Selective Insurance Group (SGZ)

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

(Mark One)

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended: March 31, 2012

or

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from_____________________________to_____________________________

 

Commission File Number: 001-33067

 

SELECTIVE INSURANCE GROUP, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

New Jersey		22-2168890
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)
40 Wantage Avenue
Branchville, New Jersey		07890
(Address of Principal Executive Offices)		(Zip Code)

 

(973) 948-3000

(Registrant’s Telephone Number, Including Area Code)

 

 

(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

 

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.

Yesx           No ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, 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).

Yesx           No ¨

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 the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer x		Accelerated filer ¨
Non-accelerated filer ¨		Smaller reporting company ¨

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨          No x

As of March 31, 2012, there were 54,805,134 shares of common stock, par value $2.00 per share, outstanding. 

 

 

SELECTIVE INSURANCE GROUP, INC.
Table of Contents

 

		Page No.
PART I.   FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets as of March 31, 2012 (Unaudited) and December 31, 2011	1
	Unaudited Consolidated Statements of Income for the Quarter Ended March 31, 2012 and 2011	2
	Unaudited Consolidated Statements of Comprehensive Income for the Quarter Ended March 31, 2012 and 2011	3
	Unaudited Consolidated Statements of Stockholders’ Equity for the Quarter Ended March 31, 2012 and 2011	4
	Unaudited Consolidated Statements of Cash Flow for the Quarter Ended March 31, 2012 and 2011	5
	Notes to Unaudited Interim Consolidated Financial Statements	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Forward-Looking Statements	24
	Introduction	24
	Critical Accounting Policies and Estimates	25
	Financial Highlights of Results for First Quarter 2012 and 2011	25
	Results of Operations and Related Information by Segment	26
	Financial Condition, Liquidity, Short-term Borrowings, and Capital Resources	43
	Ratings	45
	Off-Balance Sheet Arrangements	46
	Contractual Obligations, Contingent Liabilities, and Commitments	46
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	46
Item 4.	Controls and Procedures	46
PART II.  OTHER INFORMATION
Item 1.	Legal Proceedings	47
Item 1A.	Risk Factors	47
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47
Item 5.	Other Information	48
Item 6.	Exhibits	49

 

 

PART I. FINANCIAL INFORMATION 

ITEM 1.  FINANCIAL STATEMENTS
SELECTIVE INSURANCE GROUP, INC.		Unaudited
CONSOLIDATED BALANCE SHEETS		March 31,				December 31,
($ in thousands, except share amounts)		2012				2011
ASSETS
Investments:
Fixed maturity securities, held-to-maturity – at carrying value
(fair value:  $711,731 – 2012; $758,043 – 2011)		$	667,192				712,348
Fixed maturity securities, available-for-sale – at fair value
(amortized cost:  $2,897,522 – 2012; $2,766,856 – 2011)			3,034,511				2,897,373
Equity securities, available-for-sale – at fair value
(cost of:  $130,213 – 2012; $143,826 – 2011)			152,986				157,355
Short-term investments (at cost which approximates fair value)			174,472				217,044
Other investments			125,140				128,301
Total investments			4,154,301				4,112,421
Cash			261				762
Interest and dividends due or accrued			35,369				35,842
Premiums receivable, net of allowance for uncollectible accounts of:  $3,730 – 2012; $3,768 – 2011			491,401				466,294
Reinsurance recoverables, net			446,393				561,855
Prepaid reinsurance premiums			137,262				147,686
Current federal income tax			-				731
Deferred federal income tax			116,417				120,094
Property and equipment – at cost, net of accumulated depreciation and amortization of:  $162,559 – 2012; $160,294 – 2011			43,918				43,947
Deferred policy acquisition costs			144,331				135,761
Goodwill			7,849				7,849
Other assets			52,095				52,227
Total assets		$	5,629,597				5,685,469
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Reserve for losses and loss expenses		$	3,035,773				3,144,924
Unearned premiums			937,909				906,991
Notes payable			307,366				307,360
Current federal income tax			5,576				-
Accrued salaries and benefits			113,941				119,297
Other liabilities			146,114				148,569
Total liabilities		$	4,546,679				4,627,141
Stockholders’ Equity:
Preferred stock of $0 par value per share:
Authorized shares 5,000,000; no shares issued or outstanding		$	-				-
Common stock of $2 par value per share
Authorized shares 360,000,000
Issued:  97,809,949 – 2012; 97,246,711 – 2011			195,620				194,494
Additional paid-in capital			262,336				257,370
Retained earnings			1,127,142				1,116,319
Accumulated other comprehensive income			52,984				42,294
Treasury stock – at cost (shares:  43,004,815 – 2012; 42,836,201 – 2011)			(555,164	)			(552,149	)
Total stockholders’ equity			1,082,918				1,058,328
Commitments and contingencies
Total liabilities and stockholders’ equity		$	5,629,597				5,685,469

