Selective Insurance Group, Inc. — 2010 Form 10-K
Business context and period: Annual report for the fiscal year ended December 31, 2010, with comparisons to 2009 and 2008. Selective is a property and casualty insurer operating primarily in 22 Eastern and Midwestern states. Its two segments are Insurance Operations and Investments; Commercial Lines represented about 82% of net premiums written.
Financial performance and condition
| Metric | 2010 | 2009 | Change / context |
|---|---|---|---|
| Total revenue | $1.565 billion | $1.514 billion | Up 3% |
| Net premiums written | $1.391 billion | $1.423 billion | Down 2% |
| Net premiums earned | $1.417 billion | $1.431 billion | Down 1% |
| Net investment income | $145.7 million | $118.5 million | Up 23%; improved alternative investment results more than offset lower fixed-income income |
| Net realized investment losses | $7.1 million | $46.0 million | Losses narrowed, including lower OTTI charges |
| Income from continuing operations, after tax | $69.3 million | $44.7 million | Up 55% |
| Net income | $65.5 million | $36.4 million | Up 80%; includes a $3.8 million after-tax loss on disposal of discontinued operations |
| Diluted EPS | $1.20 | $0.68 | Continuing-operations diluted EPS was $1.27 versus $0.83 |
| Underwriting result | Loss of $22.2 million | Profit of $2.4 million | Combined ratio 101.6% versus 99.8%; above 100% indicates underwriting loss |
| Operating income (non-GAAP) | $73.9 million | $74.5 million | Down 1%; operating return on average equity was 7.1% versus 7.9% |
| Operating cash flow | $159.2 million | $227.6 million | Down 30% |
| Total assets / stockholders’ equity | $5.232 billion / $1.071 billion | $5.115 billion / $1.002 billion | Equity increased; book value per share rose to $19.95 from $18.83 |
| Debt | $262.3 million | $274.6 million | Debt-to-capitalization 19.7%, down from 21.5% |
Cash and short-term investments totaled approximately $162 million at year-end, including $51 million at the Parent and $111 million at the insurance subsidiaries. Consolidated cash alone was $0.6 million. The $30 million revolving credit facility was undrawn and expires August 11, 2011. Insurance subsidiaries paid $48 million in dividends to the Parent in 2010; the stated 2011 ordinary dividend limit was $110 million, subject to regulatory requirements.
Material changes versus prior periods
- Catastrophe losses climbed to $56.5 million from $8.5 million in 2009, adding about 4.0 points to the 2010 loss ratio. The company reported losses from more than 20 storms.
- Favorable prior-year reserve development was about $43.6 million, versus $29.4 million in 2009. Favorable commercial auto and general liability development was partly offset by approximately $22 million of unfavorable workers compensation development.
- Insurance underwriting weakened: the combined ratio increased to 101.6% from 99.8%. Personal Lines premiums written grew 13%, but its combined ratio worsened to 106.4% statutory; Commercial Lines premiums written fell 5%.
- Investment income recovered from 2009’s alternative-investment losses, with alternative investments contributing $20.3 million of income versus a $21.7 million loss. Fixed-maturity income declined by about $10.9 million as reinvestment yields fell.
- Investment portfolio management was outsourced to two external managers. The company reduced municipal exposure and increased corporate fixed-income allocation; the fixed-maturity portfolio retained an average S&P rating of AA.
- The company sold its HR outsourcing business in 2009. In 2010, it recorded a further after-tax disposal loss of $3.8 million, including a revaluation of contingent sale proceeds.
Outlook, risks, and unusual items
Management forecast 2011 statutory and GAAP combined ratios of 101%–102%, including an assumed two points of catastrophe losses and excluding any reserve development. Year-end 2011 weighted-average shares were expected to be approximately 55 million. Management cited pricing pressure and a slow economic recovery, while reporting 2010 Commercial Lines renewal price increases of 3.1%, stable 87% renewal retention, and Personal Lines price increases exceeding 5%.
- Reserves: Net loss and loss expense reserves were $2.516 billion at year-end. Management’s reasonable reserve range was $2.356 billion–$2.665 billion; the estimate is judgment-sensitive, particularly for general liability, workers compensation, and commercial auto. Environmental claims are slow-developing and highly uncertain.
- Catastrophe and terrorism exposure: Regional concentration increases exposure to severe weather. The 2010 TRIA deductible would have been about $189 million; the filing notes proposed changes and TRIA’s then-current authorization through December 31, 2014.
- Investments: Low reinvestment yields may continue to pressure fixed-income income. Municipal bonds were about 36% of the investment portfolio; management said it was monitoring public-sector credit risk. Alternative investments involve subjective valuations, limited liquidity, and up to $63.6 million of remaining commitments.
- Accounting change: New insurance acquisition-cost guidance, effective for periods beginning after December 15, 2011, was expected to eliminate a significant portion of the $209.6 million deferred acquisition cost balance and reduce GAAP equity; the amount was not specified.
- Ratings and regulation: A.M. Best affirmed the A+ financial strength rating with a negative outlook; other listed financial strength outlooks were stable. Insurance-subsidiary dividends to the Parent require regulatory review or approval.
- Contingencies: The company said ordinary-course litigation and other lawsuits were not expected to materially affect consolidated financial condition, but adverse outcomes could affect results or cash flows in particular periods. KPMG issued unqualified opinions on the financial statements and internal control over financial reporting.
Important facts for investors to verify
- Whether 2011 underwriting results achieve the 101%–102% combined-ratio outlook, and how catastrophe losses and pricing affect that outcome.
- Whether workers compensation severity and reserve assumptions develop adversely; compare reported reserve development with the disclosed reserve range and sensitivities.
- Whether investment income can withstand lower reinvestment yields and whether alternative-investment valuations and commitments remain manageable.
- Credit quality and concentration in municipal bonds, along with the effect of any rating changes on capital, liquidity, and investment values.
- The realized GAAP equity impact of the new acquisition-cost accounting guidance and the timing and collectability of contingent HR sale proceeds.
- Availability of Parent liquidity after the revolving credit facility’s August 2011 expiration, and the regulatory capacity for subsidiary dividends.