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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: September 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 (Zip Code)
offices)
(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 October 31, 2003: 27,168,083
SELECTIVE INSURANCE GROUP, INC
Consolidated Balance Sheets
UNAUDITED
SEPTEMBER 30, DECEMBER 31,
(in thousands, except share amounts) 2003 2002
- ---------------------------------------------------------------------------------------------------------------------
ASSETS
Investments:
Debt securities, held-to-maturity - at amortized cost
(fair value: $83,179-2003; $114,785-2002) $ 79,314 109,318
Debt securities, available-for-sale - at fair value
(amortized cost: $1,845,381-2003; $1,671,347-2002) 1,954,796 1,772,061
Equity securities, available-for-sale - at fair value
(cost of: $152,651-2003; $ 120,036-2002) 254,402 196,913
Short-term investments - (at cost which approximates fair value) 37,424 24,700
Other investments 29,859 23,559
-------------- ------------
Total investments 2,355,795 2,126,551
Cash 149 2,228
Interest and dividends due or accrued 22,233 22,689
Premiums receivables, net of allowance for uncollectible accounts of: 433,979 353,935
$3,121-2003 and $2,814-2002
Other trade receivables, net of allowance for uncollectible accounts of: 21,243 19,769
$1,079-2003; $867-2002
Reinsurance recoverable on paid losses and loss expenses 6,411 7,272
Reinsurance recoverable on unpaid losses and loss expenses 187,451 160,374
Prepaid reinsurance premiums 53,983 46,141
Deferred federal income tax - 8,707
Real estate, furniture, equipment, and software development-at cost, net of
accumulated depreciation and amortization 53,180 52,424
Deferred policy acquisition costs 173,769 148,158
Goodwill 43,612 42,808
Other assets 28,660 38,791
-------------- ------------
Total assets $ 3,380,465 3,029,847
============== ============
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Reserve for losses $ 1,368,337 1,232,322
Reserve for loss expenses 183,345 171,103
Unearned premiums 679,894 557,141
Senior convertible notes 115,937 115,937
Notes payable 121,500 145,500
Current federal income tax 9,257 2,565
Deferred federal income tax 2,113 -
Other liabilities 185,381 153,177
-------------- ------------
Total liabilities 2,665,764 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: 41,426,666-2003; 40,780,950-2002 82,853 81,562
Additional paid-in capital 109,541 95,435
Retained earnings 592,971 562,553
Accumulated other comprehensive income 137,258 115,434
Treasury stock - at cost (shares: 14,274,087-2003; 14,185,020-2002) (197,458) (195,295)
Unearned stock compensation and notes receivable from stock sales (10,464) (7,587)
-------------- ------------
Total stockholders' equity 714,701 652,102
-------------- ------------
Total liabilities and stockholders' equity $ 3,380,465 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 NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(in thousands, except per share amounts) 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------
Revenues:
Net premiums written $ 317,513 267,439 $ 947,779 817,171
Net (increase) in unearned premiums and prepaid
reinsurance premiums (27,832) (15,448) (114,912) (86,387)
--------- ------- --------- -------
Net premiums earned 289,681 251,991 832,867 730,784
Net investment income earned 27,324 24,493 84,103 74,097
Net realized gains 1,029 1,521 8,373 1,219
Diversified insurance services revenue 24,453 21,321 69,272 60,873
Other income 855 1,134 2,299 2,874
--------- ------- --------- -------
Total revenues 343,342 300,460 996,914 869,847
--------- ------- --------- -------
Expenses:
Losses incurred 172,821 157,342 502,546 457,136
Loss expenses incurred 31,363 25,632 90,481 75,815
Policy acquisition costs 91,132 79,071 263,412 224,499
Dividends to policyholders 914 1,358 3,852 4,685
Interest expense 4,145 3,452 13,135 10,457
Diversified insurance services expenses 21,592 19,416 61,865 55,975
Other expenses 2,494 350 6,383 5,684
--------- ------- --------- -------
Total expenses 324,461 286,621 941,674 834,251
--------- ------- --------- -------
Income from continuing operations, before federal income
tax 18,881 13,839 55,240 35,596
--------- ------- --------- -------
Federal income tax expense (benefit) :
Current 5,970 3,904 13,394 9,067
Deferred (1,806) (1,177) (657) (3,250)
--------- ------- --------- -------
Total federal income tax expense 4,164 2,727 12,737 5,817
--------- ------- --------- -------
Loss from discontinued operations, net of tax - - - (708)
Gain on disposition of discontinued operations, net of tax - - - 586
--------- ------- --------- -------
Total discontinued operations, net of tax - - - (122)
--------- ------- --------- -------
Net income $ 14,717 11,112 $ 42,503 29,657
========= ======= ========= =======
Earnings per share:
Basic net income from continuing operations $ 0.56 0.43 $ 1.63 1.18
Basic net income from discontinued operations - - - -
--------- ------- --------- -------
Basic net income $ 0.56 0.43 $ 1.63 1.18
========= ======= ========= =======
Diluted net income from continuing operations $ 0.53 0.41 $ 1.54 1.11
Diluted net income from discontinued operations - - - -
--------- ------- --------- -------
Diluted net income $ 0.53 0.41 $ 1.54 1.11
========= ======= ========= =======
Dividends to stockholders $ 0.15 0.15 $ 0.45 0.45
See accompanying notes to unaudited interim consolidated financial statements.
3
SELECTIVE INSURANCE GROUP, INC.