 

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

 

 

SELECTIVE INSURANCE GROUP, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME		Quarter ended
		March 31,
($ in thousands, except per share amounts)		2012				2011
Revenues:
Net premiums earned		$	378,829				351,343
Net investment income earned			32,628				43,473
Net realized gains (losses):
Net realized investment gains			4,779				6,390
Other-than-temporary impairments			(257	)			(532	)
Other-than-temporary impairments on fixed maturity securities recognized in other comprehensive income			(164	)			(98	)
Total net realized gains			4,358				5,760
Other income			3,533				2,880
Total revenues			419,348				403,456
Expenses:
Losses and loss expenses incurred			252,906				249,206
Policy acquisition costs			127,958				115,044
Interest expense			4,700				4,557
Other expenses			10,593				8,491
Total expenses			396,157				377,298
Income before federal income tax			23,191				26,158
Federal income tax expense (benefit):
Current			7,178				4,276
Deferred			(2,080	)			1,382
Total federal income tax expense			5,098				5,658
Net income		$	18,093				20,500
Earnings per share:
Basic net income		$	0.33				0.38
Diluted net income		$	0.33				0.37
Dividends to stockholders		$	0.13				0.13

 

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

 

 

SELECTIVE INSURANCE GROUP, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
		Quarter ended March 31,
($ in thousands)		2012				2011
Net income		$	18,093				20,500
Other comprehensive income (loss), net of tax:
Unrealized gains (losses) on investment securities:
Unrealized holding gains (losses) arising during period			12,873				(606	)
Non-credit portion of other-than-temporary impairments
recognized in other comprehensive income			238				117
Amortization of net unrealized gains on held-to-maturity securities			(516	)			(764	)
Less: reclassification adjustment for gains included in net income			(2,833	)			(3,737	)
Total unrealized gains (losses) on investment securities			9,762				(4,990	)
Defined benefit pension plans:
Amortization of net actuarial loss included in net income			903				718
Amortization of prior service cost included in net income			25				24
Total defined benefit pension plans			928				742
Other comprehensive income (loss)			10,690				(4,248	)
Comprehensive income		$	28,783				16,252

 

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

 

 

SELECTIVE INSURANCE GROUP, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
		Quarter ended March 31,
($ in thousands)		2012				2011
Common stock:
Beginning of year		$	194,494				192,725
Dividend reinvestment plan
(shares:  22,916 – 2012; 22,697 – 2011)			46				46
Stock purchase and compensation plans
(shares:  540,322 – 2012; 453,409 – 2011)			1,080				907
End of period			195,620				193,678
Additional paid-in capital:
Beginning of year			257,370				244,613
Dividend reinvestment plan			358				360
Stock purchase and compensation plans			4,608				3,602
End of period			262,336				248,575
Retained earnings:
Beginning of year, as previously reported							1,176,155
Add: Adjustment for the cumulative effect on prior years of applying retroactively the new method of accounting for deferred policy acquisition costs (Note 4)							(53,068	)
Balance at beginning of year, as adjusted			1,116,319				1,123,087
Net income			18,093				20,500
Dividends to stockholders ($0.13 per share – 2012 and 2011)			(7,270	)			(7,176	)
End of period			1,127,142				1,136,411
Accumulated other comprehensive income:
Beginning of year			42,294				7,024
Other comprehensive income (loss)			10,690				(4,248	)
End of period			52,984				2,776
Treasury stock:
Beginning of year			(552,149	)			(549,408	)
Acquisition of treasury stock
(shares:  168,614 – 2012; 135,095 – 2011)			(3,015	)			(2,496	)
End of period			(555,164	)			(551,904	)
Total stockholders’ equity		$	1,082,918				1,029,536

