Selective Insurance - 10-Q quarterly report FY

 

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As of June 30, 2007, there were 53,473,907 shares of common stock, par value $2.00, outstanding.

 

 

Table of Contents

The accompanying notes are an integral part of these unaudited interim consolidated financial statements.

The accompanying notes are an integral part of these unaudited interim consolidated financial statements.

Selective Insurance Group, Inc. also has authorized, but not issued, 5,000,000 shares of preferred stock, without par value, of which 300,000 shares have been designated Series A junior preferred stock, without par value.

The accompanying notes are an integral part of these unaudited interim consolidated financial statements.

The accompanying notes are an integral part of these unaudited interim consolidated financial statements.

NOTE 1. Organization
Selective Insurance Group, Inc., through its subsidiaries, (collectively known as “Selective”) offers property and casualty insurance products and diversified insurance services and products. Selective Insurance Group, Inc. was incorporated in New Jersey in 1977 and its main offices are located in Branchville, New Jersey. Selective Insurance Group, Inc.’s Common Stock is publicly traded on the NASDAQ Global Select Market under the symbol, “SIGI.”

Selective classifies its business into three operating segments:

NOTE 2. Basis of Presentation
These interim unaudited consolidated financial statements (“Financial Statements”) include the accounts of Selective Insurance Group, Inc. and its subsidiaries, and have been prepared in conformity with (i) accounting principles generally accepted in the United States of America (“GAAP”) and (ii) the rules and regulations of the United States Securities and Exchange Commission (“SEC”) regarding interim financial reporting. The preparation of the Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported financial statement balances, as well as the disclosure of contingent assets and liabilities. Actual results could differ from those estimates. All significant intercompany accounts and transactions between Selective Insurance Group, Inc. and its subsidiaries are eliminated in consolidation.

These Financial Statements reflect all adjustments that, in the opinion of management, are normal, recurring and necessary for a fair presentation of Selective’s results of operations and financial condition. These Financial Statements cover the second quarters ended June 30, 2007 (“Second Quarter 2007”) and June 30, 2006 (“Second Quarter 2006”) and the six-month periods ended June 30, 2007 (“Six Months 2007”) and June 30, 2006 (“Six Months 2006”). These Financial Statements do not include all of the information and disclosures required by GAAP and the SEC for audited financial statements. Results of operations for any interim period are not necessarily indicative of results for a full year. Consequently, these Financial Statements should be read in conjunction with the consolidated financial statements contained in Selective’s Annual Report on Form 10-K for the year ended December 31, 2006 (“2006 Annual Report”).

NOTE 3. Statement of Cash Flow
At December 31, 2006, Selective changed its definition of cash equivalents for presentation in the Statements of Cash Flow. Accordingly, the Six Months 2006 Statement of Cash Flow has been restated to conform with this policy change. In addition, certain amounts in the Statement of Cash Flow for Six Months 2006 have been reclassified to conform to reclassifications made to the balance sheet in the prior year. These reclassifications resulted in immaterial changes to individual line items in the operating activities and investing activities sections of the Statements of Cash Flow, but had no impact on total cash flows from operating activities. Neither the policy change nor the reclassifications had any effect on Selective’s net income or stockholders’ equity. For additional information, refer to Item 8. “Financial Statements and Supplementary Data,” Note 2 of Selective’s 2006 Annual Report.

NOTE 4. Adoption of Accounting Pronouncements
On January 1, 2007, Selective adopted Financial Accounting Standards No. 155, Accounting for Certain Hybrid Financial Instruments — an amendment of FASB Statements No. 133 and 140 (“FAS 155”). Under the guidance contained in FAS 155, companies are required to evaluate interests in securitized financial assets to identify whether such interests are freestanding derivatives or hybrid financial instruments that contain an embedded derivative. During the fourth quarter of 2006, the Financial Accounting Standards Board (“FASB”) recommended a narrow scope exception for securitized interests if: (i) the securitized interest itself has no embedded derivative (including interest rate related derivatives) that would be required to be accounted for separately other than an embedded derivative that results solely from the embedded call options in the underlying financial assets; and (ii) the investor does not control the right to accelerate the settlement. The adoption of FAS 155 did not have a material impact on the results of operations or financial condition of Selective during Second Quarter 2007 and Six Months 2007.

