SELECTIVE INSURANCE GROUP INC annual report, FY2012

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Business context and reporting period

Selectice Insurance Group, Inc. is a property and casualty insurance holding company reporting for the fiscal year ended December 31, 2012. It operates Standard Insurance, Excess and Surplus (E&S) Insurance, and Investments segments, distributing primarily through independent agents. The filing also provides unaudited fourth-quarter results.

Financial performance and condition

  • Revenue and premiums: Total revenue was $1.734 billion, up 9% from 2011. Net premiums written rose 12% to $1.667 billion; net premiums earned rose 10% to $1.584 billion.
  • Profit: Net income was $38.0 million, or $0.68 diluted per share, versus $22.0 million, or $0.40, in 2011. Operating income, a non-GAAP measure, was $32.1 million, up from $21.2 million. Return on average equity was 3.5%; operating return on average equity was 3.0%.
  • Underwriting and margins: The GAAP combined ratio improved to 104.0% from 107.2%, but remained above 100%, indicating an underwriting loss. Statutory combined ratio improved to 103.5% from 106.7%. The underwriting loss narrowed to $64.0 million from $103.6 million.
  • Investments: Pre-tax net investment income declined 11% to $131.9 million; after-tax investment income was $100.3 million. Net realized investment gains were $9.0 million, compared with $2.2 million in 2011. The portfolio totaled $4.330 billion, with 89% in fixed maturities; its pre-tax yield was 3.1%, down from 3.7%.
  • Cash flow and liquidity: Operating cash flow was $226.7 million, versus $123.0 million in 2011. Cash and short-term investments totaled approximately $215 million at year-end. The company reported $1.091 billion of stockholders’ equity and $307.4 million of debt; year-end debt-to-capitalization was approximately 22%.
  • Fourth quarter: Net income was $1.3 million, versus $18.0 million in fourth-quarter 2011. The quarter recorded an underwriting loss of $36.5 million, versus underwriting income of $7.9 million a year earlier.

Material changes versus the prior comparable period

  • Premium growth reflected rate increases, improved retention, and expansion of E&S following the 2011 acquisitions. E&S net premiums written increased to $113.3 million from $24.1 million; its 2012 statutory combined ratio was 118.8%.
  • Catastrophe losses were $98.6 million, down from $118.8 million in 2011, but remained a substantial drag on underwriting. Excluding catastrophe impacts, the reported combined ratio was 98.2% in 2012 versus 98.9% in 2011.
  • Hurricane Sandy was the largest storm loss in company history. Standard and E&S operations incurred $136.0 million of gross losses, with $46.6 million net after reinsurance. Separately, gross flood losses were approximately $1.039 billion and were 100% ceded to the federal NFIP. The company recognized $18.3 million of flood claims-handling fees.
  • Net favorable prior-year reserve development was approximately $26 million, down from $39 million in 2011. Net reserves for losses and loss expenses were $2.659 billion; gross reserves were $4.069 billion, including large NFIP-related amounts.
  • The company retrospectively adopted new insurance acquisition-cost accounting guidance in 2012. This reduced reported deferred acquisition costs and restated prior-period financial information; the filing reports 2011 book value per share of $19.45 as restated, versus $20.39 originally reported.

Outlook, commentary, and risks

  • Management targets a 95% statutory combined ratio by year-end 2014, equivalent to 92% excluding an assumed three points of catastrophe losses. For 2013, it expects a 96% statutory combined ratio excluding catastrophes and prior-year development, plus a three-point catastrophe estimate. E&S is expected to produce a 100%–102% combined ratio in 2013.
  • Standard Commercial Lines renewal pure price increased 6.2% in 2012; the reported increase for January 2013 was 7.5%. Management said achieving price increases above predicted loss trends is central to its underwriting targets.
  • Management expected 2013 after-tax investment income of approximately $90–$95 million, below the $100 million earned in 2012, citing persistently low reinvestment yields. The 2013 catastrophe reinsurance program increased placed limits by 43%; management expected ceded premium to rise by $11 million.
  • Ratings were A/Stable from A.M. Best, A/Negative from S&P, A2/Negative from Moody’s, and A+/Stable from Fitch. A.M. Best had lowered its rating to A in 2012; the filing warns that a downgrade below A- could affect business and trigger a line-of-credit default provision.
  • Key exposures include catastrophe concentration in the Eastern and Midwestern U.S. (New Jersey was 23.3% of 2012 net premiums written), reserve-estimation uncertainty, reinsurance recoverability, low interest rates, investment credit and municipal-bond risk, and regulatory and economic uncertainty. TRIA was scheduled to expire December 31, 2014; the company’s stated 2013 TRIA deductible was approximately $209 million.
  • The Parent issued $185 million of 5.875% senior notes due 2043 in February 2013, intending to redeem its $100 million 7.5% junior subordinated notes due 2066 and use remaining proceeds for general corporate purposes. Pro forma debt-to-capitalization was expected to be 26%.
  • Management reported effective disclosure controls and internal control over financial reporting; KPMG issued unqualified opinions on the financial statements and internal controls. Ordinary-course litigation was not expected to be material overall, though the filing notes that adverse outcomes could affect individual periods.

Important facts for investors to verify

  • Whether reported rate increases and retention gains continue to outpace claims-cost trends, and whether the 2013 and 2014 combined-ratio targets are achieved.
  • Ultimate Sandy losses, NFIP reimbursement timing and collectability, and the net impact after catastrophe reinsurance and claims-handling fees.
  • Reserve adequacy, particularly for workers’ compensation and general liability; the disclosed reasonable range for net loss reserves was $2.456 billion–$2.805 billion, excluding certain asbestos, environmental, and continuous-exposure claims.
  • Investment-income performance as higher-yielding securities mature, including the effect on earnings of low rates, credit deterioration, and municipal-bond exposure.
  • Rating outlooks and capital metrics, the completion and cost of the 2013 debt refinancing, and the availability of regulated subsidiary dividends to fund Parent obligations and shareholder dividends.
  • The full audited financial statements and notes for detailed cash-flow, segment, reinsurance, reserve, and contractual-obligation disclosures; this summary is based on the provided filing text.