Consolidated Statements of Stockholders' Equity
UNAUDITED
NINE MONTHS ENDED SEPTEMBER 30,
(in thousands, except per share amounts) 2003 2002
- ---------------------------------------------------------------------------------------------------------------------------
Common stock:
Beginning of year $ 81,562 79,177
Dividend reinvestment plan
(shares: 33,714-2003; 35,294-2002) 67 71
Convertible subordinated debentures
(shares: 16,522 -2003; 347,312-2002) 33 695
Stock purchase and compensation plans
(shares: 595,480-2003; 612,623-2002) 1,191 1,225
------------- --------
End of period 82,853 81,168
------------- --------
Additional paid-in capital:
Beginning of year 95,435 77,126
Dividend reinvestment plan 801 790
Convertible subordinated debentures 86 1,764
Stock purchase and compensation plans 13,219 11,350
------------- --------
End of period 109,541 91,030
------------- --------
Retained earnings:
Beginning of year 562,553 536,188
Net income 42,503 42,503 29,657 29,657
Cash dividends to stockholders ($0.45 per share) (12,085) (11,649)
------------- --------
End of period 592,971 554,196
------------- --------
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 21,824 21,824 17,738 17,738
------------- ------------ -------- ------
End of period 137,258 115,775
------------- --------
Comprehensive income 64,327 47,395
============ ======
Treasury stock:
Beginning of year (195,295) (192,284)
Acquisition of treasury stock
(shares 89,067-2003; 105,031-2002) (2,163) (2,436)
------------- --------
End of period (197,458) (194,720)
------------- --------
Unearned stock compensation and notes receivable from stock
sales:
Beginning of year (7,587) (7,084)
Unearned stock compensation (6,625) (3,784)
Amortization of deferred compensation expense and
amounts received on notes 3,748 2,745
------------- --------
End of period (10,464) (8,123)
------------- --------
Total stockholders' equity $ 714,701 639,326
============= ========
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
NINE MONTHS ENDED SEPTEMBER 30,
(in thousands) 2003 2002
- ------------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 42,503 29,657
----------- --------
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 121,180 75,812
Increase in unearned premiums, net of prepaid reinsurance and advance premiums 116,198 87,508
Decrease (increase) in federal income tax recoverable 5,761 (1,419)
Depreciation and amortization 7,806 6,719
Amortization of deferred compensation 3,693 2,638
Increase in premiums receivables (80,044) (47,769)
Increase in other trade receivables (1,474) (394)
Increase in deferred policy acquisition costs (25,611) (22,399)
Decrease in interest and dividends due or accrued 456 2,197
Decrease in reinsurance recoverable on paid losses and loss expenses 861 6,777
Net realized gains on investments (8,373) (1,219)
Net realized gain on sale of subsidiary - (901)
(Decrease) increase in pension liability (1,918) 592
Increase in accrued salaries and benefits 7,928 5,825
Increase in accrued insurance expenses 8,766 4,864
Other, net 9,815 (18,135)
----------- --------
Net adjustments 165,044 100,696
----------- --------
Net cash provided by operating activities 207,547 130,353
----------- --------
INVESTING ACTIVITIES
Purchase of debt securities, available-for-sale (456,228) (525,987)
Purchase of equity securities, available-for-sale (36,379) (7,769)
Purchase of other investments (7,366) (6,312)
Purchase and adjustments of subsidiaries acquired (net of cash equivalents acquired of
$1,127 in 2002) (804) (3,139)
Sale of subsidiary (net of cash of $385) - 15,421
Sale of debt securities, available-for-sale 168,627 184,437
Redemption and maturities of debt securities, held-to-maturity 30,068 47,940
Redemption and maturities of debt securities, available-for-sale 118,142 73,576
Sale of equity securities, available-for-sale 6,344 15,940
Proceeds from other investments 1,066 9
Increase in net payable for security transactions 16,371 55,672
Net additions to real estate, furniture, equipment and software development (7,203) (8,833)
----------- --------
Net cash used in investing activities (167,362) (159,045)
----------- --------
FINANCING ACTIVITIES
Dividends to stockholders (12,085) (11,649)
Principal payment of notes payable (24,000) -
Acquisition of treasury stock (2,163) (2,436)
Net proceeds from issuance of senior convertible notes - 98,214
Net proceeds from dividend reinvestment plan 868 861
Net proceeds from stock purchase and compensation plans 7,785 8,791
Proceeds received on notes receivable from stock sales 55 107
----------- --------
Net cash (used in) provided by financing activities (29,540) 93,888
----------- --------
Net increase in short-term investments and cash 10,645 65,196
Short-term investments and cash at beginning of year 26,928 26,450
----------- --------
Short-term investments and cash at end of period $ 37,573 91,646
=========== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION
Cash paid during the period for:
Interest $ 13,738 9,364
Federal income tax 6,371 6,600
Supplemental schedule of non-cash financing activity:
Conversion of convertible subordinated debentures 117 2,459
Unearned stock compensation 6,625 3,784
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 third quarters ended
September 30, 2003 (Third Quarter 2003) and September 30, 2002 (Third
Quarter 2002) and the nine month periods ended September 30, 2003 (Nine
Months 2003) and September 30, 2002 (Nine 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
tax benefit included in the loss from discontinued operations was $0.4
million for Nine Months 2002. There were no amounts recorded in 2003 or
for Third Quarter 2002.
Operating results from discontinued operations are as follows:
UNAUDITED, UNAUDITED,
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(in thousands) 2003 2002 2003 2002
- ------------------------------------------------------------------------------------------------------
Net revenue $ - - $ - 8,186
Pre-tax loss - - - (1,085)
After-tax loss $ - - $ - (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 $7.0 million for
Third Quarter 2003 and $20.1 million for Nine Months 2003, compared
with $6.4 million for Third Quarter 2002 and $26.4 million for Nine
Months 2002. These transactions were eliminated in all consolidated
statements.
