Selective Insurance Group 10-K 2005
Documents found in this filing:
AND EXCHANGE COMMISSION
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, and (2) has been subject to such filing requirements for
the past 90 days.
the registrant's definitive Proxy Statement for the 2005 Annual Meeting of
Stockholders to be held on April 27, 2005 are incorporated by reference into
Part III of this report.
In this Annual Report on Form 10-K, Selective Insurance Group, Inc. (Selective) and its management discuss and make statements regarding their intentions, beliefs, and current expectations regarding Selective's future operations and performance. Such statements, including information incorporated by reference, are "forward-looking statements" as that term is defined in the Private Securities Litigation Reform Act of 1995 (PSLRA). The PSLRA provides a safe harbor under the Securities Act of 1933 and the Securities Exchange Act of 1934 for forward-looking statements. These statements relate to our intentions, beliefs, projections, estimations or forecasts of future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our or our industry's actual results, levels of activity, or performance to be materially different from those expressed or implied by the forward-looking statements. In some cases, you can identify forward-looking statements by use of words such as "may," "will," "could," "would," "should," "expect," "plan," "anticipate," "target," "project," "intend," "believe," "estimate," "predict," "potential," "pro forma," "seek," "likely," "continue," or other comparable terminology. These statements are only predictions, and we can give no assurance that such expectations will prove to be correct. We undertake no obligation, other than as may be required under the federal securities laws, to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Factors that could cause Selective's actual results to differ materially from those projected, forecasted or estimated in forward-looking statements are discussed in further detail later in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in the section entitled, "Risk Factors." These risk factors may not be exhaustive. Selective operates in a continually changing business environment and new risk factors emerge from time-to-time. Selective can neither predict such new risk factors nor assess the impact, if any, of such new risk factors on its 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.
Item 1. Business.
Financial information about Selective's three operating segments is contained in this report in Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations," Item 8, "Financial Statements and Supplementary Data," and Note 11 to the consolidated financial statements, "Segment Information."
Description of Operating Segment Products and Markets
Selective's Insurance Operations segment sells its property and casualty insurance products and services through six insurance subsidiaries (Insurance Subsidiaries), which are listed on the following table together with their respective ratings by A.M. Best Company, Inc. (A.M. Best), and state of domicile by which they are primarily regulated:
In 2004, Selective was ranked as the 54th largest property and casualty group in the United States based on the combined net premiums written (NPW), or premiums for all sold policies, by the Insurance Subsidiaries in 2003 by A.M. Best in its list, "Top Property/Casualty Writers." Selective was also named in 2004 to the "Ward's 50 Benchmark Group." In preparing this list, the Ward Group, a management consulting group specializing in the insurance industry, analyzes more than 2,900 property-casualty insurance companies and lists the top 50 companies that it believes excelled at balancing safety, consistency and performance over the previous five years.
The underwriting performance of insurance companies is measured under accounting principles generally accepted in the United States of America (GAAP) by three different ratios of losses and expenses to net premiums earned:
A combined ratio under 100% indicates that an insurance company is generating an underwriting profit and a combined ratio over 100% indicates that an insurance company is generating an underwriting loss.
The following table shows the results of the Insurance Operations segment for the last three completed fiscal years:
As an insurance company, Selective is regulated by each of the states where it does business. As part of that regulation, Selective is required to file financial statements with the states prepared in accordance with Statutory Accounting Practices (SAP) promulgated by the National Association of Insurance Commissions (NAIC) and adopted by the various states. Statutory accounting differs from GAAP accounting in many ways, but the most significant is the treatment of underwriting expenses. Under SAP, underwriting expenses are recognized immediately, whereas, under GAAP, they are deferred and amortized over the life of the policy in correlation with the related premium revenue. In addition, the statutory underwriting expense ratio is calculated using written premium as the denominator. Selective's management makes extensive use of statutory financial information in the management of its operations.
Business and Products
Geographic Market Focus
The Insurance Subsidiaries are licensed to do business in states other than those shown on the table above and in other regions of the United States. Selective, however, focuses its marketing efforts on the Eastern region of the United States, where it can better focus on the regional market and independent insurance agents who serve it. Selective also believes that this regional geographic area is large enough to avoid a concentration of catastrophic risk.
Insurance Agent Distribution Model
For its commitment to the independent agency system and its furtherance of the interests of professional, independent insurance agents, the Professional Insurance Agents (PIA) named Selective the PIA National "Company of Excellence" for 2004. The selection is made by a panel of PIA judges based on nominations from PIA member agents.
Selective appoints independent insurance agents as licensed representatives of one or more of the Insurance Subsidiaries and enters into agency agreements with them pursuant to applicable state laws and regulations. As of December 31, 2004, Selective had approximately 750 independent insurance agency appointments in-force. Selective believes that it has strong relationships with its appointed independent agents. Selective's primary strategy is to build relationships with well-established, independent insurance agents and carefully monitor each agent's profitability, financial stability, staff, and mix of business against plans that Selective develops annually with the agent.
Because of the high concentration of business with independent agents and Selective's commitment to independent agents as its delivery channel, Selective's management devotes a considerable amount of time meeting with its independent insurance agents to (i) advise them on company developments, (ii) get feedback on products and services, and (iii) sell them on doing more business with Selective. Over the past several years, Selective's senior management has averaged approximately two working months meeting directly with independent agents, including the following:
Selective pays commissions to its appointed independent agents pursuant to calculations and specific percentages stated in the agency agreement. Under the agency agreement, agents are not permitted to receive compensation for the business they place with Selective from any other source than Selective. The agency agreement provides for commissions to be paid based on a percentage of the premium written. Selective and its agents also negotiate other commission arrangements, including additional commissions based on the underwriting results of the business the agent writes with Selective. Agents may also agree to put some of their commission at risk based on the underwriting results of the business the agent writes with Selective.
In 2004, the New York Attorney General announced that he was investigating various alleged inappropriate solicitation practices between insurance companies, agents and brokers. Regulators in various other states have also announced similar investigations into these alleged inappropriate practices. In December 2004, Selective and the other largest insurance companies in New Jersey received a letter of inquiry from the New Jersey Department of Banking and Insurance (DOBI) requesting information about arrangements and dealings of two of the Insurance Subsidiaries with agents and brokers. The Insurance Subsidiaries are responding to the DOBI's inquiry. Selective believes that its arrangements and dealings with independent agents and brokers are in compliance with all applicable statutes and regulations. Selective anticipates new rules, regulations or statutes in this area but does not believe, based upon its review of various proposals being discussed by the NAIC, that they will have a material impact on its business.
Selective also enters into loss control services agreements with agents in certain situations. Under these agreements, agents provide Selective with certain services, including, but not limited to underwriting evaluation, underwriting audits, safety and loss control surveys, inspections and accident investigations. For their services in these cases, agents may receive a flat annual fee or a percentage of collected premiums on a specific program of business.
On certain limited programs of business, Selective has entered into brokerage agreements with a small number of agencies to allow them to solicit, receive and transmit to Selective proposals for insurance and to receive and report claims/loss notices. These brokerage agreements contain a schedule pursuant to which the agent is eligible to receive a commission based on certain accounts written and/or lines of business. The brokerage agreements do not permit the agents to receive compensation for the business they place with Selective from any source other than Selective.
and Field Model Business Strategy
Selective manages its information technology projects through a project management office (PMO). The PMO is staffed by certified individuals who apply a set of disciplines and techniques for delivering projects on time, within budget, and in line with end-user expectations. The PMO has developed proprietary methodologies to (i) communicate project management standards and methodology, (ii) provide project management training and tools, (iii) review project status and cost, and (iv) provide non-technology project management consulting services to the rest of Selective. The PMO meets monthly with Selective's senior management to review all major projects and report on the status of other projects. Selective believes that the PMO is a significant factor in the success of its technology implementation and creates a competitive advantage for Selective.
