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, 2000 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: <TABLE> <S> <C> Common stock, par value $2 per share, outstanding as of April 28, 2000: 26,075,672 </TABLE> 1
2 SELECTIVE INSURANCE GROUP, INC Consolidated Balance Sheets <TABLE> <CAPTION> Unaudited - ---------------------------------------------------------------------------------------------------------------------------- March 31, December 31, ($ in thousands, except share amounts) 2000 1999 - ---------------------------------------------------------------------------------------------------------------------------- ASSETS INVESTMENTS: <S> <C> <C> Debt securities, held-to-maturity - at amortized cost (fair value: $256,380-2000; $271,604-1999) $ 256,014 271,384 Debt securities, available-for-sale - at fair value (amortized cost: $1,176,237-2000; $1,141,167-1999) 1,158,603 1,122,786 Equity securities, available-for-sale - at fair value (cost of: $120,462-2000; $115,626-1999) 253,026 251,998 Short-term investments - (at cost which approximates fair value) 19,067 48,807 Other investments 15,942 15,963 ---------------- ---------------- Total investments 1,702,652 1,710,938 Cash 6,966 8,588 Interest and dividends due or accrued 21,820 23,545 Premiums receivables 260,074 248,910 Other trade receivables 16,061 15,488 Reinsurance recoverable on paid losses and loss expenses 13,426 9,797 Reinsurance recoverable on unpaid losses and loss expenses 177,123 192,044 Prepaid reinsurance premiums 31,312 32,531 Current Federal income tax 2,684 4,417 Deferred Federal income tax 17,909 16,129 Real estate, furniture, equipment, and software development 54,902 54,558 Deferred policy acquisition costs 112,271 109,095 Goodwill 51,676 52,001 Other assets 35,340 29,504 ---------------- ---------------- Total assets $ 2,504,216 2,507,545 ================ ================ LIABILITIES AND STOCKHOLDERS' EQUITY LIABILITIES: Reserve for losses $ 1,075,302 1,092,026 Reserve for loss expenses 179,953 181,782 Unearned premiums 425,517 413,601 Convertible subordinated debentures 4,936 6,157 Short-term debt 66,352 51,302 Notes payable 75,428 75,428 Other liabilities 113,511 117,285 ---------------- ---------------- Total liabilities 1,940,999 1,937,581 ---------------- ---------------- STOCKHOLDERS' EQUITY: Common stock of $2 par value per share: Authorized shares: 180,000,000 Issued: 38,353,517-2000; 37,964,405-1999 76,707 75,929 Additional paid-in capital 57,036 53,470 Retained earnings 521,465 514,477 Accumulated other comprehensive income 73,427 76,694 Treasury stock - at cost (shares: 12,233,962-2000; 11,406,722-1999) (156,841) (143,875) Deferred compensation expense and notes receivable from stock sales (8,577) (6,731) ---------------- ---------------- Total stockholders' equity 563,217 569,964 ---------------- ---------------- Total liabilities and stockholders' equity $ 2,504,216 2,507,545 ================ ================ </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) 2000 1999 - --------------------------------------------------------------------------------------------------- Revenues: <S> <C> <C> Net premiums written $ 212,961 207,725 Net increase in unearned premiums and prepaid reinsurance premiums (13,135) (14,697) -------------- -------------- Net premiums earned 199,826 193,028 Net investment income earned 23,300 23,473 Net realized gains 2,273 8,597 Diversified insurance services revenue 17,668 8,882 Other income 780 725 -------------- -------------- Total revenues 243,847 234,705 -------------- -------------- Expenses: Losses incurred 127,787 125,534 Loss expenses incurred 18,521 18,348 Policy acquisition costs 61,856 60,351 Dividends to policyholders 1,881 1,861 Interest expense 2,708 2,162 Diversified insurance services expenses 16,391 8,246 Other expenses 2,126 1,529 -------------- -------------- Total expenses 231,270 218,031 -------------- -------------- Income before Federal income tax 12,577 16,674 -------------- -------------- Federal income tax expense(benefit) : Current 1,688 3,573 Deferred (21) (922) -------------- -------------- Total Federal income tax expense 1,667 2,651 -------------- -------------- Net income $ 10,910 14,023 ============== ============== Earnings per share: Basic $ 0.43 0.50 Diluted $ 0.40 0.48 Dividends to stockholders $ 0.15 0.14 </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) 2000 1999 --------------------------------------------------------------------------------------------------------------- Common stock: <S> <C> <C> <C> <C> Beginning of year $ 75,929 74,833 Dividend reinvestment plan (shares: 19,128-2000; 15,690-1999) 38 31 Convertible subordinated debentures (shares: : 172,451-2000; 3,954-1999) 345 8 Stock purchase and compensation plans (shares: 197,533-2000; 238,607-1999) 395 477 -------------- -------------- End of period 76,707 75,349 -------------- -------------- Additional paid-in capital: Beginning of year 53,470 45,449 Dividend reinvestment plan 255 258 Convertible subordinated debentures 864 11 Stock purchase and compensation plans 2,447 3,389 -------------- -------------- End of period 57,036 49,107 -------------- -------------- Retained Earnings: Beginning of year 514,477 477,118 Net income 10,910 10,910 14,023 14,023 Cash dividends to stockholders ($.15 per share-2000; $.14 per share-1999) (3,922) (3,946) -------------- -------------- End of period 521,465 487,195 -------------- -------------- Accumulated other comprehensive income: Beginning of year 76,694 114,323 Other comprehensive income-decrease in net Unrealized gains, net of deferred income tax effect (3,267) (3,267) (10,592) (10,592) -------------- ------------- -------------- ------------ End of period 73,427 103,731 -------------- -------------- Comprehensive income 7,643 3,431 ============= ============ Treasury stock: Beginning of year (143,875) (97,990) Acquisition of treasury stock (shares: 827,240-2000; 693,915-1999) (12,966) (13,392) -------------- -------------- End of period (156,841) (111,382) -------------- -------------- Deferred compensation expense and notes receivable from stock sales: Beginning of year (6,731) (6,150) Deferred compensation expense (2,531) (3,048) Amortization of deferred compensation expense and amounts received on notes 685 588 -------------- -------------- End of period (8,577) (8,610) -------------- -------------- Total stockholders' equity $ 563,217 595,390 ============== ============== </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) Three months ended March 31, 2000 1999 ---- ---- OPERATING ACTIVITIES <S> <C> <C> Net Income $ 10,910 14,023 -------------- -------------- Adjustments to reconcile net income to net cash provided by operating activities: (Decrease) increase in reserves for losses and loss expenses, net of reinsurance recoverable on unpaid losses and loss expenses (3,632) 9,903 Net increase in unearned premiums and prepaid reinsurance premiums 13,135 14,698 Federal income tax 1,712 2,573 Depreciation and amortization 3,891 2,339 Increase in premiums receivables (11,164) (15,770) Increase in other trade receivables (573) (946) Increase in deferred policy acquisition costs (3,176) (4,380) Decrease in interest and dividends due or accrued 1,725 371 Increase in reinsurance recoverable on paid losses and loss expenses (3,629) (1,857) Net realized gains on investments (2,273) (8,597) Other- net (6,058) (11,643) -------------- -------------- Net adjustments (10,042) (13,309) -------------- -------------- Net cash provided by operating activities 868 714 -------------- -------------- INVESTING ACTIVITIES Purchase of debt securities, available-for-sale (64,606) (75,323) Purchase of equity securities, available-for-sale (10,863) (2,840) Purchase of other investments (38) (31) Purchase adjustments of Selective HR Solutions, Inc. (5,816) - Sale of debt securities, available-for-sale 11,030 22,026 Redemption and maturities of debt securities, held-to-maturity 15,354 29,685 Redemption and maturities of debt securities, available-for-sale 18,571 3,018 Sale of equity securities, available-for-sale 8,309 11,646 Proceeds from other investments 57 103 Decrease in net payable for security transactions (218) (11,279) Net additions to real estate, furniture, equipment and software development (2,817) (1,841) -------------- -------------- Net cash used in investing activities (31,037) (24,836) -------------- -------------- FINANCING ACTIVITIES Dividends to stockholders (3,922) (3,946) Acquisition of treasury stock (12,966) (13,392) Proceeds from short-term debt 15,050 1,505 Net proceeds from dividend reinvestment plan 293 289 Net proceeds from stock purchase and compensation plans 2,842 3,866 Increase in deferred compensation expense and amounts received on notes receivable from stock sales (2,490) (2,996) -------------- -------------- Net cash used in financing activities (1,193) (14,674) -------------- -------------- Net decrease in short-term investments and cash (31,362) (38,796) Short-term investments and cash at beginning of year 57,395 58,836 -------------- -------------- Short-term investments and cash at end of year $ 26,033 20,040 ============== ============== SUPPLEMENTAL DISCLOSURES OF CASH FLOWS INFORMATION Cash paid during the period for: Interest $ 3,479 3,028 Federal income tax - - Supplemental schedule of non-cash financing activity: Conversion of convertible subordinated debentures 1,221 28 </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 (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 a 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, 1999. 2. RECLASSIFICATIONS Certain amounts in the Company's prior year consolidated financial statements have been reclassified to conform with the 2000 presentation. Such reclassification had no effect on the Company's net income or stockholders' equity. 3. CURRENT ACCOUNTING PRONOUNCEMENTS In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FASB 133"). 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. This statement was previously effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Earlier application was encouraged, but was permitted only as of the beginning of any fiscal quarter that begins after issuance of financial statements of prior periods. In June 1999, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 137, which defers the effective date of FASB 133 to all fiscal quarters of fiscal years beginning after June 15, 2000. The Company does not anticipate the adoption of this statement to have a material effect on the Company's result of operations or financial condition. 4. SEGMENT INFORMATION The Company is primarily engaged in writing property and casualty insurance. The Company has classified its business into three segments which are Insurance Operations (commercial lines underwriting, personal lines underwriting), Investments, investments are evaluated based on after-tax investment returns, and Diversified Insurance Services . The insurance segment is evaluated based on GAAP underwriting results, and the diversified insurance operations are evaluated based on results of operations in accordance with Generally Accepted Accounting Principals ("GAAP"). The 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. Similarly, management of the investment portfolio is separate from the insurance underwriting segment and, therefore, has been classified as a segment. The Diversified Insurance Services business is managed independently from the other segments and, therefore, has been classified separately. The Diversified Insurance Services segment consists of medical managed care operations, professional employer organization operations, preferred provider organization operations, software development and program administration operations, the flood business managed by the Company for the National Flood Insurance Program and income from alternative market affiliation programs. The segments' results are determined taking into account the net revenues generated in each of the businesses, less the costs of operation. In computing the results of each segment, no adjustment is made for interest expense, net general corporate expenses or federal income taxes. The Company does not maintain separate investment portfolios for the segments and, therefore, does not allocate assets to the segments. 6