6
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 in the case of the Investments segment) and pre-tax
income (loss) for the individual segments:
REVENUE BY SEGMENT UNAUDITED, UNAUDITED,
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(in thousands) 2003 2002 2003 2002
- -----------------------------------------------------------------------------------------------------------------
INSURANCE OPERATIONS:
Commercial lines net premiums earned $ 235,564 201,819 $ 674,911 582,049
Personal lines net premiums earned 54,117 50,172 157,956 148,735
Miscellaneous income 838 1,084 2,177 2,507
----------- ------- ----------- -------
Total insurance operations revenues 290,519 253,075 835,044 733,291
INVESTMENTS:
Net investment income 27,324 24,493 84,103 74,097
Net realized gain on investments 1,029 1,521 8,373 1,219
----------- ------- ----------- -------
Total investment revenues 28,353 26,014 92,476 75,316
DIVERSIFIED INSURANCE SERVICES:
Diversified insurance services revenues, from
continuing operations 24,453 21,321 69,272 60,873
----------- ------- ----------- -------
TOTAL ALL SEGMENTS 343,325 300,410 996,792 869,480
----------- ------- ----------- -------
Other income 17 50 122 367
----------- ------- ----------- -------
TOTAL REVENUES FROM CONTINUING OPERATIONS $ 343,342 300,460 $ 996,914 869,847
=========== ======= =========== =======
UNAUDITED, UNAUDITED,
INCOME (LOSS), BEFORE FEDERAL INCOME TAX QUARTER ENDED NINE MONTHS ENDED
BY SEGMENT SEPTEMBER 30, SEPTEMBER 30,
(in thousands) 2003 2002 2003 2002
- -----------------------------------------------------------------------------------------------------------------
INSURANCE OPERATIONS:
Commercial lines underwriting $ 70 (5,818) $ (15,394) (15,785)
Personal lines underwriting (6,350) (4,302) (11,392) (14,694)
----------- ------- ----------- -------
Underwriting loss, before federal income tax (6,280) (10,120) (26,786) (30,479)
INVESTMENTS:
Net investment income 27,324 24,493 84,103 74,097
Net realized gain on investments 1,029 1,521 8,373 1,219
----------- ------- ----------- -------
Total investment income, before federal income tax 28,353 26,014 92,476 75,316
DIVERSIFIED INSURANCE SERVICES:
Income from continuing operations, before federal
income tax 2,861 1,905 7,407 4,898
----------- ------- ----------- -------
TOTAL ALL SEGMENTS 24,934 17,799 73,097 49,735
----------- ------- ----------- -------
Interest expense (4,145) (3,452) (13,135) (10,457)
General corporate expenses (1,908) (508) (4,722) (3,682)
----------- ------- ----------- -------
INCOME FROM CONTINUING OPERATIONS, BEFORE FEDERAL
INCOME TAX $ 18,881 13,839 $ 55,240 35,596
=========== ======= =========== =======
7
5. REINSURANCE
The following table is a listing of direct, assumed and ceded amounts
by income statement caption:
UNAUDITED, UNAUDITED,
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(in thousands) 2003 2002 2003 2002
- --------------------------------------------------------------------------------------------------------
Premiums written:
Direct $ 345,274 297,030 $ 1,036,897 898,765
Assumed 13,469 9,448 24,313 18,696
Ceded (41,230) (39,039) (113,431) (100,290)
---------- ------- ------------ --------
Net $ 317,513 267,439 $ 947,779 817,171
========== ======= ============ ========
Premiums earned:
Direct $ 317,951 277,942 $ 919,591 806,337
Assumed 7,374 6,193 18,865 15,599
Ceded (35,644) (32,144) (105,589) (91,152)
---------- ------- ------------ --------
Net $ 289,681 251,991 $ 832,867 730,784
========== ======= ============ ========
Losses and loss expenses incurred:
Direct $ 236,425 184,474 $ 642,401 547,791
Assumed 6,022 5,932 15,949 15,468
Ceded (38,263) (7,432) (65,323) (30,308)
---------- ------- ------------ --------
Net $ 204,184 182,974 $ 593,027 532,951
========== ======= ============ ========
Flood business, which we cede 100% to the National Flood Insurance
Program (NFIP), is included in the above amounts as follows:
UNAUDITED, UNAUDITED,
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(in thousands) 2003 2002 2003 2002
- -----------------------------------------------------------------------------------------------------------
Ceded premiums written $ (19,302) (15,314) $ (50,177) (40,736)
Ceded premiums earned (15,240) (12,590) (43,051) (35,061)
Ceded losses and loss expenses incurred (27,416) (2,422) (31,044) (4,203)
- Included in direct losses and loss expenses incurred
for Quarter and Nine Months ended September 30, 2003 are
losses from Hurricane Isabel. $24.2 million of these losses
are flood related which we 100% cede to the NFIP and $10.0
million are non-flood related.
- Included in ceded losses and loss expenses incurred from our
flood business for Quarter Ended and Nine Months ended
September 30, 2003 are $24.2 million of losses incurred from
Hurricane Isabel.
- In addition to flood business, increases in ceded written and
earned premium are primarily related to our Terrorism treaty
placed on February 1, 2003.
- Assumed written and earned premium increased primarily due to
an increase in mandatory pool assumptions.
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 (TRIA) 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 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
8
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 terrorism 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 September 2003.
6. COMPREHENSIVE INCOME
The Company's comprehensive income for Third Quarter 2003, Nine Months
2003, and the corresponding periods in the prior year are:
UNAUDITED, UNAUDITED,
QUARTER ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
(in thousands) 2003 2002 2003 2002
- -----------------------------------------------------------------------------------------------------------
Net income $ 14,717 11,112 $ 42,503 29,657
----------- ------ ----------- ------
Other comprehensive income (loss), increase
(decrease) in net unrealized gain on
available-for-sale securities, net of
deferred income tax effect (12,747) 15,315 21,824 17,738
----------- ------ ----------- ------
Comprehensive income $ 1,970 26,427 $ 64,327 47,395
=========== ====== =========== ======
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 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 $15.1 million as of September 30,
2003 and $17.0 million as of September 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 September 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
9
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 NINE MONTHS
SEPTEMBER 30, ENDED SEPTEMBER 30,
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 2003 2002 2003 2002
- ----------------------------------------------------------------------------------------------------------------
Net income, as reported $ 14,717 11,112 42,503 29,657
Add: Stock-based employee compensation reported in
net income, net of related tax effect 1,078 207 2,400 1,715
Deduct: Total stock-based employee compensation
expense determined under fair value-based method for
all awards, net of related tax effects (771) (620) (3,136) (3,001)
----------- ------ ------ ------
Pro forma net income $ 15,024 10,699 41,767 28,371
=========== ====== ====== ======
Net income per share:
Basic - as reported $ 0.56 0.43 1.63 1.18
Basic - pro forma 0.57 0.42 1.60 1.13
Diluted - as reported 0.53 0.41 1.54 1.11
Diluted - pro forma 0.54 0.40 1.52 1.06
9. COMMITMENTS AND CONTINGENCIES
Included in other investments is approximately $29.8 million of
investments in limited partnerships as of September 30, 2003, and $23.5
million as of December 31, 2002. At September 30, 2003 the Company has
an additional limited partnership investment commitment of up to $21.7
million. There is no certainty that any additional investment will be
required.
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 are vigorously defending this action, as we believe the
Company has significant defenses to defeat the action. Further, since
the suit remains in its early stages, management cannot at this time
provide a meaningful estimate or range of estimates of a potential
loss, if any.
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;
10
- 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 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. This discussion is
prepared in accordance with accounting principles generally accepted in the
United States of America (GAAP) unless otherwise noted.
RESULTS OF OPERATIONS
The following discussion is a comparison of the third quarter ended September
30, 2003 (Third Quarter 2003) and the nine month period ended September 30, 2003
(Nine Months 2003) to the third quarter ended September 30, 2002 (Third Quarter
2002) and the nine month period ended September 30, 2002 (Nine Months 2002).