Selective's main technology systems are the following:
Most of Selective's independent agents have automated agency management systems. Selective provides integration products that allow these agency systems to interface with Selective's main technology systems. Consequently, agent service and response times to customers are significantly reduced because billing, claims, and rating inquiries are made without duplicative data entry processes.
In addition to the advantages that Selective's technology provides independent agents, Selective believes that its use of technology has reduced its overall expenses and increased its overall employee productivity.
Selective's technology operations are located in Branchville, New Jersey and Glastonbury, Connecticut.
As of December 31, 2004, Selective had approximately:
Selective believes that its underwriting process, which addresses "one risk at a time," is unique. It requires communication and interaction among:
Selective believes that its LCRs and the wide range of loss control services that they provide to Selective's insureds to improve their risk management are an advantage of Selective's field underwriting model. For its middle market to large business accounts, LCRs generally conduct loss control surveys before the risk is underwritten. This survey process permits Selective to select above average risks and helps insureds better manage their exposures. Many of the services that Selective provides are similar to those provided by national property and casualty companies to only their largest risks, including thermographic infrared surveys, hazard assessment and analysis, and OSHA construction and general industry certification training. LCRs also conduct loss control service calls after an account is written. This process permits Selective to reduce the risks on accounts already written by reducing loss frequency. Through its website, Selective offers a variety of loss control education materials, including a large library of coverage-specific safety materials and videos.
Selective also has an underwriting service center (USC) located in Richmond, Virginia. The USC assists Selective's agents by servicing small-to-mid-size business customers. In the USC, Selective employees, who are licensed agents, respond to customer inquiries about insurance coverage, billing transactions, and other matters. The agent, as consideration for these services, receives a commission that is slightly lower than the standard. Selective has found that the USC also provides additional opportunities to increase NPW, as larger agencies, notably those owned by agency aggregators such as large banks, seek insurance companies that have service center capabilities. Underwriters in the USC work closely with AMSs and the Regions.
Selective has analyzed and continues to analyze its underwriting profitability by line of business, account, and agency product type. Selective's goal is to continue to underwrite the risks that it understands well and that, in aggregate, are profitable.
Claim settlement authority levels are established for each CMS and CMS supervisor based on their experience and expertise, up to a regional branch office limit of $100,000. Casualty claims with exposure potential generally in excess of $100,000, significant exposure to catastrophic injury or damage, property claims with an exposure greater than $50,000, and claims involving lawsuits against us and/or questions of coverage are reported to the corporate headquarters, where senior claim specialists review the claims and determine the appropriate reserve. All environmental and other latent exposure claims are referred to a centralized environmental claims unit at the home office, which specializes in the management and consistency of decisions regarding coverage application for these types of exposures.
Selective has a centralized special investigative unit (SIU) that investigates potential insurance fraud and abuse, and supports efforts by regulatory bodies and trade associations to curtail the cost of fraud. The SIU adheres to uniform internal procedures to improve detection and takes action on potentially fraudulent claims. It is Selective's policy to notify the proper authorities of its findings. Selective believes this policy sends a clear message that it will not tolerate fraudulent activity committed against itself or its customers. The SIU also supervises anti-fraud training for CMSs and other employees, including AMSs.
Selective also has a claims service center (CSC), co-located with the USC, in Richmond, Virginia. The CSC provides enhanced services to Selective's policyholders, including immediate claim triage 24 hours a day, seven days a week. The CSC is designed to reduce the cycle time on first-party automobile claims and increase the usage of Selective's discounts at body shops, glass repair shops, and car rental agencies.
Selective has also implemented additional loss and loss expense cost containment initiatives. These initiatives include: (i) a comprehensive managed care program, which has reduced workers' compensation and automobile loss costs; (ii) voluntary automobile repair shop and rental programs; (iii) legal bill review; and (iv) salvage and subrogation review.
In addition to treaty and facultative reinsurance, the Insurance Subsidiaries are partially protected by the Terrorism Risk Insurance Act of 2002 (TRIA). The act establishes a temporary federal program of shared public and private compensation for insured commercial property and casualty losses resulting from an "act of terrorism," as defined in the Act (certified loss). The bill limits certified losses to "international terrorism" defined as an act committed on behalf of any foreign person or foreign interest where the damage from the event is in excess of $5 million and the event was not committed in the course of a war declared by the United States. Terrorism acts related to the use of nuclear, biological or chemical (NBC) weapons are covered by TRIA provided that the Secretary of the Treasury certifies the loss. Please refer to the Insurance Regulation section of Item 1 and the Reinsurance section of Item 7. "Management Discussion and Analysis of Financial Condition and Results of Operation" for further discussion of TRIA.
The following table summarizes the significant reinsurance treaties covering the Insurance Subsidiaries:
Reinsurance does not legally discharge an insurer from its liability for the full face amount of its policies, but it does make the reinsurer liable to the insurer to the extent of the reinsurance ceded. Accordingly, reinsurance involves credit risk and is generally subject to aggregate loss limits. Selective monitors the financial condition of reinsurers on an ongoing basis and reviews its reinsurance arrangements periodically through a management-composed reinsurance market security committee. Selective selects reinsurers based on their (i) financial condition, (ii) their ratings from A.M. Best and Standard and Poor's Insurance Rating Services (S&P), (iii) business practices, and (iv) the prices of their product offerings. Selective also gathers information regarding reinsurers from its reinsurance brokers, direct reinsurers, and market sources. In general, Selective only enters into reinsurance agreements with reinsurers that have an "A-" or better rating by A.M. Best.
Selective's five largest reinsurers, based on 2004 ceded premiums, and their respective ratings by A.M. Best are shown on the following table:
Under the Pooling Agreement, all of the Insurance Subsidiaries mutually reinsure all insurance risks written by them and outstanding as of June 30, 1995 and thereafter written pursuant to the respective percentage set forth opposite each Insurance Subsidiary's name on the table below:
Net Loss and Loss Expense Reserves
When a claim is reported to an Insurance Subsidiary, claims personnel establish a "case reserve" for the estimated amount of the ultimate payment. The amount of the reserve is primarily based upon a case-by-case evaluation of the type of claim involved, the circumstances surrounding each claim, and the policy provisions relating to the type of losses. The estimate reflects the informed judgment of claims personnel based on general insurance reserving practices, as well as the experience and knowledge of the claims person. Until the claim is resolved, these estimates are revised as deemed necessary by the responsible claims personnel based on subsequent developments and periodic reviews of the cases.
In addition to case reserves, and in accordance with industry practice, Selective maintains estimates of reserves for losses and loss expenses incurred but not yet reported (IBNR). Using generally accepted actuarial reserving techniques, Selective projects estimates of ultimate losses and loss expenses at each reporting date. The difference between: (i) projected ultimate loss and loss expense reserves; and (ii) case loss reserves and loss expense reserves thereon are carried as the IBNR reserve. To determine the final projected ultimate loss and loss expense reserves, Selective's management performs a review. This review incorporates meetings with its Actuarial Department to review the latest loss and loss expense reserve analyses, which are performed quarterly. During these meetings, the range of reserves determined annually at the end of Selective's reporting year are also considered in addition to the most recent loss trends. Loss trends include, but are not limited to large loss activity, environmental claim activity, large case reserve additions or reductions for prior accident years, and reinsurance recoverable issues. Since loss trends take a longer time to manifest themselves in actuarial analyses, Selective's review also includes factors such as: (i) per claim information; (ii) Selective and industry historical loss experience; (iii) legislative enactments, judicial decisions, legal developments in the imposition of damages, and changes in political attitudes; and (iv) trends in general economic conditions, including the effects of inflation.
