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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: June 30, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _____________ to _____________
Commission file number: 0-8641
SELECTIVE INSURANCE GROUP, INC.
--------------------------------------------------
(Exact name of registrant as specified in its charter)
New Jersey 22-2168890
- ---------------------------------------- ---------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
40 Wantage Avenue
Branchville, New Jersey 07890
- --------------------------------------------- ----------------------------
(Address of principal executive offices) (Zip Code)
(973) 948-3000
----------------------------------------
(Registrant's telephone number,
including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such report), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act)
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date:
Common stock, par value $2 per share, outstanding as of July 31, 2003:
27,004,834
SELECTIVE INSURANCE GROUP, INC
Consolidated Balance Sheets
UNAUDITED
JUNE 30, DECEMBER 31,
(in thousands, except share amounts) 2003 2002
- ---------------------------------------------------------------------------------------------------------------------
ASSETS
Investments:
Debt securities, held-to-maturity - at amortized cost
(fair value: $92,592-2003; $114,785-2002) $ 87,895 109,318
Debt securities, available-for-sale - at fair value
(amortized cost: $1,800,617-2003; $1,671,347-2002) 1,937,420 1,772,061
Equity securities, available-for-sale - at fair value
(cost of: $143,583-2003; $ 120,036-2002) 237,557 196,913
Short-term investments - (at cost which approximates fair value) 23,508 24,700
Other investments 26,218 23,559
------------- ----------
Total investments 2,312,598 2,126,551
Cash 568 2,228
Interest and dividends due or accrued 22,531 22,689
Premiums receivables, net of allowance for uncollectible accounts of:
$3,002-2003 and $2,814-2002 433,365 353,935
Other trade receivables, net of allowance for uncollectible accounts of:
$1,088-2003; $867-2002 21,162 19,769
Reinsurance recoverable on paid losses and loss expenses 10,443 7,272
Reinsurance recoverable on unpaid losses and loss expenses 163,163 160,374
Prepaid reinsurance premiums 48,397 46,141
Deferred federal income tax - 8,707
Real estate, furniture, equipment, and software development-at cost, net of
accumulated depreciation and amortization 53,099 52,424
Deferred policy acquisition costs 166,519 148,158
Goodwill 43,571 42,808
Other assets 32,784 38,791
------------- ----------
Total assets $ 3,308,200 3,029,847
============= ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Reserve for losses $ 1,299,838 1,232,322
Reserve for loss expenses 178,542 171,103
Unearned premiums 646,477 557,141
Senior convertible notes 115,937 115,937
Notes payable 139,500 145,500
Current federal income tax 3,636 2,565
Deferred federal income tax 10,783 -
Other liabilities 201,489 153,177
------------- ----------
Total liabilities 2,596,202 2,377,745
------------- ----------
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: 41,257,983-2003; 40,780,950-2002 82,516 81,562
Additional paid-in capital 105,037 95,435
Retained earnings 582,306 562,553
Accumulated other comprehensive income 150,005 115,434
Treasury stock - at cost (shares: 14,253,553-2003; 14,185,020-2002) (196,906) (195,295)
Unearned stock compensation and notes receivable from stock sales (10,960) (7,587)
------------- ----------
Total stockholders' equity 711,998 652,102
------------- ----------
Total liabilities and stockholders' equity $ 3,308,200 3,029,847
============= ==========
See accompanying notes to unaudited interim consolidated financial statements.
2
SELECTIVE INSURANCE GROUP, INC.
Consolidated Statements of Income
UNAUDITED UNAUDITED
QUARTER ENDED SIX MONTHS ENDED
JUNE 30, JUNE 30,
(in thousands, except per share amounts) 2003 2002 2003 2002
- -----------------------------------------------------------------------------------------------------------------------------
Revenues:
Net premiums written $ 306,863 268,287 $ 630,266 549,732
Net (increase) in unearned premiums and prepaid
reinsurance premiums (30,724) (23,789) (87,080) (70,939)
--------- --------- --------- --------
Net premiums earned 276,139 244,498 543,186 478,793
Net investment income earned 29,436 25,100 56,779 49,604
Net realized gains (losses) 3,369 (411) 7,344 (302)
Diversified insurance services revenue 23,481 20,720 44,819 39,553
Other income 662 940 1,444 1,739
--------- --------- --------- --------
Total revenues 333,087 290,847 653,572 569,387
--------- --------- --------- --------
Expenses:
Losses incurred 158,997 153,289 329,725 299,794
Loss expenses incurred 30,744 25,811 59,118 50,183
Policy acquisition costs 87,731 74,734 172,280 145,428
Dividends to policyholders 1,383 1,406 2,938 3,327
Interest expense 4,451 3,499 8,990 7,005
Diversified insurance services expenses 20,801 19,121 40,273 36,560
Other expenses 1,980 2,907 3,889 5,333
--------- --------- --------- --------
Total expenses 306,087 280,767 617,213 547,630
--------- --------- --------- --------
Income from continuing operations, before
federal income tax 27,000 10,080 36,359 21,757
--------- --------- --------- --------
Federal income tax expense(benefit):
Current 5,644 (328) 7,424 5,163
Deferred 1,607 2,037 1,149 (2,073)
--------- --------- --------- --------
Total federal income tax expense 7,251 1,709 8,573 3,090
--------- --------- --------- --------
Loss from discontinued operations, net of tax - (712) - (708)
Gain on disposition of discontinued operations, net of tax - 586 - 586
--------- --------- --------- --------
Total discontinued operations, net of tax - (126) - (122)
--------- --------- --------- --------
Net income $ 19,749 8,245 $ 27,786 18,545
========= ========= ========= ========
Earnings per share:
Basic net income from continuing operations $ 0.76 0.33 $ 1.07 0.75
Basic net income from discontinued operations - - - (0.01)
--------- --------- --------- --------
Basic net income $ 0.76 0.33 $ 1.07 0.74
========= ========= ========= ========
Diluted net income from continuing operations $ 0.72 0.31 $ 1.01 0.70
Diluted net income from discontinued operations - - - -
--------- --------- --------- --------
Diluted net income $ 0.72 0.31 $ 1.01 0.70
========= ========= ========= ========
Dividends to stockholders $ 0.15 0.15 $ 0.30 0.30
See accompanying notes to unaudited interim consolidated financial statements.
3
SELECTIVE INSURANCE GROUP, INC.
Consolidated Statements of Stockholders' Equity
UNAUDITED
SIX MONTHS ENDED JUNE 30,
(in thousands, except per share amounts) 2003 2002
- --------------------------------------------------------------------------------------------------------------------------
Common stock:
Beginning of year $ 81,562 79,177
Dividend reinvestment plan
(shares: 23,545-2003; 23,052-2002) 47 46
Convertible subordinated debentures
(shares: 16,522-2003; 18,219-2002) 33 37
Stock purchase and compensation plans
(shares: 436,966-2003; 523,305-2002) 874 1,047
---------- -------
End of period 82,516 80,307
---------- -------
Additional paid-in capital:
Beginning of year 95,435 77,126
Dividend reinvestment plan 531 525
Convertible subordinated debentures 86 92
Stock purchase and compensation plans 8,985 10,966
---------- -------
End of period 105,037 88,709
---------- -------
Retained earnings:
Beginning of year 562,553 536,188
Net income 27,786 27,786 18,545 18,545
Cash dividends to stockholders ($0.30 per share) (8,033) (7,707)
---------- -------
End of period 582,306 547,026
---------- -------
Accumulated other comprehensive income:
Beginning of year 115,434 98,037
Other comprehensive income, increase
in net unrealized gains on available-for-sale securities,
net of deferred income tax effect 34,571 34,571 2,423 2,423
---------- ------ ------- ------
End of period 150,005 100,460
---------- -------
Comprehensive income 62,357 20,968
====== ======
Treasury stock:
Beginning of year (195,295) (192,284)
Acquisition of treasury stock
(shares 68,533-2003; 96,200-2002) (1,611) (2,221)
---------- -------
End of period (196,906) (194,505)
---------- -------
Unearned stock compensation and notes receivable
from stock sales:
Beginning of year (7,587) (7,084)
Unearned stock compensation (5,436) (5,085)
Amortization of deferred compensation expense and
amounts received on notes 2,063 2,426
---------- -------
End of period (10,960) (9,743)
---------- -------
Total stockholders' equity $ 711,998 612,254
========== =======
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 unaudited interim consolidated financial statements.