 

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

  

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

 

 

SELECTIVE INSURANCE GROUP, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOW		Quarter ended
		March 31,
($ in thousands)		2012				2011
Operating Activities
Net income		$	18,093				20,500
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			9,748				8,001
Stock-based compensation expense			3,329				3,135
Undistributed losses (income) of equity method investments			764				(2,482	)
Net realized gains			(4,358	)			(5,760	)
Changes in assets and liabilities:
Increase in reserves for losses and loss expenses, net of reinsurance recoverables			6,311				22,196
Increase in unearned premiums, net of prepaid reinsurance and advance premiums			41,769				11,297
Decrease in net federal income taxes			4,227				5,663
Increase in premiums receivable			(25,107	)			(15,958	)
(Increase) decrease in deferred policy acquisition costs			(8,570	)			996
Decrease in interest and dividends due or accrued			1,108				355
Decrease in accrued salaries and benefits			(5,356	)			(4,976	)
Decrease in accrued insurance expenses			(13,476	)			(17,082	)
Other-net			7,373				2,105
Net adjustments			17,762				7,490
Net cash provided by operating activities			35,855				27,990
Investing Activities
Purchase of fixed maturity securities, available-for-sale			(226,525	)			(114,320	)
Purchase of equity securities, available-for-sale			(39,724	)			(59,780	)
Purchase of other investments			(2,990	)			(5,008	)
Purchase of short-term investments			(368,210	)			(316,769	)
Purchase of subsidiary			255				-
Sale of subsidiary			287				415
Sale of fixed maturity securities, available-for-sale			14,308				14,907
Sale of short-term investments			410,780				321,487
Redemption and maturities of fixed maturity securities, held-to-maturity			38,879				38,483
Redemption and maturities of fixed maturity securities, available-for-sale			84,124				19,771
Sale of equity securities, available-for-sale			57,513				56,836
Distributions from other investments			5,299				9,122
Sale of other investments			-				16,357
Purchase of property and equipment			(2,263	)			(1,366	)
Net cash used in investing activities			(28,267	)			(19,865	)
Financing Activities
Dividends to stockholders			(6,713	)			(6,605	)
Acquisition of treasury stock			(3,015	)			(2,496	)
Net proceeds from stock purchase and compensation plans			769				1,008
Excess tax benefits from share-based payment arrangements			870				(181	)
Net cash used in financing activities			(8,089	)			(8,274	)
Net decrease in cash			(501	)			(149	)
Cash, beginning of year			762				645
Cash, end of period		$	261				496

 

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

 

NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1. Organization
Selective Insurance Group, Inc., through its subsidiaries, (collectively referred to as “we,” “us,” or “our”) offers standard and excess and surplus lines (“E&S”) property and casualty insurance products. Selective Insurance Group, Inc. (referred to as the “Parent”) was incorporated in New Jersey in 1977 and its main offices are located in Branchville, New Jersey. The Parent’s common stock is publicly traded on the NASDAQ Global Select Market under the symbol “SIGI.”

 

We classify our business into two operating segments:

·

Insurance Operations, which sells property and casualty insurance products and services in both the standard and E&S markets; and

·

Investments, which invests the premiums collected by our insurance operations.

 

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

 

These Financial Statements reflect all adjustments that, in our opinion, are normal, recurring, and necessary for a fair presentation of our results of operations and financial condition. The Financial Statements cover the first quarters ended March 31, 2012 (“First Quarter 2012”) and March 31, 2011 (“First Quarter 2011”). The Financial Statements do not include all of the information and disclosures required by GAAP and the SEC for audited financial statements. Results of operations for any interim period are not necessarily indicative of results for a full year. Consequently, the Financial Statements should be read in conjunction with the consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2011 (“2011 Annual Report”).

 

NOTE 3. Reclassification 

Certain prior year amounts in these Financial Statements and related footnotes have been reclassified to conform to the current year presentation. Such reclassifications had no effect on our net income, stockholders’ equity, or cash flows.

 

NOTE 4. Adoption of Accounting Pronouncements 

In October 2010, the FASB issued ASU 2010-26, Financial Services-Insurance (Topic 944): Accounting for Costs Associated with Acquiring or Renewing Insurance Contracts (“ASU 2010-26”). ASU 2010-26 requires that only costs that are incremental or directly related to the successful acquisition of new or renewal insurance contracts are to be capitalized as a deferred acquisition cost. This includes, among other items, sales commissions paid to agents, premium taxes, and the portion of employee salaries and benefits directly related to time spent on acquired contracts. We adopted this guidance on January 1, 2012, with retrospective application and, as such, all historical data in this Form 10-Q has been restated to reflect the revised guidance.

 

 

The following tables provide select restated financial information:

 

Balance Sheet Information
December 31, 2011
($ in thousands)		As Originally Reported				Effect of Change				As Adopted
Deferred policy acquisition costs		$	214,069				(78,308	)			135,761
Deferred federal income tax recoverable			92,686				27,408				120,094
Retained earnings			1,167,219				(50,900	)			1,116,319

  

Income Statement Information

First Quarter 2011

 

($ in thousands, except per share amounts)		As Originally Reported				Effect of Change				As Adopted
Policy acquisition costs		$	113,430				1,614				115,044
Deferred federal income tax expense			1,947				(565	)			1,382
Net income			21,549				(1,049	)			20,500
Net income per share:
Basic		$	0.40				(0.02	)			0.38
Diluted			0.39				(0.02	)			0.37

 

Cash Flow Information

First Quarter 2011

 

($ in thousands, except per share amounts)		As Originally Reported				Effect of Change				As Adopted
(Increase) decrease in deferred policy acquisition costs		$	(618	)			1,614				996
Decrease in net federal income taxes recoverable			6,228				(565	)			5,663

  

In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs (“ASU 2011-04”). This guidance changes the wording used to describe the requirements in U.S. GAAP for measuring fair value and disclosing information about fair value measurements to improve consistency in the application and description of fair value between GAAP and International Financial Reporting Standards. ASU 2011-04 clarifies that the concepts of highest and best use and valuation premise in a fair value measurement are relevant only when measuring the fair value of nonfinancial assets, and are not relevant when measuring the fair value of financial assets or liabilities. In addition, ASU 2011-04 expands the disclosures for unobservable inputs for Level 3 fair value measurements, requiring quantitative information to be disclosed related to: (i) the valuation processes used; (ii) the sensitivity of the fair value measurement to changes in unobservable inputs and the interrelationships between those unobservable inputs; and (iii) the use of a nonfinancial asset in a way that differs from the asset’s highest and best use. ASU 2011-04 was effective prospectively for interim and annual periods beginning after December 15, 2011. We have included the disclosures required by this guidance in our notes to the consolidated financial statements, where appropriate.

 

In June 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220): Presentation of Comprehensive Income (“ASU 2011-05”). ASU 2011-05 requires that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The standard eliminates the option to report other comprehensive income and its components in the statement of stockholders’ equity. Based on an amendment issued in December 2011, companies are not required to present separate line items on the income statement for reclassification adjustments out of accumulated other comprehensive income into net income, as would have been required under the initial ASU. This guidance, which is ASU 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05, is effective concurrently with ASU 2011-05. We have retroactively restated our financial statements in this Form 10-Q to comply with the presentation required under this accounting guidance.

 

 

In September 2011, the FASB issued ASU 2011-08, Intangibles-Goodwill and Other (Topic 350): Testing Goodwill for Impairment, which simplifies the requirements to test goodwill for impairment.  This guidance permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount.  If, after assessing events and circumstances, an entity determines that it is not more likely than not that the fair value of the reporting unit is less than the carrying amount, then performing the two-step impairment test is unnecessary.  However, if the entity concludes otherwise, then it is required to perform the quantitative impairment test.  This guidance was effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, and early adoption was permitted. The adoption of this guidance did not impact our financial condition or results of operation.

