Selective Insurance Group, Inc. — Q2 2014 Form 10-Q
Business and period: Selective writes standard property-and-casualty insurance, excess-and-surplus (E&S) coverage, and invests insurance premiums. This unaudited filing covers the quarter and six months ended June 30, 2014, compared with the same 2013 periods.
Financial performance
Amounts in $ millions, except per-share data and ratios.
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Revenue | 506.8 | 468.9 | 1,015.9 | 928.9 |
| Net premiums earned | 463.6 | 426.3 | 920.1 | 847.2 |
| Pre-tax income from continuing operations | 39.5 | 36.2 | 64.6 | 65.1 |
| Net income | 29.3 | 27.1 | 47.3 | 48.4 |
| Diluted EPS | $0.51 | $0.48 | $0.83 | $0.86 |
| GAAP combined ratio | 97.8% | 98.9% | 99.4% | 98.0% |
| Statutory combined ratio | 97.5% | 97.7% | 99.2% | 97.3% |
| Operating income (non-GAAP) | 26.4 | 23.8 | 39.7 | 43.9 |
| Diluted operating EPS (non-GAAP) | $0.46 | $0.42 | $0.70 | $0.78 |
- Quarterly revenue rose 8% and net income rose 8%; first-half revenue rose 9%, while net income declined 2%. First-half operating income fell 10%.
- First-half net premiums written were $956.6 million, up 5%. Management attributed growth primarily to renewal pricing and retention in Standard Commercial Lines.
- Investment income before tax increased 8% in both periods: $36.8 million for Q2 and $72.3 million year to date. The annualized after-tax portfolio yield was 2.3% for the first half.
- Net cash from operations was $72.7 million for the first half, versus $97.9 million a year earlier. Cash at period-end was $1.5 million; cash plus short-term investments was approximately $168 million.
- At June 30, total assets were $6.49 billion, investments $4.74 billion, total liabilities $5.25 billion, and stockholders’ equity $1.24 billion. Notes payable were $392.3 million; debt-to-capital was approximately 24.1%. Book value per share was $21.96, up from $20.63 at year-end.
Material changes and management commentary
- Q2 underwriting improved year over year, but first-half combined ratios worsened. The first-half loss ratio rose 2.3 points as catastrophe and non-catastrophe property losses outweighed pricing and reserve benefits.
- Catastrophe losses were $27.2 million in Q2 and $61.6 million for six months, versus $19.6 million and $21.2 million, respectively, a year earlier. Management cited severe winter weather and subsequent storms.
- Non-catastrophe property losses were unusually high: approximately $73 million in Q2 and $164.4 million year to date, about four combined-ratio points above comparable 2013 periods.
- Favorable prior-year casualty reserve development increased to $17.5 million in Q2 and $31.5 million year to date, mainly from improving general-liability claims trends. Workers’ compensation trends were described as stable.
- Renewal pure price increases were 6.0% overall for the first half; earned increases were 7.1%, compared with an estimated loss-cost trend of about 3%. Standard Personal Lines retention declined amid targeted reductions in less-profitable exposures.
- E&S improved: its statutory combined ratio was 99.9% for Q2 and 98.8% year to date, versus 106.8% and 102.6% in 2013. Standard Personal Lines remained loss-making, with a 105.3% first-half GAAP combined ratio.
- An $8 million first-quarter sale of renewal rights to a small self-insured public-entity book benefited first-half results; the company retained servicing responsibilities for policies in force at sale.
- Investment fair-value gains lifted first-half other comprehensive income by $43.2 million after tax. The 10-year Treasury yield fell 50 basis points in the first half, improving bond valuations but reinforcing pressure on reinvestment yields. Unrealized/unrecognized investment losses improved to $13.3 million from $52.0 million at year-end; management viewed them as temporary and primarily interest-rate-related.
Outlook, risks, and contingencies
- Management’s 2014 expectations: a 92% combined ratio excluding catastrophe losses and assuming no additional prior-year casualty reserve development; catastrophe losses of five points for the year; overall renewal price increases of approximately 6%; after-tax investment income of approximately $100 million; and weighted-average shares of approximately 57.4 million. The catastrophe-loss outlook was raised by one point; pricing guidance was lowered to the low end of the prior 6%–7% range.
- The company’s long-term target is a 12% operating return on average equity; first-half operating return was 6.6%, versus 8.0% in 2013. Management cited higher property losses and low investment yields as challenges.
- Insurance subsidiaries expected to pay approximately $57.5 million in dividends to the parent in 2014; $28.8 million had been paid through June. Such dividends are subject to regulatory approval. The parent’s $30 million credit line was undrawn; $58 million was outstanding from the Federal Home Loan Bank. Debt principal payments include $13 million in December 2014 and $45 million in December 2016.
- A.M. Best reaffirmed the company’s “A (Excellent)” financial-strength rating with a stable outlook. The filing notes that a downgrade below “A-” could trigger a credit-facility default and affect business with customers or agents. Other agencies’ ratings and outlooks differed.
- Key risks include claims severity and reserve estimates, catastrophe exposure, investment-market and low-yield risk, and uncertainty around federal flood-program rules and funding. The 2014 Flood Affordability Act altered prior NFIP reforms; the company was working with FEMA on implementation. Litigation was described as not expected to materially affect consolidated financial condition, though adverse outcomes could materially affect particular periods’ results or cash flows.
- The filing reports no material change in market-risk disclosures, no material off-balance-sheet arrangements, and no material change in contractual obligations since year-end. Management concluded disclosure controls were effective.
Most important facts for investors to verify
- Whether the full-year combined-ratio guidance is achievable given elevated catastrophe and property losses, and the assumption of no further favorable or adverse reserve development.
- Whether earned pricing continues to exceed loss-cost trends, particularly as renewal pricing moderates and personal-lines retention remains lower.
- The adequacy of casualty reserves and sustainability of favorable general-liability development.
- Actual catastrophe losses versus the five-point full-year assumption, and the impact of continued severe weather.
- Investment income and portfolio yields under low-rate conditions, including sensitivity to changes in interest rates and unrealized investment values.
- NFIP reform implementation, program funding, and any effects on flood operations, servicing obligations, or reputation.
- Parent liquidity and access to regulated-subsidiary dividends, debt-service capacity, and maintenance of credit ratings and covenants.