Selective Insurance Group 10-K 2010
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
For the fiscal year ended December 31, 2009
For the transition period from __________ to __________.
Commission file number 1-33067
SELECTIVE INSURANCE GROUP, INC.
(Exact name of registrant as specified in its charter)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
x Yes ¨ No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
¨ Yes x No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.
x Yes ¨ No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
¨ Yes ¨ No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained here in, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).
¨ Yes x No
The aggregate market value of the voting company common stock held by non-affiliates of the registrant, based on the closing price on the NASDAQ Global Select Market, was $663,122,319 on June 30, 2009. As of February 12, 2010, the registrant had outstanding 53,173,723 shares of common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement for the 2010 Annual Meeting of Stockholders to be held on April 28, 2010 are incorporated by reference into Part III of this report.
SELECTIVE INSURANCE GROUP, INC.
Table of Contents
Item 1. Business.
Selective Insurance Group, Inc. is a holding company for seven insurance subsidiaries (collectively referred to as “we,” “us,” or “our”) that principally offer property and casualty insurance products and services in the East and Midwest of the United States. We are a New Jersey corporation formed in 1977, and our headquarters are in Branchville, New Jersey. Our common stock is traded on the NASDAQ Global Select Market under the symbol “SIGI.” In 2009, we were ranked as the 48th largest property and casualty group in the United States in A.M. Best and Company’s annual list of “Top 200 U.S. Property/Casualty Groups.”
In 2009, we classified our business into two operating segments:
We eliminated our third operating segment, Diversified Insurance Services in two steps in 2009: In the first quarter, we reclassified our federal flood insurance administrative services (“Flood”) business into Insurance Operations because of changes in the way we managed the business; and (ii) in the fourth quarter, we sold our human resource administration outsourcing (“HR Outsourcing”) business. See Note 13. “Discontinued Operations” of this Form 10-K for additional information.
We derive substantially all of our income in three ways:
We measure the performance of our Insurance Operations by its combined ratio. Under generally accepted accounting principles in the United States (“GAAP”), the combined ratio is calculated by adding the loss and loss adjustment expense ratio, which is the ratio of incurred loss and loss adjustment expense to NPE and the expense ratio, which is the ratio of policy acquisition and other underwriting expenses to NPE. A combined ratio under 100% generally indicates an underwriting profit and a combined ratio over 100% generally indicates an underwriting loss. The statutory combined ratio does not reflect investment income, federal income taxes, or other non-operating income or expense.
We measure the performance of our Investment Operations by its pre- and after-tax investment income, as well as its associated return on invested assets. Our investment philosophy includes setting certain return and risk objectives for the fixed maturity and equity portfolios. We generally measure our performance by comparing our returns for each of these components of our portfolio to a weighted-average benchmark of comparable indices.
Our Insurance Operations and Investment Operations are heavily regulated by the departments of insurance in the states in which our Insurance Subsidiaries are organized and licensed. Each insurance subsidiary is required to file financial statements with such states, prepared in accordance with statutory accounting principles (“SAP”). SAP have been promulgated by the National Association of Insurance Commissioners (“NAIC”) and adopted by the various states. The purpose of state insurance regulation is to protect the policyholders, focusing on solvency and liquidation value. GAAP, which we are required to use as a holding company, focuses more on the potential for profit than liquidation. There are significant differences between SAP and GAAP. However, we use SAP to manage our Insurance Operations and discuss these differences further under “Measure of Insurance Operations Profitability.”
We derive substantially all of our Insurance Operations revenue from selling insurance products and services to businesses and individuals in exchange for premium. Sales to businesses, non-profit organizations, and local government entities, which are called Commercial Lines, represent about 84% of our revenue. Sales to individuals, which are called Personal Lines, represent about 16% of our revenue. The bulk of our sales are annual insurance policies. Commercial Lines sales are seasonally heaviest in January and July and lowest during the fourth quarter of the year.