Our net income was $14.7 million, or $0.53 per diluted share, for Third Quarter
2003, compared with $11.1 million, or $0.41 per diluted share, for Third Quarter
2002. Our net income was $42.5 million, or $1.54 per diluted share, for Nine
Months 2003, compared with $29.7 million, or $1.11 per diluted share, for Nine
Months 2002. Included in net income are net realized capital gains, after-tax,
of $0.7 million for Third Quarter 2003 and $5.4 million for Nine Months 2003,
compared with $1.0 million for Third Quarter 2002 and $0.8 million for Nine
Months 2002.
OPERATING SEGMENTS
The Company is primarily engaged in writing property and casualty insurance. The
Company has classified its businesses into three segments: Insurance Operations
(commercial lines underwriting, personal lines underwriting), Investments, and
Diversified Insurance Services (managed care, flood insurance and human resource
administration outsourcing). Insurance Operations are evaluated based on
underwriting results determined in accordance with GAAP; Investments are
evaluated based on after-tax investment returns; and the Diversified Insurance
Services are evaluated based on several measures including, but not limited to,
results of operations determined in accordance with GAAP. For an additional
description of accounting policies, refer to Note 1 to our consolidated
financial statements on pages 43 through 47 of our 2002 Annual Report to
Shareholders (incorporated herein by reference to our Annual Report on Form 10-K
for the year ended December 31, 2002) and the discussion beginning on page 20 of
this report on Form 10-Q. See Note 4 to the September 30, 2003 unaudited interim
consolidated financial statements on pages 6 and 7 of this report on Form 10-Q
for revenues and related income before federal income tax for each individual
segment discussed below.
11
Insurance Operations Segment
Unaudited, Unaudited,
ALL LINES Quarter ended September 30, Nine Months ended September 30,
($ in thousands) 2003 2002 2003 2002
- -------------------------------------------------------------------------------------------------------------------
GAAP INSURANCE OPERATIONS RESULTS
Net premiums written $ 317,513 267,439 947,779 817,171
============= ============= ======= =======
Net premiums earned $ 289,681 251,991 832,867 730,784
Less:
Losses and loss expenses incurred 204,184 182,974 593,027 532,951
Net underwriting expenses incurred 90,863 77,779 262,774 223,627
Dividends to policyholders 914 1,358 3,852 4,685
------------- ------------- ------- -------
Underwriting loss $ (6,280) (10,120) (26,786) (30,479)
------------- ------------- ------- -------
GAAP RATIOS:
Loss and loss expense ratio 70.5% 72.6 71.2% 72.9
Underwriting expense ratio 31.4% 30.9 31.5% 30.6
Dividends to policyholders ratio 0.3% 0.5 0.5% 0.7
------------- ------------- ------- -------
Combined ratio 102.2% 104.0 103.2% 104.2
============= ============= ======= =======
Net premiums written increased by approximately $50.1 million, or 19%, to $317.5
million in Third Quarter 2003 and by $130.6 million, or 16%, to $947.8 million
in Nine Months 2003 when compared with the same periods in 2002. Net premiums
written for Third Quarter 2003 included $68.3 million in net new business
written, an increase of 31% compared with $52.2 million in Third Quarter 2002.
Nine Months 2003 included $203.7 million in net new business written, an 18%
increase over $172.0 million for Nine Months 2002. The lower combined ratio
reflects almost four years of commercial lines renewal premium price increases
totaling 75%. These renewal premium price increases were approximately 12% in
Third Quarter 2003 compared with approximately 19% in Third Quarter 2002 and 13%
for Nine Months 2003 compared with 19% for Nine Months 2002.
The loss and loss expense ratio decreased 2.1 points to 70.5% for Third Quarter
2003 and 1.7 points to 71.2% for Nine 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 net premium written. The Third Quarter
2003 loss and loss expense ratio was negatively impacted by $13.5 million of
weather-related catastrophes, or 4.7 points, compared with $3.1 million, or 1.2
points, in Third Quarter 2002. Included in Nine Months 2003 results were
weather-related catastrophe events that occurred mainly in the first and third
quarters of 2003, adding $25.3 million to losses incurred and 3.0 points to the
loss and loss expense ratio, compared with $10.4 million and 1.4 points for Nine
Months 2002.
The underwriting expense ratio increased 0.5 points to 31.4% for Third Quarter
2003 and 0.9 points to 31.5% for Nine Months 2003 compared with the same periods
in 2002. Expenses related to employee retirement plans increased $0.6 million,
or 34%, for Third Quarter 2003 when compared with Third Quarter 2002 and $2.2
million, or 40%, for Nine Months 2003 when compared to the same period in 2002.
Additionally, profit-based agent commissions incurred increased $2.5 million, or
60% for Third Quarter 2003 and $6.0 million, or 50% for Nine Months 2003 when
compared with the same periods one year earlier due to improved underwriting
profitability. These profit-based commissions are offered to agents to incent
them to increase their premium volume with their most profitable business.
However, these commissions are deferred and expensed ratably in relation to
earned premium for proper matching.. As our insurance business has become more
profitable, these commissions have increased, however not necessarily
proportionate with earned premium, because some of our agents do not quality for
these commissions because their level of profitability does not meet company
standards. Also impacting the expense ratio is 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.
Overall productivity, as measured by fiscal year net premiums written per
insurance operations employee, was approximately $662,000 for the twelve-month
period ended September 30, 2003, up from $580,000 for the same period in 2002.
Our strategic initiatives which are designed to either reduce costs and/or
increase business include: i) streamlined processing for small commercial lines
accounts (One & Done); ii) a web-based commercial lines automated system, and
iii) claim and underwriting Service Centers. These initiatives are partially
offsetting the increased expenses noted above and increasing our productivity
measure.
