may not agree to annual amounts on the
consolidated financial statements due to rounding.
(1) Refer to the Glossary of Terms on page 20 of our 2002 Annual Report
to Shareholders, incorporated by reference herein, for definitions
of specific terms.
(2) See Note 12 to the consolidated financial statements and Financial
Review for a discussion of discontinued operations.
(3) Income from continuing operations and net income for the third
quarter of 2001 were reduced by $8 million, after taxes, due to
increases in reserves of $8 million pre-tax for Insurance Operations
and $4 million pre-tax for Diversified Insurance Services. See
Financial Review for a discussion of the reserve increases.
(4) See Note 6(b) and Note 7 to the consolidated financial statements
and Financial Review for a discussion of dividend restrictions.
(5) These ranges of high and low prices of the Company's common stock,
as reported by The Nasdaq National Market, represent actual
transactions. All price quotations do not include retail markups,
markdowns and commissions. The range of high and low prices for
common stock for the period beginning January 1, 2003 and ending
January 31, 2003 was $26.48 to $22.93 and the last sale price on
January 31, 2003 was $23.44
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None
PART III
The Company will file with the Securities and Exchange Commission, within 120
days after the end of the fiscal year covered by this report, a definitive Proxy
Statement pursuant to Regulation 14A under the Securities Exchange Act of 1934
in connection with its 2003 Annual Meeting of Stockholders, which meeting will
include the election of directors. In accordance with General Instruction G(3)
of Form 10-K, the information required by Items 10, 11, 12 and 13 below is
incorporated herein by reference to the Proxy Statement.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
Incorporated herein by reference to the sections entitled: (i) "Election of
Directors," "Nominees," "Continuing Directors" and "Executive Officers of the
Company" in the Proxy Statement, and (ii) "Section 16(a) Beneficial Ownership
Reporting Compliance" in the Proxy Statement.
67
ITEM 11. EXECUTIVE COMPENSATION.
Incorporated herein by reference to the sections entitled: (i) "Compensation of
Directors," and "Compensation Committee Interlocks and Insider Participation" in
the Proxy Statement and (ii) "Executive Compensation and Other Information"
"Summary Compensation Table," "Footnotes to Summary Compensation Table," "Stock
Options and Stock Appreciation Rights," "Options and SAR Exercises and
Holdings," "Pension Plans" in the Proxy Statement.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
Incorporated herein by reference to the sections entitled: (i) "General Matters"
in the Proxy Statement; (ii) "Stock Ownership of Directors and Officers" in
the Proxy Statement; and (iii) "Equity Compensation Plan Information" in the
Proxy Statement.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Incorporated herein by reference to the section entitled "Interest of Management
and Others in Certain Transactions" in the Proxy Statement.
ITEM 14. CONTROLS AND PROCEDURES.
As of date within 90 days of the filing date of this annual report, an
evaluation of the effectiveness of the design and operation of the Company's
disclosure controls and procedures was performed under the supervision and with
the participation of the Company's management, including the chief executive
officer and chief financial officer. Based on that evaluation, the Company's
management, including the chief executive officer and chief financial officer,
concluded that the Company's disclosure controls and procedures were effective
as of the evaluation date. Subsequent to the evaluation date, there have been no
significant changes in the Company's internal controls or in other factors that
could significantly affect internal controls.
68
PART IV
ITEM 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this report:
(1) Consolidated financial statements:
The consolidated financial statements of the Company listed below are included
in Item 8. Financial Statements and Supplementary Data.
Form 10-K
Page
Consolidated Balance Sheets as of December 31, 2002 and 2001.................................................... 39
Consolidated Statements of Income for the Years ended December 31, 2002, 2001 and 2000.......................... 40
Consolidated Statements of Stockholders' Equity for the Years ended December 31, 2002, 2001 and 2000............ 41
Consolidated Statements of Cash Flows for the Years ended December 31, 2002, 2001 and 2000...................... 42
Notes to Consolidated Financial Statements, December 31, 2002, 2001 and 2000.................................... 43-66
(2) Financial statement schedules:
The financial statement schedules, with Independent Auditors' Report thereon,
required to be filed are listed below by page number as filed in this report.
All other schedules are omitted as the information required is inapplicable,
immaterial, or the information is presented in the consolidated financial
statements or related notes.
Form 10-K
Page
Summary of Investments - Other than Investments in Related Parties at
Schedule I December 31, 2002................................................................................. 73
Condensed Financial Information of Registrant at December 31, 2002
Schedule II and 2001, and for the years ended December 31, 2002, 2001 and 2000................................ 74-76
Supplementary Insurance Information for the years ended
Schedule III December 31, 2002, 2001 and 2000.................................................................. 77-79
Schedule IV Reinsurance for the years ended December 31, 2002, 2001 and 2000.................................. 80
Allowance for Uncollectible Premiums and Other Receivables for the
Schedule V years ended December 31, 2002, 2001 and 2000...................................................... 81
Supplemental Information for the years ended December 31, 2002, 2001
Schedule VI and 2000.......................................................................................... 82
Independent Auditors Report.......................................................................................... 70
(3) Exhibits:
The exhibits required by Item 601 of Regulation SK are listed in the Exhibit
Index, which immediately precedes the exhibits filed with this Form 10-K or
incorporated in this report by reference, and is incorporated herein by this
reference.