Insurance Operations Products and Services
The types of insurance we sell in our Insurance Operations fall into three broad categories:
The main Commercial Lines we underwrite and insure primarily through traditional insurance and, to a lesser extent, through alternative risk management products, such as retrospective rating plans, self-insured group retention programs, or individual self-insured accounts, are as follows:
The main Personal Lines we underwrite and insure are as follows:
Product Development and Pricing
Our Insurance Operations policies are contracts that specify our coverages – what we will pay to or for an insured upon specified losses. We develop our coverages internally and by adopting and modifying forms and statistical data licensed from third party aggregators, notably Insurance Services Office, Inc. (“ISO”). Determining the price to charge for our coverages is complicated. At the time we underwrite and issue a policy, we do not know what our actual costs for the policy will be in the future. To calculate and project future costs, we examine and analyze historical statistical data and factor in expected changes in loss trends. In the last five years, we have also developed predictive models for our Insurance Operations. Predictive models analyze historical statistical data regarding our insureds and their loss experience and, applying and analyzing that information to risks of current insureds and prospective insureds, provide us with an analysis and prediction of the likely profitability of the account. The model’s predictive capabilities are limited by the amount and quality of the statistical data available. As a regional insurance group, our Insurance Operations’ loss experience is not large enough in all circumstances to analyze and project future costs. We use data from ISO to supplement ours. Also, by using ISO’s policy language, policy writing rules, prospective loss cost information, and rates, our Insurance Operations ensure compliance with all applicable legal and regulatory requirements.
Customers and Customer Markets
Commercial Lines customers represent 84% of our total DPW. The following provides a breakdown of these customers by policy size:
Approximately 20% of the Large Account premium includes alternative risk transfer mechanisms. Personal Lines customers represent 16% our total direct premiums. We do not sub-divide our Personal Lines customers by size or class. No one customer accounts for 10% or more of our premium.
Our Insurance Operations only do business in the United States, of which we currently operate in 22 states. We primarily market our products and services in the East and Midwest regions of the country. We believe that this geographic diversification lessens our exposure to regulatory, competitive, and catastrophic risk. The principal states where we conduct business and their respective percentage of our total NPW over the last three fiscal years is shown in the following table:
Distribution and Marketing
We sell and distribute our Insurance Operations products and services exclusively through independent insurance agents. As of December 31, 2009, we had appointed and entered into agency agreements with approximately 960 independent agencies. As these agencies often have multiple offices, we have approximately 2,000 independent agency offices selling our products and services. We pay our agencies commissions and other consideration for business placed with us (and we do not authorize our agencies to receive other monies for our insurance). We seek to compensate our agencies fairly and consistent with market practices. No one agency is responsible for 10% or more of our Insurance Operations premium.
Independent insurance agents and brokers write approximately 80% of commercial property and casualty insurance and approximately 35% of the personal lines insurance business in the United States according to a study released in 2009 by the Independent Insurance Agents and Brokers of America. We believe that independent insurance agents will remain a significant force in overall insurance industry premium production because they represent more than one insurance group and can provide insureds with a wider choice of Commercial Lines and Personal Lines insurance products than if they represented only one insurer. Because our agencies also generally represent several of our competitors and we face competition within our distribution channel, it is sometimes difficult to develop brand recognition among our customers, who do not always differentiate between insurance carriers and insurance coverages because of their reliance on their independent insurance agent. Our primary marketing strategy with agents is to:
We received an overall satisfaction score of 8.5 out of 10 for the second consecutive year from our agent survey, which demonstrates that our field model and technology makes it easier for our agents to do business with us.
Field and Technology Strategies Supporting Independent Agent Distribution
We use the service mark “High-Tech x High-Touch = HT2 SM” to describe our Insurance Operations business strategy. “High-Tech” refers to our advanced technology that we use to make it easy for our independent insurance agents and customers to do business with us. “High-Touch” refers to the close relationships that we have with our independent insurance agents and customers due to our field business model that places underwriters, claims representatives, technical staff, and safety management representatives near our agents and customers.
