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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (Fee required)
For the fiscal year ended...December 31, 2003 OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (No fee required)
For the transition period from ____________to____________.
Commission file number 0-8641
SELECTIVE INSURANCE GROUP, INC.
(Exact name of registrant as specified in its charter)
New Jersey 22-2168890
(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
40 Wantage Avenue, Branchville, New Jersey 07890
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (973) 948-3000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Title of Each Class:
1.6155% Senior Convertible Notes due September 24, 2032
8.75% Convertible Subordinated Debentures due January 1, 2008
(Title of class)
Common Stock, par value $2 per share
(Title of class)
Preferred Share Purchase Rights
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months and (2) has been subject to such filing requirements for
the past 90 days.
[X] Yes [ ] No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
[X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act)
[X] Yes [ ] No
State the aggregate market value of the voting stock held by non-affiliates of
the registrant based on last sale price on the Nasdaq National Market on June
30, 2003.
Common Stock, par value $2 per share: $650,927,707
Indicate the number of shares outstanding of each of the registrant's
classes of common stock as of January 31, 2004.
Common Stock, par value $2 per share: 27,301,987
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's definitive Proxy Statement for the 2004 Annual
Meeting of Stockholders are incorporated by reference to Part III of this
report.
Portions of the registrant's 2003 Annual Report to Shareholders are incorporated
by reference in Parts I and II of this report.
FORWARD-LOOKING STATEMENTS
Some of the statements in this report, including information incorporated by
reference, contain forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934. These statements relate to our intentions, beliefs, projections,
estimations or forecasts of future events or our future financial performance
and involve known and unknown risks, uncertainties and other factors that may
cause our or our industry's actual results, levels of activity, or performance
to be materially different from those expressed or implied by the
forward-looking statements. In some cases, you can identify forward-looking
statements by use of words such as "may," "will," "could," "would," "should,"
"expect," "plan," "anticipate," "target," "project," "intend," "believe,"
"estimate," "predict," "potential," "pro forma," "seek," "likely" or "continue"
or other comparable terminology. These statements are only predictions, and we
can give no assurance that such expectations will prove to be correct.
Factors which could cause our actual results to differ materially from those
projected, forecasted or estimated by us in forward-looking statements, include,
but are not limited to:
- the frequency and severity of catastrophic events, including, but not
limited to, hurricanes, tornadoes, windstorms, earthquakes, hail,
severe winter weather, fires, explosions and terrorism;
- adverse economic, market or regulatory conditions;
- the concentration of our business in a number of east coast and
midwestern states;
- the adequacy of our loss reserves;
- the cost and availability of reinsurance;
- our ability to collect on reinsurance and the solvency of our
reinsurers;
- uncertainties related to insurance premium rate increases and business
retention;
- changes in insurance regulations that impact our ability to write
and/or cease writing insurance policies in one or more states,
particularly changes in New Jersey automobile insurance laws and
regulations;
- our ability to maintain favorable ratings from A.M. Best, Standard &
Poor's, Moody's and Fitch;
- fluctuations in interest rates and the performance of the financial
markets;
- our entry into new markets and businesses; and
- other risks and uncertainties we identify in filings with the
Securities and Exchange Commission, including but not limited to our
Annual Report on Form 10-K.
We undertake no obligation, other than as may be required under the federal
securities laws, to publicly update or revise any forward-looking statements,
whether as a result of new information, future events or otherwise. All of the
forward-looking statements in this report are qualified by reference to the
factors discussed under "Risk Factors" beginning on page 18 of this report.
These risk factors may not be exhaustive. We operate in a continually changing
business environment, and new risk factors emerge from time to time. We cannot
predict such new risk factors, nor can we assess the impact, if any, of such new
risk factors on our businesses or the extent to which any factor or combination
of factors may cause actual results to differ materially from those expressed or
implied in any forward-looking statements in this report. In light of these
risks, uncertainties and assumptions, the forward-looking events discussed in
this report might not occur.
For these statements, we claim the protection of the safe harbor for
forward-looking statements contained in Section 27A of the Securities Act of
1933 and Section 21E of the Securities Exchange Act of 1934.
1
PART I
ITEM 1. BUSINESS.
GENERAL
Selective Insurance Group, Inc., (Parent) is a holding company that was
established in 1977. The Parent, through its subsidiaries, (collectively,
Selective or the Company) offers property and casualty insurance products and
diversified insurance services products. The Company maintains a website at
www.selective.com. Our Annual Report on Form 10-K, Quarterly Reports on Form
10-Q and Current Reports on Form 8-K, and amendments to those reports, filed or
furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of
1934, are available free of charge on our website as soon as practicable after
the electronic filing of such material with, or the furnishing of it to, the
Securities and Exchange Commission.
We offer commercial and personal insurance products through Selective Insurance
Company of America (SICA), Selective Way Insurance Company (SWIC), Selective
Insurance Company of the Southeast (SISE), Selective Insurance Company of South
Carolina (SISC), and Selective Insurance Company of New York (SINY)
(collectively, the Insurance Subsidiaries). Our Diversified Insurance Services'
products are sold by: Alta Services, LLC (Alta), a New Jersey-based managed care
company that provides medical claims handling services to our Insurance
Subsidiaries and other insurers, Consumer Health Network Plus, LLC (CHN), a New
Jersey-based preferred provider organization (PPO), Northeast Health Direct, LLC
(NHD), a New England-based PPO and SelecTech, LLC, a New Jersey-based third
party administrator (collectively, CHN Solutions), Selective HR Solutions, Inc.,
a Florida-based human resource administration outsourcing organization (HR
outsourcing), and a division of SICA (Flood) that provides flood insurance and
claim administration services to homeowners and commercial customers.
Our insurance products are sold through approximately 800 independent agents in
20 northeastern, midatlantic, southeastern and midwestern states. We offer a
broad range of commercial insurance and alternative risk management products to
small- and mediumsized businesses and government entities in these states. Our
commercial insurance products represent over 80% of net premiums written. We
also provide personal insurance products to individuals and families which
represent approximately 20% of net premiums written and are limited to about
half our states. We write business in the following states: Connecticut,
Delaware, Georgia, Illinois, Indiana, Iowa, Kentucky, Maryland, Michigan,
Minnesota, Missouri, New Jersey, New York, North Carolina, Ohio, Pennsylvania,
Rhode Island, South Carolina, Virginia and Wisconsin.
We have diversified our businesses to develop fee-based revenues. We offer
diversified insurance services which include: flood business serviced by us for
the federal government's National Flood Insurance Program, managed care services
and HR outsourcing products and services.
The Company has classified its business into three operating segments: Insurance
Operations (commercial lines underwriting and personal lines underwriting),
Investments, and Diversified Insurance Services (managed care, flood insurance
and HR outsourcing). Amounts from our software development and program
administration business, which we sold during 2002, have been reclassified in
prior years as discontinued operations. For a discussion of, and information
about, our segments and discontinued operations, see Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
Item 8. "Financial Statements and Supplementary Data," Note 10 to the
consolidated financial statements, "Segment Information," and Note 13 to the
consolidated financial statements, "Discontinued Operations."
INSURANCE OPERATIONS SEGMENT
The Insurance Operations segment sells and services property and casualty
insurance products. Our principal strategy is to generate profitable premium
growth based on superior customer service and strong franchise value with our
independent agents. In addition, we strive to maintain and build on Selective's
position as a market leader among regional property and casualty insurers.
The segment is managed by type of business: commercial lines underwriting and
personal lines underwriting. Lines of business covered by the commercial lines
underwriting segment include: fire/inland marine, workers' compensation, general
liability, automobile, business owners' policy and bonds. The personal lines
underwriting lines of business include automobile and homeowners' insurance
coverages. In addition to lines of business, we also analyze the results of this
segment by regional office, agent and strategic business unit, which are
organized around classes of customers to analyze insurance needs unique to those
customers.
For the ten years ended December 31, 2003, our average statutory loss and loss
expense ratio was 72.0%, which outperformed the property and casualty industry's
average ratio of 79.4%, as reported by A.M. Best Company (A.M. Best). (See
"glossary of terms" on Exhibit 13 on Form 10-K). We attribute our performance to
the franchise value we have created with our independent agency force, expertise
in underwriting property and casualty insurance risks, and our penetration of
2
high quality markets in the northeastern, southeastern, midatlantic and
midwestern states. For the ten years ended December 31, 2003, our average
statutory underwriting expense ratio was 31.0% compared with 26.5% for the
property and casualty industry. Our historical statutory underwriting expense
ratio is higher than the industry average primarily due to: (i) the industry
average underwriting expense ratio reflects the inclusion of direct writers of
insurance, companies that do not use independent agents, which generally have
lower distribution costs than we do, and (ii) over 80% of our net premiums
written are in the more expensive commercial lines business compared with the
industry at 54%, as reported by A.M. Best. Our average statutory combined ratio
of 103.8% over the last ten year period outperformed the property and casualty
industry average statutory combined ratio of 107.1% over that period.
The table below sets forth a comparison of certain Company and industry
statutory ratios:
Simple
Average of
All Periods
Presented 2003 2002 2001 2000 1999 1998 1997 1996 1995 1994
--------- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
CERTAIN COMPANY RATIOS: (1)
Loss 61.5% 59.4 61.4 64.1 66.4 65.0 59.9 56.8 60.6 60.4 60.6
Loss expense 10.5 10.9 10.9 10.2 9.3 9.4 10.3 11.4 10.8 10.8 11.1
Underwriting expense 31.0 30.7 30.3 31.5 31.7 30.5 32.2 31.2 30.8 29.4 31.6
Policyholders' dividends 0.8 0.5 0.6 0.9 0.9 0.8 0.7 0.7 0.7 1.0 1.0
Statutory combined ratio (2) 103.8 101.5 103.2 106.7 108.2 105.7 103.2 100.1 102.9 101.6 104.3
Growth (decline) in net premiums written 7.5 15.7 13.8 10.5 3.6 8.1 4.4 3.7 (8.6) 8.5 14.8
CERTAIN INDUSTRY RATIOS: (1) (3)
Loss 66.4 63.3 68.9 75.4 68.6 65.4 63.1 60.3 65.4 65.7 68.1
Loss expense 13.0 12.8 12.8 13.1 12.9 13.4 13.1 12.5 12.9 13.2 13.0
Underwriting expense 26.5 24.5 25.2 26.6 27.5 27.9 27.7 27.1 26.4 26.3 26.0
Policyholders' dividends 1.2 0.5 0.6 0.8 1.4 1.3 1.7 1.7 1.1 1.4 1.3
Statutory combined ratio (2) 107.1 101.1 107.4 115.9 110.4 108.1 105.6 101.6 105.8 106.4 108.5
Growth in net premiums written 5.6 10.2 14.9 8.5 4.7 1.9 1.8 2.9 3.4 3.6 3.8
COMPANY FAVORABLE (UNFAVORABLE) TO
INDUSTRY:
Statutory combined ratio 3.3 (0.4) 4.2 9.2 2.2 2.4 2.4 1.5 2.9 4.8 4.2
Growth (decline) in net premiums written 1.9 5.5 (1.1) 2.0 (1.1) 6.2 2.6 0.8 (12.0) 4.9 11.0
Note: Some amounts may not foot due to rounding.
1. The ratios and percentages are based upon Statutory Accounting
Principles (SAP) prescribed or permitted by state insurance departments
in the states in which each company is domiciled. Effective January 1,
2001, the Company adopted a codified set of statutory accounting
principles, as required by the National Association of Insurance
Commissioners (NAIC). These principles were not retroactively applied,
but would not have had a material effect on the ratios presented above.
These principles may differ from accounting principles generally
accepted in the United States of America (GAAP). For definitions of
these ratios, please refer to Exhibit 13 on Form 10-K.
2. A statutory combined ratio under 100% generally indicates an
underwriting profit and a statutory combined ratio over 100% generally
indicates an underwriting loss. Because of investment income, a company
may still be profitable although its statutory combined ratio exceeds
100%.
3. Source: A.M. Best. The industry ratios for 2003 have been estimated by
A.M. Best.
3
INSURANCE OPERATIONS RESULTS
Year Ended December 31,
(in thousands) 2003 2002 2001
- ----------------------------------------------------------------------------------------
GAAP INSURANCE OPERATIONS RESULTS
Net premiums written $ 1,219,159 1,053,487 925,420
============ ========= =======
Net premiums earned $ 1,133,070 988,268 883,048
Losses and loss expenses incurred 798,630 714,580 655,884
Net underwriting expenses incurred 354,638 306,669 279,527
Policyholders' dividends 5,054 5,762 8,275
------------ --------- -------
Underwriting loss $ (25,252) (38,743) (60,638)
============ ========= =======
GAAP RATIOS:
Losses and loss expense ratio 70.5% 72.3% 74.3%
Underwriting expense ratio 31.3% 31.0% 31.7%
Policyholders' dividends ratio 0.4% 0.6% 0.9%
------------ --------- -------
Combined ratio 102.2% 103.9% 106.9%
============ ========= =======
The Company's GAAP combined ratio was 102.2% in 2003, compared with 103.9% in
2002 and 106.9% in 2001. The decrease for 2003 when compared with 2002 resulted
primarily from 15 consecutive quarters of double-digit commercial line renewal
price increases, which resulted in an improvement in the commercial lines GAAP
combined ratio of 1.2 points, to 101.5% in 2003 from 102.7% in 2002 and 104.9%
in 2001. The personal lines GAAP combined ratio improved to 105.5% in 2003 from
108.8% in 2002 and 113.5% in 2001.
The primary difference between the statutory combined ratio and the combined
ratio (GAAP basis) is that policy acquisition costs and other underwriting
expenses are divided by net premiums written on a statutory basis, while on a
GAAP basis these expenses are divided by net premiums earned. In addition, on a
GAAP basis, policy acquisition costs are deferred and amortized over the life of
the underlying policies.
The following table shows the distribution of total net premiums written, by
state, for the periods indicated:
Year Ended December 31,
----------------------------------
NET PREMIUMS WRITTEN 2003 2002 2001
- -------------------- ---- ---- ----
New Jersey 38.5% 39.8 40.3
Pennsylvania 13.7 13.8 13.5
New York 10.4 10.8 11.5
Maryland 6.9 6.6 7.0
Virginia 5.5 5.3 5.1
North Carolina 3.8 4.0 3.2
Illinois 2.9 2.9 3.0
Georgia 2.9 2.5 2.4
Indiana 2.5 2.4 2.6
South Carolina 2.1 2.1 2.5
Ohio 2.0 2.0 2.1
Michigan 1.7 1.5 1.3
Delaware 1.5 1.5 1.6
Wisconsin 1.4 1.5 1.6
Other states 4.2 3.3 2.3
----- ----- -----
Total 100.0% 100.0 100.0
----- ----- -----
AGENCY DISTRIBUTION FORCE
We sell insurance products through independent insurance agents. Our strong
agency relationships start with providing a broad range of products, an ease of
doing business due to our field presence and technology initiatives, superior
underwriting and claims service, stable markets, consistent underwriting
standards, and opportunity for growth and profitability. We have competitive
commission schedules and agents earn average commissions of approximately 15% of
their direct premiums written, and in addition can earn up to a maximum of 17.5%
of direct premium written under our agency profit sharing plan. We have six
regional offices and a service center office strategically located throughout
our geographic service area so that our staff can maintain a high level of
communication with agents. Senior management interacts frequently with agents
through a variety
4
of company-sponsored events where groups of agents advise and help management
develop corporate strategies and key initiatives. In each operating territory,
agency sales and customer service representative meetings are held where leading
local agents discuss with management how we can improve product offerings,
customer service and overall efficiency.
We continue to work with independent insurance agents to generate profitable
premium growth. While the long-term effects of ongoing agency consolidation and
bank acquisitions of agencies cannot be fully anticipated, we are taking steps
to work even more closely with our best agents including those purchased by
banks or other institutional entities.
FIELD STRATEGY
We deploy field underwriters - agency management specialists (AMS) and field
claim adjusters - claims management specialists (CMS) into the territories
serviced by our agents. As of December 31, 2003, there were approximately 75
AMSs and 130 CMSs working in our operating territories. Working and living near
agents and customers enables AMSs to work cooperatively with agents to evaluate
new business opportunities and develop strong relationships based on technical
excellence and regular, personal interaction. The AMSs work account-by-account
to ensure we make good underwriting decisions. CMSs also work and live close to
agents and customers so they are able to be on-site quickly after a loss occurs,
as well as conduct on-site inspections and obtain knowledge about potential
exposures. We believe that personal, early intervention by CMSs results in
higher levels of customer satisfaction, quicker, more accurate claim
settlements, and better fraud detection.
AMSs and CMSs are supported by six regional field offices located throughout our
operating territories and underwriting and claim service centers in Richmond,
Virginia. In addition to supporting agency service and relationship objectives,
the regional offices and Underwriting Service Center are responsible for
handling renewal business. The AMSs, regional office underwriting teams, service
center underwriters, and agents work together with corporate management to
maintain underwriting discipline and business quality. The account-by-account
and team strategy for underwriting supports our objective of retaining
established accounts with favorable underwriting results.
UNDERWRITING
The AMSs, regional offices and agents all play an integral role in the
underwriting process, subject to our underwriting guidelines for particular
policies and types of customers. The regional offices work with our strategic
business units, which are organized by type of customer and line of business, to
develop products and underwriting guidelines as well as growth and profitability
objectives. The actuarial department, located in our corporate headquarters,
also works with the regions and the strategic business units to determine
pricing and to monitor profitability. These activities are also based on AMS
input regarding agents' needs for products and pricing. As our competitors
implement across-the-board rate increases, we are able to write the type of
business that fits our profile, at a sound price, through our one risk at a time
field-underwriting model.
The Underwriting Service Center helps our independent insurance agents serve
their small-to-mid-size business customers throughout all of our operating
territories. Through the Underwriting Service Center, Selective employees who
are licensed agents, utilize technology to respond by e-mail, phone and/or fax
to customer inquiries about insurance coverage, billing transactions and more.
In return for the services provided, the commission we pay to the independent
insurance agent is reduced by two points. The Underwriting Service Center also
creates opportunities for additional sales and we believe positions us
particularly well to compete for business from larger agencies, including those
owned by banks and other agency aggregators who seem to be most interested in
service center capabilities.
One & Done, our Internet-enabled small business system, allows agents to quote,
bind and process small business policies from their offices, usually within
minutes, without any intervention by the Company. Because property valuations
and our underwriting criteria are embedded in the system, agents using these
templates can quickly provide policies to owners of small businesses. This tool
has been designed to support agents' skills at selecting good accounts and
allows them to have more time to work on larger, more complex accounts. One &
Done also allows us to produce new business at a lower underwriting expense
ratio and provides the infrastructure to significantly grow these historically
profitable business segments. Because of these features, we believe that this
system is improving our competitive position in the small commercial lines
marketplace.
During 2003, we completed a full implementation of a web-based version of our
commercial lines automated system (CLAS). This version of CLAS has been
developed based on input from our agents and is designed to deliver real-time
transaction processing capability for quotes, new business issuance, endorsement
processing and renewal quoting. Transactions are available to agents and company
employees in a collaborative environment enabling simultaneous decision-making
in a straight through processing environment. In 2004, we are beginning the
process of integrating the CLAS system with agency management system vendors for
billing and claims inquiry as well as integrated rating. We expect these
additional capabilities to be completed during 2004.
Our 60 loss control representatives are responsible for surveying and assessing
accounts from a risk/safety standpoint. Accounts receiving additional safety
consulting services include larger insureds, those with a higher exposure to
loss,
5
accounts with particular needs, and insureds with higher-than-expected losses.
The Loss Control Department not only helps us identify better-than-average
accounts, it also helps business owners avoid losses and assists accounts that
experience loss frequency or severity problems.
The Premium Audit Department conducts audits of a commercial accounts' financial
records during the policy year, or at the end of a policy term, to adjust
interim or final audit premium payments for those policies where sales or
payroll are used to calculate premiums. The Department's procedures better match
premium payments with more accurate sales and payroll information. This allows
adequate levels of premium to be collected prior to policy expiration,
minimizing the potential for uncollectible additional premiums after a policy
has expired.
Commercial Lines and Personal Lines Underwriting highlights for the past three
years are as follows:
COMMERCIAL LINES UNDERWRITING HIGHLIGHTS
Net Net GAAP
Premiums Premiums Underwriting GAAP
($ IN THOUSANDS) Written Earned Income (Loss) Combined Ratio
- ------------------------------------------------------------------------------------------------------------------------------
Total Commercial Lines 2003 $ 999,486 920,409 (13,528) 101.5%
2002 849,215 788,454 (21,135) 102.7
2001 723,842 678,321 (32,970) 104.9
Fire/Inland Marine 2003 143,185 130,305 660 99.5
2002 121,042 111,951 8,725 92.2
2001 99,501 92,489 (1,569) 101.7
Workers' Compensation 2003 240,860 221,024 (20,790) 109.4
2002 203,070 193,399 (20,488) 110.6
2001 180,322 170,129 (11,518) 106.8
General Liability 2003 281,064 256,217 (1,190) 100.5
2002 235,612 213,118 (5,756) 102.7
2001 191,885 179,287 374 99.8
Automobile 2003 274,958 255,626 17,127 93.3
2002 233,589 216,311 1,151 99.5
2001 199,016 186,674 (15,379) 108.2
Business Owners' Policy (BOP) 2003 46,511 43,875 (8,121) 118.5
2002 42,565 39,695 (3,611) 109.1
2001 36,468 34,004 (7,002) 120.6
Bonds 2003 11,757 12,461 (582) 104.7
2002 12,461 13,105 (1,237) 109.4
2001 15,780 14,994 1,992 86.7
Other 2003 1,151 901 (632) 170.2
2002 876 875 81 90.7
2001 870 744 132 82.3
PERSONAL LINES UNDERWRITING HIGHLIGHTS
Net Net GAAP
Premiums Premiums Underwriting GAAP
($ IN THOUSANDS) Written Earned Income (Loss) Combined Ratio
- ------------------------------------------------------------------------------------------------------------------------------
Total Personal Lines 2003 $ 219,673 212,661 (11,724) 105.5%
2002 204,272 199,814 (17,608) 108.8
2001 201,578 204,727 (27,668) 113.5
Automobile 2003 180,776 175,788 (3,875) 102.2
2002 169,090 166,442 (17,507) 110.5
2001 169,545 172,265 (29,705) 117.2
Homeowners 2003 33,163 31,234 (7,844) 125.1
2002 28,518 26,985 (423) 101.6
2001 26,118 26,414 851 96.8
Other 2003 5,734 5,639 (5) 100.1
2002 6,664 6,387 322 95.0
2001 5,915 6,048 1,186 80.4
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CLAIMS
Timely investigation and the fair settlement of meritorious claims is one of the
most important customer services we provide. In addition, we aggressively
investigate suspicious or potentially fraudulent claims so that appropriate
action can be taken before payment is authorized. Company policy emphasizes the
maintenance of timely and adequate reserves for claims, and the cost-effective
delivery of claims services by controlling losses and loss expenses.
CMSs are primarily responsible for investigating and settling claims directly
with policyholders and claimants. By promptly and personally investigating
claims, the CMS is able to provide personal service and quickly resolve claims.
In territories where there is insufficient claim volume to justify the placement
of a CMS, or when particular claim expertise is required, we use independent
adjusters to investigate and settle claims.
Claim settlement authority levels are established for each CMS and supervisor
based on their experience and expertise, up to a regional branch office limit of
$100,000. Casualty claims with exposure potential generally in excess of
$100,000, significant exposure to catastrophic injury or damage, property claims
with an exposure greater than $50,000, as well as claims involving lawsuits
against us and/or questions of coverage are reported to the home office where
senior claim specialists review the claims and determine the appropriate
reserve. CMSs also provide guidance on the handling of the claim until its final
disposition. All environmental and other latent exposure claims are referred to
a centralized environmental claims unit at the home office, which specializes in
the management and consistency of decisions regarding coverage application to
these varied exposures.
The Claim Service Center services all of our operating territories. The goal of
the Claim Service Center is to enhance service with immediate claim triage on a
twenty-four hours a day, 7 days a week basis. The Center is designed to reduce
the cycle time on first party automobile claims and increase the usage of
Selective's discounts at body shops and car rental agencies. The Center became
operational in the second quarter of 2002 and it is estimated that it saved
approximately $1 million in 2003.
We have a home office fraud unit to manage our field fraud investigators. The
fraud unit adheres to uniform internal procedures to improve detection and
action on potentially fraudulent claims. Our automated claim system tracks
suspicious claims and determines the economic impact when a claim is not paid
because it is judged to have been fraudulent. It is our policy to notify the
proper authorities of our findings. We believe that this sends a clear message
that we will not tolerate fraudulent activity committed against our company and
our customers. Also, we provide anti-fraud training for underwriting employees
or others who may be involved in claim handling matters.
We have also implemented additional loss cost containment initiatives. These
initiatives include: (i) a comprehensive managed care program, administered by
CHN Solutions, which has reduced workers' compensation and automobile loss
costs; and (ii) voluntary automobile repair shop and rental programs.
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), and
reinsurance contracts handled on an individual policy or per-risk basis
requiring the agreement of the reinsurer as to each risk insured (facultative
reinsurance). Reinsurance does not legally discharge an insurer from its
liability for the full face amount of its policies, but does make the reinsurer
liable to the insurer to the extent of the reinsurance ceded.
We have a Reinsurance Security Committee that reviews and approves all
reinsurers with whom we do business. The Reinsurance Security Committee reviews
the financial condition of the reinsurer as well as applicable company ratings
from: (i) A.M. Best; and (ii) Standard and Poor's Insurance Rating Services
(S&P). Further information is obtained from our reinsurance brokers, direct
reinsurers and market information sources. Company guidelines require a
reinsurer to have an "A-" or better rating by A.M. Best. However, the Committee
may approve reinsurers who have ratings below "A-" or who have not been assigned
a rating in certain circumstances. The Committee may also disapprove reinsurers
with acceptable A.M. Best ratings after review of other financial or operational
data.
We continuously monitor the reinsurance program to determine that its protection
is not excessive, but adequate to ensure the availability of funds to provide
for losses while maintaining adequate funds for business growth. Our five
largest reinsurers based on 2003 ceded premiums are: Partner Reinsurance Company
of the US, Axa Reassurances (Paris), General Reinsurance Corporation, Hartford
Steam Boiler Inspection & Insurance Company and Motors Insurance Corporation.
Our flood book of business is ceded 100% to the federal government's National
Flood Insurance Program. In addition, we cede no-fault claims for medical
benefits in excess of $75,000 to the New Jersey Unsatisfied Claim and Judgment
Fund (UCJF).
7
Due to change in New Jersey regulations, cessions to UCJF will discontinue for
claims covered under policies with effective dates of January 1, 2004 or later.
We have reinsurance contracts that cover both property and casualty business.
Our Property Excess of Loss treaty, renewed effective July 1, 2003, covers each
property risk in excess of a $2.0 million retention up to $20.0 million in three
layers with the Company retaining 25% of the $5.0 million excess of $5.0 million
second layer. This is a change from the 2002 treaty, when the Company had no
participation in the second layer and treaty coverage up to $15.0 million. The
current treaty provides coverage up to $16.7 million per risk in excess of the
Company's $2.0 million retention and a $1.3 million co-participation in the
second layer. In 2002, the treaty provided coverage up to $13.0 million per risk
in excess of the Company's $2.0 million retention. The property treaty
distinguishes between certified (Terrorism Risk Insurance Act of 2002 [TRIA]
events or foreign acts) and non-certified (all other or domestic) terrorism
losses. The treaty provides coverage for certified terrorism (TRIA) losses for
all risks up to $75.0 million in total insured value per location. The treaty
provides annual certified terrorism limits of $9.0 million for the first layer,
$11.3 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. Consistent with the
2002 treaty: nuclear, biological and chemical losses are excluded from the
Property Excess of Loss treaty, however; our Terrorism Excess of Loss treaty,
discussed later in this section, 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.
Our New Jersey Homeowners' 75% Quota Share treaty renewed January 1, 2004 at the
2003 expiring $75.0 million per occurrence limit with form following coverage.
Under this treaty the reinsurers follow our original policies including any loss
from a terrorism event. Premiums ceded under this treaty in 2003 remained flat
compared with 2002 at approximately $19.2 million. Terms and conditions remained
relatively the same.
Our Property Catastrophe treaty renewed at existing limits of $150.0 million and
retention of $15.0 million. The structure for the property catastrophe
reinsurance program was unchanged from 2003 for the January 1, 2004 renewal,
remaining in five layers and covering: (i) 95% of losses in excess of $15.0
million up to $25.0 million; (ii) 95% of losses in excess of $25.0 million up to
$50.0 million; (iii) 95% of losses in excess of $50.0 million up to $85.0
million; (iv) 83.5% of losses in excess of $85.0 million up to $120.0 million;
(v) 83.5% of losses in excess of $120.0 million up to $165.0 million. Total
coverage under the program is $133.3 million. Terrorism coverage is excluded as
per definition of TRIA, as well as nuclear, biological and chemical losses.
However, these losses are covered under our separate Terrorism Excess of Loss
treaty, which is discussed later in this section. The overall program cost for
this treaty in 2003 is $6.9 million, compared with $7.1 million in 2002. The
$15.0 million retention could be reduced to a minimum retention of $1.0 million
for a New Jersey region catastrophe, due to a provision under the treaty that
provides Selective up to $14.0 million of benefit from the New Jersey Homeowners
75% Quota Share treaty.
The Casualty Excess of Loss treaty, renewed effective July 1, 2003, provides a
per occurrence coverage of $47.2 million in excess of the Company's $2.0 million
retention and $0.8 million co-participation in the layer covering $3.0 million
in excess of the $2.0 million retention. This structure is unchanged from 2002.
Effective July 1, 2003, each umbrella policy is covered up to $15.0 million
compared to $10.0 million in 2002 treaty year. The casualty treaty distinguishes
between certified and non-certified terrorism 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 $94.4 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, which is discussed later in this
section, does cover these exposures once our $15.0 million annual aggregate
retention 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.
On November 26, 2002 TRIA legislation was signed into law. The program
terminates on December 31, 2005. TRIA requires sharing the risk of future losses
from terrorism between private insurers and the federal government, and is
applicable to almost all commercial lines of insurance. Insurance companies with
direct commercial insurance exposure in the United States of America are
required to participate in the program. In following this legislation, Selective
offers its commercial policyholders an option to purchase terrorism coverage
that will provide protection against a TRIA certified event. An event has to
cause at least $5.0 million in losses to be certified as an act of terrorism.
Each participating insurance company is responsible for paying out a certain
amount in claims - a deductible - before Federal assistance becomes available.
This deductible is based on a percentage of commercial lines direct earned
premiums from the prior calendar year. The deductible equaled or equals: 7% of
2002 commercial lines direct earned premium for the 2003 calendar year, 10% of
2003 commercial direct earned premium for 2004 calendar year and 15% of 2004
commercial direct earned premium for 2005 calendar year. For losses above an
insurer's deductible, the federal government will cover 90%, while the insurer
contributes 10%. While the provisions of TRIA will serve to mitigate our
exposure in the event of a large-scale terrorist
8
attack, our deductible is substantial, approximating $60.0 million in 2003 and
$97.0 million in 2004. Therefore, we continue to monitor concentrations of risk.
Effective February 1, 2003 and renewed effective January 1, 2004, Selective has
a separate Terrorism Excess of Loss treaty that covers $45.0 million in the
aggregate in excess of a $15.0 million retention in the aggregate for TRIA, as
well as, nuclear, biological and chemical losses not covered by the Act. Any
TRIA, nuclear, biological and chemical losses incurred within a calendar year
that are retained by the Insurance Subsidiaries under the terms of other
reinsurance treaties, discussed earlier in this section, or specifically
excluded from those treaties count towards the $15.0 million aggregate retention
for the terrorism treaty. The treaty has a 10% return of premium provision if no
losses are ceded to the treaty. The 2004 annual treaty cost decreased 8.3%
compared with 2003. During 2003, we did not incur any terrorism losses, nor did
we cede any losses to this treaty.
The Surety Excess of Loss treaty renewal included an increase in Company
retention to $1.0 million in 2004 from $0.8 million in 2003 as well as an
increase in premium to an estimated $1.8 million for 2004 from $1.6 million in
2003. The Surety Excess of Loss treaty is structured in two layers that cover up
to $8.0 million per principal/per loss at 90%, with Selective retaining 10% of
the exposure. The Surety 17.5% Quota Share treaty we had in prior years was
cancelled effective January 1, 2004. The Company ceded $2.5 million in premium
and an estimated $1.0 million in losses to the Surety Quota Share in 2003.
In compliance with New Jersey regulation, the Insurance Subsidiaries ceded
premium and no-fault claims for medical benefits in excess of $75,000 to the New
Jersey Unsatisfied Claim and Judgment Fund (UCJF). Due to change in New Jersey
regulations, the cessions to UCJF will discontinue for policies with effective
dates of January 1, 2004 or later. Claims covered under policies issued or
renewed prior to January 1, 2004 will continue to be paid by the UCJF.
POOLING ARRANGEMENTS
The Insurance Subsidiaries participate in an inter-company pooling and expense
sharing arrangement (pool or pooling agreement). The pool permits each Insurance
Subsidiary to rely on the capacity of the entire pool, rather than only its own
capital and surplus and it prevents any one Insurance Subsidiary from suffering
any undue losses, as all Insurance Subsidiaries share underwriting profits and
losses in proportion to their pool participation percentages. The pool permits
all Insurance Subsidiaries to obtain a uniform rating from A.M. Best. Effective
January 1, 2004, the Company purchased a company, that has two state insurance
licenses, but currently writes no business. This Company will be renamed
Selective Insurance Company of New England and will be given a 0.5%
participation in the pooling agreement with Selective Way Insurance Company
giving up a 0.5% participation.
The pool participation percentage of each Insurance Subsidiary approximates the
ratio of that subsidiary's policyholders' surplus to our aggregate
policyholders' surplus. The percentages are as follows:
2003 2004
---- ----
Selective Insurance Company of America 55.5% 55.5%
Selective Way Insurance Company 21.5% 21.0%
Selective Insurance Company of South Carolina 9.0% 9.0%
Selective Insurance Company of the Southeast 7.0% 7.0%
Selective Insurance Company of New York 7.0% 7.0%
Selective Insurance Company of New England - 0.5%
Through the pooling agreement, SICA assumes from the other Insurance
Subsidiaries, net of applicable reinsurance, all of their combined premiums,
losses, loss expenses and underwriting expenses and SICA cedes to the other
Insurance Subsidiaries 44.5% of the Insurance Subsidiaries' combined premiums,
losses, loss expenses and underwriting expenses. Through the pool, the Insurance
Subsidiaries also share underwriting and administration expenses. Accounts are
rendered within forty-five days after the end of the calendar quarter and are
settled within sixty days after the end of the calendar quarter. The pool may be
terminated at the end of any calendar month by any Insurance Subsidiary giving
ninety days prior notice of termination.
NET LOSS AND LOSS EXPENSE RESERVES
Significant periods of time can elapse between the occurrence of an insured
loss, the reporting of the loss to the insurer and the insurer's payment of that
loss. To recognize liabilities for unpaid losses and loss expenses, insurers
establish reserves as balance sheet liabilities representing estimates of
amounts needed to pay reported and unreported net losses and loss expenses.
When a claim is reported to an insurance subsidiary, its claims personnel
establish a "case reserve" for the estimated amount of the ultimate payment. The
amount of the reserve is primarily based upon a case-by-case evaluation of the
type of claim
9
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 the estimate of ultimate losses and loss expenses at each
reporting date. The difference between; (i) projected ultimate loss and loss
expense reserves and (ii) case loss reserves and loss expense reserves thereon
is carried as the IBNR reserve. By using both estimates of reported claims and
IBNR determined using generally accepted actuarial reserving techniques, we
estimate the ultimate net liability for losses and loss expenses. The ultimate
actual liability may be higher or lower than reserves established. We do not
discount to present value 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. Beginning in 2003, we are using independent actuaries to
certify the adequacy of our reserves. When reviewing reserves, we analyze
historical data and estimate the impact of various factors such as: (i) per
claim information; (ii) Company and industry historical loss experience; (iii)
legislative enactments, judicial decisions, legal developments in the imposition
of damages, and changes in political attitudes; and (iv) trends in general
economic conditions, including the effects of inflation. This process assumes
that past experience, adjusted for the effects of current developments and
anticipated trends, is an appropriate basis for predicting future events. There
is no precise method, however, for subsequently evaluating the impact of any
specific factor on the adequacy of reserves because the eventual deficiency or
redundancy is affected by many factors.
The anticipated effect of inflation is implicitly considered when estimating
reserves for net losses and loss expenses. While anticipated increases due to
inflation are considered in estimating ultimate claim costs, the increase in the
average severity of claims is caused by a number of factors that vary with the
individual type of policy written. Future average severity is projected based on
historical and anticipated trends and is adjusted for anticipated changes in
general economic trends.
After taking into account all relevant factors, we believe that the reserve for
net losses and loss expenses at December 31, 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. For further discussion and information about loss
and loss expense reserves, see Note 6 and Note 18(a) to the consolidated
financial statements under Item 8. "Financial Statements and Supplementary
Data."
The table on page 12 provides information about reserves for net losses and loss
expenses and presents the development of balance sheet net reserves for 1993
through 2003. The top three lines of the table reconcile gross reserves to net
reserves for unpaid losses and loss expenses recorded at the balance sheet date
for each of the indicated years. The upper portion of the table shows the
re-estimated amount of the previously recorded gross and net reserves with
related reinsurance recoverable, based on experience as of the end of each
succeeding year. The estimate is either increased or decreased as more
information becomes known about the frequency and severity of claims for
individual years.
The lower section of the table shows the cumulative amount paid with respect to
the previously recorded reserves as of the end of each succeeding year. For
example, as of December 31, 2003, we paid $698.2 million of the currently
estimated $773.6 million of losses and loss expenses that were incurred through
the end of 1993; thus, the difference, an estimated $75.4 million of losses and
loss expenses incurred through 1993, remained unpaid as of December 31, 2003.