12
Commercial Lines Underwriting
Unaudited, Unaudited,
COMMERCIAL LINES Quarter ended September 30, Nine Months ended September 30,
($ in thousands) 2003 2002 2003 2002
- ---------------------------------------------------------------------------------------------------------------
GAAP INSURANCE OPERATIONS RESULTS
Net premiums written $ 261,397 215,265 $ 780,821 662,026
============= ======= ============= =======
Net premiums earned $ 235,564 201,819 $ 674,911 582,049
Less:
Losses and loss expenses incurred 160,688 142,099 472,270 412,001
Net underwriting expenses incurred 73,892 64,180 214,183 181,148
Dividends to policyholders 914 1,358 3,852 4,685
------------- ------- ------------- -------
Underwriting loss $ 70 (5,818) $ (15,394) (15,785)
------------- ------- ------------- -------
GAAP RATIOS:
Loss and loss expense ratio 68.2% 70.4 70.0% 70.8
Underwriting expense ratio 31.4% 31.8 31.7% 31.1
Dividends to policyholders ratio 0.4% 0.7 0.6% 0.8
------------- ------- ------------- -------
Combined ratio 100.0% 102.9 102.3% 102.7
============= ======= ============= =======
Commercial Lines Underwriting accounted for approximately 82% of net premiums
written in Nine Months 2003 compared with 81% in Nine Months 2002. Net premiums
written increased $46.1 million, or 21%, to $261.4 million for Third Quarter
2003 and $118.8 million, or 18%, to $780.8 million for Nine Months 2003 compared
with the same periods in 2002. Net premiums written included $59.3 million in
net new business written for Third Quarter 2003, a 34% increase when compared
with $44.2 million in net new business written for Third Quarter 2002, and
$177.9 million in net new business written in Nine Months 2003, a 17% increase
when compared with $152.1 million in net new business written in Nine Months
2002.
For Third Quarter 2003, the Commercial Lines Underwriting combined ratio
decreased 2.9 points to 100.0% from 102.9% for the same period in 2002. The
lower combined ratio is driven by our renewal premium price increases, which
continue to outpace loss trends. We have had fourteen straight quarters of
double-digit renewal premium price increases, including increases that averaged
12% in Third Quarter 2003 compared with 19% in Third Quarter 2002, and 13% for
Nine Months 2003 compared with 19% for Nine Months 2002. At our current pricing
level, we are six points above current loss trends. Importantly, policyholder
retention improved 3 points to 81% for Nine Months 2003, compared with the same
period last year. We monitor retention closely because ultimately, higher
retentions yield better loss ratios and lower expenses. Underwriting initiatives
across our commercial lines business have also resulted in improved loss ratios
in those lines. Our Commercial Lines Underwriting combined ratio for Nine Months
2003 decreased to 102.3% from 102.7% for Nine Months 2002. This 0.4 point
decrease is mainly attributable to the renewal price increases, higher retention
and underwriting improvements discussed above.
For Third Quarter 2003 the Commercial Lines Underwriting loss and loss expense
ratio decreased 2.2 points while Nine Months 2003 decreased 0.8 points when
compared with the same periods in 2002. Included in the Third Quarter 2003 ratio
are the impact of weather-related catastrophes, including Hurricane Isabel, of
3.7 points compared with 1.2 points in Third Quarter 2002. Nine Months 2003
include 2.8 points from weather-related storms, including Hurricane Isabel and
severe winter storms which occurred in the first three months of 2003, compared
with 1.3 points for Nine Months 2002.
Aside from the severe weather, our commercial property business, which accounted
for 14% of Commercial Lines Underwriting net earned premium for Third Quarter
2003 and for Third Quarter 2002, posted favorable results for the quarter, with
a loss and loss expense ratio of 61.5%, including 19.6 points from catastrophes.
For the same period last year, the loss and loss expense ratio was 57.5%,
including 5.9 points from catastrophes. In addition to price, the progress we
have made in our commercial property line can be attributed to: better insurance
to value estimates across our book of business; a shift to risks of better
construction quality and newer buildings; and an overall focus on low-to-medium
hazard property exposures.
Also contributing to the Commercial Lines Underwriting improvement is our
commercial automobile line of business, which accounted for 28% of Commercial
Lines Underwriting net premiums earned in Third Quarter 2003 and 27% in Third
Quarter 2002. This line registered another strong quarter, with a loss and loss
expense ratio of 63.5%, down over six points compared with Third Quarter 2002.
This line has been favorably impacted by a vehicle mix which contains a smaller
percentage of heavy vehicles. Underwriting initiatives that more accurately
target vehicle costs and classifications have also contributed to the
improvement.
Our workers' compensation business, which accounted for 23% of commercial lines
underwriting net premiums earned in Third Quarter 2003 and 24% in Third Quarter
2002, showed a modest improvement when compared with the same period last year,
posting a loss and loss expense ratio of 82.5% for Third Quarter 2003, compared
with 83.1% for Third Quarter 2002. Even though these results are getting better,
they are still unacceptable on their own. Our account-based strategy focuses on
writing this line as a companion product, with only 5% of workers compensation
policies being stand-alone. Workers
13
compensation insurance continues to be impacted by external factors, including:
a regulatory climate that makes it difficult to obtain rate increases in some
states; inflationary medical costs; increasing indemnity benefits; the slow
economic recovery; and a decreasing number of workers' compensation only
providers. However, we believe the strict underwriting measures we have put in
place over the last three years, including: writing primarily small- to mid-size
employers in low to medium hazard classes, requiring job site inspections and
increasing by 36% the number of highly trained loss control representatives we
employ, coupled with an aggressive pricing strategy, will make this a more
manageable line for Selective.
Personal Lines Underwriting
Unaudited, Unaudited,
PERSONAL LINES Quarter ended September 30, Nine Months ended September 30,
($ in thousands) 2003 2002 2003 2002
- --------------------------------------------------------------------------------------------------------------
GAAP INSURANCE OPERATIONS RESULTS
Net premiums written $ 56,116 52,174 $ 166,958 155,145
============ ====== ============= =======
Net premiums earned $ 54,117 50,172 $ 157,956 148,735
Less:
Losses and loss expenses incurred 43,496 40,875 120,757 120,950
Net underwriting expenses incurred 16,971 13,599 48,591 42,479
------------ ------ ------- -------
Underwriting (loss) $ (6,350) (4,302) $ (11,392) (14,694)
------------ ------ ------- -------
GAAP RATIOS:
Loss and loss expense ratio 80.4% 81.5 76.4% 81.3
Underwriting expense ratio 31.3% 27.1 30.8% 28.6
------------ ------ ------- -------
Combined ratio 111.7% 108.6 107.2% 109.9
============ ====== ======= =======
Personal Lines Underwriting accounted for approximately 18% of net premiums
written for Nine Months 2003 compared with 19% for Nine Months 2002.
