PAGE UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark one) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended . . . . . . . . .September 30, 1997 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from . . . . . . . . . . . .to Commission file number: 0-8641 SELECTIVE INSURANCE GROUP, INC. (Exact name of registrant as specified in its charter) New Jersey 22-2168890 - -------------------------------- ---------------------------------- (State or other jurisdiction (I.R.S. Employer Identification No.) of incorporation or organization) 40 Wantage Avenue, Branchville, New Jersey 07890 ------------------------------------------ ------------ (Address of principal executive offices) (Zip Code) 973-948-3000 ------------------------------- (Registrant's telephone number, including area code) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such report), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] Indicate the number of shares outstanding of each of the issuer's classes of common stock as of the latest practicable date: Common stock, par value $2 per share, outstanding as of October 31, 1997: 14,684,949 (see note 1) -1- PAGE Item 1. Financial Statements. - ------------------------------ SELECTIVE INSURANCE GROUP, INC. ------------------------------- Consolidated Balance Sheets ------------------------------- (unaudited) (dollars in thousands) ASSETS September 30 December 31 - ------ 1997 1996 Investments: ------------ ---------- Debt securities, held-to-maturity - at amortized cost (fair value of $424,444-1997; $445,273-1996)......... $ 409,653 432,792 Debt securities, available-for-sale - at fair value (amortized cost of $1,032,221-1997; $965,965-1996)....... 1,061,144 985,372 Equity securities, available-for-sale - at fair value (cost of $113,107-1997; $99,383-1996).......... 214,312 161,096 Short-term investments (at cost which approximates fair value) 9,965 33,924 Other investments (at cost which approximates fair value)........................... 19,300 10,530 --------- --------- Total investments ...................... 1,714,374 1,623,714 Cash....................................... 7,413 6,098 Interest and dividends due or accrued ..... 22,881 24,167 Premiums and other receivables............. 209,823 152,008 Reinsurance recoverable on paid losses and loss expenses..................... 12,176 7,863 Reinsurance recoverable on unpaid losses and loss expenses......................... 135,054 150,208 Prepaid reinsurance premiums............... 30,697 30,813 Deferred Federal income tax................ 10,706 30,771 Real estate, furniture and equipment....... 47,347 48,993 Deferred policy acquisition costs.......... 102,504 83,150 Excess of cost over fair value of net assets acquired....................... 9,544 9,894 Other assets............................... 25,817 22,058 --------- --------- Total assets............................ $ 2,328,336 2,189,737 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY - ------------------------------------ Liabilities: - ----------- Reserve for losses......................... $ 1,004,559 1,015,601 Reserve for loss expenses.................. 178,046 174,192 Unearned premiums.......................... 395,298 332,040 Convertible subordinated debentures........ 6,879 6,912 Short-term debt ........................... 15,500 - Notes payable.............................. 96,857 96,857 Current Federal income tax................. 4,032 3,729 Other liabilities ......................... 77,240 86,107 --------- --------- Total liabilities....................... 1,778,411 1,715,438 --------- --------- Stockholders' Equity: - -------------------- Common stock of $2 par value per share: Authorized shares-90,000,000 Issued: 18,140,742-1997; 17,911,087-1996 . 36,281 35,822 Additional paid-in capital................. 64,548 53,882 Net unrealized gains on available-for-sale securities, net of deferred income tax effect............................ 84,583 52,728 Retained earnings.......................... 426,487 386,601 Treasury stock - at cost (shares: 3,447,668-1997; 3,366,631-1996) (54,251) (50,680) Deferred compensation expense and notes receivable from stock sales................ (7,723) (4,054) --------- --------- Total stockholders' equity ............. 549,925 474,299 --------- --------- Total liabilities and stockholders' equity $ 2,328,336 2,189,737 ========= ========= See accompanying notes to unaudited consolidated financial statements. -2- PAGE SELECTIVE INSURANCE GROUP, INC. ================================ Consolidated Statements of Income (unaudited) (in thousands, except per share data) Quarter ended Nine Months Ended September 30 September 30 1997 1996 1997 1996 ------ ------ ------ ------ Revenues: - -------- Net premiums written.................$ 200,680 196,765 573,126 544,979 Increase in unearned premiums, net of prepaid reinsurance premiums ........... (30,764) (24,659) (63,374) (20,112) ------- ------- ------- ------- Net premiums earned ................. 169,916 172,106 509,752 524,867 Net investment income earned......... 24,479 23,908 73,605 71,702 Net realized gains (losses) on investments.................. 