(b) Reports on Form 8-K.
The Registrant filed no reports on Form 8-K during the last quarter of
2002.
69
INDEPENDENT AUDITOR'S REPORT
The Board of Directors and Stockholders
Selective Insurance Group, Inc.
We have audited the consolidated financial statements of Selective Insurance
Group, Inc., and its subsidiaries as listed in the accompanying index. In
connection with our audits of the consolidated financial statements, we have
also audited the financial statement schedules as listed in the accompanying
index. These consolidated financial statements and financial statement schedules
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements and financial
statement schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Selective Insurance
Group, Inc. and its subsidiaries as of December 31, 2002 and 2001, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2002, in conformity with accounting
principles generally accepted in the United States of America. Also, in our
opinion the related financial statement schedules, when considered in relation
to the basic financial statements taken as a whole, present fairly, in all
material respects, the information set forth therein.
/s/ KPMG LLP
New York, New York
February 5, 2003
70
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.
By: /s/ Gregory E. Murphy March 17, 2003
- ------------------------------------
Gregory E. Murphy
Chairman of the Board, President and
Chief Executive Officer
By: /s/ Dale A. Thatcher March 17, 2003
- ------------------------------------
Dale A. Thatcher,
Executive Vice President of Finance,
Chief Financial Officer and Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the date indicated.
By: /s/ Gregory E. Murphy March 17, 2003
- ------------------------------------
Gregory E. Murphy
Chairman of the Board, President and
Chief Executive Officer
By: /s/ Paul D. Bauer March 17, 2003
- ------------------------------------
Paul D. Bauer
Director
By: /s/ A. David Brown March 17, 2003
- ------------------------------------
A. David Brown
Director
By: /s/ William A. Dolan, II March 17, 2003
- ------------------------------------
William A. Dolan, II
Director
By: /s/ C. Edward Herder March 17, 2003
- ------------------------------------
C. Edward Herder
Director
71
By: /s/ William M. Kearns, Jr. March 17, 2003
- ------------------------------------
William M. Kearns, Jr.
Director
By: /s/ Joan M. Lamm-Tennant, Ph.D. March 17, 2003
- ------------------------------------
Joan M. Lamm-Tennant, Ph.D.
Director
By: /s/ S. Griffin McClellan, III March 17, 2003
- ------------------------------------
S. Griffin McClellan, III
Director
By: /s/ John F. Rockart March 17, 2003
- ------------------------------------
John F. Rockart
Director
By: /s/ William M. Rue March 17, 2003
- ------------------------------------
William M. Rue
Director
By: /s/ J. Brian Thebault March 17, 2003
- ------------------------------------
J. Brian Thebault
Director
72
SCHEDULE I
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
SUMMARY OF INVESTMENTS-OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 2002
Type of investment AMORTIZED COST FAIR CARRYING
(in thousands) OR COST VALUE AMOUNT
-------------- --------- ---------
DEBT SECURITIES:
Held-to-maturity:
U.S. government and government agencies $ 2,102 2,112 2,102
Obligations of states and political subdivisions 103,215 108,583 103,215
Mortgage-backed securities 4,001 4,090 4,001
---------- --------- ---------
Total debt securities, held-to-maturity 109,318 114,785 109,318
---------- --------- ---------
Available-for-sale:
U.S. government and government agencies 203,540 217,574 217,574
Obligations of states and political subdivisions 435,188 460,131 460,131
Corporate securities 507,275 539,473 539,473
Asset-backed securities 21,857 22,542 22,542
Mortgage-backed securities 503,487 532,341 532,341
---------- --------- ---------
Total debt securities, available-for-sale 1,671,347 1,772,061 1,772,061
---------- --------- ---------
EQUITY SECURITIES, AVAILABLE-FOR-SALE:
Common stocks:
Public utilities 2,573 6,462 6,462
Banks, trust and insurance companies 19,999 31,712 31,712
Industrial, miscellaneous and all other 97,464 158,739 158,739
---------- --------- ---------
Total equity securities, available-for-sale 120,036 196,913 196,913
---------- --------- ---------
Short-term investments 24,700 24,700 24,700
Other investments 23,559 23,559 23,559
---------- --------- ---------
Total investments $1,948,960 2,132,018 2,126,551
========== ========= =========
73
SCHEDULE II
SELECTIVE INSURANCE GROUP, INC
(PARENT CORPORATION)
BALANCE SHEETS
December 31,
(in thousands, except share amounts) 2002 2001
--------- --------
ASSETS
Debt securities, available-for-sale - at fair value (1)
(cost: $71,358 - 2002; $0 - 2001) $ 72,142 --
Short-term investments 10,311 15,534
Cash 59 218
Investment in subsidiaries 842,334 734,683
Current federal income tax 3,453 2,359
Deferred federal income tax 3,253 3,581
Other assets 7,435 13,573
--------- --------
Total assets $ 938,987 769,948
========= ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Senior convertible notes $ 115,937 --
Note payable 145,500 160,350
Other liabilities 25,448 18,438
--------- --------
Total liabilities 286,885 178,788
--------- --------
STOCKHOLDERS' EQUITY:
Preferred stock of $0 par value per share:
Authorized shares: 5,000,000; no shares issued or outstanding
Common stock of $2 par value per share:
Authorized shares: 180,000,000
Issued: 40,780,950 - 2002; 39,588,746 - 2001 81,562 79,177
Additional paid-in capital 95,435 77,126
Retained earnings 564,358 536,188
Accumulated other comprehensive income 113,629 98,037
Treasury stock - at cost (shares: 14,185,020 - 2002; 14,056,403 - 2001;) (195,295) (192,284)
Unearned stock compensation and notes receivable from stock sales (7,587) (7,084)
--------- --------
Total stockholders' equity 652,102 591,160
--------- --------
Total liabilities and stockholders' equity $ 938,987 769,948
========= ========
(1) As part of the Company's senior convertible note issuance, $72 million of
these debt securities have been placed in an irrevocable trust, to provide funds
for the notes payable maturities scheduled in the next three years.
