Selective Insurance Group, Inc. — Q3 2010 Form 10-Q
Business context and reporting period. The company provides property and casualty insurance, primarily in 22 Eastern and Midwestern states, through its Insurance Operations and Investments segments. This unaudited filing covers the quarter and nine months ended September 30, 2010, compared with the same periods in 2009. Amounts below are in U.S. dollars; financial statement amounts are generally in millions.
Key financial results and condition
| Metric | Q3 2010 | Q3 2009 | Nine months 2010 | Nine months 2009 |
|---|---|---|---|---|
| Total revenue | $389.7 | $390.2 | $1,170.5 | $1,124.2 |
| Net premiums earned | $354.7 | $355.9 | $1,063.1 | $1,078.1 |
| Pre-tax income from continuing operations | $22.1 | $21.8 | $52.6 | $13.1 |
| Net income from continuing operations | $18.8 | $20.6 | $45.5 | $23.0 |
| Net income, including discontinued operations | $17.2 | $13.0 | $41.8 | $15.8 |
| Diluted earnings per share | $0.32 | $0.24 | $0.77 | $0.30 |
| Net investment income | $33.0 | $36.6 | $104.2 | $78.7 |
| Operating income (non-GAAP) | $18.8 | $23.8 | $47.6 | $49.2 |
Q3 GAAP combined ratio was 101.1% (100.0% prior year); the nine-month ratio was 102.0% (99.7%). Statutory combined ratios were 100.3% and 101.4%, respectively. Ratios above 100% indicate underwriting losses. Annualized return on average equity was 6.4% for Q3 and 5.3% for the nine-month period. Dividends were $0.13 per share for the quarter and $0.39 year to date.
- Cash flow: Nine-month operating cash flow was $103.3 million, down from $167.3 million. Investing activities used $72.6 million and financing activities used $31.1 million. Cash from continuing operations at period-end was $0.4 million.
- Liquidity and capital: Management reported $265 million of cash and short-term investments, including $53 million at the Parent and $212 million at insurance subsidiaries. Statutory surplus was $1.0 billion; GAAP equity was $1.09 billion. Total debt was $262.3 million, with a 19.4% debt-to-capitalization ratio. The $30 million revolving credit facility was undrawn and expires August 2011.
- Balance sheet: Total assets were $5.33 billion and total liabilities $4.24 billion at September 30, 2010. Book value per share was $20.41, versus $18.83 at year-end 2009.
- Investments: The portfolio totaled $4.0 billion. Fixed maturities had an average credit rating of AA; non-investment-grade holdings were 1% of that portfolio. Nine-month net realized investment losses were $3.3 million, including $17.2 million of impairment charges recognized in earnings.
Material changes versus the prior period
- Revenue was nearly flat in Q3 and increased 4% for nine months. Net premiums written declined 3% in both comparison periods; commercial lines weakness was partly offset by 13% growth in personal lines premiums written.
- Underwriting results weakened: the nine-month underwriting result shifted from $2.9 million of income to a $21.7 million loss. Management cited $52.1 million of catastrophe losses through September, $43.6 million above the prior-year period, partly offset by $32 million of favorable prior-year casualty reserve development.
- Nine-month net investment income rose 32%, largely because alternative investments generated $11.2 million of income versus a $26.5 million loss in 2009. Q3 investment income fell 10%, primarily from lower fixed-maturity yields. The annualized after-tax yield on fixed maturities was 2.8%, compared with 3.4% a year earlier.
- Nine-month earnings improved substantially versus 2009, largely reflecting lower impairment losses and improved investment results. Q3 continuing-operations net income, however, declined to $18.8 million from $20.6 million. Non-GAAP operating income declined 21% in Q3 and 3% year to date.
- Accumulated other comprehensive income improved to $48.2 million from a $12.5 million deficit at year-end 2009, mainly due to unrealized investment gains.
Outlook, commentary, risks and unusual items
- Insurance outlook: Management described commercial lines pricing as highly competitive and overall pricing power as weak. Commercial renewal pure price increases were 2.8% in Q3 and 3.1% year to date; retention was 75% and 76%, respectively. Personal lines growth and 82% retention were positive, but personal lines statutory combined ratios remained elevated at 103.2% for Q3 and 105.9% year to date.
- Investment outlook: The company completed the transition to external investment managers, lowered equity exposure, and said it would continue emphasizing liquidity, high-quality investments, and diversified investment-grade corporate bonds. Management remained cautious about alternative investments and noted up to $92.1 million of remaining investment commitments through 2023.
- Discontinued operation: Selective HR was sold in December 2009. Revisions to assumptions about worksite retention and new business reduced estimated sale proceeds to approximately $6.9 million from $12.3 million at year-end 2009; $1.7 million had been received by September 30, 2010. The revision resulted in after-tax disposal charges of $1.6 million for Q3 and $3.7 million for nine months.
- Accounting change: A newly issued insurance acquisition-cost standard was expected to eliminate a significant portion of the $218.6 million deferred acquisition-cost asset and reduce GAAP equity; the impact was still being evaluated. The standard was to take effect for periods beginning after December 15, 2011, with early adoption permitted.
- Risks and contingencies: Principal sensitivities include catastrophe losses, reserve estimates and workers’ compensation severity, weak premium demand and pricing, low reinvestment yields, municipal and structured-security credit quality, and investment impairment judgments. Litigation is generally expected not to be material, but the filing cautions that adverse outcomes in some matters could materially affect results or cash flows in individual periods. The company also highlighted regulatory uncertainty, including implementation of the Dodd-Frank Act.
- Ratings: A.M. Best affirmed A+ with a negative outlook; S&P affirmed A and moved the outlook to stable; Fitch affirmed A+ and moved the outlook to stable. The filing reports Moody’s A2 rating with a stable outlook, last reaffirmed in 2008.
Important facts for investors to verify
- Whether catastrophe activity, workers’ compensation severity and reserve development continue to pressure combined ratios and underwriting profitability.
- Whether commercial premium declines stabilize and personal-lines growth can be sustained without worsening loss performance.
- How lower fixed-maturity reinvestment yields and alternative-investment returns affect future investment income and operating earnings.
- The ultimate credit performance and impairment exposure in municipal, mortgage-backed, and other structured securities, and the recoverability of Selective HR contingent sale proceeds.
- The eventual equity impact of the new deferred acquisition-cost accounting standard, as well as regulatory approval and availability of subsidiary dividends to the Parent.