The "cumulative redundancy (deficiency)" represents the aggregate change in the
estimates over all prior years. For example, the 1993 reserve developed a $30.1
million net redundancy over the course of the succeeding ten years while on a
gross basis, the 1993 reserve developed a $51.1 million deficiency over the same
period. The net amount has been included in income over the past ten years. The
cumulative net deficiencies in 2002, 2001, 2000 and 1999 are the result of
normal reserve development inherent in the uncertainty in establishing reserves,
anticipated loss trends, growth in business, as well as increased reinsurance
retentions. Also contributing to the deficiency was our contractor completed
operations business, which is part of our general liability line of business.
Prior to 2002 we had more exposure to faulty workmanship and materials for both
the general contractor and subcontractors and inadequate limits on
subcontractors. After 2002 we took extensive underwriting actions to limit our
exposure. We adopted the Insurance Service Office (ISO) general liability
insurance form, which excluded subcontractors for faulty workmanship and placed
mold limitations or exclusions on all policies and required subcontractors to
carry equal insurance limits to those carried by the general contractor. We also
mandated that insureds be named on any potential subcontractors policy as an
additional insured on a primary and noncontributory basis. Approximately half of
the cumulative gross deficiency for 1998 and prior is related to unlimited
medical payments ceded to the Unsatisfied Claim and Judgment fund in the state
of New Jersey.
10
In evaluating this information, each amount includes the total of all changes in
amounts for prior periods. For example, the amount of redundancy to losses
settled in 2003, but incurred in 1999, will be included in the cumulative net
redundancy (deficiency) amounts in 2002, 2001, 2000 and 1999. This table does
not present accident or policy year development data, which certain readers may
be more accustomed to analyzing. Conditions and trends that have affected
development of the reserves in the past may not necessarily occur in the future.
Accordingly, it may not be appropriate to extrapolate redundancies or
deficiencies based on this table.
11
ANALYSIS OF NET LOSS AND LOSS EXPENSE DEVELOPMENT
(in millions) 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
- ------------- ---- ---- ---- ---- ---- ---- ---- ---- ---- ---- ----
Gross reserves for
unpaid losses and
loss expenses at
December 31 $ 917.7 999.4 1,120.1 1,189.8 1,161.2 1,193.3 1,273.8 1,272.7 1,298.3 1,403.4 1,587.8
Reinsurance
recoverable on unpaid
losses and loss
expenses at
December 31 $ (114.0) (111.5) (121.4) (150.2) (124.2) (140.5) (192.0) (160.9) (166.5) (160.4) (184.6)
Net reserves for
unpaid losses and
loss expenses at
December 31 $ 803.7 887.9 998.7 1,039.6 1,037.0 1,052.8 1,081.8 1,111.8 1,131.8 1,243.1 1,403.2
Net reserves
estimated as of:
One year later $ 801.0 900.6 989.5 1,029.5 1,034.5 1,044.2 1,080.7 1,125.5 1,151.7 1,258.1
Two years later 790.0 899.5 977.6 1,028.1 1,024.8 1,035.9 1,088.2 1,152.7 1,175.8
Three years later 788.5 894.9 974.4 1,020.5 1,014.0 1,033.3 1,115.6 1,181.9
Four years later 782.9 894.7 965.2 1,014.4 998.1 1,040.3 1,134.4
Five years later 780.3 892.2 960.8 1,000.9 997.9 1,049.9
Six years later 778.9 888.9 955.2 1,002.1 1,003.6
Seven years later 772.1 890.2 956.7 1,006.5
Eight years later 770.1 891.3 959.5
Nine years later 770.0 894.9
Ten years later 773.6
Cumulative net
redundancy
(deficiency) $ 30.1 (7.0) 39.2 33.1 33.4 2.9 (52.6) (70.1) (44.0) (15.0)
======== ======= ======= ======= ======= ======= ======= ======= ======= =======
Cumulative amount of
net reserves paid
through:
One year later $ 224.6 259.4 280.4 303.6 313.7 328.1 348.2 399.3 377.1 384.0
Two years later 382.3 443.4 481.6 519.6 531.1 537.5 600.3 649.1 627.3
Three years later 497.7 573.7 628.0 674.7 665.5 703.8 767.5 815.3
Four years later 567.4 661.3 722.2 760.8 760.8 797.1 870.8
Five years later 611.1 716.0 773.3 820.0 812.2 856.1
Six years later 642.8 748.4 811.9 850.9 849.7
Seven years later 662.6 774.6 832.9 877.3
Eight years later 677.5 790.2 852.0
Nine years later 687.9 804.0
Ten years later 698.2
Re-estimated gross
liability $ 968.8 1,097.0 1,177.0 1,235.1 1,216.0 1,265.4 1,364.9 1,377.9 1,379.5 1,435.6
Re-estimated
reinsurance
recoverable $ (195.1) (202.2) (217.6) (228.6) (212.4) (215.5) (230.6) (196.0) (203.7) (177.5)
======== ======= ======= ======= ======= ======= ======= ======= ======= =======
Re-estimated net
liability $ 773.6 894.9 959.5 1,006.5 1,003.6 1,049.9 1,134.4 1,181.9 1,175.8 1,258.0
======== ======= ======= ======= ======= ======= ======= ======= ======= =======
Cumulative gross
(deficiency) $ (51.1) (97.6) (56.9) (45.3) (54.8) (72.1) (91.1) (105.2) (81.2) (32.1)
======== ======= ======= ======= ======= ======= ======= ======= ======= =======
Cumulative net
redundancy
(deficiency) $ 30.1 (7.0) 39.3 33.1 33.4 2.9 (52.6) (70.1) (44.0) (15.0)
======== ======= ======= ======= ======= ======= ======= ======= ======= =======
Note: Some amounts may not foot due to rounding.
12
The table set forth below reconciles Statutory to GAAP losses and loss expense
reserves:
RECONCILIATION OF STATUTORY TO GAAP LOSSES AND LOSS EXPENSE RESERVES
(in thousands) 2003 2002
- --------------------------------------------------------------------------------------------------------
Statutory losses and loss expense reserves (1) $ 1,404,186 1,244,575
Provision for uncollectible reinsurance 2,325 1,450
Elimination of inter-company profit in loss expense reserves (2) (2,896) (2,757)
Other (413) (217)
------------- ---------
GAAP losses and loss expense reserve - net 1,403,202 1,243,051
Reinsurance recoverable on unpaid losses and loss expenses 184,611 160,374
------------- ---------
GAAP losses and loss expense reserves - gross $ 1,587,813 1,403,425
============= =========
(1) Statutory losses and loss expense reserves, net of reinsurance recoverable
on unpaid losses and loss expenses.
(2) Alta Services LLC, an affiliate of the insurance companies, charges a fee
for managed care services which is included in loss expense.
ENVIRONMENTAL RESERVES
Reserves established for liability insurance include exposure to environmental
claims, both asbestos and non-asbestos. These claims have arisen primarily under
older policies containing exclusions for environmental liability which certain
courts, in interpreting such exclusions, have determined do not bar such claims.
The emergence of these claims is slow and highly unpredictable. Since 1986,
policies issued by the Insurance Subsidiaries have contained a more expansive
exclusion for losses related to environmental claims. Our asbestos and
non-asbestos environmental claims have arisen primarily from exposures in
municipal government, small commercial risks and homeowners policies.
"Asbestos claims" are claims presented to us in which bodily injury is alleged
to have occurred as a result of exposure to asbestos and/or asbestos-containing
products. During the past two decades, the insurance industry has experienced
the emergence and development of an increasing number of asbestos claims. At
December 31, 2003, asbestos claims constituted 91% of our 3,058 environmental
claims compared with 90% of our 2,593 outstanding environmental claims at
December 31, 2002.
"Non-asbestos claims" are pollution and environmental claims alleging bodily
injury or property damage presented, or expected to be presented, to us other
than asbestos. These claims include landfills, leaking underground storage tanks
and mold. In past years, landfill claims have accounted for a significant
portion of our environmental claim unit's litigation costs.
Although we have had limited mold claims activity in the past, and do not write
business in states that have historically been most exposed to these claims, in
order to support and affirm the exclusion of mold claims we added the Insurance
Services Office (ISO) mold coverage limitation endorsement to all homeowner
renewals beginning in the fourth quarter of 2002, except in New York where the
exclusion has not been approved.
We refer all environmental claims to our centralized environmental claim unit,
which specializes in the claim management of these exposures. Environmental
reserves are evaluated on a case-by-case basis. As cases progress, the ability
to assess potential liability often improves. Reserves are then adjusted
accordingly. In addition, each case is reviewed in light of other factors
affecting liability, including judicial interpretation of coverage issues.
IBNR reserve estimation for environmental claims is often difficult because, in
addition to other factors, there are significant uncertainties associated with
critical assumptions in the estimation process such as average clean-up costs,
third-party costs, potentially responsible party shares, allocation of damages,
insurer litigation costs, insurer coverage defenses and potential changes to
state and federal statutes. However, management is not aware of any emerging
trends that could result in future reserve adjustments. Moreover, normal
historically based actuarial approaches are difficult to apply because relevant
history is not available. In addition, while models can be applied, such models
can produce significantly different results with small changes in assumptions.
As a result, management does not calculate a specific environmental loss range,
as it believes it would not be meaningful.
13
The table below summarizes the number of asbestos and non-asbestos claims
outstanding at December 31, 2003, 2002 and 2001. For additional information
about environmental reserves, see Note 18(a) to the consolidated financial
statements in Item 8. "Financial Statements and Supplementary Data."
Environmental Claims Activity 2003 2002 2001
- ----------------------------------------------------------------------------------------------------
ASBESTOS RELATED CLAIMS (1)
Claims at beginning of year 2,346 2,038 1,868
Claims received during year 720 725 606
Claims closed during year(2) (294) (417) (436)
--------- ------ ------
Claims at end of year 2,772 2,346 2,038
========= ====== ======
Average net loss settlement on closed claims $ 548 344 449
Amount paid to administer claims $ 419 230 123
Net survival ratio (3) 17 15 17
NON-ASBESTOS RELATED CLAIMS (1)
Claims at beginning of year 247 240 212
Claims received during year 133 105 138
Claims closed during year(2) (94) (98) (110)
--------- ------ ------
Claims at end of year 286 247 240
========= ====== ======
Average net loss settlement on closed claims $ 7,900 16,609 14,827
Amount paid to administer claims $ 723 851 907
Net survival ratio (3) 9 10 10
(1) The number of environmental claims presented in the tables includes all
multiple claimants who are associated with the same site or incident.
(2) Includes claims dismissed, settled, or otherwise resolved.
(3) The net survival ratio was calculated utilizing a three-year average for
net losses and expenses paid.
INSURANCE REGULATION
GENERAL
Insurance companies are subject to supervision and regulation in the states in
which they are domiciled and transact business. Such supervision and regulation
relates to numerous aspects of an insurance company's business and financial
condition. The primary purpose of such supervision and regulation is the
protection of policyholders. The extent of regulation varies, and generally is
derived from state statutes which delegate regulatory, supervisory and
administrative authority to state insurance departments. We believe that we are
in compliance in all material respects with applicable regulatory requirements
as of the date of this report. Although the U.S. federal government does not
directly regulate the insurance industry, federal initiatives from time to time
can have an impact on the industry.
On November 26, 2002 TRIA legislation was signed into law. The program
terminates on December 31, 2005. TRIA requires sharing the risk of future losses
from terrorism between private insurers and the federal government, and is
applicable to almost all commercial lines of insurance. Insurance companies with
direct commercial insurance exposure in the United States of America are
required to participate in the program. With the signing of this legislation,
all previously approved exclusions for terrorism were rescinded. Policyholders
have the option to accept or decline the terrorism coverage we offer in our
policies, or negotiate other terms. These provisions apply to new policies
written after enactment. An event has to cause at least $5.0 million in losses
to be certified as an act of terrorism. Each participating insurance company
will be responsible for paying out a certain amount in claims - a deductible -
before Federal assistance becomes available. This deductible is based on a
percentage of commercial lines direct earned premiums from the prior calendar
year. The deductible equaled or equals: 7% of 2002 commercial lines direct
earned premium for the 2003 calendar year, 10% of 2003 commercial lines direct
earned premium for the 2004 calendar year and 15% of 2004 commercial lines
direct earned premium for the 2005 calendar year. For losses above an insurer's
deductible, the federal government will cover 90%, while the insurer contributes
10%. While the provisions of TRIA will serve to mitigate our exposure in the
event of a large-scale terrorist attack, our deductible is substantial,
approximating $60.0 million in 2003 and $97.0 million in 2004. Therefore, we
continue to monitor concentrations of risk. Effective February 1, 2003 and
renewed effective January 1, 2004, Selective has a separate reinsurance treaty
that covers $45.0 million in the aggregate in excess of a $15.0 million
retention in the aggregate for TRIA, and nuclear, biological and chemical losses
not covered by the act. Any TRIA, nuclear, biological and chemical losses
incurred within a calendar year that are retained by the Insurance Subsidiaries
under the terms of other reinsurance treaties, or specifically excluded from
those treaties count towards the $15.0 million aggregate retention for the
terrorism treaty. During 2003, we did not incur any terrorism losses, nor did we
cede any losses to this treaty.
14
The Financial Services Modernization Act of 1999, also known as the
Gramm-Leach-Bliley Act and regulations thereunder (the Act) govern the privacy
of consumer financial information. The regulations limit disclosure by financial
institutions of "nonpublic personal information" about individuals who obtain
financial products or services for personal, family, or household purposes. The
Act and the regulations generally apply to disclosures to non-affiliated third
parties, subject to specified exceptions, but not to disclosures to affiliates.
Many states in which we operate have adopted laws that are at least as
restrictive as the Act and the regulations. This is an evolving area of
regulation requiring continued monitoring to ensure continued compliance with
the Act.
While we believe we are in compliance with all currently effective and
applicable laws affecting our operations, we cannot currently quantify the
financial impact we would incur to satisfy revised or additional regulatory
requirements that may be imposed in the future.
STATE REGULATION
The authority of the state insurance departments extends to such matters as the
establishment of standards of solvency, which must be met and maintained by
insurers, the licensing of insurers and agents, the imposition of restrictions
on investments, premium rates for property and casualty insurance, the payment
of dividends and distributions, the provisions which insurers must make for
current losses and future liabilities, the deposit of securities for the benefit
of policyholders and the approval of policy forms. State insurance departments
also conduct periodic examinations of the financial and business affairs of
insurance companies and require the filing of annual and other reports relating
to the financial condition of insurance companies. Regulatory agencies require
that premium rates not be excessive, inadequate or unfairly discriminatory. In
general, the Insurance Subsidiaries must file all rates for commercial and
personal insurance with the insurance department of each state in which they
operate.
All states have enacted legislation that regulates insurance holding company
systems. Each insurance company in a holding company system is required to
register with the insurance supervisory agency of its state of domicile and
furnish information concerning the operations of companies within the holding
company system that may materially affect the operations, management or
financial condition of the insurers. Pursuant to these laws, the respective
departments may examine the Parent and the Insurance Subsidiaries at any time,
require disclosure or prior approval of material transactions of the Insurance
Subsidiaries with any affiliate and require prior approval or notice of certain
transactions, such as dividends or distributions to the Parent from the
Insurance Subsidiary domiciled in that state.
NATIONAL ASSOCIATION OF INSURANCE COMMISSIONERS (NAIC) GUIDELINES
The Insurance Subsidiaries are subject to the general statutory accounting
principles and reporting formats established by the NAIC. The NAIC also
promulgates model insurance laws and regulations relating to the financial and
operational regulations of insurance companies, which includes the Insurance
Regulatory Information System (IRIS). IRIS identifies 11 industry ratios and
specifies "usual values" for each ratio. Departure from the usual values on four
or more of the ratios can lead to inquiries from individual state commissioners
about certain aspects of the insurer's business. The Insurance Subsidiaries have
consistently met all of the IRIS ratio tests.
NAIC model laws and rules are not usually applicable unless enacted into law or
promulgated into regulation by the individual states. The adoption of certain
NAIC model laws and regulations is a key aspect of the NAIC Financial
Regulations Standards and Accreditation Program, which also sets forth minimum
staffing, and resource levels for all states. All of the domiciliary states of
the Insurance Subsidiaries are accredited, with the exception of New York.
Examinations conducted by accredited states can be accepted by other states. The
NAIC intends to create an eventual nationwide regulatory network of accredited
states.
The NAIC Model Act is also intended to enhance the regulation of insurer
solvency. This act contains certain risk-based capital (RBC) requirements for
property and casualty insurance companies. The requirements are designed to
assess capital adequacy and to raise the level of protection that statutory
surplus provides for policyholders. RBC measures the four major areas of risk to
which property and casualty insurers are exposed: (i) asset risk; (ii) credit
risk; (iii) underwriting risk; and (iv) off-balance sheet risk. Insurers with a
ratio below 200% of their total adjusted capital to their Authorized Control
Level, as calculated in the Model Act, are subject to different levels of
regulatory intervention and action. Based upon the unaudited 2003 statutory
financial statements for the Insurance Subsidiaries, each Insurance Subsidiary's
total adjusted capital exceeded the Authorized Control Level.
INVESTMENTS SEGMENT
The long-term objective of our investment policy is to maximize after-tax
returns while providing liquidity and preserving assets and stockholders'
equity. The current investment mix is 85% debt securities, 12% equity
securities, 1% short-term investments, and 2% other investments. High credit
quality has always been a cornerstone of our investment strategy, as
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evidenced by the fact that 99% of our debt securities are investment grade. The
average rating of our debt securities is "AA", S&P's second highest credit
quality rating.
We emphasize liquidity requirements in response to an unpredictable underwriting
environment and the need to minimize the exposure to catastrophic events. To
provide liquidity while maintaining consistent performance, maturities of debt
securities are "laddered" so that some issues are always approaching maturity,
thereby providing a source of predictable cash flow. To reduce sensitivity to
interest rate fluctuations, we invest our debt portfolio primarily in
intermediate-term securities. The average maturity of the portfolio was 5.5
years at December 31, 2003 compared with 5.3 years at December 31, 2002.
We continue to follow the investment philosophy that has historically proven
successful for us. The strategy is to purchase debt securities in sectors that
represent the most attractive relative value and maintain a moderate equity
exposure. Managing investment risk by adhering to these strategies is intended
to protect the interests of our stockholders as well as those of our
policyholders and, at the same time, enhance our financial strength and
underwriting capacity.
For additional information about investments, see the sections titled
"Investments" in Item 7. "Management's Discussion and Analysis of Financial
Condition and Results of Operations," beginning on page 34, and Item 8.
"Financial Statements and Supplementary Data," Note 3 to the consolidated
financial statements, "Investments."
DIVERSIFIED INSURANCE SERVICES SEGMENT
Our Diversified Insurance Services segment provides synergies with our Insurance
Subsidiaries and creates new opportunities for agents to bring value added
services and products to their customers. Our Diversified Insurance Services
operation has three core functions: human resource administration outsourcing
(HR outsourcing), managed care and flood insurance. The businesses fit into our
business model in one of two ways: complementary (they share a common marketing
or distribution system) or vertically (one company uses the other's products or
services in its own production or supply output). The flood and HR outsourcing
products are currently sold through our independent agent distribution channel,
while our managed care businesses provide an integral service used by our claims
operation, as well as by other insurance carriers. In December 2001, the
Company's management adopted a plan to divest itself of its 100% ownership
interest in PDA Software Services, Inc. (PDA), which had historically been
reported as part of the Diversified Insurance Services segment. This divestiture
plan was completed in May 2002 when the Company sold all of the issued and
outstanding shares of capital stock of PDA, as well as certain software
applications developed by PDA, at a net gain of $0.5 million. For additional
information about discontinued operations see Item 8. "Financial Statements and
Supplementary Data," Note 13 to the consolidated financial statements,
"Discontinued Operations."
The results for this segment's continuing operations are as follows:
FOR THE YEAR ENDED DECEMBER 31,
($ in thousands) 2003 2002 2001
- ----------------------------------------------------------------------------
HR OUTSOURCING
Net revenue $ 44,096 38,127 34,352
Pre-tax (loss) (379) (1,397) (6,599)
MANAGED CARE
Net revenue 22,061 22,525 19,088
Pre-tax profit 3,151 3,010 3,686
FLOOD INSURANCE
Net revenue 23,630 18,317 14,571
Pre-tax profit 6,094 3,863 2,093
OTHER
Net revenue 2,053 1,827 1,615
Pre-tax profit 357 438 393
TOTAL
Net revenue 91,840 80,796 69,626
Pre-tax profit (loss) 9,223 5,914 (427)
After-tax profit (loss) 6,160 4,051 (201)
After-tax return on net revenue 6.7% 5.0 (0.3)%
HUMAN RESOURCE ADMINISTRATION OUTSOURCING
Selective HR Solutions, Inc. (Selective HR) provides human resource
administration outsourcing services, including benefits, payroll and employee
management services, and risk and compliance management products and services,
including workers' compensation. HR outsourcing by the nature of its product
package, provides a high level of day-to-day services to its
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customers, which we believe is attractive to small business owners, who can be
accessed through existing relationships with our independent agents.
We continue to focus on further educating the Company's agency distribution
force in order to better leverage their existing business owner relationships in
an effort to improve upon the approximately 100 agents that are selling this
product. Since the acquisition of Selective HR in 1999, the number of worksite
employees has increased to just more than 20,000 from the approximately 12,000
at the time of the acquisition.
MANAGED CARE
The goal of our managed care program, delivered through CHN Solutions, is to
return patients to their normal routine, at work and at home, and to ensure that
medical costs are delivered in the most cost-effective manner possible. Our
managed care program provides workers' compensation and automobile medical claim
services, health network services, third party administrative services and
discounted access to the number one membership-based medical provider network in
New Jersey, while bearing no underwriting risk. Our medical claim services
include first report of injury, referrals to medical providers, comprehensive
medical case management, as well as medical bill audits and re-pricing. Our
managed care program also provides medical claim management services under New
Jersey's Automobile Insurance Cost Reduction Act. As part of our managed care
program there are two preferred provider organizations, which are networks of
physicians, hospitals and other medical providers, that have agreed, by
contract, to discount their rates to members.
Network expansion continues to be a major initiative for our managed care
program. During 2003, our medical provider network expanded to 88,000 locations
from 83,000 locations in 2002.
FLOOD INSURANCE
Selective is a servicing carrier for the federal government's National Flood
Insurance Program (NFIP). We provide a market for flood insurance to our agents
and also have flood-only appointments with over 5,700 agents across the country.
As a servicing carrier, not an underwriter, Selective bears no risk of
policyholder loss, since the premiums we collect are ceded 100% to the federal
government. We receive a servicing fee from which we pay agency commissions and
other related expenses. In addition to the servicing fees, we receive fees for
handling claims. Currently, Selective is servicing more than 162,000 flood
policies under this program as compared with 135,000 at this time last year. The
program is subject to an annual renewal from Congress. During 2003, the NFIP
recognized Selective for our growth during fiscal 2002 by presenting Selective
with its "Administrators Club" award for the second consecutive year.
DIVERSIFIED INSURANCE SERVICES REGULATION
The companies of our Diversified Insurance Services segment are subject to
certain laws and regulations.
Selective HR provides, among other things, co-employee services. As a
co-employer for some of its clients, federal, state and local laws and
regulations relating to labor, tax and employment matters affect Selective HR.
By contracting with its clients and creating a co-employer relationship with
employees assigned to work at client company locations, Selective HR assumes
certain contractual obligations, legal obligations and responsibilities of an
employer under these laws and regulations. Many of these laws and regulations do
not specifically address the obligations and responsibilities of co-employers.
If these laws and regulations, such as the Employee Retirement Income Security
Act, and federal and state employment laws and tax laws, are ultimately applied
to a co-employer's relationship with their worksite employees, they could have a
material adverse effect on Selective HR's results of operations or financial
condition.
Some states in which Selective HR operates have passed licensing or registration
requirements for co-employers. These laws and regulations vary from state to
state but generally provide for monitoring the fiscal responsibility of
co-employers. CHN Solutions operates as a managed care organization (MCO) and/or
a preferred provider organization (PPO) and is subject to laws and/or
regulations in some states where they do business, which require them to be
licensed to operate as an MCO or a PPO.
In New Jersey, a state from which CHN Solutions derives substantial revenue,
regulations implementing the Healthcare Quality Act may deem insured health
benefit plans who contract with PPOs to be Managed Care Plans. Managed Care
Plans may be required, through PPO contracts, to provide enrollees with
information regarding the plan and the network and also to afford providers with
certain protections. We are not currently subject to these regulations. If this
changes in the future, it may require additional expenditure to achieve
compliance, which would not be material to our consolidated results of
operations or financial condition.
Both federal and state laws regarding privacy of medical records and patient
privacy also affect CHN Solutions. Because CHN Solutions does not provide
health insurance, or health care services, it is not a "covered entity" under
the federal Health Insurance Portability and Accountability Act of 1996 (HIPAA)
statute or regulations. This is an evolving area of regulation requiring us to
continually monitor and review our operations.
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While Selective HR and CHN Solutions believe they are currently in compliance
with all laws and regulations affecting their operations, there can be no
assurance that, in the future, they will be able to satisfy new or revised
licensing and regulatory requirements.
SelecTech is overseen by CHN Solutions and provides third-party administrative
services to self-insured accounts. SelecTech also works closely with our
subsidiary, SRM Insurance Brokerage, LLC, to assist businesses and government
entities looking for customized insurance products and services. When operating
as an insurance adjuster, SelecTech is subject to the laws and/or regulations in
some of the states in which it does business, which require it to be licensed as
an adjuster.
COMPETITION
We face significant competition in both the Insurance Operations and Diversified
Insurance Services segments.
Our Insurance Operations compete with regional and national insurance companies,
including direct writers of insurance coverage. Many of these competitors have
greater financial, technical and operating resources. In addition, we face
competition within each insurance agency, which sells our insurance, because
most of our agencies represent more than one insurance company. Based on net
premiums written for 2002 (latest publicly available information), A.M. Best
ranks the Company the 61st largest property and casualty group in the United
States of America.
The property and casualty insurance industry is highly competitive on the basis
of both price and service. There are many companies competing for the same
insurance customers in the geographic areas in which we operate. We compete in
these areas based on superior service at a reasonable price. During 2003, a
Goldman Sachs survey of independent agents showed Selective to be in the top
five regional companies in terms of service.
During 2003, our managed care unit was ranked as the number one PPO in New
Jersey by NJBIZ, a source for business news and information in New Jersey.
Additionally, Employee Benefits News, a publication serving employee benefits
decision makers ranked our managed care unit the 11th largest nationwide based
on membership, and includes 88,000 medical provider locations. Currently, our HR
Outsourcing unit's co-employer component is ranked the 12th largest in the
nation by Florida Trend Magazine and our Flood unit is the 10th largest
write-your-own carrier for the federal government's National Flood Insurance
Program based on 2002 Statutory Annual Statement information.
Please refer to the "Risk Factors" section below, and Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of Operations" for
the potential impact these items could have on our ability to compete.
SEASONALITY
The Company's insurance business experiences modest seasonality with regard to
premiums written, which are usually highest in January and July of each year due
to certain commercial lines renewals and the lowest during the fourth quarter.
Although the written premium experiences modest seasonality, premiums are earned
ratably over the period of coverage. Losses and loss expenses incurred tend to
remain consistent throughout the year, unless a catastrophe occurs. Catastrophes
can occur at any time during the year from weather-related events that include,
but are not limited to, hail, tornadoes, windstorms and hurricanes.
EMPLOYEES
We currently employ approximately 2,240 employees of which 1,760 work in our
Insurance Operations and Investments segment and 480 work in our Diversified
Insurance Services segment. The largest single concentration of employees is the
850 that work at our offices in Branchville, New Jersey.
AVAILABLE INFORMATION
Our annual report on Form10-K, quarterly reports on Form 10-Q, current reports
on Form 8-K and amendments to those reports are available without charge on our
website, www.selective.com, as soon as reasonably practicable after they are
filed electronically with the SEC. We are providing the address to our Internet
site solely for the information of investors. We do not intend the address to be
an active link or to otherwise incorporate the contents of the website into this
report.
RISK FACTORS
The following are certain risk factors that can affect our business and our
results of operations and financial condition. There may be other risk factors,
and this list is not exhaustive. We operate in a continually changing business
environment, and new risk factors emerge from time to time. We cannot predict
such new risk factors, nor can we assess the impact, if any, of such new risk
factors on our business.
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CATASTROPHIC EVENTS CAN HAVE A SIGNIFICANT IMPACT ON OUR FINANCIAL AND
OPERATIONAL CONDITION.
Results of property and casualty insurers are subject to weather and other
conditions. While one year may be relatively free of major weather or other
disasters, another year may have numerous such events causing results for such a
year to be materially worse than for other years.
Our Insurance Subsidiaries have experienced, and are expected in the future to
experience, catastrophe losses. It is possible that a catastrophic event or a
series of multiple catastrophic events could have a material adverse effect on
the operating results and financial condition of the Insurance Subsidiaries,
thereby limiting the ability of the Insurance Subsidiaries to pay dividends.
Various events can cause catastrophes, both natural and man-made, including
hurricanes, tornadoes, windstorms, earthquakes, hail, terrorism, explosions,
severe winter weather and fires. The frequency and severity of these
catastrophes are inherently unpredictable. The extent of losses from a
catastrophe is a function of both the total amount of insured exposures in the
area affected by the event and the severity of the event. Although catastrophes
can cause losses in a variety of property and casualty lines, most of the
catastrophe-related claims of our Insurance Subsidiaries historically have been
related to commercial property and homeowners' coverages.
Our Insurance Subsidiaries seek to reduce their exposure to catastrophe losses
through the purchase of catastrophe reinsurance. Reinsurance may prove
inadequate if:
- a major catastrophic loss exceeds the reinsurance limit, or
- an insurance subsidiary pays a number of smaller catastrophic loss
claims, which individually fall below the subsidiary's retention
level.
- The Modeling Software used to analyze the Company's risk proves
inadequate.
In the past 10 years the single largest catastrophe event generated claims of
$14.9 million before reinsurance and $14.1 million net of reinsurance. In that
same period, total catastrophe losses in any one year ranged from $2.8 million
to $31.2 million before reinsurance and $2.2 million to $30.3 million net of
reinsurance.
OUR GEOGRAPHIC CONCENTRATION TIES OUR PERFORMANCE TO THE ECONOMIC AND REGULATORY
CONDITIONS AND WEATHER-RELATED EVENTS IN THE EAST COAST AND MIDWESTERN STATES.
Our property and casualty insurance business is concentrated geographically.
Thirty-nine percent of our net premiums written are for insurance policies
written in New Jersey. Other east coast states, including Connecticut, Delaware,
Georgia, Maryland, New York, North Carolina, Pennsylvania, Rhode Island, South
Carolina, Virginia and several midwestern states, including Illinois, Indiana,
Iowa, Kentucky, Michigan, Minnesota, Missouri, Ohio and Wisconsin, account for
substantially all of our other business. Consequently, unusually severe storms
or other natural or man-made disasters which destroy property in the states in
which we write insurance could adversely affect our operations. Our revenues and
profitability are also subject to prevailing economic and regulatory conditions
in those states in which we write insurance. Because our business is
concentrated in a limited number of markets, we may be exposed to risks of
adverse developments that are greater than the risks of having business in a
greater number of markets.
WE FACE SIGNIFICANT COMPETITION FROM OTHER REGIONAL AND NATIONAL INSURANCE
COMPANIES, AGENTS AND FROM SELF-INSURANCE.
We compete with regional and national insurance companies, including direct
writers of insurance coverage. Many of these competitors are larger than we are
and have greater financial, technical and operating resources. In addition, we
face competition within each insurance agency, which sells our insurance,
because most of our agencies represent more than one insurance company.
The property and casualty insurance industry is highly competitive on the basis
of both price and service. If our competitors price their products more
aggressively, our ability to grow or renew our business as well as our
profitability may be adversely impacted. There are many companies competing for
the same insurance customers in the geographic areas in which we operate. The
Internet may also emerge as a significant source of new competition, both from
existing competitors using their brand name and resources to write business
through this distribution channel and from new competitors.
We also face competition because of entities which self-insure, primarily in the
commercial insurance market. Many of our customers and potential customers are
examining the benefits and risks of self-insuring as an alternative to
traditional insurance.
A number of new, proposed or potential legislative or industry developments
could further increase competition in the property and casualty insurance
industry. These developments include:
- the Gramm-Leach-Bliley Act, which could result in increased
competition from new entrants to the insurance market, including banks
and other financial service companies;
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- programs in which state-sponsored entities provide property insurance
in catastrophe-prone areas or other alternative market types of
coverage; and
- changing practices caused by the Internet, which has led to greater
competition in the insurance business and, in some cases, greater
expectations for customer service.
New competition from these developments could cause the supply or demand for
insurance to change, which could adversely affect our results of operations and
financial condition.
WE ARE HEAVILY REGULATED IN THE STATES IN WHICH WE OPERATE.
We are subject to extensive supervision and regulation in the states in which we
transact business. The primary purpose of supervision and regulation is to
protect individual policyholders and not shareholders or other investors. Our
business can be adversely affected by private passenger automobile insurance
regulations and any other regulations affecting property and casualty insurance
companies. For example, laws and regulations can lead to forced reductions in
rates to levels which we do not believe are adequate for the risks we insure.
Other laws and regulations can limit our ability to cancel or refuse to renew
policies and require us to offer coverage to all consumers. Changes in laws and
regulations, or their interpretations, pertaining to insurance, including
workers' compensation, healthcare or managed care, preferred provider
organizations and human resource outsourcing administration organizations, may
also have an adverse effect on our business. Although the federal government
does not directly regulate the insurance industry, federal initiatives, from
time to time, can also impact the insurance industry.
In addition, proposals intended to control the cost and availability of
healthcare services have been debated in the U.S. Congress and state
legislatures. Although we do not write health insurance in our managed care
business, nor assume any healthcare risk, rules affecting healthcare services
can affect workers' compensation, commercial and personal automobile, liability
and other insurance which we do write. We cannot determine whether or in what
form healthcare reform legislation may be adopted by the U.S. Congress or any
state legislature. We also cannot determine the nature and effect, if any, that
the adoption of healthcare legislation or regulations, or changing
interpretations, at the federal or state level would have on us.
Examples of regulatory risks include:
Automobile Insurance Regulation
In March 1999, we began to implement a state-mandated 15% rate reduction for all
personal automobile policies in New Jersey. As a result of this roll-back, our
annual premiums in this line have been reduced. The effect of this rollback
continued through 2001 decreasing premium collected and adversely impacting
profitability. In addition, the New Jersey Urban Enterprise Zone (UEZ) Program
requires New Jersey auto insurers, including us, to have a market share in
certain urban territories which is in proportion to their statewide market
share. Due to mandated urban rate caps, the premiums on these urban policies are
typically insufficient to cover losses.
In October 2001, the Company withdrew a filing, originated in July 2000, seeking
an overall 18.9% rate increase and reached an agreement with the New Jersey
Department of Banking and Insurance (DOBI). The agreement exhibited signs of
more regulatory flexibility in the rate-setting process and involved rate
increases for some coverages, decreases for others, tier changes for each change
in risk, as well as discounts for certain customers. Additional rate changes for
New Jersey personal automobile business were approved in January 2002, effective
March 1, 2002 and February 2003, effective March 1, 2003 by the DOBI.
We are periodically subject to potential legislation, that if passed, could
adversely affect the Company's results of operation. In May 2003, legislation
was introduced to allow claimants to file lawsuits for non-economic damages
without proving that the injuries sustained had a serious impact on their life.
This legislation ultimately was not passed.
We are also potentially subject to unfair competition based on uneven
application of regulatory requirements by state regulators. As an example, in
New Jersey, a new market entrant was recently permitted to use insurance credit
scoring to price personal automobile insurance policies while all other insurers
were precluded from doing the same. New Jersey has indicated that it will allow
us and all other insurers that write personal automobile business to use credit
scoring in the near future. However, if we are not allowed to use credit
scoring, our ability to competitively price our New Jersey personal automobile
business could be adversely affected and could affect potential profitability of
this business.
South Carolina law established a joint underwriting association for automobile
insurance. We were required to be a member along with other automobile insurers
in South Carolina. As a member of this association, we had to write automobile
insurance for some involuntary risks, and we shared in the profit or loss of the
association. On March 1, 2003, the association was replaced by an assigned risk
plan. This plan will assign risks which are unable to obtain coverage
voluntarily to insurers based on their statewide market share. This business is
and will most likely continue to be unprofitable.
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Workers' Compensation Insurance Regulation
Because we voluntarily write workers' compensation insurance, we are required by
state law to support the involuntary market. Insurance companies that underwrite
voluntary workers' compensation insurance can either directly write involuntary
coverage, which is assigned by state regulatory authorities, or participate in a
sharing arrangement, where the business is written by a servicing carrier and
the profits or losses of that serviced business are shared among the
participating insurers. We currently participate through a sharing arrangement,
in all states except New Jersey, where we currently write involuntary coverage
directly. Historically, this business has been unprofitable whether written
directly or handled through a sharing arrangement.
Homeowners Insurance Regulation
We are subject to regulatory provisions that are designed to address potential
availability and/or affordability problems in the homeowners property insurance
marketplace. Involuntary market mechanisms, such as the New Jersey Insurance
Underwriting Association (FAIR Plan), generally result in assessments to us. The
New Jersey FAIR Plan writes fire and extended coverage on homeowners for those
individuals unable to secure insurance elsewhere. Insurance companies who
voluntarily write homeowners insurance in New Jersey are assessed a portion of
any deficit from the New Jersey FAIR Plan based on their share of the voluntary
market. Similar involuntary plans exist in most other states where we operate.
