SELECTIVE INSURANCE GROUP INC annual report, FY2018

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Selective Insurance Group, Inc. (SIGI) — 2018 Form 10-K

Business and period. The filing reports the fiscal year ended December 31, 2018, with comparisons to 2017 and 2016. Selective is a property-and-casualty insurance holding company selling through independent agents. Its reportable businesses are Standard Commercial Lines, Standard Personal Lines, E&S Lines, and Investments.

Financial performance and condition

  • Revenue and premiums: Total revenue was $2.586 billion, up 5% from $2.470 billion. Net premiums written rose 6% to $2.514 billion; net premiums earned rose 6% to $2.436 billion.
  • Earnings: Net income was $178.9 million, up 6%; diluted EPS was $3.00, up from $2.84. Income before federal tax fell 19% to $211.7 million, while the effective tax rate declined to 15.5% from 35.6%. The 2017 rate included a $20.2 million Tax Reform deferred-tax charge.
  • Underwriting and returns: Underwriting income declined 21% to $121.2 million. The combined ratio worsened to 95.0% from 93.3% (below 100% indicates an underwriting profit). GAAP ROE was 10.2%; non-GAAP operating ROE was 12.5%, above the company’s 12% target.
  • Investment performance: Net investment income increased 21% to $195.3 million before tax and 35% to $160.5 million after tax. Net realized and unrealized investment losses were $54.9 million, versus gains of $6.4 million in 2017. This included $29.4 million of equity-market losses recognized in income under newly adopted accounting guidance.
  • Cash flow and liquidity: Operating cash flow was $454.9 million, compared with $379.5 million in 2017. Cash and short-term investments totaled $324 million at year-end; total invested assets were $5.961 billion. Management said year-end capital and liquidity were at record levels. The Parent held $146 million in cash and investments, against a stated target of at least $160 million to cover two years of expected Parent needs.
  • Capital and debt: Stockholders’ equity was $1.792 billion, up from $1.713 billion. Long-term debt was $439.5 million; there was no balance on the Parent’s $30 million line of credit. Debt-to-capitalization was 19.7%, and the weighted-average effective debt rate was 5.3%. The Insurance Subsidiaries’ statutory surplus totaled $1.768 billion.
  • Other balance-sheet measures: Gross loss and loss expense reserves were $3.894 billion, with $3.356 billion net of reinsurance. The investment portfolio was 89% fixed income and had an average credit quality of AA-. Book value per share increased to $30.40 from $29.28.

Material changes and segment results

  • Premium growth was broad-based: Standard Commercial Lines NPW increased 6%, Standard Personal Lines 4%, and E&S Lines 7%.
  • The consolidated combined ratio deteriorated by 1.7 points. The loss and loss expense ratio rose to 61.5% from 58.7%, reflecting higher catastrophe and non-catastrophe property losses and lower favorable prior-year reserve development; improved expenses partly offset the increase.
  • Catastrophe losses were $88.0 million, or 3.6 combined-ratio points, up from $67.3 million and 2.9 points in 2017. Events included Hurricanes Florence and Michael and severe winter storms.
  • Standard Commercial Lines underwriting income fell 27% to $109.1 million; its combined ratio increased to 94.3% from 91.6%. Commercial auto remained a significant weakness: its 2018 combined ratio was 115.7%, and the line had been unprofitable for three years. Workers compensation improved substantially, with a 70.3% combined ratio, aided by $83.0 million of favorable prior-year development.
  • Standard Personal Lines underwriting income rose 15% to $12.8 million, with a 95.8% combined ratio. E&S reduced its underwriting loss to $0.7 million from $6.3 million, but remained slightly unprofitable at a 100.3% combined ratio.
  • Net favorable prior-year loss development was $29.9 million, lower than $39.2 million in 2017 and $65.8 million in 2016. Favorable workers compensation and general liability development was partly offset by unfavorable commercial auto and E&S casualty development.
  • Comprehensive income declined to $105.8 million from $204.9 million, primarily reflecting a $73.1 million other comprehensive loss, including declines in investment-security values.

Outlook, risks, and unusual items

  • 2019 guidance: Management set a 12% non-GAAP operating ROE target. Guidance assumptions include a GAAP combined ratio excluding catastrophe losses of 92.0% (assuming no prior-year casualty reserve development), catastrophe losses of 3.5 points, after-tax net investment income of $175 million (including $8 million from alternatives), an effective tax rate of approximately 19%, and 60 million diluted weighted-average shares.
  • Management priorities: Match or exceed loss-cost inflation with renewal price increases; pursue disciplined growth and geographic expansion; improve commercial auto, personal auto, and E&S profitability; and continue investment-portfolio and customer-experience initiatives. Management noted commercial auto severity and frequency pressures and competitive pricing conditions.
  • Reserving uncertainty: Management’s reasonable range for net loss reserves was $3.003 billion to $3.556 billion, compared with recorded net reserves of $3.356 billion. Reserve estimates are judgmental and may change materially. Commercial auto had adverse prior-year development of $36.7 million; E&S casualty had adverse development of $12.0 million.
  • Catastrophe and reinsurance exposure: Hurricanes are the company’s largest natural-catastrophe exposure, with geographic concentration in the Eastern and Midwestern U.S. Management stated the catastrophe program exhausts at approximately a modeled 1-in-225-year hurricane event. The 2019 TRIPRA deductible was $339 million; protection depends on program terms and federal certification.
  • Other material risks: Insurance results are exposed to reserve inadequacy, social and economic inflation, reinsurance counterparty risk, investment-market and interest-rate changes, competition and distribution-partner concentration, regulatory change, cyber incidents, and restrictions on subsidiary dividends. The NFIP authorization was scheduled to expire May 31, 2019, creating uncertainty for the flood business; NFIP flood premiums and losses are fully ceded to the federal program.
  • Contingencies and reporting: The company reported ordinary-course insurance and other litigation, but did not believe any matter then known would materially affect consolidated financial condition. It cautioned that an adverse litigation outcome could affect results or cash flows in particular periods. KPMG issued unqualified opinions on the financial statements and internal control over financial reporting.

Investor verification priorities

  1. Track commercial auto pricing, claim frequency and severity, reserve development, and progress toward underwriting profitability.
  2. Compare actual catastrophe losses and reinsurance recoveries with the 2019 guidance assumptions and modeled protection.
  3. Monitor workers compensation and general liability favorable development for sustainability, and assess the recorded reserves against management’s disclosed range.
  4. Reconcile investment income growth with investment-market losses, including the equity accounting change, unrealized fixed-income losses, and alternative-investment returns.
  5. Assess whether the 2019 operating ROE and combined-ratio guidance is achieved, including the effect of the assumed tax rate and no prior-year reserve development.
  6. Verify NFIP reauthorization and any changes to WYO compensation, and monitor regulatory limits on dividends from insurance subsidiaries to the Parent.