Personal Lines Underwriting net premiums written increased $3.9 million, or 8%,
to $56.1 million for Third Quarter 2003 and $11.8 million, or 8%, to $167.0
million for Nine Months 2003 when compared with the same periods in 2002. Net
premiums written included net new business written of $8.9 million in Third
Quarter 2003, a 12% increase when compared with $8.0 million in Third Quarter
2002. Net new business written in Nine Months 2003 was $25.8 million, a 30%
increase over the $19.9 million written in Nine Months 2002.
Personal Lines Underwriting combined ratio was 111.7% for Third Quarter 2003, up
3.1 points from the same period in 2002. The increase reflects: increased
weather-related catastrophe losses of $4.9 million, or 9.0 points, in Third
Quarter 2003 compared with $0.7 million, or 1.5 points in Third Quarter 2002.
These losses were mainly in our homeowners line of business, which accounted for
15% of personal lines net earned premium for Third Quarter 2003, compared with
13% for Third Quarter 2002. Homeowners had a loss and loss expense ratio of
127.6% for Third Quarter 2003, of which 54.7 points are attributable to
weather-related catastrophes, primarily Hurricane Isabel, compared with 75.5%
for Third Quarter 2002, which had 6.6 points from catastrophes. This line was
further impacted by several non-catastrophe large losses in Third Quarter 2003.
Partially offsetting the poor homeowners results were improved personal
automobile results, which constituted 82% of personal lines underwriting net
premium earned in Third Quarter 2003 and 83% in Third Quarter 2002. The personal
automobile line produced a loss and loss expense ratio of 73.2% for Third
Quarter 2003, compared with 79.1% for Third Quarter 2002. The improved results
were attributable to our business in New Jersey, which accounted for 72% of our
overall personal automobile net premiums written for Third Quarter 2003 and 71%
for Third Quarter 2002, and 73% for Nine Months 2003 and 2002. In New Jersey we
are earning higher premiums from price and tier changes, which increased average
premium per vehicle 23% since December 31, 2000. These pricing improvements are
reflected in our New Jersey personal automobile loss and loss expense ratio of
72.4% for Third Quarter 2003, over a six-point improvement from the same period
in 2002.
While we are encouraged by our progress, the New Jersey personal automobile
insurance market remains volatile. In May 2003, legislation was introduced that,
if passed, would reverse some of this progress by allowing claimants to file
lawsuits for non-economic damages without proving that the injuries sustained
had a serious impact on their life. We cannot presently predict if, or when,
this legislation may pass, however, if it does, this change could generate a
significant increase in liability losses and could lead to liability rate
inadequacy and could adversely affect the Company's results of operations.
However, the Company would file for premium rate increases to help offset these
adverse effects.
Efforts to control our exposure in New York, due to the high cost of required
participation in the involuntary personal automobile market, are beginning to
pay off. Our net premiums written in New York decreased 17%, to $2.1 million,
for Third Quarter 2003 compared with $2.5 million for Third Quarter 2002, and
12% to $6.8 million for Nine Months 2003 compared with $7.7 million for the same
period last year. Since December 31, 2002, the number of vehicles in-force in
New York has dropped 19%, to below 9,000. Our assigned risk charge, while still
excessive, was $0.4 million for Third Quarter
14
2003, compared with $1.0 million for Third Quarter 2002 and $1.6 million for
Nine Months 2003 compared with $2.5 million for Nine Months 2002. We have
further renegotiated this charge, which is applied to our quota of the New York
automobile involuntary plan premium from 72.5% to 33.3% effective January 1,
2004. We anticipate that the reduction in this charge will save us approximately
$1.1 million in 2004.
The Personal Lines Underwriting expense ratio increased 4.2 points to 31.3% at
Third Quarter 2003 from 27.1% at Third Quarter 2002. The increase is
attributable to higher profit based commissions paid to our independent agents
of $1.2 million, or 2.2 points in Third Quarter 2003, compared with $0.7
million, or 1.4 points in Third Quarter 2002. Additionally, in Third Quarter
2002, a one-time underwriting benefit of $1.5 million or 2.9 points was recorded
from certain non-voluntary pools.
The Personal Lines Underwriting combined ratio was 107.2% for Nine Months 2003,
down 2.7 points from the same period in 2002. The decrease is attributable to a
6.9 point decrease in our personal automobile loss and loss expense ratio for
Nine Months 2003 to 74% compared with 80.9% for the same period in 2002. These
improvements reflect the pricing and other initiatives discussed above.
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 (TRIA) 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 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 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 (TRIA) losses for all risks up
to $75.0 million in total insured value per location. The policy provides annual
certified terrorism 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, for the contract year ending June
2004, compared to contract year ending June 2003.
Investments Segment
Although lower interest rates continue to put pressure on investment returns, we
generated a 12% increase in investment income to $27.3 million for Third Quarter
2003, up from $24.5 million for Third Quarter 2002. For Nine Months 2003 we
generated a 14% increase to $84.1 million, compared with $74.1 million for the
same period last year. The increase reflects
15
an increased asset base as our overall investment portfolio reached $2.4 billion
at September 30, 2003, compared with $2.1 billion at September 30, 2002. The
increased asset base is driven by $207.5 million of operating cash flow for Nine
Months 2003 compared with $130.4 million for Nine 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 $0.2 million, after-tax, to investment income for Third
Quarter 2003, compared with a loss of $0.4 million for Third Quarter 2002 and
income of $1.7 million for Nine Months 2003 compared with a loss of $50,000 for
Nine Months 2002. The after-tax portfolio yield is 3.7%, compared with 3.9% for
the same period last year, reflecting downward pressure from maturing bonds that
are being replaced by bonds with lower interest rates.
We anticipate that we will be out of the Alternative Minimum Tax position by
year-end, which will continue to drive our appetite for tax-advantaged
investments. The timing of this shift is working to the advantage of our
investment portfolio, as municipal bonds remain attractive relative to Treasury
securities on a historical basis.
We continue to maintain a conservative, diversified investment portfolio, with
our bond holdings representing 86% of invested assets. Approximately 63% 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 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.
Realized gains net of realized losses included losses of $1.2 million attributed
to impairment charges from investment write-downs during Third Quarter 2003.
There were no impairment charges recorded during Third Quarter 2002. The Company
realized gains and losses from the sale of available-for-sale debt and equity
securities during Third Quarter 2003 and Third Quarter 2002 and during Nine
Months 2003 and Nine Months 2002.
