SELECTIVE INSURANCE GROUP INC quarterly report, Q1 FY2018

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Selective Insurance Group, Inc. — Q1 2018 Form 10-Q

Business context and reporting period

Selective Insurance Group is a property-and-casualty insurer operating through ten insurance subsidiaries. Its reportable segments are Standard Commercial Lines, Standard Personal Lines, Excess and Surplus (E&S) Lines, and Investments. This unaudited filing covers the quarter ended March 31, 2018, compared with Q1 2017.

Key financial metrics

  • Revenue: $626.7 million, up 4%; net premiums earned rose 6% to $591.8 million. Net premiums written increased 4% to $624.6 million.
  • Earnings: Net income was $18.9 million, or $0.32 diluted per share, versus $50.4 million, or $0.85, a year earlier. Non-GAAP operating income was $27.3 million ($0.46 per diluted share), compared with $51.1 million ($0.86).
  • Underwriting and margins: The consolidated combined ratio increased to 99.2% from 91.2%. After-tax underwriting income fell to $3.7 million from $32.0 million. Standard Commercial Lines had a 98.5% combined ratio; Personal Lines, 102.0%; and E&S, 101.1%.
  • Investment income: Pre-tax net investment income rose 16% to $43.2 million; after-tax investment income increased 30% to $35.8 million. Net realized and unrealized investment losses were $10.5 million, including $14.1 million of unrealized equity-security losses recognized in earnings.
  • Cash flow: Operating cash flow was negative $7.7 million, versus positive $24.5 million in Q1 2017. Investing cash flow was negative $59.5 million and financing cash flow positive $39.4 million. Cash and restricted cash totaled $16.9 million at quarter-end.
  • Financial position and liquidity: Total assets were $7.66 billion and stockholders’ equity $1.66 billion at March 31. Total debt was approximately $494.2 million; the debt-to-capital ratio was 22.9%. Cash and short-term investments were $184 million, including $29 million at the Parent and $155 million at insurance subsidiaries. Book value per share was $28.25, down from $29.28 at year-end 2017.

Material changes versus Q1 2017

  • Loss and loss expense incurred increased 21% to $384.9 million. Catastrophe losses rose to $26.0 million from $12.2 million, and non-catastrophe property losses to $105.7 million from $71.4 million. Management cited East Coast winter storms, the January deep freeze, and severe fires.
  • Prior-year reserve development was $3.9 million favorable overall, compared with $13.9 million favorable in Q1 2017. Q1 2018 included $8.0 million favorable casualty development and $4.1 million unfavorable property development; commercial auto had $8.0 million unfavorable casualty development.
  • Commercial Lines underwriting income fell to $6.8 million from $42.5 million; Personal Lines and E&S recorded underwriting losses. Commercial auto’s combined ratio was 111.3%, and commercial property’s was 115.5%.
  • Investment income growth partly offset weaker underwriting. The reported investment result was also affected by the adoption of accounting guidance requiring changes in equity-security fair value to be recorded in earnings rather than other comprehensive income.
  • Other comprehensive loss was $63.4 million, mainly reflecting investment-security valuation declines as interest rates rose. The company said the increase in unrealized fixed-income losses reflected higher rates, not underlying credit concerns, and considered the securities temporarily impaired.
  • The statutory corporate tax rate fell from 35% to 21% under Tax Reform. The quarter’s effective tax rate was 5.0%, compared with 25.4% in Q1 2017; management’s full-year expectation was higher.

Guidance, outlook, risks, and unusual items

  • After Q1 results below expectations, management revised 2018 guidance to a GAAP combined ratio, excluding catastrophe losses, of approximately 92.0%, assuming no additional prior-year casualty reserve development; catastrophe losses of 3.5 points; after-tax net investment income of $150 million, including $8 million from alternative investments; an effective tax rate of approximately 18%; and weighted-average shares of approximately 59.6 million.
  • Management described a competitive, low-growth insurance market and said it was pursuing price increases, underwriting and claims improvements, new business, and geographic expansion. It expects continued pressure on E&S premium growth while it prioritizes profitability. Planned expansion included New Mexico and Utah by year-end 2018 and Arizona and Utah for Personal Lines by early 2019.
  • Commercial auto remains a profitability concern; management reported 7.3% renewal pure price increases in Q1 and ongoing efforts to reduce higher-risk exposures. E&S also remained below its targeted profitability level.
  • The investment portfolio was 92% fixed income, with a weighted-average credit rating of AA- and 97% investment-grade holdings. Risk assets were 8% of invested assets; management said it might increase the allocation toward approximately 10%, depending on market conditions. Fixed-income portfolio duration was 3.9 years versus approximately 3.8 years for insurance liabilities.
  • NFIP authorization was due to expire July 31, 2018. The filing cited uncertainty about reauthorization and potential changes to the WYO program, including a scheduled reduction in the expense allowance from 30.9% to 29.9% effective October 2018.
  • Other risks include reserve-estimation uncertainty, catastrophe and property-loss volatility, interest-rate and credit-spread movements, and litigation. The company said it did not believe any legal action at quarter-end would materially affect its consolidated financial condition, results, or cash flows, while noting that an adverse litigation outcome could affect particular periods.
  • The company anticipated $100 million of insurance-subsidiary dividends to the Parent in 2018, subject to regulatory approval. It had $232.7 million of remaining commitments to alternative investments, which may or may not require funding.

Important facts for investors to verify

  • Whether the revised 2018 combined-ratio, catastrophe-loss, investment-income, tax-rate, and share-count guidance was achieved, particularly given the assumption of no further prior-year casualty development.
  • Whether catastrophe and non-catastrophe property losses, commercial auto trends, and reserve development improved or deteriorated in subsequent quarters.
  • Whether NFIP authorization was extended and how program changes affected the company’s flood business and WYO economics.
  • How much of the Q1 earnings decline reflected underlying underwriting performance versus equity-security fair-value accounting and other investment items.
  • Whether the expected subsidiary dividends were approved and paid, and whether liquidity, debt levels, investment commitments, and capital ratios remained within management’s stated targets.