Based on its review, Selective's management determines the ultimate net liability for losses and loss expenses. Such an assessment requires considerable judgment given that it is frequently not possible to determine whether a change in the data is an anomaly until some time after the event. Even if a change is determined to be permanent, it is not always possible to reliably determine the extent of the change until sometime later. However, given that there is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of reserves because the eventual deficiency or redundancy is affected by many factors, Selective also began using independent actuaries in 2003 to opine on the adequacy of its reserves. The changes in these estimates, resulting from the continuous review process and the differences between estimates and ultimate payments, are reflected in the consolidated statements of income for the period in which such estimates are changed. Any changes in the liability estimate may be material to the results of operations in future periods. Selective does not discount to present value that portion of its loss reserves expected to be paid in future periods; however, the loss reserves include anticipated recoveries for salvage and subrogation claims.
After taking into account all relevant factors, Selective believes that the reserve for net losses and loss expenses at December 31, 2004, is adequate to provide for the ultimate net costs of claims incurred as of that date. Establishment of appropriate reserves is an inherently uncertain process and there can be no certainty that currently established reserves will prove adequate in light of subsequent actual experience. For further discussion and information about loss and loss expense reserves, see Item 8, "Financial Statements and Supplementary Data," Note 7 to the consolidated financial statements.
The table on page 13 provides information about reserves for net losses and loss expenses and presents the development of balance sheet net reserves for 1994 through 2004. The top three lines of the table reconcile gross reserves to net reserves for unpaid losses and loss expenses recorded at the balance sheet date for each of the indicated years. The upper portion of the table shows the re-estimated amount of the previously recorded gross and net reserves with related reinsurance recoverable, based on experience as of the end of each succeeding year. The estimate is either increased or decreased as more information becomes known about the frequency and severity of claims for individual years.
The lower section of the table shows the cumulative amount paid with respect to the previously recorded reserves as of the end of each succeeding year. For example, as of December 31, 2004, Selective paid $815.9 million of the currently estimated $898.3 million of losses and loss expenses that were incurred through the end of 1994; thus, the difference, an estimated $82.4 million of losses and loss expenses incurred through 1994, remained unpaid as of December 31, 2004.
The "cumulative redundancy (deficiency)" represents the aggregate change in the estimates over all prior years. For example, the 1994 reserve developed a $10.4 million net deficiency over the course of the succeeding ten years while, on a gross basis, the 1994 reserve developed a $112.1 million deficiency over the same period. The net amount has been included in net income over the past ten years. The cumulative net deficiencies in 2003, 2002, 2001 and 2000 are the result of normal reserve development inherent in the uncertainty in establishing reserves, anticipated loss trends, growth in business, as well as increased reinsurance retentions.
In evaluating this information, each amount includes the total of all changes in amounts for prior periods. For example, the amount of deficiency to losses settled in 2004, but incurred in 2000, will be included in the cumulative net deficiency amounts in 2003, 2002, 2001 and 2000. This table does not present accident or policy year development data, which certain readers may be more accustomed to analyzing. Conditions and trends that have affected development of the reserves in the past may not necessarily occur in the future. Accordingly, it may not be appropriate to extrapolate redundancies or deficiencies based on this table. During 1999, Selective significantly increased gross and ceded reserves by $37.5 million for prior accident years related to unlimited medical claims ceded to the Unsatisfied Claim and Judgment fund in the state of New Jersey. Approximately 40% of the cumulative gross deficiency for years 1998 and prior stems from this increase.
Analysis of Net Loss and Loss Expense Development
Note: Some amounts may not foot due to rounding.
Reconciliation of Statutory to GAAP
Losses and Loss Expense Reserves
The statutory combined ratio is a standard measure of underwriting profitability. This ratio is the sum of (i) the ratio of incurred losses and loss adjustment expenses to net earned premium; (ii) the ratio of expenses incurred for commissions, premium taxes, administrative and other underwriting expenses to net written premium; and (iii) the ratio of dividends to policyholders to net earned premium. The GAAP combined ratio is calculated in the same manner, except that it is based on GAAP amounts and the denominator for each component is net earned premium.
When the combined ratio is under 100%, underwriting results are generally considered profitable; when the combined ratio is over 100%, underwriting results are generally considered unprofitable. The combined ratio does not reflect investment income, federal income taxes, or other non−operating income or expense. Selective has consistently produced a lower combined ratio than the property and casualty insurance industry in general outperforming the industry for the past ten years by an average of 3 points.
The following table reconciles losses and loss expense reserves under statutory accounting principles and GAAP:
"Asbestos claims" are claims presented to us in which bodily injury is alleged to have occurred as a result of exposure to asbestos and/or asbestos‑containing products. During the past two decades, the insurance industry has experienced the emergence and development of an increasing number of asbestos claims. At December 31, 2004, asbestos claims constituted 91% of our 3,310 environmental claims compared with 91% of our 3,058 outstanding environmental claims at December 31, 2003.
"Non‑asbestos claims" are pollution and environmental claims alleging bodily injury or property damage presented, or expected to be presented to us, other than asbestos claims. These claims include landfills, leaking underground storage tanks and mold. In past years, landfill claims have accounted for a significant portion of Selective's environmental claim unit's litigation costs. During 2004, Selective also experienced adverse development in its homeowners line of business as a result of unfavorable trends in claims for groundwater contamination caused by leakage of certain underground heating oil storage tanks in New Jersey. Increased frequency was triggered, in part, by the state's robust real estate market, leading to an increase in home tank inspections. To address this issue, Selective began restricting writings of policies with coverage for underground heating oil storage tanks, company wide, approximately two years ago, and are reviewing possible coverage changes for existing business.
Although Selective has had limited mold claims activity in the past and does not write business in states that have historically been most exposed to these claims, in order to support and affirm the exclusion of mold claims, Selective added the Insurance Services Office (ISO) mold coverage limitation endorsement to all homeowner renewals beginning in the fourth quarter of 2002, except in New York where the exclusion has not been approved.
Selective refers all environmental claims to its centralized environmental claim unit, which specializes in the claim management of these exposures. Environmental reserves are evaluated on a case‑by‑case basis. As cases progress, the ability to assess potential liability often improves. Reserves are then adjusted accordingly. In addition, each case is reviewed in light of other factors affecting liability, including judicial interpretation of coverage issues.
IBNR reserve estimation for environmental claims is often difficult because, in addition to other factors, there are significant uncertainties associated with critical assumptions in the estimation process, such as average clean-up costs, third-party costs, potentially responsible party shares, allocation of damages, insurer litigation costs, insurer coverage defenses and potential changes to state and federal statutes. However, management is not aware of any emerging trends that could result in future reserve adjustments. Moreover, normal historically based actuarial approaches are difficult to apply because relevant history is not available. In addition, while models can be applied, such models can produce significantly different results with small changes in assumptions. As a result, management does not calculate a specific environmental loss range, as it believes it would not be meaningful.