3,386 (35) 5,355 1,328 Other income......................... 1,120 1,255 3,392 3,286 ------- ------- ------- ------- Total revenues.................... 198,901 197,234 592,104 601,183 ------- ------- ------- ------- Expenses: - -------- Losses incurred ..................... 98,279 104,445 293,934 325,240 Loss expenses incurred............... 20,094 18,418 59,643 57,262 Policy acquisition costs............. 50,978 54,161 153,686 159,569 Dividends to policyholders........... 1,007 1,164 3,300 3,909 Interest expense..................... 2,454 2,299 7,193 6,945 Other expenses....................... 1,857 1,875 6,237 3,998 ------- ------- ------- ------- Total expenses.................... 174,669 182,362 523,993 556,923 ------- ------- ------- ------- Income before Federal income tax 24,232 14,872 68,111 44,260 ------- ------- ------- ------- Federal income tax expense: Current.............................. 5,340 2,547 13,000 7,183 Deferred............................. 497 73 2,912 365 ------- ------- ------- ------- Total Federal income tax expense......................... 5,837 2,620 15,912 7,548 ------- ------- ------- ------- Net income...........................$ 18,395 12,252 52,199 36,712 ======= ======= ======= ======= Earnings per share: - ------------------ Net income-primary................$ 1.25 0.84 3.56 2.53 Net income-fully diluted .........$ 1.22 0.82 3.47 2.46 Dividends to stockholders............$ 0.28 0.28 0.84 0.84 See accompanying notes to unaudited consolidated financial statements. -3- PAGE SELECTIVE INSURANCE GROUP, INC. Consolidated Statements of Cash Flows (unaudited) Nine months ended Sept. 30 (in thousands) 1997 1996 ---- ---- Operating Activities - -------------------- Net income $ 52,199 36,712 Adjustments to reconcile net income to net cash provided by operating activities: Increase in interest and dividends due or accrued 1,286 669 Increase in premiums and other receivables (57,815) (11,435) Increase in reinsurance recoverable on paid losses and loss expenses (4,313) (4,022) Decrease in net Federal income tax asset 3,215 576 Increase in deferred policy acquisition costs (19,354) (6,300) Increase in reserves for losses and loss expenses,net of reinsurance recoverable on unpaid losses and loss expenses 7,966 40,310 Increase in unearned premiums, net of prepaid reinsurance premiums 63,374 20,112 Depreciation and amortization 6,245 3,680 Net realized gains on investments (5,355) (1,328) Other - net (15,571) (25,624) ------ ------ Net adjustments (20,322) 16,638 ------ ------ Net cash provided by operating activities 31,877 53,350 ------ ------ Investing Activities Purchase of debt securities, held-to-maturity (31,730) (56,968) Purchase of debt securities, available-for-sale (120,948) (65,722) Purchase of equity securities, available-for-sale (21,815) (24,295) Purchase of other investments (9,000) - Sale of debt securities, available-for-sale 29,057 13,217 Redemption and maturities of debt securities, held-to-maturity 54,788 59,057 Redemption and maturities of debt securities, available-for-sale 25,883 29,264 Sale of equity securities, available-for-sale 13,697 5,017 Proceeds from other investments 223 79 Increase in net payable from security transactions 2,891 49 Net additions to real estate, furniture and equipment (2,311) (2,915) ------ ------ Net cash used in investing activities $ (59,265) (43,217) ------ ------ See accompanying notes to unaudited consolidated financial statements. -4- PAGE SELECTIVE INSURANCE GROUP, INC. Consolidated Statements of Cash Flows, continued (unaudited) Nine months ended Sept 30 (in thousands) 1997 1996 ---- ---- Financing Activities - -------------------- Dividends to stockholders $ (12,313) (12,214) Acquisition of treasury stock (3,571) (161) Proceeds from short-term debt 15,500 - Net proceeds from dividend reinvestment plan 849 901 Net proceeds from stock purchase and compensation plans 10,243 5,598 Increase in deferred compensation expense and proceeds received on notes receivable from stock sales (5,964) (2,889) ------ ------ Net cash provided by (used in) financing activities 4,744 (8,765) ------ ------ Net decrease in short-term investments and cash (22,644) 1,368 Short-term investments at beginning of year 40,022 54,033 ------ ------ Short-term investments and cash at end of period $ 17,378 55,401 ====== ====== Supplemental disclosures of cash flow information Cash paid during the period for: Interest $ 7,256 7,333 Federal income tax 12,697 6,971 Supplemental schedule of non-cash financing activity: Conversion of convertible subordinated debentures 33 380 See accompanying notes to unaudited consolidated financial statements. -5- PAGE Notes to Unaudited Consolidated Financial Statements - ---------------------------------------------------- 1. Basis of Presentation The interim financial statements are unaudited but reflect all adjustments which, in the opinion of management, are necessary to provide a fair presentation of the results of the Selective Insurance Group, Inc. and its consolidated subsidiaries (collectively, the "Company") for the interim periods presented. References herein to "Selective" are to Selective Insurance Group, Inc. All such adjustments are of a normal recurring nature. The results of operations for any interim period are not necessarily indicative of results for the full year. These financial statements should be read in conjunction with the financial statements and notes thereto contained in the Company's Annual Report on Form 10-K for the year ended December 31, 1996. On October 28, 1997 the Company's board of directors declared a 2 for 1 stock split payable on December 1, 1997 to shareholders of record on November 17, 1997. Giving retroactive effect for the 2 for 1 stock split for the shares outstanding at October 31, 1997, of 14,689,949, there would be 29,369,898 shares outstanding. 