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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(MARK ONE)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended: March 31, 2004
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from ________________ to ____________
Commission file number: 0-8641
SELECTIVE INSURANCE GROUP, INC.
-------------------------------
(Exact name of registrant as specified in its charter)
New Jersey 22-2168890
- -------------------------------- --------------------------------
(State or other jurisdiction of (IRS Employer Identification No.)
incorporation or organization)
40 Wantage Avenue
Branchville, New Jersey 07890
- ---------------------------------------- --------
(Address of principal executive offices) (Zip Code)
(973) 948-3000
-----------------------------------------
(Registrant's telephone number, including
area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such report), and (2) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act)
Yes [X] No [ ]
Indicate the number of shares outstanding of each of the issuer's classes of
common stock as of the latest practicable date:
Common stock, par value $2 per share, outstanding as of March 31, 2004:
27,719,426
SELECTIVE INSURANCE GROUP, INC
Consolidated Balance Sheets
(in thousands, except share amounts)
UNAUDITED
MARCH 31, DECEMBER 31,
2004 2003
- ---------------------------------------------------------------------------------------------------------
ASSETS
INVESTMENTS:
Debt securities, held-to-maturity - at amortized cost
(fair value: $68,718-2004; $75,478-2003) $ 65,982 72,321
Debt securities, available-for-sale - at fair value
(amortized cost: $1,963,601-2004; $1,914,635-2003) 2,084,082 2,010,064
Equity securities, available-for-sale - at fair value
(cost of: $172,844-2004; $ 163,602-2003) 315,560 296,561
Short-term investments - (at cost which approximates fair value) 43,861 23,043
Other investments 38,708 35,655
------------ ---------
Total investments 2,548,193 2,437,644
Cash 52 12
Interest and dividends due or accrued 23,918 24,001
Premiums receivables, net of allowance for uncollectible accounts of:
$3,121-2004 and 2003 459,251 407,633
Other trade receivables, net of allowance for uncollectible accounts of:
$687-2004; $1,085-2003 23,073 21,567
Reinsurance recoverable on paid losses and loss expenses 11,039 7,726
Reinsurance recoverable on unpaid losses and loss expenses 176,477 184,611
Prepaid reinsurance premiums 51,308 52,817
Real estate, furniture, equipment, and software development-at cost, net of
accumulated depreciation and amortization 53,063 53,317
Deferred policy acquisition costs 184,622 172,386
Goodwill 43,230 43,612
Other assets 33,985 33,456
------------ ---------
Total assets $ 3,608,211 3,438,782
============ =========
LIABILITIES AND STOCKHOLDERS' EQUITY
LIABILITIES:
Reserve for losses $ 1,428,055 1,400,770
Reserve for loss expenses 192,995 187,043
Unearned premiums 708,353 649,906
Senior convertible notes 115,937 115,937
Notes payable 121,500 121,500
Current federal income tax 8,398 7,961
Deferred federal income tax 26,497 12,677
Commissions payable 41,173 53,717
Accrued salaries and benefits 56,911 56,942
Other liabilities 107,930 82,545
------------ ---------
Total liabilities 2,807,749 2,688,998
------------ ---------
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: 42,082,362-2004; 41,567,552-2003 84,165 83,135
Additional paid-in capital 129,554 113,283
Retained earnings 635,062 612,208
Accumulated other comprehensive income 171,078 148,452
Treasury stock - at cost (shares: 14,362,936-2004; 14,284,612-2003) (200,588) (197,792)
Unearned stock compensation and notes receivable from stock sales (18,809) (9,502)
------------ ---------
Total stockholders' equity 800,462 749,784
------------ ---------
Total liabilities and stockholders' equity $ 3,608,211 3,438,782
============ =========
See accompanying notes to unaudited interim consolidated financial statements.
2
SELECTIVE INSURANCE GROUP, INC
Consolidated Statements of Income
(in thousands, except per share amounts)
UNAUDITED
QUARTER ENDED
MARCH 31,
2004 2003
- --------------------------------------------------------------------------------------------
REVENUES:
Net premiums written $ 375,262 323,403
Net (increase) in unearned premiums and prepaid reinsurance premiums (59,956) (56,356)
---------- -------
Net premiums earned 315,306 267,047
Net investment income earned 29,460 27,343
Net realized gains 5,346 3,975
Diversified insurance services revenue 24,231 21,338
Other income 777 782
---------- -------
Total revenues 375,120 320,485
---------- -------
EXPENSES:
Losses incurred 176,559 170,728
Loss expenses incurred 33,758 28,374
Policy acquisition costs 97,464 84,549
Dividends to policyholders 1,089 1,555
Interest expense 4,005 4,539
Diversified insurance services expenses 22,038 19,471
Other expenses 2,671 1,909
---------- -------
Total expenses 337,584 311,125
---------- -------
Income before federal income tax 37,536 9,360
---------- -------
FEDERAL INCOME TAX EXPENSE (BENEFIT):
Current 8,372 1,780
Deferred 1,636 (458)
---------- -------
Total federal income tax expense 10,008 1,322
---------- -------
Net income $ 27,528 8,038
========== =======
EARNINGS PER SHARE:
Basic net income $ 1.04 0.31
Diluted net income $ 0.88 0.29
Dividends to stockholders $ 0.17 0.15
See accompanying notes to unaudited interim consolidated financial statements.
3
SELECTIVE INSURANCE GROUP, INC.
Consolidated Statements of Stockholders' Equity
(in thousands, except per share amounts)
UNAUDITED
THREE MONTHS ENDED
MARCH 31,
2004 2003
- ---------------------------------------------------------------------------------------------------------
COMMON STOCK:
Beginning of year $ 83,135 81,562
Dividend reinvestment plan
(shares: 13,723-2004; 12,251-2003) 28 24
Convertible subordinated debentures
(shares: 9,180 -2004; 7,768-2003) 18 16
Stock purchase and compensation plans
(shares: 491,907-2004; 341,551-2003) 984 683
-------------- --------
End of period 84,165 82,285
-------------- --------
ADDITIONAL PAID-IN CAPITAL:
Beginning of year 113,283 95,435
Dividend reinvestment plan 479 263
Convertible subordinated debentures 47 39
Stock purchase and compensation plans 15,745 6,961
-------------- --------
End of period 129,554 102,698
-------------- --------
RETAINED EARNINGS:
Beginning of year 612,208 562,553
Net income 27,528 27,528 8,038 8,038
Cash dividends to stockholders ($0.17 per share-2004; $0.15
per share-2003) (4,674) (4,010)
-------------- --------
End of period 635,062 566,581
-------------- --------
ACCUMULATED OTHER COMPREHENSIVE INCOME:
Beginning of year 148,452 115,434
Other comprehensive income, increase in net unrealized gains
on available-for-sale securities, net of deferred income tax
effect of: $12,183-2004; $(671)-2003 22,626 22,626 (1,246) (1,246)
-------------- ------ -------- ------
End of period 171,078 114,188
-------------- --------
Comprehensive income 50,154 6,792
====== ======
TREASURY STOCK:
Beginning of year (197,792) (195,295)
Acquisition of treasury stock
(shares 78,324-2004; 61,968-2003) (2,796) (1,442)
-------------- --------
End of period (200,588) (196,737)
-------------- --------
UNEARNED STOCK COMPENSATION AND NOTES RECEIVABLE FROM STOCK
SALES:
Beginning of year (9,502) (7,587)
Unearned stock compensation (11,097) (5,488)
Amortization of deferred compensation expense and
amounts received on notes 1,790 948
-------------- --------
End of period (18,809) (12,127)
-------------- --------
Total stockholders' equity $ 800,462 656,888
============== ========
The Company also has authorized, but not issued, 5,000,000 shares of preferred
stock without par value of which 300,000 shares have been designated Series A
junior preferred stock without par value.
See accompanying notes to unaudited interim consolidated financial statements.
4
SELECTIVE INSURANCE GROUP, INC.