Although the United States government does not directly regulate the insurance industry, federal initiatives from time-to-time can have an impact on the industry. For example, on November 26, 2002, TRIA legislation was signed into law and will be in effect through December 31, 2005. TRIA requires sharing the risk of future losses from terrorism between private insurers and the federal government, and is applicable to almost all commercial lines of insurance. Insurance companies with direct commercial insurance exposure in the United States are required to participate in this program. TRIA rescinded all previously approved exclusions for terrorism. Policyholders for non-workers compensation policies have the option to accept or decline the terrorism coverage Selective offers in its policies, or negotiate other terms. The terrorism coverage is mandatory for all workers' compensation primary policies. In addition, ten of the twenty states Selective writes commercial property coverage in mandate the coverage of fire following an act of terrorism. These provisions apply to new policies written after enactment of TRIA. In 2004, approximately 90% of our commercial non-workers compensation policyholders purchased terrorism coverage. A terrorism act has to be certified by the Secretary of Treasury in order to be covered by TRIA. TRIA limits the certified losses to "international terrorism" defined as an act committed on behalf of any foreign person or foreign interest where the damage from the event is in excess of $5 million and the event was not committed in the course of a war declared by the United States. Terrorism acts related to the use of nuclear, biological or chemical (NBC) weapons are covered by TRIA provided that the Secretary of the Treasury certifies the loss. Each participating insurance company will be responsible for paying out a certain amount in claims (a deductible) before federal assistance becomes available. This deductible is based on a percentage of commercial lines direct earned premiums from the prior calendar year. For 2004, the deductible equaled 10% of 2003 commercial lines direct earned premium. For 2005, it will equal 15% of 2004 commercial lines direct earned premium.
For losses above an insurer's deductible, the federal government will cover 90%, while the insurer contributes 10%. Although the provisions of TRIA will serve to mitigate Selective's exposure in the event of a large-scale terrorist attack, Selective's deductible is substantial, approximately $97 million in 2004 and $169.0 million in 2005. Selective, therefore, continues to monitor concentrations of risk. Selective maintains a reinsurance treaty that covers $45 million in the aggregate in excess of a $15 million retention in the aggregate for TRIA certified losses and non-certified NBC losses.
The Financial Services Modernization Act of 1999, also known as the Gramm-Leach-Bliley Act (GLB), and related regulations govern the privacy of consumer financial information. GLB limits disclosure by financial institutions of "nonpublic personal information" about individuals who obtain financial products or services for personal, family, or household purposes. GLB generally applies to disclosures to non-affiliated third parties, but not to disclosures to affiliates. Many states in which Selective operates have adopted laws that are at least as restrictive as GLB. Privacy of consumer financial information is an evolving area of regulation requiring continued monitoring to ensure continued compliance with GLB.
Selective cannot quantify the financial impact it would incur to satisfy revised or additional regulatory requirements that may be imposed in the future.
All states have enacted legislation that regulates insurance holding company systems. Each insurance company in a holding company system is required to register with certain insurance supervisory agencies and furnish information concerning the operations of companies within the holding company system that may materially affect the operations, management, or financial condition of the insurers. Pursuant to these laws, the respective departments may: (i) examine Selective and the Insurance Subsidiaries at any time; (ii) require disclosure or prior approval of material transactions of the Insurance Subsidiaries with any affiliate; and (iii) require prior approval or notice of certain transactions, such as dividends or distributions to the Parent from the Insurance Subsidiary domiciled in that state.
National Association of
Insurance Commissioners (NAIC) Guidelines
NAIC model laws and regulations are not usually applicable unless enacted into law or promulgated into regulation by the individual states. The adoption of certain NAIC model laws and regulations is a key aspect of the NAIC Financial Regulations Standards and Accreditation Program, which also sets forth minimum staffing and resource levels for all states. All of the Insurance Subsidiaries states of domicile, except New York, are accredited by the NAIC. Examinations conducted by, or along with, accredited states can be accepted by other states. The NAIC intends to create an eventual nationwide regulatory network of accredited states.
The NAIC model laws and regulations are also intended to enhance the regulation of insurer solvency. These model laws and regulations contain certain risk-based capital requirements for property and casualty insurance companies designed to assess capital adequacy and to raise the level of protection that statutory surplus provides for policyholders. Risk-based capital is measured by the four major areas of risk to which property and casualty insurers are exposed: (i) asset risk; (ii) credit risk; (iii) underwriting risk; and (iv) off-balance sheet risk. Insurers with a ratio below 200% of their total adjusted capital to their "Authorized Control Level," as calculated pursuant to the NAIC model laws and regulations, are subject to different levels of regulatory intervention and action. Based upon the unaudited 2004 statutory financial statements for the Insurance Subsidiaries, each Insurance Subsidiary's total adjusted capital substantially exceeded 200% of the Authorized Control Level.
At December 31, 2004, Selective's investment portfolio consisted of $2,366.9 million (83%) of fixed maturity securities, $331.9 million (12%) of equity securities, $98.7 million (4%) of short-term investments, and $44.1 million (1%) of other investments.
Selective's fixed maturity portfolio is comprised primarily of highly rated securities with almost 100% rated investment grade. The average rating of its fixed maturity securities is "AA" by S & P, their second highest credit quality rating. Selective expects to continue to invest primarily in high quality, fixed maturity investments.
Selective's overall fixed maturity investment strategy is to make security purchases that are attractively priced in relation to perceived credit risks. Selective manages the interest rate risk associated with holding fixed maturity investments by monitoring and maintaining the average duration of the portfolio with a view toward achieving an adequate after-tax return without subjecting the portfolio to an unreasonable level of interest rate risk. The average duration of the fixed maturity portfolio, excluding short-term investments was 4.3 years at December 31, 2004 compared with 4.5 years at December 31, 2003.
Selective's Investment segment operations are based in Branchville, New Jersey.
For additional information about investments, see the sections entitled, "Investments," in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations," and Item 8. "Financial Statements and Supplementary Data," Note 4 to the consolidated financial statements.
Diversified Insurance Services Segment
The Diversified Insurance Services segment fits into Selective's business model in one of two ways: (i) complementary by sharing a common marketing or distribution system and creating new opportunities for independent agents to bring value-added services and products to their customers, or (ii) vertically by one subsidiary using another's products or services in its own production or supply output or vice versa.
The results for this segment's continuing operations are as follows:
Human Resource Administration Outsourcing
SHRS enters into agreements with clients that establish a three-party relationship under which SHRS and the client are co-employers of the employees who work at the client's location (worksite employees). Under its agreements, SHRS assumes responsibility for personnel administration and compliance with many employment-related governmental regulations, while the client retains the employees' services for its business. Because SHRS provides employer-related services to a much larger number of employees than any individual client, SHRS can perform these services more efficiently, provide a greater variety of employee benefits, and is able to devote more attention to human resource management than the client otherwise would.
Selective continues to focus on further educating its agents in an effort to improve upon their knowledge and effectiveness in selling HR Outsourcing services and products in order to expand SHRS's business. Currently, 56 of the approximately 750 independent agents of the Insurance Subsidiaries actively sell the product, as well as 48 independent agents in Florida. Since Selective acquired SHRS in 1999, the number of worksite employees has increased to approximately 23,000 from approximately 12,000. SHRS also enters into agreements with client companies pursuant to which it provides limited services, such as payroll-only administration, which does not give rise to any co-employment relationships.
Network expansion continues to be a major initiative for CHN Solutions' managed care program. During 2004, CHN Solutions' medical provider network expanded to approximately 95,000 locations from 88,000 locations in 2003 and was ranked as the number one PPO in New Jersey by Business News New Jersey, a source for business news and information in New Jersey.