On January 1, 2007, Selective adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes — an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 calls for a two-step process to evaluate tax positions based on the recognition, derecognition, and measurement of benefits related to income taxes. The process begins with an initial assessment of whether a tax position, based on its technical merits and applicability to the facts and circumstances, will “more-likely-than-not” be sustained upon examination, including related appeals or litigation. The “more-likely-than-not” threshold is defined as having greater than a 50% chance of being realized upon settlement. Tax positions that are “more-likely-than-not” sustainable are then measured to determine how much of the benefit should be recorded in the financial statements. This determination is made by considering the probabilities of the amounts that could be realized upon effective settlement. Each tax position is evaluated individually and must continue to meet the threshold in each subsequent reporting period or the benefit will be derecognized. A position that initially failed to meet the “more-likely-than-not” threshold should be recognized in a subsequent period if: (i) a change in facts and circumstances results in the position’s ability to meet the threshold; (ii) the issue is settled with the taxing authority; or (iii) the statute of limitations expires. FIN 48 is effective for fiscal years beginning after December 15, 2006. Selective has analyzed its tax positions in all federal and state jurisdictions in which it is required to file income tax returns for all open tax years. The open tax years for the federal returns are 2003 though 2006. The Internal Revenue Service completed a limited scope examination of tax year 2003 and 2004 that resulted in a favorable adjustment. Selective did not have any unrecognized tax benefits as of January 1, 2007. Selective believes its tax positions will be sustained on audit and does not anticipate any adjustments that will result in a material change to its financial position. As a result, there was no material change in Selective’s liability for unrecognized tax benefits.

In February 2007, the FASB issued Financial Accounting Standards No. 159, The Fair Value Option for Financial Assets and Financial Liabilities — Including an amendment of FASB Statement No. 115(“FAS 159”), which provides companies with an option to report selected financial assets and liabilities at fair value. FAS 159 requires companies to provide additional information that will help investors and other users of financial statements to more easily understand the effect of the company’s choice to use fair value on its earnings. FAS 159 also requires companies to display the fair value of those assets and liabilities for which the company has chosen to use fair value on the face of the balance sheet. We are currently evaluating the impact FAS 159 may have on our financial statements.

NOTE 5. Reinsurance
The following table contains a listing of direct, assumed, and ceded reinsurance amounts by income statement caption. For more information concerning reinsurance, refer to Note 7, “Reinsurance” in Item 8. “Financial Statements and Supplementary Data” in Selective’s 2006 Annual Report.

The ceded premiums and losses included in the above table related to Selective’s flood operations are as follows:

NOTE 6. Segment Information
Selective has classified its operations into three segments, the disaggregated results of which are reported to and used by senior management to manage Selective’s operations:

The Insurance Operations and Diversified Insurance Services segments share a common marketing and distribution system and create new opportunities for independent insurance agents to bring value-added services and products to their customers. Selective’s commercial and personal lines property and casualty insurance products, flood insurance, and human resource administration outsourcing products are principally sold through independent insurance agents.

Selective and its subsidiaries also provide services to each other in the normal course of business. These transactions, which are eliminated in all consolidated statements, totaled $4.5 million in Second Quarter 2007 and $8.9 million in Six Months 2007 compared with $5.0 million in Second Quarter 2006 and $9.8 million in Six Months 2006. In computing the results of each segment, Selective does not make adjustments for interest expense, net general corporate expenses, or federal income taxes. Selective also does not maintain separate investment portfolios for the segments and, therefore, does not allocate assets to the segments.

The following presents revenues (net investment income and net realized gains on investments in the case of the Investments segment) and pre-tax income for the individual segments:

NOTE 7. Retirement Plans
The following tables show the costs of the Retirement Income Plan for Selective Insurance Company of America (“Retirement Income Plan”) and the retirement life insurance component (“Retirement Life Plan”) of the Welfare Benefits Plan for Employees of Selective Insurance Company of America. For more information concerning these plans, refer to Note 16, “Retirement Plans” in Item 8. “Financial Statements and Supplementary Data” in the 2006 Annual Report.

In Second Quarter 2007, Selective restructured its personal lines department. As part of this restructuring, an early retirement enhancement option was offered to eligible employees. The present value of the enhancement to be made in conjunction with this early retirement option is equal to $0.9 million for pension benefits and $0.1 million for postretirement life benefits. These amounts are reflected as expense in the results for Second Quarter and Six Months 2007.

As indicated in its 2006 Annual Report, Selective had originally anticipated contributing $4.2 million to the Retirement Income Plan in 2007. That estimate has been revised to $8.2 million, of which $6.1 million has been paid as of June 30, 2007.