Consolidated Statements of Cash Flows
(in thousands)
UNAUDITED
THREE MONTHS ENDED
MARCH 31,
2004 2003
- --------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net income $ 27,528 8,038
---------- --------
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 41,371 44,828
Increase in unearned premiums, net of prepaid reinsurance and advance premiums 59,580 56,357
Decrease (increase) in federal income tax recoverable 3,409 (800)
Depreciation and amortization 3,927 2,236
Amortization of deferred compensation 1,767 920
Increase in premiums receivables (51,618) (53,336)
Increase in other trade receivables (1,506) (2,317)
Increase in deferred policy acquisition costs (12,236) (11,241)
Decrease in interest and dividends due or accrued 86 1,356
Increase in reinsurance recoverable on paid losses and loss expenses (3,313) (2,425)
Net realized gains (5,346) (3,975)
(Decrease) increase in accrued salaries and benefits (31) 3,444
Decrease in accrued insurance expenses (15,130) (8,353)
Other, net 6,682 6,248
---------- --------
Net adjustments 27,642 32,942
---------- --------
Net cash provided by operating activities 55,170 40,980
---------- --------
INVESTING ACTIVITIES
Purchase of debt securities, available-for-sale (115,524) (174,666)
Purchase of equity securities, available-for-sale (18,594) (14,534)
Purchase of other investments (3,157) (220)
Purchase and adjustments of subsidiaries acquired (net of cash equivalents acquired of
$4,890 in 2004) (407) -
Sale of debt securities, available-for-sale 23,336 70,037
Redemption and maturities of debt securities, held-to-maturity 6,349 16,631
Redemption and maturities of debt securities, available-for-sale 42,866 48,251
Sale of equity securities, available-for-sale 13,748 1,499
Proceeds from other investments 2,249 3
Increase in net payable for security transactions 19,663 15,943
Net additions to real estate, furniture, equipment and software development (2,198) (2,382)
---------- --------
Net cash used in investing activities (31,669) (39,438)
---------- --------
FINANCING ACTIVITIES
Dividends to stockholders (4,674) (4,010)
Acquisition of treasury stock (2,796) (1,442)
Net proceeds from dividend reinvestment plan 507 287
Net proceeds from stock purchase and compensation plans 4,297 2,156
Proceeds received on notes receivable from stock sales 23 28
---------- --------
Net cash used in financing activities (2,643) (2,981)
---------- --------
Net increase (decrease) in short-term investments and cash 20,858 (1,439)
Short-term investments and cash at beginning of year 23,055 26,928
---------- --------
Short-term investments and cash at end of period $ 43,913 25,489
========== ========
SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION
CASH PAID DURING THE PERIOD FOR:
Interest $ 4,094 4,832
Federal income tax 6,600 2,000
SUPPLEMENTAL SCHEDULE OF NON-CASH FINANCING ACTIVITY:
Conversion of convertible subordinated debentures 65 55
Unearned stock compensation 11,097 5,488
See accompanying notes to unaudited interim consolidated financial statements.
5
NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
The interim consolidated financial statements, which have been prepared
in accordance with accounting principles generally accepted in the
United States of America (GAAP) are unaudited, but reflect all
adjustments which, in the opinion of management, are necessary to
provide a fair statement of the results of Selective Insurance Group,
Inc. and its consolidated subsidiaries for the interim periods
presented. References herein to "Selective" are to Selective Insurance
Group, Inc. and its subsidiaries. All such adjustments are of a normal
recurring nature. The results of operations for any interim period are
not necessarily indicative of results for a full year. These interim
consolidated financial statements cover the first quarters ended March
31, 2004 (First Quarter 2004) and March 31, 2003 (First Quarter 2003).
This document should be read in conjunction with the consolidated
financial statements and notes thereto contained in our Annual Report
on Form 10-K for the year ended December 31, 2003.
2. RECLASSIFICATIONS
Certain amounts in the Company's prior year interim consolidated
financial statements and related footnotes have been reclassified to
conform to the 2004 presentation. Such reclassification had no effect
on the Company's net income or stockholders' equity.
3. ADOPTION OF ACCOUNTING PRONOUNCEMENTS
In December 2003, the Financial Accounting Standards Board (FASB)
issued revised FASB Interpretation No. 46, "Consolidation of Variable
Interest Entities" (FIN 46R), which is a revised interpretation of
Accounting Research Bulletin No. 51, "Consolidated Financial
Statements". FIN 46R is required to be applied starting with fiscal
years beginning after December 15,2003. FIN 46R requires the
consolidation of a variable interest entity (VIE) by an enterprise if
that enterprise either absorbs a majority of the VIE's expected losses
or receives a majority of the VIE's expected residual returns as a
result of ownership, contractual or other financial interests in the
VIE. Prior to FIN 46R, entities were generally consolidated by an
enterprise that had a controlling financial interest through ownership
of a majority voting interest in the entity.
FIN 46R defines a VIE as an entity in which equity investors do not
have the characteristics of a controlling financial interest nor do
they have sufficient equity at risk for the entity to finance its
activities without additional subordinated financial support. The
Company has no interests in VIEs or potential VIEs commonly referred to
as special-purpose entities and as such, the adoption of this revised
interpretation on March 31, 2004 has had no effect on the Company's
results of operations or financial condition.
4. ACQUISITION OF WHOLLY-OWNED SUBSIDIARY
On January 1, 2004, the Company purchased a property and casualty
insurance company, domiciled in Maine, with approximately $5.0 million
in surplus that was not currently writing any business, for $5.3
million. The acquisition has been accounted for using the purchase
method of accounting as prescribed by FASB Statement of Financial
Accounting Standards No. 141, "Business Combinations." The acquisition
included assets of approximately $4.9 million in cash and cash
equivalents, $0.1 million in bonds and $0.3 million of goodwill, which
is being accounted for in accordance with FASB Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangible Assets."
There were no liabilities acquired in connection with this acquisition.
5. CONCENTRATION OF CREDIT RISK
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 $16.2 million as of March 31,
2004 and $15.5 million as of December 31, 2003. 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 March 31, 2004 the maximum exposure to
any one account for earned payroll is approximately $0.6 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.
6
The Insurance Operations and HR outsourcing businesses are also subject
to geographic concentration. Approximately 37% of our net premiums
written are for insurance policies written in New Jersey while 40% 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.
6. REINSURANCE
The following table is a listing of direct, assumed and ceded amounts
by income statement caption:
UNAUDITED,
QUARTER ENDED
MARCH 31,
(in thousands) 2004 2003
- ---------------------------------------------------------
PREMIUMS WRITTEN:
Direct $ 403,107 351,188
Assumed 5,868 5,850
Ceded (33,713) (33,635)
---------- -------
Net $ 375,262 323,403
========== =======
PREMIUMS EARNED:
Direct $ 342,506 295,159
Assumed 8,022 5,405
Ceded (35,222) (33,517)
---------- -------
Net $ 315,306 267,047
========== =======
LOSSES AND LOSS EXPENSES INCURRED:
Direct $ 222,369 207,860
Assumed 6,959 4,732
Ceded (19,011) (13,490)
---------- -------
Net $ 210,317 199,102
========== =======
Flood business, which we cede 100% to the federal government's National
Flood Insurance Program (NFIP), is included in the above amounts as
follows:
UNAUDITED,
QUARTER ENDED
MARCH 31,
(in thousands) 2004 2003
- --------------------------------------------------------------
Ceded premiums written $(16,124) (13,558)
Ceded premiums earned (16,576) (13,572)
Ceded losses and loss expenses incurred (5,057) (665)
Assumed business increased primarily due to an increase in mandatory
pool assumptions. Additionally, the increase in ceded losses and loss
expenses incurred related to our Flood business and was primarily
attributable to increases in loss reserves associated with Hurricane
Isabel, which occurred in third quarter 2003. For additional
information regarding our reinsurance programs refer to Item 8.
"Financial Statements and Supplementary Data", Note 5 to the
consolidated financial statements beginning on page 59 of the 10-K
section of our Annual Report to Shareholders for the year ended
December 31, 2003.
7
7. STOCK-BASED COMPENSATION
The FASB Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (FAS 123) establishes
financial accounting and reporting standards for stock-based
compensation plans. As permitted by FAS 123, the Company uses the
accounting method prescribed by Accounting Principles Board Opinion No.
25 "Accounting for Stock Issued to Employees" (APB 25) to account for
its stock-based compensation plans. Companies using APB 25 are required
to make pro forma 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.
The FASB Statement of Financial Accounting Standards No. 148,
"Accounting for Stock-Based Compensation - Transition and Disclosure"
(FAS 148) amends FAS 123 to provide alternative methods of transition
to FAS 123's fair value method of accounting for stock-based
compensation. The Company has adopted the pro forma footnote
disclosure-only provisions of FAS 148. Based on the fair value method
consistent with the provisions of FAS 148, the Company's net income and
earnings per share would have been reduced to the following pro forma
amounts indicated below:
UNAUDITED,
QUARTER ENDED
MARCH 31,
(in thousands, except per share amounts) 2004 2003
- -------------------------------------------------------------------------------------
Net income, as reported $ 27,528 8,038
Add: Stock-based employee compensation reported in net
income, net of related tax effect 1,149 598
Deduct: Total stock-based employee compensation
expense determined under fair value-based method for all
awards, net of related tax effects (2,088) (1,612)
---------- ------
Pro forma net income $ 26,589 7,024
========== ======
NET INCOME PER SHARE:
Basic - as reported $ 1.04 0.31
Basic - pro forma 1.00 0.27
Diluted - as reported 0.88 0.29
Diluted - pro forma 0.85 0.26
8. 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 carrying value of these notes was $115.9 million at March
31, 2004 and December 31, 2003. The Convertible Notes are convertible
at the option of the holders, if the conditions for conversion are
satisfied, into 12.9783 shares of the Company's common stock per $1,000
principal amount of notes surrendered at a conversion price of $29.29.