Selective is ranked "one of the top" flood insurance writers for the NFIP, and has received the endorsement of the Independent Insurance Agents and Brokers of America for its WYO program. Currently, Selective is servicing more than 188,000 flood policies under the NFIP through over 6,000 independent agents in 48 states and the District of Columbia, as compared to 162,000 policies at this time last year. Sixty-eight percent of Selective's new WYO business in 2004 was processed by agents through Flood OnLine, our web-based system.
Diversified Insurance Services Regulation
CHN Solutions operates as a managed care organization and/or a preferred provider organization (PPO) and is subject to laws and/or regulations in the states in which it does business. Some states in which CHN Solutions transacts business have licensing and other statutory or regulatory requirements applicable to CHN Solutions' business, including laws that require licensing of businesses that provide medical review services. Some of these laws apply to medical review of care covered by workers' compensation insurance. These laws typically establish minimum standards for qualifications of personnel, confidentiality, internal quality control and dispute resolution procedures. In addition, some states regulate the operation of managed care provider networks. If additional statutory or regulatory requirements are imposed, to the extent CHN Solutions is governed by these requirements, increased costs of operation for CHN Solutions may result.
Both federal and state laws regarding privacy of medical records and patient privacy may also affect CHN Solutions. Because CHN Solutions does not provide health insurance, or health care services, it is not a "covered entity" under the federal Health Insurance Portability and Accountability Act of 1996 and related regulations. This, however, is an evolving area of regulation that requires us to continually monitor and review our operations.
Regulation in the healthcare, automobile personal injury protection, and workers' compensation businesses is constantly evolving. Selective is unable to predict what additional government initiatives affecting its business may be promulgated in the future, if any. Selective's businesses may be adversely affected by failure to obtain necessary licenses and government approvals or failure to adapt to new or modified regulatory requirements. While SHRS and CHN Solutions believe they are currently in compliance with all laws and regulations affecting their operations, there can be no assurance that, in the future, they will be able to satisfy new or revised licensing and regulatory requirements.
Property and casualty insurance is highly competitive on the basis of both price and service, and is extensively regulated by state insurance departments. In 2004, Selective was ranked as the 54th largest property and casualty group in the United States based on the combined NPW, or premiums for all sold policies, by the Insurance Subsidiaries in 2003 by A.M. Best in its list, "Top Property/Casualty Writers." The Insurance Operations compete with regional insurers, such as Cincinnati Financial, Ohio Casualty, and Harleysville, and national insurance companies, such as St. Paul Travelers, The Hartford, and Zurich. Selective also competes against direct writers of insurance coverage, primarily in personal lines, such as GEICO and Progressive. Many of these competitors have greater financial, technical and operating resources. Purchasers of property and casualty insurance products do not always differentiate between insurance carriers and differences in coverage. The more significant competitive factors for most of Selective's insurance products are price, coverage terms and claims service. In addition, Selective also faces competition within each insurance agency that sells its insurance products as most of the agencies represent more than one insurance company.
With regard to the Diversified Insurance Services segment, during 2004 CHN Solutions was ranked as the number one PPO in New Jersey by Business News New Jersey, a source for business news and information in New Jersey. Additionally, Employee Benefits News, a publication serving employee benefits decision makers ranked CHN Solutions as the 11th largest nationwide based on membership. In 2004, SHRS would have been ranked as the 12th largest co-employer in the nation when compared to a ranking published by Florida Trend magazine, based on employee count. Based on information obtained from Statutory Annual Statements, Selective believes that its Flood unit is the 8th largest write-your-own carrier for the federal government's National Flood Insurance Program .
Please refer to Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" and its section entitled "Risk Factors," for the potential impact these items could have on Selective's ability to compete.
Executive Officers of the Registrant
The following table sets forth biographical information about Selective's Chief Executive Officer, Executive Officers and senior management, as of March 2, 2005:
Information regarding Selective's directors is included in the definitive Proxy Statement for the 2005 Annual Meeting of Stockholders to be held on April 27, 2005 in "Information About Proposal 1, Election of Directors," and is also incorporated by reference into Part III of this Form 10-K.
Selective has a website, www.selective.com, through which its SEC reports, filings, and materials under Section 13(a) of 15(d) of the Exchange Act are available free of charge as soon as reasonably practicable after they are electronically filed with, or furnished to the SEC.
Item 2. Properties.
Item 3. Legal Proceedings.
Although the ultimate outcome of these matters is not presently determinable, Selective does not believe that the total amounts that it will ultimately have to pay in all of these lawsuits in the aggregate will have a material adverse effect on its financial condition, results of operations, or liquidity.
Selective has previously described certain legal proceedings that primarily involve claims for damages, exclusive of interest and costs, that do not exceed and have not previously exceeded ten percent (10%) of the current assets of Selective and its subsidiaries on a consolidated basis. As such, Selective will not further describe the following legal proceedings in subsequent reports:
Three Selective subsidiaries, Consumer Health Network Plus, LLC (CHN), Alta Services, LLC (Alta) and Selective Insurance Company of America (SICA), were named as defendants, together with ten other unrelated parties, in Berlin Medical Associates PA, et al. v. CMI New Jersey Operating Corp., et al., a purported class action that was filed on May 21, 2003, in the Superior Court of New Jersey, Law Division - Camden County. The plaintiffs are several non-hospital health care providers that have preferred provider contracts with CHN. The complaint alleges that CHN breached the preferred provider contracts by improperly reviewing and reducing the amount of its payments for services provided to insureds of insurance carriers, including SICA, which had contracted to lease CHN's network. The complaint, which does not quantify the amount of damages sought, further alleges that insurance carriers were unjustly enriched by CHN's actions. The Selective subsidiaries have vigorously defended this lawsuit and, together with the other defendants, filed a motion to dismiss. After a hearing on that motion, the court ordered the plaintiffs to amend their complaint. The plaintiffs did so in March 2004, and did not name Alta as a defendant. In May 2004, all remaining defendants, including CHN and SICA, moved to dismiss the amended complaint, and in July 2004, they filed a motion to dismiss the class action allegations. Both motions to dismiss were granted by the court on January 14, 2005. On February 28, 2005, the plaintiffs filed an appeal of the decision to grant both motions to dismiss. If the appeal is successful, CHN and SICA will continue to vigorously defend the case. Given the procedural history of the litigation, it is extremely difficult to provide a meaningful estimate or range of any potential loss. At this time, however, Selective believes that an unfavorable outcome in the case would not have a material adverse effect on its financial condition, results of operations, or liquidity.
One of Selective's subsidiaries, Selective Insurance Company of the Southeast (SISE), is one of nine property and casualty insurance company defendants named in Howell, et al. v. State Farm, et al., a purported class action filed on May 18, 2004, in the United States District Court for the District of Maryland, Baltimore Division. The court has not yet ruled on class certification. The plaintiffs hold Standard Flood Insurance Policies (SFIP) issued by the defendant insurers, who are participants in the WYO program of the NFIP. The FIA is an agency within the Federal Emergency Management Administration (FEMA). All claims under SFIPs are 100% reinsured by FEMA. The suit alleges that the insurers underpaid flood claims arising from Hurricane Isabel in breach of their contractual obligations, fiduciary duties, and the implied covenant of good faith and fair dealing, and seeks unspecified monetary damages. The insurers, including SISE, have denied the allegations, noting that they adjusted the claims as fiduciary agents of the U.S. Government in accordance with specific federal guidelines. The insurers also have filed a motion to dismiss certain of the claims, which the court has not yet decided. Given the early stages of the litigation, it is extremely difficult to provide a meaningful estimate or range of any potential loss. FEMA's Office of the General Counsel, however, has advised the defendant carriers that, in its opinion, the claims were adjusted in accordance with the law and that FEMA will indemnify and reimburse the defense costs of the defendant insurers, including SISE. Consequently, Selective believes that its exposure in the case is minimal and not material.