  

NOTE 5. Statements of Cash Flow

Cash paid during the period for interest and federal income taxes was as follows:

  

		Quarter ended March 31,
($ in thousands)		2012				2011
Cash paid during the period for:
Interest		$	2,111				1,969
Federal income tax			-				173

 

NOTE 6. Investments

(a) The amortized cost, carrying value, unrecognized holding gains and losses, and fair values of held-to-maturity (“HTM”) fixed maturity securities were as follows:

 

March 31, 2012						Net
						Unrealized								Unrecognized				Unrecognized
		Amortized				Gains				Carrying				Holding				Holding				Fair
($ in thousands)		Cost				(Losses)				Value				Gains				Losses				Value
Foreign government		$	5,292				272				5,564				-				(109	)			5,455
Obligations of state and political
subdivisions			570,970				10,526				581,496				30,826				(29	)			612,293
Corporate securities			64,686				(1,873	)			62,813				6,250				-				69,063
Asset-backed securities (“ABS”)			7,856				(1,372	)			6,484				1,379				-				7,863
Commercial mortgage-backed
securities (“CMBS”)			13,520				(2,685	)			10,835				6,222				-				17,057
Total HTM fixed maturity securities		$	662,324				4,868				667,192				44,677				(138	)			711,731

  

December 31, 2011						Net
						Unrealized								Unrecognized				Unrecognized
		Amortized				Gains				Carrying				Holding				Holding				Fair
($ in thousands)		Cost				(Losses)				Value				Gains				Losses				Value
Foreign government		$	5,292				292				5,584				-				(88	)			5,496
Obligations of state and political
subdivisions			614,118				11,894				626,012				31,529				(156	)			657,385
Corporate securities			64,840				(2,189	)			62,651				6,887				-				69,538
ABS			8,077				(1,469	)			6,608				1,353				(7	)			7,954
CMBS			14,455				(2,962	)			11,493				6,177				-				17,670
Total HTM fixed maturity securities		$	706,782				5,566				712,348				45,946				(251	)			758,043

 

Unrecognized holding gains/losses of HTM securities are not reflected in the consolidated financial statements, as they represent fair value fluctuations from the later of: (i) the date a security is designated as HTM; or (ii) the date that an other-than-temporary impairment (“OTTI”) charge is recognized on an HTM security, through the date of the balance sheet. Our HTM securities had an average duration of 2.9 years as of March 31, 2012.

 

During First Quarter 2012, two securities with a carrying value of $4.4 million and a net unrecognized gain position of $0.1 million were reclassified from HTM designations to available-for-sale (“AFS”) designation due to credit rating downgrades by Moody’s Investors Service. These unexpected rating downgrades raised significant concerns about the issuers’ credit worthiness, which changed our intention to hold these securities to maturity. There were no downgrades on securities in our HTM portfolio from Standard and Poor’s Financial Services, or Fitch Ratings in First Quarter 2012.

 

 

(b) The cost/amortized cost, unrealized gains (losses), and fair value of AFS securities were as follows:

 

March 31, 2012
		Cost/
		Amortized				Unrealized				Unrealized				Fair
($ in thousands)		Cost				Gains				Losses				Value
U.S. government and government agencies1		$	316,520				18,764				(104	)			335,180
Foreign government			36,903				1,252				(338	)			37,817
Obligations of states and political subdivisions			628,968				41,622				(1,517	)			669,073
Corporate securities			1,236,899				59,389				(1,343	)			1,294,945
ABS			93,390				1,408				(56	)			94,742
CMBS2			109,931				4,686				(2,569	)			112,048
Residential mortgage-backed
securities (“RMBS”)3			474,911				16,626				(831	)			490,706
AFS fixed maturity securities			2,897,522				143,747				(6,758	)			3,034,511
AFS equity securities			130,213				23,166				(393	)			152,986
Total AFS securities		$	3,027,735				166,913				(7,151	)			3,187,497

 

December 31, 2011
		Cost/
		Amortized				Unrealized				Unrealized				Fair
($ in thousands)		Cost				Gains				Losses				Value
U.S. government and government agencies1		$	333,504				20,292				-				353,796
Foreign government			33,687				1,042				(556	)			34,173
Obligations of states and political subdivisions			578,214				44,491				(46	)			622,659
Corporate securities			1,168,439				50,167				(5,296	)			1,213,310
ABS			77,706				1,289				(46	)			78,949
CMBS2			107,838				6,427				(1,667	)			112,598
RMBS3			467,468				16,187				(1,767	)			481,888
AFS fixed maturity securities			2,766,856				139,895				(9,378	)			2,897,373
AFS equity securities			143,826				13,617				(88	)			157,355
Total AFS securities		$	2,910,682				153,512				(9,466	)			3,054,728

 

¹ U.S. government includes corporate securities fully guaranteed by the Federal Deposit Insurance Corporation (“FDIC”) with a fair value of $61.5 million at March 31, 2012 and $76.5 million at December 31, 2011.

² CMBS includes government guaranteed agency securities with a fair value of $68.4 million at March 31, 2012 and $72.9 million at December 31, 2011.

³ RMBS includes government guaranteed agency securities with a fair value of $102.8 million at March 31, 2012 and $98.2 million at December 31, 2011.

 

Unrealized gains/losses of AFS securities represent fair value fluctuations from the later of: (i) the date a security is designated as AFS; or (ii) the date that an OTTI charge is recognized on an AFS security, through the date of the balance sheet. These unrealized gains and losses are recorded in accumulated other comprehensive income (“AOCI”) on the Consolidated Balance Sheets.

 

 

c) The following tables summarize, for all securities in a net unrealized/unrecognized loss position at March 31, 2012 and December 31, 2011, the fair value and gross pre-tax net unrealized/unrecognized loss by asset class and by length of time those securities have been in a net loss position:

 

March 31, 2012		Less than 12 months								12 months or longer
($ in thousands)		Fair Value				Unrealized Losses1				Fair Value				Unrealized Losses1
AFS securities
U.S. government and government agencies		$	12,738				(104	)			-				-
Foreign government			5,868				(338	)			-				-
Obligations of states and political subdivisions			56,839				(1,507	)			1,202				(10	)
Corporate securities			94,148				(1,005	)			12,310				(338	)
ABS			3,971				(27	)			1,318				(29	)
CMBS			4,432				(9	)			15,603				(2,560	)
RMBS			40,136				(282	)			15,733				(549	)
Total fixed maturity securities			218,132				(3,272	)			46,166				(3,486	)
Equity securities			11,248				(393	)			-				-
Subtotal		$	229,380				(3,665	)			46,166				(3,486	)

 

		Less than 12 months												12 months or longer
($ in thousands)		Fair Value				Unrealized Losses1				Unrecognized Gains2				Fair Value				Unrealized Losses1				Unrecognized Gains2
HTM securities
Obligations of states and political subdivisions		$	1,842				(88	)			81				6,682				(389	)			241
ABS			-				-				-				2,834				(968	)			748
CMBS			-				-				-				2,691				(1,252	)			749
Subtotal		$	1,842				(88	)			81				12,207				(2,609	)			1,738
Total AFS and HTM		$	231,222				(3,753	)			81				58,373				(6,095	)			1,738

 

 

December 31, 2011		Less than 12 months								12 months or longer
($ in thousands)		Fair Value				Unrealized Losses1				Fair Value				Unrealized Losses1
AFS securities:
Foreign government		$	8,299				(556	)			-				-
Obligations of states and political subdivisions			517				(1	)			1,740				(45	)
Corporate securities			157,510				(4,415	)			14,084				(881	)
ABS			15,808				(14	)			702				(32	)
CMBS			4,822				(48	)			14,564				(1,619	)
RMBS			29,803				(625	)			15,007				(1,142	)
Total fixed maturity securities			216,759				(5,659	)			46,097				(3,719	)
Equity securities			743				(88	)			-				-
Subtotal		$	217,502				(5,747	)			46,097				(3,719	)

 

 

		Less than 12 months												12 months or longer
($ in thousands)		Fair Value				Unrealized Losses1				Unrecognized Gains2				Fair Value				Unrealized Losses1				Unrecognized Gains2
HTM securities
Obligations of states and political subdivisions		$	7,244				(94	)			78				9,419				(519	)			324
ABS			-				-				-				2,816				(1,009	)			737
CMBS			-				-				-				2,794				(1,447	)			761
Subtotal		$	7,244				(94	)			78				15,029				(2,975	)			1,822
Total AFS and HTM		$	224,746				(5,841	)			78				61,126				(6,694	)			1,822

 

1	Gross unrealized losses include non-OTTI unrealized amounts and OTTI losses recognized in AOCI.  In addition, this column includes remaining unrealized gain or loss amounts on securities that were transferred to an HTM designation in the first quarter of 2009 for those securities that are in a net unrealized/unrecognized loss position.
2	Unrecognized gains represent fair value fluctuations from the later of:  (i) the date a security is designated as HTM; or (ii) the date that an OTTI charge is recognized on an HTM security.

 

 

As evidenced by the table below, our unrealized/unrecognized loss positions improved by $2.6 million as of March 31, 2012 compared to December 31, 2011 as follows:

 

($ in thousands)
March 31, 2012												December 31, 2011
Number of Issues				% of Market/Book				Unrealized Unrecognized Loss				Number of Issues				% of Market/Book				Unrealized Unrecognized Loss
	153				80% - 99%			$	6,071				140				80% - 99%			$	10,166
	1				60% - 79%				1,516				-				60% - 79%				-
	1				40% - 59%				442				1				40% - 59%				469
	-				20% - 39%				-				-				20% - 39%				-
	-				0% - 19%				-				-				0% - 19%				-
								$	8,029											$	10,635

 

We have reviewed the securities in the tables above in accordance with our OTTI policy, as described in Note 2. “Summary of Significant Accounting Policies” in Item 8. “Financial Statements and Supplementary Data.” of our 2011 Annual Report.

  

At March 31, 2012, we had 155 securities in an aggregate unrealized/unrecognized loss position of $8.0 million, $4.4 million of which have been in a loss position for more than 12 months. Securities with non-credit OTTI impairments comprised $2.6 million of the $4.4 million balance, with the remainder related to securities that were, on average, 4% impaired compared to their amortized cost.

  

At December 31, 2011, we had 141 securities in an aggregate unrealized/unrecognized loss position of $10.6 million, $4.9 million of which had been in a loss position for more than 12 months. Non-credit OTTI impairments comprised $2.1 million of the $4.9 million balance, with the remainder related to securities that were, on average, 6% impaired compared to their amortized cost.

 

We do not have the intent to sell any securities in an unrealized/unrecognized loss position nor do we believe we will be required to sell these securities, and therefore we have concluded that they are temporarily impaired as of March 31, 2012. This conclusion reflects our current judgment as to the financial position and future prospects of the entity that issued the investment security and underlying collateral. If our judgment about an individual security changes in the future, we may ultimately record a credit loss after having originally concluded that one did not exist, which could have a material impact on our net income and financial position in future periods.

 

(d) Fixed maturity securities at March 31, 2012, by contractual maturity, are shown below. Mortgage-backed securities are included in the maturity tables using the estimated average life of each security. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

Listed below are HTM fixed maturity securities at March 31, 2012:

 

($ in thousands)		Carrying Value				Fair Value
Due in one year or less		$	81,754				86,784
Due after one year through five years			495,428				525,309
Due after five years through 10 years			83,147				91,452
Due after 10 years			6,863				8,186
Total HTM fixed maturity securities		$	667,192				711,731

 

Listed below are AFS fixed maturity securities at March 31, 2012:

 

($ in thousands)		Fair Value
Due in one year or less		$	321,292
Due after one year through five years			1,876,518
Due after five years through 10 years			810,211
Due after 10 years			26,490
Total AFS fixed maturity securities		$	3,034,511

  

  

(e) The following table outlines a summary of our other investment portfolio by strategy and the remaining commitment amount associated with each strategy:

 

Other Investments		Carrying Value								March 31, 2012
		March 31,				December 31,				Remaining
($ in thousands)		2012				2011				Commitment
Alternative Investments
Secondary private equity		$	29,761				30,114				8,590
Energy/power generation			24,149				25,913				10,420
Private equity			23,175				21,736				4,389
Distressed debt			15,081				16,953				3,074
Real estate			12,825				13,767				10,506
Mezzanine financing			9,167				8,817				15,256
Venture capital			7,327				7,248				800
Total alternative investments			121,485				124,548				53,035
Other securities			3,655				3,753				1,235
Total other investments		$	125,140				128,301				54,270

 

The carrying value of our other investments decreased by $3.2 million compared to year end 2011. The carrying value was impacted in First Quarter 2012 by distributions of $8.1 million, partially offset by income of $2.0 million and additional contributions of $3.0 million under our existing commitments.

  

For a description of our seven alternative investment strategies outlined above, as well as redemption, restrictions, and fund liquidations, refer to Note 5. “Investments” in Item 8. “Financial Statements and Supplementary Data.” of our 2011 Annual Report.

