Selective Insurance Group, Inc. — Q3 2014 Form 10-Q
Business context and reporting period. Selective writes standard and excess-and-surplus property and casualty insurance, alongside an investment segment. This filing covers the quarter and nine months ended September 30, 2014; comparisons are with the corresponding 2013 periods unless stated otherwise. Financial statements are unaudited.
Financial and operating results
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total revenue | $515.4 million | $486.8 million | $1,531.3 million | $1,415.7 million |
| Net premiums earned | $462.6 million | $437.6 million | $1,382.8 million | $1,284.8 million |
| Pre-tax income from continuing operations | $75.3 million | $44.5 million | $139.9 million | $109.6 million |
| Net income | $53.2 million | $32.7 million | $100.5 million | $81.1 million |
| Diluted EPS | $0.93 | $0.57 | $1.75 | $1.43 |
| Operating income, non-GAAP | $43.3 million | $23.9 million | $82.9 million | $67.8 million |
| Insurance operations GAAP combined ratio | 92.6% | 97.7% | 97.1% | 97.9% |
Q3 revenue rose 6% and net income rose 63%; nine-month revenue rose 8% and net income rose 24%. Q3 improvement reflected lower catastrophe losses and increased favorable prior-year casualty reserve development. Year-to-date improvement was more modest because catastrophe and non-catastrophe property losses increased.
- Underwriting: Q3 insurance underwriting gain was $34.4 million, versus $10.2 million; nine-month gain was $39.5 million, versus $26.8 million. The Q3 loss ratio improved to 58.6% from 64.7%, while the expense ratio increased to 33.8% from 32.7%.
- Business segments: Standard operations posted a Q3 GAAP combined ratio of 91.6% and nine-month ratio of 96.9%. E&S recorded a Q3 underwriting loss of $1.4 million and combined ratio of 103.8%; its nine-month combined ratio was 100.4%.
- Catastrophes and reserves: Catastrophe losses were $5.4 million (1.2 points) in Q3 versus $11.9 million (2.7 points); nine-month losses were $66.9 million (4.8 points) versus $33.1 million (2.6 points). Favorable prior-year casualty reserve development was $7.5 million in Q3 and $39.5 million year to date.
- Investment income and gains: Pre-tax net investment income was $34.3 million in Q3 and $106.6 million year to date, up 6% and 7%. Net realized gains were $15.2 million and $27.0 million, respectively, primarily from rebalancing high-dividend equity holdings. No OTTI charges were recorded in Q3 2014; nine-month 2014 OTTI was $1.4 million.
- Cash flow: Nine-month operating cash flow was $158.1 million, down from $238.0 million. Investing activities used $134.7 million and financing activities used $21.1 million. Ending cash was $2.5 million; cash plus short-term investments was $184.1 million.
- Balance sheet and debt: At September 30, total assets were $6.58 billion, investments $4.80 billion, loss reserves $3.45 billion, total liabilities $5.31 billion, and stockholders’ equity $1.27 billion. Notes payable were $392.3 million; debt-to-capital was approximately 23.6%. Book value per share was $22.45, up from $20.63 at year-end 2013.
- Liquidity and capital: Parent had no balance outstanding on its $30 million credit line. The insurers had $58 million of FHLBI borrowings and approximately $38 million of additional capacity under the stated borrowing limit. Statutory surplus was $1.3 billion. The fixed-income portfolio’s weighted-average credit rating was AA-; its duration was 3.6 years versus estimated insurance-liability duration of 3.8 years.
Material changes and management outlook
- Net premiums earned increased 6% in Q3 and 8% year to date. Standard commercial lines growth and earned rate increases were important contributors; E&S premiums earned rose 13% in Q3 and 12% year to date.
- Renewal pure price increases were 5.8% overall for the first nine months, with earned price increases of 6.8%, above management’s estimated loss-inflation trend of about 3%. Personal-lines retention declined amid targeted actions to reduce exposure to less profitable coverages.
- In March 2014, the company sold renewal rights to its self-insured group pooled public-entity book for $8 million. The proceeds were included in other income and reduced the nine-month combined ratio by 0.6 points.
- Management expected for full-year 2014: a combined ratio of 92% excluding catastrophe losses and additional prior-year casualty development; catastrophe losses of 4 to 4.5 points; overall renewal price increases of about 5.5%; after-tax investment income of about $105 million; and weighted-average shares of about 57.4 million.
- The company reported a 91.8% statutory combined ratio excluding catastrophes for the first nine months, in line with its 92% full-year goal. It noted pressure on industry commercial-lines pricing and a low-rate environment; estimated after-tax fixed-income yield was about 2.25%.
- The board declared a $0.14 per-share dividend payable December 1, 2014, an 8% increase from the prior declaration. Q3 dividends paid were $0.13 per share.
Risks, contingencies and unusual items
- Management identified loss reserves, pension assumptions, investment impairments and reinsurance as critical estimates. New mortality information was expected to potentially produce an approximately $20 million pre-tax charge to OCI in Q4 2014, assuming other post-retirement-plan assumptions remained unchanged.
- Unrealized investment loss positions totaled $19.3 million, down from $52.0 million at year-end 2013. Management attributed losses mainly to interest rates, said it did not intend or expect to be required to sell the affected securities, and cautioned that changed credit judgments could result in future losses.
- NFIP reform and funding remain uncertain. The company participates in the federal flood-insurance write-your-own program, under which flood losses are ceded to the NFIP; policy changes, funding uncertainty, and potential conflicts between federal program requirements and state regulation could affect the business.
- Insurance subsidiaries face ordinary-course claims litigation and other actions, including class actions and claims alleging extra-contractual or punitive damages. Management expects ultimate liabilities not to be material to consolidated financial condition, but adverse outcomes could materially affect particular periods’ results or cash flows.
- Potential effects of HUD’s disparate-impact regulation on homeowners pricing and underwriting remain uncertain, including the outcomes of related litigation and rulemaking.
- A.M. Best affirmed an A (Excellent) rating with stable outlook; Fitch affirmed A+ with stable outlook; Moody’s affirmed A2 with negative outlook; S&P affirmed A- and revised its outlook to positive. A rating below A- from A.M. Best would trigger a credit-line event of default.
Investor verification priorities
- Assess whether reserve releases—especially general-liability development—and the relatively low Q3 catastrophe burden are repeatable; compare them with the higher year-to-date catastrophe losses.
- Track the full-year combined-ratio, catastrophe-loss, pricing and investment-income expectations against actual results, and confirm the effects of the $8 million renewal-rights sale.
- Review reserve adequacy, reinsurance recoverables and catastrophe protection, including exposure to severe weather and the E&S segment’s adverse development.
- Monitor investment portfolio interest-rate and credit risk, unrealized marks, alternative-investment commitments, and the effect of the expected pension-related OCI charge.
- Verify insurer dividend capacity and regulatory approval, parent liquidity and debt service, and developments in NFIP funding/reform, HUD regulation and material litigation.