NOTE 8. Comprehensive Income
The components of comprehensive income, both gross and net of tax, for Second Quarter 2007 and Second Quarter 2006 are as follows:

The components of comprehensive income, both gross and net of tax, for Six Months 2007 and Six Months 2006 are as follows:

As of December 31, 2006, Selective adopted Statement of Financial Accounting Standard No. 158,Employer’s Accounting for Defined Benefit Pensions and Other Postretirement Benefits (“FAS 158”). Selective recorded the impact of adopting FAS 158 in accumulated other comprehensive income (“AOCI”), a separate component of stockholders’ equity, resulting in a decrease in equity of $13.7 million, after tax. Selective included this decrease in AOCI as a component of comprehensive income, which is separately presented in the 2006 Consolidated Statement of Stockholders’ Equity. Subsequent to the filing of our 2006 Annual Report, Selective identified that, although the impact of adopting FAS 158 was properly included as a decrease to AOCI, it should not have been reflected as a component of comprehensive income. The impact of appropriately excluding the FAS 158 adjustment increases comprehensive income from $146.1 million, as presented, to $159.8 million, as adjusted.

NOTE 9. Stockholders’ Equity
On January 30, 2007, the Board of Directors of Selective Insurance Group, Inc. declared a two-for-one stock split of Selective Insurance Group, Inc.’s common stock, par value $2.00 per share (“Common Stock”), in the form of a share dividend of one additional share of Common Stock for each outstanding share of Common Stock (the “Share Dividend”). The Share Dividend was paid on February 20, 2007 to stockholders of record as of the close of business on February 13, 2007. The effect of the Share Dividend has been recognized retroactively in all share and per share data, as well as the capital stock account balances, in the accompanying consolidated financial statements, notes to consolidated financial statements and supplemental financial data.

On March 8, 2007, Selective Insurance Group, Inc. entered into a written trading plan under Rule 10b5-1 under the Securities Exchange Act of 1934 (“Trading Plan”) with a broker to facilitate the purchase of its Common Stock. Rule 10b5-1 allows a company to purchase its shares at times when it ordinarily would not be in the market because of self-imposed trading blackout periods, such as the time preceding its quarterly earnings releases. On April 24, 2007, the Board of Directors extended the then existing share repurchase program through December 31, 2007. During Six Months 2007, Selective Insurance Group, Inc. repurchased approximately 5.2 million shares of its Common Stock at a total cost of $133.4 million and has no shares remaining under its previously authorized stock repurchase program. In total, 10 million shares were repurchased for $259.8 million under this program. On July 24, 2007, the Board of Directors of Selective Insurance Group, Inc. authorized a new share repurchase program for up to 4 million shares, which expires on July 26, 2009.

NOTE 10. Commitments and Contingencies
Other investments, as shown on the consolidated balance sheet, were $175.5 million as of June 30, 2007 and $144.8 million as of December 31, 2006. At December 31, 2006, Selective had additional other investment commitments of up to $110.5 million, of which $9.2 million was paid during Second Quarter 2007 and $29.4 million during Six Months 2007. At June 30, 2007, Selective had contractual obligations that expire at various dates through 2022 to further invest up to $134.1 million in these other investments. There is no certainty that any such additional investments will be required.

Selective’s Insurance Subsidiaries are also from time-to-time involved in other legal actions, some of which assert claims for substantial amounts. These actions include, among others, putative state class actions seeking certification of a state or national class. Such putative class actions have alleged, for example, improper reimbursement of medical providers paid under workers compensation and personal and commercial automobile insurance policies. Selective’s Insurance Subsidiaries are also from time-to-time involved in individual actions in which extra-contractual damages, punitive damages, or penalties are sought, such as claims alleging bad faith in the handling of insurance claims. An amended complaint in one such case, Fields, et al. v. Selective Insurance Company of South Carolina, et al., was filed in Fulton County, Georgia in April 2007, and alleges that various Selective entities and employees induced the plaintiffs to settle four prior wrongful death cases by negligently and fraudulently failing to disclose a $1 million umbrella policy that was available to cover any verdict or judgment in the wrongful death cases. The Fields plaintiffs seek damages allegedly arising from, among other things, the non-disclosure of the umbrella coverage, together with interest, attorneys’ fees, treble damages under Georgia’s racketeering statute, and punitive damages. Selective believes that it has valid defenses to these cases, including the Fields case. Selective’s management expects that the ultimate liability, if any, with respect to such lawsuits, after consideration of provisions made for estimated losses, will not be material to Selective’s consolidated financial condition. Nonetheless, given the large or indeterminate amounts sought in certain of these actions, and the inherent unpredictability of litigation, an adverse outcome in certain matters could, from time-to-time, have a material adverse effect on Selective’s consolidated results of operations or cash flows in particular quarterly or annual periods.

Forward-Looking Statements
In this Quarterly Report on Form 10-Q, Selective and its management discuss and make statements regarding their intentions, beliefs, current expectations, and projections regarding Selective’s future operations and performance. Such statements are “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are often identified by words such as “anticipates,” “believes,” “expects,” “will,” “should” and “intends” and their negatives. Selective and its management caution prospective investors that such forward-looking statements are not guarantees of future performance. Risks and uncertainties are inherent in Selective’s future performance. Factors that could cause actual results to differ materially from those indicated by such forward-looking statements include, but are not limited to, those discussed under Item 1A. “Risk Factors” in the Annual Report. These risk factors may not be exhaustive. We operate in a continually changing business environment and new risk factors emerge from time-to-time. We can neither predict such new risk factors nor can we assess the impact, if any, of such new risk factors on our businesses or the extent to which any factor or combination of factors may cause actual results to differ materially from those expressed or implied in any forward-looking statements in this report. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this report might not occur. Selective and its management make forward-looking statements based on currently available information and assume no obligation to update these statements due to changes in underlying factors, new information, future developments, or otherwise.

Introduction
Selective Insurance Group, Inc., (“Selective,” “we,” or “our”) offers property and casualty insurance products and diversified insurance services through its various subsidiaries. Selective classifies its businesses into three operating segments: (i) Insurance Operations, (ii) Investments, and (iii) Diversified Insurance Services.

The purpose of the Management’s Discussion and Analysis (“MD&A”) is to provide an understanding of the consolidated results of operations and financial condition, and known trends and uncertainties that may have a material impact in future periods. Consequently, investors should read the MD&A in conjunction with Selective’s consolidated financial statements in the Annual Report. For reading ease, we have written the MD&A in the first person plural.

In the MD&A, we will discuss and analyze the following:

Critical Accounting Policies and Estimates
These unaudited interim consolidated financial statements include amounts based on informed estimates and judgments of management for those transactions that are not yet complete. Such estimates and judgments affect the reported amounts in the financial statements. Those estimates and judgments that were most critical to the preparation of the financial statements involved the following: (i) reserves for losses and loss expenses; (ii) deferred policy acquisition costs; (iii) pension and postretirement benefit plan actuarial assumptions; and (iv) other-than-temporary investment impairments. These estimates and judgments require the use of assumptions about matters that are highly uncertain and, therefore, are subject to change as facts and circumstances develop. If different estimates and judgments had been applied, materially different amounts might have been reported in the financial statements. Our 2006 Annual Report, pages 33 through 40, provides a discussion of each of these critical accounting policies.

Net investment income earned in Second Quarter 2007 increased 9% over Second Quarter 2006 and contributed $3.3 million to the $6.6 million revenue growth in the quarter this year compared to last year. On a year-to-date basis, net investment income earned increased 10% compared to Six Months 2006 and contributed $7.1 million to the $26.0 million revenue growth in Six Months 2007 compared to Six Months 2006. Increased net investment income is primarily attributable to a higher invested asset base resulting from net investable cash flows of $326.9 million for the year ended December 31, 2006. This net investable cash flow, which includes net proceeds of $96.8 million from our $100.0 million junior subordinated notes offering in the third quarter of 2006, is partially offset by treasury stock purchases of 4.1 million shares under our authorized program at a total cost of $110.1 million for the full year 2006. During Six Months 2007, Selective Insurance Group, Inc. purchased an additional 5.2 million shares at a total cost of $133.4 million, driving the negative investable cash flow for that period of $42.9 million.

Diversified Insurance Services revenue contributed $3.1 million to the $6.6 million revenue growth in Second Quarter 2007 compared to Second Quarter 2006, and contributed $5.0 million to the $26.0 million revenue growth in Six Months 2007 compared to Six Months 2006. This was primarily the result of (i) increased flood revenue of $2.1 million to $12.3 million in Second Quarter 2007 and $3.7 million to $22.6 million in Six Months 2007 generated by higher levels of serviced premium, and (ii) increased flood claims revenue of $1.0 million to $1.4 million in Second Quarter 2007 and $0.9 million to $1.4 million in Six Months 2007 generated by northeastern storms occurring in Second Quarter 2007.

Insurance Operations
Our Insurance Operations segment writes property and casualty insurance business through seven insurance subsidiaries (the “Insurance Subsidiaries”). Our Insurance Operations segment sells property and casualty insurance products and services primarily in 21 states in the Eastern and Midwestern United States through 845 independent insurance agencies. Selective has at least one Insurance Subsidiary licensed to do business in each of the 50 states. Our Insurance Operations segment consists of two components: (i) commercial lines (“Commercial Lines”), which markets primarily to businesses, and represents approximately 87% of net premiums written (“NPW”), and (ii) personal lines (“Personal Lines”), which markets primarily to individuals and represents approximately 13% of NPW. The underwriting performance of these lines is generally measured by four different statutory ratios: (i) loss and loss expense ratio; (ii) underwriting expense ratio; (iii) dividend ratio; and (iv) combined ratio. For further details regarding these ratios see the discussion in the “Insurance Operations Results” section of Item 1. “Business” of Selective’s 2006 Annual Report.