SELECTIVE INSURANCE GROUP INC quarterly report, Q1 FY2014

Selective Insurance Group, Inc. — Q1 2014 Form 10-Q

Reporting period: Quarter ended March 31, 2014; comparisons are primarily with Q1 2013. Selective writes standard and excess-and-surplus property and casualty insurance and invests the resulting premiums.

Key financial results

MetricQ1 2014Q1 2013Change
Total revenue$509.1 million$459.9 million+11%
Net premiums earned$456.5 million$420.9 million+8%
Net investment income$35.5 million$32.9 million+8%
Pre-tax income from continuing operations$25.1 million$28.9 million-13%
Net income$18.0 million$21.3 million-16%
Diluted EPS$0.31$0.38-18%
Operating income, non-GAAP$13.3 million$20.1 million-34%
Operating return on average equity, non-GAAP4.5%7.2%-2.7 points

All-lines GAAP combined ratio was 101.1%, versus 97.1% a year earlier; the statutory ratio was 100.8%, versus 96.8%. A ratio above 100% indicates an underwriting loss. Net loss and loss expense incurred rose 19% to $320.5 million, while net underwriting expenses rose 1% to $139.7 million. Quarterly dividends were $0.13 per share.

Operating cash flow was $35.8 million, compared with $28.1 million. Investing activities used $27.7 million, versus $99.1 million; financing activities used $8.0 million, versus providing $71.1 million. Cash was $0.2 million at quarter-end; cash plus short-term investments was approximately $138 million.

At March 31, total assets were $6.37 billion, total liabilities $5.18 billion, and stockholders’ equity $1.19 billion. Invested assets totaled $4.64 billion. Notes payable were $392.4 million; debt-to-capitalization was approximately 25%. Statutory surplus was $1.3 billion. The $30 million parent credit line was undrawn. Book value per share was $21.09, up from $20.63 at year-end 2013.

Material changes and drivers

  • Severe winter weather materially worsened underwriting results. Catastrophe losses were $34 million, or 7.5 combined-ratio points, versus $1.6 million, or 0.4 points. Non-catastrophe property losses were approximately $91 million, about five points above Q1 2013.
  • Favorable prior-year casualty reserve development was $14 million, or 3.1 points, compared with $2 million, or 0.4 points. The filing attributes much of the 2014 benefit to improving general-liability claim trends for 2009–2012 accident years.
  • Renewal rights to the small self-insured group book were sold for $8 million. The proceeds were included in other income and benefited reported underwriting results; the company will continue servicing policies in force at the sale date.
  • Standard Insurance Operations recorded a $6.0 million underwriting loss, compared with a $12.1 million gain. Its GAAP combined ratio rose to 101.4% from 96.9%. E&S underwriting income improved to $1.0 million from $0.1 million, with a 97.0% GAAP combined ratio versus 99.7%.
  • Investment portfolio unrealized gains increased as rates fell; the 10-year Treasury yield declined 31 basis points. Net unrealized/unrecognized investment losses improved to $31.4 million from $52.0 million at year-end.

Outlook, risks, and unusual items

  • Management’s 2014 expectations: full-year combined ratio of 92% excluding catastrophe losses and assuming no additional prior-year casualty reserve development; four points of catastrophe losses; approximately $100 million of after-tax investment income; and approximately 57.4 million weighted-average shares.
  • Management expected 2014 renewal pure price increases of 6%–7% overall and in each of Standard Commercial, Standard Personal, and E&S lines. Q1 increases were 6.4%, 6.8%, and 4.1%, respectively. Management said commercial earned rate increases exceeded its approximately 3% loss-cost trend.
  • Low reinvestment yields remain a headwind as maturing and called bonds are replaced at lower rates. The fixed-income portfolio’s average credit rating was AA− and duration was 3.5 years, compared with approximately 3.8 years for insurance liabilities.
  • The company expects $9.8 million of 2014 contributions to its retirement income plan; $2.7 million had been funded by quarter-end. Other-investment commitments remaining were $52.6 million.
  • NFIP reforms remain uncertain following the March 2014 Flood Insurance Affordability Act’s modification of prior rate increases. The filing identifies potential program, regulatory-conflict, and reputational risks to the company’s flood business.
  • Management said ordinary-course litigation was not expected to materially affect consolidated financial condition, but adverse outcomes in certain unpredictable cases could materially affect results or cash flows in a particular period. Investment impairment assessments and insurance reserves depend on estimates that may change.
  • Rating context: A.M. Best affirmed A (stable) in 2013; Fitch affirmed A+ with a negative outlook in Q1 2014; S&P had lowered its rating to A− with a stable outlook in 2013; Moody’s A2 outlook was negative. A.M. Best downgrading below A− would trigger a credit-line default provision.

Important facts for investors to verify

  • Whether elevated property losses normalize and whether management achieves the 92% ex-catastrophe combined-ratio target.
  • Whether favorable casualty reserve development continues, and how sensitive results are to changes in reserve estimates.
  • How much reported earnings and underwriting ratios benefited from the one-time $8 million renewal-rights sale.
  • Whether premium increases and retention remain sufficient to outpace loss-cost trends, including in workers’ compensation and personal lines.
  • How low interest rates affect reinvestment income, investment yields, and asset-liability matching.
  • Developments in NFIP funding and implementation of the 2014 flood-law changes, as well as insurer dividend approvals and debt repayment capacity.