To support our independent agents, we employ a field model in both underwriting and claims. The field model places various employees in the field, usually working from home offices near our agents. We believe that we build better and stronger relationships with our agents because of the close proximity of our field employees to our agents and the resulting direct and regular interaction with our agents and our customers.
At December 31, 2009, we had approximately 1,900 employees. Our employees that work primarily from the field as of December 31, 2009 are shown on the following table:
We support our field model with our corporate headquarters in Branchville, New Jersey, and five regional branch offices (“Regions”). As of December 31, 2009, the Regions and their office locations were as follows:
Underwriting Process Involving Agents and Field Model
Our underwriting process requires communication and interaction among:
We also have an underwriting service center (“USC”) located in Richmond, Virginia. The USC assists our independent agents by servicing Personal Lines and Commercial Lines Small Business and Middle Market accounts. At the USC, our employees are licensed agents who respond to customer inquiries about insurance coverage, billing transactions, and other matters. For the convenience of using the USC and not having to handle certain transactions, our independent agents agree to receive a slightly lower than standard commission for the premium associated with the USC. As of December 31, 2009, our USC was servicing Commercial Lines NPW of $54 million and Personal Lines NPW of $32 million. The $86 million total serviced by the USC represents 6% of our total NPW.
We believe that our field underwriting model has a distinct advantage in its ability to provide a wide range of front-line safety management services focused on improving an insured’s safety and risk management programs, as expressed by its service mark “Safety Management: Solutions for a safer workplace®”. Safety management services include: (i) risk evaluation and improvement surveys intended to evaluate potential exposures and provide solutions for mitigation; (ii) Internet-based safety management educational resources, including a large library of coverage-specific safety materials, videos and on line courses, such as defensive driving and employee educational safety courses; (iii) thermographic infrared surveys aimed at identifying electrical hazards; and (iv) OSHA construction and general industry certification training. Risk improvement efforts for existing customers are designed to improve loss experience and policyholder retention through valuable ongoing consultative service. Our safety management goal is to partner with our insureds to identify and eliminate potential loss exposures.
Claims Management and Field Claims Model
Effective, fair, and timely claims management is one of the most important services that we provide our customers and agents. It also is one of the critical factors in achieving underwriting profitability. We have structured our claims organization to emphasize (i) cost-effective delivery of claims services and control of loss and loss expenses and (ii) maintenance of timely and adequate claims reserves. We believe that we can achieve lower claims expenses through our field model and locating claims representatives in close proximity to our customers and independent agents. In 2009, we undertook a number of initiatives to reduce claim cycle times and improve workflows, including: (i) claims automation; (ii) enhancement of claims quality and control; (iii) litigation management; (iv) compliance enhancement and bill review; (v) enhancement of workers compensation review; and (vi) enhancement of salvage and subrogation review. We expect these initiatives to accelerate the timing of the establishment and inflate the severity of reserves, although we expect lower loss costs to be ultimately realized through reduced legal and loss adjustment expenses and a more efficient claims process.
CMSs are primarily responsible for investigating and settling a significant portion of our claims directly with insureds and claimants. By promptly and personally investigating claims, we believe CMSs are able to provide better customer and agent service and quickly resolve claims within their authority. In the rare circumstances where we have insufficient claim volume to justify the placement of a CMS or when a particular claim expertise is required, we use independent adjusters. All workers compensation claims are handled in the Regions. Because of the special nature of property claims, CMSs refer those claims above certain amounts to our general property adjusters for consultation. All environmental claims are referred to our specialized corporate environmental unit.
We also have a claims service center (“CSC”), co-located with the USC, in Richmond, Virginia. The CSC receives all first notices of loss from our insureds. The CSC is designed to: (i) reduce the claims settlement time on first-and third-party automobile property damage claims; (ii) increase our use of body shops, glass repair shops, and car rental agencies that have contracted with us at discounted rates; (iii) handle and settle small property claims; and (iv) investigate and negotiate auto liability claims. Upon receipt of a claim, the CSC, as appropriate, will assign the matter to the appropriate Region or the specialized area in the corporate headquarters.
We have a special investigations 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 take action on potentially fraudulent claims. It is our practice to notify the proper authorities of its findings. This practice sends a clear message that we will not tolerate fraudulent activity committed against us or our customers. The SIU also supervises anti-fraud training for CMSs and other employees, including AMSs.
We try to do as much of our business as possible with technology. In recent years, we have made significant investments in information technology platforms, integrated systems, Internet-based applications, and predictive modeling initiatives. We did this to provide:
In 2009, for the second consecutive year, we received the Interface Partner Award from Applied Systems Client Network, an automated solutions provider to independent insurance agents, for promoting efficient communication between insurance carriers and independent agents. The award recognized our leadership and innovation, specifically citing our commitment to providing agents with download, real-time inquiry, and real-time rating.
We manage our information technology projects through a project management office (“EPMO”). The EPMO is staffed by certified individuals who apply methodologies to: (i) communicate project management standards; (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 the organization. Our senior management meets periodically with the EPMO to review all major projects and receive reports on the status of other projects. We believe that the EPMO is a factor in the success of our technology implementation and is a competitive advantage. Our technology operations are located in Branchville, New Jersey and Glastonbury, Connecticut. We also have agreements with two consulting and information technology services companies from India that have a significant presence in the United States to provide supplemental staffing services to our information technology operation. Together, they provide approximately 25% of our total capacity for skilled technology resources. However, we retain all management oversight of projects and ongoing information technology production operations. We also believe we would be able to manage an efficient transition to new vendors and not experience significant impact to our operations if we terminated either vendor.
Insurance Operations Competition
The property and casualty market is highly competitive and few companies have significant market share. We compete with three types of companies, primarily on the basis of price, coverage terms, claims service, safety management services, ease of technology, and financial ratings:
Some of these competitors are public companies and some are mutual companies. Some, like us, rely solely on independent insurance agents for distribution of their products and services and have competition within their distribution channel. Others employ their own agents who only represent one insurance group. Others use a combination of independent and captive agents.
We also face competition, primarily in Commercial Lines, from entities that self-insure their own risks. From time-to-time, some of our customers and potential customers evaluate the benefits and risks of alternative risk mechanisms, such as self-insurance. Generally, only large entities have the capacity to self-insure. However, in the public sector some small and mid-sized public entities do have the opportunity to partially self-insure their risks through the use of risk pools or joint insurance funds that are generally created by legislative act.
Because agent and customer concerns about our ability to pay claims in the future are such an important factor in our competitiveness, our financial ratings are important to our ability to compete. Major financial rating agencies evaluated us on our financial strength, operating performance, strategic position, and ability to meet policyholder obligations. We believe that our ability to write insurance business is most significantly influenced by our rating from A.M. Best & Company (“A.M. Best”). We have had our current rating of “A+ (Superior)” for the last 48 years. A.M. Best uses its highest Financial Strength Rating of “Secure,” and a descriptor of “Superior,” for its “A+” rating, which it defines as, “assigned to companies that have, in our opinion, a superior ability to meet their ongoing obligations to policyholders.” It is the second highest of 15 ratings. Only approximately 10% of commercial and personal insurance companies carry an “A+” or better rating from A.M. Best.
Our A.M. Best Financial Strength Rating of “A+ (Superior)” was most recently reaffirmed in the second quarter of 2009, at which time our outlook was revised to “negative” from “stable.” In taking their rating action regarding our outlook, A.M. Best cited our risk-adjusted capitalization deterioration in 2008 from investment losses and impairment charges and our ability to improve operating results in the current challenging commercial lines environment.
We believe our A.M. Best rating is a competitive advantage in the marketplace and influences where independent insurance agents place their business. A downgrade from A.M. Best to a rating below “A-” could affect our ability to write new business with customers and/or agents, some of whom are required (under various third party agreements) to maintain insurance with a carrier that maintains a minimum A.M. Best rating; usually an “A-.”
Our ratings by other major rating agencies are as follows:
While customers and agents may be aware of our S&P and Moody’s financial strength ratings, these ratings are not as important in insurance decision-making. They do, however, affect our ability to access capital markets. For further discussion on this, please see the “Financial Condition, Liquidity and Capital Resources” section of Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” of this Form 10-K.
Other factors that might impact our competitiveness are discussed in Item 1A. “Risk Factors,” of this Form 10-K.
We use reinsurance to protect our capital resources and insure us against losses on property and casualty risks that we underwrite. We use two main reinsurance vehicles: (i) a reinsurance pooling agreement between our Insurance Subsidiaries in which each company agrees to share in premiums and losses based on certain specified percentages; and (ii) reinsurance contracts and arrangements that cover various policies that our Insurance Operations issue to insureds.
Reinsurance Pooling Agreement
The primary purposes of the reinsurance pooling agreement between our Insurance Subsidiaries are the following;
Under the Pooling Agreement, all of the Insurance Subsidiaries mutually reinsure all insurance risks written by them pursuant to the respective percentage set forth opposite each Insurance Subsidiary’s name on the table below:
Reinsurance Treaties and Arrangements
By entering reinsurance treaties and arrangements, we are able to increase underwriting capacity and accept larger risks and a larger number of risks without directly increasing capital or surplus. All of our reinsurance treaties are for traditional reinsurance; we do not purchase finite reinsurance. Under our reinsurance treaties, the reinsurer generally assumes a portion of the losses we cede to them in exchange for a portion of the premium. Amounts not reinsured are known as retention. Reinsurance does not legally discharge us from liability under the terms and limits of our policies, but it does make our reinsurer liable to us for the amount of liability we cede to them. Accordingly, we have counterparty credit risk to our reinsurers. We attempt to mitigate this credit risk by: (i) pursuing relationships in most cases with reinsurers rated “A-” or higher; and (ii) requiring collateral to secure reinsurance obligations. Some of our reinsurance contracts include provisions that permit us to terminate or commute the reinsurance treaty if the reinsurer’s financial condition or rating deteriorates. We continuously monitor the financial condition of our reinsurers. We also continuously review the quality of reinsurance recoverables and reserves for uncollectible reinsurance.
We primarily use the following three reinsurance treaty and arrangement types for property and casualty insurance:
The following is a summary of our property reinsurance treaties and arrangements covering our Insurance Subsidiaries:
The following is a summary of our casualty reinsurance treaties and arrangements covering our Insurance Subsidiaries:
We also have other smaller reinsurance treaties, such as our Surety and Fidelity Excess of Loss Reinsurance Treaty and our Equipment Breakdown Coverage Reinsurance Treaty. For further discussion on reinsurance, see the “Reinsurance” section of Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” of this Form 10-K.
Net Loss and Loss Expense Reserves
We establish loss and loss expense reserves that are estimates of the amounts we will need to pay in the future for claims and related expenses for insured losses that have already occurred. Estimating reserves as of any date involves a considerable degree of judgment by management and is inherently uncertain. We regularly review our reserving techniques and our overall amount of reserves. We also review:
See “Critical Accounting Policies and Estimates” in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results for Operations.” of this Form 10-K for full discussion regarding our loss reserving process.
Our loss and loss expense reserve development over the preceeding 10 years is shown on the following table, which has five parts:
This table does not present accident or policy year development data. Conditions and trends that have affected past reserve development may not necessarily occur in the future. As a result, extrapolating redundancies or deficiencies based on this table is inherently uncertain.
Note: some amounts may not foot due to rounding.
We experienced favorable prior year loss and loss expense reserve development in 2009, 2008, and 2007:
The significant cumulative loss and loss expense reserve net deficiencies seen between 1999 and 2003 reflect the property and casualty industry’s soft market pricing during those years – with 1999 seeing its lowest pricing levels. As a whole, the property and casualty industry underestimated reserves and loss trends and created intense pricing competition.
The following table reconciles losses and loss expense reserves under SAP and GAAP at December 31 as follows:
Our general liability and excess liability reserves include exposure to environmental claims, which include asbestos claims and non-asbestos claims. Our exposure to environmental liability is primarily due to: (i) policies written prior to the absolute pollutions endorsement in the mid 1980’s; and (ii) underground storage tank leaks mainly form New Jersey homeowners’ policies. Our environmental claims stem primarily from insured exposures in municipal government, small non-manufacturing commercial risks, and homeowners policies. The emergence of these claims is slow and highly unpredictable.
“Asbestos claims” are claims for bodily injury alleged to have occurred from exposure to asbestos-containing products. In the past, we were the insurer of various distributors of asbestos and/or asbestos-containing products, and, in some cases, the manufacturers of these products. Over the last 20 years, an increasing number of asbestos claims have been made against the insurance industry. While most of our claims are the result of incidental exposure, we insure a former manufacturer of asbestos related products, which comprises approximately half of our outstanding claims. Favorable emergence on our reported claims resulted in a reduction in incurred losses in 2009 of approximately $2.9 million, net of reinsurance. At December 31, 2009, asbestos claims constituted 22% of our $41.6 million net environmental reserves compared to 29% of $44.1 million net environmental reserves at December 31, 2008.
“Non-asbestos claims” are claims alleging bodily injury or property damage from pollution or other environmental contaminants other than asbestos. These claims primarily include landfills and leaking underground storage tanks. In past years, landfill claims have accounted for a significant portion of our environmental claim unit’s litigation costs. Over the past few years, we have been experiencing adverse development in our homeowners line of business due to unfavorable trends in claims for groundwater contamination from leaking underground heating oil storage tanks in New Jersey. During 2009, claims related to leaking underground heating oil storage tanks began to stabilize.
Our environmental claims are handled in our centralized and specialized environmental claim unit. Environmental reserves are evaluated on a claims-by-claims basis. The ability to assess potential exposure often improves as an environmental claim develops, including judicial determinations of coverage issues. As a result, reserves are adjusted accordingly.
Estimating IBNR reserves for environmental claims is difficult because, in addition to other factors, there are significant uncertainties associated with estimating critical assumptions, such as average clean-up costs, third-party costs, potentially responsible party shares, allocation of damages, litigation and coverage defense costs, and potential state and federal legislative changes. Normal historically based actuarial approaches are difficult to apply to environmental claims because past loss history is not indicative of future potential environmental losses. In addition, while models can be applied, such models can produce significantly different results with small changes in assumptions. As a result, we do not calculate a specific environmental loss range. Historically, our environmental claims have been significantly less volatile and uncertain than other competitors in the commercial lines industry. In part, this is due to the fact that we are the primary insurance carrier on the majority of our environmental exposures, thus providing more certainty in our reserve position compared to the insurance marketplace.
Measure of Insurance Operations Profitability
We manage and evaluate the performance and profitability of our Insurance Operations in accordance with SAP, which differs from GAAP. We base our incentive compensation to our employees and our independent agents on the SAP results of our Insurance Operations. In addition, our rating agencies use SAP information to evaluate our performance, including against our industry peers.
We measure our statutory underwriting performance by four different ratios:
SAP differs in several ways from GAAP, under which we report our financial results to shareholders and the Securities Exchange Commission (“SEC”):
Our Insurance Operations statutory results for the last three completed fiscal years are shown on the following table: