Selective Insurance Group, Inc. — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011; comparisons are with the same 2010 periods unless noted. Selective writes property and casualty insurance, principally across 22 Eastern and Midwestern states, and reports Insurance Operations and Investments segments. Amounts below are in millions except per-share data and ratios.
Financial results and key metrics
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $394.1 | $389.7 | $1,197.1 | $1,170.5 |
| Net premiums earned | $359.0 | $354.7 | $1,065.9 | $1,063.1 |
| Net investment income | $35.8 | $33.0 | $118.6 | $104.2 |
| Pre-tax income (loss) from continuing operations | $(40.8) | $22.1 | $(11.8) | $52.6 |
| Net income (loss) | $(20.1) | $17.2 | $3.7 | $41.8 |
| Diluted EPS | $(0.37) | $0.32 | $0.07 | $0.77 |
| Insurance GAAP combined ratio | 119.0% | 101.1% | 110.5% | 102.0% |
Insurance underwriting produced losses of $68.1 million in Q3 and $111.9 million year to date. Net catastrophe losses were $67.4 million for the quarter and $112.4 million for the nine months, versus $11.9 million and $52.2 million, respectively, in 2010. Hurricane Irene accounted for $40.4 million of Q3 net catastrophe losses; the filing also cites Tropical Storm Lee and other events. The company recorded $2.5 million of investment impairment charges in Q3 and $3.3 million year to date. Operating income, a non-GAAP measure excluding specified investment results and discontinued operations, was a loss of $18.2 million in Q3 and income of $0.6 million year to date.
Net premiums written rose 8% in Q3 to $396.8 million and 4% year to date to $1,133.2 million. Management attributed growth to improved audit and endorsement premiums, renewal pricing and retention, plus the acquired E&S renewal book. Commercial Lines renewal price increases were 2.7%; Personal Lines increases were 5.9% in Q3 and 6.3% year to date. Personal Lines growth was accompanied by a 141.4% Q3 statutory combined ratio, while Commercial Lines’ ratio was 110.7%.
Operating cash flow was $126.6 million for the nine months, up from $103.3 million. Investing activities used $107.0 million and financing activities used $19.9 million; cash ended the period at $0.3 million. Management separately reported $163 million of cash and short-term investments available across the Parent and insurance subsidiaries, including $20 million added during Q3 for anticipated catastrophe claims.
At September 30, total assets were $5,749.0 million, total liabilities $4,662.4 million and stockholders’ equity $1,086.6 million. Investments totaled $4,062.8 million. Notes payable were $262.4 million, essentially unchanged from year-end 2010; debt-to-capital was 19.4%. Statutory surplus was approximately $1.0 billion. Book value per share was $20.04, compared with $19.95 at December 31, 2010. The quarterly dividend remained $0.13 per share.
Material changes and notable items
- Catastrophe claims drove the sharp deterioration in underwriting and earnings; management said the company expected to pierce the first layer of its catastrophe excess-of-loss treaty for the first time since 1989. It incurred a $0.7 million reinstatement premium.
- Net investment income increased 8% in Q3 and 14% year to date, mainly from alternative investments. The fixed-maturity portfolio’s average credit rating shifted from AA to AA-, partly following the U.S. sovereign downgrade; the portfolio had $112.0 million of pre-tax unrealized gains on AFS securities.
- Selective acquired renewal rights to Alterra’s commercial E&S book in August; the acquired book generated about $77 million of gross premiums in 2010. In September, it agreed to acquire Montpelier U.S. Insurance Company for an indicated value of about $55 million, with closing expected in Q4 2011 and pre-acquisition liabilities subject to reinsurance and collateral arrangements.
- Q3 included a $0.7 million after-tax charge related to revaluing contingent proceeds from the 2009 sale of Selective HR. Estimated sale proceeds were approximately $5.9 million, with $2.5 million received to date.
- The company reclassified 68 securities, with $222.2 million carrying value, from held-to-maturity to available-for-sale after unexpected credit-rating downgrades changed its intent to hold them to maturity.
Outlook, risks and contingencies
Management forecast full-year 2011 GAAP and statutory combined ratios of approximately 108%, including an assumed two points of Q4 catastrophe losses and excluding any additional favorable or unfavorable reserve development. Year-end weighted-average shares were expected to be about 55 million. The company cited ongoing pricing pressure, low investment yields, economic weakness and elevated catastrophe activity; it expected bond portfolio yields to continue declining if market conditions persisted. It also described a strategy of improving risk selection, pursuing rate increases and expanding into E&S lines. The A.M. Best A+ rating had a negative outlook; management stated a downgrade below A- could affect business and trigger a credit-facility default.
Key exposures include uncertain catastrophe and prior-year reserve development; reinsurance recoverability and treaty exhaustion; investment-market, credit and interest-rate volatility; municipal bond and structured-security risks; and potential litigation outcomes. Ordinary-course claims litigation was not expected to be material overall, but the company cautioned that an adverse result in certain matters could materially affect a particular period’s results or cash flows. Insurance-subsidiary dividends to the Parent require regulatory approval, creating a potential constraint on parent-company debt service and shareholder dividends. The company had $60.7 million of remaining alternative-investment commitments, with no certainty all will be called.
Adoption of insurance acquisition-cost guidance effective in 2012 was expected to reduce after-tax equity by approximately $55 million, or about $1 per share of book value, without a material effect on operating results. Management said disclosure controls were effective and reported no material change in internal control over financial reporting during the period.
Important facts for investors to verify
- Whether catastrophe claims, including Irene and Lee, develop beyond current estimates and how much of the losses are recovered under reinsurance.
- Whether the approximately 108% full-year combined-ratio outlook is achieved, and the effect of non-catastrophe losses and reserve development.
- Personal Lines’ elevated loss ratio and the pace at which rate increases and portfolio maturation improve underwriting profitability.
- Investment income’s reliance on alternative-investment returns, credit quality and unrealized gains, as well as any further impairments or rating changes.
- Completion and economics of the Montpelier U.S. Insurance Company acquisition, including the scope and collateralization of legacy reinsurance arrangements.
- Actual capital and book-value effect of the 2012 acquisition-cost accounting change, and the availability of regulated subsidiary dividends to support Parent obligations.