SICA was named as a defendant in two alleged class action lawsuits filed in the Third Judicial Circuit, Madison County, Illinois, on October 11, 2003 (Eavenson I) and October 27, 2003 (Eavenson II). Both cases are captioned Mark J. Eavenson, D.C., d/b/a/ Multi-Care Specialists, P.C. v. Selective Insurance Company of America. The first complaint (Eavenson I) was amended on June 18, 2004. The second complaint (Eavenson II) was amended on December 3, 2004. Neither of the amended nor original complaints quantify the money damages being sought. In Eavenson I, the plaintiff alleges that SICA's use of non-parties' preferred provider payment schedules, which reduces the medical provider's bill and/or denies payment of part or all of it, violates the Illinois Consumer Fraud Act and results in SICA's unjust enrichment. The plaintiff also alleges that SICA inappropriately uses these schedules when making payments for medical services, on behalf of its insureds, pursuant to its automobile, homeowners, commercial liability and workers' compensation policies. Discovery is on-going and SICA's motion to dismiss the amended complaint is pending, but not yet scheduled for argument. The court has not yet certified whether a class exists. The Eavenson II amended complaint contains similar allegations to those in Eavenson I regarding SICA's use of PPO networks. The Eavenson II complaint also alleges that SICA's use of the PPO networks represents a civil conspiracy, violates the Illinois Consumer Fraud Act, and results in SICA's unjust enrichment. SICA has not yet responded to the amended complaint and the court has not yet certified whether a class exists. Discovery is on-going and SICA anticipates that it will file a motion to dismiss the amended complaint shortly. SICA is vigorously defending both Eavenson I and Eavenson II. Given the early stages of the litigation, it is extremely difficult to provide a meaningful estimate or range of any potential loss. At this time, Selective believes that, should the case ultimately be decided unfavorably, it would not have a material adverse effect on its financial condition, results of operations, or liquidity.
Item 4. Submission of Matters to a Vote of Security
Item 5. Market For Registrant's Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities.
(a) Market Information
On February 28, 2005, the closing price of Selective as reported on the Nasdaq National Market was $46.01.
Selective's ability to declare dividends is restricted by covenants contained in senior notes that it issued on May 4, 2000 (2000 Senior Notes) and August 12, 1994 (1994 Senior Notes). See Note 8 to the consolidated financial statements entitled, "Indebtedness." All such covenants were met during 2004 and 2003. At December 31, 2004, the amount available for dividends to holders of Selective's common shares under such restrictions was $325.6 million for the 1994 Senior Notes and $287.9 million for the 2000 Senior Notes.
Selective's ability to receive dividends, loans, or advances from its Insurance Subsidiaries is subject to the approval and/or review of the insurance regulators in the respective domiciliary states of the Insurance Subsidiaries. Such approval and review is made under the respective domiciliary states' insurance holding company act, which generally requires that any transaction between related companies be fair and equitable to the insurance company and its policyholders. Selective does not believe that such restrictions limit the ability of the Insurance Subsidiaries to pay dividends to Selective now or in the foreseeable future. Selective currently expects to continue to pay quarterly cash dividends on shares of its common stock in the future.
(d) Securities Authorized for Issuance Under Equity
Sales of Unregistered Securities
(f) Purchases of Equity Securities by the Issuer and
Item 6. Selected Financial Data.
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Factors, that could cause our actual results to differ materially from those projected, forecasted or estimated by us in forward-looking statements are discussed in further detail later in this Item 7 under "Risk Factors." 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 generates earnings from its three segments: (i) Insurance Operations (ii) Diversified Insurance Services, and (iii) Investments. The most important measures on which Selective's management focuses in evaluating financial condition and operating performance include combined ratio, growth in revenue, and return on equity. To this end, Selective must balance returns from the three sources under current market conditions to maximize the overall return to shareholders. Selective is disciplined in its risk selection and expense control. Selective patiently builds relationships in markets where it sees long-term profitable growth opportunities. Growth for Selective has predominately been generated organically with the objective of fulfilling strategic goals and providing a risk appropriate return to shareholders.
In 2004, each of our three operating segments, which consist of our Insurance Operations segment, Investment segment and Diversified Insurance Services segment contributed to our strong financial performance. The Insurance Operations segment was led by its core commercial lines operations (Commercial Lines), which represents 84% of its business. The Commercial Lines component of our Insurance Operations segment produced growth in net premiums written of more than 14% to $1.1 billion for 2004, compared to $1.0 billion in 2003 and $849.2 million in 2002 due to: (i) $235.9 million of new commercial business in 2004 compared to $231.2 million of new business in 2003 and $197.4 million in 2002; (ii) increased commercial renewal pricing, including exposure, of 9% in 2004 compared to 13% in 2003 and 19% in 2002; and (iii) retention of 82% for the year, which was up from 80% in 2003 and 78% in 2002.
The Investments segment produced net investment income earned for the year of $120.5 million compared to $114.7 million in 2003 and $103.1 million in 2002. Net investment income earned increased as a result of an increased investment base of $2.8 billion in 2004, compared to $2.4 billion in 2003 and $2.1 billion in 2002. This increased investment base was largely due to increased operating cash flows of $367.1 million in 2004 compared with $281.9 million in 2003 and $180.1 million in 2002. Proceeds of $49.9 million from the November 2004 debt issuance contributed to the investment base in 2004 over 2003 and 2002. Lower investment rates available in the marketplace reduced the overall pre-tax investment yields to 4.7% for 2004, compared to 5.1% for 2003 and 5.4% for 2002. The Investments segment also included net realized gains of $24.6 million in 2004 compared to $12.8 million in 2003 and $3.3 million in 2002. Net realized gains in 2004 included a $14.9 million gain on the sale of an equity security within the investment portfolio as compared to prior periods.
The Diversified Insurance Services segment produced $104.4 million of revenue and $9.3 million of net income for 2004, compared to $91.8 million of revenue and $6.2 million of net income for 2003 and $80.8 million of revenue and $4.1 million of net income for 2002. The segment's after tax return on revenue increased to 8.9% for 2004, compared to 6.7% for 2003 and 5.0% for 2002. These improvements were largely attributable to the flood insurance and human resource administration outsourcing operations. Higher margin claim revenue related to an active hurricane season in our flood insurance operation, coupled with pricing improvements and increased worksite lives in our human resource outsourcing operation, resulted in the improved profitability and return on revenue compared to prior years.
The result of these segments' strong performance was an increase in total revenue of 16% to $1.6 billion in 2004 compared to $1.4 billion in 2003 and $1.2 billion in 2002. Net income increased 94% to $128.6 million in 2004 compared to $66.3 million in 2003 and $42.0 million in 2002. Selective's overall financial strength has provided a competitive advantage in the marketplace, and directly impacted where agents place their business. Only 7% of commercial lines companies have "A+" or higher ratings from A.M. Best, and we have been rated "A+" for 43 consecutive years. This is an important factor as the property and casualty insurance market becomes increasingly more competitive. Pricing in the Property and Casualty industry is cyclical. Since 2000 prices have been increasing resulting in improving earnings. In 2004, the rate of increase has slowed. Currently, the low available investment returns and rating agency pressures to generate consistent results encourage pricing discipline. However, as the pricing environment changes, Selective must balance the competitive pressures to reduce prices with preservation of the franchise and the goal of providing consistent returns to stockholders. In managing Selective's operations, management believes that Selective's technology, its ability to analyze and improve its underwriting results, its field model and its relationship with independent insurance agents, maintenance of its ratings with A.M. Best and other rating agencies, and its management of its investment portfolio are important factors to Selective's long-term success.