7 The following summaries present revenues (net investment income and net realized gains (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) 2000 1999 - -------------------------------------------------------------------------------------------------- INSURANCE OPERATIONS: <S> <C> <C> Commercial lines net premiums earned $ 145,879 136,772 Personal lines net premiums earned 53,947 56,256 ----------- ----------- Total insurance operations revenues 199,826 193,028 INVESTMENTS: Net investment income 23,300 23,473 Net realized gains on investments 2,273 8,597 ----------- ------------ Total investment revenues 25,573 32,070 DIVERSIFIED INSURANCE SERVICES REVENUES 17,668 8,882 ----------- ------------ TOTAL REVENUES ALL SEGMENTS $ 243,067 233,980 =========== ============ </TABLE> Income or (loss) before Federal income tax by segment <TABLE> <CAPTION> Unaudited, Quarter ended March 31, - --------------------------------------------------------------------------------------------------- ($ in thousands) 2000 1999 - --------------------------------------------------------------------------------------------------- INSURANCE OPERATIONS: <S> <C> <C> Commercial lines underwriting $ (8,217) (13,882) Personal lines underwriting (2,344) 643 ------------ ------------ Underwriting loss, before Federal income tax (10,561) (13,239) INVESTMENTS: Net investment income 23,300 23,473 Net realized gains on investments 2,273 8,597 ------------ ------------ Total investment income,before Federal income tax 25,573 32,070 DIVERSIFIED INSURANCE SERVICES: Income before federal income tax 1,277 636 ------------ ------------ Total all segments 16,289 19,467 Interest expense (2,708) (2,162) General corporate expenses (1,004) (631) ------------ ------------ Income before Federal income tax $ 12,577 16,674 ============ ============ </TABLE> 7
8 5. REINSURANCE The following is a table of assumed and ceded amounts by income statement caption: <TABLE> <CAPTION> Unaudited, Quarter ended March 31, - ------------------------------------------------------------------------------------------------------ ($ in thousands) 2000 1999 - ------------------------------------------------------------------------------------------------------ <S> <C> <C> Premiums written: Assumed (1) $ 4,803 7,803 Ceded (21,272) (18,204) Premiums earned: Assumed(1) 3,438 6,659 Ceded (22,491) (19,347) Losses incurred: Assumed(1) 476 4,420 Ceded (18,039) (14,386) Loss expenses incurred: Assumed(1) 239 621 Ceded (576) (45) </TABLE> (1) Assumed business has declined when compared with the prior year due to a decrease in involuntary commercial automobile plans. 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 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 our diversified insurance services 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 the Company's results of operations, financial condition and liquidity for the interim periods indicated. References to the "Company" and to "Selective" mean Selective Insurance Group, Inc. and its consolidated subsidiaries, collectively. RESULTS OF OPERATIONS The following discussion is a comparison of First Quarter Ended March 31, 2000 ("First Quarter 2000") to First Quarter Ended March 31, 1999 ("First Quarter 1999"). OPERATING SEGMENTS The Company is primarily engaged in writing property and casualty insurance. The Company has classified its 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 (formerly called Fee-For-Service Operations). All segments are evaluated based on their underwriting or operating results, which are prepared in accordance with Generally Accepted Accounting Principles ("GAAP"). For an additional description of these accounting policies, refer to Note 1 to the Company's 8
9 Consolidated Financial Statements on pages 41 through 43 of the 1999 Annual Report on Form 10-K for the year ended December 31, 1999. See note 4 to the March 31, 2000 Unaudited Consolidated Financial Statements on page 6 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, 2000 ($ in thousands) 2000 1999 - --------------------------------------------------------------------------------------------------- TOTAL INSURANCE OPERATIONS <S> <C> <C> Net premiums written $ 212,961 207,725 ============= ============= Net premiums earned 199,826 193,028 Losses and loss expenses incurred 146,308 144,214 Net underwriting expenses incurred 62,198 60,192 Dividends to policyholders 1,881 1,861 ------------- ------------- Underwriting loss $ (10,561) (13,239) ------------- ------------- GAAP RATIOS: Loss and loss expense ratio 73.2% 74.7 Underwriting expense ratio 31.1% 31.2 Dividends to policyholders ratio 1.0% 1.0 ------------- ------------- Combined ratio 105.3% 106.9 ============= ============= </TABLE> Net premiums written for First Quarter 2000 were up approximately $5 million, or 3% to $213 million, including $49 million in net new business, when compared to the same period one year ago. The new business written was partially offset by; i) a decrease in involuntary personal automobile premiums of $4 million transferred to a servicing carrier and ii) a reduction in premiums of approximately $4 million in New Jersey personal automobile due to the 15% rate rollback mandated by the New Jersey Automobile Insurance Cost Reduction Act (AICRA). The combined ratio decreased 1.6 points to 105.3%, for First Quarter 2000. The ratio of losses and loss expenses incurred to net premiums earned decreased 1.5 points for First Quarter 2000 to 73.2% compared to the same period one year ago. In the First Quarter 2000 weather-related catastrophes added only 0.4 points to the loss ratio compared with 2.2 points for the same period one year ago. The underwriting expense ratio decreased to 31.1% for First Quarter 2000 when compared to the same period one year ago. Overall, productivity in First Quarter 2000, as measured by fiscal year net premiums written per Insurance Operations employee, was approximately $462,000, down slightly from $472,000 for First Quarter 1999. Commercial Lines Underwriting <TABLE> <CAPTION> Unaudited, Quarter ended COMMERCIAL LINES March 31, 2000 ($ in thousands) 2000 1999 - ------------------------------------------------------------------------------------------------- GAAP INSURANCE OPERATION RESULTS <S> <C> <C> Net premiums written $ 162,064 149,063 ============ =========== Net premiums earned 145,879 136,772 Losses and loss expenses incurred 105,343 101,772 Net underwriting expenses incurred 46,872 47,021 Dividends to policyholders 1,881 1,861 ------------ ----------- Underwriting loss $ (8,217) (13,882) ------------ ----------- GAAP RATIOS: Loss and loss expense ratio 72.2 % 74.4 Underwriting expense ratio 32.1 % 34.4 Dividends to policyholders ratio 1.3 % 1.4 ------------ ----------- Combined ratio 105.6 % 110.2 ============ =========== </TABLE> 9
10 Commercial Lines Underwriting, which consists of six strategic business units ("SBUs"), accounted for approximately 76% of net premiums written during First Quarter 2000. Net premiums written increased $13 million, or 9%, for First Quarter 2000 compared to the same period in 1999. These increases were reflected in the performance of all commercial SBUs and included $37 million in net new business for First Quarter 2000, compared to $42 million for the same period one year ago. The Company's ability to continue growing its book of business going forward is affected by competitive forces in the marketplace as we implement price increases on an account-by-account basis, with larger increases targeted at under-performing business. The commercial lines pricing environment appears to be improving as the market has stabilized and pricing is moving upward. In the First Quarter of 2000, the Company increased its renewal premium year over year approximately 8%, of which about 5 to 6 % represented pure price increases. For the month of April our renewal premium increased about 12% of which 8% was pure price increases. The Company expects to meet its preliminary goal of an 8% pure price increase as we move into the second and third quarter of 2000. We expect the benefit of price increases will begin impacting our results in the second half of 2000 and continue into 2001. For First Quarter 2000, the Commercial Lines combined ratio decreased 4.6 points to 105.6% when compared to the same period one year ago. The lower combined ratio reflects a decrease in the loss and loss expense ratio of 2.2 points due primarily to lower weather-related catastrophe losses in the First Quarter 2000. In the First Quarter 2000 weather-related catastrophes added only 0.4 points to the loss ratio compared with 2.8 points for the same period one year ago. The underwriting expense ratio decreased 2.3 points to 32.1% for First Quarter 2000. Lower expense levels for First Quarter 2000 reflected: i) decreases in premium taxes and assessments of approximately 0.6 points primarily due to non-recurring charges in the First Quarter 1999; ii) a net decrease in the commission ratio of 0.3 points, due primarily to lower profit sensitive commissions; and iii) other expenses increased at rates less than our 3% net premiums written growth rate. Personal Lines Underwriting <TABLE> <CAPTION> Unaudited, Quarter ended PERSONAL LINES March 31, 2000 ($ in thousands) 2000 1999 - ------------------------------------------------------------------------------------------------- GAAP INSURANCE OPERATION RESULTS <S> <C> <C> Net premiums written $ 50,897 58,662 =========== =========== Net premiums earned 53,947 56,256 Losses and loss expenses incurred 40,965 42,442 Net underwriting expenses incurred 15,326 13,171 Underwriting (loss) or gain (2,344) 643 ----------- ----------- GAAP RATIOS: Loss and loss expense ratio 75.9 % 75.4 Underwriting expense ratio 28.4 % 23.4 ----------- ----------- Combined ratio 104.3 % 98.8 =========== =========== </TABLE> Personal Lines Underwriting net premiums written decreased $8 million, or 13 %, for First Quarter 2000 when compared with the same period in 1999. Net premiums written included net new business written of $12 million in First Quarter 2000 compared with $20 million one year ago. This new business reflects the expansion efforts in Personal Lines in states outside of New Jersey offset by decreasing new business within New Jersey. Premiums written in New Jersey, for the First Quarter 2000, were reduced by approximately $4 million due to the 15% rate rollback mandated by the New Jersey auto reform legislation effective March 1999. Premiums written declined by an additional $4 million due to outsourcing New Jersey involuntary auto business to a third party carrier. In March 1999, the New Jersey Automobile Insurance Cost Reduction Act (AICRA) became effective and provided for a statewide average premium reduction of 15%. In September 1999, the Company's plan to reduce medical costs, as allowed under AICRA was approved by the state. The Company currently estimates the cost savings from the reform law to be in the 4 - 5% range which do not offset the mandatory 15% reduction. The Company continues to expect the combined ratio for the New Jersey Personal Automobile line of business to be in the range of 105 - 109% by the end of 2000. The Personal Lines SBU combined ratio was 104.3% for First Quarter, up 5.5 points from First Quarter 1999. This increase was primarily due to an increase in the underwriting expense ratio for personal lines of 5 points. Underwriting expenses are increasing while net premiums earned are decreasing, adversely affecting this ratio. Underwriting expenses included an additional $0.4 million of fees paid to the third party carrier for New Jersey involuntary automobile premiums. 10
