1 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 March 31, 2001 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) <TABLE> <S> <C> New Jersey 22-2168890 State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 40 Wantage Avenue Branchville, New Jersey 07890 (Address of principal executive offices) (Zip Code) </TABLE> 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 $2 per share, outstanding as of April 30, 2001: 25,279,730 1
2 SELECTIVE INSURANCE GROUP, INC Consolidated Balance Sheets <TABLE> <CAPTION> Unaudited - --------------------------------------------------------------------------------------------------------------- March 31 December 31 ($ in thousands, except share amounts) 2001 2000 - --------------------------------------------------------------------------------------------------------------- <S> <C> <C> ASSETS Investments: Debt securities, held-to-maturity - at amortized cost (fair value: $212,315 - 2001; $231,057 - 2000) $ 204,388 225,177 Debt securities, available-for-sale - at fair value (amortized cost: $1,253,517 - 2001; $1,184,698 - 2000) 1,290,721 1,202,758 Equity securities, available-for-sale - at fair value (cost of: $107,076 - 2001; $104,830 - 2000) 219,502 239,578 Short-term investments - (at cost which approximates fair value) 48,380 95,908 Other investments 13,671 13,642 ----------- ----------- Total investments 1,776,662 1,777,063 Cash 8,482 8,759 Interest and dividends due or accrued 20,748 22,808 Premiums receivables 298,170 274,031 Other trade receivables 26,557 24,915 Reinsurance recoverable on paid losses and loss expenses 12,226 9,332 Reinsurance recoverable on unpaid losses and loss expenses 170,511 160,869 Prepaid reinsurance premiums 32,815 33,097 Current Federal income tax 611 1,681 Deferred Federal income tax 9,928 8,971 Real estate, furniture, equipment, and software development 57,036 57,820 Deferred policy acquisition costs 125,509 118,413 Goodwill 48,504 49,338 Other assets 36,332 25,905 ----------- ----------- Total assets $ 2,624,091 2,573,002 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Reserve for losses $ 1,114,428 1,099,929 Reserve for loss expenses 169,153 172,727 Unearned premiums 463,123 436,506 Convertible subordinated debentures 3,845 3,848 Notes payable 159,786 159,786 Other liabilities 138,608 122,409 ----------- ----------- Total liabilities 2,048,943 1,995,205 ----------- ----------- STOCKHOLDERS' EQUITY: Common stock of $2 par value per share: Authorized shares: 180,000,000 Issued: 39,073,699 - 2001; 38,783,742 - 2000 78,147 77,568 Additional paid-in capital 68,479 63,074 Retained earnings 530,178 525,669 Accumulated other comprehensive income 97,259 99,325 Treasury stock - at cost (shares: 13,903,125 - 2001; 13,577,266 - 2000) (188,785) (181,552) Deferred compensation expense and notes receivable from stock sales (10,130) (6,287) ----------- ----------- Total stockholders' equity 575,148 577,797 ----------- ----------- Total liabilities and stockholders' equity $ 2,624,091 2,573,002 =========== =========== </TABLE> See accompanying notes to unaudited consolidated financial statements. 2
3 SELECTIVE INSURANCE GROUP, INC. Consolidated Statements of Income <TABLE> <CAPTION> Unaudited Quarter ended March 31 --------------------------- ($ in thousands, except per share amounts) 2001 2000 --------- --------- <S> <C> <C> Revenues: Net premiums written $ 239,916 212,961 Net increase in unearned premiums and prepaid reinsurance premiums (26,899) (13,135) --------- --------- Net premiums earned 213,017 199,826 Net investment income earned 23,808 23,300 Net realized gains 840 2,273 Diversified insurance services revenue 21,723 17,668 Other income 773 780 --------- --------- Total revenues 260,161 243,847 --------- --------- Expenses: Losses incurred 137,624 127,787 Loss expenses incurred 19,334 18,521 Policy acquisition costs 65,366 61,856 Dividends to policyholders 1,755 1,881 Interest expense 3,647 2,708 Diversified insurance services expenses 20,160 16,391 Other expenses 2,820 2,126 --------- --------- Total expenses 250,706 231,270 --------- --------- Income before Federal income tax 9,455 12,577 --------- --------- Federal income tax expense(benefit) : Current 1,172 1,688 Deferred (16) (21) --------- --------- Total Federal income tax expense 1,156 1,667 --------- --------- Net income $ 8,299 10,910 ========= ========= Earnings per share: Basic $ 0.34 0.43 Diluted $ 0.32 0.40 Dividends to stockholders $ 0.15 0.15 </TABLE> See accompanying notes to unaudited consolidated financial statements. 3