4
SELECTIVE INSURANCE GROUP, INC.
Consolidated Statements of Cash Flows
UNAUDITED
SIX MONTHS ENDED JUNE 30,
(in thousands) 2003 2002
- ------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 27,786 18,545
----------- ---------
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 72,166 48,910
Increase in unearned premiums, net of prepaid reinsurance premiums 87,080 70,938
Decrease (increase) in federal income tax recoverable 1,946 (1,919)
Depreciation and amortization 4,797 4,323
Amortization of deferred compensation 2,035 2,319
Increase in premiums receivables (79,430) (65,257)
Increase in other trade receivables (1,393) (1,006)
Increase in deferred policy acquisition costs (18,361) (19,904)
Decrease in interest and dividends due or accrued 158 162
Decrease (increase) in reinsurance recoverable on paid losses and loss expenses (3,171) 6,491
Net realized (gains) losses on investments (7,344) 302
Net realized (gain) on sale of subsidiary - (901)
Increase in pension liability 3,104 1,652
Other, net 10,934 7,782
----------- ---------
Net adjustments 72,521 53,892
----------- ---------
Net cash provided by operating activities 100,307 72,437
----------- ---------
INVESTING ACTIVITIES
Purchase of debt securities, available-for-sale (315,275) (324,718)
Purchase of equity securities, available-for-sale (24,589) (2,678)
Purchase of other investments (3,156) (688)
Purchase and adjustments of subsidiaries acquired (net of cash equivalents acquired of
$1,127 in 2002) (763) (3,139)
Sale of subsidiary (net of cash of $385) - 15,421
Sale of debt securities, available-for-sale 130,919 148,837
Redemption and maturities of debt securities, held-to-maturity 21,472 31,883
Redemption and maturities of debt securities, available-for-sale 61,284 39,417
Sale of equity securities, available-for-sale 1,665 15,342
Proceeds from other investments 497 6
Increase in net payable for security transactions 40,261 832
Net additions to real estate, furniture, equipment and software development (4,859) (6,729)
----------- ---------
Net cash used in investing activities (92,544) (86,214)
----------- ---------
FINANCING ACTIVITIES
Dividends to stockholders (8,033) (7,707)
Principal payment of notes payable (6,000) -
Acquisition of treasury stock (1,611) (2,221)
Net proceeds from dividend reinvestment plan 578 571
Net proceeds from stock purchase and compensation plans 4,423 6,928
Proceeds received on notes receivable from stock sales 28 107
----------- ---------
Net cash used in financing activities (10,615) (2,322)
----------- ---------
Net decrease in short-term investments and cash (2,852) (16,099)
Short-term investments and cash at beginning of year 26,928 26,450
----------- ---------
Short-term investments and cash at end of period $ 24,076 10,351
=========== =========
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION Cash paid during the period for:
Interest $ 8,854 6,836
Federal income tax 6,371 4,300
Supplemental schedule of non-cash financing activity:
Conversion of convertible subordinated debentures 117 127
Unearned stock compensation 5,436 5,085
See accompanying notes to unaudited interim consolidated financial statements.
5
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The interim consolidated financial statements are unaudited, but
reflect all adjustments which, in the opinion of management, are
necessary to provide a fair statement of the results of the Selective
Insurance Group, Inc. and its consolidated subsidiaries for the interim
periods presented. References herein to "Selective" are to Selective
Insurance Group, Inc. All such adjustments are of a normal recurring
nature. The results of operations for any interim period are not
necessarily indicative of results for a full year. These interim
consolidated financial statements cover the second quarters ended June
30, 2003 (Second Quarter 2003) and June 30, 2002 (Second Quarter 2002)
and the six month periods ended June 30, 2003 (Six Months 2003) and
June 30, 2002 (Six Months 2002). This document should be read in
conjunction with the consolidated financial statements and notes
thereto contained in our Annual Report on Form 10-K for the year ended
December 31, 2002.
2. RECLASSIFICATIONS
Certain amounts in the Company's prior year interim consolidated
financial statements have been reclassified to conform to the 2003
presentation. Such reclassification had no effect on the Company's net
income or stockholders' equity.
3. DISCONTINUED OPERATIONS
In December 2001, the Company's management adopted a plan to divest
itself of its 100% ownership interest in PDA Software Services, Inc.
(PDA). During May 2002, the Company sold all of the issued and
outstanding shares of capital stock and certain software applications
of PDA for proceeds of $16.5 million at a net gain of $0.6 million. The
amount of tax benefit included in loss from discontinued operations is
$0.4 million for Second Quarter 2002 and Six Months 2002. The amount of
tax expense for the Second Quarter 2002 and Six Months 2002 for the
gain on disposition of discontinued operations is $0.4 million.
Operating results from discontinued operations are as follows:
UNAUDITED, UNAUDITED,
QUARTER ENDED SIX MONTHS
JUNE 30, ENDED JUNE 30,
(in thousands) 2003 2002 2003 2002
- ---------------------------------------------------------------------------
Net revenue $ - 3,729 $ - 8,186
Pre-tax loss - (1,092) - (1,085)
After-tax loss $ - (712) $ - (708)
4. 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 accounting
principles generally accepted in the United States of America (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.
Selective and its subsidiaries provide services to each other in the
normal course of business. These transactions totaled $6.8 million for
Second Quarter 2003 and $13.1 million for Six Months 2003, compared
with $5.0 million
6
for Second Quarter 2002 and $20.2 million for Six Months 2002. These
transactions were eliminated in all consolidated statements.
In computing the results of each segment, no adjustment is made for
interest expense, net general corporate expenses or federal income
taxes. The Company does not maintain separate investment portfolios for
the segments and, therefore, does not allocate assets to the segments.
The following summaries present revenues (net investment income and net
realized gains or losses in the case of the Investments segment) and
pre-tax income (loss) for the individual segments:
UNAUDITED, UNAUDITED,
QUARTER ENDED SIX MONTHS ENDED
REVENUE BY SEGMENT JUNE 30, JUNE 30,
(in thousands) 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------
INSURANCE OPERATIONS:
Commercial lines net premiums earned $ 223,722 195,192 $ 439,347 380,230
Personal lines net premiums earned 52,417 49,306 103,839 98,563
Miscellaneous income 646 653 1,338 1,423
=========== ======== =========== ========
Total insurance operations revenues 276,785 245,151 544,524 480,216
INVESTMENTS:
Net investment income 29,436 25,100 56,779 49,604
Net realized gain (loss) on investments 3,369 (411) 7,344 (302)
=========== ======== =========== ========
Total investment revenues 32,805 24,689 64,123 49,302
DIVERSIFIED INSURANCE SERVICES:
Diversified insurance services revenues, from
continuing operations 23,481 20,720 44,819 39,553
----------- -------- ----------- --------
TOTAL ALL SEGMENTS 333,071 290,560 653,466 569,071
=========== ======== =========== ========
Other income 16 287 106 316
----------- -------- ----------- --------
TOTAL REVENUES FROM CONTINUING OPERATIONS $ 333,087 290,847 $ 653,572 569,387
=========== ======== =========== ========
UNAUDITED, UNAUDITED,
INCOME (LOSS), BEFORE FEDERAL INCOME TAX QUARTER ENDED SIX MONTHS ENDED
BY SEGMENT JUNE 30, JUNE 30,
(in thousands) 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------------------
INSURANCE OPERATIONS:
Commercial lines underwriting $ (1,256) (6,102) $ (15,464) (9,967)
Personal lines underwriting (1,257) (5,215) (5,042) (10,392)
----------- -------- ----------- --------
Underwriting loss, before federal income tax (2,513) (11,317) (20,506) (20,359)
INVESTMENTS:
Net investment income 29,436 25,100 56,779 49,604
Net realized gain (loss) on investments 3,369 (411) 7,344 (302)
----------- -------- ----------- --------
Total investment income, before federal income tax 32,805 24,689 64,123 49,302
DIVERSIFIED INSURANCE SERVICES:
Income from continuing operations, before federal
income tax 2,680 1,599 4,546 2,993
----------- -------- ----------- --------
TOTAL ALL SEGMENTS 32,972 14,971 48,163 31,936
----------- -------- ----------- --------
Interest expense (4,451) (3,499) (8,990) (7,005)
General corporate expenses (1,521) (1,392) (2,814) (3,174)
----------- -------- ----------- --------
INCOME FROM CONTINUING OPERATIONS, BEFORE FEDERAL
INCOME TAX $ 27,000 10,080 36,359 21,757
=========== ======== =========== ========
7
5. REINSURANCE
The following table is a listing of direct, assumed and ceded amounts
by income statement caption:
UNAUDITED, UNAUDITED,
QUARTER ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
(in thousands) 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------
Premiums written:
Direct $ 342,114 297,064 $ 694,937 603,697
Assumed 5,082 3,760 11,020 9,416
Ceded (40,333) (32,537) (75,691) (63,381)
----------- ------- ----------- --------
Net $ 306,863 268,287 $ 630,266 549,732
=========== ======= =========== ========
Premiums earned:
Direct $ 308,160 270,778 $ 604,954 530,357
Assumed 6,174 4,910 11,667 9,574
Ceded (38,195) (31,190) (73,435) (61,138)
----------- ------- ----------- --------
Net $ 276,139 244,498 $ 543,186 478,793
=========== ======= =========== ========
Losses and loss expenses incurred:
Direct $ 196,141 182,688 $ 405,559 363,512
Assumed 5,495 5,993 10,527 9,536
Ceded (11,895) (9,581) (27,243) (23,071)
----------- ------- ----------- --------
Net $ 189,741 179,100 $ 388,843 349,977
=========== ======= =========== ========
Flood business, which we cede 100% to the National Flood Insurance
Program, is included in the above amounts as follows:
UNAUDITED, UNAUDITED,
QUARTER ENDED SIX MONTHS
JUNE 30, ENDED JUNE 30,
(in thousands) 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------
Ceded premiums written $ (17,317) (13,858) (30,875) (25,422)
Ceded premiums earned (14,239) (11,995) (27,811) (22,472)
Ceded losses and loss expenses incurred (3,169) (850) (3,812) (1,956)
Additional increases in ceded written and earned premium is primarily
related to the increase in reinsurance rates and subject premium for
our major reinsurance treaties.
6. COMPREHENSIVE INCOME
The Company's comprehensive income for Second Quarter 2003, Six Months
2003, and the corresponding periods in the prior year are:
UNAUDITED, UNAUDITED,
QUARTER ENDED SIX MONTHS
JUNE 30, ENDED JUNE 30,
(in thousands) 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------
Net income $ 19,749 8,245 $ 27,786 18,545
---------- ------ --------- ------
Other comprehensive income, increase in net
unrealized gain on available-for-sale
securities, net of deferred income tax effect 35,817 8,443 34,571 2,423
---------- ------ --------- ------
Comprehensive income $ 55,566 16,688 $ 62,357 20,968
========== ====== ========= ======
7. 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, 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
8
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 $13.6 million as of June 30, 2003
and $15.5 million as of June 30, 2002. 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 June 30, 2003 the maximum exposure to
any one account for earned payroll is approximately $1.3 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 43% 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.
8. 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.
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.
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:
UNAUDITED, UNAUDITED,
QUARTER ENDED SIX MONTHS
JUNE 30, ENDED JUNE 30,
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 2003 2002 2003 2002
- --------------------------------------------------------------------------------------------------------------------
Net income, as reported $ 19,749 8,245 27,786 18,545
Add: Stock-based employee compensation reported in
net income, net of related tax effect 724 675 1,322 1,507
Deduct: Total stock-based employee compensation
expense determined under fair value-based method for
all awards, net of related tax effects (753) (676) (2,365) (2,382)
--------- ----- ------ ------
Pro forma net income $ 19,720 8,244 26,743 17,670
========= ===== ====== ======
Net income per share:
Basic - as reported $ 0.76 0.33 1.07 0.74
Basic - pro forma 0.76 0.33 1.03 0.71
Diluted - as reported 0.72 0.31 1.01 0.70
Diluted - pro forma 0.72 0.31 0.98 0.66
9. COMMITMENTS AND CONTINGENCIES
Included in other investments is approximately $26.2 million of
investments in limited partnerships as of June 30, 2003, and $23.5
million as of December 31, 2002. At June 30, 2003 the Company has an
additional limited partnership investment commitment of up to $25.6
million, including a $10.0 million commitment to a limited
partnership, which the Company has made no investment in as of June
30, 2003. There is no certainty that any additional investment will
be required.
9
On May 21, 2003, a purported class action was brought against Consumer
Health Network Plus, LLC, Alta Services, LLC and Selective Insurance
Company of America , wholly-owned subsidiaries of Selective, together
with ten other unrelated defendants. The lawsuit alleges that the
defendants breached participating provider agreements and were unjustly
enriched. We will vigorously defend this action, as we believe the
Company has significant defenses to defeat the action. Further, since
the suit has only been recently filed and an answer is not required
until September 12, 2003, management cannot at this time provide a
meaningful estimate or range of estimates of a potential loss, if any.
10. SUBSEQUENT EVENT
Our property and casualty excess of loss treaties were renewed
effective July 1, 2003. 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 excess of the $2.0 million retention. The casualty
program provides coverage of $47.2 million in excess of the Company's
$2.0 million retention and $0.8 million participation. The casualty
treaty distinguishes between Terrorism Risk Insurance Act (TRIA), and
non-TRIA losses. Non-TRIA losses are treated like any other loss. The
annual aggregate limit for certified terrorism losses is capped at two
times each layer's occurrence limit, or $96.0 million. Consistent with
the 2002 treaty, nuclear, biological and chemical losses are excluded,
but there is no exclusion for mold losses or cyber risks. The
following additional exclusions were added to the 2003 - 2004 treaty:
1) "Fortune 500" companies ($8.0 plus billion in sales); 2) war; 3)
asbestos; and 4) pharmaceutical manufacturers. Due to the type of
exposures the Company insures, these additional exclusions are not
expected to have a material impact on our results.
Under the property excess of loss treaty, the Company retains the first
$2.0 million of any loss and 25% of any loss (up to $1.3 million) in
the $5.0 million excess of $5.0 million second layer. This is a change
from 2002, when the Company had no participation in the second layer.
The current treaty provides coverage of up to $16.8 million per risk in
excess of the Company's $2.0 million retention. In 2002, the treaty
provided coverage of up to $13.0 million per risk in excess of the
Company's retention of $2.0 million and $1.3 million participation in
the second layer. As with the casualty treaty, the property treaty
distinguishes between certified and non-certified terrorism losses. The
policy provides coverage for certified terrorism losses for all risks
up to a $75.0 million total insured value, per location. The policy
provides annual certified terroism limits of $9.0 million for the first
layer, $15.0 million for the second layer and $20.0 million for the
third layer. Claims arising from non-certified terrorist acts are
treated like any other loss and are not subject to limitations or
annual aggregate caps. Consistent with the 2002 treaty; nuclear,
biological and chemical losses are excluded.
The estimated reinsurance cost for the property and casualty excess of
loss treaties decreased approximately $1.1 million over the fiscal year
ending June 2003.
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 represent our expectations and
we can give no assurance that such expectations will prove to be correct.
Factors that could cause our actual results to differ materially from those
projected, forecasted or estimated by us in forward-looking statements, include,
but are not limited to:
- the frequency and severity of catastrophic events, including
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;
10
- changes in insurance regulations that impact our ability to write
and/or cease writing insurance policies in one or more states
particularly changes in New Jersey automobile insurance laws and
regulations;
- our ability to maintain favorable ratings from A.M. Best,
Standard & Poor's, Moody's and Fitch;
- fluctuations in interest rates and the performance of the
financial markets;
- our entry into new markets and businesses; and
- other risks and uncertainties we identify in this report and
other filings with the Securities and Exchange Commission.