Results of Operations
For 2004, net premiums written were $1.4 billion, an increase of 12% over 2003 net premiums written of $1.2 billion, which were 16% higher than 2002 net premiums written of $1.1 billion. Net premiums earned were $1.3 billion, an increase of 16% over 2003 net premiums earned of $1.1 billion, which were 15% higher than 2002 net premiums earned of just under $1.0 billion. These increases were largely attributable to Commercial Lines renewal premium written price increases, including exposure, that averaged 9% for 2004, 13% for 2003, and 19% for 2002. As expected, these price increases have decelerated during 2004; however, commercial lines earned price increases have outpaced loss trends for the year. Combined ratios, and ultimately earnings, would be unfavorably impacted if earned premium price increases cease to outpace loss costs trends in the future. However, underwriting improvements resulting in lower loss ratios could partially offset the unfavorable result of loss trends. Additional factors contributing to the growth in net premiums written were: (i) net new business written of $265.9 million for 2004 compared with $264.9 million for 2003 and $224.8 million for 2002; and (ii) commercial lines year-on-year retention improvement of two points during 2004 to 82%, compared with 80% for 2003 and 78% for 2002.
The loss and loss expense ratio decreased 4.8 points to 65.7% in 2004 compared to 70.5% in 2003. In 2003 the loss and loss expense ratio decreased by 1.8 points to 70.5% compared to 72.3% in 2002. The improvements were primarily due to increased premium rates, underwriting improvements in both our commercial and personal lines of business, and loss control efforts, which included 1,700 inspections and value-added safety visits in 2004 for accounts of all sizes in an effort to prevent claims. Earned premium price increases outpaced loss trends by 2.3 points in 2004 compared to 3.1 points 2003. Additionally, weather-related catastrophe losses in 2004 improved 1.3 points compared to 2003, while weather-related catastrophe losses in 2003 were 1.6 points worse compared to 2002.
The underwriting expense ratio decreased 0.4 points to 30.9% for 2004 compared to 31.3% for 2003 and 31.0% for 2002. Overall productivity, as measured by fiscal year net premiums written per insurance operations employee, increased approximately 14% to $789,000 in 2004 compared to $694,000 for 2003 and $592,000 for 2002. Contributing to the productivity gains are our strategic initiatives that are designed to either reduce costs and/or increase business, which include: (i) streamlined processing for small commercial lines accounts (One & Done); and (ii) web-based commercial lines and personal lines automated systems. These technology enhancements allow agents to initiate and self-service a portion of our business from their offices. Currently, agents are originating 85% of all new commercial policies while agency-originated endorsements through our CLAS system have reached almost 55% during the fourth quarter of 2004. Partially offsetting these productivity gains in 2004 and 2003 were increases in profit-based incentives to employees and agents coupled with the costs of complying with Section 404 of the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley). Profit-based incentive to employees and agents resulted in increases to the underwriting expense ratio of 0.8 points in 2004 compared to 2003, while the cost of complying with Section 404 of the Sarbanes-Oxley Act impacted the underwriting expense ratio by 0.2 points in 2004. Our Working Smarter initiative is putting a renewed focus on expense management company-wide and we expect to achieve at least $3.0 million in savings from this initiative, of which $1.0 million is expected in 2005.
For 2004, our overall combined ratio was 96.9%, down from 102.2% for 2003 and 103.9% for 2002. The decrease in the combined ratio is attributable to the decreases in the loss and loss expense ratio and the underwriting expense ratio discussed above.
Commercial Lines Results
Commercial lines net premiums written were $1.1 billion for 2004, or approximately 84% of total net premiums written, compared to $999.5 million for 2003 and $849.2 million for 2002. Growth in our core Commercial Lines operation was led by new business and renewal premium price increases coupled with increased retention. Included in the net premiums written totals are new business of $235.9 million in 2004, compared to $231.2 million in 2003 and $197.4 million in 2002. Ease of doing business is a key factor in getting business commitments from agents. Each of our 71 field underwriters generates about $3.0 million in new commercial premium each year. It is our hands-on-ability to review and price each risk that differentiates us from other carriers and provides a competitive advantage to earn more of an agent's best business. Renewal premium price increases, including exposure, were 9% for 2004 compared to 13% for 2003 and 19% for 2002. We anticipate these premium price increases will continue to decelerate in 2005 as prices are softening industry-wide. Retention was 82% for 2004, compared with 80% in 2003 and 78% in 2002. One factor in improved retention is our underwriting Service Center. Currently the Service Center manages $61.1 million in commercial premium compared to $42.0 million in 2003 and $24.5 million in 2002. Retention for the Service Center business is about five points better than our traditional commercial business.
The loss and loss expense ratio decreased 5.3 points to 64.0% in 2004, compared to 69.3% in 2003. In 2003 the loss and loss expense ratio decreased by 1.1 points to 69.3% compared to 70.4% in 2002. The improvements were primarily due to increase premium rates, underwriting improvements in our commercial lines business, and loss control efforts, which included 1,700 inspections and value-added safety visits in 2004 for accounts of all sizes in an effort to prevent claims. Earned premium price increases outpaced loss trends by 1.8 points in 2004 compared to 2.9 points 2003. Additionally, weather-related catastrophe losses in 2004 improved 0.9 points compared to 2003, while weather-related catastrophe losses in 2003 were 1.3 points worse compared to 2002.
The commercial lines underwriting expense ratio was 31.7% in 2004, which was comparable to both 2003 and 2002. Underlying improvements in the expense ratio are being offset by higher profit-based incentive compensation as was noted in the overall Insurance Operations discussion above. In 2005, we are expanding several expense initiatives to enhance our ability to increase performance without increasing price. This includes eliminating low-value work from the organization, and streamlining operations, such as what we have done with the automation of commercial policy endorsements.
For 2004, our commercial lines combined ratio was 96.1% down from 101.5% in 2003 and 102.7% in 2002. This steady trend of improving performance is based on almost five years of double-digit commercial renewal price increases; ongoing underwriting enhancements; heightened loss control efforts; and the value of the Selective agency relationships.
Our general liability line of business accounted for $329.9 million or 29% of total Commercial Lines statutory net premiums written in 2004, compared to $281.1 million in 2003 and $235.6 million in 2002. The statutory combined ratio was 98.7% in 2004, compared to 99.1% in 2003 and 101.0% in 2002. Our favorable performance trend in this line reflects our long-term improvement strategy that incorporates higher pricing, heightened loss control efforts and continued underwriting enhancements. Partially offsetting the favorable performance in this line of business were increases in the statutory loss and loss expense reserves for prior year development of approximately $19 million, of which approximately $11 million related to our products/completed operations business in 2004. Also included in the increases to the statutory loss and loss expense reserves was $1.7 million that was the result of rating agency downgrades of certain reinsurers, which caused us to reevaluate our ability to collect under certain reinsurance contracts. During 2003, our general liability business included approximately $22 million in prior year development, of which approximately $18 million related to our products/completed operations business. This deficiency in both years was created mainly by our contractor completed operations business. Prior to 2002, we had more exposure to faulty workmanship and materials for both the general contractors and subcontractors and inadequate limits on subcontractors. After 2002, we took extensive underwriting actions to limit our exposure. We adopted the Insurance Service Office (ISO) general liability insurance form, which excluded subcontractors for faulty workmanship. We also placed mold limitations or exclusions on most policies and required subcontractors to carry equal insurance limits to those carried by the general contractor as well as mandated that our insureds be named on any potential subcontractor's policy as an additional insured on a primary and noncontributory basis.