16
The following tables present the period of time that these securities, sold at a
loss during these periods, were continuously in an unrealized loss position
prior to sale:
Unaudited, Unaudited,
Quarter ended September 30, Quarter ended September 30,
2003 2002
--------------------------- ----------------------------
Fair Value on Realized Fair Value on Realized
(in millions) Sale Date Loss Sale Date Loss
- ------------------------- ------------ ------------ ------------- ------------
Period of time in an
unrealized loss position
Debt securities:
0 - 6 months $ 17.5 0.3 7.8 0.2
7 - 12 months - - 5.0 -
Greater than 12 months - - - -
------------ ------------ ------------ ------------
Total debt securities 17.5 0.3 12.8 0.2
------------ ------------ ------------ ------------
Equities:
0 - 6 months 1.0 0.1 - -
7 - 12 months - - - -
Greater than 12 months - - - -
------------ ------------ ------------ ------------
Total equities 1.0 0.1 - -
------------ ------------ ------------ ------------
Total $ 18.5 0.4 12.8 0.2
============ ============ ============ ============
Unaudited, Unaudited,
Nine Months ended September 30, Nine Months ended September 30,
2003 2002
--------------------------- ---------------------------
Fair Value on Realized Fair Value on Realized
(in millions) Sale Date Loss Sale Date Loss
- ------------------------- ------------ ------------ ------------ ------------
Period of time in an
unrealized loss position
Debt securities:
0 - 6 months $ 22.5 0.3 26.6 4.7
7 - 12 months - - - -
Greater than 12 months - - 2.4 0.7
------------ ------------ ------------ ------------
Total debt securities 22.5 0.3 29.0 5.4
------------ ------------ ------------ ------------
Equities:
0 - 6 months 1.0 0.1 - -
7 - 12 months - - - -
Greater than 12 months - - - -
------------ ------------ ------------ ------------
Total equities 1.0 0.1 - -
------------ ------------ ------------ ------------
Total $ 23.5 0.4 29.0 5.4
============ ============ ============ ============
These securities were sold despite the fact that they were in a loss position
due to heightened credit risk of the individual security sold, the need to
reduce our exposure to certain issuers, industries or sectors in light of
changing economic conditions, or tax planning strategies.
17
UNREALIZED LOSSES
The following table summarizes, for all available-for-sale securities in an
unrealized loss position at September 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) September 30, 2003 December 31, 2002
- ---------------------------- --------------------------- ---------------------------
Gross Gross
Period of time in unrealized Fair Unrealized Fair Unrealized
loss position Value Loss Value Loss
------------ ------------ ------------ ------------
Debt securities:
0 - 6 months $ 187.5 3.4 110.8 3.3
7 - 12 months 5.6 - 12.9 0.3
Greater than 12 months 10.8 0.9 19.8 3.0
------------ ------------ ------------ ------------
Total debt securities 203.9 4.3 143.5 6.6
------------ ------------ ------------ ------------
Equities:
0 - 6 months 5.2 0.2 15.6 2.3
7 - 12 months - - 15.9 3.2
Greater than 12 months 17.1 2.5 8.3 2.4
------------ ------------ ------------ ------------
Total equities 22.3 2.7 39.8 7.9
------------ ------------ ------------ ------------
Total $ 226.2 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 September 30, 2003 by
maturity:
Amortized Fair
(in millions) Cost Value
- --------------------------------------------- -------- --------
One year or less $ 24.2 23.4
Due after one year through five years 37.7 37.1
Due after five years through ten years 106.4 104.4
Due after ten years through fifteen years 39.9 39.0
Due after fifteen years - -
-------- --------
Total $ 208.2 203.9
======== ========
At September 30, 2003 our investment portfolio included non-investment grade
securities with an amortized cost of $26.8 million, 1% of the portfolio, and a
fair value of $27.6 million. At December 31, 2002, non-investment grade
securities in our investment portfolio represented less than 1% of the
portfolio, with an amortized cost of $14.7 million and a fair value of $13.3
million. The unrealized loss on these securities represented 12% of our total
unrealized loss at September 30, 2003, and 10% at December 31, 2002. The fair
value of these securities was determined by independent pricing services or bid
prices provided by various broker dealers. The Company did not have a material
investment in non-traded securities at September 30, 2003, or at December 31,
2002. The Company regularly reviews the diversification of the investment
portfolio compared with an investment grade corporate index. At September 30,
2003, 19% of the market value of our corporate bond and preferred stock
portfolios were represented by investments in banks, only one of which was in an
unrealized loss position, compared with 11% in the benchmark corporate index.
The average Moody's rating for the banking portfolio is "A1" with the lowest
rated securities at "Baa1" and the average Standard and Poor's rating is "A",
with the lowest rated security at "BBB".
18
Diversified Insurance Services Segment
Unaudited, Unaudited,
Quarter ended September 30, Nine Months ended September 30,
($ IN THOUSANDS) 2003 2002 2003 2002
- ------------------------------------------ ------------ ------------ ------------- ----------------
MANAGED CARE
Net revenue $ 5,375 5,845 $ 17,412 17,243
Pre-tax profit 953 549 3,015 2,464
FLOOD INSURANCE
Net revenue 7,386 5,268 17,917 14,036
Pre-tax profit 2,400 1,374 4,590 3,028
HUMAN RESOURCE ADMINISTRATION OUTSOURCING
Net revenue 11,137 9,753 32,453 28,229
Pre-tax (loss) (520) (37) (408) (885)
OTHER
Net revenue 555 455 1,490 1,365
Pre-tax profit 28 19 210 291
TOTAL
Net revenue 24,453 21,321 69,272 60,873
Pre-tax profit 2,861 1,905 7,407 4,898
Net income, from continuing operations 1,892 1,256 4,972 3,266
Return on net revenue 7.7 % 5.9 7.2 % 5.4
The Diversified Insurance Services segment's continuing operations generated
$24.5 million of revenue and $1.9 million of net income for Third Quarter 2003
compared with $21.3 million of revenue and $1.3 million of net income for the
Third Quarter 2002. Continuing operations from these same businesses generated
$69.3 million of revenue and $5.0 million of net income for Nine Months 2003
compared with $60.9 million of revenue and $3.3 million of net income for the
same period in 2002. The segment generated a return on net revenue of 7.7% for
the Third Quarter 2003 and 7.2% for the Nine Months 2003, compared with 5.9% for
the Third Quarter 2002 and 5.4% for the Nine Months 2002.
Managed Care
Our medical provider network has expanded to 92,178 locations as of September
30, 2003 from 81,454 locations as of September 30, 2002. Network and client
expansion as well as pricing continue to be our key initiatives. Revenues
decreased 8% to $5.4 million for Third Quarter 2003 compared with $5.8 million
for Third Quarter 2002 due to the loss of several large clients. Nine Months
2003 increased slightly to $17.4 million compared with $17.2 million for Nine
Months 2002. Despite reduced revenues, pre-tax profit improved to $1.0 million
for Third Quarter 2003 compared with $0.5 million for Third Quarter 2002 and
$3.0 million for Nine Months 2003 compared with $2.5 million for Nine Months
2002 primarily due to expense reduction initiatives.
Flood Insurance
Premium growth of 26.0% for Third Quarter 2003 and 23.2% for Nine 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 $5.6 million for Third Quarter 2003 compared with
$4.0 million for the comparable period last year, and $14.6 million for Nine
Months 2003 compared with $10.8 million for the same period last year. This
growth brings our total premium served to $62.7 million compared with $51.4
million a year ago. Premium growth has resulted in increased servicing fees of
$6.5 million for Third Quarter 2003 compared with $5.2 million for Third Quarter
2002 and $16.8 million for Nine Months 2003 compared with $13.8 million for Nine
Months 2002. Included in Third Quarter 2003 net revenue is $0.8 million from
claim administrative servicing fees from Hurricane Isabel claims. Pre-tax profit
increased to $2.4 million due to the aforementioned growth and claim
administration fees for Third Quarter 2003 compared with $1.4 million for Third
Quarter 2002 and $4.6 million for Nine Months 2003 compared with $3.0 million
for Nine Months 2002.
Human Resource Administration Outsourcing (HR outsourcing)
Revenue for Selective HR Solutions Inc., provider of our human resources
administration outsourcing product, was $11.1 million for Third Quarter 2003, up
14% compared with $9.8 million last year. Nine Months 2003 increased 15% to
$32.5 million compared with $28.2 million for Nine Months 2002. Pre-tax loss was
$0.5 million for Third Quarter 2003, while Third Quarter 2002 broke even. For
Nine Months 2003, pre-tax loss was $0.4 million compared with a pre-tax loss of
$0.9 million for same period last year. Third Quarter 2003 and Nine Months 2003,
were impacted by a one-time pre-tax charge of $0.5 million for the potential
escheatment of certain payroll-related checks. On a year-to-date basis, pricing
continues to move higher, as our workers' compensation fees increased 9.5% and
client administration fees rose 6%. For Nine Months 2003, we added 4,314 new
worksite lives, which pushed our total to 20,198 compared with 21,592 at the
same time last year.
19
Federal Income Taxes
Total federal income tax expense increased $1.4 million for Third Quarter 2003
and $6.9 million for Nine Months 2003 to $4.2 million and $12.7 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 Third Quarter
2003 was 22%, compared with 20% for the same period last year and 23% for Nine
Months 2003, compared with 16% 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. On November 4, 2003 the Board has
declared a 2 cent increase in the cash dividend to $0.17 per share payable to
stockholders of record. 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. Effective November 4, 2003, the Board of Directors
has approved a new common stock repurchase program. Under the program, that runs
until November 30, 2005, the Parent has the authority to repurchase up to 2.5
million shares. Under our previous common stock repurchase program, which ran
from 1996 to May 31, 2003, the Parent had repurchased 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 Nine
Months 2003, cash provided by operating activities was $207.5 million compared
with $130.4 million for Nine Months 2002. The improvement is a result of the
significant net premium written growth and improved underwriting results.
Total assets increased 12%, or $350.6 million, at September 30, 2003 from
December 31, 2002. Invested assets increased $229.2 million primarily due to net
purchases of $186.9 million funded by $207.5 million of operating cash flow,
$33.6 million increase in net unrealized gains on the portfolio, and $10.3
million of bonds purchased in late September that did not settle until October.
Increased premium volume drove increases in premium receivables of $80.0 million
and deferred policy acquisition costs of $25.6 million. Reinsurance recoverable
on unpaid losses and loss expenses increased $27.1 million due to $19.1 million
of flood reserves from Hurricane Isabel, which we 100% ceded to the National
Flood Insurance Program. 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 12%, or $288.0 million, at September 30, 2003 from
December 31, 2002. Increased premium volume is primarily responsible for the
increase in unearned premium reserves of $122.8 million. Loss and loss expense
reserves increased $148.3 million as a result of: (i) increasing loss trends,
which include inflation and rising medical costs, (ii) $19.1 million of flood
reserves from Hurricane Isabel mentioned above and (iii) $10.0 million in
non-flood related losses from Hurricane Isabel as of September 30, 2003.
Securities payable, classified within other liabilities, increased $10.3 million
for the reason noted above. Deferred federal income tax liability increased
$10.8 million from a receivable of $8.7 million at December 31, 2002 to a
payable of $2.1 million at September 30, 2003 primarily due to the increase in
unrealized gains in the debt and equity portfolios. Notes payable decreased
$24.0 million due to a scheduled payment in May on the 8.63% Senior Notes of
$6.0 million and a scheduled payment in August on the 8.77% Senior Notes of
$18.0 million.
20
OFF-BALANCE SHEET ARRANGEMENTS, CONTRACTUAL OBLIGATIONS AND CONTINGENT
LIABILITIES AND COMMITMENTS
At September 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 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 September 30, 2003 we have available revolving lines of credit amounting
to $45.0 million, a $5.0 million decrease from the $50.0 million available at
December 31, 2002, under which no balances are outstanding as of either period.
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 September 30, 2003, the Company had accrued $1.6 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 September 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 $686.5 million
at September 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)
21
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 loss and loss expense 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 September 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
22
that have materially affected, or are reasonably likely to materially affect,
the Company's internal control over financial reporting.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS - NONE
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 October 8, 2003, the Company furnished a report on Form 8-K under
Item 12 thereof announcing the impact of weather-related catastrophe on
third quarter 2003 results. The Company's press release dated October
8, 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.
23
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 November 11, 2003
- ----------------------------------
Gregory E. Murphy
Chairman, President and Chief Executive Officer
By: /s/ Dale A. Thatcher November 11, 2003
- ----------------------------------
Dale A. Thatcher
Executive Vice President of Finance, Chief Financial Officer and Treasurer
24
SELECTIVE INSURANCE GROUP, INC.
INDEX TO EXHIBITS
Exhibit No.
- -----------
* 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
25