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 our Annual Report on Form 10-K for the year ended December 31, 2002. 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.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion relates to our results of operations, financial
condition, liquidity and capital resources, off-balance sheet arrangements,
contractual obligations and contingent liabilities and commitments and critical
accounting policies for the interim periods indicated.
RESULTS OF OPERATIONS
The following discussion is a comparison of the second quarter ended June 30,
2003 (Second Quarter 2003) and the six month period ended June 30, 2003 (Six
Months 2003) to the second quarter ended June 30, 2002 (Second Quarter 2002) and
the six month period ended June 30, 2002 (Six Months 2002).
Our net income was $19.7 million, or $0.72 per diluted share, for Second Quarter
2003, compared with $8.2 million, or $0.31 per diluted share, for Second Quarter
2002. Our net income was $27.8 million, or $1.01 per diluted share, for Six
Months 2003, compared with $18.5 million, or $0.70 per diluted share, for Six
Months 2002. Included in net income are net realized capital gains, after-tax,
of $2.2 million for Second Quarter 2003 and $4.8 million for Six Months 2003,
compared with net realized capital losses, after-tax, of $0.3 million for Second
Quarter 2002 and $0.2 million for Six Months 2002.
OPERATING SEGMENTS
The Company is primarily engaged in writing property and casualty insurance. The
Company has classified its businesses into three segments: Insurance Operations
(commercial lines underwriting, personal lines underwriting), Investments, and
Diversified Insurance Services (managed care, flood insurance and human resource
administration outsourcing). Insurance Operations are evaluated based on
underwriting results determined in accordance with GAAP; Investments are
evaluated based on after-tax investment returns; and the Diversified Insurance
Services are evaluated based on several measures including, but not limited to,
results of operations determined in accordance with GAAP. For an additional
description of accounting policies, refer to Note 1 to our consolidated
financial statements on pages 43 through 47 of our 2002 Annual Report to
Shareholders (incorporated herein by reference to our Annual Report on Form 10-K
for the year ended December 31, 2002) and the discussion beginning on page 20 of
this report on Form 10-Q. See Note 4 to the June 30, 2003 unaudited interim
consolidated financial statements on pages 6 and 7 of this report on Form 10-Q
for revenues and related income before federal income tax for each individual
segment discussed below.
11
Insurance Operations Segment
- -------------------------------------------------------------------------------------------------------------
Unaudited, Unaudited,
ALL LINES Quarter ended June 30, Six Months ended June 30,
($ in thousands) 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------
GAAP INSURANCE OPERATIONS RESULTS
Net premiums written $ 306,863 268,287 630,266 549,732
========= ========== ======== =========
Net premiums earned $ 276,139 244,498 543,186 478,793
Less:
Losses and loss expenses incurred 189,741 179,100 388,843 349,977
Net underwriting expenses incurred 87,528 75,309 171,911 145,848
Dividends to policyholders 1,383 1,406 2,938 3,327
--------- ---------- -------- ---------
Underwriting loss $ (2,513) (11,317) (20,506) (20,359)
--------- ---------- -------- ---------
GAAP RATIOS:
Loss and loss expense ratio 68.7 % 73.2 71.6 % 73.1
Underwriting expense ratio 31.7 % 30.8 31.7 % 30.5
Dividends to policyholders ratio 0.5 % 0.6 0.5 % 0.7
--------- ---------- -------- ---------
Combined ratio 100.9 % 104.6 103.8 % 104.3
========= ========== ======== =========
Net premiums written increased by approximately $38.6 million, or 14%, to $306.9
million in Second Quarter 2003 and by $80.5 million, or 15%, to $630.3 million
in Six Months 2003 when compared with the same periods in 2002. Net premiums
written for Second Quarter 2003 included $70.9 million in net new business
written, an increase of 33% compared with $53.4 million in Second Quarter 2002.
Six Months 2003 included $136.9 million in net new business written, an 11%
increase over $123.1 million for Six Months 2002. The lower combined ratio
reflects three-plus years of commercial lines renewal premium price increases,
which were approximately 13% in Second Quarter 2003 compared with approximately
19% in Second Quarter 2002 and 14% for Six Months 2003 compared with 19% for
Six Months 2003.
The loss and loss expense ratio decreased 4.5 points to 68.7% for Second Quarter
2003 and 1.5 points to 71.6% for Six Months 2003 when compared with the same
periods in 2002. The improvements are primarily due to increased premium rates,
underwriting improvements and improved retention, mainly in our commercial lines
business, which comprises over 82% of our insurance operations. Also
contributing to the decrease were lower weather-related catastrophe losses,
which had an immaterial impact on our Second Quarter 2003 loss ratio, compared
with 2.4 points for Second Quarter 2002. However, included in Six Months 2003
results were three weather-related catastrophe events that occurred in the first
quarter of 2003, adding $11.8 million to losses incurred and 2.2 points to the
loss and loss expense ratio, compared with $7.2 million and 1.5 points for Six
Months 2002.
The underwriting expense ratio increased 0.9 points to 31.7% for Second Quarter
2003 and 1.2 points to 31.7% for Six Months 2003 compared with the same periods
last year. This increase is partially attributable to a changed deferred
acquisition cost amortization estimate that management believes better matches
underwriting expenses with earned premium by quarter. The change in estimate
will have no impact for the full year. Expenses realted to employee retirement
plans increased $0.8 million, or 14%, for Second Quarter 2003 when compared with
Second Quarter 2002 and $1.6 million, or 15%, for Six Months 2003 when compared
to the same period last year. Additionally, profit-based agent commissions
incurred increased $1.2 milion, or 29% for Second Quarter 2003 and $3.5
million, or 45% for Six Months 2003 when compared with the same periods one
year earlier due to improved underwriting profitability.
Overall productivity, as measured by fiscal year net premiums written per
insurance operations employee, was approximately $639,000 for the twelve-month
period ended June 30, 2003, up from $574,000 for the same period in 2002. Our
strategic initiatives which are designed to either reduce costs and/or increase
business include: i) streamlined processing for small commercial lines accounts
(One & Done); ii) a web-based commercial lines automated system, and iii) claim
and underwriting Service Centers. These initiatives are expected to reduce our
underwriting expense ratio and increase our productivity measure.
12
Commercial Lines Underwriting
Unaudited, Unaudited,
COMMERCIAL LINES Quarter ended June 30, Six Months ended June 30,
($ in thousands) 2003 2002 2003 2002
- --------------------------------------------------------------------------------------------------------------
GAAP INSURANCE OPERATIONS RESULTS
Net premiums written $ 249,670 214,847 $ 519,424 446,761
========= ========== ========== =========
Net premiums earned $ 223,722 195,192 $ 439,347 380,230
Less:
Losses and loss expenses incurred 151,388 138,205 311,582 269,902
Net underwriting expenses incurred 72,207 61,683 140,291 116,968
Dividends to policyholders 1,383 1,406 2,938 3,327
--------- ---------- ---------- ---------
Underwriting loss $ (1,256) (6,102) $ (15,464) (9,967)
--------- ---------- ---------- ---------
GAAP RATIOS:
Loss and loss expense ratio 67.7 % 70.8 70.9 % 70.9
Underwriting expense ratio 32.3 % 31.6 31.9 % 30.8
Dividends to policyholders ratio 0.6 % 0.7 0.7 % 0.9
--------- ---------- ---------- ---------
Combined ratio 100.6 % 103.1 103.5 % 102.6
========= ========== ========== =========
Commercial Lines Underwriting accounted for approximately 82% of net premiums
written in Six Months 2003 compared with 81% in Six Months 2002.
Net premiums written increased $34.8 million, or 16%, to $249.7 million for
Second Quarter 2003 and $72.7 million, or 16%, to $519.4 million for Six Months
2003 compared with the same periods in 2002. Net premiums written included $62.3
million in net new business written for Second Quarter 2003, a 35% increase when
compared with $46.2 million in net new business written for Second Quarter 2002,
and $120.0 million in net new business written in Six Months 2003, an 8%
increase when compared with $111.2 million in net new business written in Six
Months 2002.
For Second Quarter 2003, the Commercial Lines Underwriting combined ratio
decreased 2.5 points to 100.6% from 103.1% for the same period in 2002. The
lower combined ratio reflects renewal premium price increases of 13% in Second
Quarter 2003 compared with 19% in Second Quarter 2002 and 14% for Six Months
2003 compared with 19% for Six Months 2003. Importantly, retention improved 3
points for Second Quarter and 2 points for Six Months 2003, compared with the
same periods last year. We monitor retention closely because ultimately, higher
retentions yield better loss ratios and lower expenses.
Our commercial property line, which accounted for 10% of commercial lines net
premiums earned for both Second Quarter 2003 and Second Quarter 2002, was a big
driver for the improvement in the quarter, posting a loss and loss expense ratio
of 38.3% for Second Quarter 2003, about 31-points below the loss and loss
expense ratio for Second Quarter 2002. Commercial automobile, which accounted
for 28% of commercial lines net premiums earned in Second Quarter 2003 and 27%
in Second Quarter 2002, also registered a strong quarter, with a loss and loss
expense ratio of 64.1%, down almost seven-points compared with Second Quarter
2002. These improvements in Second Quarter 2003 were mainly due to price
increases, underwriting improvements and decreased weather-related catastrophe
losses of $4.3 million, or 2.3 points when compared with Second Quarter 2002.
Our workers' compensation business, which accounted for 24% of commercial lines
net premiums earned in Second Quarter 2003 and 25% in Second Quarter 2002,
continued to under-perform, posting a loss and loss expense ratio of 87.2% for
Second Quarter 2003, compared with 89.7% for Second Quarter 2002. Even though
these results are unacceptable on their own, our account-based strategy ensures
we do not write this line as a stand-alone product. Instead, it is offered as a
companion product to one of our more profitable lines of business. In fact, less
than 5% of our workers' compensation business is unsupported. Our appetite is
for low-to-medium hazards that do not pose a high potential for catastrophic
loss. We continue to tighten underwriting guidelines to eliminate the most
unprofitable classes of business, and we're taking full advantage of rate
opportunities, where allowed by law, as well as additional pricing opportunities
generated by credit reductions, higher pricing tiers and limited use of dividend
plans. As a result of these initiatives, over the last three years, our workers'
compensation pricing increased 48%, while policy count declined to 8% of our
total commercial policy count, from 9% during that same period. For the first
six months of 2003, we received an additional overall price increase of 14%,
including 16% in New Jersey, our largest workers' compensation market. New
Jersey workers' compensation net premiums written where $15.7 million, or 6% of
total commercial lines net premiums written, for Second Quarter 2003 and $34.0
million, or 7% of total commercial lines net premiums written, for Six Months
2003.
Our Commercial Lines Underwriting combined ratio for Six Months 2003 increased
to 103.5% from 102.6% for Six Months 2002. This 0.9 point increase is mainly
attributable to weather-related catastrophe losses in First Quarter 2003 that
impacted losses incurred by $10.1 million, or 2.3 points for Six Months 2003,
compared with $5.2 million, or 1.4 points for Six Months 2002. Also impacting
the combined ratio was the changed deferred acquisition cost amortization
estimate discussed above.
13
Personal Lines Underwriting
Unaudited, Unaudited,
PERSONAL LINES Quarter ended June 30, Six Months ended June 30,
($ in thousands) 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------
GAAP INSURANCE OPERATIONS RESULTS
Net premiums written $ 57,193 53,440 $ 110,842 102,971
========= ========== ========= =========
Net premiums earned $ 52,417 49,306 $ 103,839 98,563
Less:
Losses and loss expenses incurred 38,353 40,895 77,261 80,075
Net underwriting expenses incurred 15,321 13,626 31,620 28,880
--------- ---------- --------- ---------
Underwriting (loss) $ (1,257) (5,215) $ (5,042) (10,392)
--------- ---------- --------- ---------
GAAP RATIOS:
Loss and loss expense ratio 73.2 % 82.9 74.4 % 81.2
Underwriting expense ratio 29.2 % 27.6 30.5 % 29.3
--------- ---------- --------- ---------
Combined ratio 102.4 % 110.5 104.9 % 110.5
========= ========== ========= =========
Personal Lines Underwriting accounted for approximately 18% of net premiums
written for Six Months 2003 compared with 19% for Six Months 2002.
Personal Lines Underwriting net premiums written increased $3.8 million, or 7%,
to $57.2 million for Second Quarter 2003 and $7.9 million, or 8%, to $110.8
million for Six Months 2003 when compared with the same periods in 2002. Net
premiums written included net new business written of $8.6 million in Second
Quarter 2003, a 19% increase when compared with $7.2 million in Second Quarter
2002. Net new business written in Six Months 2003 was $16.9 million, a 42%
increase over the $11.9 million written in Six Months 2002.
Personal Lines Underwriting combined ratio was 102.4% for Second Quarter 2003,
down 8.1 points from the same period in 2002. The decrease reflects: (i) fewer
weather-related catastrophe losses of, $0.2 million, or 0.3 points, in Second
Quarter 2003 compared with $1.5 million, or 3.0 points in Second Quarter 2002
mainly in our homeowners line of business, and (ii) a six-point decrease in our
personal automobile combined ratio to 103.8% for Second Quarter 2003 compared
with 110.0% for the same period in 2002.
In New Jersey which accounted for 72% of our overall personal automobile net
premiums written for Second Quarter 2003 and 2002, and 73% for Six Months 2003
and 2002 we are making progress in our personal automobile book of business as
we earn higher premiums from price and tier changes. Average premium per
vehicle is up 21% since December 31, 2000. These improvements are reflected in
our New Jersey personal automobile loss and loss expense ratio of 73.8% for
Second Quarter 2003, close to an eight-point improvement from the same period
in 2002. Additionally, (i) State lawmakers passed automobile insurance reform
legislation this quarter that offers the opportunity for improved rate
adequacy, a less restrictive excess profits calculation, and more streamlined
rate filings; (ii) New Jersey average premium per vehicle increased 10% over
Second Quarter 2002 levels; and (iii) the number of insured vehicles has
declined by about 2,000 since December 31, 2002 to 109,000.
Efforts to control our exposure in New York, due to the high cost of required
participation in the involuntary automobile insurance market, are ongoing. Our
net premiums written in New York decreased 12%, to $1.8 million, for Second
Quarter 2003 compared with $2.0 million for Second Quarter 2002, and 10% to $3.6
million for Six Months 2003 compared with $4.0 million for the same period last
year. Since December 31, 2002, the number of vehicles we insure has dropped 12%,
to below 10,000. A 15% rate increase for New York personal automobile, effective
April 15, 2003, has been approved and implemented. We are pursuing additional
rate increases later this year, however there is no quarantee that this request
will be approved. While we've seen improvements in the loss and loss expense
ratio for this business, the business remains unprofitable due to the adverse
impact of the assigned risk charges incurred. The loss and loss expense ratio
for Second Quarter 2003 was 64.5% compared with 77.0% for the same period last
year, and 74.6% for Six Months 2003 compared with 83.0% for Six Months 2002. The
assigned risk charges were $0.6 million for Second Quarter 2003 and added almost
34 points to the New York automobile personal lines underwriting expense ratio,
compared with $0.9 million and 46 points for Second Quarter 2002. These charges
were $1.2 million, or 34 points, for Six Months 2003 compared with $1.5 million,
or 38 points, for Six Months 2002. Overall, these assigned risk charges added
1.2 points to the overall personal lines underwriting expense ratio for Second
Quarter and Six Months 2003, compared with 1.8 points for Second Quarter 2002,
and 1.5 points for Six Months 2002.
Personal Lines Underwriting combined ratio was 104.9% for Six Months 2003, down
5.6 points from the same period in 2002. The decrease is attributable to a
6.2-point decrease in our personal automobile combined ratio to 103.8% for Six
Months 2003 compared with 110.0% for the same period in 2002. These improvements
reflect the pricing and other initiatives discussed above.
14
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.
Our property and casualty excess of loss treaties were renewed effective July
1, 2003, with reduced premium rates and increased protection in the structure.
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 excess of the $2.0
million retention. The casualty program provides coverage of $47.2 million in
excess of the Company's $2.0 million retention and $0.8 million participation.
This structure is unchanged from 2002. In light of the Terrorism Risk Insurance
Act of 2002 (TRIA), the casualty treaty distinguishes between certified (TRIA
or foreign acts) and non-certified (all other or domestic) losses.
Non-certified terrorism losses are treated like any other losses. The annual
aggregate limit for certified terrorism losses is capped at two times each
layer's occurrence limit, or $96.0 million. Consistent with the 2002 treaty:
nuclear, biological and chemical losses are excluded from the casualty excess
of loss treaty however; our terrorism excess of loss treaty does cover these
exposures once our $15.0 million annual aggregate deductible is met. There is
no exclusion for mold or cyber risks in this contract. The following additional
exclusions were added to the 2003 - 2004 treaty: 1) "Fortune 500" companies ($8
plus billion in sales); 2) war; 3) asbestos; and 4) pharmaceutical
manufacturers. Due to the types of exposures the Copany insures, these
additional exclusions are not expected to have a material impact on our
results.
Under the property excess of loss treaty, the Company retains the first $2.0
million of any loss and 25% of any loss (up to $1.3 million) in the $5.0 million
excess of $5.0 million second layer. This is a change from 2002, when the
Company had no participation in the second layer. The current treaty provides
coverage of up to $16.8 million per risk in excess of the Company's $2.0
million retention and $1.3 million participation in the second layer. In 2002,
the treaty provided coverage of up to $13.0 million per risk in excess of the
Company's retention of $2.0 million. As with the casualty treaty, the property
treaty distinguishes between certified and non-certified terrorism losses. The
policy provides coverage for certified terrorism losses for all risks up to
$75.0 million in total insured value per location. The policy provides annual
certified terroism limits of $9.0 million for the first layer, $15.0 million
for the second layer and $20.0 million for the third layer. Claims arising from
non-certified terrorist acts are treated like any other losses and are not
subject to limitations or annual aggregate caps. Nuclear, biological and
chemical losses are excluded from the property excess of loss treaty however;
our terrorism excess of loss treaty does cover these exposures once our $15.0
million annual aggregate deductible is met. There is no exclusion for mold or
cyber risks in this contract. Consistent with the 2002 treaty; nuclear,
biological and chemical losses are excluded.
The estimated reinsurance cost for the property and casualty excess of loss
treaties decreased approximately $1.1 million, over the fiscal year ending June
2003.
Investments Segment
Although lower interest rates continue to put pressure on investment returns, we
generated a 15% increase in after-tax investment income to $21.4 million for
Second Quarter 2003, up from $18.6 million for Second Quarter 2002. For Six
Months 2003 we generated an 11% increase to $41.2 million, compared with $37.1
million for the same period last year. The increase reflects an increased asset
base as our overall investment portfolio reached $2.3 billion at June 30, 2003,
compared with $2.1 billion at December 31, 2002. The increased asset base is
driven by $100.3 million of operating cash flow for Six Months 2003 compared
with $72.4 million for Six Months 2002 due to improved underwriting results.
Also contributing to the increase were our limited partnership investments.
These investments, which are subject to market fluctuations, added $1.3 million,
after-tax, to investment income for Second Quarter 2003, compared with $0.1
million for Second Quarter 2002 and $1.5 million for Six Months 2003 compared
with $0.4 for Six Months 2002. The after-tax portfolio yield is 3.7%, compared
with 4.0% for the same period last year, reflecting downward pressure from
maturing bonds that are being replaced by bonds with lower interest rates.
We continue to maintain a conservative, diversified investment portfolio, with
our bond holdings representing 88% of invested assets. Approximately 62% of our
debt securities portfolio is rated "AAA." Our portfolio has an average rating of
"AA," with only 1% of the portfolio rated below investment grade.
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
15
our consolidated statements of income. Our assessment of a decline in value
includes our current judgment as to the financial position and future prospects
of the entity that issued the investment security. Broad changes in the overall
market or interest rate environment, generally will not lead to a write-down. If
our judgment about an individual security changes in the future we may
ultimately record a realized loss after having originally concluded that the
decline in value was temporary, which could have a material impact on our net
income and financial position of future periods.
In evaluating potential impairment of debt securities we evaluate certain
factors, including but not limited to the following:
- Whether the decline appears to be issuer or industry specific;
- The degree to which an issuer is current or in arrears in making
principal and interest payments on the debt securities in
question;
- The issuer's current financial condition and its ability to make
future scheduled principal and interest payments on a timely
basis;
- Buy/hold/sell recommendations published by outside investment
advisors and analysts; and
- Relevant rating history, analysis and guidance provided by rating
agencies and analysts.
In evaluating potential impairment of equity securities, we evaluate certain
factors, including but not limited to the following:
- Whether the decline appears to be issuer or industry specific;
- The relationship of market prices per share to book value per
share at the date of acquisition and date of evaluation;
- The price-earnings ratio at the time of acquisition and date of
evaluation;
- The financial condition and near-term prospects of the issuer,
including any specific events that may influence the issuer's
operations;
- The recent income or loss of the issuer;
- The independent auditors' report on the issuer's recent financial
statements;
- The dividend policy of the issuer at the date of acquisition and
the date of evaluation;
- Any buy/hold/sell recommendations or price projections published
by outside investment advisors; and
- Any rating agency announcements.
Realized gains and losses 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, if any, in the period such determination is made. There
were no impairment charges recorded during Second Quarter 2003 or Second Quarter
2002. The Company realized gains and losses from the sale of available-for-sale
debt and equity securities during Second Quarter 2003 and Second Quarter 2002.
The following table presents the period of time that debt securities, sold at a
loss during these periods, were continuously in an unrealized loss position
prior to sale. Equity securities sold during these periods were not in a
continuous unrealized loss position prior to sale:
Unaudited, Unaudited,
Quarter ended June 30, Quarter ended June 30,
(in millions) 2003 2002
- --------------------------------------------------------------------------------------------------
Fair Fair
Period of time in an unrealized Value on Realized Value on Realized
loss position Sale Date Loss Sale Date Loss
--------- -------- --------- --------
Debt securities:
0 - 6 months $ - - 7.1 4.3
7 - 12 months - - - -
Greater than 12 months - - 2.3 0.6
--------- -------- --------- --------
Total debt securities $ - - 9.4 4.9
========= ======== ========= ========
Unaudited, Unaudited,
Six Months ended June 30, Six Months ended June 30,
(in millions) 2003 2002
- --------------------------------------------------------------------------------------------------
Fair Fair
Period of time in an unrealized Value on Realized Value on Realized
loss position Sale Date Loss Sale Date Loss
--------- -------- --------- --------
Debt securities:
0 - 6 months $ - - 7.1 4.3
7 - 12 months - - 6.7 0.3
Greater than 12 months 5.0 - 2.3 0.6
--------- -------- --------- --------
Total debt securities $ 5.0 - 16.1 5.2
========= ======== ========= ========
16
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 June 30, 2003 and December 31, 2002, 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:
Unaudited
(in millions) June 30, 2003 December 31, 2002
- --------------------------------------------------------------------------------------------------
Gross Gross
Period of time in unrealized loss Fair Unrealized Fair Unrealized
position Value Loss Value Loss
--------- -------- --------- --------
Debt securities:
0 - 6 months $ 67.7 0.9 110.8 3.3
7 - 12 months 16.8 0.3 12.9 0.3
Greater than 12 months 19.5 2.0 19.8 3.0
--------- -------- --------- --------
Total debt securities 104.0 3.2 143.5 6.6
--------- -------- --------- --------
Equities:
0 - 6 months 12.9 0.1 15.6 2.3
7 - 12 months 9.9 0.2 15.9 3.2
Greater than 12 months 16.1 3.5 8.3 2.4
--------- -------- --------- --------
Total equities 38.9 3.8 39.8 7.9
--------- -------- --------- --------
Total $ 142.9 7.0 183.3 14.5
========= ======== ========= ========
The following table presents information regarding our available-for-sale debt
securities that were in an unrealized loss position at June 30, 2003 by
maturity:
Amortized Fair
(in millions) Cost Value
- -----------------------------------------------------------------------------------
One year or less $ 19.6 18.6
Due after one year through five years 21.2 21.0
Due after five years through ten years 39.9 38.8
Due after ten years through fifteen years 26.5 25.6
Due after fifteen years - -
--------- -----
Total $ 107.2 104.0
========= =====
At June 30, 2003 our investment portfolio included non-investment grade
securities with an amortized cost of $21.1 million, or less than 1% of the
portfolio, and a fair value of $21.8 million. At December 31, 2002,
non-investment grade securities in our investment portfolio also represented
less than 1% of the portfolio, with an amortized cost of $14.7 million and a
fair value of $13.3 million. The unrealized loss on these securities represented
10% of our total unrealized loss at June 30, 2003, and at December 31, 2002. The
fair value of these securities was determined by independent pricing services or
bid prices provided by various broker dealers. The Company did not have a
material investment in non-traded securities at June 30, 2003, or at December
31, 2002.
The Company regularly reviews the diversification of the investment portfolio
compared with an investment grade corporate index. At June 30, 2003, 20% of the
market value of our corporate bond and preferred stock portfolios were
represented by investments in banks, only one of which was in an unrealized loss
position, compared with 11% in the benchmark corporate index. The average
Moody's rating for the banking portfolio is "A1" with the lowest rated security
at "Baa2" and the average Standard and Poor's rating is "A", with the lowest
rated security at "B+".
17
Diversified Insurance Services Segment
Unaudited, Unaudited,
Quarter ended June 30, Six months ended June 30,
($ IN THOUSANDS) 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------
MANAGED CARE
Net revenue $ 6,409 6,082 $ 12,037 11,398
Pre-tax profit 1,113 1,099 2,063 1,915
FLOOD INSURANCE
Net revenue 5,926 4,807 10,531 8,768
Pre-tax profit 1,418 1,004 2,190 1,654
HUMAN RESOURCE ADMINISTRATION OUTSOURCING
Net revenue 10,665 9,372 21,316 18,476
Pre-tax profit (loss) 36 (624) 111 (848)
OTHER
Net revenue 481 459 935 911
Pre-tax profit 113 120 182 272
TOTAL
Net revenue 23,481 20,720 44,819 39,553
Pre-tax profit 2,680 1,599 4,546 2,993
Net income 1,779 1,068 3,080 2,010
Return on net revenue 7.6% 5.2 6.9% 5.1
The Diversified Insurance Services segment's continuing operations generated
$23.5 million of revenue and $1.8 million of net income for Second Quarter 2003
compared with $20.7 million of revenue and $1.1 million of net income for the
Second Quarter 2002. Continuing operations from these same businesses generated
$44.8 million of revenue and $3.1 million of net income for Six Months 2003
compared with $39.6 million of revenue and $2.0 million of net income for the
same period in 2002. The segment generated a return on net revenue of 7.6% for
the Second Quarter 2003 and 6.9% for the Six Months 2003, compared with 5.2% for
the Second Quarter 2002 and 5.1% for the Six Months 2002.
Managed Care
Our medical provider network has expanded to 89,086 locations as of June 30,
2003 from 80,400 locations as of June 30, 2002. Network and client expansion as
well as pricing initiatives have resulted in an increase in managed care
revenues of 5% to $6.4 million for Second Quarter 2003 compared with $6.1
million for Second Quarter 2002 and 6% to $12.0 million for Six Months 2003
compared with $11.4 million for Six Months 2002. Pre-tax profit remained
relatively flat for the Second Quarter 2003 compared with the same period in
2002. Included in Second Quarter 2003 results is a one-time, pre-tax $0.5
million lease and related expense charge involving the consolidation of the
managed care operation to one office location. The move is expected to generate
annual pre-tax savings of $0.4 million. This charge had less of an impact on
pre-tax profit for the Six Months 2003, which increased 8% to $2.1 million
compared with $1.9 million for Six Months 2002.
Flood Insurance
Premium growth of 25% for Second Quarter 2003 and 22% for Six Months 2003
compared with the same periods a year ago have been driven by enhanced marketing
efforts with the personal lines underwriting operation. These efforts have
resulted in new business of $5.1 million for Second Quarter 2003 compared with
$3.8 million for the comparable period last year, and $9.0 million for Six
Months 2003 compared with $6.8 million for the same period last year. This
growth brings our total premium served to $58.7 million compared with $48.8
million a year ago. Premium growth has resulted in increased servicing fees of
$5.9 million for Second Quarter 2003 compared with $4.8 million for Second
Quarter 2002 and $10.5 million for Six Months 2003 compared with $8.8 million
for Six Months 2002. Pre-tax profit has also increased due to this growth to
$1.4 million for Second Quarter 2003 compared with $1.0 million for Second
Quarter 2002 and $2.2 million for Six Months 2003 compared with $1.7 million for
Six Months 2002.
Human Resource Administration Outsourcing (HR outsourcing)
Revenue for Selective HR Solutions Inc., provider of our human resources
outsourcing product, was $10.7 million for Second Quarter 2003, up 14% compared
with $9.4 million last year. Six Months 2003 increased 15% to $21.3 million
compared with $18.5 million for Six Months 2002. Pre-tax profit was $36,000 for
Second Quarter 2003, compared with a pre-tax loss of $0.6 million for the Second
Quarter 2002. For Six Months 2003, pre-tax profit was $0.1 million compared with
a pre-tax loss of $0.8 million for same period last year. On a year-to-date
basis, pricing continues to move higher, as our workers' compensation fees
increased 11% and client administration fees rose 7%. For Six Months 2003, we
added 3,500 new worksite lives, which pushed our total to 19,700.
18
Federal Income Taxes
Total federal income tax expense increased by $5.5 million for both Second
Quarter 2003 and for Six Months 2003 to $7.3 million and $8.6 million,
respectively, compared with the same periods last year. Our effective tax rate
differs from the federal corporate rate of 35% primarily as a result of
tax-advantaged investment income. The effective tax rate for the Second Quarter
2003 was 27%, compared with 17% for the same period last year and 24% for Six
Months 2003, compared with 14% for the same period last year. The increase is
attributable to improved underwriting results, increased capital gains on
investment sales and the re-balancing of our debt securities portfolio. This
re-balancing increased our allocation to taxable bonds in order to maximize
after-tax yield.
Financial Condition, Liquidity and Capital Resources
Selective Insurance Group, Inc. (Parent) is an insurance holding company whose
principal assets are 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.
Dividends from Diversified Insurance Services subsidiaries are restricted only
by the operating needs of those subsidiaries.
Based upon the 2002 statutory financial statements, the insurance subsidiaries
are permitted to pay the Parent in 2003 ordinary dividends in the aggregate
amount of $51.1 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, refer to Note 7 to our Consolidated Financial
Statements on page 54 and 55 of the 10-K section of our Annual Report to
Shareholders for the year ended December 31, 2002. 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.
The Parent's cash requirements include principal and interest payments on the
various senior notes and subordinated debentures, dividends to stockholders and
general operating expenses. Our common stock repurchase program, which commenced
in 1996 terminated on May 31, 2003. Up to termination, the Parent had
repurchased under the stock repurchase program a total of 7.3 million shares of
its common stock at a total cost of approximately $140.5 million. The Parent
generates cash from the sale of its common stock under various stock plans, the
dividend reinvestment program, and from investment income. For Six Months 2003,
cash provided by operating activities was $100.3 million compared with $72.4
million for Six Months 2002. The improvement is a result of the significant net
premium written growth and improved underwriting results.
Total assets increased 9%, or $278.4 million, at June 30, 2003 from December 31,
2002. Invested assets increased $186.0 million primarily due to $100.3 million
of operating cash flow, $53.2 million increase in net unrealized gains on the
portfolio, and $34.9 million of bonds purchased in late June that did not settle
until July. Increased premium volume drove increases in premium receivables of
$79.4 million and deferred policy acquisition costs of $18.4 million. Securities
receivable, classified within other assets, decreased $6.0 million due to bonds
sold in late December that settled in January 2003.
Total liabilities increased 9%, or $218.5 million, at June 30, 2003 from
December 31, 2002. Increased premium volume is primarily responsible for the
increase in unearned premium reserves of $89.3 million. Loss and loss expense
reserves increased $75.0 million as a result of increasing loss trends, which
include inflation and rising medical costs. Loss trends have increased 6% since
year-end, however our price increases are outpacing these loss trends by
approximately 7 points. Securities payable, classified within other liabilities,
increased $34.9 million for the reason noted above. Deferred federal income tax
liability increased $19.5 million from a receivable of $8.7 million at December
2002 to a payable of almost $10.8 million at June 2003 primarily due to the
increase in unrealized gains in the debt and equity portfolios. Notes payable
decreased $6.0 million due to a scheduled payment in May on the 8.63% Senior
Notes.
OFF-BALANCE SHEET ARRANGEMENTS, CONTRACTUAL OBLIGATIONS AND CONTINGENT
LIABILITIES AND COMMITMENTS
At June 30, 2003 and 2002, 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
19
Company had engaged in such relationships.
Our future cash payments associated with contractual obligations pursuant to
operating leases for office space and equipment, senior convertible notes,
convertible subordinated debentures and notes payable have not materially
changed since December 31, 2002. We fully expect to have the capacity to repay
and/or refinance these obligations as they come due.
As of June 30, 2003 and December 31, 2002 we have available revolving lines of
credit amounting to $50.0 million, under which no balances are outstanding as
of either period. As of July 1, 2003, our available revolving lines of credit
have been revised to $45.0 million. 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 our consolidated financial
statements on page 64 of the 10-K section of our Annual Report to Shareholders
for the year ended December 31, 2002.
CRITICAL ACCOUNTING POLICIES
We have identified the policies below as critical to our business operations and
the understanding of our results of operations. For a detailed discussion of the
application of these and other accounting policies, see Note 1 to our
consolidated financial statements on pages 43 through 47 of our 2002 Annual
Report to Shareholders. Note that our preparation of the unaudited interim
consolidated financial statements requires us to make estimates and assumptions
that affect the reported amount of assets and liabilities, disclosure of
contingent assets and liabilities at the date of our financial statements, and
the reported amounts of revenue and expenses during the reporting period. There
can be no assurance that actual results will not differ from those estimates.
Reserves for Losses and Loss Expenses
Significant periods of time can elapse between the occurrence of an insured
loss, the reporting of the loss to the insurer and the insurer's payment of that
loss. To recognize liabilities for unpaid losses and loss expenses, insurers
establish reserves as balance sheet liabilities representing estimates of
amounts needed to pay reported and unreported net losses and loss expenses. As
of June 30, 2003, the Company had accrued $1.5 billion of loss and loss expense
reserves compared with $1.4 billion at December 31, 2002.
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
are carried as the IBNR reserve. By using both estimates of reported claims and
IBNR determined using generally accepted actuarial reserving techniques, we
estimate the ultimate net 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. A
range has not been established at June 30, 2003 because management believes it
would not be meaningful. 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 $624.1 million
at June 30, 2003 and $588.5 million at December 31, 2002. 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
20
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.
After taking into account all relevant factors, we believe that the reserve for
net losses and loss expenses at June 30, 2003, 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 would 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 there from are made in the
accounting period in which the adjustment arose.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in the information about market risk set
forth in our Annual Report on Form 10-K for the year-ended December 31, 2002.
ITEM 4. CONTROL AND PROCEDURES
Management has developed and implemented a policy and procedure for reviewing
disclosure controls and procedures and internal controls on a quarterly basis.
Management, including the Company's Chief Executive Officer and Chief Financial
Officer, has evaluated the effectiveness of the Company's disclosure controls
and procedures (as such term is defined in Rules 13a - 15(e) and 15d - 15(e)
under the Securities Exchange Act of 1934) as of the end of the period covered
by this report. Based on that evaluation, the company's Chief Executive Officer
and Chief Financial Officer have concluded that, as of the end of such period,
the Company's disclosure controls and procedures are effective.
There have not been any changes in the company's internal controls over
financial reporting (as such term is defined in Rules 13a - 15(f) and 15d -
15(f) under the Securities Exchange Act of 1934) during the fiscal quarter to
which this report relates that have materially affected, are reasonably likely
to materially affect, the Company's internal control over financial reporting.
21
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS -
On May 21, 2003, a purported class action was brought against Consumer Health
Network Plus, LLC (CHN), Alta Services, LLC (Alta) and Selective Insurance
Company of America (SICA), wholly-owned subsidiaries of Selective, together with
ten other unrelated defendants, in the New Jersey Superior Court in Camden
County by Berlin Medical Associates, P.A. and four other New Jersey health care
providers. The plaintiffs allege they are entitled to unspecified compensatory
damages with interest, punitive damages, attorneys fees, costs and an injunction
against the defendants. The plaintiffs allege that the defendants took improper
and unauthorized reductions from the providers' fees for services submitted
under automobile insurance policies providing coverage for personal injury
protection (PIP) under New Jersey law. The plaintiffs purport to represent the
interests of a class consisting of all New Jersey healthcare providers
(excluding hospitals) who are or were members of these PPOs. Defendants'
responses to the complaint are due by September 12, 2003. CHN, Alta and SICA are
vigorously defending against these claims. We believe the Company has
significant defenses to defeat this action.
ITEM 2. CHANGES IN SECURITIES - NONE
ITEM 3. DEFAULTS UPON SENIOR SECURITIES - NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS - NONE
ITEM 5. OTHER INFORMATION - NONE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
The exhibits required by Item 601 of Regulation S-K are listed in
the Exhibit Index, which immediately precedes the exhibits filed
with this Form 10-Q.
(b) Reports on Form 8-K:
On April 3, 2003, the Company filed a report on Form 8-K announcing
the impact of weather-related catastrophe and other large property
losses on first quarter 2003 results. The Company's press release
dated April 3, 2003 was attached as Exhibit 99.1.
No other reports on Form 8-K were filed during the period covered
by this report, however
On May 6, 2003, the Company furnished a report on Form 8-K under
Item 12 thereof (but provided under Item 9 pursuant to SEC interim
guidance for Item 12) with respect to the issuance of a press
release announcing its financial results for the quarter ended
March 31, 2003. The Company's press release dated May 6, 2003 was
attached as Exhibit 99.1.
22
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SELECTIVE INSURANCE GROUP, INC.
REGISTRANT
By: /s/ Gregory E. Murphy August 11, 2003
- -----------------------------------------------
Gregory E. Murphy
Chairman, President and Chief Executive Officer
By: /s/ Dale A. Thatcher August 11, 2003
- -----------------------------------------------
Dale A. Thatcher
Executive Vice President of Finance, Chief Financial Officer and Treasurer
23
SELECTIVE INSURANCE GROUP, INC.
INDEX TO EXHIBITS
Exhibit No.
*10.1 Seventh amendment, dated June 27, 2003, effective through June 26,
2004, 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.
*10.2 Amendment, dated June 30, 2003, to the Promissory Note of $20,000,000
Line of Credit with State Street Bank and Trust Company with respect to
Selective Insurance Company of America and Selective Insurance Group,
Inc.
*11 Statement Re: Computation of Per Share Earnings.
*31.1 Certification of Chief Executive Officer in accordance with Section 302
of the Sarbanes-Oxley Act of 2002,
*31.2 Certification of Chief Financial Officer in accordance with Section 302
of the Sarbanes-Oxley Act of 2002,
*32.1 Certification of Chief Executive Officer in accordance with Section 906
of the Sarbanes-Oxley Act of 2002.
*32.2 Certification of Chief Financial Officer in accordance with Section 906
of the Sarbanes-Oxley Act of 2002.
- --------------------
* Filed herewith
24