Information should be read in conjunction with the Notes to consolidated
financial statements of Selective Insurance Group, Inc., and its subsidiaries in
Item 8 of the 2002 Report on Form 10-K.
74
SCHEDULE II (CONTINUED)
SELECTIVE INSURANCE GROUP, INC
(PARENT CORPORATION)
STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31,
----------------------------------
(in thousands) 2002 2001 2000
-------- ------- -------
REVENUES:
Dividends from subsidiaries $ 21,248 29,229 38,519
Net investment income earned 707 240 312
Realized gains (losses) 829 (1,092) 227
Other income 185 540 848
-------- ------- -------
Total revenues 22,969 28,917 39,906
-------- ------- -------
EXPENSES:
Interest expense 15,386 15,287 13,745
Other expenses 5,890 4,416 5,602
-------- ------- -------
Total expenses 21,276 19,703 19,347
-------- ------- -------
Income before federal income tax and equity in
undistributed income of subsidiaries 1,693 9,214 20,559
-------- ------- -------
FEDERAL INCOME TAX (BENEFIT) EXPENSE:
Current (3,919) (5,989) (4,552)
Deferred 54 576 (1,424)
-------- ------- -------
Total federal income tax benefit (3,865) (5,413) (5,976)
-------- ------- -------
Income before equity in undistributed income of
subsidiaries, net of tax 5,558 14,627 26,535
Equity in undistributed income of subsidiaries, net of tax 38,216 11,066 --
-------- ------- -------
Net income $ 43,774 25,693 26,535
======== ======= =======
Information should be read in conjunction with the Notes to consolidated
financial statements of Selective Insurance Group, Inc. and its subsidiaries in
Item 8 of the 2002 Report on Form 10-K.
75
SCHEDULE II (CONTINUED)
SELECTIVE INSURANCE GROUP, INC
(PARENT CORPORATION)
STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
-----------------------------------
(in thousands) 2002 2001 2000
--------- ------- -------
OPERATING ACTIVITIES:
Net income $ 43,774 25,693 26,535
--------- ------- -------
Adjustments to reconcile net income to net cash provided by
operating activities:
Equity in undistributed income of subsidiaries, net of tax (38,216) (11,066) --
Dividend in excess of subsidiaries' income -- -- 15,366
Increase in net federal income tax recoverable (2,590) (940) (1,646)
Net realized (gains) losses (829) 1,092 (227)
Amortization 725 136 108
Amortization of deferred compensation 3,848 3,006 3,462
Other, net 9,418 (4,084) 6,242
--------- ------- -------
Net adjustments (27,644) (11,856) 23,305
--------- ------- -------
Net cash provided by operating activities 16,130 13,837 49,840
--------- ------- -------
INVESTING ACTIVITIES:
Purchase of debt securities, available-for-sale (71,931) -- --
Purchase of other investments -- (243) (1,000)
Purchase of subsidiaries -- (97) (5,999)
Sale of subsidiary 15,733 -- --
Sale of equity securities, available-for-sale -- 95 2,201
--------- ------- -------
Net cash used in investing activities (56,198) (245) (4,798)
--------- ------- -------
FINANCING ACTIVITIES:
Dividends to stockholders (15,604) (15,174) (15,343)
Capital contribution to subsidiaries (58,500) -- --
Acquisition of treasury stock (3,011) (10,732) (37,677)
Proceeds from senior convertible notes 112,750 -- --
Proceeds from notes payable -- -- 88,440
Principal payment on note payable (14,850) (11,767) (7,143)
Proceeds from short-term debt -- -- 40,200
Paydown of short-term debt -- -- (91,502)
Increase from issuance of common stock 18,252 15,604 8,962
Increase in unearned stock compensation and notes receivable
from stock sale
(4,351) (3,803) (3,018)
--------- ------- -------
Net cash provided by (used in) financing activities 34,686 (25,872) (17,081)
--------- ------- -------
Net (decrease) increase in cash and short-term investments (5,382) (12,280) 27,961
Cash and short-term investments at beginning of year 15,752 28,032 71
--------- ------- -------
Cash and short-term investments at end of year $ 10,370 15,752 28,032
========= ======= =======
Information should be read in conjunction with the Notes to consolidated
financial statements of Selective Insurance Group, Inc. and its subsidiaries in
Item 8 of the 2002 Report on Form 10-K.