2. Recent Accounting Pronouncements The Financial Accounting Standards Board ("FASB") has issued Statement of Financial Accounting Standards No. 128, "Earnings per Share" ("FASB 128"). FASB 128 supersedes Accounting Principles Board Opinion No. 15 "Earnings per Share" ("APB 15") and specifies the computation, presentation, and disclosure requirements for earnings per share ("EPS") for entities with publicly held common stock or potential common stock (that is, securities such as options, warrants, convertible securities, or contingent stock agreements). The objective of FASB 128 is to simplify the computation of EPS and to make the United States standard for computing EPS more compatible with the EPS standards of other countries and with that of the International Accounting Standards Committee. FASB 128 will be effective for financial statements for both interim and annual periods ending after December 15, 1997. The adoption of FASB 128 is not expected to have a material effect on the Company's EPS disclosures. The FASB has issued Statement of Financial Accounting Standards No. 129, "Disclosure of Information about Capital Structure" ("FASB 129"). FASB 129 specifies required disclosures about capital structure that had already been included in a number of previously existing separate statements and opinions and applies to all entities, public and non-public. FASB 129 will be effective for financial statements for periods ending after December 15, 1997. The FASB has issued Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("FASB 130"). FASB 130 establishes standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements. Comprehensive income includes all changes in equity during a period except those resulting from investments by owners and distribution to owners. Under FASB 130, an enterprise will continue to display an amount for net income, but will also be required to report other items that are included in comprehensive income. FASB 130 will be effective -6- PAGE for financial statements for periods beginning after December 15, 1997. Early application is permitted. The FASB issued Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" ("FASB 131"). FASB 131 establishes standards for the way that public business enterprises report information about operating segments in their annual financial statements and requires that those enterprises report selected financial information about operating segments in interim financial reports issued to shareholders. Currently there is an "industry approach" to segment disclosures whereas in FASB 131 segment disclosures are operating segments. Operating segments are components of an enterprise that; (i) engage in business activities from which it may earn revenues and incur expenses; (ii) generate operating results which are regularly reviewed by the enterprise's chief operating decision maker and (iii) have financial information available. FASB 131 will be effective for financial statements for periods beginning after December 15, 1997, although earlier application is encouraged. The Company's primary operating subsidiaries write property and casualty insurance, and the Company presently classifies its business into two industry segments, personal insurance and commercial insurance. The business of the commercial insurance segment is conducted by seven customer- focused Strategic Business Units ("SBUs"), which are contractors, habitational and recreational, mercantile and service, manufacturing and processing, public entities, bonding and selective risk managers. The Company currently reports certain disclosures by the SBU operating segments and when FASB 131 is effective, all required segment disclosures will be reported by SBU operating segments. 