Selective Insurance Group, Inc. — Q2 2010 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2010; comparisons are to the corresponding 2009 periods unless noted. Selective writes property and casualty insurance, principally across 22 Eastern and Midwestern states, and reports Insurance Operations and Investments segments. Dollar amounts below are in millions except per-share data.
Financial results and key metrics
| Metric | Q2 2010 | Q2 2009 | Six months 2010 | Six months 2009 |
|---|---|---|---|---|
| Total revenue | $387.7 | $377.2 | $780.8 | $734.0 |
| Net premiums earned | $352.2 | $358.3 | $708.4 | $722.2 |
| Net investment income | $36.5 | $26.4 | $71.3 | $42.1 |
| Net realized investment losses | $(3.3) | $(11.3) | $(3.3) | $(35.3) |
| Net income | $18.8 | $15.7 | $24.6 | $2.8 |
| Diluted EPS | $0.35 | $0.29 | $0.45 | $0.05 |
| GAAP combined ratio | 100.9% | 98.3% | 102.5% | 99.6% |
| Operating income, non-GAAP | $22.2 | $22.7 | $28.8 | $25.4 |
Continuing-operations pre-tax income was $22.8 million in Q2 and $30.5 million for the first half; the filing’s headline pre-tax net income measure also reflects discontinued-operation disposal losses. Total expenses were $364.9 million in Q2 and $750.3 million for the first half. The filing reports continuing-operations tax expense of $2.8 million and $3.8 million, respectively. Dividends were $0.13 per share in Q2 and $0.26 for the first half.
- Underwriting and premiums: Net premiums written fell 3% in both Q2 ($353.5 million) and the first half ($721.6 million). Insurance Operations recorded underwriting losses of $3.2 million in Q2 and $17.8 million in the first half. The combined ratio rose 2.6 points and 2.9 points, respectively; a ratio above 100% indicates underwriting losses.
- Cash flow: Operating cash flow was $58.2 million for the first half, versus $74.0 million in 2009. Investing activities used $33.1 million and financing activities used $25.3 million. Cash from continuing operations ended the period at $0.6 million.
- Balance sheet and liquidity: Total assets were $5.23 billion and stockholders’ equity $1.05 billion at June 30, 2010, compared with $5.11 billion and $1.00 billion at year-end 2009. Investments totaled $3.89 billion. Cash and short-term investments were $344 million, primarily held at insurance subsidiaries. Book value per share increased to $19.65 from $18.83 at year-end.
- Debt and capital: Notes payable were $262.3 million, down from $274.6 million at year-end; debt-to-capitalization was 20.0%. The $30 million revolving credit facility had no balance outstanding. The company reported compliance with debt covenants; next principal repayment was $13 million in 2014.
Material changes versus the prior period
- Net income increased 20% in Q2 and substantially for the first half, largely reflecting stronger alternative-investment returns and lower realized/impairment losses. Alternative investments generated $4.9 million of Q2 income and $8.8 million for the first half, versus losses of $8.9 million and $29.4 million in the comparable 2009 periods.
- Investment income gains were partly offset by lower fixed-maturity income from lower reinvestment yields, more low-yielding short-term investments, and investment-management outsourcing costs of approximately $0.5 million in Q2 and $2.2 million year to date.
- Underwriting performance weakened: catastrophe losses increased by $10.7 million in Q2 and $33.6 million for the first half. Favorable prior-year casualty reserve development partly offset these losses—approximately $11 million in Q2 and $20 million for the first half.
- Commercial Lines renewal pure price increased 3.3% in Q2 and year to date, but Commercial Lines retention declined one point to 75% and 76%, respectively. Personal Lines premiums grew, supported by rate actions, new business, and 83% retention.
- Net realized investment losses narrowed to $3.3 million for the first half from $35.3 million, while earnings-recognized OTTI charges declined to $14.4 million from $39.6 million.
Outlook, commentary, risks, and unusual items
- Outlook: No consolidated earnings guidance is provided. Management described commercial insurance pricing as highly competitive and the economic recovery as slow and uncertain. It planned to target stronger pricing on weaker-performing commercial business while emphasizing retention of better-performing accounts. Personal Lines rate increases and business growth initiatives continued.
- Reinsurance: July 1 property excess-of-loss coverage renewed on substantially the same terms, with a 2% rate decrease. Casualty excess-of-loss coverage renewed on the same terms, with a 9% rate increase.
- Investment and credit risks: The portfolio’s average fixed-maturity credit rating was AA+; non-investment-grade bonds were 1% of that portfolio. Management noted municipal issuer budget uncertainty, investment-market volatility, low yields, and potential credit deterioration. Credit-related impairments included RMBS and CMBS losses; management’s estimates of future cash flows and temporary impairments could change.
- Discontinued operation: Following the 2009 sale of Selective HR, the company recorded after-tax disposal losses of $1.3 million in Q2 and $2.1 million for the first half, primarily from revising contingent sale proceeds. Estimated proceeds fell to approximately $9.3 million from $12.3 million at December 31, 2009.
- Capital and regulatory matters: A.M. Best reaffirmed the company’s A+ financial-strength rating with a negative outlook; S&P and Fitch outlooks were also negative. The filing discusses the Dodd-Frank Act, signed July 21, 2010, and uncertainty about its eventual effect. Insurance-subsidiary dividends remain subject to regulatory approval.
- Other exposures: Ordinary-course claims litigation is not expected to be material overall, but the filing cautions that adverse outcomes in certain unpredictable cases could materially affect results or cash flows in individual periods. Up to $94.8 million of additional alternative-investment commitments may be called through 2023; funding is not certain.
Important facts for investors to verify
- Whether catastrophe losses, workers’ compensation severity, and prior-year reserve development continue to pressure the combined ratio.
- Whether premium growth and commercial pricing can offset weak exposure levels, premium declines, and competitive retention pressure.
- The sustainability and volatility of alternative-investment returns, and the effect of lower fixed-income reinvestment yields and outsourced management costs.
- Developments in RMBS, CMBS, municipal and other investment credit quality, including the assumptions underlying impairment judgments and fair values.
- Availability of subsidiary dividends and liquidity to support parent-company debt service, shareholder dividends, and up to $94.8 million of potential investment commitments.
- Changes in insurer ratings, litigation outcomes, and the practical effects of new financial and insurance regulation.