4 SELECTIVE INSURANCE GROUP, INC. Consolidated Statements of Stockholders' Equity <TABLE> <CAPTION> Unaudited Unaudited March 31 March 31 ($ in thousands, except per share amounts) 2001 2000 - ------------------------------------------------------------------------------------------------------------- <S> <C> <C> <C> <C> Common stock: Beginning of year $ 77,568 75,929 Dividend reinvestment plan (shares: 13,456-2001; 19,128-2000) 26 38 Convertible subordinated debentures (shares: : 423-2001; 172,451-2000) 1 345 Stock purchase and compensation plans (shares: 276,078-2001; 197,533-2000) 552 395 ----------- ------- End of period 78,147 76,707 ----------- ------- Additional paid-in capital: Beginning of year 63,074 53,470 Dividend reinvestment plan 263 255 Convertible subordinated debentures 2 864 Stock purchase and compensation plans 5,140 2,447 ----------- ------- End of period 68,479 57,036 ----------- ------- Retained Earnings: Beginning of year 525,669 514,477 Net income 8,299 8,299 10,910 10,910 Cash dividends to stockholders ($.15 per share) (3,790) (3,922) ----------- ------- End of period 530,178 521,465 ----------- ------- Accumulated other comprehensive income: Beginning of year 99,325 76,694 Other comprehensive income-decrease in net unrealized gains, net of deferred income tax effect (2,066) (2,066) (3,267) (3,267) ------ ------ ------ ------ End of period 97,259 73,427 ----------- ------- Comprehensive income 6,233 7,643 ===== ===== Treasury stock: Beginning of year (181,552) (143,875) Acquisition of treasury stock (shares: 325,859-2001; 827,240-2000) (7,233) (12,966) ----------- ------- End of period (188,785) (156,841) ----------- ------- Deferred compensation expense and notes receivable from stock sales: Beginning of year (6,287) (6,731) Deferred compensation expense (4,492) (2,531) Amortization of deferred compensation expense and amounts received on notes 649 685 ----------- ------- End of period (10,130) (8,577) ----------- ------- Total stockholders' equity $ 575,148 563,217 =========== ======= </TABLE> See accompanying notes to unaudited consolidated financial statements. 4
5 SELECTIVE INSURANCE GROUP, INC. Consolidated Statements of Cash Flows <TABLE> <CAPTION> Unaudited ($ in thousands) Quarter ended March 31 2001 2000 --------- --------- <S> <C> <C> OPERATING ACTIVITIES Net Income $ 8,299 10,910 --------- --------- Adjustments to reconcile net income to net cash provided by operating activities: Increase (decrease) in reserves for losses and loss expenses, net of reinsurance recoverable on unpaid losses and loss expenses 1,283 (3,632) Net increase in unearned premiums and prepaid reinsurance premiums 26,899 13,135 Federal income tax 1,226 1,712 Depreciation and amortization 3,509 3,891 Increase in premiums receivables (24,139) (11,164) Increase in other trade receivables (1,642) (573) Increase in deferred policy acquisition costs (7,096) (3,176) Decrease in interest and dividends due or accrued 2,060 1,725 Increase in reinsurance recoverable on paid losses and loss expenses (2,894) (3,629) Net realized gains on investments (841) (2,273) Other--net (5,763) (6,058) --------- --------- Net adjustments (7,398) (10,042) --------- --------- Net cash provided by operating activities 901 868 --------- --------- INVESTING ACTIVITIES Purchase of debt securities, available-for-sale (111,452) (64,606) Purchase of equity securities, available-for-sale (4,329) (10,863) Purchase of other investments (31) (38) Purchase adjustments of Selective HR Solutions, Inc. (97) (5,816) Sale of debt securities, available-for-sale 11,200 11,030 Redemption and maturities of debt securities, held-to-maturity 20,810 15,354 Redemption and maturities of debt securities, available-for-sale 31,534 18,571 Sale of equity securities, available-for-sale 2,936 8,309 Proceeds from other investments 2 57 Increase (decrease) in net payable for security transactions 11,593 (218) Net additions to real estate, furniture, equipment and software development (1,371) (2,817) Net cash used in investing activities --------- --------- (39,205) (31,037) --------- --------- FINANCING ACTIVITIES Dividends to stockholders (3,790) (3,922) Acquisition of treasury stock (7,233) (12,966) Proceeds from short-term debt -- 15,050 Net proceeds from dividend reinvestment plan 289 293 Net proceeds from stock purchase and compensation plans 5,692 2,842 Increase in deferred compensation expense and amounts received on notes receivable from stock sales (4,459) (2,490) --------- --------- Net cash used in financing activities (9,501) (1,193) --------- --------- Net decrease in short-term investments and cash (47,805) (31,362) Short-term investments and cash at beginning of year 104,667 57,395 --------- --------- Short-term investments and cash at end of year $ 56,862 26,033 ========= ========= SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION Cash paid during the period for: Interest $ 2,536 3,479 Federal income tax -- -- Supplemental schedule of non-cash financing activity: Conversion of convertible subordinated debentures 3 1,221 </TABLE> See accompanying notes to unaudited consolidated financial statements. 5
6 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 statement of the results of the Selective Insurance Group, Inc. and its consolidated subsidiaries 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 a full year. These financial statements should be read in conjunction with the financial statements and notes thereto contained in our Annual Report on Form 10-K for the year ended December 31, 2000. 2. RECLASSIFICATIONS Certain amounts in our prior year consolidated financial statements have been reclassified to conform with the 2001 presentation. Such reclassification had no effect on our net income or stockholders' equity. 3. ADOPTION OF ACCOUNTING PRONOUNCEMENTS During First Quarter 2001, we adopted Financial Accounting Standards Board Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (FASB 133) and Financial Accounting Standards No. 138, "Accounting for Certain Derivative Instruments and Certain Hedging Activities" (FASB 138). FASB 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts, (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. FASB 138 amends the accounting and reporting standards of FASB 133 for certain derivative instruments and certain hedging activities. The adoption of these standards had no material effect on the Company's results of operations or financial condition. 4. SEGMENT INFORMATION We are primarily engaged in writing property and casualty insurance. We have classified our business into three segments, which are Insurance Operations (commercial lines underwriting, personal lines underwriting), Investments, and Diversified Insurance Services. We evaluate the performance of the insurance segments based on their underwriting results prepared in accordance with accounting principles generally accepted in the United States of America (GAAP), we evaluate Investment performance based on after-tax investment returns, and we evaluate performance in Diversified Insurance Services in terms of net income and earnings before interest, taxes, depreciation and amortization (EBITDA) returns on revenue. The GAAP underwriting results of the Insurance Operations segment are determined taking into account net premiums earned, incurred losses and loss expenses, policy acquisition costs and other underwriting expenses and policyholders dividends. Management of the investment portfolio is separate from the insurance underwriting segment and, therefore, has been classified as a segment. The operating results of the Investments segment take into account net investment income and net realized gains and losses. The Diversified Insurance Services business is managed independently from 6
7 the other segments and, therefore, has been classified separately. The Diversified Insurance Services segment consists of the flood business managed for the National Flood Insurance Program, medical cost containment operations, professional employer organization operations, software development and program administration operations, and fee based income from alternative market affiliation programs. The segment's results are determined taking into account the net revenues generated in each of the businesses, less the costs of operations. In computing the results of each segment, no adjustment is made for interest expense, net general corporate expenses or federal income taxes. We do not maintain separate investment portfolios for the segments and, therefore, do not allocate assets to the segments. The following summaries present revenues (net investment income and net realized gains or losses in the case of the investments segment) and pre-tax income for the individual segments: Revenue by segment <TABLE> <CAPTION> Unaudited, Quarter ended March 31 - -------------------------------------------------------------------------------- ($ in thousands) 2001 2000 - -------------------------------------------------------------------------------- <S> <C> <C> INSURANCE OPERATIONS: Commercial lines net premiums earned $162,671 145,879 Personal lines net premiums earned 50,346 53,947 -------- -------- Total insurance operations revenues 213,017 199,826 INVESTMENTS: Net investment income 23,808 23,300 Net realized gains on investments 840 2,273 -------- -------- Total investment revenues 24,648 25,573 DIVERSIFIED INSURANCE SERVICES REVENUES 21,723 17,668 -------- -------- TOTAL REVENUES ALL SEGMENTS $259,388 243,067 ======== ======== </TABLE> Income or (loss) before Federal income tax by segment <TABLE> <CAPTION> Unaudited, Quarter ended March 31 - -------------------------------------------------------------------------------- ($ in thousands) 2001 2000 - -------------------------------------------------------------------------------- <S> <C> <C> INSURANCE OPERATIONS: Commercial lines underwriting $ (8,288) (8,217) Personal lines underwriting (3,983) (2,344) -------- -------- Underwriting loss, before Federal income tax (12,271) (10,561) INVESTMENTS: Net investment income 23,808 23,300 Net realized gains on investments 840 2,273 -------- -------- Total investment income, before Federal income tax 24,648 25,573 DIVERSIFIED INSURANCE SERVICES: Income before federal income tax 1,563 1,277 -------- -------- Total all segments 13,940 16,289 Interest expense (3,647) (2,708) General corporate expenses (838) (1,004) -------- -------- Income before Federal income tax $ 9,455 12,577 ======== ======== </TABLE> 7