3. Lines of Credit During the second quarter of 1997, the Company increased its existing revolving line of credit with a bank from $10 million to $25 million. Selective itself may only borrow up to $20 million of the line. A commitment fee of .12%, or $30,000, on the $25 million is payable annually. The agreement provides that the principal outstanding on the revolving line shall bear interest as elected by the Company under either a daily prime rate quoted by the bank, the London Interbank Offer Rate ("Libor") plus .28%, (Libor loans may be made for interest periods of one, two, three, or six months), or a daily money market rate quoted by the bank. During the first quarter of 1997, the Company entered into an additional revolving line of credit agreement with a bank under which it may borrow up to $25 million, of which Selective itself may only borrow up to $20 million. A commitment fee of .12% on the $25 million is payable annually. The agreement provides that the principal outstanding on the revolving line shall bear interest as elected by the Company under either a daily prime rate quoted by the bank, Libor plus .28% (Libor loans may be made for interest periods of one, two, three, or six months), or a daily money market rate quoted by the bank. At September 30, 1997, there was $15,500,000 of short-term debt outstanding under the two lines of credit and the weighted average interest rate on these borrowings was 6.04%. -7- PAGE 4. Reinsurance The following is a table of assumed and ceded amounts by income statement caption: Quarter ended Nine months ended September 30 September 30 (in thousands) 1997 1996 1997 1996 - -------------------------------------------------------------------------- Net premiums written: Assumed $ 7,397 7,559 18,509 22,206 Ceded (23,280) (17,356) (61,976) (64,809) Net premiums earned: Assumed $ 6,882 7,292 17,802 23,927 Ceded (21,292) (23,248) (62,092) (73,683) Losses incurred: Assumed $ 5,094 8,361 10,738 15,837 Ceded(1) (12,121) (17,016) (21,849) (58,181) Loss expenses incurred: Assumed $ 659 589 1,599 1,628 Ceded (564) (742) (1,434) (2,864) (1) The significant decrease in ceded losses incurred for the nine months ended September 30, 1997 reflected the higher level of flood claims, winter storm claims and one severe liability claim, in the nine months ended September 30, 1996, which generated reinsurance loss recoveries of $18 million, $5 million and $6 million, respectively, for the nine months ended September 30, 1996. The flood business is ceded 100% to the National Flood Insurance Program and therefore, the Company is a servicer and not an underwriter of this type of insurance and bears no risk of policyholder loss. 5. Reclassifications Certain amounts in the Company's prior year consolidated financial statements have been reclassified to conform with the 1997 presentation. Such reclassifications had no effect on the Company's net income or stockholders' equity. -8- PAGE Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations --------------------------------------------------------------- The following discussion relates to the Company's results of operations, financial condition and liquidity for the interim periods indicated. References herein to the "Company" are references to Selective Insurance Group, Inc. and its consolidated subsidiaries, collectively. References herein to "Selective" are to Selective Insurance Group, Inc. The statements, other than historical information, contained in this Form 10-Q including, without limitation, the statements under "Management's Discussion and Analysis of Financial Condition and Results of Operations" are, or may be deemed to be, forward-looking statements. Such statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially. Such factors include, without limitation: (i) the competitive nature of the insurance industry, (ii) the effects of changes in insurance laws and regulations, particularly New Jersey personal automobile insurance, (iii) the frequency and scope of storms and other casualties, and (iv) changes in self-insurance and other alternatives to traditional insurance. Results of Operations - --------------------- Comparison of Third Quarter and Nine Months Ended September 30, 1997, to Third Quarter and Nine Months Ended September 30, 1996: Revenues Net premiums written for the third quarter and nine months ended September 30, 1997 increased by 2%, or $4 million, and 5%, or $28 million, respectively, over the same periods in 1996. Most of the increase in net premiums written was in the personal lines Strategic Business Unit ("SBU"), and reflected an increase in premiums written of 29%, or $16 million, for the quarter ended September 30, 1997 and 23%, or $36 million, for the first nine months of 1997. This increase in net premiums written occurred in the New Jersey personal automobile line of insurance. New Jersey personal automobile net premiums written included the results of a conversion of six-month term policies to one-year policies (the "Conversion"), effective April 1, 1997. The Conversion increased net premiums written by approximately $15 million and $35 million for the quarter and nine months ended September 30, 1997, respectively, but had no effect on net premiums earned or cash flow. The commercial SBUs net premiums written for the third quarter and nine months ended September 30, 1997, decreased by 8%, or $12 million, and 2%, or $8 million, respectively, over the same periods in 1996. During the third quarter ended September 30, 1996, net premiums written increased due to a revision of certain reinsurance agreements, pursuant to which the Company realized a one-time increase in net premiums written of approximately $8 million reflecting the Company's buyout of certain ceded reinsurance unearned premium reserves at June 30, 1996. Excluding the effects of the prior year reinsurance buyout, the slight decrease for the quarter and nine months ended September 30, 