SELECTIVE INSURANCE GROUP INC quarterly report, Q2 FY2019

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Selective Insurance Group, Inc. — Q2 2019 Form 10-Q

Business context and reporting period

Selective is a property-and-casualty insurer operating through ten insurance subsidiaries. Its reportable segments are Standard Commercial Lines, Standard Personal Lines, Excess and Surplus (E&S) Lines, and Investments. This unaudited filing covers the quarter and six months ended June 30, 2019, compared with the same 2018 periods.

Financial performance and condition

  • Q2 results: Revenue was $708.2 million, up 9%; net income was $72.3 million, up 23%; diluted EPS was $1.21 versus $0.99. Non-GAAP operating income was $69.1 million, up 15%, and diluted non-GAAP operating EPS was $1.16 versus $1.01.
  • First-half results: Revenue was $1.407 billion, up 10%; net income was $133.6 million, up 72%; diluted EPS was $2.23 versus $1.30. Non-GAAP operating income rose 41% to $123.1 million, or $2.06 per diluted share versus $1.46. The prior-year comparison benefited from investment-market fluctuations; 2019 operating income excludes investment gains and losses and $4.2 million of debt-retirement costs.
  • Underwriting: The combined ratio improved to 93.1% from 93.7% in Q2 and to 93.9% from 96.4% for the first half; below 100% indicates underwriting profit. First-half net premiums written grew 7% to $1.374 billion. Underwriting income increased 17% to $44.6 million in Q2 and 83% to $78.2 million year to date.
  • Investment income and returns: Net investment income was $58.5 million in Q2, up 28%, and $109.1 million for six months, up 23%. After-tax investment income increased 27% and 21%, respectively; portfolio after-tax yields were 3.0% and 2.9%, compared with 2.7% and 2.6%. First-half annualized non-GAAP operating ROE was 12.8%, above the company’s 12% 2019 target.
  • Cash flow and liquidity: Operating cash flow was $165.1 million for the first half, versus $92.3 million. At June 30, cash excluding restricted cash plus short-term investments totaled $292 million; the Parent reported $257 million of cash and liquid investments. Cash and restricted cash on the cash-flow statement totaled $7.6 million.
  • Balance sheet and capital: Total assets were $8.576 billion, stockholders’ equity $2.060 billion, and loss and loss expense reserves $4.027 billion. Equity increased 15% from year-end, primarily reflecting investment-security appreciation. Long-term debt was $550.8 million versus $439.5 million at December 31; debt-to-capital was 21.1%. Book value per share rose to $34.71 from $30.40.

Material changes and notable items

  • Investment gains and lower interest rates materially affected reported results and equity. First-half unrealized after-tax gains on fixed-income securities were approximately $145 million; total after-tax unrealized gains on fixed-income and equity securities were $164.5 million at June 30.
  • Catastrophe losses were $29.5 million in Q2 versus $18.7 million and $50.3 million for the first half versus $44.8 million. Favorable prior-year casualty reserve development was $17 million in Q2 and $27 million year to date, partly offset by unfavorable property reserve development of $11.3 million and $10.6 million, respectively.
  • E&S underwriting returned to profit: its combined ratio was 95.0% in Q2 and 93.6% year to date, compared with 114.7% and 107.9%. Commercial automobile remained challenged, with a 106.5% combined ratio for the first half, despite improvement from 110.0%.
  • The company issued $300 million of 5.375% senior notes due 2049 and used part of the proceeds to redeem $185 million of 5.875% notes due 2043. The refinancing generated $290.8 million in net proceeds before use of funds and $4.2 million in pretax debt-retirement costs.
  • Lease accounting adoption added operating-lease right-of-use assets of $20.7 million and lease liabilities of $21.0 million at January 1, 2019. The filing reports no material impact from adoption of the nonemployee share-based-payment standard.

Outlook, risks, and contingencies

  • Management maintained a 2019 target of 12% non-GAAP operating ROE and reported first-half performance above target. Updated full-year expectations are a 91.0% GAAP combined ratio excluding catastrophe losses (previous guidance: 92.0%), assuming no additional prior-year casualty reserve development; catastrophe losses of 3.5 points; after-tax net investment income of $180 million, including $13 million from alternative investments; an effective tax rate of approximately 19%; and 60 million diluted weighted-average shares.
  • Management reported 3.5% overall renewal pure price increases and 7% first-half premium growth. Priorities include disciplined pricing and growth, improved underwriting and claims, customer-facing technology, and active investment-portfolio management. Management cautioned that lower interest rates heighten the importance of underwriting returns.
  • Insurance subsidiaries’ dividends to the Parent are subject to regulatory approval. The company anticipated $110 million of subsidiary dividends in 2019 and reported $55 million paid in the first half. Restrictions could affect Parent liquidity, debt service, or shareholder dividends. The Parent had no balance on its $30 million bank line of credit; it also reported $288.9 million of remaining Federal Home Loan Bank borrowing capacity, subject to collateral and other requirements.
  • The NFIP was authorized only through September 30, 2019 at the time of filing. Potential program lapse, changes to WYO carrier compensation, conflicting directives, or increased private-market competition could affect the company’s flood business.
  • Management cited commercial-auto profitability pressure, workers’ compensation reliance on favorable prior-year reserve emergence, catastrophe exposure, investment and interest-rate risk, and uncertainty in loss-reserve estimates. Litigation is described as ordinary-course; the company did not identify a matter it believed would materially affect consolidated financial condition, results, or cash flows, but acknowledged unpredictable outcomes could affect particular periods.

Important facts for investors to verify

  • Whether the 91.0% ex-catastrophe combined-ratio outlook is achieved, and how actual catastrophe losses and reserve development compare with assumptions.
  • Commercial-auto accident-year loss trends, renewal pricing, retention, and progress toward underwriting profitability.
  • Workers’ compensation reserve adequacy and whether favorable prior-year casualty development continues; assess the sensitivity of results to adverse development.
  • NFIP authorization and any changes to program terms or WYO compensation.
  • Investment-income delivery against the $180 million after-tax outlook, including alternative-investment returns and the effect of interest-rate and market movements.
  • Debt, capital, and liquidity developments, including regulatory approval of subsidiary dividends and funding of contractual alternative-investment commitments.