A CHANGE IN OUR MARKET SHARE IN NEW JERSEY COULD ADVERSELY IMPACT THE RESULTS IN
OUR PRIVATE PASSENGER AUTOMOBILE BUSINESS.
New Jersey insurance regulations require New Jersey auto insurers to
involuntarily write private passenger automobile insurance for individuals who
are unable to obtain insurance in the voluntary market. These policies are
priced according to a separate rating scheme, which is established by the
assigned risk plan and subject to approval by DOBI. The amount of involuntary
insurance which an insurer must write in New Jersey depends on the insurer's
statewide market share - the greater the market share the more involuntary
coverage the insurer is required to write. The underwriting of involuntary
personal automobile insurance in New Jersey has been historically unprofitable.
During 2002, DOBI issued an order exempting State Farm Indemnity Company, which
had approximately 17% of the market share for New Jersey private passenger
automobile insurance, from the state's "take-all-comers" law, assigned risk
program, and UEZ program. As a result of State Farm's exemption from the
assigned risk program, in 2003 every other participating insurer's share of the
program, including Selective's, was increased to offset the unapplied State Farm
share. State Farm's exemption, which could remain in effect through 2005, will
continue to result in an elevated share of the assigned risk market for
Selective. Because the UEZ business has been historically unprofitable, any
increase in this business is expected to reduce earnings.
THE PROPERTY AND CASUALTY INSURANCE INDUSTRY IS CYCLICAL.
Historically, the results of the property and casualty insurance industry have
been subject to significant fluctuations due to competition, economic
conditions, interest rates and other factors. For example, in 2003, 2002 and
2001, commercial lines premium pricing increased, but had decreased for several
years preceding 2000. Furthermore, the industry's profitability is affected by
unpredictable developments, including:
- natural and man-made disasters;
- fluctuations in interest rates and other changes in the investment
environment that affect returns on our investments;
- inflationary pressures that affect the size of losses; and
- judicial decisions that affect insurers' liabilities.
The demand for property and casualty insurance, particularly commercial lines,
can also vary with the overall level of economic activity.
WE ARE A HOLDING COMPANY, AND WE MAY BE RESTRICTED IN DECLARING DIVIDENDS, AND
THUS MAY NOT HAVE ACCESS TO THE CASH THAT IS NEEDED TO MEET OUR CASH NEEDS.
Substantially all of our operations are conducted through our subsidiaries.
Restrictions on our subsidiaries' ability to pay dividends or to make other cash
payments to us may materially affect our ability to pay principal and interest
on our indebtedness and dividends on our common stock.
Our subsidiaries are permitted under the terms of our debt agreements to incur
indebtedness up to certain levels that may restrict or prohibit the making of
distributions, the payment of dividends or the making of loans by our
subsidiaries to us. We cannot assure that the agreements governing the current
and future indebtedness of our subsidiaries will permit our subsidiaries to
provide us with sufficient dividends, distributions or loans to fund our cash
needs.
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The Insurance Subsidiaries' sources of funds consist primarily of premiums,
investment income and proceeds from sales and redemption of investments. Such
funds are applied primarily to payment of claims, insurance operating expenses,
income taxes and the purchase of investments, as well as dividends and other
payments.
The Insurance Subsidiaries may declare and pay dividends to us only if they are
permitted to do so under the insurance regulations of their respective
domiciliary state. All of the states in which our Insurance Subsidiaries are
domiciled regulate the payment of dividends. Some states, including New Jersey,
North Carolina and South Carolina, require that we give notice to the relevant
state insurance commissioner prior to our Insurance Subsidiaries declaring any
dividends and distributions payable to us. During the notice period, the state
insurance commissioner may disallow all or part of the proposed dividend if it
determines that the insurer's surplus as regards policyholders is not reasonable
in relation to the insurer's liabilities and adequate to its financial needs, or
in the case of New Jersey, if the regulatory authority determines that the
insurer is otherwise in a hazardous financial condition.
Notwithstanding the foregoing, if insurance regulators otherwise determine that
payment of a dividend or any other payment to an affiliate would be detrimental
to an insurance subsidiary's policyholders or creditors, because of the
financial condition of the insurance subsidiary or otherwise, the regulators may
block dividends or other payments to affiliates that would otherwise be
permitted without prior approval.
The Diversified Insurance Services subsidiaries may also declare and pay
dividends. The potential dividends are restricted only by the operating needs of
the subsidiaries. The Diversified Insurance Services subsidiaries' sources of
funds consist primarily of fees for services rendered. Such funds are applied
primarily to payment of operating expenses as well as dividends and other
payments.
OUR RESERVES MAY NOT BE ADEQUATE TO COVER ACTUAL LOSSES AND EXPENSES.
We are required to maintain loss reserves for our estimated liability for losses
and loss expenses associated with reported and unreported claims for each
accounting period. From time to time we have to increase reserves, and if our
reserves are inadequate, we will be required to further increase reserves. An
increase in reserves results in an increase in losses and a reduction in our net
income and stockholders' equity for the period in which the deficiency in
reserves is identified and could have a material adverse effect on our results
of operations, liquidity and financial condition. Our reserve amounts are
estimated based on what we expect the ultimate settlement and claim
administration expenses to be. These estimates are based on facts and
circumstances of which we are aware, predictions of future events, and trends in
claims severity and frequency and other subjective factors. There is no method
for precisely estimating our ultimate liability for settlement and claims.
We regularly review our reserving techniques and our overall amount of reserves.
We also review:
- information regarding each claim for losses;
- our loss history and the industry's loss history;
- legislative enactments, judicial decisions and legal developments
regarding damages;
- changes in political attitudes; and
- trends in general economic conditions, including inflation.
We cannot be certain that the reserves we establish are adequate or will be
adequate in the future.
OUR ABILITY TO REDUCE OUR EXPOSURE TO RISKS DEPENDS ON THE AVAILABILITY AND COST
OF REINSURANCE.
We transfer our exposure to some risks to others through reinsurance
arrangements with other insurance and reinsurance companies. Under our
reinsurance arrangements, another insurer assumes a specified portion of our
losses and loss adjustment expenses in exchange for a specified portion of
policy premiums. The availability, amount and cost of reinsurance depend on
market conditions and may vary significantly. Any decrease in the amount of our
reinsurance will increase our risk of loss. Furthermore, we face a credit risk
with respect to reinsurance. When we obtain reinsurance, we are still liable for
those transferred risks if the reinsurer cannot meet those obligations.
Therefore, the inability of any of our reinsurers to meet its financial
obligations could materially and adversely affect our operations.
OUR INVESTMENTS SUPPORT OUR OPERATIONS AND PROVIDE A SIGNIFICANT PORTION OF OUR
REVENUES AND EARNINGS.
We, like many other property and casualty insurance companies, depend on income
from our investment portfolio for a significant portion of our revenues and
earnings. Any significant decline in our investment income as a result of
falling interest rates, decreased dividend payment rates or general market
conditions would have an adverse effect on our results. Fluctuations in interest
rates cause inverse fluctuations in the market value of our debt portfolio. Any
significant decline in the market value of our investments would reduce our
shareholders' equity and our policyholders' surplus which could impact our
ability to write additional premiums. In addition, our notes payable are subject
to certain debt-to-capitalization restrictions which could also be impacted by a
significant decline in investment values.
22
WE DEPEND ON OUR INDEPENDENT INSURANCE AGENTS.
We market and sell our insurance products through independent, non-exclusive
insurance agencies and brokers. Agencies and brokers are not obligated to
promote our insurance products, and they may also sell our competitors'
insurance products. As a result, our business depends in part on the marketing
and sales efforts of these agencies and brokers. As we diversify and expand our
business geographically, we may need to expand our network of agencies and
brokers to successfully market our products. If these agencies and brokers fail
to market our products successfully, our business may be adversely impacted.
Also, independent agents may decide to sell their businesses to banks, other
insurance agencies, or other businesses. Agents with a Selective appointment may
decide to buy other agents. Changes in ownership of agencies or expansion of
agencies through acquisition could adversely affect an agency's ability to
control growth and profitability, thereby adversely affecting our business.
WE MAY BE ADVERSELY IMPACTED BY A CHANGE IN OUR RATINGS.
Insurance companies are subject to financial strength ratings produced by
external rating agencies. Higher ratings generally indicate financial stability
and a strong ability to pay claims. Ratings are assigned by rating agencies to
insurers based upon factors relevant to policyholders. Ratings are not
recommendations to buy, hold or sell our common stock.
The principal agencies that cover the property and casualty industry are A.M.
Best Company, Standard & Poor's Rating Services (S&P), Moody's Investor Service
(Moody's) and Fitch Rating Service (Fitch). We believe our ability to write
business is most influenced by our rating from A.M. Best. We are currently rated
"A+" (Superior) by A.M. Best, which is their second highest of fifteen ratings.
A significant downgrade from A.M. Best could materially adversely affect the
business we write. We believe that ratings from S&P, Moody's or Fitch, although
important, have less of an impact on our business. We are currently rated "A" by
S&P, "A2" by Moody's and "A" by Fitch. We cannot be sure that we will maintain
our current A.M. Best, S&P's, Moody's or Fitch's ratings. An unfavorable change
in any of these ratings could make it more expensive for us to access capital
markets and maintain our current lines of credit, or increase the interest rate
charged to us under our current lines of credit. The Company had no outstanding
borrowings on these lines at December 31, 2003 or 2002.
WE EMPLOY ANTI-TAKEOVER MEASURES THAT MAY DISCOURAGE POTENTIAL ACQUIRORS OF OUR
COMPANY, WHICH COULD ADVERSELY AFFECT THE VALUE OF OUR COMMON STOCK.
We own, directly or indirectly, all of the shares of stock of Insurance
Subsidiaries domiciled in the states of New Jersey, New York, North Carolina,
South Carolina and Maine. State insurance laws require prior approval by state
insurance departments of any acquisition or control of a domestic insurance
company or of any company which controls a domestic insurance company. Any
purchase of 10% or more of our outstanding common stock would require prior
action by all or some of the insurance commissioners of the above-referenced
states.
In addition, other factors may discourage, delay or prevent a change of control
of Selective. These include, among others, provisions in our certificate of
incorporation, as amended, relating to:
- supermajority voting and fair price to our business combinations;
- staggered terms for our directors;
- supermajority voting requirements to amend the foregoing provisions;
- our stockholder rights plan;
- guaranteed payments which must be made to our officers upon a change
of control; and
- the ability of our board of directors to issue "blank check" preferred
stock.
The New Jersey Shareholders Protection Act provides, among other things, that a
New Jersey corporation, such as Selective, may not engage in business
combinations specified in the statute with a shareholder having indirect or
direct beneficial ownership of 10% or more of the voting power of our
outstanding stock (an interested shareholder) for a period of five years
following the date on which the shareholder became an interested shareholder,
unless the business combination is approved by the board of directors of the
corporation before the date the shareholder became an interested shareholder.
These provisions also could have the effect of depriving shareholders of an
opportunity to receive a premium over the prevailing market price if a hostile
takeover were attempted and may adversely affect the value of our common stock.
WE DEPEND ON KEY PERSONNEL.
The success of our business is dependent, to a large extent, on our ability to
attract and retain key employees, in particular our senior officers, key
management, sales, information systems, underwriting, claims, managed care, HR
outsourcing and corporate personnel. Competition to attract and retain key
personnel is intense. While we have employment agreements with a number of key
managers, in general, we do not have employment contracts or non-compete
arrangements with our employees and cannot ensure that we will be able to
attract and retain key personnel.
23
WE FACE RISKS FROM TECHNOLOGY-RELATED FAILURES.
Increasingly, our businesses are dependent on computer and Internet-enabled
technology. Our inability to anticipate or manage problems with technology
associated with scalability, security, functionality or reliability could
adversely affect our ability to write business and service accounts and could
adversely impact our results of operations and financial conditions.
WE FACE RISKS IN THE HUMAN RESOURCE ADMINISTRATION OUTSOURCING BUSINESS.
Regulatory
The operations of Selective HR are affected by numerous federal and state laws
and regulations relating to employment matters, benefits plans and taxes. In
performing services for its clients, Selective HR assumes some obligations of an
employer under these laws and regulations. If these federal or state laws are
ultimately applied in a manner unfavorable to Selective HR, it could have a
material adverse effect on our operations and financial condition.
Liability for worksite employee payroll
When providing co-employment services, Selective HR assumes the obligations to
pay the salaries, wages and related benefit costs and payroll taxes of its
clients' worksite employees. Clients are required to fund these obligations for
us. If clients failed to fund these obligations, and if these obligations were
significant, it could have a material adverse effect on our results of
operations or financial condition.
Liabilities for Client and Employee Actions
Selective HR establishes, by contract, division of responsibility with the
client for various personnel management matters, including compliance with and
liability under various governmental regulations. Because of this relationship,
however, Selective HR may be subject to liability for the clients' violations of
laws and regulations. Although the agreements with clients generally obligate
them to indemnify Selective HR for any liability attributable to the conduct of
the clients, Selective HR may not be able to collect on the contractual
indemnification claim. In addition, worksite employees may be deemed to be
agents of Selective HR subjecting Selective HR to liability for the actions of
those worksite employees which could have a material adverse effect on our
results of operations or financial condition.
CLASS ACTION LITIGATION COULD AFFECT OUR BUSINESS PRACTICES AND FINANCIAL
RESULTS.
Our industries have been the target of class action litigation in areas
including the following:
- after-market crash parts;
- urban homeowner underwriting practices;
- health maintenance organization practices; and
- discounting and payment of personal injury protection claims.
It is possible that future class action litigation could adversely affect
results of our insurance and diversified insurance services businesses and our
financial condition.
UNIONIZATION OF MEDICAL PROVIDERS COULD IMPACT OUR OPERATIONS.
Our subsidiary, CHN Solutions, builds medical provider networks and leases
networks to insurers, medical management companies, third party administrators
and other medical claim payors. The lessors receive medical fee discounts from
network providers in exchange for potential patient volume commitments from CHN
Solutions' client and payor base. If medical providers, such as physicians,
decided to unionize, that might impair CHN Solutions' ability to maintain and
grow networks, negotiate fee discount arrangements and lease networks to their
customers. These events would have an adverse impact not only on CHN Solutions,
but also on Selective as a whole because we rely, in part, on provider networks
and discounts to manage our claim medical expenses. Those events could also have
an adverse effect on our results of operations and financial condition.
24
ITEM 2. PROPERTIES.
Situated on approximately 125 acres in Branchville, New Jersey, is our 315,000
square foot facility owned by Wantage Avenue Holding Company, Inc., a subsidiary
of Selective. This office complex and the information technology office below
are used by all segments of the business. All regional, field underwriting,
information technology office, service centers, and subsidiary office locations,
as indicated below, are leased. The regional offices are used by the Insurance
Operations segment. The subsidiary offices are used by the Diversified Insurance
Services segment. Our facilities are substantially fully utilized and are
adequate for the conduct of our business.
REGIONAL INSURANCE OFFICES SERVICE OFFICES DIVERSIFIED INSURANCE SERVICES OFFICES
- -------------------------- --------------- --------------------------------------
CHESAPEAKE REGION UNDERWRITING SERVICE CENTER CHN SOLUTIONS
HUNT VALLEY, MARYLAND RICHMOND, VIRGINIA HAMILTON, NEW JERSEY
6 North Park Drive, Suite 200 1100 Boulders Parkway, Suite 601 IBIS Plaza
Scott A. Hewitt Craig G. Borens 3525 Quakerbridge Road
Vice President Vice President Leonard V. Weinman
President and Chief Executive Officer
MID-AMERICA REGION CLAIMS SERVICE CENTER
COLUMBUS, OHIO RICHMOND, VIRGINIA SELECTIVE HR SOLUTIONS, INC.
8800 Lyra Drive, Suite 200 1100 Boulders Parkway, Suite 601 SARASOTA, FLORIDA
Timothy J. Violand Nellie Jiwa 6920 Professional Parkway East
Vice President Assistant Vice President James W. Coleman, Jr.
President and Chief Executive Officer
NEW JERSEY REGION INFORMATION TECHNOLOGY OFFICE
HAMILTON, NEW JERSEY GLASTONBURY, CONNECTICUT
1395 Yardville-Hamilton Square Road 500 Winding Brook Drive
Edward F. Drag, II Bradford S. Allen
Senior Regional Vice President Senior Vice President
PENNSYLVANIA REGION
ALLENTOWN, PENNSYLVANIA
1275 Glenlivet Drive, Suite 200
Charles C. Adams
Vice President
SOUTHERN REGION
CHARLOTTE, NORTH CAROLINA
3420 Toringdon Way, Suite 300
Ronald C. Leibel
Vice President
ITEM 3. LEGAL PROCEEDINGS.
On May 21, 2003, a purported class action lawsuit was brought in the Superior
Court of New Jersey, Law Division - Camden County, against CHN, Alta and SICA
together with 10 other unrelated defendants. The lawsuit alleges that the
defendants breached participating provider agreements and insurance policies and
were unjustly enriched. We are vigorously defending this action, and the Company
and the other defendants filed a Motion to Dismiss. A hearing was held on the
Motion and the Court ordered the plaintiffs to amend their complaint by March
10, 2004. Since the lawsuit remains in its early stages, management cannot at
this time provide a meaningful estimate or range of estimates of a potential
loss, if any.
On October 15, 2003 and October 27, 2003, two related purported class action
lawsuits were brought by the same plaintiff in the Third Judicial Circuit Court
of Illinois against SICA. The first lawsuit alleges a class that covers all
states in which SICA does business, with certain exceptions, and that it
breached its insurance policies, the Illinois Consumer Fraud and Deceptive
Business Practice Act and similar laws of other states and was unjustly
enriched. The plaintiff also filed a Motion for Class Certification. We are
vigorously defending the lawsuit and have filed a Motion to Dismiss. The second
lawsuit also alleges a class that covers all states in which SICA does business,
with certain exceptions, and also alleges that it breached its insurance
policies, the Illinois Consumer Fraud and Deceptive Business Practice Act and
similar laws of other states and was unjustly enriched. We are vigorously
defending the suit and have filed Motions to Dismiss.
25
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
None
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
Information required under this item regarding the price range of our common
stock for each quarter of the two most recent fiscal years and the frequency and
amount of dividends is included in the section entitled "Quarterly Financial
Information," on page 77 under Item 8. "Financial Statements and Supplementary
Data" of this report and is incorporated by reference herein. Additional
information required under this item regarding the frequency, amount and any
restrictions on cash dividends for the two most recent fiscal years, and
information regarding restrictions and limitations on the payment of cash
dividends is found in the section entitled "Financial Condition, Liquidity and
Capital Resources" beginning on page 41 through the first paragraph on page 43,
under Item 7. "Management's Discussion and Analysis of Financial Condition and
Results of Operations" and in Item 8. "Financial Statements and Supplementary
Data," Note 8 to the consolidated financial statements included in this report
and is incorporated by reference herein.
The Company's common stock trades on The Nasdaq National Market under the
symbol: SIGI. As of December 31, 2003, there were approximately 3,593
stockholders of record.
26
ITEM 6. SELECTED FINANCIAL DATA.
Eleven-Year Financial Highlights
(All presentations are in accordance with GAAP
unless noted otherwise, number of weighted average
shares and dollars in thousands, except per share
amounts) 2003 2002 2001 2000 1999
- ------------------------------------------------------------------------------------------------------------------------------
Net premiums written.............................. $ 1,219,159 1,053,487 925,420 843,604 811,677
Net premiums earned............................... 1,133,070 988,268 883,048 821,265 799,065
Net investment income earned...................... 114,748 103,067 96,767 99,495 96,531
Net realized gains (losses) ...................... 12,842 3,294 6,816 4,191 29,377
Diversified insurance services revenue (1,3)...... 91,840 80,796 69,626 57,527 29,764
Total revenues ................................... 1,356,116 1,178,950 1,059,020 986,217 957,879
Underwriting loss (2)............................. (25,252) (38,743) (60,638) (65,122) (54,147)
Diversified insurance services income
(loss) from continuing operations (1,3)....... 9,223 5,914 (427) 5,509 4,772
Net income from continuing operations (3)......... 66,344 42,138 26,318 26,686 54,241
Loss from discontinued operations (3)............. - (169) (625) (151) (524)
Net income........................................ 66,344 41,969 25,693 26,535 53,717
Comprehensive income.............................. 99,362 59,366 24,405 49,166 16,088
Total assets ..................................... 3,438,782 3,029,847 2,684,344 2,590,903 2,507,545
Notes payable and debentures (6).................. 238,621 262,768 156,433 163,634 81,585
Stockholders' equity.............................. 749,784 652,102 591,160 577,797 569,964
Statutory premiums to surplus ratio (2,4)......... 1.8:1 1.9:1 1.8:1 1.7:1 1.6:1
Statutory combined ratio (1,2,5).................. 101.5% 103.2 106.7 108.2 105.7
Combined ratio (1,2,5)............................ 102.2% 103.9 106.9 107.9 106.8
Yield on investment, before-tax................... 5.1% 5.4 5.4 5.8 5.6
Debt to capitalization............................ 24.1% 28.7 21.0 22.1 12.5
Return on average equity.......................... 9.5% 6.8 4.4 4.6 9.1
Per share data:
Net income from continuing operations:
Basic............................................. $ 2.54 1.67 1.07 1.07 2.00
Diluted........................................... 2.40 1.57 1.00 1.01 1.88
Net income:
Basic ............................................ $ 2.54 1.66 1.05 1.07 1.98
Diluted .......................................... 2.40 1.56 0.98 1.01 1.87
Dividends to stockholders ........................ $ 0.62 0.60 0.60 0.60 0.59
Stockholders' equity ............................. $ 27.48 24.52 23.15 22.92 21.46
Price range of common stock:
High ............................................. $ 33.00 31.48 28.21 25.88 22.50
Low .............................................. 21.81 19.36 19.94 14.63 16.50
Close ............................................ 32.36 25.18 21.73 24.25 17.19
Number of weighted average shares:
Basic ............................................ 26,131 25,301 24,583 24,907 27,081
Diluted .......................................... 27,645 26,922 26,424 26,572 28,877
27
1998 1997 1996 1995 1994 1993
- ------------------------------------------------------------------------------------------------------------
748,873 717,618 692,239 757,021 697,941 607,462
722,992 676,268 694,947 742,817 680,270 594,919
99,196 100,530 96,952 91,640 80,657 77,326
(2,139) 6,021 2,786 900 4,230 4,528
14,100 8,236 7,061 4,529 3,482 2,912
837,329 794,183 804,780 843,100 771,682 682,510
(24,986) (3,022) (21,982) (17,468) (35,119) (54,530)
2,217 765 1,950 856 591 545
53,570 69,608 55,551 53,042 38,276 22,678
- - - - - -
53,570 69,608 55,551 53,042 38,276 22,678
78,842 105,931 51,539 105,035 1,078 21,380
2,432,168 2,306,191 2,189,737 2,119,804 1,870,718 1,725,736
88,791 96,559 103,769 111,292 111,378 61,291
607,583 565,316 474,299 436,749 329,164 322,807
1.5:1 1.5:1 1.7:1 2.1:1 2.4:1 2.6:1
103.2 100.1 102.9 101.6 104.3 108.5
103.6 100.3 102.9 102.3 105.1 109.1
5.7 6.0 6.1 6.4 6.5 6.8
13.2 14.6 18.0 20.3 25.3 16.0
9.1 13.4 12.2 13.9 11.7 7.1
1.88 2.41 1.92 1.86 1.38 0.83
1.74 2.27 1.83 1.81 1.29 0.81
1.88 2.41 1.92 1.86 1.38 0.83
1.74 2.27 1.83 1.81 1.29 0.81
0.56 0.56 0.56 0.56 0.56 0.56
21.30 19.32 16.31 15.17 11.62 11.74
29.25 28.38 19.38 19.19 15.38 15.50
16.69 18.31 15.50 12.25 11.50 10.25
20.13 27.00 19.00 17.75 12.63 15.25
28,480 28,909 28,860 28,481 27,759 27,271
30,412 30,925 30,360 29,846 29,356 29,133
1. Flood business is included in statutory underwriting results in accordance
with prescribed statutory accounting practices. On a GAAP basis only, flood
servicing revenue and expense has been reclassified from underwriting
results to Diversified Insurance Services. Prior years have been restated
to reflect the exclusion of results from discontinued operations.
2. See the Glossary of Terms on Exhibit 13 on Form 10-K.
3. See Item 8. "Financial Statements and Supplementary Data," Note 13 to the
consolidated financial statements and Item 7. "Management's Discussion and
Analysis of Financial Condition and Results of Operations," the section
entitled "Results of Operations" for a discussion of discontinued
operations and Item 8. "Financial Statements and Supplementary Data," Note
10 for components of income (loss).
4. Regulatory and rating agencies use the statutory premiums to surplus ratio
as a measure of solvency, viewing an increase in the ratio as a possible
increase in solvency risk. Management and analysts also view this ratio as
a measure of the effective use of capital since, as the ratio increases,
revenue per dollar of invested capital increases, indicating the possible
opportunity for an increased return.
5. Changes in both the GAAP and statutory combined ratios are viewed by
management and analysts as indicative of changes in the profitability of
underwriting operations. A ratio over 100% is indicative of an underwriting
loss, and a ratio below 100% is indicative of an underwriting profit.
6. See Item 8. "Financial Statements and Supplementary Data," Note 7 to the
consolidated financial statements for a discussion of senior convertible
notes issued during 2002.
28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS.
RESULTS OF OPERATIONS(1)
2003 COMPARED WITH 2002 AND 2001
Financial Highlights
(dollars in thousands) 2003 2002 2001
- -----------------------------------------------------------------------------------------------------------------
Net premiums written $ 1,219,159 1,053,487 925,420
Diversified insurance services revenue(2) 91,840 80,796 69,626
Net investment income earned 114,748 103,067 96,767
Net realized gains 12,842 3,294 6,816
Net income 66,344 41,969 25,693
Statutory combined ratio 101.5% 103.2 106.7
Combined ratio 102.2% 103.9 106.9
Return on average equity 9.5% 6.8 4.4
(1)- Refer to the Glossary of Terms on Exhibit 13 of the 2003 Form 10-K for
definitions of terms used in this financial review, incorporated by
reference herein.
(2)- From continuing operations, refer to Item 8. "Financial Statements and
Supplementary Data," Note 13 to the consolidated financial statements and
this section for further discussion.
2003 was a successful year in which Selective's distinctive competitive
advantage and growth strategies enabled us to increase net premiums written to
$1.2 billion, a 16% increase over 2002's $1.1 billion. Driven by continued
improvements across our entire operation, net income was $66.3 million, or $2.40
per diluted share on 27,645,000 weighted average shares compared with $42.0
million, or $1.56 per diluted share on 26,922,000 weighted average shares in
2002 and $25.7 million or $0.98 per diluted share in 2001 on 26,424,000 weighted
average shares. The 58% increase in net income for 2003 compared with 2002 was
mainly attributable to our core commercial lines operation, where we have
achieved double digit renewal price increases for 15 straight quarters. These
increases averaged 13% for 2003, compared with 19% in 2002 and 16% in 2001.
However, we anticipate commercial lines renewal price increases will decelerate
in 2004, but expect them to continue to outpace loss trends.
Net investment income earned for the year was $114.7 million compared with
$103.1 million in 2002 and $96.8 million in 2001. Pre-tax investment yield was
5.1% for 2003, compared with 5.4% for both 2002 and 2001, however net investment
income was driven higher by an increased investment base of $2.4 billion in
2003, compared with $2.1 billion in 2002. This increased investment base was
largely due to operating cash flows of $281.9 million in 2003, compared with
$180.1 million in 2002 and $52.7 million in 2001.
We manage our business in three segments: Insurance Operations (commercial lines
underwriting and personal lines underwriting), Investments, and Diversified
Insurance Services. The summaries below provide further information about these
segments.
INSURANCE OPERATIONS
ALL LINES
($ in thousands) 2003 2002 2001
- ----------------------------------------------------------------------------------------
GAAP INSURANCE OPERATIONS RESULTS
Net premiums written $ 1,219,159 1,053,487 925,420
============ ========= ========
Net premiums earned $ 1,133,070 988,268 883,048
Less:
Losses and loss expenses incurred 798,630 714,580 655,884
Net underwriting expenses incurred 354,638 306,669 279,527
Dividends to policyholders 5,054 5,762 8,275
------------ --------- --------
Underwriting loss $ (25,252) (38,743) (60,638)
------------ --------- --------
GAAP RATIOS:
Loss and loss expense ratio 70.5% 72.3 74.3
Underwriting expense ratio 31.3% 31.0 31.7
Dividends to policyholders ratio 0.4% 0.6 0.9
------------ --------- --------
Combined ratio 102.2% 103.9 106.9
============ ========= ========
29
For 2003, net premiums written were just over $1.2 billion, an increase of 16%
over 2002 net premiums written of just less than $1.1 billion which were 14%
higher than 2001 net premiums written of $925.4 million. The 2003 increase
included approximately $261.8 million in new business, up 19% over last year's
$220.6 million, while 2001 included $187.9 million of new business. Net premiums
written for commercial lines grew 18% in 2003, while personal lines were up 8%.
This growth reflects our ongoing strategy to primarily focus on our core
commercial lines operation, while building a smaller, but profitable personal
lines segment. Net premiums written are recognized as earned premium in the
statements of income over the period that coverage is provided. The vast
majority of net premiums written have a coverage period of twelve months. It
should be noted that when premium rates increase, the effect of those increases
will not immediately affect earned premium. Rather, those increases will be
recognized ratably over the period of coverage. For 2003, our overall combined
ratio was 102.2% including 2.7 points from weather-related catastrophe losses,
which include the effects of several winter storms and Hurricane Isabel, down
from 103.9% in 2002, which included 1.1 points from catastrophe losses, and
106.9% in 2001, which included 0.4 points from catastrophe losses.
COMMERCIAL LINES RESULTS
ALL LINES
($ in thousands) 2003 2002 2001
- ---------------------------------------------------------------------------------------------
GAAP INSURANCE OPERATIONS RESULTS
Net premiums written $ 999,486 849,215 723,842
========== ======== ========
Net premiums earned $ 920,409 788,454 678,321
Less:
Losses and loss expenses incurred 637,469 554,742 481,067
Net underwriting expenses incurred 291,414 249,085 221,949
Dividends to policyholders 5,054 5,762 8,275
---------- -------- --------
Underwriting loss $ (13,528) (21,135) (32,970)
---------- -------- --------
GAAP RATIOS:
Loss and loss expense ratio 69.3% 70.4 70.9
Underwriting expense ratio 31.7% 31.6 32.7
Dividends to policyholders ratio 0.5% 0.7 1.3
---------- -------- --------
Combined ratio 101.5% 102.7 104.9
========== ======== ========
Commercial lines net premiums written were $999.5 million for 2003, or
approximately 82% of total net premiums written, $849.2 million for 2002 and
$723.8 million for 2001. Growth in our core commercial lines operation was led
by a 13% increase in renewal pricing for the year, compared with 19% for 2002
and 16% for 2001. We anticipate these increases will decelerate in 2004.
Commercial lines policies in force were 325,100 at December 31, 2003 compared
with 302,672 in 2002 and 295,860 in 2001. Retention was 81% for 2003, compared
with 78% in 2002 and 75% in 2001. Included in the net premiums written totals
are new business of $228.1 million in 2003, compared with $193.2 million in 2002
and $163.3 million in 2001. We believe the increase in new business was
primarily attributable to our field strategy, which puts underwriting and claims
specialists in direct contact with our agencies. This new business growth also
reflects continued agency integration of our small business and technology
initiatives through systems such as One & Done, our Internet-based policy system
that allows agents to issue small business policies, those with premiums under
$10,000, from their offices. In 2003, agents generated $25.3 million of new
small commercial business through One & Done, compared with $18.8 million in
2002 and $7.0 million in 2001. Agents entered 14,700 policies or 33% of new
commercial policies through One & Done, 52% more than 2002.
The Company's commercial lines combined ratio for the year was 101.5%, compared
with 102.7% in 2002 and 104.9% in 2001. Price increases, combined with
underwriting improvements, are driving these profitability improvements. Our
commercial lines statutory combined ratios showed similar improvements, as 2003
finished at 100.9% compared with 102.2% in 2002 and 104.5% in 2001.
Our commercial lines loss and loss expense ratio was 69.3% in 2003, including
2.4 points from weather-related catastrophe losses, compared with 70.4% in 2002,
including 1.1 points from catastrophe losses, and 70.9% in 2001, including 0.4
points from catastrophe losses. The 1.1 point decrease in the ratio in 2003 from
2002 was attributable to the renewal price increases, discussed above, which had
a favorable effect of 7.5 points on the loss and loss expense ratio. This was
partially offset by 4.6 points attributable to loss trends, 1.3 points of
additional catastrophe losses and 0.5 points of other costs, including adverse
development and reinsurance costs. The 0.5 point decrease in the ratio in 2002
from 2001 was attributable to the renewal price increases which had an effect
of 7.4 points on the loss and loss expense ratio. This was partially offset by
4.7 points of loss trends, 1.0 point of additional catastrophes losses and 1.2
points of other costs, including adverse development and reinsurance costs.
Loss trends include the effects of such items as general, legal and regulatory,
jury verdict and medical inflation.
30
The commercial lines underwriting expense ratio increased modestly to 31.7% in
2003 from 31.6% in 2002 which was better than the 32.7% in 2001. Improvement in
the underwriting expense ratio, of 0.5 points, is being masked by the impact of
incentive-based agent and employee profit sharing expense. These expenses, which
are ratably recognized to properly match expenses with revenues under GAAP, were
$20.5 million in 2003, $12.4 million in 2002, and $7.7 million in 2001. The
underlying improvement is being driven by technology initiatives, such as our
web-based commercial lines automated system (CLAS), that provides a secure,
powerful and easy-to-use platform that allows independent agents to service
their customers at point of contact. Through CLAS, agents seamlessly process
certain new and renewal business, and endorsement transactions without any
Selective involvement. One & Done, which has a marginal underwriting expense
ratio of about 23%, also adds to the improvement by providing agents with
straight-through small business processing capability. 33% of commercial lines
new business transactions came through One & Done in 2003, compared with 25% in
2002. These initiatives help lower the underwriting expense ratio since agents
are performing tasks that in the past would have been performed by a Selective
employee, allowing us to improve productivity.
GENERAL LIABILITY BUSINESS
Our general liability line of business, which accounted for $281.1 million or
28% of total commercial lines net premiums written in 2003, compared with $235.6
million in 2002 and $191.9 million in 2001, saw its loss and loss expense ratio
decline to 66.8% in 2003 from 68.6% in 2002 and 65.0% in 2001. The improved
profitability is the result of price increases and tightened underwriting
guidelines such as restricting the amount of work a contractor is able to
sub-contract and setting minimum limits of liability coverage. However, during
2003, our Products/Completed Operations business demonstrated significant prior
year development. Estimates for prior year losses increased by $17.9 million,
with $14.0 million in accident years 2000 and prior. This deficiency was created
mainly by our contractor completed operations business. Prior to 2002, we had
more exposure to faulty workmanship and materials for both the general
contractor and subcontractors and inadequate limits on subcontractors. After
2002, we took extensive underwriting actions to limit our exposure. We adopted
the Insurance Service Office (ISO) general liability insurance form which
excluded subcontractors for faulty workmanship. We also placed mold limitations
or exclusions on most policies and required subcontractors to carry equal
insurance limits to those carried by the general contractor as well as mandated
that our insureds be named on any potential subcontractor's policy as an
additional insured on a primary and noncontributory basis. This business is
inherently volatile which makes it more difficult to reserve.
COMMERCIAL AUTOMOBILE BUSINESS
Our commercial automobile line of business had a loss and loss expense ratio of
63.9% in 2003, compared with 69.6% in 2002 and 78.8% in 2001. The results of
this line, which had $275.0 million of net premiums written in 2003, or 28% of
total commercial lines net premiums written, compared with $233.6 million in
2002 and $199.0 million in 2001, are being driven by price increases and
stricter underwriting standards, including a changed vehicle mix which reduced
the percentage of extra-heavy vehicles and the removal of certain classes of
business we determined to be unprofitable.
WORKERS' COMPENSATION BUSINESS
The workers' compensation line of business, improved modestly to an 85.3%
loss and loss expense ratio compared with 86.3% at 2002, but higher than the
77.9% ratio in 2001. Workers' compensation net premiums written were $240.9
million or 24% of total commercial lines net premium written for 2003, compared
with $203.1 million in 2002 and $180.3 million in 2001. Our account-based
strategy focuses on writing this line as a companion product, with less than 5%
of workers' compensation policies written stand-alone. We no longer accept new
workers' compensation business on a stand-alone basis, it must be packaged with
at least one other line of business. Workers' compensation results continue 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 the combination of
rate increases, credit reductions, decreased use of dividend plans and shifting
business to higher-priced tiers, will make this a more manageable line for
Selective. We continue to seek premium price increases, with a targeted 6% for
the overall workers' compensation line of business in 2004, including about 7%
in New Jersey, which represents 26% of total workers' compensation net premiums
written.
COMMERCIAL PROPERTY BUSINESS
Our commercial property line of business, which had net premiums written of
$106.3 million or 11% of total commercial lines net premiums written, had a loss
and loss expense ratio of 68.6% including 18.6 points from weather-related
catastrophe losses in 2003, compared with 60.7%, including 8.5 points from
catastrophe losses in 2002 and 67.9%, including 2.4 points from catastrophe
losses in 2001. In addition to price increases, the progress we have made in our
commercial property line can be attributed to: better insurance-to-value
estimates across our book of business; a shift of risks to better construction
quality and newer buildings; and an overall focus on low-to-medium hazard
property exposures.
31
PERSONAL LINES RESULTS
ALL LINES
($ in thousands) 2003 2002 2001
- ----------------------------------------------------------------------------------------
GAAP INSURANCE OPERATIONS RESULTS
Net premiums written $ 219,673 204,272 201,578
========== ======== ========
Net premiums earned $ 212,661 199,814 204,727
Less:
Losses and loss expenses incurred 161,161 159,838 174,817
Net underwriting expenses incurred 63,224 57,584 57,578
---------- -------- --------
Underwriting loss $ (11,724) (17,608) (27,668)
---------- -------- --------
GAAP RATIOS:
Loss and loss expense ratio 75.8% 80.0 85.4
Underwriting expense ratio 29.7% 28.8 28.1
---------- -------- --------
Combined ratio 105.5% 108.8 113.5
========== ======== ========
Personal lines net premiums written were $219.7 million in 2003, $204.3 million
in 2002, and $201.6 million in 2001. The increase in net premiums written is
attributable to renewal price increases reaching an average of 7.1% in 2003,
compared with approximately 9.0% in 2002 and 2.1% in 2001.
The personal lines combined ratio for the year was 105.5%, including 3.9 points
from weather-related catastrophe losses, compared with 108.8% in 2002, which
included 1.4 points from catastrophe losses and 113.5% in 2001, which included
0.5 points from catastrophe losses. The personal lines loss and loss expense
ratio was 75.8% in 2003, down from 80.0% in 2002 and 85.4% in 2001. The 2003
improvement in both the combined ratio and the loss and loss expense ratio was
primarily the result of an improving New Jersey personal automobile loss and
loss expense ratio discussed below. The improvement in the personal lines
combined ratio in 2002 from 2001 reflects an $8.0 million pre-tax reserve charge
taken during 2001 due to less favorable savings for the Company's New Jersey
private passenger automobile liability coverage from New Jersey's Automobile
Insurance Cost Reduction Act (AICRA). The charge added 4.0 points to the overall
personal lines and 6.3 points to the New Jersey personal automobile combined
ratio for 2001.
The personal lines underwriting expense ratio increased to 29.7% in 2003 from
28.8% in 2002 and 28.1% in 2001. Excluding the impact of incentive-based agent
and employee profit sharing expenses, which are discussed in the commercial
lines results section, the personal lines underwriting expense ratio increased
0.1 point in 2003 compared to 2002. These expenses amounted to $6.9 million in
2003, $4.9 million in 2002, and $4.1 million in 2001.
PERSONAL AUTOMOBILE BUSINESS
Our personal automobile line of business, with net premiums written of $180.8
million, or 82% of total personal lines net premiums written, had a loss and
loss expense ratio of 74.3% in 2003, compared with 80.4% on $169.1 million of
net premium written for 2002 and 88.7% from $169.5 million of net premiums
written in 2001. This improvement reflects continued progress in our New Jersey
personal automobile business resulting from significant actions taken over the
last four years, including aggressive pricing initiatives; a redesign of our
rating tiers; and an improving political and regulatory climate. New Jersey,
which represents 73% of total personal automobile net premiums written, had a
loss and loss expense ratio of 72.1% in 2003, compared with 79.1% in 2002 and
90.9% in 2001. Our average premium per vehicle in New Jersey increased 10.5%
over 2002, which was 9.3% higher than 2001, due to these price increases and
tier changes. The number of vehicles we insure declined to 106,700 in 2003,
compared with 111,000 in 2002 and 121,000 in 2001. This reduction was due to
lower new business submissions.
HOMEOWNERS BUSINESS
Our homeowners line of business, which had $33.2 million of net written
premiums, or 15% of total personal lines net premiums written, compared with
$28.5 million in 2002 and $26.1 million in 2001, suffered from extreme
weather-related losses in 2003. The 2003 loss and loss expense ratio was 90.8%,
but included 23.0 points from weather-related catastrophe losses, compared with
77.9% in 2002, which included 8.6 points from catastrophe losses and 75.5% in
2001, which included 2.6 points from catastrophe losses. We have implemented an
action plan in this line of business that includes: premium rate increases,
increased pricing due to underwriting on an insurance to value (ITV) basis, and
adding a wind and other deductible clause to policies.
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 permits greater diversification of business and the ability
to offer increased coverage while limiting maximum net losses. Reinsurance does
not legally discharge an insurer from its liability for the full
32
face amount of its policies, but does make the reinsurer liable to the insurer
to the extent of the reinsurance ceded. We have reinsurance contracts that cover
both property and casualty business.
PROPERTY REINSURANCE
Our Property Excess of Loss treaty, renewed effective July 1, 2003, covers each
property risk in excess of a $2.0 million retention up to $20.0 million in three
layers with the Company retaining 25% of the $5.0 million excess of $5.0 million
second layer. This is a change from the 2002 treaty, when the Company had no
participation in the second layer and treaty coverage up to $15.0 million. The
current treaty provides coverage up to $16.7 million per risk in excess of the
Company's $2.0 million retention and a $1.3 million co-participation in the
second layer. In 2002, the treaty provided coverage up to $13.0 million per risk
in excess of the Company's $2.0 million retention. The property treaty
distinguishes between certified (Terrorism Risk Insurance Act of 2002 (TRIA)
events or foreign acts) and non-certified (all other or domestic) terrorism
losses. The treaty provides coverage for certified terrorism (TRIA) losses for
all risks up to $75.0 million in total insured value per location. The treaty
provides annual certified terrorism limits of $9.0 million for the first layer,
$11.3 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. Consistent with the
2002 treaty: nuclear, biological and chemical losses are excluded from the
Property Excess of Loss treaty, however, our Terrorism Excess of Loss treaty,
discussed later in this section, 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.
Our New Jersey Homeowners 75% Quota Share treaty renewed January 1, 2004 at the
2003 expiring $75.0 million per occurrence limit with form following coverage.
Under this treaty, the reinsurers follow our original policies including any
loss from a terrorism event. Premiums ceded under this treaty in 2003 remained
flat compared with 2002 at approximately $19.2 million. Terms and conditions
remained relatively the same.
Our Property Catastrophe treaty renewed at existing limits of $150.0 million and
retention of $15.0 million. The structure for the property catastrophe
reinsurance program was unchanged from 2003 for the January 1, 2004 renewal,
remaining in five layers and covering: (i) 95% of losses in excess of $15.0
million up to $25.0 million; (ii) 95% of losses in excess of $25.0 million up to
$50.0 million; (iii) 95% of losses in excess of $50.0 million up to $85.0
million; (iv) 83.5% of losses in excess of $85.0 million up to $120.0 million;
(v) 83.5% of losses in excess of $120.0 million up to $165.0 million. Total
coverage under the program is $133.3 million. Terrorism coverage is excluded as
per definition of TRIA, as well as nuclear, biological and chemical losses.
However, these losses are covered under a separate Terrorism Excess of Loss
treaty, which is discussed later in the Casualty Reinsurance section. The
overall program cost for this treaty in 2003 is $6.9 million, compared with $7.1
million in 2002. The $15.0 million retention could be reduced to a minimum
retention of $1.0 million for a New Jersey region catastrophe, due to a
provision under the treaty that provides Selective up to $14.0 million of
benefit from the New Jersey Homeowners 75% Quota Share treaty.
CASUALTY REINSURANCE
The Casualty Excess of Loss treaty, renewed effective July 1, 2003, provides per
occurrence coverage of $47.2 million in excess of the Company's $2.0 million
retention and $0.8 million co-participation in the layer covering $3.0 million
in excess of the $2.0 million retention. This structure is unchanged from 2002.
Effective July 1, 2003, each umbrella policy is covered up to $15.0 million
compared to $10.0 million in 2002 treaty year. The casualty treaty distinguishes
between certified and non-certified terrorism 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 $94.4 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, which is discussed later in this
section, does cover these exposures once our $15.0 million annual aggregate
retention 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.
TERRORISM REINSURANCE
On November 26, 2002 TRIA legislation was signed into law. The program
terminates on December 31, 2005. TRIA requires sharing the risk of future losses
from terrorism between private insurers and the federal government, and is
applicable to almost all commercial lines of insurance. Insurance companies with
direct commercial insurance exposure in the United States of America are
required to participate in the program. In following this legislation, Selective
offers its commercial policyholders an option to purchase terrorism coverage
that will provide protection against a TRIA certified event. An event has to
cause at least $5.0 million in losses to be certified as an act of terrorism.
Each participating insurance company is responsible for paying out a certain
amount in claims - a deductible - before Federal assistance becomes available.
This deductible is based on a percentage of commercial lines direct earned
premiums from the prior calendar year. The deductible equaled or equals: 7% of
2002 commercial lines direct earned premium for the 2003 calendar year, 10% of
33
2003 commercial direct earned premium for 2004 calendar year and 15% of 2004
commercial direct earned premium for 2005 calendar year. For losses above an
insurer's deductible, the federal government will cover 90%, while the insurer
contributes 10%. While the provisions of TRIA will serve to mitigate our
exposure in the event of a large-scale terrorist attack, our deductible is
substantial, approximating $60.0 million in 2003 and $97.0 million in 2004.
Therefore, we continue to monitor concentrations of risk. Effective February 1,
2003 and renewed effective January 1, 2004, Selective has a separate Terrorism
Excess of Loss treaty that covers $45.0 million in the aggregate in excess of a
$15.0 million retention in the aggregate for TRIA, as well as, nuclear,
biological and chemical losses not covered by the Act. Any TRIA, nuclear,
biological and chemical losses incurred within a calendar year that are retained
by the Insurance Subsidiaries under the terms of other reinsurance treaties,
discussed earlier in this section, or specifically excluded from those treaties
count towards the $15.0 million aggregate retention for the terrorism treaty.
The treaty has a 10% return of premium provision if no losses are ceded to the
treaty. The 2004 annual treaty cost decreased 8% compared with 2003. During
2003, we did not incur any terrorism losses, nor did we cede any losses to this
treaty.
OTHER REINSURANCE
Our surety reinsurance program was revised effective January 1, 2004 to more
effectively serve our needs. The Surety Excess of Loss treaty renewal included
an increase in Company retention to $1.0 million in 2004 from $0.8 million in
2003 as well as an increase in premium to an estimated $1.8 million for 2004
from $1.6 million in 2003. The Surety Excess of Loss treaty is structured in two
layers that cover up to $8.0 million per principal/per loss at 90%, with
Selective retaining 10% of the exposure. The Surety 17.5% Quota Share treaty we
had in prior years was cancelled effective January 1, 2004. The Company ceded
$2.5 million in premium and an estimated $1.0 million in losses to the Surety
Quota Share treaty in 2003.
In compliance with New Jersey regulation, the Insurance Subsidiaries ceded
premium and no-fault claims for medical benefits in excess of $75,000 to the New
Jersey Unsatisfied Claim and Judgment Fund (UCJF). Due to change in New Jersey
regulations, the cessions to UCJF will discontinue for policies with effective
dates of January 1, 2004 or later. Claims covered under policies issued or
renewed prior to January 1, 2004 will continue to be paid by the UCJF.
INVESTMENTS
Although lower interest rates have put pressure on investment returns, we still
generated an increase in before-tax investment income to $114.7 million for the
year, compared with $103.1 million for 2002 and $96.8 million in 2001. The
increase reflects an increased asset base as our overall investment portfolio
reached $2.4 billion. This was due to strong operating cash flows of $281.9
million in 2003, compared with $180.1 million in 2002 and $52.7 in 2001, in
addition to our convertible debt offering in 2002 which added $116.0 million in
assets. Our before-tax portfolio yield was 5.1% in 2003 compared with 5.4% in
2002 and 2001.
We continue to maintain a conservative, diversified investment portfolio, with
debt security holdings representing 85% of invested assets. 62% of our debt
securities portfolio is rated "AAA" while the portfolio has an average rating of
"AA," Standard & Poor's second highest credit quality rating. High credit
quality continues to be a cornerstone of our investment strategy, as evidenced
by the fact that 99% of the debt securities are investment grade.
The following table presents the Moody's and Standard & Poor's ratings of our
debt securities portfolio:
Rating 2003 2002
- -----------------------------------------------
Aaa/AAA 62% 59%
Aa/AA 21% 19%
A/A 12% 16%
Baa/BBB 4% 5%
Other 1% 1%
--- ---
Total 100% 100%
=== ===
We emphasize liquidity requirements in response to an unpredictable underwriting
environment and the need to minimize the exposure to catastrophic events. To
provide liquidity while maintaining consistent performance, debt security
maturities are "laddered" so that some issues are always approaching maturity,
thereby providing a source of predictable cash flow. To reduce sensitivity to
interest rate fluctuations, we invest our debt securities portfolio primarily in
intermediate-term securities. The average maturity of the portfolio at December
31, 2003 was 5.5 years compared with 5.3 years at December 31, 2002.
We continue to follow an investment philosophy that has historically proven
successful. The strategy is to purchase debt securities in sectors that
represent the most attractive relative value and maintain a moderate equity
exposure. Managing investment risk by adhering to these strategies is intended
to protect the interests of our stockholders as well as those of our
policyholders and, at the same time, enhance our financial strength and
underwriting capacity.
At December 31, 2003, our investment portfolio included non-investment grade
securities with an amortized cost of $25.2 million, or 1% of the portfolio, and
a fair value of $27.2 million. At December 31, 2002, non-investment grade
securities in
34
our investment portfolio represented less than 1%, with an amortized cost of
$14.7 million and a fair value of $13.3 million. The unrealized loss on these
securities represented 5% of our total unrealized loss at December 31, 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 in 2003
or 2002.
The Company regularly reviews the diversification of the investment portfolio
compared with an investment grade corporate index. At December 31, 2003, 18% of
the market value of our corporate bond and preferred stock portfolios were
represented by investments in banks, some of which were in an unrealized loss
position, compared with 11% in the benchmark corporate index. The average
Moody's rating for the banking portfolio is "A1" with the lowest rated security
at "Baa1" and the average Standard and Poor's rating is "A," with the lowest
rated security at "BBB."
The Company regularly reviews its investment portfolio for declines in value,
focusing attention on securities whose market value is less than 85% of their
cost/amortized cost at the time of review. If we believe a decline in the value
of a particular investment is temporary, we record the decline as an unrealized
loss in accumulated other comprehensive income. If we believe the decline is
"other than temporary," we write down the carrying value of the investment and
record a realized loss in our consolidated statements of income. Our assessment
of a decline in value includes our current judgment as to the financial position
and future prospects of the entity that issued the investment security. Broad
changes in the overall market or interest rate environment generally will not
lead to a write-down. If our judgment about an individual security changes in
the future, we may ultimately record a realized loss after having originally
concluded that the decline in value was temporary, which could have a material
impact on our net income and financial position of future periods. Factors
considered, but not limited to, in evaluating potential impairment of debt
securities include the following:
- Whether the decline appears to be issuer or industry specific;
- The degree to which an issuer is current or in arrears in making
principal and interest payments on the debt securities in question;
- The issuer's current financial condition and its ability to make
future scheduled principal and interest payments on a timely basis;
- Buy/hold/sell recommendations published by outside investment advisors
and analysts; and
- Relevant rating history, analysis and guidance provided by rating
agencies and analysts.
Factors considered, but not limited to, in evaluating potential impairment of
equity securities include the following:
- Whether the decline appears to be issuer or industry specific;
- The relationship of market prices per share to book value per share at
the date of acquisition and date of evaluation;
- The price-earnings ratio at the time of acquisition and date of
evaluation;
- The financial condition and near-term prospects of the issuer,
including any specific events that may influence the issuer's
operations;
- The recent income or loss of the issuer;
- The independent auditors' report on the issuer's recent financial
statements;
- The dividend policy of the issuer at the date of acquisition and the
date of evaluation;
- Any buy/hold/sell recommendations or price projections published by
outside investment advisors; and
- Any rating agency announcements.
REALIZED GAINS AND LOSSES
Realized gains and losses are determined on the basis of the cost of specific
investments sold or written-down, and are credited or charged to income.
Realized losses include impairment charges from investment write-downs for other
than temporary declines of $1.2 million for 2003, $7.1 million for 2002 and $1.4
million for 2001. These securities were written down due to heightened credit
risk that was security specific and would not impact other securities held.
35
The Company realized gains and losses from the sale of available-for-sale debt
and equity securities during 2003, 2002 and 2001. The following table presents
the period of time that securities, sold at a loss during these years, were
continuously in an unrealized loss position prior to sale:
(in millions) 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------------
Fair Fair Fair
Period of time in an Value on Realized Value on Realized Value on Realized
unrealized loss position Sale Date Loss Sale Date Loss Sale Date Loss
-----------------------------------------------------------------------------------
Debt securities:
0 - 6 months $ 48.4 1.2 28.4 5.0 4.7 0.3
7 - 12 months 10.6 0.4 4.9 0.1 - -
Greater than 12 months 8.8 0.7 3.7 1.3 13.6 1.2
-------- --- ---- --- ---- ---
Total debt securities 67.8 2.3 37.0 6.4 18.3 1.5
-------- --- ---- --- ---- ---
Equity Securities:
0 - 6 months 1.5 0.1 - - 3.3 0.7
7 - 12 months - - - - 9.9 3.0
Greater than 12 months 1.7 0.3 - - 1.2 0.8
-------- --- ---- --- ---- ---
Total equity securities 3.2 0.4 - - 14.4 4.5
-------- --- ---- --- ---- ---
Total $ 71.0 2.7 37.0 6.4 32.7 6.0
======== === ==== === ==== ===
These securities were sold despite the fact that they were in a loss position.
The decision to sell these securities was due to: (i) heightened credit risk of
the individual security sold, (ii) the decision to reduce our exposure to
certain issuers, industries or sectors in light of changing economic conditions,
or (iii) tax management purposes.
UNREALIZED LOSSES
The following table summarizes, for all available-for-sale securities in an
unrealized loss position at December 31, 2003 and 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:
(in millions) 2003 2002
- ---------------------------------------------------------------------------------------------------------
Gross Gross
Period of time in unrealized loss Fair Unrealized Fair Unrealized
position Value Loss Value Loss
----------------------------------------------------
Debt securities:
0 - 6 months $ 143.2 2.3 110.8 3.3
7 - 12 months 57.3 1.3 12.9 0.3
Greater than 12 months 5.5 0.1 19.8 3.0
------------------- -------------------
Total debt securities 206.0 3.7 143.5 6.6
------------------- -------------------
Equities:
0 - 6 months 1.5 - 15.6 2.3
7 - 12 months - - 15.9 3.2
Greater than 12 months 17.4 0.3 8.3 2.4
------------------- -------------------
Total equity securities 18.9 0.3 39.8 7.9
------------------- -------------------
Total $ 224.9 4.0 183.3 14.5
=================== ===================
The following table presents information regarding our available-for-sale debt
securities that were in an unrealized loss position at December 31, 2003 by
contractual maturity:
Amortized Fair
(in millions) Cost Value
- -------------------------------------------------------------------------
One year or less $ 13.8 13.7
Due after one year through five years 66.3 65.2
Due after five years through ten years 105.3 103.5
Due after ten years through fifteen years 24.3 23.6
Due after fifteen years - -
------- -----
Total $ 209.7 206.0
======= =====
36
DIVERSIFIED INSURANCE SERVICES
The Diversified Insurance Services businesses create a fee-based source of
revenue that is not dependent on insurance underwriting cycles. These businesses
are not capital intensive and allow us to develop alternate revenue streams in
growing markets. Our Diversified Insurance Services strategy focuses on
businesses that provide synergy with our insurance agency force and create new
opportunities for agents to bring value added services and products to their
customers. The Diversified Insurance Services operations include three core
functions: human resource administration outsourcing (HR outsourcing), managed
care and flood insurance. These businesses fit into our business model in one of
two ways: complementary (they share a common marketing or distribution system)
or vertically (one company uses the other's products or services in its own
product or supply output). The flood and HR outsourcing products are sold
through our independent agent distribution channel, while our managed care
businesses provide a service used by our claims operation, as well as by other
insurance carriers. We measure the performance of these companies based on
several measures, including, but not limited to, results of operations in
accordance with GAAP.
FOR THE YEAR ENDED DECEMBER 31,
($ in thousands) 2003 2002 2001
- -----------------------------------------------------------------------------------------------------
HR OUTSOURCING
Net revenue $ 44,096 38,127 34,352
Pre-tax (loss) (379) (1,397) (6,599)
MANAGED CARE
Net revenue 22,061 22,525 19,088
Pre-tax profit 3,151 3,010 3,686
FLOOD INSURANCE
Net revenue 23,630 18,317 14,571
Pre-tax profit 6,094 3,863 2,093
OTHER
Net revenue 2,053 1,827 1,615
Pre-tax profit 357 438 393
TOTAL
Net revenue 91,840 80,796 69,626
Pre-tax profit (loss) 9,223 5,914 (427)
After-tax profit (loss) 6,160 4,051 (201)
After-tax return on net revenue 6.7% 5.0% (0.3)%
The continuing operations of Diversified Insurance Services generated $91.8
million of net revenue and $6.2 million of net income for 2003, compared with
$80.8 million of net revenue and $4.1 million of net income for 2002 and $69.6
million of net revenue and $0.2 million of net loss for 2001. The segment's
return on net revenue increased to 6.7% for 2003, compared with 5.0% for 2002
and (0.3)% for 2001. Operating cash flow from the segment was $10.5 million in
2003, $16.3 million in 2002 and $3.6 million in 2001.
HUMAN RESOURCE OUTSOURCING
Our HR outsourcing company, Selective HR Solutions, Inc., provides human
resource administration, including benefits, payroll and employee management
services, and risk and compliance management products and services, including
workers' compensation insurance. HR outsourcing, by the nature of its product
package, provides a high level of day-to-day services to its customers, which we
believe will be attractive to small business owners, who can be accessed through
existing relationships with our independent agents. Under certain product
offerings the company enters into a co-employment relationship with its clients
and as such assumes the obligations to pay the salaries, wages and related
benefit costs, and payroll taxes of its clients' worksite employees. For
additional information regarding the risks associated with this business, refer
to the "Risk Factors" section of Item 1. "Business" on page 24.
HR outsourcing net revenues increased 16% to $44.1 million for 2003, compared
with $38.1 million for 2002 and $34.4 million for 2001. Net loss decreased to
$0.1 million for 2003, compared with $0.7 million for 2002 and $4.2 million for
2001. Although the ramp-up time to sell this product has been longer than we
originally anticipated, we are finding increasing support among our agency force
for the value-added benefit that HR outsourcing brings to their clients. For
2003, workers' compensation prices were up more than 8% compared with 5% in
2002, while client administration prices rose about 5% compared with 8% in 2002.
This stronger pricing is a direct result of our pricing initiatives, which began
in 2002, and we expect it to continue to drive further gains into 2004. In
addition, cost reduction initiatives that have taken place since 2001 have led
to the steadily improving results.
37
MANAGED CARE
Our managed care company, CHN Solutions, provides workers' compensation and
automobile medical claim services, third party administrative services and
discounted access to the largest membership based medical provider network in
New Jersey while bearing no underwriting risks. Although there is no
underwriting risk associated with this business, there is the risk that the
unionization of medical providers could impact our ability to maintain and grow
our networks, negotiate fee discount arrangements and lease networks to our
customers. For additional information regarding the risks associated with this
business, refer to the "Risk Factors" section of Item 1. "Business" on page 24.
During 2003, our medical provider network expanded to just over 88,000 locations
from 83,000 locations in 2002 and 60,000 locations in 2001. Managed care net
revenues decreased to $22.1 million for 2003, compared with $22.5 million for
2002 and $19.1 million for 2001. Net income remained flat at $2.0 million in
2003 compared with 2002, but down from $2.4 million in 2001.. The decrease in
net revenue during 2003 was attributable to aggressive competition from several
major competitors in New Jersey, as well as our pricing strategy that led to the
loss of several large clients. Further impacting net income were increased costs
related to litigation, including a purported class action lawsuit. For
information regarding this lawsuit, see Item 3. "Legal Proceedings" and Item 8.
"Financial Statements and Supplementary Data," Note 18(e) to the consolidated
financial statements. Lower revenue and increased litigation costs were offset
by significant reductions in operating expenses from the consolidation of two
offices as well as lower labor costs from staff reductions. Increases in net
revenues during 2002 as compared with 2001 were the result of network and client
expansion, largely attributable to the acquisition of NHD, a 16,000-location
network that operates in Connecticut and certain regions within the states of
Massachusetts, Vermont, and New Hampshire. Increased legal expenses and benefit
costs tempered growth in 2002 as compared with 2001.
FLOOD INSURANCE
Selective is a servicing carrier for the federal government's National Flood
Insurance Program. Through this program, Selective is able to provide a market
for flood insurance to over 5,700 agents across the country. As a servicing
carrier, Selective bears no risk of policyholder loss since the program is fully
reinsured by the federal government. Currently, Selective is servicing more than
162,000 flood policies under this program, compared with 135,000 in 2002 and
115,000 in 2001. Premium growth combined with claim administrative servicing
fees related to Hurricane Isabel claims resulted in an overall increase in net
revenues in 2003 of 29% to $23.6 million, compared with $18.3 million for 2002
and $14.6 million for 2001. This increase in net revenues resulted in a
corresponding increase in net income to $4.0 million for 2003, compared with
$2.5 million for 2002 and $1.4 million for 2001.
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), which had
historically been reported as part of the Diversified Insurance Services
segment. This divestiture plan was completed in May 2002 when the Company sold
all of the issued and outstanding shares of capital stock of PDA as well as
certain software applications developed by PDA at a net gain of $0.5 million. In
addition, the Company recovered $5.0 million of capitalized software development
costs, see Item 8. "Financial Statements and Supplementary Data," Note 13 to the
consolidated financial statements.
FEDERAL INCOME TAXES
Our total federal income tax expense increased $10.8 million in 2003 to $21.6
million, compared with $10.8 million in 2002 and $(2.6) million in 2001. These
amounts reflect an effective tax rate of 24.6% for 2003, compared with 20.4% in
2002, and (11.1)% in 2001. The increase was attributable to improved
underwriting results, increased capital gains on investment sales and higher
levels of taxable investment income. The benefit in 2001 is reflective of
underwriting losses and higher levels of tax-exempt income in that year. Our
effective tax rate differs from the federal corporate tax rate of 35% primarily
as a result of tax-exempt investment income and the dividends received
deduction.
38
The Company has a net deferred tax liability of $12.7 million at December 31,
2003, compared with a net deferred tax asset of $8.7 million at December 31,
2002. The application of Alternative Minimum Tax (AMT) credits against regular
tax in the current year, as well as increases in unrealized gains on the
available-for-sale investment portfolio, deferred policy acquisition costs, and
accelerated depreciation partially offset by the increase in the discount on
loss and LAE reserves and increased unearned premium reserves led to this
change. The following table presents the Company's taxable income (loss),
pre-tax financial statement income, and net deferred tax (liability) asset:
(in millions) 2003 2002 2001
- --------------------------------------------------------------------------------------------------
Current taxable income (loss), from continuing
operations $ 78.8 42.9 (17.5)
Pre-tax financial statement income 88.0 52.9 23.7
Net deferred tax (liability) asset (12.7) 8.7 9.4
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We have identified the policies described below as critical to our business
operations and the understanding of our results of operations. For additional
discussion on the application of these and other accounting policies, see Item
8. "Financial Statements and Supplementary Data," Note 2 to the consolidated
financial statements. Our preparation of the consolidated financial statements
requires us to make estimates and assumptions that affect the reported amount of
assets and liabilities, disclosure of contingent assets and liabilities at the
date of our consolidated financial statements, and the reported amounts of
revenue and expenses during the reporting period. There can be no assurance that
actual results will not differ from those estimates.
RESERVES FOR LOSSES AND LOSS EXPENSES
Significant periods of time can elapse between the occurrence of an insured
loss, the reporting of the loss to the insurer and the insurer's payment of that
loss. To recognize liabilities for unpaid losses and loss expenses, insurers
establish reserves as balance sheet liabilities representing estimates of
amounts needed to pay reported and unreported net losses and loss expenses. As
of December 31, 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
is carried as the IBNR reserve. By using both estimates of reported claims and
IBNR determined using generally accepted actuarial reserving techniques, we
estimate the ultimate net liability for losses and loss expenses. We have
established a range of reasonably possible IBNR losses for non-environmental net
claims of approximately $661.5 million to $818.4 million at December 31, 2003
and of approximately $531.7 million to $674.6 million at December 31, 2002. A
low and high reasonable IBNR selection was derived primarily by considering the
range of indications calculated using generally accepted actuarial techniques.
Such techniques assume that past experience, adjusted for the effects of current
developments and anticipated trends, are an appropriate basis for predicting
future events. Our net carried IBNR reserves for non-environmental claims,
including loss expense reserves, were $733.7 million at December 31, 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. Beginning in 2003, we are using independent actuaries to
certify the adequacy of our reserves. When reviewing reserves, we analyze
historical data and estimate the impact of various factors such as: (i) per
claim information; (ii) Company and industry historical loss experience; (iii)
legislative enactments, judicial decisions, legal developments in the imposition
of damages, and changes in political attitudes; and (iv) trends in general
economic conditions, including the effects of inflation. This process assumes
that past experience, adjusted for the effects of current developments and
anticipated trends, is an appropriate basis for
39
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 our reserves 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 our
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.
The table below summarizes the number of asbestos and non-asbestos claims
outstanding at December 31, 2003, 2002 and 2001. For additional information
about our environmental reserves, see Item 1. "Business," page 13 and Item 8.
"Financial Statements and Supplementary Data," Note 18(a) to the consolidated
financial statements.
Environmental Claims Activity 2003 2002 2001
- ----------------------------------------------------------------------------------------------------------------
ASBESTOS RELATED CLAIMS (1)
Claims at beginning of year 2,346 2,038 1,868
Claims received during year 720 725 606
Claims closed during year(2) (294) (417) (436)
-------- ------ ------
Claims at end of year 2,772 2,346 2,038
======== ====== ======
Average net loss settlement on closed claims $ 548 344 449
Amount paid to administer claims $ 419 230 123
Net survival ratio (3) 17 15 17
NON-ASBESTOS RELATED CLAIMS (1)
Claims at beginning of year 247 240 212
Claims received during year 133 105 138
Claims closed during year(2) (94) (98) (110)
-------- ------ ------
Claims at end of year 286 247 240
======== ====== ======
Average net loss settlement on closed claims $ 7,900 16,609 14,827
Amount paid to administer claims $ 723 851 907
Net survival ratio (3) 9 10 10
(1) The number of environmental claims presented in the tables includes all
multiple claimants who are associated with the same site or incident.
(2) Includes claims dismissed, settled, or otherwise resolved.
(3) The net survival ratio was calculated utilizing a three-year average for
net losses and expenses paid.
Of the 2,772 asbestos related claims, 1,627 involve four insureds. The case
reserves associated with these four insureds amounted to $3.9 million on a net
and gross basis as of December 31, 2003. About 70 environmental claims involve
approximately 13 landfill sites. The landfill sites account for case reserves of
$16.3 million on a gross basis and $16.1 million on a net basis. The remaining
claims, which account for $7.5 million of case reserves on a gross basis and
$6.7 million on a net basis, involve leaking underground storage tanks and other
latent environmental exposures. The overall net survival ratio for asbestos and
non-asbestos related claims was 10 years for 2003 and 11 years for 2002 and
2001.
After taking into account all relevant factors, we believe that the reserve for
net losses and loss expenses at December 31, 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
40
premiums written have a coverage period of twelve months. This means we record
1/12 of the net premiums written as earned premium each month, until the full
amount is recognized. When premium rates increase, the effect of those increases
do not immediately affect earned premium. Rather, those increases are recognized
ratably over the period of coverage. Unearned premiums and prepaid reinsurance
premiums, which are recorded on the consolidated balance sheets, represent that
portion of premiums written that are applicable to the unexpired terms of
policies in force.
DEFERRED POLICY ACQUISITION COSTS
Policy acquisition costs, which include commissions, premium taxes, fees, and
certain other costs of underwriting policies, are deferred and amortized over
the same period in which the related premiums are earned. Deferred policy
acquisition costs are limited to the estimated amounts recoverable after
providing for losses and loss expenses that are expected to be incurred, based
upon historical and current experience. Anticipated investment income is
considered in determining whether a premium deficiency exists. The methods of
making such estimates and establishing the deferred costs are continually
reviewed by the Company, and any adjustments therefrom are made in the
accounting period in which the adjustment arose.
PENDING ADOPTION OF AN ACCOUNTING PRONOUNCEMENT
In January 2003, the FASB issued FASB Interpretation No. 46, Consolidation of
Variable Interest Entities, an Interpretation of Accounting Research Bulletin
No. 51 ("the Interpretation"). The Interpretation was originally effective for
public companies at the beginning of fiscal periods beginning after June 15,
2003. In October 2003, the FASB agreed to defer the effective date of the
Interpretation to the end of fiscal periods ending after December 15, 2003. In
December 2003, the FASB further deferred the effective date of the
Interpretation to the end of fiscal periods ending after March 15, 2004, for
potential variable interest entities other than those commonly referred to as
special-purpose entities. Since the Company has no entities commonly referred to
as special-purpose entities, we will adopt the Interpretation as of March 31,
2004. The Company does not believe the adoption of the Interpretation will have
a material impact on its results of operations or financial condition.
PENSION AND POSTRETIREMENT BENEFIT PLAN ACTUARIAL ASSUMPTIONS
The Company's pension benefit and postretirement life benefit obligations and
related costs are calculated using actuarial concepts, within the framework of
Statement of Financial Accounting Standards No. 87 Employers' Accounting for
Pensions (SFAS 87) and Statement of Financial Accounting Standards No. 106,
Employers' Accounting for Postretirement Benefit Other than Pension (SFAS 106),
respectively. Two key assumptions, the discount rate and the expected return on
plan assets, are important elements of expense and/or liability measurement. We
evaluate these key assumptions annually. Other assumptions involve demographic
factors such as retirement age, mortality, turnover and rate of compensation
increases.
The discount rate enables us to state expected future cash flow as a present
value on the measurement date. The guideline for setting this rate is a
high-quality long-term corporate bond rate. A lower discount rate increases the
present value of benefit obligations and increases pension expense. We reduced
our discount rate to 6.75% in 2003 from 7.25% in 2002 to reflect market interest
rate conditions. We have further reduced our discount rate to 6.25% for 2004.
To determine the expected long-term rate of return on the plan assets, we
consider the current and expected asset allocation, as well as historical and
expected returns on each plan asset class. A lower expected rate of return on
pension plan assets will increase pension expense. Our long-term expected return
on plan assets was 8.25% in 2003 and 8.50% in 2002.
Changes in the related pension and post-retirement benefit expense may occur in
the future due to changes in these assumptions.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Selective Insurance Group, Inc., (Parent) is a holding company whose principal
assets are its investments in its subsidiaries. The Parent's primary means of
meeting its liquidity requirements is through dividends from these subsidiaries.
The payment of dividends from the Insurance Subsidiaries is governed by state
regulatory requirements, and these dividends are generally payable only from
earned surplus as reported in our statutory Annual Statements as of the
preceding December 31. Based upon the 2003 unaudited statutory financial
statements, the Insurance Subsidiaries are permitted to pay the Parent in 2004
ordinary dividends in the aggregate amount of approximately $64.0 million. There
can be no assurance that the Insurance Subsidiaries will be able to pay
dividends to the Parent in the future in an amount sufficient to enable the
Parent to meet its liquidity requirements. For additional information regarding
regulatory limitations on the payment of dividends by the Insurance Subsidiaries
to the Parent and amounts available for the payment of such dividends, see Item
8. "Financial Statements and Supplementary Data," Note 8 to the consolidated
financial statements.
The payment of dividends from Diversified Insurance Services subsidiaries are
restricted only by the available operating cash flows of those subsidiaries.
Growth in the Diversified Insurance Services segment has augmented consolidated
cash flows from operations by generating $10.5 million in 2003, compared with
$16.3 million in 2002 and $3.6 million in 2001. The
41
operating cash flows from the Diversified Insurance Services segment, which are
only restricted by ongoing operational needs of those businesses, resulted in
dividends to the Parent of $8.9 million in 2003 with no dividends being made in
2002, and $5.0 million in 2001.
The Parent also generates cash from the sale of its common stock under various
stock plans, the dividend reinvestment program, and from investment income, all
of which approximated $10.0 million and reduced the Parent's annual cash
requirements from $33.1 million to $23.1 million.
The Parent's cash requirements include principal and interest payments on the
senior convertible notes, various notes payable and convertible subordinated
debentures, dividends to stockholders and general operating expenses. As
indicated in the table on page 43, the Company has contractual obligations
pursuant to various notes payable of $24.0 million in 2004. As part of our
senior convertible note issuance in 2002, the Company established an irrevocable
trust in the approximate amount of $72.0 million. As of December 2003,
approximately $53.0 million remains in the trust to provide funds for the notes
with maturities in the next two years. The 2002 convertible note issuance has a
contingent conversion feature that allows conversion of the notes when the stock
price has maintained a 20% premium to the conversion price of $29.29, or $35.15,
for 20 of 30 consecutive trading days ending on the last trading day of the
previous calendar quarter. On any business day in the following calendar
quarter, the holders may surrender notes for conversion into shares of common
stock, or cash at the Company's option. If this trigger is met, it will add 3.9
million shares to our diluted earnings per share calculation. See Item 8.
"Financial Statements and Supplementary Data," Note 7(a) to the consolidated
financial statements for additional information on our senior convertible notes.
The Company also continually reviews its financial debt agreements for any
potential rating triggers that could dictate a significant change in terms of
the agreements if the Company's credit rating were to suddenly and drastically
change. The principal agencies that issue financial strength ratings for the
property and casualty industry are: A.M. Best Company (A.M. Best), Standard &
Poor's Rating Services (S&P), Moody's Investor Service (Moody's) and Fitch
Ratings Service (Fitch). We believe our ability to write business is most
influenced by our rating from A.M. Best. We are currently rated "A+" (Superior)
by A.M. Best, which is their second highest of fifteen ratings. A significant
downgrade from A.M. Best, could materially adversely affect the business we
write. We believe that ratings from S&P, Moody's or Fitch, although important,
have less of an impact on our business. A rating downgrade to below "A-" in its
A.M. Best or S&P rating would be considered an event of default under the terms
of the Company's line of credit agreements. The Company had no outstanding
borrowings on these lines at December 31, 2003 or 2002.
Dividends to stockholders are declared and paid at the discretion of the Board
of Directors based upon the Company's operating results, financial condition,
capital requirements, contractual restrictions and other relevant factors. The
Parent has paid regular quarterly cash dividends to its stockholders for 75
consecutive years, including a $0.02 increase per share in the fourth quarter of
2003, to $0.17 per share, and currently plans to continue to pay quarterly cash
dividends. For information regarding restrictions on the Parent's ability to pay
dividends to its stockholders, see Item 8. "Financial Statements and
Supplementary Data," Note 7(b) to the consolidated financial statements.
On November 4, 2003, the Board of Directors authorized a 2.5 million share stock
repurchase program scheduled to expire on November 30, 2005. This program
replaces the previous program that expired on May 31, 2003. No shares were
repurchased under the current program and 7.3 million shares at an aggregate
cost of $140.5 million were repurchased under the expired program.
In addition to the cash requirements of the Parent, our operating obligations
and cash outflows include: claim settlements; commissions; labor costs; premium
taxes; general and administrative expenses; investment purchases; and capital
expenditures. The Insurance Subsidiaries also have additional investment
commitments for their limited partnership investments of up to $32.4 million;
however, there is no certainty that any additional investment will be required.
The Insurance Subsidiaries satisfy their obligations and cash outflows through
premium collections, interest and dividend income and maturities of investments.
Financial instruments that could potentially subject the Company to
concentration of credit risk include accounts receivable associated with our HR
Outsourcing subsidiary, which acts as a co-employer with certain clients. As a
co-employer, we contractually assume substantial employer rights,
responsibilities and risks of our clients' employees, who are considered
co-employees. Co-employer payroll and related service fees that were earned, but
unpaid, were $15.5 million as of December 31, 2003 and $12.2 million as of
December 31, 2002. Certain states, in which we conduct this business, limit a
co-employer's liability for earned payroll to minimum wage. This would reduce
the Company's potential liability for accrued co-employer payroll. In the event
that a client does not pay their related payroll and service fees prior to the
applicable payroll date, the Company has the right to cancel the co-employer
contract or, at its option, require letters of credit or other collateral. As of
December 31, 2003, the maximum exposure to any one account for earned, but
unpaid, payroll is approximately $1.2 million.
42
The Insurance Subsidiaries and HR outsourcing operation are also subject to
geographic concentration. Approximately 39% of our net premiums written are for
insurance policies written in New Jersey, while 39% of our HR outsourcing
co-employer client payroll is within the state of Florida. Other east coast
states, including Connecticut, Delaware, Georgia, Maryland, New York, North
Carolina, Pennsylvania, Rhode Island, South Carolina, Virginia and several
midwestern states, including Illinois, Indiana, Iowa, Kentucky, Michigan,
Minnesota, Missouri, Ohio and Wisconsin, account for substantially all of our
other business. Consequently, changes to economic or regulatory conditions in
these states could adversely affect the Company.
Cash provided by operating activities amounted to $281.9 million in 2003, $180.1
million in 2002, and $52.7 million in 2001. This increase in 2003 is a result
of: i) a 16% increase in net premiums written and improved underwriting
profitability, driven by rate increases in renewal premiums; and ii) increased
investment income from a larger investment portfolio.
Since cash inflow from premiums is received in advance of cash outflow required
to settle claims, we accumulate funds that we invest. At December 31, 2003, we
had $2.4 billion in investments compared with $2.1 billion in 2002, as a result
of the aforementioned increased operating cash flow. Our investment program is
structured with staggered maturities so that liquidation of available-for-sale
debt securities should not be necessary in the ordinary course of business.
Total assets increased 13%, or $408.9 million, to $3.4 billion at December 31,
2003 from December 31, 2002. Invested assets increased $311.1 million primarily
due to net purchases of $259.3 million funded by $281.9 million of operating
cash flow and a $50.8 million increase in net unrealized gains on the portfolio.
Increased premium volume drove increases in premiums receivable of $53.7 million
and deferred policy acquisition costs of $24.2 million. Reinsurance recoverable
on unpaid losses and loss expenses increased $24.2 million due to: (i) $11.1
million of flood reserves from Hurricane Isabel, which we 100% cede to the
federal government's National Flood Insurance Program, (ii) a $5.9 million
increase in ceded claims with the New Jersey Unsatisfied Claim and Judgment Fund
and (iii) growth in policy count and exposures.
Total liabilities increased 13%, or $311.3 million, to $2.7 billion at December
31, 2003 from December 31, 2002. Loss and loss expense reserves increased $184.4
million as a result of growth in policy count and exposure and adverse loss
development of approximately $15.0 million. Increased premium volume resulted in
higher unearned premium reserves of $92.8 million. Notes payable decreased $24.0
million due to a scheduled payment made in May 2003 on the 8.63% Senior Notes of
$6.0 million and a scheduled payment made in August 2003 on the 8.77% Senior
Notes of $18.0 million. Deferred federal income tax liability increased $21.4
million to a payable of $12.7 million at December 31, 2003 from a receivable of
$8.7 million at December 31, 2002 primarily due to the increase in unrealized
gains in the debt and equity portfolios. Commissions payable increased to $53.7
million at December 31, 2003 compared with $37.5 million at December 31, 2002.
This increase is attributable to improved underwriting profitability, which
generated $24.6 million in agent profit sharing commissions compared with $16.5
million last year, as well as increased premium-based commission amounts due to
higher premium levels. Accrued salaries and benefits increased $12.0 million
resulting from the rising costs of employee benefits as well as the increase in
incentive-based employee profit sharing of $5.5 million.
OFF-BALANCE SHEET ARRANGEMENTS, CONTRACTUAL OBLIGATIONS AND CONTINGENT
LIABILITIES AND COMMITMENTS
At December 31, 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 as of December 31, 2003
are summarized below:
Contractual obligations
- ----------------------------------------------------------------------------------------------------------
Less than 1-3 3-5 After 5
(in millions) Total 1 year years years years
- ----------------------------------------------------------------------------------------------------------
Operating leases $ 23.9 7.1 10.5 4.7 1.6
Senior convertible notes 305.0 - - - 305.0
Convertible subordinated debentures 1.2 - - 1.2 -
Notes payable 121.5 24.0 42.3 30.6 24.6
------- ---- ---- ---- -----
Total $ 451.6 31.1 52.8 36.5 331.2
======= ==== ==== ==== =====
The senior convertible notes have a contingent conversion feature that allows
conversion of the notes when the stock price has maintained a 20% premium to the
conversion price of $29.29, or $35.15, for 20 of 30 consecutive trading days
ending on
43
the last trading day of such calendar quarter. On any business day in the
following calendar quarter, the holders may surrender notes for conversion into
shares of common stock, or cash at the Company's option. If this trigger is met,
it will add 3.9 million shares to our diluted earnings per share calculation. We
expect to have the capacity to repay and/or refinance all of these obligations
as they come due.
We currently have available revolving lines of credit amounting to $45.0
million, under which no balances are outstanding as of either December 31, 2003
or 2002. See Item 8. "Financial Statements and Supplementary Data," Note 7(d) to
the consolidated financial statements for more information. We have issued no
guarantees on behalf of others and have no trading activities involving
non-exchange traded contracts accounted for at fair value. We have no material
transactions with related parties other than those disclosed in Item 8.
"Financial Statements and Supplementary Data," Note 17 to the consolidated
financial statements.
AUDIT COMMITTEE APPROVAL OF NON-AUDIT SERVICES
Information required in accordance with Section 10A(i)(2) of the Securities
Exchange Act of 1934, as amended, as added by Section 202 of the Sarbanes-Oxley
Act of 2002, regarding non-audit services is included in the Company's Proxy
Statement for the 2004 Annual Meeting of Stockholders, which is incorporated
herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of potential loss in fair value arising from adverse
fluctuations in interest rates, market rates and prices, foreign currency
exchange rates, and other relevant market rate or price changes. The following
is a discussion of the Company's primary market risk exposures and how they were
being managed as of December 31, 2003. Our market risk sensitive instruments are
for other than trading purposes.
Our investment policy is constructed with the long-term objective of maximizing
after-tax returns while providing liquidity and preserving assets and
stockholders' equity. The current investment mix is 85% debt securities, 12%
equity securities, 1% short-term investments and 2% other investments. We have
no direct exposure to commodity risk and minimal exposure to foreign exchange
risk.
To reduce the sensitivity of interest rate fluctuations, we invest our debt
securities portfolio primarily in intermediate-term securities. At December 31,
2003, 94% of the portfolio was ten years or less to maturity, with the average
maturity of 5.5 years. Based on our fixed income asset allocation and security
selection process, we believe that our fixed income bond portfolio is not highly
prone to prepayment risk. In general, the market value of the bond portfolio
rises more from a downward move in interest rates than the market value declines
from an equal upward move in interest rates.
Our portfolio of marketable equity securities is exposed to equity price risk
arising from potential volatility in equity market prices. We attempt to
minimize the exposure to equity price risk by maintaining a diversified
portfolio limiting concentrations in any one company or industry.
For the overall investment portfolio, there were no significant changes in our
primary market risk exposures or in how those exposures are managed compared
with the year ended December 31, 2002. We do not currently anticipate
significant changes in our primary market risk exposures or in how those
exposures are managed in future reporting periods based upon what is known or
expected to be in effect in future reporting periods.
We utilize sensitivity analysis to measure the potential loss in future
earnings, fair values or cash flows of market sensitive instruments. The
sensitivity analysis hypothetically assumes: (i) a parallel 200 basis point
shift in interest rates up and down in 100 basis point increments; and (ii) a
20% change in equity prices up and down in 10% increments at December 31, 2003
and 2002.
In the analysis, we include investments in debt securities and investments in
equity securities. The primary market risk to the Company's market sensitive
instruments is interest rate risk and equity price risk.
This analysis is not intended to provide a precise forecast of the effect of
changes in market interest rates and equity prices on our income or
stockholders' equity. Further, the calculations do not take into account any
actions we may take in response to market fluctuations.
44
The following table presents the sensitivity analysis of each component of
market risk as of December 31, 2003 and 2002:
2003
INTEREST RATE SHIFT IN BASIS POINTS
--------------------------------------------------------------------
($ IN MILLIONS) -200 -100 0 100 200
- ---------------------------------------------------------------------------------------------------------------
MARKET VALUE OF DEBT
SECURITY PORTFOLIO 2,273.5 2,176.7 2,085.5 2,005.0 1,925.1
MARKET VALUE CHANGE FROM BASE (%) 9.0% 4.4% 0.0% (3.9)% (7.7)%
2002
Interest Rate Shift in Basis Points
--------------------------------------------------------------------
-200 -100 0 100 200
- ---------------------------------------------------------------------------------------------------------------
Market value of debt
security portfolio $2,057.7 $1,968.6 $1,886.8 $1,806.5 $1,724.2
Market value change from base (%) 9.1% 4.3% 0.0% (4.3)% (8.6)%
2003
CHANGE IN EQUITY VALUES IN PERCENT
--------------------------------------------------------------------
-20% -10% 0% 10% 20%
- ---------------------------------------------------------------------------------------------------------------
MARKET VALUE OF EQUITY PORTFOLIO 237.2 266.9 296.6 326.2 355.9
2002
Change in Equity Values in Percent
--------------------------------------------------------------------
-20% -10% 0% 10% 20%
- ---------------------------------------------------------------------------------------------------------------
Market value of equity portfolio $157.5 $177.2 $196.9 $216.6 $236.3
45
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Consolidated Balance Sheets
December 31,
(in thousands, except share amounts) 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
ASSETS
INVESTMENTS:
Debt securities, held-to-maturity - at amortized cost
(fair value: $75,478-2003; $114,785-2002) $ 72,321 109,318
Debt securities, available-for-sale - at fair value
(amortized cost: $1,914,635-2003; $1,671,347-2002) 2,010,064 1,772,061
Equity securities, available-for-sale - at fair value
(cost of: $163,602-2003; $120,036-2002) 296,561 196,913
Short-term investments - (at cost which approximates fair value) 23,043 24,700
Other investments 35,655 23,559
-------------- ---------
Total investments (Note 3) 2,437,644 2,126,551
Cash 12 2,228
Interest and dividends due or accrued 24,001 22,689
Premiums receivable, net of allowance for uncollectible
accounts of: $3,121-2003; $2,814-2002 407,633 353,935
Other trade receivables, net of allowance for uncollectible
accounts of: $1,085-2003; $867-2002 21,567 19,769
Reinsurance recoverable on paid losses and loss expenses 7,726 9,675
Reinsurance recoverable on unpaid losses and loss expenses (Note 5) 184,611 160,374
Prepaid reinsurance premiums (Note 5) 52,817 46,141
Deferred federal income tax (Note 12) - 8,707
Real estate, furniture, equipment, and software development - at cost,
net of accumulated depreciation and amortization of:
$79,199-2003; $70,628-2002 53,317 52,424
Deferred policy acquisition costs (Note 2j) 172,386 148,158
Goodwill (Note 2k) 43,612 42,808
Other assets 33,456 36,388
-------------- ---------
Total assets $ 3,438,782 3,029,847
============== =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Reserve for losses (Note 6) $ 1,400,770 1,232,322
Reserve for loss expenses (Note 6) 187,043 171,103
Unearned premiums 649,906 557,141
Senior convertible notes (Note 7) 115,937 115,937
Notes payable (Note 7) 121,500 145,500
Current federal income tax 7,961 2,565
Deferred federal income tax 12,677 -
Commissions payable 53,717 37,545
Accrued salaries and benefits 56,942 44,894
Other liabilities 82,545 70,738
-------------- ---------
Total liabilities 2,688,998 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: 41,567,552-2003; 40,780,950-2002 83,135 81,562
Additional paid-in capital 113,283 95,435
Retained earnings 612,208 562,553
Accumulated other comprehensive income 148,452 115,434
Treasury stock - at cost (shares: 14,284,612-2003; 14,185,020-2002) (197,792) (195,295)
Unearned stock compensation and notes receivable from stock sales (9,502) (7,587)
-------------- ---------
Total stockholders' equity (Notes 8 and 9) 749,784 652,102
Commitments and contingencies (Notes 5 and 18)
Total liabilities and stockholders' equity $ 3,438,782 3,029,847
============== =========
See accompanying notes to consolidated financial statements.
46
Consolidated Statements of Income
Years ended December 31,
(in thousands, except per share amounts) 2003 2002 2001
- ----------------------------------------------------------------------------------------------------------------------
Revenues:
Net premiums written $ 1,219,159 1,053,487 925,420
Net (increase) in unearned premiums and prepaid
reinsurance premiums (86,089) (65,219) (42,372)
------------ --------- ---------
Net premiums earned 1,133,070 988,268 883,048
Net investment income earned 114,748 103,067 96,767
Net realized gains 12,842 3,294 6,816
Diversified insurance services revenue 91,840 80,796 69,626
Other income 3,616 3,525 2,763
------------ --------- ---------
Total revenues 1,356,116 1,178,950 1,059,020
------------ --------- ---------
Expenses:
Losses incurred 675,506 609,048 567,778
Loss expenses incurred 123,124 105,532 88,106
Policy acquisition costs 356,050 307,505 277,897
Dividends to policyholders 5,054 5,762 8,275
Interest expense 17,148 15,093 14,526
Diversified insurance services expenses 82,617 74,882 70,053
Other expenses 8,637 8,221 8,687
------------ --------- ---------
Total expenses 1,268,136 1,126,043 1,035,322
------------ --------- ---------
Income from continuing operations,
before federal income tax 87,980 52,907 23,698
============ ========= =========
Federal income tax expense (benefit)
Current 17,756 19,841 (1,874)
Deferred 3,880 (9,072) (746)
------------ --------- ---------
Total federal income tax expense (benefit) 21,636 10,769 (2,620)
------------ --------- ---------
Loss from discontinued operations, net of tax:
$(377)-2002; $(234)-2001 - (708) (625)
Gain on disposition of discontinued operations,
net of tax: $290-2002 - 539 -
------------ --------- ---------
Total discontinued operations, net of tax - (169) (625)
------------ --------- ---------
Net income $ 66,344 41,969 25,693
============ ========= =========
Earnings per share:
Basic net income from continuing operations $ 2.54 1.67 1.07
Basic net loss from discontinued operations - (0.01) (0.02)
------------ --------- ---------
Basic net income $ 2.54 1.66 1.05
============ ========= =========
Diluted net income from continuing operations $ 2.40 1.57 1.00
Diluted net loss from discontinued operations - (0.01) (0.02)
------------ --------- ---------
Diluted net income $ 2.40 1.56 0.98
============ ========= =========
Dividends to stockholders $ 0.62 0.60 0.60
See accompanying notes to consolidated financial statements.
47
Consolidated Statements of Stockholders' Equity
Years ended December 31,
(in thousands, except per share amounts) 2003 2002 2001
- ------------------------------------------------------------------------------------------------------------
Common stock:
Beginning of year $ 81,562 79,177 77,568
Dividend reinvestment plan
(shares: 43,882-2003; 46,353-2002;
47,672-2001) 88 93 95
Convertible subordinated debentures
(shares: 20,758-2003; 347,312-2002;
8,190-2001) 41 695 16
Stock purchase and compensation plans
(shares: 721,962-2003; 798,539-2002;
749,142-2001) 1,444 1,597 1,498
---------- -------- --------
End of year 83,135 81,562 79,177
---------- -------- --------
Additional paid-in capital:
Beginning of year 95,435 77,126 63,074
Dividend reinvestment plan 1,107 1,049 1,043
Convertible subordinated debentures 109 1,747 41
Stock purchase and compensation plans 16,632 15,513 12,968
---------- -------- --------
End of year 113,283 95,435 77,126
---------- -------- --------
Retained earnings:
Beginning of year 562,553 536,188 525,669
Net income 66,344 66,344 41,969 41,969 25,693 25,693
Cash dividends to stockholders
($0.62 per share-2003; $0.60 per share
2002; $0.60 per share-2001) (16,689) (15,604) (15,174)
---------- -------- --------
End of year 612,208 562,553 536,188
---------- -------- --------
Accumulated other comprehensive income:
Beginning of year 115,434 98,037 99,325
Other comprehensive income (loss),
increase (decrease) in net unrealized
gains on available-for-sale securities, net
of deferred income tax effect 33,018 33,018 17,397 17,397 (1,288) (1,288)
---------- ------ -------- ------ -------- ------
End of year 148,452 115,434 98,037
---------- -------- --------
Comprehensive income 99,362 59,366 24,405
====== ====== ======
Treasury stock:
Beginning of year (195,295) (192,284) (181,552)
Acquisition of treasury stock
(shares: 99,592-2003; 128,617-2002;
479,137-2001) (2,497) (3,011) (10,732)
---------- -------- --------
End of year (197,792) (195,295) (192,284)
---------- -------- --------
Unearned stock compensation and notes
receivable from stock sales:
Beginning of year (7,587) (7,084) (6,287)
Unearned stock compensation (7,065) (4,480) (3,845)
Amortization of deferred compensation
expense and amounts received on notes 5,150 3,977 3,048
---------- -------- --------
End of year (9,502) (7,587) (7,084)
---------- -------- --------
Total stockholders' equity $ 749,784 652,102 591,160
========== ======== ========
The Company also has authorized, but not issued, 5,000,000 shares of preferred
stock without par value of which 300,000 shares have been designated Series A
junior preferred stock without par value.
See accompanying notes to consolidated financial statements.
48
Consolidated Statements of Cash Flows
Years ended December 31,
(in thousands) 2003 2002 2001
- ---------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 66,344 41,969 25,693
----------- -------- --------
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 160,151 101,927 20,040
Increase in unearned premiums, net of prepaid reinsurance and advance premiums 86,797 65,218 42,372
Increase in net federal income tax payable (recoverable) 9,001 (290) (4,016)
Depreciation and amortization 11,106 8,103 12,245
Amortization of deferred compensation 5,095 3,848 3,006
Increase in premiums receivable (53,698) (33,194) (28,809)
(Increase) decrease in other trade receivables (1,798) 5,870 (4,576)
Increase in deferred policy acquisition costs (24,228) (16,507) (13,238)
(Increase) decrease in interest and dividends due or accrued (1,312) 384 (265)
(Increase) decrease in reinsurance recoverable on paid losses and loss expenses 1,949 8,001 (6,365)
Net realized gains (12,842) (3,294) (6,816)
Increase in accrued salaries and benefits 12,048 3,879 4,040
Increase in accrued insurance expenses 21,811 11,949 19,560
Gain on disposition of discontinued operations - (829) -
Other-net 1,494 (16,977) (10,188)
----------- -------- --------
Net adjustments 215,574 138,088 26,990
----------- -------- --------
Net cash provided by operating activities 281,918 180,057 52,683
=========== ======== ========
INVESTING ACTIVITIES
Purchase of debt securities, available-for-sale (615,126) (656,542) (326,099)
Purchase of equity securities, available-for-sale (54,208) (11,586) (62,619)
Purchase of other investments (9,008) (9,324) (1,462)
Purchase and adjustments of subsidiaries acquired (net of cash acquired of $48 in 2002) (804) (3,139) (97)
Sale of subsidiary (net of cash of $385) - 15,349 -
Sale of debt securities, available-for-sale 220,679 223,821 45,221
Redemption and maturities of debt securities, held-to-maturity 37,076 66,411 49,807
Redemption and maturities of debt securities, available-for-sale 153,735 92,866 131,174
Sale of equity securities, available-for-sale 18,683 16,430 56,376
Proceeds from other investments 1,384 798 71
Increase (decrease) in net payable for security transactions 2,474 (3,781) 4,800
Net additions to real estate, furniture, equipment and software development (9,751) (11,775) (6,824)
----------- -------- --------
Net cash used in investing activities (254,866) (280,472) (109,652)
----------- -------- --------
FINANCING ACTIVITIES
Dividends to stockholders (16,689) (15,604) (15,174)
Acquisition of treasury stock (2,497) (3,011) (10,732)
Net proceeds from issuance of senior convertible notes - 112,750 -
Principal payment of notes payable (24,000) (7,143) (7,143)
Net proceeds from dividend reinvestment plan 1,195 1,142 1,138
Net proceeds from stock purchase and compensation plans 11,011 12,630 10,621
Proceeds received on notes receivable from stock sales 55 129 42
----------- -------- --------
Net cash (used in) provided by financing activities (30,925) 100,893 (21,248)
----------- -------- --------
Net (decrease) increase in short-term investments and cash (3,873) 478 (78,217)
Short-term investments and cash at beginning of year 26,928 26,450 104,667
----------- -------- --------
Short-term investments and cash at end of year $ 23,055 26,928 26,450
=========== ======== ========
See accompanying notes to consolidated financial statements.
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2003, 2002, and 2001
NOTE 1 ORGANIZATION
Selective Insurance Group, Inc., headquartered in Branchville, New Jersey, is a
holding company for five property and casualty insurance companies that offer
primary and alternative market insurance for commercial and personal risks.
Through other subsidiaries, the company offers medical claim management
services; human resources benefits and administration services; risk management
products and services; and flood insurance policy, administration and claim
services.
NOTE 2 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Consolidation Policy
The consolidated financial statements include the accounts of Selective
Insurance Group, Inc. (Selective) and its subsidiaries (collectively, the
"Company") and have been prepared in accordance with accounting principles
generally accepted in the United States of America (GAAP). All material
intercompany accounts and transactions have been eliminated.
In January 2003, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 46, Consolidation of Variable Interest Entities, an
Interpretation of Accounting Research Bulletin No. 51 ("the Interpretation").
The Interpretation was originally effective for public companies at the
beginning of fiscal periods beginning after June 15, 2003. In October 2003, the
FASB agreed to defer the effective date of the Interpretation to the end of
fiscal periods ending after December 15, 2003. In December 2003, the FASB
further deferred the effective date of the Interpretation to the end of fiscal
periods ending after March 15, 2004, for potential variable interest entities
other than those commonly referred to as special-purpose entities. Since the
Company has no entities commonly referred to as special-purpose entities, we
will adopt the Interpretation as of March 31, 2004. The Company does not believe
the adoption of the Interpretation will have a material impact on its results of
operations or financial condition.
(b) Use of Estimates
The preparation of the consolidated financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the reported
financial statement balances, as well as the disclosure of contingent assets and
liabilities. Actual results could differ from those estimates.
(c) Reclassifications
Certain amounts in the Company's prior years' consolidated financial statements
and related footnotes have been reclassified to conform with the 2003
presentation. Such reclassification had no effect on the Company's net income or
stockholders' equity.
(d) Investments
Held-to-maturity debt securities are carried at amortized cost, which is
calculated using the scientific method, because management has the ability and
intent to hold such securities until maturity. Available-for-sale debt and
equity securities are carried at fair value. Limited partnerships are carried
using the equity method, which approximates fair value. Net unrealized gains and
losses on held-to-maturity debt securities are not reflected in accumulated
other comprehensive income. Net unrealized gains and losses on
available-for-sale debt and equity securities, net of deferred income tax
effect, are included as a separate component of accumulated other comprehensive
income. No material investments of the Company were non-income producing for the
years ended December 31, 2003 and 2002.
Realized gains and losses are determined on the basis of the cost of specific
investments sold and are credited or charged to income. In the event that a
decline in fair value of an investment is considered to be other than temporary,
such investments are written down to their fair value at the date the impairment
was determined and the amount of the write-down is included in realized losses.
Realized losses from investment write-downs were $1.2 million for 2003, $7.1
million for 2002, and $1.4 million for 2001.
(e) Fair Values of Financial Instruments
The following methods and assumptions were used by the Company in estimating its
fair value disclosures for financial instruments:
(1) Investment Securities: Fair values for held-to-maturity debt securities
are based on quoted market prices where available, or from independent pricing
services. The fair values of available-for-sale debt and equity securities,
which also represent their carrying amounts, are based on quoted market prices.
Other investments are carried at either cost or the equity method, which
approximates fair value.
(2) Indebtedness: The fair value of the convertible subordinated debentures
and the 1.6155% Senior Convertible Notes due September 24, 2032, are based on
quoted market prices. The fair values of the 8.77% Senior Notes due August 1,
2005, the
50
8.63% Senior Notes due May 4, 2007, and the 8.87% Senior Notes due May 4, 2010
were estimated using a cash flow analysis based upon the Company's current
incremental borrowing rate for the remaining term of the loan.
See Note 4 for a summary table of the fair value and related carrying
amounts of financial instruments.
(f) Allowance for Doubtful Accounts
The Company estimates an allowance for doubtful accounts on its premiums, other
trade receivables, and reinsurance recoverables. The allowance for premiums and
other trade receivables is based on historical write-off percentages adjusted
for the effects of current and anticipated trends. The allowance for reinsurance
recoverables is based on the specific identification method. The allowance for
premium receivables was $3.1 million at December 31, 2003 and $2.8 million at
December 31, 2002. The allowance for other trade receivables was $1.1 million at
December 31, 2003 and $0.9 million at December 31, 2002. The allowance for
reinsurance recoverables was $2.3 million at December 31, 2003 and $1.5 million
at December 31, 2002.
(g) Concentration of Credit Risk
Financial instruments that could potentially subject the Company to
concentration of credit risk include accounts receivable associated with our
human resource administration outsourcing subsidiary, which acts as a
co-employer with certain clients. As a co-employer, we contractually assume
substantial employer rights, responsibilities and risks of our clients'
employees, 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 $15.5 million as of December 31, 2003 and $12.2 million as of
December 31, 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 December 31, 2003 the maximum exposure to any
one account for earned payroll is approximately $1.2 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.
The Property and Casualty Insurance and HR outsourcing businesses are also
subject to geographic concentration. Approximately 39% of our net premiums
written are for insurance policies written in New Jersey while 39% of our HR
outsourcing co-employer client payroll is within the state of Florida. Other
east coast states, including Connecticut, Delaware, Georgia, Maryland, New York,
North Carolina, Pennsylvania, Rhode Island, South Carolina, Virginia and several
midwestern states, including Illinois, Indiana, Iowa, Kentucky, Michigan,
Minnesota, Missouri, Ohio and Wisconsin, account for substantially all of our
other business. Consequently, changes to economic or regulatory conditions in
these states could adversely affect the Company.
(h) Reinsurance
The Company records its ceded reinsurance transactions on a gross basis which
results in reinsurance recoverables on losses and loss expenses and ceded
unearned premiums (prepaid reinsurance premiums). The Company also discloses
reinsurance amounts for ceded premiums written and earned and ceded losses and
loss expenses incurred. See Note 5 for more information on reinsurance.
(i) Real Estate, Furniture, Equipment and Software Development
The value of real estate, furniture and equipment is stated at cost less
accumulated depreciation. Provisions for depreciation are computed using the
straight-line method over the estimated useful lives of the assets, which range
from two to forty years for financial statement purposes and the straight-line
method and various accelerated methods for federal income tax purposes. The
Company capitalizes the costs of computer software developed or obtained for
internal use and amortizes the cost using the straight-line method over
estimated useful lives of the systems being developed that range from three to
ten years.
(j) Deferred Policy Acquisition Costs
Policy acquisition costs are directly related to the writing of an insurance
policy and are deferred and amortized over the life of the policies in order to
facilitate a matching of revenues and expenses. These costs include labor costs,
commissions, premium taxes and assessments, boards, bureaus and dues, travel,
and other underwriting expenses incurred in the acquisition of premium. The
deferred policy acquisition costs are limited to the sum of unearned premiums
and anticipated investment income less anticipated losses and loss expenses,
policyholder dividends and other expenses for maintenance of policies in
51
force. The Company regularly conducts reviews for potential premium
deficiencies. There were no premium deficiencies for any of the reported years
as the sum of the anticipated losses and loss expenses, policyholder dividends
and other expenses did not exceed the related unearned premium and anticipated
investment income.
Deferred policy acquisition costs amortized to expense were $324.6 million for
2003, $280.6 million for 2002, and $257.2 million for 2001. The investment
yields assumed for each reporting period, which are based upon the Company's
actual average investment yield before-tax, as of the date of the calculation,
were 5.0% for 2003, 5.2% for 2002, and 5.4% for 2001.
(k) Goodwill
Goodwill results from business acquisitions where the cost of assets acquired
exceeds the fair value of those assets. The Company's goodwill balance by
operating segment is as follows:
(in thousands) 2003 2002
- --------------------------------------- -------- ------
Diversified insurance services goodwill $ 36,053 35,249
Insurance operations goodwill 7,559 7,559
-------- ------
Total goodwill $ 43,612 42,808
======== ======
The increase in goodwill in our Diversified Insurance Services segment of $0.8
million is due to contingent purchase price adjustments relating to our
acquisition of Northeast Health Direct, LLC (NHD) in 2002. See Note 2(r) for
additional information regarding acquisitions.
As of January 1, 2002 the Company adopted the FASB Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (FAS 142).
FAS 142 addresses the initial recognition and measurement of goodwill and other
intangible assets. FAS 142 changed the accounting for goodwill and intangible
assets that have indefinite useful lives from an amortization approach to an
impairment-only approach that requires those assets to be tested at least
annually for impairment. The statement is applied to all goodwill and other
intangible assets recognized in an entity's financial statements at that date.
No such impairments were recorded during 2003 or 2002. Goodwill amortization
expense, which is included in other expenses on the consolidated statements of
income and mainly in the Diversified Insurance Services segment, was $3.3
million for 2001. This 2001 expense amount was calculated using the
straight-line method amortized over the estimated useful lives of the assets
acquired, which ranged between nine and twenty years.
The following table shows net income and earnings per share as if FAS 142 had
been adopted during the period presented:
(in thousands, except per share amounts) 2001
- ---------------------------------------------- ----------
Income from continuing operations, as reported $ 26,318
Add back: Goodwill amortization, net of tax 2,178
----------
Adjusted income from continuing operations 28,496
Loss from discontinued operations, net of tax (625)
----------
Adjusted net income $ 27,871
==========
Basic earnings per share:
Income from continuing operations, as reported $ 1.07
Add back: Goodwill amortization, net of tax 0.09
----------
Adjusted income from continuing operations 1.16
Loss from discontinued operations, net of tax (0.02)
----------
Adjusted net income $ 1.14
==========
Diluted earnings per share:
Income from continuing operations, as reported $ 1.00
Add back: Goodwill amortization, net of tax 0.08
----------
Adjusted income from continuing operations 1.08
Loss from discontinued operations, net of tax (0.02)
----------
Adjusted net income $ 1.06
==========
(l) Reserves for Losses and Loss Expenses
In accordance with industry practice, the Company maintains reserves for losses
and loss expenses. These reserves are made up of both case reserves and reserves
for claims incurred but not yet reported (IBNR). Case reserves result from a
claim that has been reported to an insurance subsidiary and are estimated at the
amount of ultimate payment. Additional IBNR reserves are established based on
generally accepted actuarial techniques. Such techniques assume that past
experience, adjusted for the effects of current developments and anticipated
trends, are an appropriate basis for predicting future events.
52
The internal assumptions considered by the Company in the estimation of the IBNR
amounts for both environmental and non-environmental reserves at the Company's
reporting dates are based on: (i) an analysis of both paid and incurred loss and
loss expense development trends; (ii) an analysis of both paid and incurred
claim count development trends; (iii) the exposure estimates for reported
claims; (iv) recent development on exposure estimates with respect to individual
large claims and the aggregate of all claims; (v) the rate at which new
environmental claims are being reported; and (vi) patterns of events observed by
claims personnel or reported to them by defense counsel. External factors
identified by the Company in the estimation of IBNR for both environmental and
non-environmental IBNR reserves include: legislative enactments, judicial
decisions, legal developments in the determination of liability and the
imposition of damages, and trends in general economic conditions, including the
effects of inflation. Adjustments to IBNR are made periodically to take into
account changes in the volume of business written, claims frequency and
severity, the mix of business, claims processing and other items as described
that are expected by management to affect the Company's reserves for losses and
loss expenses over time.
By using both individual estimates of reported claims and generally accepted
actuarial reserving techniques, the Company estimates the ultimate net liability
for losses and loss expenses. While the ultimate actual liability may be higher
or lower than reserves established, the Company believes the reserves to be
adequate. Any changes in the liability estimate may be material to the results
of operations in future periods. The Company does not discount to present value
that portion of its loss reserves expected to be paid in future periods;
however, the loss reserves include anticipated recoveries for salvage and
subrogation claims. Such salvage and subrogation amounted to $43.6 million for
2003 and $40.5 million for 2002.
Reserves are reviewed for adequacy on a periodic basis. When reviewing reserves,
the Company analyzes historical data and estimates the impact of various factors
such as: (i) per claim information; (ii) Company and industry historical loss
experience; (iii) legislative enactments, judicial decisions, legal developments
in the imposition of damages, and changes in political attitudes; and (iv)
trends in general economic conditions, including the effects of inflation. This
process assumes that past experience, adjusted for the effects of current
developments and anticipated trends, is an appropriate basis for predicting
future events. There is no precise method, however, for subsequently evaluating
the impact of any specific factor on the adequacy of reserves because the
eventual deficiency or redundancy is affected by many factors. Based upon such
reviews, the Company believes that the estimated reserves for losses and loss
expenses are adequate to cover the ultimate cost of claims. The changes in these
estimates, resulting from the continuous review process and the differences
between estimates and ultimate payments, are reflected in the consolidated
statements of income for the period in which such estimates are changed.
(m) Premium Revenue
Net premiums written include direct writings plus reinsurance assumed and
estimates of premiums earned but unbilled on the workers' compensation and
general liability lines of insurance, less reinsurance ceded. Premiums written
are recognized as revenue over the period that coverage is provided using the
semi-monthly pro rata method. Unearned premiums and prepaid reinsurance premiums
represent that portion of premiums written that are applicable to the unexpired
terms of policies in force.
(n) Stock-Based Compensation
The FASB Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" (FAS 123) establishes financial accounting and
reporting standards for stock-based compensation plans. As permitted by FAS 123,
the Company uses the accounting method prescribed by Accounting Principles Board
Opinion No. 25 "Accounting for Stock Issued to Employees" (APB 25) to account
for its stock-based compensation plans. Companies using APB 25 are required to
make pro forma footnote disclosures of net income and earnings per share as if
the fair value method of accounting, as defined in FAS 123, had been applied.
See Note 16 for more information.
As of December 31, 2002 the Company adopted the FASB Statement of Financial
Accounting Standards No. 148, "Accounting for Stock-Based Compensation -
Transition and Disclosure" (FAS 148). FAS 148 amends FAS 123 to provide
alternative methods of transition to FAS 123's fair value method of accounting
for stock-based compensation. FAS 148 also amends the disclosure provisions of
FAS 123 to require disclosure in the Summary of Significant Accounting Policies
footnote the effects of an entity's accounting policy with respect to
stock-based employee compensation on reported net income and earnings per share.
53
The Company has adopted the pro forma footnote disclosure-only provisions of FAS
123. Based on the fair value method consistent with the provisions of FAS 123,
the Company's net income and earnings per share would have been reduced to the
following pro forma amounts indicated below:
(in thousands, except per share amounts) 2003 2002 2001
- ------------------------------------------------------------------------- ---------- ---------- ----------
Net income, as reported $ 66,344 41,969 25,693
Add: Stock-based employee compensation reported in net income,
net of related tax effect 3,311 2,502 1,955
Deduct: Total stock-based employee compensation expense determined under
fair value-based method for all awards, net of related tax effects (3,841) (3,705) (3,693)
---------- ------ ------
Pro forma net income $ 65,814 40,766 23,955
========== ====== ======
Net income per share:
Basic - as reported $ 2.54 1.66 1.05
Basic - pro forma 2.52 1.61 0.97
Diluted - as reported 2.40 1.56 0.98
Diluted - pro forma 2.38 1.52 0.91
(o) Dividends to Policyholders
The Company establishes reserves for dividends to policyholders on certain
workers' compensation policies. These dividends are based on the policyholders'
loss experience. The dividend reserves are established based on past experience,
adjusted for the effects of current developments and anticipated trends. The
expense for these dividends is recognized over a period that begins at policy
inception and ends with the payment of the dividend. The expense recognized for
these dividends was $5.1 million in 2003, $5.8 million in 2002, and $8.3 million
in 2001. The Company issues no policies that entitle the policyholder to
participate in the earnings or surplus of the Insurance Subsidiaries.
(p) Federal Income Tax
The Company uses the asset and liability method of accounting for income taxes.
Deferred federal income taxes arise from the recognition of temporary
differences between financial statement carrying amounts and the tax basis of
the Company's assets and liabilities, as well as tax on net unrealized gains or
losses on available-for-sale securities. A valuation allowance is established
when it is more likely than not that some portion of the deferred tax asset will
not be realized. The effect of a change in tax rates is recognized in the period
of enactment.
(q) Statement of Cash Flows
Short-term investments are comprised of highly liquid investments that are
readily convertible into known amounts of cash. Such investments have maturities
of 90 days or less from the date of purchase.
The Company's cash paid during the year for interest and federal income taxes
and non-cash financing activities were as follows:
(in thousands) 2003 2002 2001
- -----------------------------------------------------------------------------
Cash paid during the year for:
Interest $ 17,501 13,724 14,236
Federal income tax 11,621 10,012 -
Non-cash financing activity:
Conversion of convertible
subordinated debentures 147 2,459 58
Unearned stock compensation 7,065 4,480 3,845
(r) Acquisitions
During 2002, the Company completed the acquisition of NHD, a 16,000-location
network that operates in Connecticut and certain regions within the states of
Massachusetts, Vermont, and New Hampshire. Consumer Health Network Plus, LLC
(CHN), which is included in our Diversified Insurance Services segment, acquired
NHD for $4.0 million, including certain acquisition and financial performance
related costs, as well as additional consideration of $0.8 million that was paid
in 2003. CHN may be further required to pay additional consideration of
approximately $0.3 million in 2004 based on certain criteria related to future
financial performance. In connection with the acquisition, the Company recorded
intangible assets of $1.7 million for network physician contracts and $0.7
million for existing client contracts. The network physician contracts have
54
an indefinite life and will be reviewed annually for potential impairment. The
client contracts are being amortized over their useful lives, 3 years, with $0.2
million amortized to expense in both 2003 and in 2002. These amounts are
included in other assets on the consolidated balance sheets.
Separate pro forma information of this acquisition has not been presented, as
management has determined that such information is not material.
NOTE 3 INVESTMENTS
(a) The components of net investment income earned are as follows:
(in thousands) 2003 2002 2001
- ------------------------------------------------------------------------------------------------------------------------
Debt securities $ 105,719 98,661 91,140
Equity securities 5,707 3,820 3,495
Short-term investments 292 620 1,996
Other investments 4,614 1,403 1,880
---------- ------- ------
116,332 104,504 98,511
Investment expenses (1,584) (1,437) (1,744)
---------- ------- ------
Net investment income earned $ 114,748 103,067 96,767
========== ======= ======
(b) Net unrealized gains on held-to-maturity debt securities are as follows:
(in thousands) 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------------
Net unrealized gains $ 3,157 5,467 7,101
========== ====== =====
Increase (decrease) in net
unrealized gains $ (2,310) (1,634) 1,221
========== ====== =====
(c) Net unrealized gains on available-for-sale securities are as follows:
(in thousands) 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------------
Debt securities $ 95,429 100,714 34,309
Equity securities 132,959 76,877 116,517
---------- ------- -------
Total net unrealized gains 228,388 177,591 150,826
Deferred income tax expense (79,936) (62,157) (52,789)
---------- ------- -------
Net unrealized gains,
net of deferred income tax $ 148,452 115,434 98,037
========== ======= ======
Increase (decrease) in net unrealized gains,
net of deferred income tax expense $ 33,018 17,397 (1,288)
========== ======= ======
(d) The amortized cost, estimated fair values and unrealized gains (losses) of
held-to-maturity debt securities at December 31, 2003 and 2002, respectively,
are as follows:
Amortized Cost Unrealized Gains Unrealized Losses Fair Value
(in thousands) 2003 2002 2003 2002 2003 2002 2003 2002
-------- -------- -------- ------- -------- -------- -------- -------
U.S. government and
government agencies $ - 2,102 - 10 - - - 2,112
Obligations of states and
political subdivisions 72,128 103,215 3,152 5,385 - (17) 75,280 108,583
Mortgage-backed securities 193 4,001 5 89 - - 198 4,090
-------- -------- -------- ------- -------- -------- -------- -------
Total held-to-maturity
debt securities $ 72,321 109,318 3,157 5,484 - (17) 75,478 114,785
======== ======== ======== ======= ======== ======== ======== =======
55
(e) The cost/amortized cost, estimated fair values and unrealized gains (losses)
of available-for-sale securities at December 31, 2003 and 2002, respectively,
are as follows:
Cost/Amortized Cost Unrealized Gains Unrealized Losses Fair Value
(in thousands) 2003 2002 2003 2002 2003 2002 2003 2002
--------- --------- --------- --------- --------- --------- --------- ---------
U.S. government and
government agencies $ 157,797 203,540 11,559 14,408 (130) (374) 169,226 217,574
Obligations of states and
political subdivisions 772,430 435,188 25,741 25,292 (2,041) (349) 796,130 460,131
Corporate securities 436,180 507,275 35,493 37,555 (581) (5,357) 471,092 539,473
Asset-backed securities 24,460 21,857 717 700 - (15) 25,177 22,542
Mortgage-backed
securities 523,768 503,487 25,624 29,401 (953) (547) 548,439 532,341
---------- --------- --------- --------- --------- --------- --------- ---------
Available-for-sale
debt securities 1,914,635 1,671,347 99,134 107,356 (3,705) (6,642) 2,010,064 1,772,061
Available-for-sale
equity securities 163,602 120,036 133,286 84,776 (327) (7,899) 296,561 196,913
---------- --------- --------- --------- --------- --------- --------- ---------
Total available-for-
sale securities $2,078,237 1,791,383 232,420 192,132 (4,032) (14,541) 2,306,625 1,968,974
========== ========= ========= ========= ========= ========= ========= =========
(f) The following table summarizes, for all securities in an unrealized loss
position at December 31, 2003, the aggregate fair value and gross pre-tax
unrealized loss recorded in our accumulated other comprehensive income, by asset
class and by length of time those securities have been in an unrealized loss
position:
Less than 12 months 12 months or longer Total
Fair Unrealized Fair Unrealized Fair Unrealized
(in thousands) Value Losses Value Losses Value Losses
- ------------------------------------------------ -------- ---------- -------- ---------- -------- ----------
U.S. government and government agencies $ 9,070 130 - - 9,070 130
Obligations of states and political subdivisions 88,864 2,041 - - 88,864 2,041
Corporate securities 36,292 542 5,454 39 41,746 581
Mortgage-backed securities 66,310 953 - - 66,310 953
-------- -------- -------- -------- -------- --------
Total debt securities 200,536 3,666 5,454 39 205,990 3,705
Equity securities 1,542 - 17,378 327 18,920 327
-------- -------- -------- -------- -------- --------
Total securities in a temporary
unrealized loss position $202,078 3,666 22,832 366 224,910 4,032
======== ======== ======== ======== ======== ========
At December 31, 2003, the Company had 49 debt securities, with a fair value of
$206.0 million in an unrealized loss position of $3.7 million. The decline in 47
of these securities is attributable to changes in the interest rate environment.
These securities have a fair value of $199.2 million and unrealized losses of
$3.5 million. Issuer specific concerns account for declines in the remaining two
debt securities, with a fair value of $6.8 million and unrealized losses of $0.2
million. The Company believes these declines to be temporary.
At December 31, 2003, the Company had three equity securities with a fair value
of $18.9 million in an unrealized loss position of $0.3 million. All of these
securities had fair values no less than 98% of cost, and the Company believes
these declines to be temporary.
(g) Realized gains (losses) are as follows:
(in thousands) 2003 2002 2001
- ----------------------------------------------------------------------------------
Held-to-maturity debt securities
Gains $ 30 248 74
Losses (9) - -
Available-for-sale debt securities
Gains 8,569 8,846 2,727
Losses (3,790) (13,494) (2,098)
Available-for-sale equity securities
Gains 8,490 7,694 12,231
Losses (448) - (6,118)
-------- -------- --------
Total net realized gains 12,842 3,294 6,816
Income tax expense 4,495 1,153 2,386
-------- -------- --------
Net realized gains, net of income tax $ 8,347 2,141 4,430
======== ======== ========
56
Proceeds from the sale of available-for-sale securities were $239.4 million
during 2003, $240.3 million during 2002, and $101.6 million during 2001.
(h) The amortized cost and estimated fair value of debt securities at December
31, 2003, by contractual maturity are shown below. Mortgage-backed securities
are included in the maturity tables using the estimated average life of each
security.
Expected maturities may differ from contractual maturities because issuers may
have the right to call or prepay obligations with or without call or prepayment
penalties.
Listed below are held-to-maturity debt securities:
Amortized Fair
(in thousands) Cost Value
- --------------------------------------------------------------
Due in one year or less $ 41,657 43,174
Due after one year through
five years 29,898 31,381
Due after five years through
ten years 564 614
Due after ten years through
fifteen years 202 309
----------- ---------
Total held-to-maturity
debt securities $ 72,321 75,478
=========== =========
Listed below are available-for-sale debt securities:
Amortized Fair
(in thousands) Cost Value
- --------------------------------------------------------------
Due in one year or less $ 181,421 187,134
Due after one year through
five years 642,550 674,198
Due after five years through
ten years 979,485 1,031,508
Due after ten years through
fifteen years 111,179 117,224
----------- ---------
Total available-for-sale
debt securities $ 1,914,635 2,010,064
=========== =========
(i) Certain investments were on deposit with various state regulatory agencies
to comply with insurance laws with carrying values of $29.5 million as of
December 31, 2003 and $26.1 million at December 31, 2002.
(j) The Company is not exposed to significant concentrations of credit risk
within its investment portfolio.
(k) Included in other investments is $35.6 million of investments in limited
partnerships in 2003 and $23.5 million in 2002. These investments are purchased
and sold through an investment advisor and are carried at the equity method,
which approximates fair value. Any change in fair value of these investments is
recognized in net investment income earned in the period of change. At December
31, 2003 the Company has additional investment commitments of up to $32.4
million. There is no certainty that any additional investment will be required.
(l) The components of comprehensive income, both gross and net of tax, for 2003,
2002 and 2001 are as follows:
2003
(in thousands) Gross Tax Net
- -------------------------------------------------------------------------------
Income $ 87,980 21,636 66,344
---------- ---------- ----------
Components of other
comprehensive income:
Unrealized holding gains
during the period 65,071 22,775 42,296
Reclassification adjustment (14,274) (4,996) (9,278)
---------- ---------- ----------
Other comprehensive income 50,797 17,779 33,018
---------- ---------- ----------
Comprehensive income $ 138,777 39,415 99,362
========== ========== ==========
57
2002
(in thousands) Gross Tax Net
- -------------------------------------------------------------------------------
Income $ 52,651 10,682 41,969
---------- ---------- ----------
Components of other
comprehensive loss:
Unrealized holding gains
during the period 28,107 9,838 18,269
Reclassification adjustment (1,342) (470) (872)
---------- ---------- ----------
Other comprehensive income 26,765 9,368 17,397
---------- ---------- ----------
Comprehensive income $ 79,416 20,050 59,366
========== ========== ==========
2001
(in thousands) Gross Tax Net
- -------------------------------------------------------------------------------
Income $ 22,839 (2,854) 25,693
---------- ---------- ----------
Components of other
comprehensive income:
Unrealized holding gains
during the period 3,229 1,130 2,099
Reclassification adjustment (5,211) (1,824) (3,387)
---------- ---------- ----------
Other comprehensive loss (1,982) (694) (1,288)
---------- ---------- ----------
Comprehensive income $ 20,857 (3,548) 24,405
========== ========== ==========
NOTE 4 FAIR VALUES OF FINANCIAL INSTRUMENTS
The following table presents the carrying amounts and estimated fair values of
the Company's financial instruments as of December 31, 2003 and 2002:
2003 2002
---------------------- ---------------------
CARRYING FAIR Carrying Fair
(in thousands) AMOUNT VALUE Amount Value
- ----------------------------------- ---------- --------- --------- ---------
FINANCIAL ASSETS
Debt securities:
Held-to-maturity $ 72,321 75,478 109,318 114,785
Available-for-sale 2,010,064 2,010,064 1,772,061 1,772,061
Equity securities 296,561 296,561 196,913 196,913
Other investments 58,698 58,698 48,259 48,259
FINANCIAL LIABILITIES
Notes payable:
8.77% Senior Notes 36,000 38,037 54,000 58,059
8.63% Senior Notes Series A 24,000 25,476 30,000 32,185
8.87% Senior Notes Series B 61,500 65,837 61,500 66,525
---------- --------- --------- ---------
Total notes payable 121,500 129,350 145,500 156,769
Senior convertible notes 115,937 144,113 115,937 128,863
Convertible subordinated debentures 1,184 5,408 1,331 4,737
The Company's carrying amounts shown in the table are included in the
consolidated balance sheets. The convertible subordinated debentures are
included in "other liabilities" on the consolidated balance sheets. See Note
2(e) for the methods and assumptions used by the Company in estimating the fair
values of its financial instruments.
NOTE 5 REINSURANCE
In the ordinary course of business, the Insurance Subsidiaries assume and cede
premiums with other reinsurance and insurance companies and various pools and
associations of which they are members. A large portion of the reinsurance is
effected under reinsurance contracts known as treaties and, in some instances,
by negotiation on each individual risk. The Insurance Subsidiaries have in place
excess of loss and catastrophe reinsurance treaties that protect against losses
over
58
stipulated amounts arising from any one occurrence or event and quota share
reinsurance treaties where the Company and the reinsurer share the amount of
premium and covered losses based on a stated percentage. The reinsurance
arrangements enable greater diversification of business and can serve to limit
the maximum net loss on catastrophes and large and unusually hazardous risks.
The Insurance Subsidiaries are contingently liable to the extent that any
reinsurer becomes unable to meet its contractual obligations. The Company
reviews the financial condition of its existing reinsurers for any potential
write-offs of uncollectible amounts as well as suitability to remain on the
reinsurance program. The Company had prepaid reinsurance premiums and net
reinsurance recoverables with American Re-Insurance Company (American Re) (rated
"A+ Superior" by A.M. Best Company, Inc.) that amounted to $53.6 million at
December 31, 2003 and $62.0 million at December 31, 2002, a state insurance fund
for $71.3 million in 2003 and $64.9 million in 2002 and the federal government's
National Flood Insurance Program for $52.2 million in 2003 and $33.0 million in
2002. The Company has a $38.7 million trust fund agreement with American Re that
secures a portion of their recoverable amounts.
Under the Company's reinsurance arrangements, which are all prospective in
nature, reinsurance premiums ceded are recorded as prepaid reinsurance and
amortized over the remaining contract period in proportion to the reinsurance
protection provided, or recorded periodically, as per terms of the contract, in
a direct relationship to the direct premium recording. Reinsurance recoveries
are recognized as direct losses are incurred.
(in thousands) 2003 2002 2001
- -----------------------------------------------------------------------------------
Premiums written:
Direct $1,336,150 1,157,450 1,009,120
Assumed 32,654 24,922 21,560
Ceded (149,645) (128,885) (105,260)
---------- ---------- ----------
Net $1,219,159 1,053,487 925,420
---------- ---------- ----------
Premiums earned:
Direct $1,247,653 1,088,586 961,146
Assumed 28,386 22,359 20,327
Ceded (142,969) (122,677) (98,425)
---------- ---------- ----------
Net $1,133,070 988,268 883,048
---------- ---------- ----------
Losses and loss expenses incurred:
Direct $ 869,291 732,888 706,270
Assumed 26,105 21,055 22,255
Ceded (96,766) (39,363) (72,641)
---------- ---------- ----------
Net $ 798,630 714,580 655,884
---------- ---------- ----------
Flood business which we cede 100% to the federal government's National Flood
Insurance Program, is included in the above amounts as follows:
(in thousands) 2003 2002 2001
- ---------------------------------------------------------------------------------------
Ceded premiums written $ (65,762) (53,266) (42,433)
Ceded premiums earned (59,192) (48,012) (37,191)
Ceded losses and loss expenses incurred (44,764) (4,527) (11,416)
Assumed written and earned premium increased primarily due to an increase in
mandatory pool assumptions.
In addition to our flood business, ceded written and earned premium increased in
2003 compared with 2002 due to increased direct premium written and $4.3 million
from our Terrorism treaty placed on February 1, 2003.
Direct losses and loss expenses incurred increased in 2003 compared with 2002
primarily due to i) $40.2 million increase in flood losses which are 100% ceded
to the federal government's National Flood Insurance Program; ii) $21.4 million
increase in losses from catastrophes; and iii) an increase in exposure
attributable to premium growth.
Ceded losses and loss expenses incurred from our flood business increased in
2003 compared with 2002 due to $34.8 million of losses incurred from Hurricane
Isabel. In addition to the increase in flood business, ceded losses and loss
expenses incurred increased in 2003 compared with 2002 primarily due to: i) an
increase in losses ceded to a state insurance fund of $13.2 million; ii) an
increase in casualty losses of $6.7 million; and iii) an increase in New Jersey
homeowners property losses of $3.7 million.
59
NOTE 6 RESERVES FOR LOSSES AND LOSS EXPENSES
The table below provides a roll-forward of reserves for losses and loss expenses
for beginning and ending reserve balances:
(in thousands) 2003 2002 2001
- --------------------------------------------------------------------------------------------------------------------------
Gross reserves for losses and loss expenses at beginning of year $1,403,425 1,298,338 1,272,656
Less reinsurance recoverable on unpaid loss and loss
expenses at beginning of year 160,374 166,511 160,869
---------- ---------- ----------
Net reserves for losses and loss expenses at beginning of year 1,243,051 1,131,827 1,111,787
---------- ---------- ----------
Incurred losses and loss expenses for claims occurring in the:
Current year 783,580 694,744 642,173
Prior years 15,050 19,836 13,711
---------- ---------- ----------
Total incurred losses and loss expenses 798,630 714,580 655,884
---------- ---------- ----------
Paid losses and loss expenses occurring in the:
Current year 254,463 226,286 236,620
Prior years 384,016 377,070 399,224
---------- ---------- ----------
Total paid losses and loss expenses 638,479 603,356 635,844
---------- ---------- ----------
Net reserves for losses and loss expenses at end of year 1,403,202 1,243,051 1,131,827
Reinsurance recoverable on unpaid loss and loss
expenses at end of year 184,611 160,374 166,511
---------- ---------- ----------
Gross reserves for losses and loss expenses at end of year $1,587,813 1,403,425 1,298,338
========== ========== ==========
Incurred loss and loss expense development related to prior years was $15.0
million in 2003, $19.8 million in 2002 and $13.7 million in 2001, while net loss
and loss expense reserves increased by $160.1 million in 2003 and $111.2 million
in 2002. These changes were the result of normal reserve development inherent in
the uncertainty in establishing reserves for losses and loss expenses,
anticipated loss trends, growth in business, as well as increased reinsurance
retentions.
During 2003, our General Liability line of business, specifically
Products/Completed Operations business, demonstrated significant prior year
development. The estimates for prior year losses increased by $17.9 million,
with $14.0 million in accident years 2000 and prior. The General Liability line
of business is inherently volatile which makes it more difficult to reserve.
In addition, changes in our claims operation including senior management changes
and the development of a field claims model over the past five years have
impacted claim settlement patterns and average case reserves. During 2003 and
2002, these changes were minimal relative to the previous three years. This,
combined with higher than expected loss emergence in 2003 for past accident
years, has led us to recognize and increase in our estimates for these older
periods.
As additional information is collected in the loss settlement process, reserves
are adjusted accordingly. These adjustments are reflected in the consolidated
statements of income in the period in which such adjustments are recognized.
These changes could have a material impact on the results of operations of
future periods when the adjustments are made.
NOTE 7 INDEBTEDNESS
(a) Senior Convertible Notes
In 2002, the Company issued $305 million aggregate principal amount of 1.6155%
senior convertible notes (Convertible Notes), due September 24, 2032, at a
discount of 61.988% resulting in an effective yield of 4.25%. The Company
recorded gross proceeds of $116.0 million along with $3.2 million of deferred
charges, which are amortized over the life of the note, in connection with debt
issuance costs. Net proceeds of approximately $72.0 million were used to fund an
irrevocable trust to provide for certain payment obligations in respect of the
Company's outstanding debt obligations. The Company paid as a capital
contribution $40.0 million to the Company's insurance operating subsidiaries.
Interest on the Convertible Notes is payable semi-annually at a rate of 1.6155%
beginning March 24, 2003 until September 24, 2009, to holders of record at the
close of business on the preceding March 9 or September 9, respectively. After
that date, cash interest will not be paid on the Convertible Notes prior to
maturity unless contingent cash interest becomes payable. Contingent cash
interest becomes payable if the average market price of a Convertible Note for
the applicable five trading day period equals 120% or more of the sum of the
Convertible Note's issue price, accrued original issue discount and accrued cash
interest, if any, for a Convertible Note to the day immediately preceding the
relevant six-month period. The contingent cash interest payable per Convertible
Note in respect of any quarterly period within any six-month period will equal
the greater of (a) any regular cash dividends per share paid by the Company on
our common stock during that quarterly period multiplied by the then applicable
60
conversion rate or (b) $0.15 multiplied by 12.9783. The Convertible Notes will
be convertible at the option of the holders, if the conditions for conversion
are satisfied, into shares of the Company's common stock at a conversion price
of $29.29. These notes have a contingent conversion feature that allows
conversion of the notes when the stock price has maintained a 20% premium to the
conversion price of $29.29, or $35.15, for 20 of 30 consecutive trading days
ending on the last trading day of a calendar quarter. Then, on any business day
in the following calendar quarter, the holders may surrender notes for
conversion into shares of common stock, or cash at the Company's option. If all
the Convertible Notes were converted, the Company would be required to issue 3.9
million shares of common stock. The 20% premium trigger is in effect until and
including September 30, 2009 and declines approximately 0.11% per calendar
quarter thereafter to 10% on the last day of the quarter ending June 30, 2032.
Holders may also surrender Convertible Notes for conversion only during any
period in which the credit rating assigned to the Convertible Notes is Ba2 or
lower by Moody's Investors Service, Inc. (Moody's) or BB+ or lower by Standard
and Poor's Credit Market Services (S&P), the Convertible Notes are no longer
rated by either Moody's or S&P, or the credit rating assigned to the Convertible
Notes has been suspended or withdrawn by either Moody's or S&P. The Convertible
Notes will cease to be convertible pursuant to this credit rating criteria
during any period or periods in which all of the credit ratings are increased
above such levels. The Convertible Notes are redeemable by the Company in whole
or in part, at any time on or after September 24, 2007, at a price equal to the
sum of the issue price, plus the call premium, if any, plus accrued original
issue discount and accrued and unpaid cash interest, if any, or such Convertible
Notes to the applicable redemption date. The holders of the Convertible Notes
may require the Company to purchase all or a portion of their Convertible Notes
on either September 24, 2009, 2012, 2017, 2022, or 2027 at stated prices plus
accrued cash interest, if any, to the purchase date. The Company may pay the
purchase price in cash or shares of Company common stock or in a combination of
cash and shares of Company common stock.
The Company has various covenants under the Indenture dated September 24, 2002,
which include, but are not limited to, timely payment of securities, timely
filing of Securities and Exchange Commission and other reports, and compliance
with securities laws upon purchase of securities.
(b) Notes Payable
(1) On May 4, 2000, the Company entered into a $30.0 million and a $61.5 million
note purchase agreement with various lenders covering the 8.63% and 8.87% Senior
Notes, respectively.
Commencing on May 4, 2003, the Company paid $6.0 million in principal, together
with accrued interest thereon for the 8.63% Senior Notes. This $6.0 million
principal payment is required annually through May 4, 2007. The unpaid principal
amount of these Senior Notes accrues interest and is payable semiannually on May
4 and November 4 of each year, until the principal is paid in full.
For the 8.87% Senior Notes, the Company is required to pay $12.3 million
principal amount in each year commencing on May 4, 2006 and ending on May 4,
2010, inclusive, together with accrued interest thereon. The unpaid principal
amount of these Senior Notes accrues interest and is payable semiannually on May
4 and November 4 of each year, until the principal is paid in full.
(2) On August 12, 1994, the Company entered into a $54.0 million note purchase
agreement with various lenders covering the 8.77% Senior Notes. Commencing on
August 1, 2003, the Company paid $18.0 million in principal, together with
accrued interest thereon for the 8.63% Senior Notes. This $18.0 million
principal payment is required annually through August 1, 2005. The unpaid
principal amount of the 8.77% Senior Notes accrues interest and is payable
semiannually on February 1 and August 1 of each year, until the principal is
paid in full.
Each note purchase agreement contains restrictive business covenants that are
reviewed quarterly. They include, but are not limited to, a limitation on
indebtedness, restricted ability to declare dividends and net worth maintenance.
At December 31, 2003, the amount available for dividends to stockholders under
said restrictions was $226.4 million for the 1994 Senior Notes and $188.7
million for the 2000 Senior Notes.
(c) Convertible Subordinated Debentures
The Debentures were issued under an Indenture dated December 29, 1982,
("Indenture") in the principal amount of $25.0 million, bearing interest at a
rate of 8.75% per annum, which is payable on the unpaid principal semiannually
on January 1 and July 1 in each year to holders of record at the close of
business on the preceding December 15 and June 15, respectively. The Debentures
are convertible into common stock at an effective conversion price of $7.08 per
share. The principal amount of the Debentures, $1.2 million at 2003 and $1.3
million at 2002, including any accrued interest, is due on January 1, 2008 and
is included in other liabilities on the consolidated balance sheets.
The Indenture requires the Company to retire, through the operation of a
mandatory sinking fund, 5% of the original $25.0 million aggregate principal
amount of the debentures on, or before December 31 of each of the years from
1993, to and including, 2006. Voluntary conversions have satisfied this
obligation in its entirety.
61
(d) Short-Term Debt
The Company has revolving lines of credit with State Street Corporation, $20.0
million, and Wachovia Bank, $25.0 million, totaling $45.0 million at December
31, 2003. The lines of credit in 2002 were $25.0 million for State Street
Corporation, and $25.0 million for Wachovia Bank, totaling $50.0 million. At
December 31, 2003 and 2002, there were no balances outstanding. Interest is
determined on a LIBOR, prime rate or money market rate basis at the Company's
option. The weighted average interest rate on these borrowings was 1.67% in
2003. No borrowings were made during 2002.
NOTE 8 STOCKHOLDERS' EQUITY
On November 4, 2003, the Board of Directors authorized a 2.5 million share
common stock repurchase program scheduled to expire on November 30, 2005. This
program replaces the Company's previous common stock repurchase program
authorized by the Board of Directors on July 29, 1996 and extended on July 28,
1998, May 7, 1999, November 2, 1999, February 3, 2000, May 31, 2001 and May 31,
2002, which allowed the Company to repurchase up to 8.0 million shares. No
shares were repurchased under the current program and 7.3 million shares at a
total cost of $140.5 million were repurchased under the expired program. The
Company acquired no shares in 2003, 11,000 shares for $0.2 million in 2002, and
0.3 million shares for $7.5 million in 2001.
The Company maintains a dividend reinvestment plan. On November 18, 2003, the
Company registered with the Securities and Exchange Commission 1,012,873 shares
of which 12,873 were previously registered unissued shares of the dividend
reinvestment plan. At December 31, 2003, 998,830 shares of common stock were
available for issuance. Shares purchased under this plan are issued at fair
value. As of December 31, 2003, the Company had an additional 5.7 million shares
reserved for various stock compensation plans, retirement plans and debt
offerings.
Shares repurchased in conjunction with restricted stock vestings and option
exercises were 100,000 shares at a cost of $2.5 million in 2003, 117,000 shares
at a cost of $2.8 million in 2002 and 133,000 shares at a cost of $3.2 million
in 2001.
Selective's ability to declare and pay dividends on common stock is affected by
the ability of its subsidiaries to declare and pay dividends to the holding
company. The dividends from Diversified Insurance Services subsidiaries are
restricted only by the operating needs of those subsidiaries. The dividends from
Insurance Subsidiaries are under the regulatory limitations of the states in
which the Insurance Subsidiaries are domiciled: New Jersey, New York, North
Carolina and South Carolina.
In all such jurisdictions, domestic insurers are prohibited from paying
"extraordinary dividends" without approval of the insurance commissioner of the
respective state. Additionally, New Jersey and South Carolina require notice of
the declaration of any ordinary or extraordinary dividend distribution. During
the notice period, the relevant state regulatory authority may disallow all or
part of the proposed dividend if it determines that the insurer's surplus, with
regard to policyholders, is not reasonable in relation to the insurer's
outstanding liabilities and adequate for its financial needs.
Based on the unaudited 2003 statutory financial statements, the maximum ordinary
dividends that can be paid to Selective in 2004 are:
(in millions)
- -----------------------------------------------------------------
Selective Insurance Company of America $ 37.7
Selective Way Insurance Company 13.6
Selective Insurance Company of the Southeast 4.1
Selective Insurance Company of South Carolina 3.6
Selective Insurance Company of New York 4.6
----------
Total $ 63.6
==========
The statutory capital and surplus of the Insurance Subsidiaries in excess of
these ordinary dividend amounts must remain with the Insurance Subsidiaries in
the absence of the approval of a request for an extraordinary dividend.
62
NOTE 9 PREFERRED SHARE PURCHASE RIGHTS PLAN
On February 2, 1999, Selective's Board of Directors approved the amended and
restated stockholder rights plan. The rights to purchase one two-hundredth of a
share of Selective Series A Junior Preferred Stock at an exercise price of $80
are attached to all shares of Selective common stock and are exercisable ten
days after an announcement that a person or group has acquired 15% or more of
the common stock (Acquiring Person) or ten business days after a person
commences or announces its intent to make a tender offer which would result in
their acquiring 15% or more of the common stock (Acquiring Person). If a person
or group becomes an Acquiring Person, each right will entitle the holder, other
than the Acquiring Person, to purchase the number of Selective common shares
having a market value of two times the exercise price of $80.
If Selective is acquired in a merger, or 50% or more of its assets are sold,
each right other than the rights of an Acquiring Person, will be exercisable to
purchase shares of the acquiring company having twice the market value of the
$80 exercise price.
Before an Acquiring Person acquires 50% or more of the common shares,
Selective's Board may exchange rights, other than the rights of an Acquiring
Person, at an exchange ratio of one share of common stock per right. The rights
expire February 2, 2009, unless Selective's Board redeems them at $0.01 per
right before a person or group triggers the plan or unless Selective's Board
exchanges them for common stock.
NOTE 10 SEGMENT INFORMATION
The Company is primarily engaged in writing property and casualty insurance. The
Company has classified its business into three segments, which is at the same
level of disaggregation as that reviewed by senior management: Insurance
Operations (commercial lines underwriting, personal lines underwriting),
Investments, and Diversified Insurance Services. Insurance Operations are
evaluated based on GAAP underwriting results, Investments are evaluated based on
after-tax investment returns, and the Diversified Insurance Services are
evaluated based on several measures including, but not limited to, results of
operations in accordance with GAAP. The Company does not aggregate any of its
operating segments.
The GAAP underwriting results of the Insurance Operations segment are determined
taking into account net premiums earned, incurred losses and loss expenses,
policyholders dividends, policy acquisition costs and other underwriting
expenses. Management of the Investments segment is separate from the Insurance
Operations segment and, therefore, has been classified as a separate segment.
The operating results of the Investments segment takes into account net
investment income and net realized gains and losses on investments. The
Diversified Insurance Services segment is managed independently from the other
segments and, therefore, has been classified separately. The Diversified
Insurance Services segment consists of managed care, flood operations and human
resource administration outsourcing (HR outsourcing). The segment results are
determined taking into account the net revenues generated in each of the
businesses, less the costs of operations. Prior years have been restated to
exclude software development and administration, which are accounted for as
discontinued operations in 2002 and 2001.
Selective and its subsidiaries provide services to each other in the normal
course of business. These transactions totaled $27.1 million in 2003, $32.1
million in 2002 and $14.1 million in 2001. These transactions were eliminated in
all consolidated financial statements.
In computing the results of each segment, no adjustment is made for interest
expense, net general corporate expenses or federal income taxes. The Company
does not maintain separate investment portfolios for the segments and,
therefore, does not allocate assets to the segments.
63
The following summaries present revenues (net investment income and net realized
gains on investments in the case of the Investments segment) and pre-tax income
for the individual segments:
REVENUE BY SEGMENT
(in thousands) 2003 2002 2001
- ---------------------------------------- ---------- ---------- ----------
INSURANCE OPERATIONS:
Commercial lines net premiums earned $ 920,409 788,454 678,321
Personal lines net premiums earned 212,661 199,814 204,727
Miscellaneous income 3,478 3,167 2,660
---------- ---------- ----------
Total insurance operations revenues 1,136,548 991,435 885,708
---------- ---------- ----------
INVESTMENTS:
Net investment income 114,748 103,067 96,767
Net realized gains on investments 12,842 3,294 6,816
---------- ---------- ----------
Total investment revenues 127,590 106,361 103,583
---------- ---------- ----------
DIVERSIFIED INSURANCE SERVICES:
Diversified insurance services revenues,
from continuing operations 91,840 80,796 69,626
---------- ---------- ----------
TOTAL ALL SEGMENTS 1,355,978 1,178,592 1,058,917
---------- ---------- ----------
Other income 138 358 103
---------- ---------- ----------
TOTAL REVENUES FROM CONTINUING
OPERATIONS $1,356,116 1,178,950 1,059,020
========== ========== ==========
Income or (loss) from continuing operations before federal income tax by
segment:
(in thousands) 2003 2002 2001
- ----------------------------------------- ---------- ---------- ----------
INSURANCE OPERATIONS:
Commercial lines underwriting $ (13,528) (21,135) (32,970)
Personal lines underwriting (11,724) (17,608) (27,668)
---------- ---------- ----------
Underwriting loss, before federal
income tax (25,252) (38,743) (60,638)
---------- ---------- ----------
INVESTMENTS:
Net investment income 114,748 103,067 96,767
Net realized gains on investments 12,842 3,294 6,816
---------- ---------- ----------
Total investment income, before federal
income tax 127,590 106,361 103,583
---------- ---------- ----------
DIVERSIFIED INSURANCE SERVICES:
Income (loss) from continuing operations,
before federal income tax 9,223 5,914 (427)
---------- ---------- ----------
TOTAL ALL SEGMENTS 111,561 73,532 42,518
Interest expense (17,148) (15,093) (14,526)
General corporate expenses (6,433) (5,532) (4,294)
---------- ---------- ----------
INCOME FROM CONTINUING OPERATIONS, BEFORE
FEDERAL INCOME TAX $ 87,980 52,907 23,698
========== ========== ==========
64
NOTE 11 EARNINGS PER SHARE
The following table provides a reconciliation of the numerators and denominators
of the basic and diluted earning per share (EPS) computations of net income for
the year ended:
2003
INCOME SHARES PER SHARE
(in thousands, except per share amounts) (NUMERATOR) (DENOMINATOR) AMOUNT
- -------------------------------------------------------------------------------------------
Basic EPS:
Net income available to common stockholders $ 66,344 26,131 $ 2.54
Effect of dilutive securities:
Restricted stock - 881
8.75% convertible subordinated debentures 67 175
Stock options - 338
Deferred shares - 120
---------- ----------
Diluted EPS:
Income available to common stockholders
and assumed conversions $ 66,411 27,645 $ 2.40
========== ========== ==========
2002
Income (Loss) Shares Per Share
(in thousands, except per share amounts) (Numerator) (Denominator) Amount
- -------------------------------------------------------------------------------------------
Basic EPS:
Net income from continuing operations $ 42,138 25,301 $ 1.67
Net (loss) from discontinued operations (169) 25,301 (0.01)
---------- ----------
Net income available to common stockholders $ 41,969 25,301 $ 1.66
========== ========== ==========
Effect of dilutive securities:
Restricted stock - 796
8.75% convertible subordinated debentures 143 363
Stock options - 359
Deferred shares - 103
---------- ----------
Diluted EPS:
Income from continuing operations $ 42,281 26,922 $ 1.57
Net (loss) from discontinued operations (169) 26,922 (0.01)
---------- ----------
Income available to common stockholders
and assumed conversions $ 42,112 26,922 $ 1.56
========== ========== ==========
65
2001
Income (Loss) Shares Per Share
(in thousands, except per share amounts) (Numerator) (Denominator) Amount
- -------------------------------------------------------------------------------------------
Basic EPS:
Net income from continuing operations $ 26,318 24,583 $ 1.07
Net (loss) from discontinued operations (625) 24,583 (0.02)
---------- ----------
Net income available to common stockholders $ 25,693 24,583 $ 1.05
========== ========== ==========
Effect of dilutive securities:
Restricted stock -- 769
8.75% convertible subordinated debentures 220 540
Stock options (141) 469
Deferred shares -- 63
---------- ----------
Diluted EPS:
Income from continuing operations $ 26,397 26,424 $ 1.00
Net (loss) from discontinued operations (625) 26,424 (0.02)
---------- ----------
Income available to common stockholders
and assumed conversions $ 25,772 26,424 $ 0.98
========== ========== ==========
During September 2002, the Company issued senior convertible notes with a
contingent conversion feature that becomes effective if the Company's common
stock trades at or above $35.15 for 20 out of 30 consecutive trading days at the
end of a calendar quarter. If the contingent conversion feature is triggered,
the Company would have to include approximately 3.9 million shares in the
diluted EPS calculation. For additional discussion of these senior convertible
notes, see Note 7(a).
NOTE 12 FEDERAL INCOME TAX
(a) A reconciliation of federal income tax on pretax earnings at the corporate
rate to the effective tax rate is as follows:
(in thousands) 2003 2002 2001
- -------------------------------------------------------------------------------------------
Tax at statutory rate of 35% $ 30,793 18,517 8,294
Tax-exempt interest (7,173) (7,138) (8,764)
Dividends received deduction (2,001) (2,222) (2,333)
Other 17 1,612 183
---------- ---------- ----------
Federal income tax expense (benefit) $ 21,636 10,769 (2,620)
========== ========== ==========
66
(b) The tax effects of the significant temporary differences that give rise to
deferred tax assets and liabilities are as follows:
(in thousands) 2003 2002
- ---------------------------------------------------------------------------
Deferred tax assets:
Net loss reserve discounting $ 77,325 70,864
Net unearned premiums 41,839 35,812
Self-insured employee benefit reserves 3,256 3,043
Pension 2,009 2,304
Deferred compensation 4,278 2,948
Alternative minimum tax 6,627 14,415
Allowance for doubtful accounts 1,229 994
Other 4,366 4,027
---------- -------
Total deferred tax assets 140,929 134,407
Deferred tax liabilities:
Deferred policy acquisition costs 60,332 51,852
Unrealized gains on available-for-sale securities 79,936 62,359
Accelerated depreciation 6,944 4,301
Premium audit accrual 1,471 2,802
Amortization of discount on bonds 1,946 2,301
Other 2,977 2,085
---------- -------
Total deferred tax liabilities 153,606 125,700
---------- -------
Deferred federal income tax (liability) asset: $ (12,677) 8,707
========== =======
Based on our tax loss carryback availability, and the historic levels of current
taxable income and pretax financial statement income, we believe that more
likely than not, the existing deductible temporary differences will reverse
during periods in which we generate net taxable income or have adequate
carryback availability. As a result, the Company has no valuation allowance
recognized for deferred tax assets.
Stockholders' equity reflects tax benefits related to compensation expense
deductions for stock options exercised of $3.4 million at December 31, 2003,
$2.4 million at December 31, 2002, and $1.3 million at December 31, 2001.
NOTE 13 DISCONTINUED OPERATIONS
In December 2001, the Company's management adopted a plan to divest itself of
its 100% ownership interest in PDA. During May 2002, the Company sold all of the
issued and outstanding shares of capital stock and certain software applications
developed by PDA for proceeds of $16.3 million at a net gain of $0.5 million.
This gain is included in discontinued operations, on the consolidated statements
of income. The tax benefit included in the loss from discontinued operations was
$0.4 million for 2002 and $0.2 million for 2001. The amount of tax expense in
2002 for the gain on disposition of discontinued operations is $0.3 million. As
a result of the sale, $5.0 million of capitalized software development cost were
recovered. We have reclassified prior period amounts to present the operating
results of PDA as a discontinued operation.
Operating results from discontinued operations are as follows:
(in thousands) 2003 2002 2001
- -------------------------------------------------------------------
Net revenue $ - 8,186 18,001
Pre-tax loss - (1,085) (859)
Net loss - (708) (625)
Gain on disposition, net of tax - 539 -
NOTE 14 RETIREMENT PLANS
(a) Retirement Plan for Nonemployee Directors
The Company terminated, effective December 31, 1997, a nonqualified defined
benefit retirement income plan for nonemployee Directors. The estimated accrued
costs for this plan were not material. As part of the termination, the present
value of each Director's future benefits, as of that date, was converted into
units based on the fair value of Selective common stock. The original
termination called for the cash value of these units based upon the fair value
of Selective common stock on retirement date to be distributed to each Director,
or at each Director's election, over a period of fifteen years after such
retirement. On May 8, 2002, the shareholders approved the conversion of the
units issued under the termination plan into shares of Selective stock. All of
the shares issued under this conversion have been deferred by the participants
for receipt
67
upon retirement, or at each Director's election, over a period of no more than 5
years after such retirement. These deferred shares, which are currently being
held in accounts on behalf of each Director, are credited with cash dividends
along with interest on those dividends. The accrued liability of these deferred
shares of stock and the related dividend and interest earnings at December 31,
2003 and December 31, 2002 was $1.5 million compared with the accrued liability
for the units outstanding at December 31, 2001 of $1.4 million.
(b) Retirement Savings Plan
The Company offers a voluntary defined contribution 401(k) retirement savings
plan to employees who meet eligibility requirements. The plan allows employees
to make voluntary contributions to a number of diversified investment options
including the Company's common stock, on a before and/or after-tax basis. Shares
of the Company's common stock issued under this plan were 14,251 during 2003,
23,496 during 2002 and 23,095 during 2001.
The number of shares of the Company's common stock available to be purchased
under the plan was 810,336 at December 31, 2003. During the first six months of
2002 and all of 2001, employees could contribute up to a maximum of 12% of their
defined compensation and these contributions were matched 50% by the Company up
to a maximum of 6%. Effective July 1, 2002 employees can contribute 50% of their
defined compensation and these contributions are matched 65% by the Company up
to a maximum of 7%.
An additional defined contribution plan is maintained by Selective HR Solutions,
a subsidiary of the Diversified Insurance Services segment, which does not
participate in the Company's defined contribution plan. Effective January 1,
2002, the plan allows employees to contribute a maximum of 25% of defined
compensation and up to 3% of contributions are matched 200% by the employer.
Prior to 2002, the maximum contribution was 15% of defined compensation.
In both plans, employees age 50 or older who are contributing the maximum may
also make additional contributions not to exceed the additional amount permitted
by the IRS.
Employer contributions for all the plans amounted to $3.7 million in 2003, $3.1
million in 2002, and $2.6 million in 2001.
(c) Deferred Compensation Plan
Effective July 1, 2002, the Company began offering a nonqualifed deferred
compensation plan (deferred compensation plan) to a group of management or
highly compensated employees (the Participants). The plan provides the
Participants the opportunity to elect to defer receipt of specified portions of
compensation and to have such deferred amounts treated as if invested in
specified investment options as a method of rewarding and retaining such
employees. A Participant in the plan may elect to defer compensation or awards
to be received from the Company or an affiliated entity, including up to: (i)
50% annual base salary; (ii) 100% of incentive compensation, and/or (iii) a
percentage of other compensation as otherwise designated by the Administrator of
the plan.
In addition to the deferrals elected by the Participants, the Company may choose
at any time to make discretionary Company contributions on a consistent basis to
the deferral accounts of all Participants in its sole discretion. No
discretionary contributions were made. The Company may also choose to make
matching contributions to the deferral accounts of some or all Participants to
the extent a Participant did not receive the maximum matching contribution
permissible under the Selective Insurance Retirement Savings Plan due to
limitations under the Internal Revenue Code or such plan.
The Company contributed $0.3 million in 2003 and $0.1 million in 2002 to the
deferred compensation plan.
(d) Retirement Income and Postretirement Plans
The Company has a noncontributory defined benefit retirement income plan
covering all employees who meet eligibility requirements. The Company's funding
policy provides that payments to the pension trust shall be equal to the minimum
funding requirements of the Employee Retirement Income Security Act, plus
additional amounts that may be approved by the Company from time to time.
Effective July 1, 2002, two new amendments to the plan were adopted. For new
entrants into the plan the monthly retirement benefits beginning at normal
retirement were decreased to 1.2% from 2.0% of the average monthly compensation
as defined. Also, for all plan participants the early retirement age was changed
to include a formula, whereby age plus years of service must sum to at least 70.
The Company also provides life insurance benefits ("postretirement benefits")
for retired employees. Substantially all the Company's employees may become
eligible for these benefits if they reach retirement age while working for the
Company and meet a minimum of ten years of eligibility service. Those who
retired prior to January 1, 1991 receive life insurance coverage which decreases
over ten years to a current ultimate value of $5,000 per retiree. Those retiring
on or after January 1, 1991 receive life insurance coverage in an amount equal
to 50% of their annual salary amount in effect at the end of their active career
to a maximum benefit of $100,000. Those retiring on or after January 1, 2002
receive life insurance coverage in an amount equal to 50% of their annual salary
amount in effect at the end of their active career to a maximum benefit of
$35,000.
The estimated cost of these benefits is accrued over the working lives of those
employees expected to qualify for such benefits as a level percentage of their
payroll costs.
68
As of December 31, 2003, the Company adopted the revised FASB statement of
Financial Accounting Standards No. 132 "Employers' Disclosures about Pensions
and Other Postretirement Benefits" (FAS 132). The revised FAS 132 addresses
disclosure items only and does not address measurement or recognition. The
revised FAS 132 requires additional disclosures to those required by the
original statement, all of which are included for all periods presented.
Retirement Income Plan Postretirement Plan
------------------------ -----------------------
(in thousands) 2003 2002 2003 2002
- --------------------------------------------- --------- --------- --------- ---------
CHANGE IN BENEFIT OBLIGATION:
Benefit obligation, beginning of year $ 97,165 82,147 6,107 6,198
Service cost 4,692 4,487 275 276
Interest cost 6,578 5,902 355 400
Amendments - 1,134 - (844)
Actuarial (gains) losses 11,045 5,768 (295) 264
Benefits paid (2,535) (2,273) (175) (187)
--------- --------- --------- ---------
Benefit obligation, end of year $ 116,945 97,165 6,267 6,107
========= ========= ========= =========
CHANGE IN FAIR VALUE OF ASSETS:
Fair value of assets, beginning of year $ 60,791 55,455 - -
Actual return on plan assets (net of expenses) 10,891 165 - -
Contributions by the employer 8,152 7,407 - -
Benefits paid (2,443) (2,236) - -
--------- --------- --------- ---------
Fair value of assets, end of year $ 77,391 60,791 - -
========= ========= ========= =========
RECONCILIATION OF FUNDED STATUS:
Funded status $ (39,554) (36,374) (6,267) (6,107)
Unrecognized prior service cost 1,438 1,688 (363) (395)
Unrecognized net (gain) loss 26,888 22,762 (228) 57
--------- --------- --------- ---------
Net amount recognized $ (11,228) (11,924) (6,858) (6,445)
========= ========= ========= =========
AMOUNTS RECOGNIZED IN THE STATEMENT OF
FINANCIAL POSITION:
Accrued benefit cost $ (11,228) (11,924) (6,858) (6,445)
Intangible asset - - - -
Accumulated comprehensive income - - - -
--------- --------- --------- ---------
Net amount recognized $ (11,228) (11,924) (6,858) (6,445)
========= ========= ========= =========
OTHER INFORMATION AS OF DECEMBER 31:
Accumulated benefit obligation $ 87,403 72,110 - -
WEIGHTED-AVERAGE LIABILITY ASSUMPTIONS AS OF
DECEMBER 31:
Discount rate 6.25% 6.75 6.25 6.75
Rate of compensation increase 5.00% 5.00 5.00 5.00
Retirement Income Plan Postretirement Plan
----------------------------------- ----------------------------------
(in thousands) 2003 2002 2001 2003 2002 2001
- --------------------------------------- -------- -------- -------- -------- -------- --------
COMPONENTS OF NET PERIODIC
BENEFIT COST:
Service cost $ 4,692 4,487 4,723 275 276 273
Interest cost 6,578 5,902 5,225 355 400 403
Expected return on plan assets (5,123) (4,904) (4,610) - - -
Amortization of unrecognized transition
obligation - - - - 23 46
Amortization of unrecognized
prior service cost 250 205 172 (32) (16) -
Amortization of unrecognized
net (gain) loss 1,151 252 11 (10) (5) (2)
-------- -------- -------- -------- -------- --------
Net periodic cost $ 7,548 5,942 5,521 588 678 720
======== ======== ======== ======== ======== ========
WEIGHTED-AVERAGE EXPENSE ASSUMPTIONS
FOR THE YEARS ENDED DECEMBER 31:
Discount rate 6.75% 7.25 7.50 6.75 7.25 7.50
Expected return on plan assets 8.25% 8.50 8.50 - - -
Rate of compensation increase 5.00% 5.00 5.00 5.00 5.00 5.00
69
All amounts in the reconciliations of funded status were recognized in the
consolidated balance sheets for 2003 and 2002. There were no amounts to be
included in other comprehensive income for the periods shown resulting from a
change in the minimum pension liability. The Company presently anticipates
contributing $7.9 million to the retirement income plan in 2004.
Our investment objective is to maximize total return while preserving capital to
meet plan obligations.
Our strategy is to utilize a long-term time horizon to design the portfolio in
such a manner as for the plan assets to achieve an appropriate balance between
equity and debt securities, alternative investments and cash. The asset
allocation is a function of the relative attractiveness of each asset class and
its risk/reward characteristics.
Our investment policy limits our asset allocation in equity investments to a
maximum of 60% of the total plan assets and alternative investments to a maximum
of 20% of the total plan assets. A combination of equity investments and
alternative investments is limited to 70% of the total market value of the plan
assets. Each individual category of private equity, hedge funds and real estate
has a limit of 10% of total plan assets. Additionally, a limit of 10% of total
plan assets is placed on non-U.S. equity investments, while no more than 10% of
total plan assets may be invested in the stock of Selective Insurance Group,
Inc., the plan sponsor. A limit of 10% of the plan's assets or 20% of debt
securities may be invested in non-investment grade securities.
Our 8.25% expected return on plan assets is based primarily on the plan's
long-term historical returns. Our expected return is supported by our actual
8.6% annualized 10 year return and 9.3% annualized return achieved since plan
inception for all plan assets. In addition to the plan's historical returns, we
consider long-term historical rates of return on the respective asset classes.
The weighted average asset allocation by percentage of the retirement income
plan at December 31 is as follows:
2003 2002
--------- ---------
Equity securities 46% 40
Debt securities 44 47
Alternative investments 8 9
Sponsoring company stock 2 2
Cash - 2
--------- ---------
Total 100% 100
========= =========
The retirement income plan holds investments in the common stock of the Company.
These investments amounted to $1.3 million at December 31, 2003 and $1.0 million
at December 31, 2002.
NOTE 15 INCENTIVE COMPENSATION PLANS
The Company has incentive compensation plans in which employees are eligible to
participate based on corporate and individual performance goals. The total
compensation costs charged to expense in connection with the plans were $13.0
million in 2003, $6.9 million in 2002 and $4.5 million in 2001.
NOTE 16 STOCK COMPENSATION PLANS
The Company has adopted the pro forma footnote disclosure-only provisions of FAS
123. See Note 2(n) for the pro forma effect on net income and earnings per share
if the Company had adopted FAS 123. The fair value of each option grant is
estimated on the date of grant using the Black Scholes option-pricing model with
the following weighted average assumptions for 2003, 2002 and 2001:
All Other Option Plans Employee Stock Purchase Plan
----------------------------- ------------------------------
2003 2002 2001 2003 2002 2001
------- ------- ------- -------- -------- --------
Risk free interest rate 3.46% 4.71% 5.07% 1.08% 1.50% 2.70%
Expected life 7 YEARS 7 years 7 years 6 MONTHS 6 months 6 months
Dividend yield 2.4% 2.4% 2.5% 2.4% 2.4% 2.5%
Expected volatility 25% 24% 24% 24% 35% 37%
70
The weighted-average fair value of options and stocks granted per share, during
the year for 2003, 2002 and 2001 is as follows:
2003 2002 2001
---------- ---------- ----------
Stock option plans $ 5.76 5.60 6.07
Restricted stock 23.54 21.19 22.86
Employee stock purchase plan:
Six month option 1.49 2.16 2.06
15% of grant date market value 3.85 3.74 2.86
---------- ---------- ----------
Total $ 5.34 5.90 4.92
========== ========== ==========
Agent stock purchase plan:
Discount* of grant date market value $ 2.74 2.41 2.40
*See Note 16(f)
A summary of the option transactions under the stock option plans is as follows:
Weighted
Stock average
Number appreciation exercise
of shares rights price
- -------------------------------- --------- -------------- ----------
Outstanding at December 31, 2000 1,835,592 14,000 $ 17.12
Granted 2001 194,350 - 22.43
Exercised 2001 (410,725) (4,000) 14.25
Forfeited 2001 (23,973) (10,000) 19.09
--------- -------------- ----------
Outstanding at December 31, 2001 1,595,244 - 18.44
Granted 2002 184,750 - 21.16
Exercised 2002 (438,963) - 16.84
Forfeited 2002 (20,827) - 21.27
--------- -------------- ----------
OUTSTANDING AT DECEMBER 31, 2002 1,320,204 - 19.31
GRANTED 2003 176,250 - 23.34
EXERCISED 2003 (313,723) - 17.13
FORFEITED 2003 (30,240) - 20.26
--------- -------------- ----------
OUTSTANDING AT DECEMBER 31, 2003 1,152,491 - $ 20.49
========= ============== ==========
Options exercisable and their weighted average exercise price at year end are
1,122,491 and $20.41 for 2003, 1,287,204 and $19.22 for 2002, and 1,562,244 and
$18.38 for 2001.
The following table summarizes information about stock options outstanding and
exercisable under the stock option plans at December 31, 2003:
Options Outstanding Options Exercisable
------------------------------------- ----------------------
Weighted
average
remaining Weighted Weighted
Range of contractual average average
exercise Number of life in exercise Number of exercise
prices shares years price shares price
- ----------------------------------------------------------------------------------------
$ 10 to 14 35,000 1.1 $ 13.55 35,000 $ 13.55
14 to 18 206,176 3.9 16.57 206,176 16.57
18 to 20 275,034 3.6 18.50 275,034 18.50
20 to 23 326,631 7.1 21.62 326,631 21.62
23 to 32 309,650 6.7 24.48 279,650 24.58
--------- ----------- -------- --------- --------
1,152,491 5.4 $ 20.49 1,122,491 $ 20.41
========= =========
(a) Stock Option Plan II
Under the Company's Stock Option Plan II, 836,046 shares of the Company's common
stock are available for issuance at December 31, 2003. The plan permits the
granting of qualified and nonqualified stock options to employees, which may or
may not have SARs attached. Options and related SARs may be granted at not less
than fair value on the date of the grant and may be
71
subject to certain vesting periods as determined by the Company's Salary and
Employee Benefits Committee (Committee). Each grant must be exercised within ten
years from the date of the grant. Under this plan, the Company did not grant any
options in 2003, but did grant 146,750 in 2002, and 161,350 in 2001.
Under the Company's Stock Option Plan II, the Committee may, at its discretion,
make restricted or unrestricted grants of common stock, or grant rights to
receive common stock, to employees in addition to or in substitution for options
and/or SARs granted. The Company did not grant restricted shares in 2003, but
did grant 208,588 in 2002, and 235,342 in 2001, and forfeited shares of 31,348
in 2003, 39,415 in 2002, and 52,969 in 2001. Each such grant must be expressly
subject to the attainment of one or more performance-related objectives for
certain executive officers, and may be subject to the attainment of one or more
performance-related objectives for other employees, as determined by the
Committee and set forth in an award agreement. Each such grant also is subject
to a vesting period or other terms, conditions, restrictions and limitations as
determined by the Committee at its discretion and set forth in an award
agreement.
During the vesting period, dividends are earned and held in escrow on the
restricted shares subject to the same vesting period and conditions as set forth
in the award agreement. Effective September 3, 1996, dividends earned on the
restricted shares are reinvested in the Company's common stock at fair value.
The Company issued through the dividend reinvestment feature (net of
forfeitures), restricted shares of 12,004 in 2003, 16,817 in 2002, and 16,929 in
2001, from the dividend reinvestment plan reserves.
Unearned stock compensation is recognized for the fair value of the restricted
shares when granted and is accounted for as a reduction of stockholders' equity.
This balance is amortized into compensation expense over the 4 year length of
the restriction along with the adjustment for the increases or decreases in the
fair value of the Company's common stock for share awards subject to
performance-related objectives. Unearned stock compensation of $4.0 million in
2003, $7.2 million in 2002, and $6.8 million in 2001 was recorded as a reduction
of stockholders' equity and the amounts amortized to compensation expense were
$3.6 million in 2003, $3.8 million in 2002, $3.0 million in 2001. This plan
expired on September 1, 2002 and was replaced with the Company's Stock Option
Plan III.
(b) Stock Option Plan III
In May 2002, the shareholders approved the Company's Stock Option Plan III,
which has 1,723,098 shares of the Company's common stock available for issuance
at December 31, 2003. The plan permits the granting of qualified and
nonqualified stock options to employees, which may or may not have stock
appreciation rights (SARs) attached. Options and related SARs may be granted at
not less than fair value on the date of the grant and may be subject to certain
vesting periods as determined by the Company's Salary and Employee Benefits
Committee (Committee). Each grant must be exercised within ten years from the
date of the grant. Under this plan, the Company granted options for 146,250
shares in 2003 and 5,000 shares in 2002.
Under the Company's Stock Option Plan III, the Committee may, at its discretion,
make restricted or unrestricted grants of common stock, or grant rights to
receive common stock, to employees in addition to or in substitution for options
and/or SARs granted. The Company granted total restricted shares of 264,069 for
2003 and 11,000 for 2002 and forfeited shares of 10,667 in 2003 with no shares
being forfeited in 2002. Each such grant must be expressly subject to the
attainment of one or more performance-related objectives for certain executive
officers, and may be subject to the attainment of one or more
performance-related objectives for other employees, as determined by the
Committee and set forth in an award agreement. Each such grant also is subject
to a vesting period or other terms, conditions, restrictions and limitations as
determined by the Committee at its discretion as set forth in an award
agreement. Dividends earned on the restricted shares are reinvested in the
Company's common stock at fair value. The Company issued through the dividend
reinvestment feature (net of forfeitures), 5,882 restricted shares in 2003 and
75 restricted shares in 2002.
Unearned stock compensation is recognized for the fair value of the restricted
shares when granted and is accounted for as a reduction of stockholders' equity.
This balance is amortized into compensation expense over the 4 year length of
the restriction along with the adjustment for the increases or decreases in the
fair value of the Company's common stock for share awards subject to the
performance related objectives. Unearned stock compensation of $5.3 million in
2003, and $0.2 million in 2002 was recorded as a reduction of stockholders'
equity and the amounts amortized to compensation expense were $1.5 million in
2003 and $14,000 in 2002.
(c) Employee Stock Purchase Plan
Under the terms of the employee stock purchase plan, the number of shares of
common stock available to be purchased is 318,062. This plan is available to all
employees who meet the eligibility requirements and provides for the issuance of
options to purchase shares of common stock. The purchase price is the lower of:
(i) 85% of the closing market price at the time the option is granted or (ii)
85% of the closing price at the time the option is exercised. The Company issued
shares to employees in the amount of 66,463 in 2003, 64,869 in 2002, and 72,460
in 2001.
72
(d) Stock Option Plan for Directors
Under the Company's stock option plan for directors, 688,000 shares of the
Company's common stock are available for issuance. Each director who is not a
full-time employee of the Company participates in the plan and automatically
receives a nonqualified option to purchase 3,000 shares of common stock at not
less than fair value on March 1 of each year. Each option becomes exercisable
one year after the option was granted and expires no more than ten years from
the date the option is granted. Under this plan, the Company granted 30,000
options in 2003 and 33,000 in 2002 and 2001.
(e) Stock Compensation Plan for Nonemployee Directors
In May 1996, the shareholders approved the stock compensation plan for
nonemployee directors, effective January 1, 1997. The purpose of this plan is to
provide for the payment of the annual compensation for the directors' services
in shares of the Company's common stock. The amount of common shares available
for issuance under the plan is 339,063. The Company issued 7,672 shares during
2003, 6,479 shares during 2002, and 6,120 shares during 2001 and charged to
expense $0.5 million in 2003, and $0.4 million in 2002 and 2001. The plan was
amended, effective January 1, 2001, to permit the directors to elect to receive
up to 50% of their compensation under the plan in cash for each calendar year.
Each non-employee director must elect on or before December 20th of each year
how compensation for the following year will be paid.
(f) Agent Stock Purchase Plan
Under the terms of the agents' stock purchase plan, the number of shares of
common stock available to be purchased is 727,816. This plan provides for
quarterly offerings in which independent insurance agents can purchase the
Company's common stock at a 10% discount with a one year restricted period
during which the shares purchased cannot be sold or transferred. Purchases made
prior to the December 1, 2001 quarterly offering were discounted at 5% with no
holding restrictions applied. The Company issued shares to agents in the amount
of 73,467 in 2003, 69,341 in 2002, and 40,883 in 2001 and charged to expense
$0.2 million in 2003, $0.2 million in 2002 and $0.1 million in 2001.
NOTE 17 RELATED PARTY TRANSACTIONS
In 1994, certain officers of Selective exercised stock options by signing
promissory notes in payment for the stock, totaling $1.0 million. The Company's
noninterest bearing promissory notes are secured by the common stock shares
issued upon exercise, which are held by the Company as collateral. The
promissory notes are full recourse and subject to certain employment
requirements. The outstanding principal amount was $0.1 million at December 31,
2003 and $0.2 million at December 31, 2002.
In August 1998, certain officers of Selective purchased stock on the open market
with proceeds advanced by the Company. These officers gave Selective promissory
notes totaling $1.8 million. The notes bear interest at 2.5% and are secured by
the purchased shares of Selective's common stock. The promissory notes are full
recourse and subject to certain employment requirements. The principal amount
outstanding was $0.6 million at December 31, 2003 and $0.7 million at December
31, 2002.
The Company has utilized the services of Chas. E. Rue & Sons, Inc., a general
insurance agency, of which William M. Rue, a director of Selective Insurance
Group, Inc., is the President and owner of more than a 5% equity interest. The
Company's Insurance Subsidiaries purchased insurance coverages from Chas. E. Rue
& Sons, Inc. with premiums of $1.3 million in 2003, $1.1 million in 2002, and
$1.0 million in 2001. As an independent agent for Selective, Chas. E. Rue &
Sons, Inc. received $1.6 million in commissions for insurance policies placed
with the Company's Insurance Subsidiaries in 2003, $1.3 million in 2002 and $1.2
million in 2001. Additionally, Chas E. Rue & Son, Inc., owns 20% of PL, LLC,
which is an insurance fund administrator that places reinsurance through the
Company. PL, LLC received reinsurance commissions of $0.1 million in 2003, $0.4
million in 2002 and $0.1 million in 2001. The Company believes that the related
party transactions with Chas. E. Rue & Sons, Inc. and PL, LLC were on terms as
fair to the Company as could have been obtained from unaffiliated third parties.
NOTE 18 COMMITMENTS AND CONTINGENCIES
(a) Reserves established for liability insurance, written primarily in the
general liability line of business, continue to reflect exposure to
environmental claims, both asbestos and non-asbestos. These claims have arisen
primarily under older policies containing exclusions for environmental liability
which certain courts, in interpreting such exclusions, have determined do not
bar such claims. The emergence of these claims is slow and highly unpredictable.
Since 1986, policies issued by the Insurance Subsidiaries have contained a more
expansive exclusion for losses related to environmental claims. There are
significant uncertainties in estimating our exposure to environmental claims
(for both case and IBNR reserves) resulting from lack of historical data, long
reporting delays, uncertainty as to the number and identity of claimants and
complex legal and coverage issues. Legal issues which arise in environmental
cases include the determination of whether a case is one for a federal or state
forum, choice of law, causation, admissibility of evidence, allocation of
damages and contribution among joint defendants, successor and predecessor
liability and whether direct action against insurers can be maintained. Coverage
issues which arise
73
in environmental cases include the interpretation and application of policy
exclusions, the determination and calculation of policy limits, the
determination of the ultimate amount of a loss, the extent to which a loss is
covered by a policy, if at all, the obligation of an insurer to defend a claim
and the extent to which a party can prove the existence of coverage. Courts have
reached different and sometimes inconsistent conclusions on these legal and
coverage issues. We do not discount to present value that portion of our loss
reserves expected to be paid in future periods.
At December 31, 2003, our reserves for environmental claims amounted to $42.3
million on a gross basis (including case reserves of $30.8 million and IBNR
reserves of $11.5 million) and $36.5 million on a net basis (including case
reserves of $28.8 million and IBNR reserves of $7.7 million). There are a total
of 3,058 environmental claims, including multiple claimants who are associated
with the same site or incident. Of these, 2,772 are asbestos related, of which
1,627 involve four insureds. The total case reserves associated with these four
insureds amounted to $3.9 million on a net and gross basis. The total case
reserves for asbestos related claims amounted to $7.0 million on a gross basis
and $6.0 million on a net basis. About 70 of the total environmental claims
involve 13 landfill sites. The landfill sites account for case reserves of $16.3
million on a gross basis and $16.1 million on a net basis. The remaining claims,
which account for $7.5 million of case reserves on a gross basis and $6.7
million on a net basis, involve leaking underground storage tanks and other
latent environmental exposures.
The following table details our exposures to various environmental claims:
2003
--------------------
GROSS NET
(in millions) --------- -------
Asbestos $ 9.3 7.0
Landfill sites 17.8 17.6
Other* 15.2 11.9
--------- -------
Total $ 42.3 36.5
========= =======
*Consists of leaking underground storage tanks, and other latent environmental
exposures.
IBNR reserve estimation is often difficult because, in addition to other
factors, there are significant uncertainties associated with critical
assumptions in the estimation process such as average clean-up costs,
third-party costs, potentially responsible party shares, allocation of damages,
insurer litigation costs, insurer coverage defenses and potential changes to
state and federal statutes. Moreover, normal historically-based actuarial
approaches are difficult to apply because relevant history is not available. In
addition, while models can be applied, such models can produce significantly
different results with small changes in assumptions.
We have established a range of reasonably possible IBNR losses for
non-environmental net claims of approximately $661.5 million to $818.4 million
at December 31, 2003 and of approximately $531.7 million to $674.6 million at
December 31, 2002. A low and high reasonable IBNR selection was derived
primarily by considering the range of indications calculated using standard
actuarial techniques. Our net IBNR reserves for non-environmental claims,
including loss expense reserves, were $733.7 million at December 31, 2003 and
$588.5 million at December 31, 2002.
74
The following table provides a roll-forward of gross and net environmental
incurred losses and loss expenses and related reserves thereon:
2003 2002 2001
---------------------------- -------------------------- ---------------------------
(in thousands) GROSS NET Gross Net Gross Net
------------- ----------- ----------- ----------- ------------ -----------
ASBESTOS
Reserves for losses and loss expenses
at the beginning of year $ 8,438 6,138 8,052 5,752 6,650 4,338
Incurred losses and loss expenses 1,371 1,371 761 761 1,665 1,677
Less losses and loss expenses paid (564) (564) (375) (375) (263) (263)
------------- ----------- ----------- ----------- ------------ -----------
Reserves for losses and loss expenses
at the end of year $ 9,245 6,945 8,438 6,138 8,052 5,752
============= =========== =========== =========== ============ ===========
NON-ASBESTOS
Reserves for losses and loss expenses
at the beginning of year $ 31,676 28,176 32,234 28,734 33,844 30,616
Incurred losses and loss expenses 5,568 5,543 2,168 2,130 1,748 1,471
Less losses and loss expenses paid (4,225) (4,200) (2,726) (2,688) (3,358) (3,353)
------------- ----------- ----------- ----------- ------------ -----------
Reserves for losses and loss expenses
at the end of year $ 33,019 29,519 31,676 28,176 32,234 28,734
============= =========== =========== =========== ============ ===========
TOTAL ENVIRONMENTAL CLAIMS
Reserves for losses and loss expenses
at the beginning of year $ 40,114 34,314 40,286 34,486 40,494 34,954
Incurred losses and loss expenses 6,939 6,914 2,929 2,891 3,413 3,148
Less losses and loss expenses paid (4,789) (4,764) (3,101) (3,063) (3,621) (3,616)
------------- ----------- ----------- ----------- ------------ -----------
Reserves for losses and loss expenses
at the end of year $ 42,264 36,464 40,114 34,314 40,286 34,486
============= =========== =========== =========== ============ ===========
Based on our aggregate reserve for net losses and loss expenses at December 31,
2003, we do not expect that liabilities associated with environmental and
non-environmental claims will have a materially adverse impact on our future
liquidity, financial position and results of operations. However, given the
complexity of coverage and other legal issues, and the significant assumptions
used in estimating such exposures, actual results could significantly differ
from our current estimates.
(b) The Company purchases annuities from life insurance companies to fulfill
obligations under claim settlements which provide for periodic future payments
to claimants. As of December 31, 2003, the Company had purchased such annuities
in the amount of $11.0 million for settlement of claims on a structured basis
for which the Company is contingently liable. To the Company's knowledge, none
of the issuers of such annuities have defaulted in their obligations thereunder.
(c) The Company has various operating leases for office space and equipment.
Such lease agreements, which expire at various times, are generally renewed or
replaced by similar leases. Rental expense under these leases amounted to $9.3
million in 2003, $8.2 million in 2002, and $9.1 million in 2001.
In addition, certain leases for rented premises and equipment are noncancelable,
and liability for payment will continue even though the space or equipment may
no longer be in use.
At December 31, 2003, the total future minimum rental commitments under
noncancelable leases was $23.9 million and such yearly amounts are as follows:
(in millions)
- ------------------------------------------
2004 $ 7.1
2005 6.0
2006 4.5
2007 3.0
2008 1.7
After 2008 1.6
-------
Total minimum payment required $ 23.9
=======
(d) The Company has additional investment commitments for its limited
partnership investments of up to $32.4 million. There is no certainty that any
additional investment will be required. See Note 3(k) for additional discussion
of our investments in limited partnerships.
75
(e) On May 21, 2003, a purported class action lawsuit was brought in the
Superior Court of New Jersey, Law Division - Camden County, against Consumer
Heath Network Plus, LLC (CHN), Alta Services, LLC, and Selective Insurance
Company of America (SICA) together with ten other unrelated defendants. The
lawsuit alleges that the defendants breached participating provider agreements
and insurance policies and were unjustly enriched. We are vigorously defending
this action, and the Company and the other defendants filed a Motion to Dismiss.
A hearing was held on the Motion and the Court ordered the plaintiffs to amend
their complaint by March 10, 2004. Since the lawsuit remains in its early
stages, management cannot at this time provide a meaningful estimate or range of
estimates of a potential loss, if any.
On October 15, 2003 and October 27, 2003, two related purported class action
lawsuits were brought by the same plaintiff in the Third Judicial Circuit Court
of Illinois against SICA. The first lawsuit alleges a class that covers all
states in which SICA does business and that it breached its insurance policies,
the Illinois Consumer Fraud and Deceptive Business Practice Act and similar laws
of other states and was unjustly enriched. The plaintiff also filed a Motion for
Class Certification. We are vigorously defending the lawsuit and have filed a
Motion to Dismiss. The second lawsuit also alleges a class that covers all
states in which SICA does business and also alleges that it breached its
insurance policies, the Illinois Consumer Fraud and Deceptive Business Practice
Act and similar laws of other states and was unjustly enriched. We are
vigorously defending the suit and have filed Motions to Dismiss.
NOTE 19 STATUTORY FINANCIAL INFORMATION
The Insurance Subsidiaries prepare their statutory financial statements in
accordance with accounting practices prescribed or permitted by the various
state insurance departments of domicile. Prescribed statutory accounting
practices include state laws, regulations and general administrative rules, as
well as a variety of publications of the National Association of Insurance
Commissioners (NAIC). Permitted statutory accounting practices encompass all
accounting practices that are not prescribed; such practices differ from state
to state, may differ from company to company within a state and may change in
the future. The Insurance Subsidiaries do not utilize any permitted statutory
accounting practices that materially affect the determination of statutory
surplus, statutory net income or risk-based capital. As of December 31, 2003 the
various state insurance departments of domicile have adopted the NAIC Accounting
Practices and Procedures manual, version as of March 2003, (NAIC SAP) in its
entirety, as a component of prescribed or permitted practices.
The Company's combined statutory capital and surplus was $666.2 million
(unaudited) in 2003 and $549.4 million in 2002. The Company's combined statutory
net income was $53.8 million (unaudited) in 2003, $29.4 million in 2002 and
$21.4 million in 2001.
The Company is required to maintain certain minimum amounts of statutory surplus
to satisfy their various state insurance departments of domicile. These
risk-based capital (RBC) requirements for property and casualty insurance
companies are designed to assess capital adequacy and to raise the level of
protection that statutory surplus provides for policyholders. Based upon the
Insurance Subsidiaries 2003 unaudited statutory financial statements, their
combined total adjusted capital exceeded the authorized control level RBC by
4.7:1, as defined by the NAIC.
NOTE 20 SUBSEQUENT EVENT
On January 1, 2004, the Parent purchased a property and casualty insurance
company, domiciled in Maine, with $5.0 million in surplus that currently does
not write any business, for $5.3 million.
76
Quarterly Financial Information(1)
First Quarter Second Quarter Third Quarter Fourth Quarter
------------------- ----------------- ----------------- -----------------
(unaudited, in thousands, except per share data) 2003 2002 2003 2002 2003 2002 2003 2002
- -----------------------------------------------------------------------------------------------------------------------------------
Net premiums written $ 323,403 281,445 306,863 268,287 317,513 267,439 271,380 236,316
Net premiums earned 267,047 234,295 276,139 244,498 289,681 251,991 300,203 257,484
Net investment income earned 27,343 24,504 29,436 25,100 27,324 24,493 30,645 28,970
Net realized gains (losses) 3,975 109 3,369 (411) 1,029 1,521 4,469 2,075
Diversified insurance services
revenue from continuing
operations(2) 21,338 18,833 23,481 20,720 24,453 21,321 22,568 19,923
Diversified insurance services
net income from continuing
operations(2) 1,301 943 1,779 1,068 1,892 1,256 1,189 785
Income from continuing operations,
net of tax(2) 8,038 10,299 19,749 8,371 14,717 11,112 23,841 12,359
Income (loss) from discontinued
operations, net of tax(2) - 2 - (126) - - - (47)
Net income 8,038 10,301 19,749 8,245 14,717 11,112 23,841 12,312
Other comprehensive
income (loss) (1,246) (6,021) 35,817 8,444 (12,747) 15,315 11,194 (341)
--------- ------- ------- ------- ------- ------- ------- -------
Comprehensive income 6,792 4,280 55,566 16,689 1,970 26,427 35,035 11,971
NET INCOME PER SHARE:
Basic 0.31 0.41 0.76 0.33 0.56 0.43 0.91 0.48
Diluted 0.29 0.39 0.72 0.31 0.53 0.41 0.86 0.46
Dividends to stockholders (3) 0.15 0.15 0.15 0.15 0.15 0.15 0.17 0.15
PRICE RANGE OF COMMON STOCK: (4)
High 26.48 27.74 26.90 31.48 31.85 28.07 33.00 26.34
Low 21.81 19.36 24.28 25.66 24.46 20.35 28.64 19.97
The addition of all quarters may not agree to annual amounts on the consolidated
financial statements due to rounding.
1. Refer to the Glossary of Terms on Exhibit 13 on Form 10-K.
2. See Note 13 to the consolidated financial statements and Financial Review for
a discussion of discontinued operations.
3. See Note 7(b) and Note 8 to the consolidated financial statements and
Financial Review for a discussion of dividend restrictions.
4. These ranges of high and low prices of the Company's common stock, as
reported by The Nasdaq National Market, represent actual transactions. All
price quotations do not include retail markups, markdowns and commissions.
The range of high and low prices for common stock for the period beginning
January 1, 2004 and ending January 31, 2004 was $35.60 to $31.72 and the last
sale price on January 31, 2004 was $35.40.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE.
None
ITEM 9A. CONTROLS AND PROCEDURES
An evaluation was carried out under the supervision and with the participation
of Selective's management, including its Chief Executive Officer and Chief
Financial Officer, of the effectiveness of the disclosure controls and
procedures (as defined in Rules 13a-15(e) of the Exchange Act). Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the disclosure controls and procedures were effective as of the end of the
period covered by this report.
No change in the Company's internal control over financial reporting (as defined
in Rule 13a-15(f) of the Exchange Act) occurred during the Company's fourth
fiscal quarter that materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting.
PART III
The Company will file with the Securities and Exchange Commission, within 120
days after the end of the fiscal year covered by this report, a definitive Proxy
Statement pursuant to Regulation 14A under the Securities Exchange Act of 1934
in connection with its 2004 Annual Meeting of Stockholders, which meeting will
include the election of directors. In
77
accordance with General Instruction G(3) of Form 10-K, the information required
by Items 10 through 14 is incorporated herein by reference to the Proxy
Statement.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
ITEM 11. EXECUTIVE COMPENSATION.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
ITEM 14. PRINCIPAL ACCOUNTANT'S FEES AND SERVICES
The information required by Items 10 through 14 is incorporated by reference to
Registrant's definitive proxy statement to be filed pursuant to Regulation 14A
under the Securities Exchange Act of 1934, as amended, within 120 days after
December 31, 2003.
78
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K.
(a) The following documents are filed as part of this report:
(1) Consolidated financial statements:
The consolidated financial statements of the Company listed below are included
in Item 8. "Financial Statements and Supplementary Data."
Form 10-K
Page
Consolidated Balance Sheets as of December 31, 2003 and 2002........................................... 46
Consolidated Statements of Income for the Years ended December 31, 2003, 2002 and 2001................. 47
Consolidated Statements of Stockholders' Equity for the Years ended December 31, 2003, 2002 and 2001... 48
Consolidated Statements of Cash Flows for the Years ended December 31, 2003, 2002 and 2001............. 49
Notes to Consolidated Financial Statements, December 31, 2003, 2002 and 2001........................... 50-76
(2) Financial statement schedules:
The financial statement schedules, with Independent Auditors' Report thereon,
required to be filed are listed below by page number as filed in this report.
All other schedules are omitted as the information required is inapplicable,
immaterial, or the information is presented in the consolidated financial
statements or related notes.
Form 10-K
Page
Independent Auditors' Report.................................................................. 80
Schedule I Summary of Investments - Other than Investments in Related Parties at December 31, 2003....... 83
Schedule II Condensed Financial Information of Registrant at December 31, 2003 and 2002, and for the years
ended December 31, 2003, 2002 and 2001........................................................ 84-86
Schedule III Supplementary Insurance Information for the years ended December 31, 2003, 2002 and 2001...... 87-89
Schedule IV Reinsurance for the years ended December 31, 2003, 2002 and 2001.............................. 90
Schedule V Allowance for Uncollectible Premiums and Other Receivables for the years ended 91
December 31, 2003, 2002 and 2001..............................................................
Schedule VI Supplemental Information for the years ended December 31, 2003, 2002 and 2001................. 92
(3) Exhibits:
The exhibits required by Item 601 of Regulation SK are listed in the Exhibit
Index, which immediately precedes the exhibits filed with this Form 10-K or
incorporated in this report by reference, and is incorporated herein by this
reference.
(b) Reports on Form 8-K.
In a report on Form 8-K dated and filed on October 8, 2003, the Company
reported, under Item 12. "Results of Operations and Financial
Condition," the impact of weather-related catastrophes on third quarter
2003 results.
79
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Stockholders
Selective Insurance Group, Inc.
We have audited the consolidated financial statements of Selective Insurance
Group, Inc., and its subsidiaries as listed in the accompanying index. In
connection with our audits of the consolidated financial statements, we have
also audited the financial statement schedules as listed in the accompanying
index. These consolidated financial statements and financial statement schedules
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements and financial
statement schedules based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States of America. Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Selective Insurance
Group, Inc. and its subsidiaries as of December 31, 2003 and 2002, and the
results of their operations and their cash flows for each of the years in the
three-year period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America. Also, in our
opinion the related financial statement schedules, when considered in relation
to the basic financial statements taken as a whole, present fairly, in all
material respects, the information set forth therein.
/s/ KPMG LLP
- ------------------
New York, New York
February 3, 2004
80
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SELECTIVE INSURANCE GROUP, INC.
By: /s/ Gregory E. Murphy March 1, 2004
-------------------------------------------
Gregory E. Murphy
Chairman of the Board, President and Chief Executive Officer
By: /s/ Dale A. Thatcher March 1, 2004
-------------------------------------------
Dale A. Thatcher
Executive Vice President of Finance, Chief Financial Officer and Treasurer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report
has been signed below by the following persons on behalf of the Registrant and
in the capacities and on the date indicated.
By: /s/ Gregory E. Murphy March 1, 2004
-------------------------------------------
Gregory E. Murphy
Chairman of the Board, President and Chief Executive Officer
By: /s/ Paul D. Bauer March 1, 2004
-------------------------------------------
Paul D. Bauer
Director
By: /s/ A. David Brown March 1, 2004
-------------------------------------------
A. David Brown
Director
By: /s/ William A. Dolan, II March 1, 2004
-------------------------------------------
William A. Dolan, II
Director
By: /s/ C. Edward Herder March 1, 2004
-------------------------------------------
C. Edward Herder
Director
81
By: /s/ William M. Kearns, Jr. March 1, 2004
-------------------------------------------
William M. Kearns, Jr.
Director
By: /s/ Joan M. Lamm-Tennant, Ph.D. March 1, 2004
-------------------------------------------
Joan M. Lamm-Tennant, Ph.D.
Director
By: /s/ S. Griffin McClellan, III March 1, 2004
-------------------------------------------
S. Griffin McClellan, III
Director
By: /s/ John F. Rockart March 1, 2004
-------------------------------------------
John F. Rockart
Director
By: /s/ William M. Rue March 1, 2004
-------------------------------------------
William M. Rue
Director
By: /s/ J. Brian Thebault March 1, 2004
-------------------------------------------
J. Brian Thebault
Director
82
SCHEDULE I
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
SUMMARY OF INVESTMENTS-OTHER THAN INVESTMENTS IN RELATED PARTIES
DECEMBER 31, 2003
Type of investment AMORTIZED COST FAIR CARRYING
(in thousands) OR COST VALUE AMOUNT
- ------------------------------------------------------------------------------------------------
DEBT SECURITIES:
Held-to-maturity:
Obligations of states and political subdivisions $ 72,128 75,280 72,128
Mortgage-backed securities 193 198 193
-------------- --------- ---------
Total debt securities, held-to-maturity 72,321 75,478 72,321
-------------- --------- ---------
Available-for-sale:
U.S. government and government agencies 157,797 169,226 169,226
Obligations of states and political subdivisions 772,430 796,130 796,130
Corporate securities 436,180 471,092 471,092
Asset-backed securities 24,460 25,177 25,177
Mortgage-backed securities 523,768 548,439 548,439
-------------- --------- ---------
Total debt securities, available-for-sale 1,914,635 2,010,064 2,010,064
-------------- --------- ---------
EQUITY SECURITIES, AVAILABLE-FOR-SALE:
Common stocks:
Public utilities 1,255 2,872 2,872
Banks, trust and insurance companies 33,004 58,983 58,983
Industrial, miscellaneous and all other 129,343 234,706 234,706
-------------- --------- ---------
Total equity securities, available-for-sale 163,602 296,561 296,561
-------------- --------- ---------
Short-term investments 23,043 23,043 23,043
Other investments 35,655 35,655 35,655
-------------- --------- ---------
Total investments $ 2,209,256 2,440,801 2,437,644
============== ========= =========
83
SCHEDULE II
SELECTIVE INSURANCE GROUP, INC
(PARENT CORPORATION)
BALANCE SHEETS
December 31,
(in thousands, except share amounts) 2003 2002
- ---------------------------------------------------------------------------------------------------
ASSETS
Debt securities, available-for-sale - at fair value (1)
(cost: $54,714 - 2003; $71,358 - 2002) $ 55,579 72,142
Short-term investments 6,786 10,311
Cash 12 59
Investment in subsidiaries 937,560 842,334
Current federal income tax 4,381 3,453
Deferred federal income tax 3,642 3,253
Other assets 11,400 7,435
----------- --------
Total assets $ 1,019,360 938,987
=========== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Senior convertible notes $ 115,937 115,937
Notes payable 121,500 145,500
Other liabilities 32,139 25,448
----------- --------
Total liabilities 269,576 286,885
----------- --------
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: 41,567,552 - 2003; 40,780,950 - 2002 83,135 81,562
Additional paid-in capital 113,283 95,435
Retained earnings 612,208 564,358
Accumulated other comprehensive income 148,452 113,629
Treasury stock - at cost (shares: 14,284,612 - 2003; 14,185,020 - 2002) (197,792) (195,295)
Unearned stock compensation and notes receivable from stock sales (9,502) (7,587)
----------- --------
Total stockholders' equity 749,784 652,102
----------- --------
Total liabilities and stockholders' equity $ 1,019,360 938,987
=========== ========
(1)As part of the Company's senior convertible note issuance in 2002, the
Company established a trust of approximately $72 million. As of December 2003,
approximately $53 million remains in the trust to provide funds for the notes
with maturities in the next two years.
Information should be read in conjunction with the Notes to consolidated
financial statements of Selective Insurance Group, Inc., and its subsidiaries in
Item 8. "Financial Statements and Supplementary Data" of the 2003 Report on Form
10-K.
84
SCHEDULE II (CONTINUED)
SELECTIVE INSURANCE GROUP, INC
(PARENT CORPORATION)
STATEMENTS OF INCOME
YEAR ENDED DECEMBER 31,
----------------------------------
(in thousands) 2003 2002 2001
- ------------------------------------------------------------------------------------------------
REVENUES:
Dividends from subsidiaries $ 26,331 21,248 29,229
Net investment income earned 2,131 707 240
Realized gains (losses) (94) 829 (1,092)
Other income 137 185 540
-------- -------- --------
Total revenues 28,505 22,969 28,917
-------- -------- --------
EXPENSES:
Interest expense 17,148 15,386 15,287
Other expenses 6,898 5,890 4,416
-------- -------- --------
Total expenses 24,046 21,276 19,703
-------- -------- --------
Income before federal income tax and equity in
undistributed income of subsidiaries 4,459 1,693 9,214
-------- -------- --------
FEDERAL INCOME TAX (BENEFIT) EXPENSE:
Current (5,067) (3,919) (5,989)
Deferred (418) 54 576
-------- -------- --------
Total federal income tax benefit (5,485) (3,865) (5,413)
-------- -------- --------
Income before equity in undistributed income of
subsidiaries, net of tax 9,944 5,558 14,627
Equity in undistributed income of subsidiaries, net of tax 54,595 38,216 11,066
-------- -------- --------
Net income $ 64,539 43,774 25,693
======== ======== ========
Information should be read in conjunction with the Notes to consolidated
financial statements of Selective Insurance Group, Inc. and its subsidiaries in
Item 8. "Financial Statements and Supplementary Data" of the 2003 Report on Form
10-K.
85
SCHEDULE II (CONTINUED)
SELECTIVE INSURANCE GROUP, INC
(PARENT CORPORATION)
STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
----------------------------------
(in thousands) 2003 2002 2001
- -------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES:
Net income $ 64,539 43,774 25,693
-------- -------- --------
Adjustments to reconcile net income to net cash provided by
operating activities:
Equity in undistributed income of subsidiaries, net of tax (54,595) (38,216) (11,066)
Increase in net federal income tax recoverable (1,345) (2,590) (940)
Net realized (gains) losses 94 (829) 1,092
Amortization of deferred compensation 5,095 3,848 3,006
Amortization - other 1,792 725 136
Other, net 2,644 9,418 (4,084)
-------- -------- --------
Net adjustments (46,315) (27,644) (11,856)
-------- -------- --------
Net cash provided by operating activities 18,224 16,130 13,837
-------- -------- --------
INVESTING ACTIVITIES:
Purchase of debt securities, available-for-sale (18,905) (71,931) -
Sale of debt securities, available-for-sale 33,885 - -
Purchase of other investments - - (243)
Purchase of subsidiaries - - (97)
Sale of subsidiary - 15,733 -
Sale of equity securities, available-for-sale - 95
-------- -------- --------
Net cash provided by (used in) investing activities 14,980 (56,198) (245)
-------- -------- --------
FINANCING ACTIVITIES:
Dividends to stockholders (16,689) (15,604) (15,174)
Capital contribution to subsidiaries (5,851) (58,500) -
Acquisition of treasury stock (2,497) (3,011) (10,732)
Proceeds from senior convertible notes - 112,750 -
Principal payment on note payable (24,000) (14,850) (11,767)
Net proceeds from dividend reinvestment plan 1,195 1,142 1,138
Net proceeds from stock purchase and compensation plans 11,011 12,630 10,621
Proceeds received on notes receivable from stock sale 55 129 42
-------- -------- --------
Net cash (used in) provided by financing activities (36,776) 34,686 (25,872)
-------- -------- --------
Net decrease in cash and short-term investments (3,572) (5,382) (12,280)
Cash and short-term investments at beginning of year 10,370 15,752 28,032
-------- -------- --------
Cash and short-term investments at end of year $ 6,798 10,370 15,752
======== ======== ========
Information should be read in conjunction with the Notes to consolidated
financial statements of Selective Insurance Group, Inc. and its subsidiaries in
Item 8. "Financial Statements and Supplementary Data" of the 2003 Report on Form
10-K.
86
SCHEDULE III
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
YEAR ENDED DECEMBER 31, 2003
Amortiza-
tion of
Reserve Losses deferred Other
Deferred policy for losses Net and loss policy operating
acquisition and loss Unearned premiums expenses acquisition expenses Net premiums
(in thousands) costs expenses premiums earned incurred costs (2) (1), (2) written
- -------------------------------------------------------------------------------------------------------------------------------
Commercial $138,214 1,188,479 481,598 920,409 637,469 270,388 26,080 999,486
Personal 34,172 214,723 115,491 212,661 161,161 54,207 9,017 219,673
Reinsurance
recoverable on
unpaid losses and
loss expenses - 184,611 - - - - - -
Prepaid
reinsurance
premiums - - 52,817 - - - - -
Interest and
general corporate
expenses - - - - - - 23,581 -
--------------- ---------- -------- ------------ -------- ----------- --------- ------------
Total $ 172,386 1,587,813 649,906 1,133,070 798,630 324,595 58,678 1,219,159
=============== ========== ======== ============ ======== =========== ========= ============
NOTE: A meaningful allocation of net investment income of $114,748 and net
realized gain on investments of $12,842 is considered impracticable
because the Company does not maintain distinct investment portfolios
for each segment.
(1) Other operating expenses includes $(1,421) of underwriting income that
is included in other income or other expense on the consolidated income
statement in Item 8. "Financial Statements and Supplementary Data" of
the 2003 Report on Form 10-K.
(2) The total, $383,273, of the amortization of deferred policy acquisition
cost $(324,595) and other operating expenses $(58,678) is reconciled to
the consolidated statements of income, as follows:
Policy acquisition costs $ 356,050
Dividends to policyholders 5,054
Interest expense 17,148
Other expenses 8,637
Other income (3,616)
-----------
Total $ 383,273
===========
87
SCHEDULE III (CONTINUED)
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
YEAR ENDED DECEMBER 31, 2002
Amortiza-
tion of
Deferred Reserve Losses deferred Other
policy for losses Net and loss policy operating Net
acquisition and loss Unearned premiums expenses acquisition expenses premiums
(in thousands) costs expenses premiums earned incurred costs (2) (1),(2) written
- ------------------------------------------------------------------------------------------------------------------------------
Commercial $ 118,022 1,018,900 402,522 788,454 554,742 230,117 24,730 849,215
Personal 30,136 224,151 108,478 199,814 159,838 50,438 7,146 204,272
Reinsurance
recoverable on
unpaid losses and
loss expenses - 160,374 - - - - - -
Prepaid reinsurance
premiums - - 46,141 - - - - -
Interest and general
corporate expenses - - - - - - 20,625 -
----------- ---------- -------- -------- -------- ----------- --------- ---------
Total $ 148,158 1,403,425 557,141 988,268 714,580 280,555 52,501 1,053,487
=========== ========== ======== ======== ======== =========== ========= =========
NOTE: A meaningful allocation of net investment income of $103,067 and net
realized gain on investments of $3,294 is considered impracticable
because the Company does not maintain distinct investment portfolios
for each segment.
(1) Other operating expenses includes $(327) of underwriting charges that
are included in other income or other expense on the consolidated
income statement in Item 8. "Financial Statements and Supplementary
Data" of the 2002 Report on Form 10-K.
(2) The total, $333,056, of the amortization of deferred policy acquisition
cost $(280,555) and other operating expenses $(52,501) is reconciled to
the consolidated statements of income, as follows:
Policy acquisition costs $ 307,505
Dividends to policyholders 5,762
Interest expense 15,093
Other expenses 8,221
Other income (3,525)
----------
Total $ 333,056
==========
88
SCHEDULE III (CONTINUED)
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
SUPPLEMENTARY INSURANCE INFORMATION
YEAR ENDED DECEMBER 31, 2001
Amortiza-
tion of
Losses deferred Other
Net and loss policy operating Net
premiums expenses acquisition expenses premiums
(in thousands) earned incurred costs (2) (1), (2) written
- ------------------------------------------------------------------------------------------
Commercial $ 678,321 480,993 201,380 28,849 723,842
Personal 204,727 174,891 55,860 1,713 201,578
Reinsurance
recoverable on
unpaid losses and
loss expenses - - - - -
Prepaid reinsurance
premiums - - - - -
Interest and general
corporate expenses - - - 18,820 -
------------ -------- ----------- --------- ---------
Total $ 883,048 655,884 257,240 49,382 925,420
============ ======== =========== ========= =========
NOTE: A meaningful allocation of net investment income of $96,767 and net
realized loss on investments of $6,816 is considered impracticable
because the Company does not maintain distinct investment portfolios
for each segment.
(1) Other operating expenses includes $868 of underwriting charges that are
included in other income or other expense on the consolidated income
statement in Item 8. "Financial Statements and Supplementary Data" of
the 2001 report on Form 10-K.
(2) The total, $306,622, of the amortization of deferred policy acquisition
cost $(257,240) and other operating expenses $(49,382) is reconciled to
the consolidated statements of income, as follows:
Policy acquisition costs $ 277,897
Dividends to policyholders 8,275
Interest expense 14,526
Other expenses 8,687
Other income (2,763)
---------
Total $ 306,622
=========
89
SCHEDULE IV
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
REINSURANCE
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
% Of
Assumed Ceded Amount
Direct From Other to Other Net Assumed
(in thousands) Amount Companies Companies Amount To Net
- ----------------------------------------------------------------------------------------------------
2003
Premiums earned:
Accident and health insurance $ 160 - - 160 -
Property and liability insurance 1,247,493 28,386 142,969 1,132,910 2.5%
------------ ---------- --------- ---------- -------
Total premiums earned $ 1,247,653 28,386 142,969 1,133,070 2.5%
============ ========== ========= ========== =======
2002
Premiums earned:
Accident and health insurance $ 201 - 3 198 -
Property and liability insurance 1,088,385 22,359 122,674 988,070 2.3%
------------ ---------- --------- ---------- -------
Total premiums earned $ 1,088,586 22,359 122,677 988,268 2.3%
============ ========== ========= ========== =======
2001
Premiums earned:
Accident and health insurance $ 198 - - 198 -
Property and liability insurance 960,948 20,327 98,425 882,850 2.3%
------------ ---------- --------- ---------- -------
Total premiums earned $ 961,146 20,327 98,425 883,048 2.3%
============ ========== ========= ========== =======
90
SCHEDULE V
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
ALLOWANCE FOR UNCOLLECTIBLE PREMIUMS AND OTHER RECEIVABLES
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
(in thousands) 2003 2002 2001
- ---------------------------------------------------------
Balance, January 1 $ 5,131 4,954 6,681
Additions 3,615 4,432 4,183
Deletions (2,215) (4,255) (5,910)
--------- ------ ------
Balance, December 31 $ 6,531 5,131 4,954
========= ====== ======
91
SCHEDULE VI
SELECTIVE INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
SUPPLEMENTAL INFORMATION
YEARS ENDED DECEMBER 31, 2003, 2002 AND 2001
Losses and loss expenses
incurred related to
------------------------------
(1) (2) Paid losses
Affiliation with Registrant Current Prior and loss
(in thousands) year years expenses
- -------------------------------------------------------------------------------
Consolidated Property & Casualty
Subsidiaries:
Year ended December 31, 2003 $ 783,580 15,050 638,479
---------- ---------- -----------
Year ended December 31, 2002 $ 694,744 19,836 603,356
---------- ---------- -----------
Year ended December 31, 2001 $ 642,173 13,711 635,844
---------- ---------- -----------
NOTE: The other information required in this schedule (e.g., deferred policy
acquisition costs, reserves for losses and loss expenses, unearned
premiums, net premiums earned, net investment income, amortization of
deferred policy acquisition costs, and net premiums written) is
contained in Schedule III in this report. In addition, the Company does
not discount loss reserves.
92
EXHIBIT INDEX
* Exhibits included within this 10-K filing
Exhibit
Number
- -------
3.1 Restated Certificate of Incorporation of Selective Insurance Group,
Inc., dated August 4, 1977, as amended, (incorporated by reference
herein to Exhibit 3.1 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1997, File No. 0-8641).
3.2 The Company's By-Laws, adopted on August 26, 1977, as amended,
(incorporated by reference herein to Exhibit 3.2 to the Company's
Annual Report on Form 10-K for the year ended December 31, 2001, file
No. 0-8641).
4.1 The form of Indenture dated December 29, 1982, between the Selective
Insurance Group, Inc. and Midlantic National Bank, as Trustee relating
to the Company's 8 3/4% Subordinated Convertible Debentures due 2008
(incorporated by reference herein to Exhibit 4.3 to the Company's
Registration Statement on Form S-3 No. 2-80881).
4.2 The form of Indenture dated September 24, 2002, between Selective
Insurance Group, Inc., and National City Bank as Trustee relating to
the Company's 1.6155% Senior Convertible Notes due September 24, 2032,
(incorporated by reference herein to the Company's Regulation Statement
in Form S-3 No. 333-101489).
4.3 Amended and Restated Rights Agreement, dated February 2, 1999, between
Selective Insurance Group, Inc. and First Chicago Trust, (incorporated
by reference herein to the Company's Current Report on Form 8-K filed
February 2, 1999, File No. 0-8641.)
10.1 The Selective Insurance Retirement Savings Plan as amended through
August 15, 1996 (incorporated by reference herein to Exhibit 4 to the
Company's Registration Statement on Form S-8 No. 333-10477).
10.1a Amendment, dated May 2, 1997, to the Selective Insurance Retirement
Savings Plan in Exhibit 10.1 above (incorporated by reference herein to
Exhibit 10.6 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1997, File No. 0-8641).
10.1b Amendment and restatement, effective January 1, 1997, to the Selective
Insurance Retirement Savings Plan, filed herewith.
10.1c Amendment Number 1 to the amended and restated Selective Insurance
Retirement Savings Plan effective January 1, 2002, filed herewith.
10.1d Amendment Number 2 to the amended and restated Selective Insurance
Retirement Savings Plan effective January 1, 1997, filed herewith.
10.2 The Retirement Income Plan for Employees of Selective Insurance Company
of America, as amended through May 6, 1994 (incorporated by reference
herein to Exhibit 10.2 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1994, File No. 0-8641).
10.2a Amendment and restatement, effective January 1, 1997, to the Retirement
Income Plan for Selective Insurance Company of America, filed herewith.
10.2b Amendment Number 1 to the amended and restated Retirement Income Plan
for Selective Insurance Company of America, effective July 1, 2002,
filed herewith.
10.2c Amendment Number 2 to the amended and restated Retirement Income Plan
for Selective Insurance Company of America, effective January 1, 2003,
filed herewith.
10.2d Amendment Number 3 to the amended and restated Retirement Income Plan
for Selective Insurance Company of America, effective January 1, 1997,
filed herewith.
10.3 Selective Insurance Company of America Deferred Compensation Plan,
effective July 1, 2002, (incorporated by reference herein to Exhibit
99.1 of the Company's Registration Statement on Form S-8, No.
333-97799).
10.4 Selective Insurance Group, Inc. Stock Option Plan II, as amended
through October 9, 1997, and related forms of option agreements
(incorporated by reference herein to Exhibits 4.1 to the Company's
Registration Statement on Form S-8 No. 333-37501).
93
10.4a The Selective Insurance Group, Inc. Stock Option Plan II, as amended
through July 28, 1998, (incorporated by reference herein to Exhibit
10.13a to the Company's Annual Report on Form 10-K for the year ended
December 31, 1993, File No. 0-8641).
10.4b The Selective Insurance Group, Inc. Stock Option Plan II, as amended
through January 31, 2000, (incorporated by reference herein to Exhibit
10.13b to the Company's Annual Report on Form 10-K for the year ended
December 31, 1999, File No. 0-8641).
10.5 The Selective Insurance Group, Inc. Stock Option Plan III (incorporated
by reference herein to Exhibit A to the Company's Definitive Proxy
Statement for its 2002 Annual Meeting of Stockholders' filed with the
Securities and Exchange Commission on April 1, 2002).
10.6 Deferred Compensation Plan for Directors (incorporated by reference
herein to Exhibit 10.5 to the Company's Annual Report on Form 10-K for
the year ended December 31, 1993, File No. 0-8641).
10.7 The Company's 1987 Employee Stock Purchase Savings Plan (incorporated
by reference herein to Exhibit 10.6 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1993, File No. 0-8641).
10.7a Amendment, dated May 2, 1997, to the 1987 Employee Stock Purchase
Savings Plan in Exhibit 10.6 above (incorporated by reference herein to
Exhibit 10.5 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1997, File No. 0-8641).
*10.8 Description of Annual Cash Incentive Program (ACIP).
10.9 The Selective Insurance Group, Inc. Stock Purchase Plan for Independent
Insurance Agents, as amended (incorporated by reference herein to the
Company's Post Effective Amendment No. 2 on Form S-3 No. 033-30833).
10.10 The Selective Insurance Group, Inc. Stock Option Plan for Directors, as
amended (incorporated by reference herein to Exhibit 4.4 of the
Company's Registration Statement on Form S-8 No. 333-10477).
10.11 The Selective Insurance Group, Inc. Stock Compensation Plan for
Nonemployee Directors (incorporated by reference herein to Exhibit 4 to
the Company's Registration Statement on Form S-8 No. 333-10465).
10.11a The Selective Insurance Group, Inc. Stock Compensation Plan for
Nonemployee Directors, as amended (incorporated by reference herein to
Exhibit A to the Company's Definitive Proxy Statement for its 2000
Annual Meeting of Stockholders filed with the Securities and Exchange
Commission on March 31, 2000).
10.12 Employment, Termination and Severance Agreements.
10.12a Employment Agreement with Gregory E. Murphy, dated August 1, 1995
(incorporated by reference herein to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30, 1995,
File No. 0-8641).
10.12a1 Amendment Number 1, dated May 1, 1998, to the Employment Agreement with
Gregory E. Murphy (incorporated by reference herein to Exhibit 10.4 to
the Company's Quarterly Report on Form 10-Q for the quarter ended June
30, 1998, File No. 0-8641).
10.12a2 Amendment Number 2, dated May 5, 2000, to the Employment Agreement with
Gregory E. Murphy (incorporated by reference herein to Exhibit 10.16a
to the Company's Quarterly Report on Form 10-Q for the quarter ended
June 30, 2000, File No. 0-8641).
10.12a3 Amendment Number 3, dated August 1, 2001, to the Employment Agreement
with Gregory E. Murphy (incorporated by reference herein to Exhibit
10.16a to the Company's Quarterly Report on Form 10-Q for the quarter
ended September 30, 2001, File No. 0-8641).
10.12b Termination Agreement, dated August 1, 1995, between Selective
Insurance Company of America and Gregory E. Murphy (incorporated by
reference herein to Exhibit 10.2 to the Company's Quarterly Report on
Form 10-Q for the quarter ended September 30, 1995, File No. 0-8641).
10.12b1 Amendment Number 1, dated December 16, 1998, to the Termination
Agreement between Selective Insurance Company of America and Gregory E.
Murphy (incorporated by reference herein to Exhibit 10.16t to the
Company's Annual Report on Form 10-K for the year ended December 31,
1998, File No. 0-8641).
10.12c Employment Agreement with Jamie Ochiltree, III, dated October 31, 1995
(incorporated by reference herein to Exhibit 10.11f to the Company's
Annual Report on Form 10-K for the year ended December 31, 1995, File
No. 0-8641).
10.12c1 Amendment Number 1, dated October 31, 1998, to the Employment Agreement
with Jamie Ochiltree, III (incorporated by reference herein to Exhibit
10.16r to the Company's Annual Report on Form 10-K for the year ended
December 31, 1998, File No. 0-8641).
94
10.12c2 Amendment Number 2, dated May 5, 2000, to the Employment Agreement with
Jamie Ochiltree, III (incorporated by reference herein to Exhibit
10.16b to the Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2000, File No. 0-8641).
10.12c3 Amendment Number 3, dated October 31, 2001, to the Employment Agreement
with Jamie Ochiltree, III (incorporated by reference herein to Exhibit
10.16c to the Company's Quarterly Report on Form 10-Q for the quarter
ended September 30, 2001, File No. 0-8641).
10.12d Termination Agreement, dated August 1, 1995, between Selective
Insurance Company of America and Jamie Ochiltree, III (incorporated by
reference herein to Exhibit 10.11j to the Company's Annual Report on
Form 10-K for the year ended December 31, 1995, File No. 0-8641).
10.12d1 Amendment Number 1, dated December 16, 1998, to the Termination
Agreement between Selective Insurance Company of America and Jamie
Ochiltree, III (incorporated by reference herein to Exhibit 10.16v to
the Company's Annual Report on Form 10-K for the year ended December
31, 1998, File No. 0-8641).
10.12e Employment Agreement, dated May 2, 1997, between Selective Insurance
Company of America and James W. Coleman, Jr. (incorporated by reference
herein to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1997, File No. 0-8641).
10.12e1 Amendment Number 1, dated May 5, 2000, to the Employment Agreement with
James W. Coleman, Jr. (incorporated by reference herein to Exhibit
10.16c to the Company's Quarterly Report on Form 10-Q for the quarter
ended June 30, 2000, File No. 0-8641).
10.12e2 Amendment Number 2, dated March 1, 2003, to the Employment Agreement
with James W. Coleman, Jr., filed herewith.
10.12f Termination Agreement, dated May 2, 1997, between Selective Insurance
Company of America and James W. Coleman, Jr. (incorporated by reference
herein to Exhibit 10.4 to the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1997, File No. 0-8641).
10.12f1 Amendment Number 1, dated December 16, 1998, to the Termination
Agreement between Selective Insurance Company of America and James W.
Coleman, Jr. (incorporated by reference herein to Exhibit 10.16w to the
Company's Annual Report on Form 10-K for the year ended December 31,
1998, File No. 0-8641).
10.12g Termination Agreement, dated September 27, 1999, between Selective
Insurance Company of America and Ronald J. Zaleski, (incorporated by
reference herein to Exhibit 10.16z to the Company's Annual Report on
Form 10-K for the year ended December 31, 1999, File No. 0-8641).
10.12h Termination Agreement, dated March 1, 2000, between Selective Insurance
Company of America and Eduard Pulkstenis (incorporated by reference
herein to Exhibit 10.16ab to the Company's Quarterly Report on Form
10-Q for the quarter ended March 31, 2000, File No. 0-8641).
10.12i Employment Agreement with Dale A. Thatcher, dated May 5, 2000
(incorporated by reference herein to Exhibit 10.16f to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, File
No. 0-8641).
10.12i1 Amendment Number 1, dated March 1, 2003, to the Employment Agreement
with Dale A. Thatcher, filed herewith.
10.12j Termination Agreement with Dale A. Thatcher, dated May 5, 2000
(incorporated by reference herein to Exhibit 10.16g to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2000, File
No. 0-8641).
10.12k Employment Agreement with Richard F. Connell, dated August 8, 2000
(incorporated by reference herein to Exhibit 10.16a to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30, 2000,
File No. 0-8641).
10.12k1 Amendment Number 1, dated March 1, 2003, to the Employment Agreement
with Richard F. Connell, filed herewith.
10.12l Termination Agreement with Richard F. Connell, dated August 8, 2000
(incorporated by reference herein to Exhibit 10.16b to the Company's
Quarterly Report on Form 10-Q for the quarter ended September 30, 2000,
File No. 0-8641).
10.12m Termination agreement with Sharon R. Cooper, dated May 3, 2001
(incorporated by reference herein to Exhibit 10.16a to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2001, File
No. 0-8641).
95
10.13 Form of Note Purchase Agreement dated as of August 1, 1994 with respect
to Selective Insurance Group, Inc. 8.77% Senior Notes due August 1,
2005 (incorporated by reference herein to Exhibit 99.2 to the Company's
Post-Effective Amendment No. 1 to the Registration Statement on Form
S-3, No. 33-30833).
10.14 Promissory Note of $25,000,000 Revolving Line of Credit with State
Street Bank and Trust Company (incorporated by reference herein to
Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the
quarter ended March 31, 1997, File No. 0-8641).
10.14a Amendment, dated June 30, 1998, to the Promissory Note of $25,000,000
Revolving Line of Credit with State Street Bank and Trust Company in
Exhibit 10.14 above, (incorporated by reference herein to Exhibit 10.2
to the Company's Quarterly Report on Form 10-Q for the quarter ended
June 30, 1998, File No. 0-8641).
10.14a1 Amendment, dated November 6, 1998, to the Promissory Note of
$25,000,000 Revolving Line of Credit with State Street Bank and Trust
Company in Exhibit 10.14 above, (incorporated by reference herein to
Exhibit 10.24 to the Company's Annual Report on Form 10-K for the year
ended December 31, 1998, File No. 0-8641).
10.14a2 Amendment, dated June 30, 2000, to the Promissory Note of $25,000,000
Revolving Line of Credit with State Street Bank and Trust Company in
Exhibit 10.14 above, (incorporated by reference herein to Exhibit 10.1
to the Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2000, File No. 0-8641).
10.14a3 Amendment, dated June 29, 2001, to the Promissory Note of $25,000,000
Revolving Line of Credit with State Street Bank and Trust Company in
Exhibit 10.14 above, (incorporated by reference herein to Exhibit 10.1
to the Company's Quarterly Report on Form 10-Q for the quarter ended
September 30, 2001, File No. 0-8641).
10.14a4 Amendment, dated June 30, 2003, to the Promissory Note of $20,000,000
Line of Credit with State Street Bank and Trust Company with respect to
Selective Insurance Company of America and Selective Insurance Group,
Inc. (incorporated by reference herein to Exhibit 10.2 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, File
No. 0-8641).
10.15 Commercial Loan Note of $25,000,000 Line of Credit with First Union
National Bank as of October 22, 1999, (incorporated by reference herein
to Exhibit 10.28 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2000, File No. 0-8641).
10.15a Fifth amendment, dated June 28, 2002, effective through June 27, 2003,
to the $25,000,000 Line of Credit Agreement dated October 22, 1999,
between Wachovia Bank, National Association (formerly known as First
Union National Bank) and Selective Insurance Group, Inc. and Selective
Insurance Company of America, (incorporated by reference herein to
Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2002, File No. 0-8641).
10.15a1 Seventh amendment, dated June 27, 2003, effective through June 26,
2004, to the $25,000,000 Line of Credit Agreement dated October 22,
1999, between Wachovia Bank, National Association and Selective
Insurance Group, Inc. and Selective Insurance Company of America
(incorporated by reference herein to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2003, File
No. 0-8641).
* 11 Computation of earnings per share, filed herewith.
* 13 Glossary of Terms, filed herewith.
* 21 Subsidiaries of Selective Insurance Group, Inc., filed herewith.
* 23 Consent of Independent Auditors, filed herewith.
* 31.1 Certification of Chief Executive Officer in accordance with
Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.
* 31.2 Certification of Chief Financial Officer in accordance with
Section 302 of the Sarbanes-Oxley Act of 2002, filed herewith.
* 32.1 Certification of Chief Executive Officer in accordance with
Section 906 of the Sarbanes-Oxley Act of 2002, furnished herewith.
* 32.2 Certification of Chief Financial Officer in accordance with
Section 906 of the Sarbanes-Oxley Act of 2002, furnished herewith.
96