Selective Insurance Group, Inc. — 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016; comparisons are primarily with 2015. The filing also reports fourth-quarter results. Selective is a property-and-casualty insurer operating standard commercial, standard personal, and excess and surplus (E&S) lines, alongside its investment segment.
Financial performance
| Metric | 2016 | 2015 | Change |
|---|---|---|---|
| Net premiums written | $2,237.3 million | $2,069.9 million | +8% |
| Net premiums earned | $2,149.6 million | $1,989.9 million | +8% |
| Total revenue | $2,284.3 million | $2,131.9 million | +7% |
| Net income | $158.5 million | $165.9 million | -4% |
| Diluted EPS | $2.70 | $2.85 | -5% |
| Operating income (non-GAAP) | $161.7 million | $157.3 million | +3% |
| Diluted operating EPS (non-GAAP) | $2.75 | $2.70 | +2% |
| Operating cash flow | $301.8 million | $381.6 million | Lower |
Net income included $4.9 million of net realized investment losses, versus $13.2 million of gains in 2015. Operating income excludes realized investment gains and losses; the two measures therefore moved in opposite directions.
- Underwriting: Insurance-segment underwriting income was $151.9 million, up 2%. The GAAP combined ratio was 92.9%, versus 92.5% in 2015 (a higher ratio is less favorable); the statutory combined ratio improved to 91.8% from 92.4%. Catastrophe losses were $59.7 million, or 2.8 points of the statutory combined ratio.
- Investment income: Pre-tax net investment income rose 8% to $130.8 million; after-tax investment income was $98.4 million versus $93.8 million. Pre-tax investment yield was 2.5% in both years.
- By insurance segment: Standard Commercial Lines produced $146.4 million of underwriting income, down from $164.5 million, with a 91.2% GAAP combined ratio versus 89.2%. Standard Personal Lines earned $12.4 million versus $1.3 million, with a 95.6% ratio versus 99.5%. E&S remained unprofitable, with a $6.9 million underwriting loss, improved from a $16.8 million loss; its ratio improved to 103.4% from 109.8%.
- Quarterly context: Fourth-quarter 2016 net income was $39.4 million, versus $45.4 million in fourth-quarter 2015; underwriting income was $35.2 million versus $49.1 million.
Financial position, liquidity, and capital
- Total assets were $7.36 billion and stockholders’ equity was $1.53 billion at year-end, compared with $6.90 billion and $1.40 billion, respectively, a year earlier.
- Invested assets totaled $5.36 billion, 92% in fixed income securities. Fixed-income portfolio credit quality averaged AA-; 97% was investment grade. Portfolio duration was 3.6 years, compared with approximately 4.0 years for insurance liabilities.
- Cash and short-term investments totaled approximately $222 million. Operating cash flow was $301.8 million; investing activities used $318.1 million and financing activities provided $15.9 million.
- Long-term debt was $438.7 million, versus $328.2 million in 2015; there was no short-term debt outstanding at year-end and no balance on the $30 million parent credit line. Debt-to-capitalization was approximately 22.3%, versus 21.7%.
- Gross loss and loss expense reserves were $3.69 billion, with $3.08 billion net of reinsurance. The filing estimates a reasonable net reserve range of $2.78 billion to $3.24 billion. Prior-year loss development was favorable by $65.8 million in 2016.
- The quarterly common dividend increased 7% to $0.16 per share in late 2016. The 2016 dividend was $0.61 per share.
Material changes and management commentary
- NPW growth accelerated across the company, led by 9% growth in Standard Commercial Lines and 11% in E&S; personal-lines NPW declined 1%. Management attributed growth to new business, agent relationships, and renewal pricing.
- Standard Commercial’s combined ratio worsened as loss and expense ratios increased. Commercial auto was a particular pressure point: its statutory combined ratio rose to 109.3% from 101.9%, amid adverse reserve development and higher claim frequency and severity.
- Management reported continued favorable workers compensation experience, including a statutory combined ratio of 80.7%, supported by prior-year reserve releases, underwriting actions, and claims initiatives. It cautioned that reserve estimates remain sensitive to changing claims patterns.
- Selective shifted from a mostly buy-and-hold investment approach toward more active management, onboarded new investment managers, and modestly increased exposure to below-investment-grade fixed income, private equity, and private credit. Risk assets were 7% of invested assets at year-end, with a long-term target of about 10%. The repositioning contributed to investment sales and impairment charges.
- Management plans to expand Standard Commercial into Arizona and New Hampshire in the second half of 2017 and expected to appoint 85 additional agencies in 2017.
Outlook, risks, and contingencies
- 2017 outlook: Management expected a statutory combined ratio of approximately 90.5%, excluding catastrophe losses and assuming no prior-year casualty reserve development; catastrophe losses of 3.5 points; after-tax investment income of approximately $110 million; and weighted-average shares of approximately 59.2 million. These are expectations, not guarantees.
- Reserving and underwriting: Reserve estimates are judgmental and may change materially. Favorable prior-year development has occurred for 11 years, but management gave no assurance it would continue. Commercial auto and E&S had adverse development in 2016; E&S had limited historical loss data and remained above a 100% combined ratio.
- Catastrophe, reinsurance, and flood: Catastrophe losses, including hurricanes, could exceed modeled or reinsured levels. The NFIP’s authorization was due to expire September 30, 2017 unless extended; changes to the program could affect Selective’s flood business. Flood premiums and losses under the WYO program are ceded to the federal government.
- Investments and tax: Interest-rate, credit-spread, equity-market, and alternative-investment valuation changes could affect earnings, equity, and statutory surplus. Management noted that a federal corporate tax rate reduction to 15%–20% could require a non-cash deferred-tax-asset write-down of approximately $36 million–$49 million.
- Other exposures: Risks include cybersecurity incidents, reliance on third-party technology providers, regulatory changes, competition and pricing pressure, and limits on dividends from regulated insurance subsidiaries. The parent’s $30 million credit line and certain debt covenants depend on financial and insurance-subsidiary metrics.
- The company disclosed ordinary-course claims litigation and certain class-action and extra-contractual matters, but stated it did not believe any case at year-end would materially affect consolidated financial condition, results, or cash flows. An adverse outcome could still affect particular periods.
Most important facts for investors to verify
- Whether 2017 underwriting guidance is achieved, particularly the assumptions excluding catastrophe losses and prior-year reserve development.
- Whether commercial auto claims trends and E&S profitability improve, and whether workers compensation reserve releases persist.
- How the more active investment strategy affects realized losses, impairments, portfolio credit quality, liquidity, and after-tax income.
- Whether the NFIP is reauthorized and what any program changes mean for flood operations.
- Parent liquidity and debt-service capacity, including regulatory approval and availability of insurance-subsidiary dividends.
KPMG issued an unqualified opinion on the consolidated financial statements and an unqualified opinion on internal control over financial reporting as of December 31, 2016.