11 The UEZ Program requires New Jersey auto insurers to write, at the Company's voluntary rate levels, an amount of urban auto insurance proportionate to their voluntary market share which is currently estimated at 3.1% for Selective. Net premiums written under the involuntary UEZ program were $3 million for both First Quarter 2000 and 1999. By June 1999, the Company had fully met its UEZ obligation by writing approximately 7,000 policies. The Company is also required to write "Liability-only" policies under the UEZ program and the Company's New Jersey liability rates charged are not sufficient to offset the higher claim frequency experienced by this business. Policies in the UEZ program tend to have a higher proportion of liability only polices than the voluntary personal automobile lines of business. The combined ratio for the involuntary business is substantially worse than our voluntary lines of business. The Company does not believe it will be assigned additional UEZ policies before 2001. The excess profits law in New Jersey sets a maximum profit level on personal automobile insurance. Under New Jersey regulations, an insurer's excess profits earned on direct insurance written in New Jersey on private passenger automobiles, as determined pursuant to an actuarial formula set forth in applicable regulations ("NJ Excess Profits"), are subject to refund or credit to policyholders. A NJ Excess Profits calculation must be made by an insurer for this purpose and submitted to the New Jersey Department of Banking and Insurance each year for the three-year period including the year for which the calculation is done and the two calendar years immediately preceding such year. For the period ended December 31, 1999, the Company did not incur an obligation to make an excess profit premium refund. The premium reductions imposed by the recently required New Jersey AICRA, the apparent lack of equivalent cost savings in the law, and the effect of policy assignments the Company was required to take pursuant to the state's UEZ law, will diminish the likelihood of a future excess profits refund. Nevertheless, due to the excess profits calculation formula, it is possible the Company could incur a refund obligation for the period ending December 31, 2000. DIVERSIFIED INSURANCE SERVICES SEGMENT <TABLE> <CAPTION> Unaudited, Quarter ended March 31, 2000 - ------------------------------------------------------------------------------------------------------ ($ in thousands) 2000 1999 - ------------------------------------------------------------------------------------------------------ FLOOD INSURANCE <S> <C> <C> Net Revenue $ 2,597 1,927 Income Before Federal Income Tax 471 360 MEDICAL COST CONTAINMENT Managed Care Net Revenue 1,711 1,871 Income Before Federal Income Tax 397 410 Preferred Provider Organization Net Revenue 1,389 N/A Income Before Federal Income Tax 32 N/A PROFESSIONAL EMPLOYER ORGANIZATION Net Revenue 7,125 N/A Income Before Federal Income Tax 298 N/A SOFTWARE DEVELOPMENT AND PROGRAM ADMINISTRATION Net Revenue 4,542 5,084 Loss Before Federal Income Tax (1) (134) OTHER Net Revenue 304 N/A Income Before Federal Income Tax 80 N/A TOTAL Net Revenue 17,668 8,882 Income Before Federal Income Tax 1,277 636 Net Income 795 396 Return on Net Revenue 4.5 4.5 </TABLE> Diversified Insurance Services businesses generated $17.7 million of revenue and $0.8 million of net income for the First Quarter 2000, compared with $8.9 million of revenue and $0.4 million of net income for the same period one year earlier. The Company expects continued, revenue growth in this segment (approximately $85 million for the year) and increased opportunities for these businesses working together with the Insurance Operations. The segment generated a return 11
12 on net revenue of 4.5% for the quarter ended March 31, 2000, consistent with the prior year, but still below our annual target of 5%. We intend to continue to focus our Diversified Insurance Services businesses on revenue growth, geographic expansion and inter-business marketing opportunities. During the First Quarter of 2000, the Company began marketing, through independent insurance agents, a product that combines Professional Employer Organizational ("PEO") services and commercial lines insurance coverages. This represents a unique way to address many risk management and human resources issues that our small to mid-sized business customers face. Flood Insurance Selective is a servicing carrier for the National Flood Insurance Program. The Company provides a market for flood insurance to its agents and also has flood-only appointments with about 2,600 agents across the country. The premiums collected by the Company are ceded 100% to the federal government. As a servicing carrier, Selective bears no risk of policyholder loss. The Company receives a servicing fee from which it pays agency commissions and other related expenses. During the first quarter of 2000, the Company had direct premiums written of $7.6 million, a 32.5% increase as compared to the same period one year ago, which increased pre-tax net income $247,000. This increase was partially offset by increased expenses due to start-up costs associated with Flood Connect LLC. In addition to the underwriting fees, the Company receives fees for handling claims. Together these