The conditions for conversion are satisfied when the price of the
Company's common stock has maintained a 20% premium to the conversion
price of $29.29, or $35.15, for 20 of 30 consecutive trading days
ending on the last trading day of a calendar quarter.
As of March 31, 2004, the conditions of conversion were met and as such
the holders may surrender the Convertible Notes for conversion into
shares of common stock, or cash at the Company's option, on any
business day during the second quarter 2004. If all such notes were
converted, the Company would be required to issue 3.9 million shares of
common stock. In accordance with the FASB Statements of Financial
Accounting Standards No. 128 "Earnings per share," the 3.9 million
shares are included in the diluted earnings per share calculation in
the quarter when the contingency is met as well as the following
quarter when the bonds are actually convertible. Therefore, the shares
are included for the three-month period ended March 31, 2004. During
any period following the period in which such contingency is not met,
the convertible notes would cease to be convertible until such time as
the contingency is again satisfied.
Holders may also surrender Convertible Notes for conversion 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 criterion 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.
8
9. SEGMENT INFORMATION
The Company is primarily engaged in writing property and casualty
insurance. The Company has classified its business into three segments,
which is at the same level of disaggregation as that reviewed by senior
management: Insurance Operations (commercial lines underwriting,
personal lines underwriting), Investments, and Diversified Insurance
Services. Insurance Operations are evaluated based on GAAP underwriting
results, Investments are evaluated based on after-tax investment
returns, and the Diversified Insurance Services are evaluated based on
several measures including, but not limited to, results of operations
in accordance with GAAP. The Company does not aggregate any of its
operating segments.
The GAAP underwriting results of the Insurance Operations segment are
determined taking into account net premiums earned, incurred losses and
loss expenses, policyholders dividends, policy acquisition costs and
other underwriting income and 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.
Selective and its subsidiaries provide services to each other in the
normal course of business. These transactions totaled $6.4 million for
First Quarter 2004, compared with $6.3 million for First Quarter 2003.
These transactions were eliminated in all interim consolidated
financial statements.
In computing the results of each segment, no adjustment is made for
interest expense, net general corporate expenses or federal income
taxes. The Company does not maintain separate investment portfolios for
the segments and, therefore, does not allocate assets to the segments.
The following summaries present revenues (net investment income and net
realized gains in the case of the Investments segment) and pre-tax
income (loss) for the individual segments:
UNAUDITED,
REVENUE BY SEGMENT QUARTER ENDED
MARCH 31,
(in thousands) 2004 2003
- ------------------------------------------------------------
INSURANCE OPERATIONS:
Commercial lines net premiums earned $259,697 215,625
Personal lines net premiums earned 55,609 51,422
Miscellaneous income 746 692
-------- -------
Total insurance operations revenues 316,052 267,739
-------- -------
INVESTMENTS:
Net investment income 29,460 27,343
Net realized gain on investments 5,346 3,975
-------- -------
Total investment revenues 34,806 31,318
-------- -------
DIVERSIFIED INSURANCE SERVICES:
Diversified insurance services revenues 24,231 21,338
-------- -------
TOTAL ALL SEGMENTS 375,089 320,395
-------- -------
Other income 31 90
-------- -------
TOTAL REVENUES $375,120 320,485
======== =======
9
UNAUDITED,
INCOME (LOSS), BEFORE FEDERAL INCOME TAX BY SEGMENT QUARTER ENDED
MARCH 31,
(in thousands) 2004 2003
- -------------------------------------------------------------------------------------
INSURANCE OPERATIONS:
Commercial lines underwriting $ 9,788 (14,207)
Personal lines underwriting (3,063) (3,786)
-------- -------
Underwriting income (loss), before federal income tax 6,725 (17,993)
-------- -------
INVESTMENTS:
Net investment income 29,460 27,343
Net realized gain on investments 5,346 3,975
-------- -------
Total investment income, before federal income tax 34,806 31,318
-------- -------
DIVERSIFIED INSURANCE SERVICES:
Income before federal income tax 2,193 1,867
-------- -------
TOTAL ALL SEGMENTS 43,724 15,192
-------- -------
Interest expense (4,005) (4,539)
General corporate expenses (2,183) (1,293)
-------- -------
INCOME BEFORE FEDERAL INCOME TAX $ 37,536 9,360
======== =======
10. RETIREMENT PLANS
As of December 31, 2003, the Company adopted the revised FASB statement
of Financial Accounting Standards No. 132R "Employers' Disclosures
about Pensions and Other Postretirement Benefits" (FAS 132R). FAS 132R
addresses disclosure items only and does not address measurement or
recognition. FAS 132R requires additional interim disclosures that were
not required by the original statement, all of which are included for
all periods presented.
RETIREMENT INCOME
PLAN POSTRETIREMENT PLAN
UNAUDITED UNAUDITED
QUARTER ENDED QUARTER ENDED
MARCH 31, MARCH 31,
(in thousands) 2004 2003 2004 2003
-------- ------ ---- -------
COMPONENTS OF NET PERIODIC BENEFIT COST:
Service cost $ 1,402 1,303 83 72
Interest cost 1,808 1,624 96 101
Expected return on plan assets (1,672) (1,249) - -
Amortization of unrecognized transition obligation - - -
Amortization of unrecognized prior service cost 53 62 (8) (8)
Amortization of unrecognized net (gain) loss 286 269 -
-------- ------ ---- ----
Net periodic cost $ 1,877 2,009 171 165
======== ====== ==== ====
WEIGHTED-AVERAGE EXPENSE ASSUMPTIONS FOR THE YEARS
ENDED DECEMBER 31:
Discount rate 6.25% 6.75 6.25 6.75
Expected return on plan assets 8.25% 8.25 - -
Rate of compensation increase 5.00% 5.00 5.00 5.00
11 COMMITMENTS AND CONTINGENCIES
Included in other investments is approximately $38.7 million of
investments in limited partnerships as of March 31, 2004, and $35.6
million as of December 31, 2003. At March 31, 2004 the Company has an
additional limited partnership investment commitment of up to $38.3
million. There is no certainty that any additional investment will be
required.
10
On May 21, 2003, a purported class action was brought by several health
care providers in the Superior Court of New Jersey, Law Division -
Camden County, against Consumer Health Network Plus, LLC, Alta
Services, LLC (Alta) and Selective Insurance Company of America, wholly
owned subsidiaries of Selective, together with ten other unrelated
defendants. The plaintiffs purport to represent a class of all New
Jersey health care providers, except hospitals, who had bills for their
services paid from personal injury protection benefits under New Jersey
automobile policies and whose payments were reduced pursuant to a
preferred provider organization discount schedule. 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. On
March 10, 2004 the plaintiffs filed an amended complaint, wherein Alta
was dropped as a defendant. All defendants expect to file a Motion to
Dismiss the amended complaint on or about May 14, 2004. Since the suit
remains in its early stages, management cannot at this time provide a
meaningful estimate or range of estimates of a potential loss, if any.
FORWARD-LOOKING STATEMENTS
Some of the statements in this report, including information incorporated by
reference contain forward-looking statements within the meaning of Section 27A
of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of
1934. These statements relate to our intentions, beliefs, projections,
estimations or forecasts of future events or our future financial performance
and involve known and unknown risks, uncertainties and other factors that may
cause our or our industry's actual results, levels of activity, or performance
to be materially different from those expressed or implied by the
forward-looking statements. In some cases, you can identify forward-looking
statements by use of words such as "may," "will," "could," "would," "should,"
"expect," "plan," "anticipate," "target," "project," "intend," "believe,"
"estimate," "predict," "potential," "pro forma," "seek," "likely" or "continue"
or other comparable terminology. These statements are only predictions, and we
can give no assurance that such predictions will prove to be correct.
Factors that could cause our actual results to differ materially from those
projected, forecasted or estimated by us in forward-looking statements, include,
but are not limited to:
- the frequency and severity of catastrophic events, including, but
not limited to, hurricanes, tornadoes, windstorms, earthquakes,
hail, severe winter weather, fires, explosions and terrorism;
- adverse economic, market or regulatory conditions;
- the concentration of our business in a number of east coast and
midwestern states;
- the adequacy of our loss reserves;
- the cost and availability of reinsurance;
- our ability to collect on reinsurance and the solvency of our
reinsurers;
- uncertainties related to insurance premium rate increases and
business retention;
- changes in insurance regulations that impact our ability to write
and/or cease writing insurance policies in one or more states
particularly changes in New Jersey automobile insurance laws and
regulations;
- our ability to maintain favorable ratings from A.M. Best,
Standard & Poor's, Moody's and Fitch;
- fluctuations in interest rates and the performance of the
financial markets;
- our entry into new markets and businesses; and
- other risks and uncertainties we identify in this report and
other filings with the Securities and Exchange Commission.