Business Owners' Policy (BOP)
Personal Lines Results
Personal Lines (Personal Lines) net premiums written were $223.4 million in 2004, or approximately 16% of total net premiums written, compared to $219.7 million in 2003 and $204.3 million in 2002. Growth in our personal lines operation was led by new business and renewal premium price increases. Included in the net premiums written totals is new business of $29.9 million in 2004, compared to $33.7 million in 2003 and $27.4 million in 2002. Price increases were 6% for 2004 compared to 7% for 2003 and 9% for 2002. During third quarter 2004, we implemented a new rate filing that allows us to use credit scoring for New Jersey auto business, as well as tier changes, which reduce rates by an average of approximately 2.5%. Additionally, a 4.3% rate reduction, effective March 15, 2005, should lead to a more competitive product, while maintaining our profitability. These enhancements should lead to greater savings for our best risks, while improving the overall book of business.
The Personal Lines loss and loss expense ratio was 74.0% in 2004, down from 75.8% in 2003 and 80.0% in 2002. The 2004 improvement in the loss and loss expense ratio was primarily the result of lower weather-related catastrophe losses, which were $2.4 million or 1.1 points in 2004 compared to $8.2 million or 3.9 points in 2003 and $2.9 million or 1.4 points in 2002. Also contributing to our improvement in the loss and loss expense ratio was the impact of price increases and lower loss frequency.
The Personal Lines underwriting expense ratio decreased to 26.9% in 2004 from 29.7% in 2003 and 28.8% in 2002. Personal lines expenses decreased $2.4 million to $60.9 million in 2004 from $63.2 million in 2003. This is primarily the result of a $1.2 million decrease in New Jersey and New York limited assignment and distributions (LAD) charges due to a reduction in LAD pricing in these states and a $0.8 million increase in New Jersey homeowners' quota share ceded commissions, a contra expense, due to decreased losses for treaty year 2004. In 2005, we expect our new automated personal lines system to drive profitable growth, as it becomes even easier to do business with us. This leads to greater scale, which reduces underwriting expenses over time as agents directly process more of the transactions directly into our system. All of these enhancements should lead to a more profitable book of Personal Lines business.
For 2004, our personal lines combined ratio was 100.9% down from 105.5% in 2003 and 108.8% in 2002. The decrease in the combined ratio was primarily attributable to the decreases in the loss and loss expense ratio as well as the underwriting expense ratio discussed above.
On November 26, 2002 the Terrorism Risk Insurance Act of 2002 (TRIA) legislation was signed into law and will terminate on December 31, 2005. The act establishes a temporary federal program of shared public and private compensation for insured commercial property and casualty losses resulting from an "act of terrorism," as defined in the Act (certified loss). Insurance companies with direct commercial insurance exposure in the United States of America are required to participate in the program. Selective offers its commercial policyholders an option to purchase terrorism coverage that will provide protection against a TRIA certified event. Some states require mandatory coverage of terrorism losses for certain lines of business and terrorism cannot be excluded under any workers' compensation policy as a cause of loss. In 2004, approximately 90% of our commercial non-workers compensation policyholders purchased terrorism coverage. See Insurance Regulation section of Item 1. "Business" for further discussion of mandatory terrorism coverages. TRIA limits the certified losses to "international terrorism," defined as an act committed on behalf of any foreign person or foreign interest where the damage from the event is in excess of $5 million and the event was not committed in the course of a war declared by the United States. Terrorism acts related to the use of nuclear, biological and chemical (NBC) weapons are covered by TRIA provided that the Secretary of the Treasury certifies the loss. Each participating insurance company is responsible for paying a deductible before federal assistance becomes available. This deductible is based on a percentage of commercial lines direct earned premiums from the prior calendar year. The deductible equaled or equals: 7% of 2002 commercial lines direct earned premium for the 2003 calendar year, 10% of 2003 commercial direct earned premium for 2004 calendar year and 15% of 2004 commercial direct earned premium for 2005 calendar year. For losses above an insurer's deductible, the federal government will cover 90%, while the insurer contributes 10%. While the provisions of TRIA will serve to mitigate our exposure in the event of a large-scale terrorist attack, our deductible is substantial, approximating $97.0 million in 2004 and $169.0 million in 2005. In addition, it is uncertain whether TRIA will be extended past its current termination date. We continue to monitor concentrations of risk and have purchased a separate terrorism treaty to supplement our protection to this highly unknown exposure.
Our Terrorism Excess of Loss treaty, effective February 1, 2003 and renewed effective January 1, 2005, covers $45.0 million in the aggregate in excess of a $15.0 million retention in the aggregate for TRIA certified losses, as well as non-certified NBC losses. All retained TRIA certified and non-certified NBC losses incurred within a calendar year are subject to this treaty. The treaty has a 10% return of premium provision if no losses are ceded to the treaty. The 2005 annual treaty cost remained flat compared with 2004. During 2004, we did not incur any terrorism losses, nor did we cede any losses to this treaty.
Our New Jersey Homeowners Property 75% Quota Share treaty renewed January 1, 2005 at the 2004 expiring $75.0 million per occurrence limit with form following coverage. Under this treaty, the reinsurers follow our original policies including any loss from a terrorism event. The renewed treaty has a reduction in net cost of an estimated $0.3 million. Terms and conditions remained relatively the same. Premiums ceded under this treaty in 2004 increased by 1% to $19.4 million compared to $19.2 million in 2003.
Our Property Catastrophe treaty renewed at existing limits of $150.0 million and retention of $15.0 million. The property catastrophe reinsurance program was changed from a five layer program in 2004 to a three layer program for the January 1, 2005 renewal. However, the total coverage under the program remained essentially unchanged at $133.4 million. Effective January 1, 2005, the three layers provide the following coverage: (i) 95% of losses in excess of $15.0 million up to $50.0 million; (ii) 95% of losses in excess of $50.0 million up to $100.0 million; and (iii) 81% of losses in excess of $100.0 million up to $165.0 million. The treaty provides one reinstatement with $266.8 million in annual aggregate limit, net of our co-participation. Terrorism coverage is excluded per the definition of TRIA, as well as NBC losses regardless of whether or not they are certified under TRIA. However, these losses are covered up to an annual aggregate of $45.0 million once our $15.0 million annual aggregate retention is met under a separate Terrorism Excess of Loss treaty, which is discussed earlier in this section. The overall program cost for this treaty in 2004 is $6.9 million, compared to $7.5 million in 2003. The $15.0 million retention could be reduced to a minimum retention of $1.0 million due to a provision under the treaty that affords Selective up to $14.0 million of benefit from other available reinsurance arrangements.
In compliance with New Jersey regulation, the Insurance Subsidiaries ceded premium and no-fault claims for medical benefits in excess of $75,000 to the New Jersey Unsatisfied Claim and Judgment Fund (UCJF). Due to a change in New Jersey regulations, the cessions to UCJF were discontinued for policies with effective dates of January 1, 2004 or later. Claims covered under policies issued or renewed prior to January 1, 2004 will continue to be paid by the UCJF.
We continue to maintain a conservative, diversified investment portfolio, with fixed maturity investments representing 83% of invested assets. 64% of our fixed maturities portfolio is rated "AAA" while the portfolio has an average rating of "AA," Standard & Poor's second highest credit quality rating. High credit quality continues to be a cornerstone of our investment strategy, as evidenced by the fact that almost 100% of the fixed maturities are investment grade.
The following table presents the Moody's and Standard & Poor's ratings of our fixed maturities portfolio: