Business context and reporting period
Selective Insurance Group, Inc. is a property-and-casualty insurer operating in standard commercial, standard personal, and excess and surplus (E&S) markets, alongside its investment segment. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2016; comparisons are with the corresponding 2015 periods. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless noted.
Financial results and key metrics
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Revenue | $581.7 | $540.5 | $1,701.9 | $1,586.3 |
| Net premiums earned | $542.4 | $507.4 | $1,596.8 | $1,473.8 |
| Net investment income | $33.4 | $32.1 | $95.3 | $91.2 |
| Income before tax | $55.4 | $65.8 | $169.6 | $168.9 |
| Net income | $38.5 | $47.0 | $119.1 | $120.5 |
| Diluted earnings per share | $0.66 | $0.81 | $2.03 | $2.08 |
| GAAP combined ratio | 94.1% | 91.2% | 92.7% | 93.2% |
| Operating income (non-GAAP) | $36.1 | $46.8 | $117.3 | $110.2 |
| Diluted operating EPS (non-GAAP) | $0.62 | $0.81 | $2.00 | $1.90 |
Q3 revenue grew 8%, but net income fell 18% and diluted EPS fell 19%. The higher combined ratio reflected increased property losses and underwriting expenses. Year-to-date revenue rose 7%; net income declined 1%, while operating income increased 6%. The 2015 year-to-date comparison benefited from substantially higher realized investment gains, largely associated with an equity investment strategy change.
- Insurance segments: Q3 underwriting gain was $32.0 million versus $44.8 million. Standard Commercial Lines’ underwriting gain fell to $30.1 million from $44.0 million, and its combined ratio worsened to 92.9% from 88.7%. Standard Personal Lines’ underwriting gain increased to $4.3 million, with a 93.8% combined ratio. E&S reported a $2.4 million underwriting loss and a 104.5% combined ratio.
- Loss experience: Q3 catastrophe losses were $10.4 million versus $6.9 million; non-catastrophe property losses were also higher. Favorable prior-year casualty reserve development was $19 million, compared with $15 million. In the nine-month period, catastrophe losses declined to $33.2 million from $56.1 million, contributing to a modest improvement in the combined ratio.
- Cash flow: Nine-month operating cash flow was $177.5 million, down from $259.0 million. Investing activities used $185.0 million; financing activities provided $8.1 million. Cash at period-end was $1.5 million. Management reported $171 million of cash and short-term investments across the Parent and insurance subsidiaries.
- Balance sheet and capital: Total assets were $7.36 billion and stockholders’ equity $1.57 billion at September 30, 2016, versus $6.90 billion and $1.40 billion at December 31, 2015. Investments totaled $5.37 billion. Loss and loss expense reserves were $3.69 billion. Short- and long-term debt totaled approximately $423.6 million; management reported a debt-to-capital ratio of about 21%.
- Investment portfolio: The after-tax portfolio yield was 1.8% year to date versus 1.9%. Lower interest rates increased unrealized fixed-income gains; after-tax unrealized gains were $113.6 million at quarter-end. The fixed-income portfolio’s average duration was 3.7 years and weighted average credit rating was AA-.
- Shareholder returns: Dividends were $0.15 per share in Q3 and $0.45 year to date. Book value per share rose to $27.22 from $24.37 at year-end 2015.
Material changes, outlook, and management commentary
- Management’s full-year 2016 guidance was an ex-catastrophe combined ratio of approximately 89.5% (assuming no additional Q4 prior-year casualty reserve development), catastrophe losses of 3.0 points, after-tax investment income of approximately $95 million, and weighted-average shares of approximately 58.5 million. The catastrophe-loss assumption was reduced from prior guidance of 3.5 points.
- The company’s nine-month statutory combined ratio was 91.2%, including 2.1 points of catastrophe losses and 2.9 points of favorable prior-year casualty reserve development. Annualized operating ROE was 10.5%; management’s stated goal is 300 basis points above its 7.9% weighted-average cost of capital.
- Management cited commercial premium growth from new business, renewal pricing, and retention. It noted pressure in commercial auto results from adverse reserve development and higher current-year claim estimates; personal lines underwriting improved, while E&S remained unprofitable. Management is pursuing targeted E&S pricing and underwriting actions.
- For Q4 2016, the company planned to shift to more active fixed-income portfolio management to pursue after-tax income and total return while maintaining similar credit quality and duration risk. Low interest rates were identified as a challenge because new bond yields are below yields on maturing holdings.
- Management described plans to expand standard commercial operations into Arizona and New Hampshire, expected to be operational by the end of 2017, and continued investment in customer-facing digital services.
- After quarter-end, Hurricane Matthew affected the Southern United States. The company estimated Q4 catastrophe losses of $10–$14 million, partly offset by approximately $1 million related to NFIP policy servicing.
- The company contributed $54.5 million to its pension plan in the first nine months and expected no further 2016 contributions. Pension benefits ceased accruing after March 31, 2016.
- Liquidity includes regulatory and contractual constraints: insurance-subsidiary dividends require regulatory approval. Management anticipated $61 million of subsidiary dividends to the Parent for 2016 and expected to refinance a $45 million FHLBI borrowing due in December 2016. Alternative and other investment commitments could require up to $134 million in additional investments, though funding is not certain.
- Management reported an A.M. Best rating of A; S&P upgraded the company to A with a stable outlook on October 25, 2016. Ordinary-course litigation was not expected to materially affect financial condition, but the filing notes that adverse outcomes in certain unpredictable matters could affect results or cash flows in particular periods.
Important facts for investors to verify
- Whether commercial auto claim frequency, severity, and reserve estimates stabilize, and whether favorable prior-year reserve development continues.
- Actual Q4 catastrophe losses, including Hurricane Matthew, relative to the company’s estimate and full-year catastrophe guidance.
- Progress against full-year underwriting, investment-income, and share-count guidance; distinguish reported net income from non-GAAP operating income.
- Investment yield and portfolio performance following the planned fixed-income strategy change, including exposure to interest-rate and credit risks.
- Availability of subsidiary dividends and refinancing for the December 2016 $45 million borrowing, as well as the funding needs of investment commitments.
- Developments in E&S profitability, commercial auto results, and the legal matters for which outcomes remain uncertain.