8 5. REINSURANCE The following is a table of assumed and ceded amounts by income statement caption: <TABLE> Unaudited, Quarter ended March 31 - -------------------------------------------------------- ($ in thousands) 2001 2000 - -------------------------------------------------------- <S> <C> <C> Premiums written: Assumed $ 5,160 4,803 Ceded (24,812) (21,272) Premiums earned: Assumed 3,497 3,438 Ceded (25,094) (22,491) Losses incurred: Assumed(1) 5,746 476 Ceded(1) (23,986) (18,039) Loss expenses incurred: Assumed 180 239 Ceded (344) (576) </TABLE> (1) Assumed and ceded losses increased compared to the prior year due to a large commercial property fire loss. FORWARD-LOOKING STATEMENTS Some of the statements in this report are not historical facts and are "forward-looking statements" (as defined in the Private Securities Litigation Reform Act of 1995). These statements use words such as "believes," "expects," "intends," "may," "will," "should," "anticipates," and other similar words, or the negative thereof, and, among other things, describe our current strategies, opinions, expectations of future results and other forward-looking information. We derive forward-looking information from information which we currently have and numerous assumptions which we make. We cannot assure that results which we anticipate will be achieved, since results may differ materially because of both known and unknown risks and uncertainties which we face. Factors which could cause actual results to differ materially from our expectations include, but are not limited to: the effects of economic conditions and conditions which affect the market for property and casualty insurance; laws, rules and regulations which apply to insurance companies, including the impact of personal automobile reform legislation in New Jersey; the effects of competition from other insurers and banks, and the trend toward self-insurance; risks we face in entering new markets and diversifying the products and services we offer; weather-related events and other catastrophes affecting our insureds, our ability to obtain rate increases and to retain business; the performance of our independent insurance agencies; and other risks and uncertainties we identify in filings with the Securities and Exchange Commission, including, but not limited to the Annual Report on Form 10-K, although we do not promise to update such forward-looking statements to reflect actual results or changes in assumptions or other factors that could affect these statements. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion relates to our results of operations, financial condition and liquidity for the interim periods indicated. RESULTS OF OPERATIONS The following discussion is a comparison of First Quarter ended March 31, 2001 (First Quarter 2001) to First Quarter ended March 31, 2000 (First Quarter 2000). Our net income was $8.3 million, or $0.32 per diluted share, for First Quarter 2001 compared to $10.9 million, or $0.40 per diluted share, for First Quarter 2000. Operating income was $7.8 million, or $0.30 per diluted share, for First Quarter 2001 compared to $9.4 million, or $0.35 per diluted share, for First Quarter 2000. Operating income, which differs from net income by the exclusion of realized gains or losses on investment sales, is used as an important financial measure by management, analysts and investors but is not intended as a substitute for net income prepared in accordance with GAAP. The Financial Accounting Standards Board (FASB) announced, in connection with finalizing the new accounting standard for business combinations, its tentative conclusion that goodwill arising from business combinations, including prior business combinations, would no longer be required to be amortized. Goodwill would instead be reviewed for impairment, and the value would be written down only in periods in which the carrying value of goodwill is more than fair value. The final standard on business combinations is expected to be issued by the FASB in the third quarter of 2001, but the FASB's tentative conclusion is subject to change, and there can be no assurance when or if a final standard will be issued. Goodwill amortization expense, which is included in other expenses, was $835,000 in First Quarter 2001, $829,000 in First Quarter 2000, $3,320,000 in 2000, $2,153,000 in 1999 and $1,346,000 in 1998. 8
9 OPERATING SEGMENTS We are primarily engaged in writing property and casualty insurance. We have classified our business into three segments, each of which is managed separately. The three segments are Insurance Operations (commercial lines underwriting and personal lines underwriting), Investments and Diversified Insurance Services. We evaluate the performance of the insurance segments based on their underwriting results prepared in accordance with accounting principles generally accepted in the United States of America (GAAP), we evaluate Investment performance based on after-tax investment returns, and we evaluate performance in Diversified Insurance Services in terms of net income and earnings before interest, taxes, depreciation and amortization (EBITDA) returns on revenue. For an additional description of accounting policies, refer to Note 1 to our Consolidated Financial Statements on pages 42 through 44 of the Annual Report to shareholders for the year ended December 31, 2000. See Note 4 to the March 31, 2001 Unaudited Consolidated Financial Statements on pages 6 and 7 of this report on Form 10-Q for revenues and related income before Federal income taxes for each individual segment discussed below. Insurance Operations Segment <TABLE> <CAPTION> Unaudited, Quarter ended March 31 ($ in thousands) 2001 2000 - ------------------------------------------------------------------------ <S> <C> <C> TOTAL INSURANCE OPERATIONS Net premiums written $ 239,916 212,961 ============ ======= Net premiums earned 213,017 199,826 Losses and loss expenses incurred 156,958 146,308 Net underwriting expenses incurred 66,575 62,198 Dividends to policyholders 1,755 1,881 ------------ ------- Underwriting loss $ (12,271) (10,561) ------------ ------- GAAP RATIOS: Loss and loss expense ratio 73.7 73.2 Underwriting expense ratio 31.3 31.1 Dividends to policyholders ratio 0.8 1.0 ----- ----- Combined ratio 105.8 105.3 ===== ===== </TABLE> Net premiums written for First Quarter 2001 increased approximately $27 million, or 13% to $240 million, including $52 million in net new business, when compared to the same period one year ago. Net premiums written for commercial lines grew 17% compared to First Quarter 2000, driven by renewal premium increases that averaged 16% (including estimated exposure growth of five points) during First Quarter 2001. Personal lines net premiums written were down about 1%. The combined ratio increased .5 points to 105.8%, for First Quarter 2001 from the First Quarter 2000 primarily as a result of higher personal lines ratio of losses and loss expenses incurred to net premiums earned. The underwriting expense ratio increased slightly to 31.3% for First Quarter 2001 compared to 31.1% for the same period one year ago. Costs that vary with premium volume, including commissions, taxes licenses and fees, and board bureau dues declined. Offsetting this decrease, labor costs increased due to increased employee benefit costs, including incentive based rewards, and new hires. Overall, productivity in First Quarter 2001, as measured by fiscal year net premiums written per Insurance Operations employee, was approximately $486,000, up from $464,000 for First Quarter 2000. Our strategic initiatives which are designed to either reduce costs or increase business include: i) the Mobile Claim System; ii) streamlined processing for small commercial lines accounts (One & Done); and iii) the consolidation of the two New Jersey offices and the consolidation of the Richmond, Virginia and Chesapeake, Maryland regional offices in conjunction with the formation of a service center in Richmond. These initiatives are expected to reduce our expense ratio and increase our productivity measure. 9
10 Commercial Lines Underwriting <TABLE> <CAPTION> Unaudited, Quarter COMMERCIAL LINES ended March 31 ($ in thousands) 2001 2000 - -------------------------------------------------------------------- <S> <C> <C> GAAP INSURANCE OPERATION RESULTS Net premiums written $ 189,559 162,064 ========= ========= Net premiums earned 162,671 145,879 Losses and loss expenses incurred 117,794 105,343 Net underwriting expenses incurred 51,410 46,872 Dividends to policyholders 1,755 1,881 --------- --------- Underwriting loss $ (8,288) (8,217) --------- --------- GAAP RATIOS: Loss and loss expense ratio 72.4% 72.2 Underwriting expense ratio 31.6% 32.1 Dividends to policyholders ratio 1.1% 1.3 --------- --------- Combined ratio 105.1% 105.6 ========= ========= </TABLE> Commercial Lines Underwriting accounted for approximately 79% of net premiums written during First Quarter 2001. Net premiums written increased $27 million, or 17%, to $190 million for First Quarter 2001 compared to $162 million for the same period in 2000. Net premiums written included approximately $44 million in net new business for First Quarter 2001, compared to $37 million for the same period one year ago. Growth in all regions was driven by a 16% average increase in renewal premiums (including estimated exposure growth of five points) for First Quarter 2001 compared to an 8% increase during the same period in 2000. Overall claim measures indicated an increase in claim frequency of approximately 5%, while claim severity was down about 2%, compared to First Quarter 2000. Our ongoing pricing initiatives more than offset the changes we are seeing on the loss side. For First Quarter 2001, the Commercial Lines combined ratio decreased .5 points to 105.1% when compared to the same period one year ago. The lower combined ratio reflected: (i) our commercial lines pricing initiatives, as the higher rates are earned over the duration of the policies; (ii) the positive effects of specific underwriting initiatives targeted to enhance under-performing classes of business, in particular the contractors' SBU; and (iii) automation, service and expense control strategies to eliminate processing duplication and reduce overhead expense. The Commercial Lines combined ratio for the full year 2000 was 107.5%. The 105.1% this quarter is beginning to reflect the positive impact of our commercial lines pricing initiatives, as these rate increases are earned into our business. Personal Lines Underwriting <TABLE> <CAPTION> Unaudited, Quarter Personal Lines ended March 31 ($ in thousands) 2001 2000 - ------------------------------------------------------------------ <S> <C> <C> GAAP Insurance Operation Results Net premiums written $ 50,357 50,897 -------- -------- Net premiums earned 50,346 53,947 Losses and loss expenses incurred 39,164 40,965 Net underwriting expenses incurred 15,165 15,326 -------- -------- Underwriting (loss) $ (3,983) (2,344) ======== ======== GAAP Ratios: Loss and loss expense ratio 77.8% 75.9 Underwriting expense ratio 30.1% 28.4 -------- -------- Combined ratio 107.9% 104.3 ======== ======== </TABLE> Personal Lines Underwriting net premiums written decreased $.5 million, or 1 %, to $50 million for First Quarter 2001 when compared to $51 million for the same period in 2000. The decrease was primarily due to a reduction in our South Carolina policies in-force as a result of a highly competitive personal lines marketplace and our reluctance to participate at inadequate rates. Overall, 10
11 personal lines net premiums written included net new business written of $8 million in First Quarter 2001 compared with $12 million during the same period one year ago. The Personal Lines combined ratio was 107.9% for First Quarter, up 3.6 points from First Quarter 2000. This increase was primarily due to unsatisfactory New Jersey personal automobile results that increased to a 111.6% combined ratio in 2001 from a 104.8% in First Quarter last year. The 6.8 point increase was primarily the result of under-priced involuntary Urban Enterprise Zone (UEZ) business. In addition, loss cost savings resulting from legislation and regulations enacted under the New Jersey Automobile Insurance Cost Reduction Act, for the purpose of reducing insurer's loss costs, have fallen significantly short of offsetting the mandatory 15% premium rate roll back in New Jersey. The UEZ Program mandated by the State of New Jersey Department of Insurance requires New Jersey automobile insurers to write, at our voluntary rate levels, an amount of auto insurance in designated urban areas proportionate to our voluntary market share, currently estimated at 2.7% compared with 3.1% last year. The UEZ business represented about 16% of our New Jersey net premiums earned in First Quarter 2001, or $4 million for both First Quarter 2001 and 2000. This business generated a combined ratio of about 180% in First Quarter 2001 compared to 195% in First Quarter 2000. As of March 31, 2001 we have slightly more UEZ exposures than required; and therefore, do not believe we will be assigned additional UEZ policies in 2001. In personal lines, New Jersey automobile insurance is still a major challenge for the entire industry. We are pursuing our personal automobile rate filing for an increase in premium rates of an average of 18.9%, but believe this will be a long and difficult process. The New Jersey personal automobile market has been further complicated by the recent exemption of the state's largest automobile insurer, with 17% market share, from the "take all comers" provision of the law by the New Jersey Insurance Department. We are uncertain at present what impact this new development may have on our New Jersey marketshare or results. Diversified Insurance Services Segment <TABLE> <CAPTION> Unaudited, Quarter ended March 31, 2001 - --------------------------------------------------------------------------- ($ in thousands) 2001 2000 - --------------------------------------------------------------------------- <S> <C> <C> FLOOD INSURANCE Net Revenue $ 3,089 2,597 Income Before Federal Income Tax 351 471 MEDICAL COST CONTAINMENT Net Revenue 4,613 3,100 Income Before Federal Income Tax 1,050 429 PROFESSIONAL EMPLOYER ORGANIZATION Net Revenue 8,939 7,125 Income Before Federal Income Tax 119 298 SOFTWARE DEVELOPMENT AND PROGRAM ADMINISTRATION Net Revenue 4,692 4,542 Loss Before Federal Income Tax (67) (1) OTHER Net Revenue 390 304 Income Before Federal Income Tax 111 80 TOTAL Net Revenue 21,723 17,668 Income Before Federal Income Tax 1,563 1,277 Net Income 1,003 795 EBITDA 3,025 2,711 Return on Net Revenue 4.6 4.5 </TABLE> Diversified Insurance Services businesses generated $21.7 million of revenue and $1.0 million of net income for First Quarter 2001, compared with $17.7 million of revenue and $0.8 million of net income for the same period one year earlier. Earnings before 11
12 interest, taxes, depreciation, and amortization (EBITDA) increased 12% to $3 million for First Quarter 2001 compared to the same period in 2000. The segment generated a return on net revenue of 4.6% for First Quarter 2001, consistent with the prior year. We expect continued revenue growth in this segment and increased opportunities for these businesses working together with the Insurance Operations. Flood Insurance During First Quarter 2001, flood direct premiums written increased 18.2% to $9.0 million compared to the same period one year ago. In addition to underwriting fees, we receive fees for handling claims. Together these fees generated $3.1 million of revenue in First Quarter 2001 compared to $2.6 million of revenue a year ago. The positive impact of increased premium volume on revenue was partially offset by a .7 point decrease in the commission rate received from the National Flood Insurance Program to 31%, from 31.7% during 2000. This factor combined with increased expenses due to start-up costs associated with Flood Connect, LLC reduced pre-tax profit for this unit to $0.4 million in First Quarter 2001 compared to $0.5 million in First Quarter 2000. Medical Cost Containment - Alta Services LLC (Alta) and Consumer Health Network Plus, LLC (CHN) During First Quarter 2001, Alta increased its client base and generated revenue of $2.6 million compared with $1.7 million in the same period of 2000. Pre-tax net income was $0.6 million in the First Quarter 2001 compared to $0.4 million in the same period of 2000. CHN has continued to expand its number of network providers, which now includes 53,000 locations as of the end of the first quarter 2001 compared to 44,000 a year ago. An increase in the number of locations coupled with an increase in network utilization has generated $1.9 million in revenue compared with $1.4 million for the same period of 2000. CHN's pre-tax net income was $0.5 million during First Quarter 2001 and $32,000 during the same period a year ago. Professional Employer Organization (PEO) - Selective HR Solutions Inc. We continued to introduce the PEO product in our operating territories during First Quarter 2001, building on existing agent/business owner relationships. During the past year, 210 agents signed on to sell the PEO product with 65 agents making PEO sales. The number of PEO worksite employees has increased 40% over First Quarter 2000 to just over 20,000. In First Quarter 2001, Selective HR Solutions generated $8.9 million in revenue compared with $7.1 million in the same period of 2000. Increased infrastructure costs more than offset the revenue growth, which resulted in pre-tax net income of $0.1 million during First Quarter 2001 compared to $0.3 million in the same period of 2000. Software Development and Program Administration -- PDA Software Services, Inc. (PDA) PDA incurred a pre-tax loss of $0.1 million in First Quarter 2001 compared to break even during the same period a year ago. These results included acquisition-related costs such as retention bonuses and the amortization of goodwill of $.5 million in both First Quarter 2001 and 2000. The retention bonuses will continue as charges against income through 2002. Revenues for First Quarter 2001 were $4.7 million, compared with $4.5 million for First Quarter 2000. Investments Segment Net investment income earned after-tax for First Quarter 2001 of $18 million, is consistent with First Quarter 2000. We had a 4.3% annualized after-tax investment yield, down slightly from 4.4% for the same period in 2000. Net realized gains after-tax for First Quarter 2001 decreased $1 million to $.5 million. Realized investment gains and losses fluctuate based on investment decisions regarding individual securities as well as tax planning considerations. FEDERAL INCOME TAXES Total Federal income tax expense decreased by $.5 million to $1 million for First Quarter 2001. The decrease reflects lower capital gains recognized for the quarter. Our effective tax rate was 12% for First Quarter 2001, compared with 13% for First Quarter 2000. Our effective tax rate differs from the Federal corporate rate of 35% primarily as a result of tax-exempt investment income. FINANCIAL CONDITION, LIQUIDITY AND CAPITAL RESOURCES Selective Insurance Group, Inc., (the Parent) is a holding company, the principal assets of which are investments in Insurance and Diversified Insurance Services subsidiaries. The Parent's primary means of meeting its liquidity requirements is through dividends 12
13 from these subsidiaries. The payment of dividends from the insurance subsidiaries is governed by state regulatory requirements, and these dividends are generally payable only from earned surplus as reported on our statutory annual statements as of the preceding December 31. The Parent's cash requirements include principal and interest payments on its senior notes and subordinated debentures, dividends to stockholders, and general operating expenses as well as the cost of shares of common stock repurchased under our common stock repurchase program, which commenced in 1996. As of March 31, 2001, we had repurchased a total of 7.2 million shares at a total cost of $138 million under the program, of which 0.2 million shares were repurchased during First Quarter 2001 at a total cost of $5 million. On May 4, 2001, the Board of Directors extended the expiration date of the stock repurchase program to May 31, 2002. There are 800,000 shares remaining under the current authorization of 8,000,000 shares. In addition to the cash requirements of the Parent, our overall obligations and cash outflow also include: claim settlements; commissions; labor costs; premium taxes; general and administrative expenses; investment purchases and capital expenditures. The insurance subsidiaries satisfy their obligations and cash outflow through premium collections, interest and dividend income and maturities of investments. For First Quarter 2001, cash provided by operating activities was $0.9 million compared to $0.8 million for First Quarter 2000. While there have been improvements in our casualty lines, we have not seen more of an improvement in operating cash flow because of a slight deterioration in the quicker paying property lines, and an increase in workers' compensation disposal rates. Total assets increased 2%, or $51 million, from December 31, 2000 to March 31, 2001. The increase was due to increases in premium receivables of $24 million and deferred policy acquisition costs of $ 8 million primarily driven by the increased premium volume; and increased reinsurance recoverables of $13 million due to increased large property losses compared to the fourth quarter of 2000. The increase in total liabilities of 3%, or $54 million, from December 31, 2000 to March 31, 2001 was mainly attributable to an increase in unearned premium reserves of $27 million and $15 million in loss reserves due primarily to the increase in premiums written. Securities payable, classified within other liabilities, increased $15 million due to bonds purchased in late March that did not settle until April 2001. RECENT LEGISLATION AND REGULATION On June 1, 2000, federal regulators issued final regulations implementing the provisions of the Financial Services Modernization Act of 1999, also known as the Gramm-Leach-Bliley Act (the Act), governing the privacy of consumer financial information. The regulations became effective on November 13, 2000, and compliance with the regulations is required by July 1, 2001. The regulations limit disclosure by financial institutions of "nonpublic personal information" about individuals who obtain financial products or services for personal, family, or household purposes. The Act and the regulations generally apply to disclosures to nonaffiliated third parties, subject to specified exceptions, but not to disclosures to affiliates. Some of the states in which we are licensed already had or have adopted laws that are at least as restrictive as the Act and its regulations. This is an evolving area of regulation requiring the Company's continued monitoring. While we believe that we are in compliance with all currently effective and applicable laws affecting our operations, we will review the steps necessary to comply with applicable privacy laws and regulations under the Act prior to the mandatory date of compliance. We do not believe satisfying this regulatory requirement will have a significant financial impact to our operations. Effective January 1, 2001, we adopted a codified set of statutory accounting principles as required by the National Association of Insurance Commissioners. The changes to the statutory accounting principles reduce the differences within statutory accounting permitted practices between states. The adoption of the codified statutory accounting principles will not have a material impact to the Risk Based Capital ratios for the insurance subsidiaries and will not significantly impact the dividend paying capabilities of the insurance subsidiaries. For a more complete discussion of statutory accounting, see Note 12 on page 52 of our Annual Report to Shareholders for the year ended December 31, 2000. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There have been no material changes in the information about market risk set forth in our Annual Report on Form 10-K. PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS - NONE 13
14 ITEM 2. CHANGES IN SECURITIES - NONE ITEM 3. DEFAULTS UPON SENIOR SECURITIES - NONE ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Selective's Annual Meeting of Stockholders was held on May 4, 2001. At the Annual Meeting, C. Edward Herder, Gregory E. Murphy, William M. Rue and Thomas D. Sayles, Jr. were elected as directors to serve for a term of three years and until their successors are elected and qualified. Votes cast and withheld for the election of directors were as follows: <TABLE> <CAPTION> Votes for Votes withheld --------- -------------- <S> <C> <C> C. Edward Herder 18,238,025 301,725 Gregory E. Murphy 18,304,849 234,910 William M. Rue 18,075,018 464,732 Thomas D. Sayles, Jr. 18,250,266 289,484 </TABLE> The directors whose terms of office continued after the Annual meeting are; Paul D. Bauer, A. David Brown, William A. Dolan II, William C. Gray, William M. Kearns Jr., Joan M. Lamm-Tennant, S. Griffin McClellan III, and J. Brian Thebault. No other matters were voted on at the Annual meeting. ITEM 5. OTHER INFORMATION None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: The exhibits required by Item 601 of Regulation S-K are listed in the Exhibit Index. (b) Reports on Form 8-K: There were no reports on Form 8-K filed during the period covered by this report. INDEX TO EXHIBITS <TABLE> <CAPTION> Exhibit No. - ----------- <S> <C> 11 Statement Re: Computation of Per Share Earnings, filed herewith. </TABLE> 14
15 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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 By: /s/ Dale A. Thatcher May 10, 2001 --------------------------------------------- Dale A. Thatcher Senior Vice President of Finance, Chief Financial Officer and Treasurer By: /s/ Gregory E. Murphy May 10, 2001 --------------------------------------------- Gregory E. Murphy Chairman, President and Chief Executive Officer 15