fees generated $2.6 million of revenue and $0.5 million in pre-tax profit for this unit for the First Quarter 2000. During the fourth quarter of 1999 the Company established a separate entity, FloodConnect,LLC, which was created to roll out nationally an internally developed flood policy processing system during the fourth quarter of 2000. As of the end of the first quarter, the scheduled roll out of this system remains on target. The system will eliminate the need for the Company to purchase policy support from an outside vendor, and it will also enable FloodConnect to provide policy processing support for other Flood servicing carriers, thus creating an opportunity for additional program administration revenues. Medical Cost Containment - Alta Services and Consumer Health Network Alta Services, LLC ("Alta") manages workers' compensation and automobile medical claims for the underwriting subsidiaries of the Company, for unrelated companies, and for self-insured businesses and employer groups. Alta bears no underwriting risk and offers a full array of medical cost containment services. Alta provides a broad range of medical claims services to Selective's insurance operations including first report of injury, referrals to medical providers, comprehensive medical case management, as well as medical bill audits and repricing. The goal of Alta's program is to return patients to their normal routine, at work and at home, and ensure medical costs are delivered in the most cost effective manner possible. In addition, Alta also provides medical services to other insurers. Recently, Alta has become a leading medical claim management vendor for medical programs under New Jersey's AICRA. During the first quarter of 2000, Alta generated revenue of $1.7 million compared with $1.9 million in the same period of 1999 which resulted in pre-tax net income of $0.4 million in both the First Quarter 2000 and 1999. Consumer Health Network ("CHN") is a preferred provider organization ("PPO"), which develops networks of medical providers and leases these networks to insurers, large employers, third party administrators, unions and other entities that pay medical claims. In return for bringing the medical providers patients, the PPO negotiates discounts for its customers. CHN has expanded its network providers from 38,000 at acquisition to 43,500 locations as of the end of the first quarter 2000 in its initial three key operating territories (New Jersey, New York, and Connecticut). Network expansion will continue to be a major initiative at CHN. The costs associated with these efforts have reduced return on revenue margins in the first quarter of 2000. CHN generated $1.4 million in revenue and $32,000 in pre-tax net income during the First Quarter 2000. Going forward, both Alta and CHN will focus on expanding their businesses by entering into new states where Selective has a major presence, starting with Pennsylvania. Also, as Selective HR Solutions (see below) enters New Jersey and other key Selective territories, both Alta and CHN will have new business opportunities to manage the day-to-day medical needs of the employees of Selective HR Solution's business customers. This is an example of the vertical integration synergies made possible by Selective's business model. Alta also oversees SelecTech, LLC ("SelecTech") which generates fees by providing third party administrative services to self-insured accounts. Self-insured businesses often need insurance services, such as managed care and other claim handling programs, and loss control that would otherwise be provided by an insurer. Professional Employer Organization - Selective HR Solutions The PEO provides human resource administration, including benefits, payroll and employee management services, and risk and compliance management products and services, including workers' compensation to small or mid-sized business. A PEO, by the nature of its product package, provides a very high level of day-to-day services to its customers, which the Company believes, will be attractive to small business owners. The Company believes that small to mid-sized businesses will begin demanding new and 12
13 better solutions to many of their operational problems. The PEO concept provides an answer to many problems employers face from hiring and retaining good employees, to providing competitive benefits, to eliminating administrative and compliance burdens that keep the business owners from focusing on their core operations. Selective HR Solutions provides the Company and its distribution force access to a product line that complements Selective's traditional commercial insurance package. As independent agents write insurance for about 70% of the small business (those with 25 or less employees) insurance market, the Company believes it can successfully market the PEO product in its operating territories through its agents. The Company will steadily introduce the PEO product in its operating territories throughout 2000 and 2001, building on existing agent/business owner relationships. As stated above, introducing the PEO product in New Jersey will also generate business opportunities for Alta and CHN. Selective HR Solutions will also begin using an Internet-enabled payroll and benefits management system in 2000, which is expected to further improve efficiency and service levels. In the First Quarter of 2000, Selective HR Solutions generated $7.1 million in revenue and $0.3 million in pre-tax net income. Software Development and Program Administration -- PDA Software Services, Inc. Technology is driving efficiencies and new operational opportunities that the insurance industry can benefit from by substantially reducing paper, excessive processing, and transaction costs. Selective has already made a significant resource commitment to technology, which was accentuated further by its acquisition of PDA Software Services, Inc. ("PDA") in late 1998. PDA has assisted in the development of the Company's automated claim and flood processing systems. In addition, PDA is also the leading vendor of administrative services to the federal government's Women, Infants and Children ("WIC") nutritional program administered by the states. Currently, PDA administers the WIC program in 12 states. PDA incurred a pre-tax loss of $1,000 in the First Quarter 2000, attributable to the amortization of goodwill incurred at the acquisition of PDA and retention bonuses as compared to a pre-tax loss of $134,000 during the same period a year ago. The retention bonuses will continue as charges against income through 2002. Revenues for First Quarter 2000 were $4.5 million, compared with $5.1 million for First Quarter 1999. Investments Segment Net investment income earned after tax for First Quarter 2000 of $23 million, decreased almost 1% or $0.2 million compared with First Quarter 1999. This decrease resulted from: 1) redemptions and maturities of higher yielding debt securities reinvested at lower fixed income yields currently available in the marketplace; and 2) a decrease in available cash due to cash used for the Company's stock repurchase program. The Company had a 4.4% annualized after-tax investment yield for First Quarter 2000, consistent with the same period in 1999. Net realized gains for First Quarter 2000 decreased $6 million to $2.3 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 $1 million to $2 million for First Quarter 2000. The decrease reflects lower capital gains recognized for the quarter. The Company's effective tax rate was 13.3% for First Quarter 2000, compared with 15.9% for First Quarter 1999. The Company's 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 an insurance holding company whose principal assets are its investments in its insurance and diversified insurance services subsidiaries. As an insurance holding company, The Parent meets its cash requirements through dividends from its insurance subsidiaries, the payments of which are subject to state regulatory requirements, and proceeds from the sales of the Company's common stock and debt. The Parent's cash requirements also include the cost of shares of common stock repurchased under its common stock repurchase program. As of March 31, 2000, the Company had repurchased a total of 5.7 million shares at a total cost of $109 million under the program, of which 0.8 million shares were repurchased during First Quarter 2000 at a total cost of $13 million. The Company is continuing its stock repurchase program, and from March 31, 2000 through May 2 repurchased 0.4 million shares at a total cost of $7 million. In total, since 1996, the Company has repurchased 6.0 million shares for $116 million at an average price per share of $19.16. At March 31, 2000, there was $66 million of short-term debt outstanding under the three lines of credit that the Company has available, compared with $51 million at December 31, 1999. The increase in the outstanding balance of $15 million was due to borrowings to fund the repurchase of our stock. The weighted average interest rate on these borrowings was 6.4% and 5.3% for 13
14 the respective periods. On May 4, 2000, the Company successfully completed a private placement bond offering in the amount of $91.5 million. The offering consisted of two tranches: a five year average life tranche of $30 million at 8.63%; and an eight year average life tranche of $61.5 million at 8.87%. The proceeds were used to pay down the short-term debt and for general corporate expenses. For First Quarter 2000 and First Quarter 1999, cash provided by operating activities was $0.9 million and $0.7 million respectively. 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; capital expenditures with respect to the Company's automation program and 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 of investments. Total assets declined 0.1%, or $3 million, from December 31, 1999 to March 31, 2000. The decrease was due to a reduction in reinsurance recoverable on unpaid losses and loss expense of $15 million driven by a decrease in losses ceded to the National Flood Insurance Program ("NFIP") of $21 million. (1999 reinsurance recoverable on unpaid losses and loss expenses included $24 million of ceded flood losses due to Hurricane Floyd ). This decrease was offset by increases in total receivables of $12 million primarily due to the increased premium volume. The increase in total liabilities of 0.2%, or $3 million, from December 31, 1999 to March 31, 2000 was mainly attributable to an increase in unearned premium reserves of $12 million due primarily to the increase in premiums written and the increase in short term debt of $15 million. These increases were partially offset by a decrease of $20 million in reserves for loss and loss expenses driven by the decrease in NFIP reserves for Flood noted above. YEAR 2000 Many currently installed computer systems and software products use only two digits to identify a year in the date field with the assumption that the first two digits of the year are always "19." Consequently, on January 1, 2000, computers that were not "Year 2000" ("Y2K") compliant may have read the year as 1900. Systems that calculate, compare or sort using the incorrect date may malfunction. As a result, prior to the end of 1999, computer systems and/or software used by many companies may need to be upgraded to comply with such "Year 2000" requirements. Significant uncertainty exists in the software industry concerning the potential effect associated with such compliance. Through May 2000, the Company did not experience Y2K related business disruptions internally or as a result of its dealings with suppliers or service providers. The Company believes that most significant Y2K insurance claims are likely to occur in the information technology business sector, and under errors and omissions (E&O) and directors and officers liability (D&O) insurance coverages. The Company has not significantly participated in the technology business sector, nor has it significantly written E&O and D&O coverage types. The Company has also communicated to agents and policyholders that policies issued do not include coverage for Y2K losses, with the possible exception of certain losses involving property damage or bodily injury which can not be quantified at this time. The Company has used the Insurance Services Office Y2K exclusionary endorsements on most commercial lines policies. In addition, the Company's casualty excess of loss treaty was amended, effective July 1, 1998, to include as covered losses all Y2K losses aggregated as a single event, with protection totaling $38 million in excess of $12 million retention. The treaty covers any Y2K claim that is asserted in the 36 month period beginning on July 1, 1998. As of May 5, 2000, the Company has not received any Y2K claims. RECENT LEGISLATION AND COMPETITION WITH BANKS On November 4, 1999, the Financial Services Modernization Act of 1999 (the "Act") was adopted and signed into law by the President on November 12, 1999. The Act permits banks to engage in non-banking, financial service businesses, including the sale and underwriting of insurance. The act repeals provisions of federal law which historically prohibited banks from engaging in the insurance business. The act also subjects banks' insurance activities to state insurance regulation. While the impact on the Company of the Act is uncertain, we may face additional insurance sales and underwriting competition from banks as a result of the Act. The Company already faces potential competitive risks from banks, because banks have acquired insurance agencies in states where we sell insurance, including some important Selective agencies. We believe that some banks could implement business strategies for operating their insurance agencies that differ from strategies we think are critical to successful independent agent distribution of insurance products . If those banks were to acquire Selective agencies we may have to replace those insurance agencies. As a result of the Act, banks will also be able to underwrite property and casualty insurance and could compete directly 14
15 with us by selling their insurance products directly through insurance agencies. 15
16 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There have been no material changes in the information about market risk set forth in the Company's Annual Report on Form 10-K. PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS - NONE 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 5, 2000. At the Annual Meeting, A. David Brown, William M. Kearns, Jr., S. Griffin McClellan III and J. Brian Thebault were 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> A. David Brown 20,371,512 1,158,941 William M. Kearns, Jr. 20,409,459 1,120,994 S. Griffin McClellan III 20,351,281 1,179,172 J. Brian Thebault 20,444,653 1,085,800 </TABLE> The directors whose terms of office continued after the Annual meeting are: Paul D. Bauer, William A. Dolan II, William C. Gray, C. Edward Herder, Joan M. Lamm-Tennant, Gregory E. Murphy, William M. Rue and Thomas D. Savles. At the Annual meeting amendments to the Company's Stock Compensation Plan for Nonemployee Directors intended to (i) permit nonemployee directors to elect to receive up to 50% of their compensation under the plan for services as a director in cash for each calendar year, (ii) to eliminate from the plan the requirement that all participants receive compensation only in shares of common stock and (iii) to extend the term of the plan from December 31, 2007 to December 31, 2010 were approved as follows: <TABLE> <CAPTION> For Against Abstain ------ ----------- ----------- <S> <C> <C> <C> Votes 17,446,309 5,823,821 260,323 </TABLE> At the Annual meeting amendments to the Company's Stock Option Plan for Directors intended to (i) extended the term of the plan for an additional ten years and (ii) increase by 450,000 the number of shares of common stock reserved for issuance under the plan to an aggregate of 850,000 shares were approved as follows: <TABLE> <CAPTION> For Against Abstain ------ ----------- ----------- <S> <C> <C> <C> Votes 15,535,802 5,601,499 393,152 </TABLE> No other matters were voted on at the Annual meeting. ITEM 5. OTHER INFORMATION Gregory E. Murphy, President and Chief Executive Officer, was named to the additional post of Chairman of the Board at the organizational meeting that immediately followed the Company's Annual meeting on May 5, 2000. Gregory E. Murphy succeeds James W. Entringer, who after eight years of service has retired from the Board of Directors of Selective Insurance. 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, 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. 16
17 SELECTIVE INSURANCE GROUP, INC. INDEX TO EXHIBITS Exhibit No. - ----------- 10.16ab Termination Agreement, dated March 1, 2000, between Selective Insurance Company of America and Edward Pulkstenis, filed herewith. 11 Statement Re: Computation of Per Share Earnings, filed herewith. 27 Financial Data Schedule, filed herewith. 17
18 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 <TABLE> <S> <C> By: /s/ Dale A. Thatcher May 11, 2000 - ---------------------------------------------------------------------------------------------------------------- Dale A. Thatcher Senior Vice President of Finance and Chief Financial Officer By: /s/ Gregory E. Murphy May 11, 2000 - ---------------------------------------------------------------------------------------------------------------- Gregory E. Murphy Chairman, President and Chief Executive Officer </TABLE> 18