76
SCHEDULE III
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
YEAR ENDED DECEMBER 31, 2002
Amortiza-
tion of
Deferred Reserve Losses deferred Other
policy for losses Net and loss policy operating Net
acquisition and loss Unearned premiums expenses acquisition expenses premiums
(in thousands) costs expenses premiums earned incurred costs (2) (1), (2) written
----------- ---------- -------- -------- -------- ----------- --------- --------
Commercial $118,022 1,018,900 402,521 788,454 554,742 230,117 24,730 849,215
Personal 30,136 224,151 108,478 199,814 159,838 50,438 7,146 204,272
Reinsurance
recoverable on
unpaid losses and
loss expenses -- 160,374 -- -- -- -- -- --
Prepaid
reinsurance
premiums -- -- 46,141 -- -- -- -- --
Interest and
general corporate
expenses -- -- -- -- -- -- 20,625 --
-------- --------- ------- ------- ------- ------- ------ ---------
Total $148,158 1,403,425 557,140 988,268 714,580 280,555 52,501 1,053,487
======== ========= ======= ======= ======= ======= ====== =========
NOTE: A meaningful allocation of net investment income of $103,067 and net
realized gain on investments of $3,294 is considered impracticable
because the Company does not maintain distinct investment portfolios
for each segment.
(1) Other operating expenses includes $(327) of underwriting charges
that are included in other income or other expense on the
consolidated income statement in Item 8 of the 2002 Report on Form
10-K.
(2) The total, $333,056, of the amortization of deferred policy
acquisition cost ($280,555) and other operating expenses ($52,501)
is reconciled to the consolidated statements of income, as follows:
Policy acquisition costs $ 307,505
Dividends to policyholders 5,762
Interest expense 15,093
Other expenses 8,221
Other income (3,525)
---------
Total $ 333,056
=========
77
SCHEDULE III (CONTINUED)
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
YEAR ENDED DECEMBER 31, 2001
Amortiza-
tion of
Deferred Reserve Losses deferred Other
policy for losses Net and loss policy operating Net
acquisition and loss Unearned premiums expenses acquisition expenses premiums
(in thousands) costs expenses premiums earned incurred costs (2) (1), (2) written
----------- ---------- -------- -------- -------- ----------- --------- --------
Commercial $103,064 902,308 341,765 678,321 480,993 201,380 28,849 723,842
Personal 28,587 229,519 104,016 204,727 174,891 55,860 1,713 201,578
Reinsurance
recoverable on
unpaid losses and
loss expenses -- 166,511 -- -- -- -- -- --
Prepaid
reinsurance
premiums -- -- 39,932 -- -- -- -- --
Interest and
general
corporate expenses -- -- -- -- -- -- 18,820 --
-------- --------- ------- ------- ------- ------- ------ ---------
Total $131,651 1,298,338 485,713 883,048 655,884 257,240 49,382 925,420
======== ========= ======= ======= ======= ======= ====== =========
NOTE: A meaningful allocation of net investment income of $96,767 and net
realized gain on investments of $6,816 is considered impracticable
because the Company does not maintain distinct investment portfolios
for each segment.
(1) Other operating expenses includes $868 of underwriting charges that
are included in other income or other expense on the consolidated
income statement in Item 8 of the 2001 Report on Form 10-K.
(2) The total, $306,622, of the amortization of deferred policy
acquisition cost ($257,240) and other operating expenses ($49,382)
is reconciled to the consolidated statements of income, as follows:
Policy acquisition costs $ 277,897
Dividends to policyholders 8,275
Interest expense 14,526
Other expenses 8,687
Other income (2,763)
---------
Total $ 306,622
=========
78
SCHEDULE III (CONTINUED)
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
YEAR ENDED DECEMBER 31, 2000
Amortiza-
tion of
Losses deferred Other
Net and loss policy operating Net
premiums expenses acquisition expenses premiums
(in thousands) earned incurred costs (2) (1), (2) written
-------- -------- ----------- --------- --------
Commercial $611,865 443,933 181,285 31,833 638,991
Personal 209,400 170,133 54,158 5,045 204,613
Reinsurance
recoverable on
unpaid losses and
loss expenses -- -- -- -- --
Prepaid reinsurance
premiums -- -- -- -- --
Interest and general
corporate expenses -- -- -- 19,247 --
-------- ------- ------- ------ -------
Total $821,265 614,066 235,443 56,125 843,604
======== ======= ======= ====== =======
NOTE: A meaningful allocation of net investment income of $99,495 and net
realized loss on investments of $4,191 is considered impracticable
because the Company does not maintain distinct investment portfolios
for each segment.
(1) Other operating expenses includes $3,111 of underwriting charges
that are included in other income or other expense on the
consolidated income statement in Item 8 of the 2000 report on Form
10-K.
(2) The total, $291,568, of the amortization of deferred policy
acquisition cost ($235,443) and other operating expenses ($56,125)
is reconciled to the consolidated statements of income, as follows:
Policy acquisition costs $ 261,540
Dividends to policyholders 7,670
Interest expense 13,745
Other expenses 12,352
Other income (3,739)
---------
Total $ 291,568
=========
79
SCHEDULE IV
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
REINSURANCE
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
% Of
Assumed Ceded Amount
Direct From Other to Other Net Assumed
(in thousands) Amount Companies Companies Amount To Net
---------- ---------- --------- ------- -------
2002
Premiums earned:
Accident and health insurance $ 201 -- 3 198 --
Property and liability insurance 1,092,471 22,711 127,112 988,070 2.3%
---------- ------ ------- ------- ------
Total premiums earned $1,092,672 22,711 127,115 988,268 2.3%
========== ====== ======= ======= ======
2001
Premiums earned:
Accident and health insurance $ 198 -- -- 198 --
Property and liability insurance 964,564 20,555 102,269 882,850 2.3%
---------- ------ ------- ------- ------
Total premiums earned $ 964,762 20,555 102,269 883,048 2.3%
========== ====== ======= ======= ======
2000
Premiums earned:
Accident and health insurance $ 365 -- -- 365 --
Property and liability insurance 900,824 14,529 94,453 820,900 1.8%
---------- ------ ------- ------- ------
Total premiums earned $ 901,189 14,529 94,453 821,265 1.8%
========== ====== ======= ======= ======
80
SCHEDULE V
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
ALLOWANCE FOR UNCOLLECTIBLE PREMIUMS AND OTHER RECEIVABLES
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(in thousands) 2002 2001 2000
------- ------ ------
Balance, January 1 $ 4,299 6,071 3,649
Additions 2,982 3,873 6,713
Deletions (3,600) (5,645) (4,291)
------- ------ ------
Balance, December 31 $ 3,681 4,299 6,071
======= ====== ======
81
SCHEDULE VI
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
SUPPLEMENTAL INFORMATION
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
Losses and loss
expenses
incurred related to
----------------------
Affiliation with Registrant (1) (2) Paid losses
Current Prior and loss
(in thousands) year years expenses
-------- ------- -----------
Consolidated Property/Casualty
Subsidiaries:
Year ended December 31, 2002 $694,744 19,836 603,356
-------- ------- -------
Year ended December 31, 2001 $642,173 13,711 635,844
-------- ------- -------
Year ended December 31, 2000 $615,095 (1,029) 584,043
-------- ------- -------
NOTE: The other information required in this schedule (e.g., deferred
policy acquisition costs, reserves for losses and loss expenses,
unearned premiums, net premiums earned, net investment income,
amortization of deferred policy acquisition costs, and net premiums
written) is contained in Schedule III in this report. In addition,
the Company does not discount loss reserves. Certain prior year
amounts have been restated to conform to 2002 presentation.
82
CERTIFICATIONS
I, Gregory E. Murphy, certify that:
1. I have reviewed this annual report on Form 10-K of Selective Insurance
Group, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this annual
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 17, 2003 By: /s/ Gregory E. Murphy
----------------------------------------
Gregory E. Murphy
Chairman, President and Chief Executive
Officer
83
I, Dale A. Thatcher, certify that:
1. I have reviewed this annual report on Form 10-K of Selective Insurance
Group, Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this annual report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this annual
report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this annual
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this annual report (the "Evaluation Date"); and
c) presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
annual report whether there were significant changes in internal controls
or in other factors that could significantly affect internal controls
subsequent to the date of our most recent evaluation, including any
corrective actions with regard to significant deficiencies and material
weaknesses.
Date: March 17, 2003 By: /s/ Dale A. Thatcher
----------------------------------------
Dale A. Thatcher
Executive Vice President,
Chief Financial Officer and Treasurer
84
EXHIBIT INDEX
* Exhibits included within this 10-K filing
Exhibit
Number
3.1 Restated Certificate of Incorporation of Selective Insurance Group,
Inc., dated August 4, 1977, as amended, (incorporated by reference
herein to Exhibit 3.1 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1997, File No. 0-8641).
3.2 The Company's By-Laws, adopted on August 26, 1977, as amended,
(incorporated by reference herein to Exhibit 3.2 to the Company's
Annual Report on Form 10-K for the year ended December 31, 2001,
file No. 0-8641).
4.1 The form of Indenture dated December 29, 1982, between the Selective
Insurance Group, Inc. and Midlantic National Bank, as Trustee
relating to the Company's 8 3/4% Subordinated Convertible Debentures
due 2008 (incorporated by reference herein to Exhibit 4.3 to the
Company's Registration Statement on Form S-3 No. 2-80881).
4.2 The form of Indenture dated September 24, 2002, between Selective
Insurance Group, Inc., and National City Bank as Trustee relating to
the Company's 1.6155% Senior Convertible Notes due September 24,
2032, (incorporated by reference herein to the Company's
Registration Statement in Form S-3 No. 333-101489).
4.3 Amended and Restated Rights Agreement, dated February 2, 1999,
between Selective Insurance Group, Inc. and First Chicago Trust,
(incorporated by reference herein to the Company's Current Report on
Form 8-K filed February 2, 1999, File No. 0-8641.)
10.1 The Selective Insurance Retirement Savings Plan as amended through
August 15, 1996 (incorporated by reference herein to Exhibit 4 to
the Company's Registration Statement on Form S-8 No. 333-10477).
10.1a Amendment, dated May 2, 1997, to the Selective Insurance Retirement
Savings Plan in Exhibit 10.1 above (incorporated by reference herein
to Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1997, File No. 0-8641).
*10.1b Amendment and restatement, effective January 1, 1997, to the
Selective Insurance Retirement Savings Plan, filed herewith.
*10.1c Amendment Number 1 to the amended and restated Selective Insurance
Retirement Savings Plan effective January 1, 2002, filed herewith.
*10.1d Amendment Number 2 to the amended and restated Selective Insurance
Retirement Savings Plan effective January 1, 1997, filed herewith.
10.2 The Retirement Income Plan for Employees of Selective Insurance
Company of America, as amended through May 6, 1994 (incorporated by
reference herein to Exhibit 10.2 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1994, File No. 0-8641).
*10.2a Amendment and restatement, effective January 1, 1997, to the
Retirement Income Plan for Selective Insurance Company of America,
filed herewith.
*10.2b Amendment Number 1 to the amended and restated Retirement Income
Plan for Selective Insurance Company of America effective July 1,
2002, filed herewith.
*10.2c Amendment Number 2 to the amended and restated Retirement Income
Plan for Selective Insurance Company of America effective January
1, 2003, filed herewith.
*10.2d Amendment Number 3 to the amended and restated Retirement Income
Plan for Selective Insurance Company of America effective January
1, 1997, filed herewith.
10.3 Selective Insurance Company of America Deferred Compensation Plan,
effective July 1, 2002, (incorporated by reference herein to Exhibit
99.1 of the Company's Registration Statement on Form S-8, No.
333-97799).
85
10.4 Selective Insurance Group, Inc. Stock Option Plan II, as amended
through October 9, 1997, and related forms of option agreements
(incorporated by reference herein to Exhibits 4.1 to the Company's
Registration Statement on Form S-8 No. 333-37501).
10.4a The Selective Insurance Group, Inc. Stock Option Plan II, as amended
through July 28, 1998, (incorporated by reference herein to Exhibit
10.13a to the Company's Annual Report on Form 10-K for the year
ended December 31, 1993, File No. 0-8641).
10.4b The Selective Insurance Group, Inc. Stock Option Plan II, as amended
through January 31, 2000, (incorporated by reference herein to
Exhibit 10.13b to the Company's Annual Report on Form 10-K for the
year ended December 31, 1999, File No. 0-8641).
10.5 The Selective Insurance Group, Inc. Stock Option Plan III
(incorporated by reference herein to Exhibit A to the Company's
Definitive Proxy Statement for its 2002 Annual Meeting of
Stockholders' filed with the Securities and Exchange Commission on
April 1, 2002).
10.6 Deferred Compensation Plan for Directors (incorporated by reference
herein to Exhibit 10.5 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1993, File No. 0-8641).
10.7 The Company's 1987 Employee Stock Purchase Savings Plan
(incorporated by reference herein to Exhibit 10.6 to the Company's
Annual Report on Form 10-K for the year ended December 31, 1993,
File No. 0-8641).
10.7a Amendment, dated May 2, 1997, to the 1987 Employee Stock Purchase
Savings Plan in Exhibit 10.6 above (incorporated by reference herein
to Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q for
the quarter ended June 30, 1997, File No. 0-8641).
10.8 The Selective Insurance Rewards Program adopted January 1, 1994,
which replaced the Annual Incentive Compensation Plan (incorporated
by reference herein to Exhibit 10.7 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1994, File No. 0-8641).
10.9 The Selective Insurance Group, Inc. Stock Purchase Plan for
Independent Insurance Agents, as amended (incorporated by reference
herein to the Company's Post Effective Amendment No. 2 on Form S-3
No. 033-30833).
10.10 The Selective Insurance Group, Inc. Stock Option Plan for Directors,
as amended (incorporated by reference herein to Exhibit 4.4 of the
Company's Registration Statement on Form S-8 No. 333-10477).
10.11 The Selective Insurance Group, Inc. Stock Compensation Plan for
Nonemployee Directors (incorporated by reference herein to Exhibit 4
to the Company's Registration Statement on Form S-8 No. 333-10465).
10.11a The Selective Insurance Group, Inc. Stock Compensation Plan for
Nonemployee Directors, as amended (incorporated by reference herein
to Exhibit A to the Company's Definitive Proxy Statement for its
2000 Annual Meeting of Stockholders filed with the Securities and
Exchange Commission on March 31, 2000).
10.12 Employment, Termination and Severance Agreements.
10.12a Employment Agreement with Gregory E. Murphy, dated August 1, 1995
(incorporated by reference herein to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30,
1995, File No. 0-8641).
10.12a1 Amendment Number 1, dated May 1, 1998, to the Employment Agreement
with Gregory E. Murphy in Exhibit 10.11c above (incorporated by
reference herein to Exhibit 10.4 to the Company's Quarterly Report
on Form 10-Q for the quarter ended June 30, 1998, File No. 0-8641).
10.12a2 Amendment Number 2, dated May 5, 2000, to the Employment Agreement
with Gregory E. Murphy in Exhibit 10.11c above (incorporated by
reference herein to Exhibit 10.16a to the Company's Quarterly Report
on Form 10-Q for the quarter ended June 30, 2000, File No. 0-8641).
10.12a3 Amendment Number 3, dated August 1, 2001, to the Employment
Agreement with Gregory E. Murphy in Exhibit 10.11c above
(incorporated by reference herein to Exhibit 10.16a to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30,
2001, File No. 0-8641).
10.12b Termination Agreement, dated August 1, 1995, between Selective
Insurance Company of America and Gregory E. Murphy (incorporated by
reference herein to Exhibit 10.2 to the Company's Quarterly Report
on Form 10-Q for the quarter ended September 30, 1995, File No.
0-8641).
10.12b1 Amendment Number 1, dated December 16, 1998, to the Termination
Agreement between Selective Insurance Company of America and Gregory
E. Murphy in Exhibit 10.11d above (incorporated by reference herein
to Exhibit 10.16t to the Company's Annual Report on Form 10-K for
the year ended December 31, 1998, File No. 0-8641).
86
10.12c Employment Agreement with Jamie Ochiltree, III, dated October 31,
1995 (incorporated by reference herein to Exhibit 10.11f to the
Company's Annual Report on Form 10-K for the year ended December 31,
1995, File No. 0-8641).
10.12c1 Amendment Number 1, dated October 31, 1998, to the Employment
Agreement with Jamie Ochiltree, III in Exhibit 10.11e above
(incorporated by reference herein to Exhibit 10.16r to the Company's
Annual Report on Form 10-K for the year ended December 31, 1998,
File No. 0-8641).
10.12c2 Amendment Number 2, dated May 5, 2000, to the Employment Agreement
with Jamie Ochiltree, III in Exhibit 10.11e above (incorporated by
reference herein to Exhibit 10.16b to the Company's Quarterly Report
on Form 10-Q for the quarter ended June 30, 2000, File No. 0-8641).
10.12c3 Amendment Number 3, dated October 31, 2001, to the Employment
Agreement with Jamie Ochiltree, III in Exhibit 10.11e above
(incorporated by reference herein to Exhibit 10.16c to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30,
2001, File No. 0-8641).
10.12d Termination Agreement, dated August 1, 1995, between Selective
Insurance Company of America and Jamie Ochiltree, III (incorporated
by reference herein to Exhibit 10.11j to the Company's Annual Report
on Form 10-K for the year ended December 31, 1995, File No. 0-8641).
10.12d1 Amendment Number 1, dated December 16, 1998, to the Termination
Agreement between Selective Insurance Company of America and Jamie
Ochiltree, III in Exhibit 10.11f above (incorporated by reference
herein to Exhibit 10.16v to the Company's Annual Report on Form 10-K
for the year ended December 31, 1998, File No. 0-8641).
10.12e Employment Agreement, dated May 2, 1997, between Selective Insurance
Company of America and James W. Coleman, Jr. (incorporated by
reference herein to Exhibit 10.3 to the Company's Quarterly Report
on Form 10-Q for the quarter ended June 30, 1997, File No. 0-8641).
10.12e1 Amendment Number 1, dated May 5, 2000, to the Employment Agreement
with James W. Coleman, Jr. in Exhibit 10.11g above (incorporated by
reference herein to Exhibit 10.16c to the Company's Quarterly Report
on Form 10-Q for the quarter ended June 30, 2000, File No. 0-8641).
*10.12e2 Amendment Number 2, dated March 1, 2003, to the Employment Agreement
with James W. Coleman, Jr., filed herewith.
10.12f Termination Agreement, dated May 2, 1997, between Selective
Insurance Company of America and James W. Coleman, Jr. (incorporated
by reference herein to Exhibit 10.4 to the Company's Quarterly
Report on Form 10-Q for the quarter ended June 30, 1997, File No.
0-8641).
10.12f1 Amendment Number 1, dated December 16, 1998, to the Termination
Agreement between Selective Insurance Company of America and James
W. Coleman, Jr. in Exhibit 10.11h above (incorporated by reference
herein to Exhibit 10.16w to the Company's Annual Report on Form 10-K
for the year ended December 31, 1998, File No. 0-8641).
10.12g Termination Agreement, dated September 27, 1999, between Selective
Insurance Company of America and Ronald J. Zaleski, (incorporated by
reference herein to Exhibit 10.16z to the Company's Annual Report on
Form 10-K for the year ended December 31, 1999, File No. 0-8641).
10.12h Termination Agreement, dated March 1, 2000, between Selective
Insurance Company of America and Eduard Pulkstenis (incorporated by
reference herein to Exhibit 10.16ab to the Company's Quarterly
Report on Form 10-Q for the quarter ended March 31, 2000, File No.
0-8641).
10.12i Employment Agreement with Dale A. Thatcher, dated May 5, 2000
(incorporated by reference herein to Exhibit 10.16f to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2000,
File No. 0-8641).
*10.12i1 Amendment Number 1, dated March 1, 2003, to the Employment Agreement
with Dale A. Thatcher, filed herewith.
10.12j Termination Agreement with Dale A. Thatcher, dated May 5, 2000
(incorporated by reference herein to Exhibit 10.16g to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2000,
File No. 0-8641).
10.12k Employment Agreement with Richard F. Connell, dated August 8, 2000
(incorporated by reference herein to Exhibit 10.16a to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30,
2000, File No. 0-8641).
*10.12k1 Amendment Number 1, dated March 1, 2003, to the Employment Agreement
with Richard F. Connell, filed herewith.
87
10.12l Termination Agreement with Richard F. Connell, dated August 8, 2000
(incorporated by reference herein to Exhibit 10.16b to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30,
2000, File No. 0-8641).
10.12m Termination agreement with Sharon R. Cooper, dated May 3, 2001
(incorporated by reference herein to Exhibit 10.16a to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2001,
File No. 0-8641).
*10.12n Termination agreement with Richard W. Berstein, dated November 5,
2002, filed herewith.
10.13 Form of Note Purchase Agreement dated as of August 1, 1994 with
respect to Selective Insurance Group, Inc. 8.77% Senior Notes due
August 1, 2005 (incorporated by reference herein to Exhibit 99.2 to
the Company's Post-Effective Amendment No. 1 to the Registration
Statement on Form S-3, No. 33-30833).
10.14 Promissory Note of $25,000,000 Revolving Line of Credit with State
Street Bank and Trust Company (incorporated by reference herein to
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1997, File No. 0-8641).
10.14a Amendment, dated June 30, 1998, to the Promissory Note of
$25,000,000 Revolving Line of Credit with State Street Bank and
Trust Company in Exhibit 10.14 above, (incorporated by reference
herein to Exhibit 10.2 to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 1998, File No. 0-8641).
10.14a1 Amendment, dated November 6, 1998, to the Promissory Note of
$25,000,000 Revolving Line of Credit with State Street Bank and
Trust Company in Exhibit 10.14 above, (incorporated by reference
herein to Exhibit 10.24 to the Company's Annual Report on Form 10-K
for the year ended December 31, 1998, File No. 0-8641).
10.14a2 Amendment, dated June 30, 2000, to the Promissory Note of
$25,000,000 Revolving Line of Credit with State Street Bank and
Trust Company in Exhibit 10.14 above, (incorporated by reference
herein to Exhibit 10.1 to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 2000, File No. 0-8641).
10.14a3 Amendment, dated June 29, 2001, to the Promissory Note of
$25,000,000 Revolving Line of Credit with State Street Bank and
Trust Company in Exhibit 10.14 above, (incorporated by reference
herein to Exhibit 10.1 to the Company's Quarterly Report on Form
10-Q for the quarter ended September 30, 2001, File No. 0-8641).
10.15 Commercial Loan Note of $25,000,000 Line of Credit with First Union
National Bank as of October 22, 1999, (incorporated by reference
herein to Exhibit 10.28 to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 2000, File No. 0-8641).
10.15a Fifth amendment, dated June 28, 2002, effective through June 27,
2003, to the $25,000,000 Line of Credit Agreement dated October 22,
1999, between Wachovia Bank, National Association (formerly known as
First Union National Bank) and Selective Insurance Group, Inc. and
Selective Insurance Company of America (incorporated by reference
herein to Exhibit 10.2 to the Company's Quarterly Report on Form
10-Q for the quarter ended June 30, 2002, File No. 0-8641).
*11 Computation of earnings per share, filed herewith.
*13 Page 20 of the Company's 2002 Annual Report to Shareholders
incorporated by reference into this Form 10-K, filed herewith.
*21 Subsidiaries of Selective Insurance Group, Inc., filed herewith.
*23 Consent of Independent Auditors, filed herewith.
*99.1 Certification of Chief Executive Officer in accordance with
Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.
*99.2 Certification of Chief Financial Officer in accordance with
Section 906 of the Sarbanes-Oxley Act of 2002, filed herewith.
88