1997, was due to:(i) agency terminations of approximately $7 million and $17 -9- PAGE million, respectively; (ii) rate reductions of approximately $4 million and $14 million, respectively, mainly in the workers' compensation line of insurance, principally due to the impact of improving loss trends; and (iii) a reduction in existing business (renewal retention) attributable to a highly competitive commercial insurance market place. In addition, the public entities SBU net premiums written was impacted by a continuing trend towards self-insurance mechanisms and other alternative markets, which reduced net premiums written for the quarter and nine months ended September 30, 1997, by approximately $11 million and $17 million, respectively. The reduction in net premiums written in the commercial SBUs, was offset by an increase of $13 million and $40 million of new insurance business issued in the quarter and nine months ended September 30, 1997, respectively. Excluding the effects of the Conversion and the prior year reinsurance buyout, the moderate decrease in net premiums written for the quarter and nine months ended September 30, 1997, translated into an overall decrease in total net premiums earned of 1%, or $2 million, for the quarter, and 3%, or $15 million, for the nine months ended September 30, 1997, compared to the same periods in 1996. Net investment income earned for the third quarter and nine months ended September 30, 1997, increased 2%, or $0.6 million, and 3%, or $2 million, respectively, over the same period in 1996. The increases were primarily due to income generated from investments acquired from cash provided by operating activities during 1996 and the investment of proceeds from short- term borrowings during 1997. The Company was able to invest the proceeds from the short-term borrowings at a higher rate than the borrowing rate. The Company's overall annualized investment yield was 6.0% and 6.1% for the nine months ended 1997 and 1996, respectively. Expenses The ratio of losses and loss expenses incurred to net premiums earned for the third quarter ended September 30, 1997 was 69.7%, a 1.7 point decrease from the ratio for the same period in 1996. During the quarter ended September 30, 1996, the Company incurred $6 million of losses (net of $0.9 million of reinsurance) as a result of weather-related claims, which increased the loss and loss expense ratio for third quarter 1996 by 3.7 points. Absent these weather-related claims, the net loss and loss expense ratio increased 2.0 points, which reflected less favorable results in the public entities SBU, primarily in the general liability and commercial automobile lines of insurance, and the personal lines SBU, primarily in personal automobile. These declines were partially offset by improved results in all other commercial SBUs. The ratio of losses and loss expenses incurred to net premiums earned for the nine months ended September 30, 1997, was 69.4%, a 3.5 point decrease from the ratio for the nine months ended September 30, 1996. The decrease in 1997 in the loss and loss expense ratio was primarily attributable to the numerous 1996 weather-related claims which primarily impacted the personal lines, mercantile and service, public entities, and habitational and recreational SBUs in the prior year. These weather-related claims, which amounted to $17 -10- PAGE million (net of $6 million of reinsurance), increased the nine months ended September 30, 1996 loss and loss expense ratio by 3.2 points. In addition to the lack of weather-related claims in the nine months ended September 30, 1997, most of the commercial SBUs ratios improved in the workers compensation line of insurance. The personal lines SBU loss and loss expense ratio of 73.8% and 73.6% for the quarter and nine months ended September 30, 1997, increased by 4.7 points and 2.5 points, respectively, when compared with the same periods for 1996 (absent the effects of weather-related claims of 1.7 points and 2.7 points, respectively). The increase was due to the results of the personal automobile line of insurance, which included a provision for the New Jersey excess profits calculation. This was partially offset by an improvement in the homeowners line of insurance mainly due to rate increases and lower reinsurance costs. The commercial SBU's loss and loss expense ratio increased by 0.6 points to 67.8%, for the quarter ended September 30, 1997, absent the effects of the weather-related claims of 4.8 points from the ratio of 72.0% for the quarter ended September 30, 1996. The slight decline reflected less favorable results in the public entities SBU. These results were offset by the mercantile and service and habitational and recreational SBUs, which had significant improvements in their loss and loss expense ratio for the quarter ended September 30, 1997, throughout most of their business classes and lines of insurance. Favorable loss experience in the workers compensation line of insurance impacted most of the commercial SBUs, with significant improvement in the manufacturing and processing SBU. The improved workers compensation results reflect positive loss trends primarily attributable to: (i) lower average medical costs due to managed care; (ii) programs which permit employees to return to work earlier; and (iii) various favorable legislative reforms. For the nine months ended September 30, 1997, the loss and loss expense ratio for the commercial SBUs decreased 5.3 points to 67.4% compared to 72.7% for the same period in 1996. Absent the effects of the 1996 weather- related claims of 3.6 points, the loss and loss expense ratio decreased 1.7 points with the most notable improvements in the mercantile and service and habatitional and recreational SBUs. These improvements were in most business classes and commercial lines of insurance in these SBUs. This improvement was partially offset by less than favorable results in the public entities SBU. The ratio of policy acquisition costs to net premiums earned for the quarter ended September 30, 1997 was 30.0%, as compared to 31.5%, for the same period in 1996, and for the nine months ended September 30, 1997 was 30.1%, as compared to 30.4%, for the same period in 1996. The decrease in the ratio for the third quarter reflected the prior year impact of the buyout of the reinsurance program. Total Federal income tax expense increased by approximately $3 million to $6 million for the quarter ended September 30, 1997, compared to $3 million for the same period of 1996. For the nine months ended September 30, 1997, the Federal income tax expense increased approximately $8 million to $16 million, compared to $8 million for the nine months in 1996. The Company's effective tax rate was 23.4% for the nine months ended September 30, 1997, compared with -11- PAGE 17.1% for the nine months of 1996. The effective tax rate for the nine months ended September 30, 1997, was higher than the nine months ended September 30, 1996, due primarily to the tax benefit from the higher level of underwriting losses due to the winter storms in 1996. The Company's effective tax rate differs from the Federal corporate rate of 35% primarily as a result of the tax-exempt investment income. Income The table below shows operating income, net realized gains, and net income, including per share amounts for the quarter and nine months ended September 30, 1997 and 1996. - ---------------------------------------------------------------------------- Quarter ended Nine months ended ($ in thousands, September September except for per share data) 1997 1996 1997 1996 - ---------------------------------------------------------------------------- Operating income, excluding net realized gains (net of tax) (1) $16,194 12,275 48,718 35,849 Net realized gains (losses), net of tax 2,201 (23) 3,481 863 Net income (1) 18,395 12,252 52,199 36,712 Per Primary Share: Operating income (1) 1.10 .84 3.32 2.47 Net realized gains (losses) .15 - .24 .06 Net income (1) 1.25 .84 3.56 2.53 (1) Operating and net income for the quarter and nine months ended September 30, 1996, include weather-related winter storm losses of $4 million, or $.28 per primary share, and $11 million, or $.76 per primary share, respectively. Financial Condition, Liquidity and Capital Resources - ---------------------------------------------------- Selective is an insurance holding company whose principal assets are its investments in its insurance subsidiaries. As an insurance holding company, Selective meets its cash requirements through proceeds from the sales of the Company's common stock and dividends from its insurance subsidiaries, the payments of which are subject to state regulatory requirements. Total assets increased 6%, or $139 million from December 31, 1996 to September 30, 1997. The growth was due to: (i) an increase in total investments, including cash, of $92 million which included cash provided by operating activities of $32 million, the draw of $16 million on the Company's lines of credit, and a $49 million increase in net unrealized gains on available-for- -12- PAGE sale securities; and (ii) an increase in premiums and other receivables of $58 million and deferred acquisition costs of $19 million mainly due to the Conversion. This was offset by a $20 million decrease in deferred Federal income taxes which mainly reflected the associated deferred taxes on the increase in unrealized gains on available-for-sale securities. The rise in total liabilities of 4%, or $63 million, from December 31, 1996 to September 30, 1997 was primarily attributable to additional borrowings of $16 million on the two lines of credit which the Company had outstanding at September 30, 1997. The lines of credit complement the cash provided by operating activities and provide the Company with increased flexibility in its cash management. Unearned premiums increased by $63 million primarily due to the Conversion. These increases were partially offset by a $7 million decrease in outstanding loss and loss expense reserves mainly due to a decrease in the flood line of insurance, an increased volume of outstanding claim files being closed with final settlements, and reduced exposure reflecting a lower level of net premiums earned in 1996 and 1997. The rate at which outstanding claims are being closed has increased due, in part, to the implementation of claims management specialists (CMSs) in the field and improved litigation management. In preparation for placing CMSs in the field, the Company actively settled certain of its liability claims in order that each CMS would have a more manageable number of claims to handle in the field. In addition, the Company is utilizing its litigation managers to more actively settle claims. For the most part, this increased claim settlement was experienced in the general liability, personal automobile and commercial automobile lines of insurance. The overall obligations and cash outflow of the Company include: claim settlements; commissions; labor costs; premium taxes; general and administrative expenses; investment purchases; interest expenses; ongoing capital expenditures with respect to the Company's automation programs; principal payments on the senior notes and dividends to policyholders and stockholders. The insurance subsidiaries satisfy their obligations and cash outflow through premium collections, interest and dividend income and maturities. Selective has authorized a share repurchase program under which it may repurchase up to one million shares of its common stock, depending on market conditions, through available cash and lines of credit. Through this program, Selective has repurchased approximately 195,000 shares at a total cost of $7 million; of which 67,000 shares, at a cost of $3 million, were acquired during the nine months ended September 30, 1997. For the nine months ended September 30, 1997 and 1996, cash provided by operating activities amounted to $32 million and $53 million, respectively. The decrease in cash provided by operating activities was mainly a result of the higher level of claim and claim expense payments (approximately $4 million) associated with the aforementioned CMS deployment and increased litigation settlement activity. In addition, the lower levels of premiums written in 1996 and 1997 (excluding the effects of the Conversion and reinsurance buyout transaction) has also impacted the cash flow from operations during the nine months of 1997. The Conversion does not have any impact on cash flow. The Company expects to continue to generate cash from operations over the balance of the year. On June 30, 1997, the Governor of New Jersey signed into law an automobile insurance reform bill. This legislation (i) eliminates automatic approval of cost-of-living increases in favor of "expedited rate filings" of 3% or less, -13- PAGE which do not require prior approval from the insurance commissioner; (ii) prohibits insurers from non-renewing good drivers (good drivers being defined as "no more than one at fault accident or four insurance point moving violations within a five year period"); and (iii) eliminates the bad driver surcharge system in favor of a tier rating system. In addition to the legislation enacted in June, Governor Whitman, upon being reelected on November 4, 1997, announced that she will pursue a cost reform agenda during the remainder of 1997 and into 1998. The Company believes that there may be further legislative initiatives in New Jersey with respect to personal automobile insurance reform. The Company cannot presently predict the form or timing of any such initiatives, nor can the Company estimate the financial effects, if any, that such initiatives may have on the Company and its operations. -14- PAGE Part II OTHER INFORMATION - -------------------------- Item 5. Other Information. On October 28, 1997, the Board of Directors of Selective approved a two-for-one common stock division affecting all authorized shares of Selective common stock. The stock will be payable December 1, 1997 to stockholders of record on November 17, 1997. As a result of the common stock division, Selective will issue on December 1, 1997 one additional share of common stock to stockholders for each share held on the record date. In connection with the common stock division, Selective's Restated Certificate of Incorporation as amended effective November 6, 1997, was amended to increase the authorized shares of common stock from 90,000,000 to 180,000,000 and the number of outstanding shares will increase from approximately 14.7 million to approximately 29.4 million. Item 6. Exhibits and Reports on Form 8-K. (a) Exhibits: The exhibits required by Item 601 of Regulation SK are listed in the Exhibit Index, which immediately precedes the exhibits filed with this form 10-Q. (b) Reports on Form 8-K: There were no reports on Form 8-K filed during the period covered by this report. -15- PAGE SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. SELECTIVE INSURANCE GROUP, INC. Registrant Date: November 14, 1997 By: /s/James W. Entringer -------------------------------------- James W. Entringer, Chairman of the Board, and Chief Executive Officer Date: November 14, 1997 By: /s/David B. Merclean ------------------------------------- David B. Merclean, Senior Vice President and Chief Financial Officer -16- PAGE SELECTIVE INSURANCE GROUP, INC. INDEX TO EXHIBITS Exhibit No. 11 Statement Re Computation of Per Share Earnings, filed herewith. 27 Financial Data Schedule, filed herewith. -17-