We undertake no obligation, other than as may be required under the federal
securities laws, to publicly update or revise any forward-looking statements,
whether as a result of new information, future events or otherwise. We do not
assume responsibility for the accuracy and completeness of the forward-looking
statements. All of the forward-looking statements in this report are qualified
by reference to the factors discussed under "Risk Factors" beginning on page 18
of our Annual Report on Form 10-K for the year ended December 31, 2003. 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.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The Company is primarily engaged in writing property and casualty insurance. The
Company has classified its businesses into three segments: Insurance Operations
(commercial lines underwriting, personal lines underwriting), Investments, and
Diversified Insurance Services (managed care, flood insurance and human resource
administration outsourcing). Insurance Operations are evaluated based on
underwriting results determined in accordance with GAAP; Investments are
evaluated based on after-tax investment returns; and the Diversified Insurance
Services are evaluated based on several measures including, but not limited to,
results of operations determined in accordance with GAAP. For an additional
description of accounting policies, refer to Item 8. "Financial Statements and
Supplementary Data," Note 2 to our consolidated financial statements on pages 50
through 55 of the 10-K section of our Annual Report to Shareholders for the
year-ended December 31, 2003 and the discussion beginning on page 19 of this
report on Form 10-Q. See Note 9 to the March 31, 2004 unaudited interim
consolidated financial statements on pages 9 and 10 of this report on Form 10-Q
for revenues and related income before federal income tax for each individual
segment discussed below.
The following discussion relates to our results of operations, financial
condition, liquidity and capital resources, off-balance sheet arrangements,
contractual obligations and contingent liabilities and commitments and critical
accounting policies for the interim periods indicated. This discussion is
prepared in accordance with accounting principles generally accepted in the
United States of America (GAAP) unless otherwise noted.
RESULTS OF OPERATIONS
The following discussion is a comparison of the first quarter ended March 31,
2004 (First Quarter 2004) to the first quarter ended March 31, 2003 (First
Quarter 2003).
Our net income was $27.5 million, or $0.88 per diluted share, for First Quarter
2004, compared with $8.0 million, or $0.29 per diluted share, for First Quarter
2003. Included in net income are net realized capital gains, after-tax, of $3.5
million for First Quarter 2004, compared with $2.6 million for First Quarter
2003.
INSURANCE OPERATIONS
UNAUDITED,
ALL LINES QUARTER ENDED
MARCH 31,
($ in thousands) 2004 2003
- -------------------------------------------------------------------------
GAAP INSURANCE OPERATIONS RESULTS:
Net premiums written $ 375,262 323,403
========= =======
Net premiums earned $ 315,306 267,047
LESS:
Losses and loss expenses incurred 210,317 199,102
Net underwriting expenses incurred 97,175 84,383
Dividends to policyholders 1,089 1,555
--------- -------
Underwriting income / (loss) $ 6,725 (17,993)
--------- -------
GAAP RATIOS:
Loss and loss expense ratio 66.7% 74.6
Underwriting expense ratio 30.9% 31.5
Dividends to policyholders ratio 0.3% 0.6
--------- -------
Combined ratio 97.9% 106.7
========= =======
Net premiums written increased by approximately $51.9 million, or 16%, to $375.3
million in First Quarter 2004 compared with First Quarter 2003. The main factors
contributing to this overall improvement were: (i) $75.5 million in net new
business written in First Quarter 2004, an increase of 16% compared with $65.1
million in First Quarter 2003, 90% of which was generated in our commercial
lines in First Quarter 2004 compared with 87% in First Quarter 2003; (ii)
commercial lines year-on-year retention improvement of 3 points to 83% in First
Quarter 2004 compared with 80% for First Quarter 2003; and (iii) commercial
lines renewal premium price increases that averaged 10% in First Quarter 2004
compared with 15% in First Quarter 2003. We anticipate these increases will
decelerate in 2004. For further information, see discussion of "Commercial Lines
Results" on the next page.
The loss and loss expense ratio decreased 7.9 points to 66.7% for First Quarter
2004 when compared with First Quarter 2003. The improvements were primarily due
to increased premium rates and underwriting improvements mainly in our
commercial lines business, which comprises 83% of net premium written for the
fiscal year ending March 31, 2004. Additionally, four-plus years of double-digit
12
commercial lines renewal premium price increases, which on a compounded basis
totaled 92%, and reduced weather catastrophe losses of $4.7 million, or 1.5
points for the First Quarter 2004, compared with $11.9 million, or 4.4 points,
in First Quarter 2003 contributed to a more favorable loss and loss expense
ratio.
The underwriting expense ratio decreased 0.6 points to 30.9% for First Quarter
2004 compared with the same period in 2003. Overall productivity, as measured by
fiscal year net premiums written per insurance operations employee, was
approximately $739,000 for the fiscal year ended March 31, 2004, up from
$608,000 for the same period in 2003. Contributing to the overall productivity
are our strategic initiatives which are designed to either reduce costs and/or
increase business, which include: i) streamlined processing for small commercial
lines accounts (One & Done) and ii) a web-based commercial lines automated
system. These technology enhancements enable agents to initiate and self-service
their Selective business. During the quarter, agents managed over 13% of
endorsements through our automated commercial lines system, and our automated
underwriting templates automatically processed 28% of renewals. We are on pace
to process, through our automated systems, 40% of certain commercial lines
transactions by year-end.
The combined ratio decreased 8.8 points to 97.9 in First Quarter 2004 compared
with 106.7 in First Quarter 2003. The reasons for the decrease in the combined
ratio are primarily attributable to the previously discussed decreases in the
loss and loss expense ratio as well as the underwriting expense ratio.
COMMERCIAL LINES RESULTS
UNAUDITED,
COMMERCIAL LINES QUARTER ENDED
MARCH 31,
($ in thousands) 2004 2003
- --------------------------------------------------------
GAAP INSURANCE OPERATIONS RESULTS:
Net premiums written $ 319,998 269,754
========= =======
Net premiums earned $ 259,697 215,625
LESS:
Losses and loss expenses incurred 166,381 160,193
Net underwriting expenses incurred 82,439 68,084
Dividends to policyholders 1,089 1,555
--------- -------
Underwriting income/(loss) $ 9,788 (14,207)
--------- -------
GAAP RATIOS:
Loss and loss expense ratio 64.1% 74.3
Underwriting expense ratio 31.7% 31.6
Dividends to policyholders ratio 0.4% 0.7
--------- -------
Combined ratio 96.2% 106.6
========= =======
Commercial Lines Underwriting accounted for approximately 83% of our net
premiums written for the fiscal year ended March 31, 2004 compared with 81% for
the same period last year. Net premiums written increased $50.2 million, or 19%,
to $320.0 million for First Quarter 2004 compared with First Quarter 2003. The
main factors contributing to this overall improvement were: (i) $68.3 million in
net new business written for First Quarter 2004, a 20% increase when compared
with $56.8 million in net new business written for First Quarter 2003; (ii)
year-on-year retention improvement of 3 points to 83% in First Quarter 2004
compared with 80% for First Quarter 2003; and (iii) renewal premium price
increases that averaged 10% in First Quarter 2004 compared with 15% in First
Quarter 2003.
Even though our long-term strategy incorporates higher pricing throughout our
Commercial Lines operation, we expect pricing increases to continue to moderate
in 2004. We anticipate earned premiums, excluding exposure, to increase 7.5% and
continue to outpace loss trends, which are expected to rise by 4% for the full
year 2004. Our projected loss trend is based upon an expected 2% increase in
CPI, including medical costs increases of 5 to 7%.
For First Quarter 2004, the Commercial Lines Underwriting loss and loss expense
ratio decreased 10.2 points when compared with the same period in 2003. Weather
related catastrophes accounted for 1.6 points of the loss and loss expense ratio
for First Quarter 2004 compared with 4.8 points in First Quarter 2003. In
addition to more favorable weather experience compared to First Quarter 2003,
our solid performance in these lines reflects our long-term improvement strategy
that incorporates higher pricing, demonstrated by our compounded 92% renewal
premium price increases achieved over the past four years, continued
underwriting enhancements, and heightened loss control efforts, all of which led
to improved financial results.
13
For First Quarter 2004, the Commercial Lines Underwriting combined ratio
decreased 10.4 points to 96.2% from 106.6% for the same period in 2003. The
favorable First Quarter 2004 results were driven by improvements in the
previously discussed loss and loss ratio, which resulted in improvements in
almost every segment of our core commercial lines operation, except for our bond
operation. The bond unit had a $2.0 million reduction of a salvage and
subrogation recoverable related to prior accident years, which increased the
overall Commercial Lines combined ratio by one point.
COMMERCIAL AUTOMOBILE BUSINESS
Our commercial automobile line of business accounted for 28% of Commercial Lines
Underwriting net premiums earned in First Quarter 2004 and First Quarter 2003.
This line registered a strong quarter, with a statutory loss and loss expense
ratio of 56.4%, down almost six points compared with 62.1% in First Quarter
2003. This line has been favorably impacted by price increases, stricter
underwriting standards, including a changed vehicle mix which reduced the
percentage of extra-heavy vehicles covered, and the removal of certain classes
of business that we determined to be unprofitable.
WORKERS COMPENSATION BUSINESS
Our workers' compensation line of business, which accounted for 24% of
commercial lines underwriting net premiums earned in First Quarter 2004 and
First Quarter 2003, showed marked improvement when compared with the same period
last year, posting a statutory loss and loss expense ratio of 80.8% for First
Quarter 2004, compared with 84.2% for First Quarter 2003. This improvement is
further supported by the fact that the Company continues to maintain an
underwriting position for the workers' compensation business that focuses on low
to medium hazard business with less than 5% of the business being unsupported by
another commercial line. In addition to focusing on low to medium hazard
business, our underwriting measures also include requiring job site inspections
and increasing the number of highly trained loss control representatives we
employ. This, together with the fact that since 2000 we have increased pricing
by 40% through a combination of rate increases, credit reductions, restricting
dividend plans and shifting business to higher-priced tiers, are the main
reasons why this book of business performed better than First Quarter 2003. Our
underwriting and pricing actions are ongoing, including a targeted 6% price
increase in 2004. A 6.2% price increase in New Jersey, which represents 24% of
our workers' compensation premium written, was effective January 1st.
GENERAL LIABILITY BUSINESS
Our general liability line of business, which accounted for 28% of Commercial
Lines Underwriting net premiums earned in First Quarter 2004 and in First
Quarter 2003, recorded a statutory loss and loss expense ratio of 58.8%, down
almost five points compared with 63.6% in First Quarter 2003. Our solid
performance in this line reflects our long-term improvement strategy that
incorporates higher pricing, continued underwriting enhancements, and heightened
loss control efforts.
COMMERCIAL PROPERTY BUSINESS
Our commercial property business, which accounted for 10% of Commercial Lines
Underwriting net premiums earned for First Quarter 2004 and First Quarter 2003,
posted a statutory loss and loss expense ratio of 63.0%, including 9.8 points of
catastrophe losses, compared with a statutory loss and loss expense ratio of
123.3%, including 43.8 points of catastrophe losses, in First Quarter 2003. We
continue to implement ongoing pricing and underwriting actions to improve
results in this line of business, which include: better insurance to value
estimates across our book of business; a shift to risks of better construction
quality and newer buildings; and an overall focus on low-to-medium hazard
property exposures.
PERSONAL LINES RESULTS
UNAUDITED,
PERSONAL LINES QUARTER ENDED
MARCH 31,
($ in thousands) 2004 2003
- --------------------------------------------------------
GAAP INSURANCE OPERATIONS RESULTS:
Net premiums written $ 55,264 53,649
========= ======
Net premiums earned $ 55,609 51,422
LESS:
Losses and loss expenses incurred 43,936 38,909
Net underwriting expenses incurred 14,736 16,299
--------- ------
Underwriting (loss) $ (3,063) (3,786)
--------- ------
GAAP RATIOS:
Loss and loss expense ratio 79.0% 75.7
Underwriting expense ratio 26.5% 31.7
--------- ------
Combined ratio 105.5% 107.4
========= ======
14
Personal Lines Underwriting accounted for approximately 17% of our net premiums
written for the fiscal year ended March 31, 2004 compared with 19% for the same
period last year. Net premiums written increased $1.6 million, or 3%, to $55.3
million for First Quarter 2004 when compared with the same period in 2003. The
combined ratio was 105.5% for First Quarter 2004, including 1.0 point of
catastrophe losses, down 1.9 points from the same period in 2003, which had a
combined ratio of 107.4%, including 3.1 points of catastrophe losses. More than
offsetting the lower catastrophe losses compared with First Quarter 2003, were
unusual fire losses in First Quarter 2004. These unusual fire losses have driven
up severity, increasing the loss and loss expense ratio to 79.0% in First
Quarter 2004 compared with 75.7% in First Quarter 2003. Additionally, the
expense ratio declined as a result of reduced expenses and a change in deferred
acquisition cost amortization estimates, which were revised to better match
acquisition expenses and earned premiums.
PERSONAL AUTOMOBILE BUSINESS
Our personal automobile results constituted 83% of personal lines underwriting
net premium earned in First Quarter 2004 and First Quarter 2003. The personal
automobile line produced a statutory loss and loss expense ratio of 71.5% for
First Quarter 2004, compared with 74.9% for First Quarter 2003. The improved
results were attributable to our business in New Jersey, which accounted for 73%
of our overall personal automobile net premiums earned for First Quarter 2004
and First Quarter 2003. Continued progress in New Jersey is the result of
significant actions taken over the last four years, including aggressive pricing
initiatives; a redesign of our rating tiers; reduced agency commissions; and an
improving political and regulatory climate. While we are pleased with this
improvement, our efforts to achieve stability in this often volatile book of
business continues. Building on a 5% rate increase effective in March 2004, our
action plans include further tier revisions expected to lower rates for our best
customers and improve our competitive position in this changing marketplace.
In New York, we no longer focus on writing personal lines due to regulatory
challenges and the high cost of the involuntary automobile insurance market that
make it extremely difficult to do business. Our net premiums written in New York
decreased 32%, to $1.2 million in First Quarter 2004 compared with $1.8 million
in First Quarter 2003. New York now accounts for only 3% of our total personal
lines net premiums written. Our statutory loss and loss expense ratio in New
York was 127.5% in First Quarter 2004 compared with 84.5% in First Quarter 2003.
HOMEOWNERS BUSINESS
Our homeowners line of business, which accounted for 15% of personal lines net
premiums earned for First Quarter 2004, compared with 14% for First Quarter
2003, had a statutory loss and loss expense ratio of 93.1% for First Quarter
2004, of which 7.1 points are attributable to weather-related catastrophes,
compared with 85.8% for First Quarter 2003, which had 20.2 points from
weather-related catastrophes. This line was further impacted by several
non-catastrophe large fire losses, which added 38.1 points to the statutory loss
and loss expense ratio in First Quarter 2004. While the unusual fire losses have
driven up severity, our underlying homeowner's book continued to improve. During
First Quarter 2004, frequency continued its downward trend; premiums continue to
rise; and we implemented ongoing enhancements to the improvement plan initiated
three years ago, including: (i) double-digit rate increases in six states; (ii)
expanding the use of credit history to apply discounts and surcharges for new
and renewal business; (iii) continuing the rollout of higher wind and hail
deductibles in coastal and selected inland territories; and (iv) expanding the
account credit, where appropriate, to encourage agents to write entire accounts.
INVESTMENTS
Although lower interest rates continue to put pressure on investment returns, we
generated an 8% increase in investment income to $29.5 million for First Quarter
2004, up from $27.3 million for First Quarter 2003. The increase reflects an
increased asset base as our investment portfolio reached $2.5 billion at March
31, 2004, compared with $2.2 billion at March 31, 2003. This increase is due to
strong operating cash flows of $281.9 million last year and $55.2 million in
First Quarter 2004 compared with $41.0 million in First Quarter 2003. Also
contributing to the increase were our limited partnership investments. These
investments, which are subject to market fluctuations, added $2.1 million to
investment income for First Quarter 2004, compared with $0.4 million for First
Quarter 2003. Our before-tax portfolio yield was 4.8% in First Quarter 2004
compared with 5.1% in First Quarter 2003.
We continue to maintain a conservative, diversified investment portfolio, with
debt security holdings representing 84% of invested assets. 63% 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.
15
The following table presents the Moody's and Standard & Poor's rating of our
debt securities portfolio:
UNAUDITED
MARCH 31, DECEMBER 31,
RATING 2004 2003
- -----------------------------------------------------
Aaa/AAA 63% 62%
Aa/AA 20% 21%
A/A 12% 12%
Baa/BBB 4% 4%
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 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 securities portfolio primarily in
intermediate-term securities. The average maturity of the portfolio at March 31,
2004 was 5.3 years compared with 5.5 years at December 31, 2003.
We continue to follow an investment philosophy that has historically proven
successful. The strategy is to purchase debt securities in sectors that we
believe 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 March 31, 2004 our investment portfolio included non-investment grade
securities with an amortized cost of $20.5 million, (1% of the portfolio), and a
fair value of $22.4 million. At December 31, 2003, non-investment grade
securities in our investment portfolio represented less than 1% of the
portfolio, with an amortized cost of $25.2 million and a fair value of $27.2
million. The unrealized loss on these securities represented 16% of our total
unrealized loss at March 31, 2004, and 5% at December 31, 2003. The fair value
of these securities was determined by independent pricing services or bid prices
provided by various broker dealers. The Company did not have a material
investment in non-traded securities at March 31, 2004, or at December 31, 2003.
The Company regularly reviews the diversification of the investment portfolio
compared with an investment grade corporate index. At March 31, 2004, 17% of the
market value of our corporate bond and preferred stock portfolios were
represented by investments in banks, only two 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
securities 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.
16
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, if any, in the period such determination is made. There
were no impairment charges recorded during First Quarter 2004 or First Quarter
2003. The Company realized gains and losses from the sale of available-for-sale
debt and equity securities during First Quarter 2004 and First Quarter 2003.
The following table presents the period of time that securities, sold at a loss
during these periods, were continuously in an unrealized loss position prior to
sale:
PERIOD OF TIME IN AN UNAUDITED, UNAUDITED,
UNREALIZED LOSS POSITION QUARTER ENDED QUARTER ENDED
MARCH 31, MARCH 31,
(in millions) 2004 2003
- --------------------------------------------------------------------------
Fair Value Fair Value
on Sale Realized on Sale Realized
Date Loss Date Loss
- --------------------------------------------------------------------------
DEBT SECURITIES:
0 - 6 months $ - - $ - -
7 - 12 months - - - -
Greater than 12 months - - 5.0 -
---------- --- ---------- ----
Total debt securities - - 5.0 -
---------- --- ---------- ----
EQUITIES:
0 - 6 months 1.8 0.2 - -
7 - 12 months - - - -
Greater than 12 months - - - -
---------- --- ---------- ----
Total equities 1.8 0.2 - -
---------- --- ---------- ----
Total $ 1.8 0.2 $ 5.0 -
========== === ========== ====
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 need to reduce our exposure to certain
issuers, industries or sectors in light of changing economic conditions, or
(iii) tax planning strategies.
17
UNREALIZED LOSSES
The following table summarizes, for all available-for-sale securities in an
unrealized loss position at March 31, 2004 and December 31, 2003, the aggregate
fair value and gross pre-tax unrealized loss recorded in our accumulated other
comprehensive income, by asset class and by length of time those securities have
continuously been in an unrealized loss position:
PERIOD OF TIME IN AN
UNREALIZED LOSS POSITION UNAUDITED
(in millions) MARCH 31, 2004 DECEMBER 31, 2003
- -----------------------------------------------------------------------
Gross Gross
Fair Unrealized Fair Unrealized
Value Loss Value Loss
- -----------------------------------------------------------------------
DEBT SECURITIES:
0 - 6 months $ 130.6 1.2 48.4 1.2
7 - 12 months 25.6 0.9 10.6 0.4
Greater than 12 months 5.6 0.1 8.8 0.7
---------- --- ---- ---
Total debt securities 161.8 2.2 67.8 2.3
---------- --- ---- ---
EQUITIES:
0 - 6 months 3.4 0.1 1.5 0.1
7 - 12 months - - - -
Greater than 12 months - - 1.7 0.3
---------- --- ---- ---
Total equities 3.4 0.1 3.2 0.4
---------- --- ---- ---
Total $ 165.2 2.3 71.0 2.7
========== === ==== ===
The following table presents information regarding our available-for-sale debt
securities that were in an unrealized loss position at March 31, 2004 by
maturity:
Amortized Fair
(in millions) Cost Value
- --------------------------------------------------------------------
One year or less $ 23.8 23.7
Due after one year through five years 59.0 57.9
Due after five years through ten years 78.9 78.0
Due after ten years through fifteen years 2.3 2.2
Due after fifteen years - -
---------- -----
Total $ 164.0 161.8
========== =====
18
DIVERSIFIED INSURANCE SERVICES
UNAUDITED,
QUARTER ENDED
MARCH 31,
($ IN THOUSANDS) 2004 2003
- ------------------------------------------------------------------
HUMAN RESOURCE ADMINISTRATION OUTSOURCING
Net revenue $ 13,046 10,651
Pre-tax (loss) 127 75
MANAGED CARE
Net revenue 4,850 5,629
Pre-tax profit 513 950
FLOOD INSURANCE
Net revenue 5,727 4,604
Pre-tax profit 1,371 772
OTHER
Net revenue 608 454
Pre-tax profit 182 70
TOTAL
Net revenue 24,231 21,338
Pre-tax profit 2,193 1,867
Net income 1,466 1,301
Return on net revenue 6.1% 6.1
The Diversified Insurance Services generated $24.2 million of net revenue and
$1.5 million of net income in First Quarter 2004 compared with $21.3 million of
revenue and $1.3 million of net income in the First Quarter 2003. The segment
generated a return on net revenue of 6.1% in the First Quarter 2004 and the
First Quarter 2003. Operating cash flow from the segment was $5.3 million in
First Quarter 2004 compared with $0.7 million in First Quarter 2003.
HUMAN RESOURCE ADMINISTRATION OUTSOURCING (HR OUTSOURCING)
HR outsourcing net revenues increased 22% to $13.0 million for First Quarter
2004 compared with $10.7 million last year. Pre-tax income was $0.1 million for
First Quarter 2004, which was flat compared with First Quarter 2003. With
expense reduction and re-underwriting initiatives firmly in place, we are
focusing our efforts on growing this business. At the end of First Quarter 2004,
our worksite lives are up 10% to 20,540 compared with 18,735 at March 31, 2003.
MANAGED CARE
Net revenues decreased 14% to $4.9 million for First Quarter 2004 compared with
$5.6 million for First Quarter 2003. This reduction reflected the loss of
business that occurred primarily as a result of industry consolidation, the
eliminations of unprofitable accounts, and the loss of one large client to a
competitor. Decreased net revenues resulted in a corresponding decrease in
pre-tax profit to $0.5 million for First Quarter 2004 compared with $1.0 million
for First Quarter 2003.
FLOOD INSURANCE
Premium growth of 19% for First Quarter 2004 compared with First Quarter 2003
has been driven by enhanced marketing efforts with the personal lines
underwriting operation that have resulted in new business of $3.9 million for
First Quarter 2004 and First Quarter 2003. This growth increases our total
premium served to $68.3 million compared with $55.3 million a year ago and has
resulted in increased servicing fees of $5.7 million for First Quarter 2004
compared with $4.6 million for First Quarter 2003. The growth has also driven
increases in pre-tax profit to $1.4 million for First Quarter 2004 compared with
$0.8 million for First Quarter 2003.
FEDERAL INCOME TAXES
Total federal income tax expense increased $8.7 million for First Quarter 2004
to $10.0 million, compared with the same period last year. These amounts reflect
an effective tax rate of 27% for the First Quarter 2004, compared with 14% for
the same period last year. The increase was attributable to improved
underwriting results, increased capital gains on investment sales, and higher
levels of taxable investment income. 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.
ADOPTION OF ACCOUNTING PRONOUNCEMENT
In December 2003, the Financial Accounting Standards Board (FASB) issued revised
FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN
46R), which is a revised interpretation of Accounting Research Bulletin No. 51,
"Consolidated Financial Statements". FIN 46R is required to be applied starting
with fiscal years beginning after December 15, 2003. FIN 46R requires the
consolidation of a variable interest entity (VIE) by an enterprise if that
enterprise either absorbs a majority of the VIE's expected losses or receives a
majority of the VIE's expected residual returns as a result of ownership,
contractual or other financial interests in the VIE. Prior to FIN 46R, entities
were generally consolidated by an enterprise that had a controlling financial
interest through ownership of a majority voting interest in the entity.
19
FIN 46R defines a VIE as an entity in which equity investors do not have the
characteristics of a controlling financial interest nor do they have sufficient
equity at risk for the entity to finance its activities without additional
subordinated financial support. The Company has no interests in VIEs or
potential VIEs commonly referred to as special-purpose entities and as such, the
adoption of this revised interpretation on March 31, 2004 has had no effect on
the Company's results of operations or financial condition.
FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES
Selective Insurance Group, Inc. (Parent) is an insurance holding company whose
principal assets are investments in its subsidiaries. The Parent's primary means
of meeting its liquidity requirements is through dividends from these
subsidiaries. The payment of dividends from the insurance subsidiaries is
governed by state regulatory requirements, and these dividends are generally
payable only from earned surplus as reported in our statutory Annual Statements
as of the preceding December 31. Based upon the 2003 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, refer to Item 8. "Financial Statements and Supplementary Data", Note
8 to the consolidated financial statements on page 62 of the 10-K section of our
Annual Report to Shareholders for the year ended December 31, 2003.
The payment of dividends from Diversified Insurance Services subsidiaries are
restricted only by the available operating cash flows of those subsidiaries.
Growth in the Diversified Insurance Services segment has augmented consolidated
cash flows from operations by generating $5.3 million in 2004, compared with
$0.7 million in 2003. The 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 $5.7 million in 2004
and $5.9 million in 2003.
The Parent also generates cash from the sale of its common stock under various
stock plans, the dividend reinvestment program, and from investment income, all
of which approximated $3.9 million and reduced the Parent's cash requirements
for the quarter from $8.4 million to $4.5 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. The
Company has contractual principal 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 March 2004, approximately $47.4 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 permits
the holders of the notes to convert the notes when the price of the Company's
common stock has maintained a 20% premium to the conversion price of $29.29, or
$35.15, for 20 of 30 consecutive trading days ending on the last trading day of
the previous calendar quarter. As this contingency was met as of March 31, 2004,
on any business day in the second quarter of 2004, the holders may surrender
notes for conversion into shares of common stock, or cash at the Company's
option. As a result of this condition being met, 3.9 million shares of common
stock were added to our diluted earnings per share calculation in both First
Quarter 2004 when the contingency was met, and in the following quarter when the
bonds are actually convertible. See Note 8 to the unaudited interim consolidated
financial statements for more information on our senior convertible notes.
Dividends to stockholders are declared and paid at the discretion of the Board
of Directors based upon the Company's operating results, financial condition,
capital requirements, contractual restrictions and other relevant factors. The
Parent has paid regular quarterly cash dividends to its stockholders for 75
consecutive years, 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, refer to Item 8. "Financial Statements and
Supplementary Data", Note 7(b) to the consolidated financial statements on page
61 of the 10-K section of our Annual Report to Shareholders for the year ended
December 31, 2003.
On November 4, 2003, the Board of Directors authorized a 2.5 million share stock
repurchase program scheduled to expire on November 30, 2005. This program
replaces the previous stock repurchase program that expired on May 31, 2003. No
shares have been repurchased under the current 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 $38.3 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.
Cash provided by operating activities amounted to $55.2 million in First Quarter
2004 and $41.0 million in First Quarter 2003. This increase in 2004 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.
20
Since cash inflow from premiums is received in advance of cash outflow required
to settle claims, we accumulate funds that we invest. At March 31, 2004, we had
$2.5 billion in investments compared with $2.4 billion at December 31, 2003. 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 5%, or $169.4 million, at March 31, 2004 from December
31, 2003. Invested assets increased $110.5 million due to net purchases of $74.9
million primarily funded by $55.2 million of operating cash flow and a $34.8
million increase in net unrealized gains on the portfolio. Increased premium
volume drove increases in premium receivables of $51.6 million and deferred
policy acquisition costs of $12.2 million. Reinsurance recoverable on paid
losses and loss expenses increased 43% or $3.3 million. The increase in the
reinsurance recoverable from the December 31, 2003 balance is primarily due to
an increase of $2.3 million for New Jersey Homeowners Quota Share and of $1.2
million due for the New Jersey Unsatisfied Claims Judgment Fund (UCJF). New
Jersey Homeowners Quota Share balance increased due to normal activity for the
first quarter of 2004. UCJF recovery collections in the first quarter of 2004
were somewhat slower than in the prior periods primarily due to the transfer of
the administration of the fund from UCJF to the New Jersey Property Liability
Insurance Guaranty Association.
Total liabilities increased 4%, or $118.8 million, at March 31, 2004 from
December 31, 2003. Loss and loss expense reserves increased $33.2 million as a
result of increased new business written. Increased premium volume is primarily
responsible for the increase in unearned premium reserves of $58.4 million.
Deferred federal income tax liability increased $13.8 million from $12.7 million
at December 31, 2003 to $26.5 million at March 31, 2004 primarily due to the
increase in unrealized gains in the debt and equity portfolios. Commissions
payable decreased $12.5 million at March 31, 2004 from December 31, 2003 which
was mainly attributable to the payment of the 2003 contingent commission in the
first quarter of 2004 offset by increases in commissions payable due to
increased premium volume. Other liabilities increased $25.4 million primarily
due to the increase in securities payable of $21.2 million at March 31, 2004
from December 31, 2003.
Total stockholders' equity increased 7%, or $50.7 million at March 31, 2004
compared to December 31, 2003. Additional paid in capital increased $16.3
million primarily from a $10.5 million increase related to restricted stock
grants, $2.9 million from stock option exercises, $1.3 million from tax
deductions related to stock compensation, $0.9 million from shares sold under
the agent stock purchase program and $0.5 million from shares sold under the
dividend reinvestment plan. Retained earnings increased $22.8 million due to net
income of $27.5 million offset by shareholder dividends of $4.7 million.
After-tax unrealized gains on our investment portfolio accounted for the $22.6
million increase in accumulated other comprehensive income. As an offset to
stockholders' equity, unearned stock compensation and notes receivable from
stock sales increased $9.3 million or 98% compared to December 31, 2003. This is
due to the issuance of the 2004 restricted stock grants in the first quarter.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We have identified the policies below as critical to our business operations and
the understanding of our results of operations. For a detailed discussion of the
application of these and other accounting policies, see Item 8. "Financial
Statements and Supplementary Data," Note 2 to our consolidated financial
statements on pages 50 through 55 of our Annual Report on Form 10-K for the year
ended December 31, 2003. Note that our preparation of the unaudited interim
consolidated financial statements requires us to make estimates and assumptions
that affect the reported amount of assets and liabilities, disclosure of
contingent assets and liabilities at the date of our financial statements, and
the reported amounts of revenue and expenses during the reporting period. There
can be no assurance that actual results will not differ from those estimates.
RESERVES FOR LOSSES AND LOSS EXPENSES
Significant periods of time can elapse between the occurrence of an insured
loss, the reporting of the loss to the insurer and the insurer's payment of that
loss. To recognize liabilities for unpaid losses and loss expenses, insurers
establish reserves as balance sheet liabilities representing estimates of
amounts needed to pay reported and unreported net losses and loss expenses. As
of March 31, 2004 and December 31, 2003, the Company had accrued $1.6 billion of
loss and loss expense reserves.
When a claim is reported to an insurance subsidiary, its claims personnel
establish a "case reserve" for the estimated amount of the ultimate payment. The
amount of the reserve is primarily based upon a case-by-case evaluation of the
type of claim involved, the circumstances surrounding each claim and the policy
provisions relating to the type of losses. The estimate reflects the informed
judgment of such personnel based on general insurance reserving practices, as
well as the experience and knowledge of the claims person. Until the claim is
resolved, these estimates are revised as deemed necessary by the responsible
claims personnel based on subsequent developments and periodic reviews of the
cases.
In accordance with industry practice, we maintain, in addition to case reserves,
estimates of reserves for losses and loss expenses incurred but not yet reported
(IBNR). We project our estimate of ultimate losses and loss expenses at each
reporting date. The difference between: (i) projected ultimate loss and loss
expense reserves and (ii) case loss reserves and loss expense reserves thereon
are carried as the IBNR reserve. By using both estimates of reported claims and
IBNR determined using generally accepted actuarial reserving techniques, we
estimate the ultimate net liability for losses and loss expenses. We have
established a range of reasonably possible IBNR losses for non-environmental net
claims of approximately $661.5 million to $818.4 million at December 31, 2003. A
range has not been established at March 31, 2004, because management believes it
would not be meaningful. A low and high reasonable IBNR selection was derived
primarily by considering the range of indications calculated using standard
actuarial
21
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 $769.3 million
at March 31, 2004 and $733.7 million at December 31, 2003. The ultimate actual
liability may be higher or lower than reserves established. We do not discount
to present value that portion of our loss and loss expense reserves expected to
be paid in future periods. However, the loss reserves include anticipated
recoveries from salvage and subrogation.
Reserves are reviewed by both internal and independent actuaries for adequacy on
a periodic basis. Beginning in 2003, we began using independent actuaries to
certify the adequacy of our reserves. When reviewing reserves, we analyze
historical data and estimate the impact of various factors such as: (i) per
claim information; (ii) Company and industry historical loss experience; (iii)
legislative enactments, judicial decisions, legal developments in the imposition
of damages, and changes in political attitudes; and (iv) trends in general
economic conditions, including the effects of inflation. This process assumes
that past experience, adjusted for the effects of current developments and
anticipated trends, is an appropriate basis for predicting future events. There
is no precise method, however, for subsequently evaluating the impact of any
specific factor on the adequacy of reserves because the eventual deficiency or
redundancy is affected by many factors.
Included in the loss and loss expense reserves on the consolidated balance
sheets are amounts for environmental claims, both asbestos and non-asbestos.
These claims have arisen primarily under older policies containing exclusions
for environmental liability which certain courts, in interpreting such
exclusions, have determined do not bar such claims. The emergence of these
claims is slow and highly unpredictable. Since 1986, policies issued by the
Insurance Subsidiaries have contained a more expansive exclusion for losses
related to environmental claims. Our asbestos and non-asbestos environmental
claims have arisen primarily from exposures in municipal government, small
commercial risks and homeowners policies.
IBNR reserve estimation for environmental claims is often difficult because, in
addition to other factors, there are significant uncertainties associated with
critical assumptions in the estimation process such as average clean-up costs,
third-party costs, potentially responsible party shares, allocation of damages,
insurer litigation costs, insurer coverage defenses and potential changes to
state and federal statutes. However, management is not aware of any emerging
trends that could result in future reserve adjustments. Moreover, normal
historically-based actuarial approaches are difficult to apply because relevant
history is not available. In addition, while models can be applied, such models
can produce significantly different results with small changes in assumptions.
As a result, management does not calculate a specific environmental loss range,
as it believes it would not be meaningful.
After taking into account all relevant factors, we believe that the reserve for
net losses and loss expenses at March 31, 2004, is adequate to provide for the
ultimate net costs of claims incurred as of that date. Establishment of
appropriate reserves is an inherently uncertain process and there can be no
certainty that currently established reserves will prove adequate in light of
subsequent actual experience.
PREMIUM REVENUE
Net premiums written equal direct premiums written, plus assumed premiums less
ceded premiums. All three components of net premiums written are recognized in
revenue over the period that coverage is provided. The vast majority of our net
premiums written have a coverage period of twelve months. This means we record
1/12 of the net premiums written as earned premium each month, until the full
amount is recognized. When premium rates increase, the effect of those increases
would not immediately affect earned premium. Rather, those increases will be
recognized ratably over the period of coverage. Unearned premiums and prepaid
reinsurance premiums, which are recorded on the consolidated balance sheets,
represent that portion of premiums written that are applicable to the unexpired
terms of policies in force.
DEFERRED POLICY ACQUISITION COSTS
Policy acquisition costs, which include commissions, premium taxes, fees, and
certain other costs of underwriting policies, are deferred and amortized over
the same period in which the related premiums are earned. Deferred policy
acquisition costs are limited to the estimated amounts recoverable after
providing for losses and loss expenses that are expected to be incurred, based
upon historical and current experience. Anticipated investment income is
considered in determining whether a premium deficiency exists. The Company
continually reviews the methods of making such estimates and establishing the
deferred costs, and any adjustments therefrom are made in the accounting period
in which the adjustment arose.
OFF-BALANCE SHEET ARRANGEMENTS, CONTRACTUAL OBLIGATIONS AND CONTINGENT
LIABILITIES AND COMMITMENTS
At March 31, 2004 and 2003, the Company did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or for other contractually narrow or limited purposes. As such, the Company is
not exposed to any financing, liquidity, market or credit risk that could arise
if the Company had engaged in such relationships.
Our future cash payments associated with contractual obligations pursuant to
operating leases for office space and equipment, senior convertible notes,
convertible subordinated debentures and notes payable have not materially
changed since December 31, 2003. We expect to have the capacity to repay and/or
refinance these obligations as they come due.
22
The senior convertible notes have a contingent conversion feature that allows
conversion of the notes when the stock price has maintained a 20% premium to the
conversion price of $29.29, or $35.15, for 20 of 30 consecutive trading days
ending on the last trading day of such calendar quarter. As this contingency has
been met as of March 31, 2004, on any business day in the second quarter of
2004, the holders may surrender notes for conversion into shares of common
stock, or cash, at the Company's option. As this condition has been met, 3.9
million shares have been added 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 March 31, 2004 or
December 31, 2003. We have issued no guarantees on behalf of others and have no
trading activities involving non-exchange traded contracts accounted for at fair
value. We have no material transactions with related parties other than those
disclosed in Item 8. "Financial Statements and Supplementary Data", Note 17 to
our consolidated financial statements on page 73 of the 10-K section of our
Annual Report to Shareholders for the year ended December 31, 2003.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in the information about market risk set
forth in our Annual Report on Form 10-K for the year-ended December 31, 2003.
ITEM 4. CONTROL AND PROCEDURES
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) as of the end of
the period covered by this report. Based on that evaluation, the Chief Executive
Officer and Chief Financial Officer concluded that the disclosure controls and
procedures were effective as of the end of the period covered by this report.
No change in the Company's internal control over financial reporting (as defined
in Rule 13a-15(f) of the Exchange Act) occurred during the Company's first
fiscal quarter that materially affected, or is reasonably likely to materially
affect, the Company's internal control over financial reporting.
PART II OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS -
On May 21, 2003, a purported class action was brought by several health
care providers in the Superior Court of New Jersey, Law Division -
Camden County, against Consumer Health Network Plus, LLC, Alta
Services, LLC (Alta) and Selective Insurance Company of America, wholly
owned subsidiaries of Selective, together with ten other unrelated
defendants. The plaintiffs purport to represent a class of all New
Jersey health care providers, except hospitals, who had bills for their
services paid from personal injury protection benefits under New Jersey
automobile insurance policies and whose payments were reduced pursuant
to a preferred provider organization discount schedule. 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. On
March 10, 2004 the plaintiffs filed an amended complaint, wherein Alta
was dropped as a defendant. All defendants expect to file a Motion to
Dismiss the amended complaint on or about May 14, 2004. Since the suit
remains in its early stages, management cannot at this time provide a
meaningful estimate or range of estimates of a potential loss, if any.
23
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES
Issuer Purchases of Equity Securities:
Total Number of Maximum Number
Shares Purchased of Shares that May Yet
Total Number of Average Price Paid as Part of Publicly Be Purchased Under the
Period Shares Purchased(1) Per Share Announced Program Announced Program(2)
- ------------------- ------------------- ------------------- ------------------- -----------------------
January 1-31, 2004 2,608 $ 33.22 - 2,500,000
February 1-29, 2004 58,488 34.87 - 2,500,000
March 1-31, 2004 17,228 38.83 - 2,500,000
------ ----------- -----
TOTAL 78,324 $ 35.69 -
====== =========== =====
- --------------------
(1) The February period included 55,725 shares purchased from employees in
connection with the vesting of restricted stock. The remaining 22,599
shares were purchases from employees in connection with stock option
exercises. All of these repurchases were made in connection with
satisfying tax withholding obligations of those employees. These shares
were not purchased as part of the publicly announced program. The
shares were purchased at the closing price of the Company's common
stock on the dates of the purchases.
(2) On November 4, 2003 the Board of Directors authorized a 2.5
million-share repurchase program scheduled to expire on November 30,
2005.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES - NONE
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Selective's Annual Meeting of Stockholders was held on April 28, 2004. At the
Annual Meeting, C. Edward Herder, CPCU, Gregory E. Murphy, and William M. Rue,
CPCU, were elected as directors to serve for a term of three years, expiring at
the 2007 Annual Meeting of Shareholders and until their successors are elected
and qualified. Votes cast for and withheld on the election of directors were as
follows:
VOTES
VOTES FOR WITHHELD
--------- --------
C. Edward Herder, CPCU 21,953,118 1,069,887
Gregory E. Murphy 21,914,780 1,108,225
William M. Rue, CPCU 21,796,601 1,226,404
The directors whose terms of office continued after the Annual meeting are; Paul
D. Bauer, A. David Brown, William A. Dolan, II, William M. Kearns, Jr., Joan M.
Lamm-Tennant, Ph.D., S. Griffin McClellan III, John F. Rockart, Ph.D., and J.
Brian Thebault.
ITEM 5. OTHER INFORMATION - NONE
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
The exhibits required by Item 601 of Regulation S-K are listed in the
Exhibit Index, which immediately precedes the exhibits filed with this
Form 10-Q.
(b) Reports on Form 8-K:
On February 3, 2004, the Company furnished a report on Form 8-K under
Item 12 thereof with respect to the issuance of a press release
announcing its financial results for the quarter and year ended
December 31, 2003. The Company's press release dated February 3, 2004
was attached as Exhibit 99.1.
On April 5, 2004, the Company furnished a report on Form 8-K under item
12 thereof announcing that commencing April 1, 2004, the Company's
senior convertible notes due 2032 are convertible into the Company's
common stock pursuant to the terms of the notes, and that approximately
3.9 million shares will be included in the Company's diluted earnings
per share calculation in the first quarter of 2004. The Company's press
release dated April 5, 2004 was attached as Exhibit 99.
24
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the Registrant has duly caused this Report to be signed on its
behalf by the undersigned, thereunto duly authorized.
SELECTIVE INSURANCE GROUP, INC.
REGISTRANT
By: /s/ Gregory E. Murphy April 30, 2004
- ------------------------------------------------------------------
Gregory E. Murphy
Chairman, President and Chief Executive Officer
By: /s/ Dale A. Thatcher April 30, 2004
- -------------------------------------------------------------------
Dale A. Thatcher
Executive Vice President of Finance, Chief Financial Officer and Treasurer
25
SELECTIVE INSURANCE GROUP, INC.
INDEX TO EXHIBITS
Exhibit No.
- -----------
* 11 Statement Re: Computation of Per Share Earnings.
* 31.1 Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002,
* 31.2 Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002,
* 32.1 Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* 32.2 Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
- ----------
* Filed herewith