 

The following table sets forth aggregated summarized financial information for the partnerships in our alternative investment portfolio. The last line of the table below reflects our share of the aggregate income, which is the portion included in our consolidated Financial Statements. As the majority of these investments report results to us on a quarter lag, the summarized financial statement information for the three-month periods ended December 31 is as follows:

 

Income Statement Information
Quarter ended December 31,
($ in millions)		2011				2010
Net investment income		$	36.1				154.2
Realized gains (losses)			750.7				(192.3	)
Net change in unrealized (depreciation) appreciation			(487.4	)			1,464.2
Net income		$	299.4				1,426.1
Selective’s insurance subsidiaries’ net income		$	2.0				11.6

 

(f) At March 31, 2012, we had 27 fixed maturity securities, with a carrying value of $63.4 million, pledged as collateral for our outstanding borrowing with the Federal Home Loan Bank of Indianapolis (“FHLBI”).  This borrowing, which has an outstanding principal balance of $58.0 million, is included in “Notes payable” on our Consolidated Balance Sheets.  In accordance with the terms of our agreement with the FHLBI, we retain all rights regarding the collateral securities, which are included in the “U.S. government and government agencies,” “RMBS,” and “CMBS” classifications of our AFS fixed maturity securities portfolio.

 

 

(g) The components of net investment income earned were as follows:

 

		Quarter ended March 31,
($ in thousands)		2012				2011
Fixed maturity securities		$	31,350				33,123
Equity securities			1,237				317
Short-term investments			38				62
Other investments			2,000				11,641
Miscellaneous income			39				25
Investment expenses			(2,036	)			(1,695	)
Net investment income earned		$	32,628				43,473

  

Net investment income earned, before tax, decreased by $10.8 million for First Quarter 2012 compared to First Quarter 2011, primarily driven by a decrease of $9.3 million in income from our alternative investments within our other investment portfolio. Our alternative investments, which are accounted for under the equity method, primarily consist of investments in limited partnerships, the majority of which report results to us on a one quarter lag.

 

h) The following tables summarize OTTI by asset type for the periods indicated:

 

First Quarter 2012
($ in thousands)		Gross				Included in Other Comprehensive Income (“OCI”)				Recognized in Earnings
Fixed maturity securities
ABS		$	32				-				32
CMBS			108				-				108
RMBS			(54	)			(164	)			110
Total fixed maturity securities			86				(164	)			250
Equity securities			171				-				171
OTTI losses		$	257				(164	)			421

 

First Quarter 2011
										Recognized in
($ in thousands)		Gross				Included in OCI				Earnings
Fixed maturity securities
Obligations of state and political subdivisions		$	17				-				17
Corporate securities			244				-				244
CMBS			74				(256	)			330
RMBS			197				158				39
OTTI losses		$	532				(98	)			630

 

 

The following table set forth, for the periods indicated, credit loss impairments on fixed maturity securities for which a portion of the OTTI charge was recognized in OCI, and the corresponding changes in such amounts:

 

		Quarter ended March 31,
($ in thousands)		2012				2011
Balance, beginning of year		$	6,602				17,723
Addition for the amount related to credit loss for which an OTTI was not previously recognized			-				-
Reductions for securities sold during the period			-				-
Reductions for securities for which the amount previously recognized in OCI was recognized in earnings because of intention or potential requirement to sell before recovery of amortized cost			-				-
Reductions for securities for which the entire amount previously recognized in OCI was recognized in earnings due to a decrease in cash flows expected			-				(3,582	)
Additional increases to the amount related to credit loss for which an OTTI was previously recognized			109				227
Accretion of credit loss impairments previously recognized due to an increase in cash flows expected to be collected			-				-
Balance, end of period		$	6,711				14,368

 

(i)

The components of net realized gains, excluding OTTI charges, were as follows:

  

		Quarter ended
		March 31,
($ in thousands)		2012				2011
HTM fixed maturity securities
Gains		$	153				1
Losses			(81	)			(214	)
AFS fixed maturity securities
Gains			405				407
Losses			(43	)			(7	)
AFS equity securities
Gains			4,775				6,203
Losses			(428	)			-
Short-term investments
Gains			-				-
Losses			(2	)			-
Total other net realized investment gains			4,779				6,390
Total OTTI charges recognized in earnings			(421	)			(630	)
Total net realized gains (losses)		$	4,358				5,760

 

Realized gains and losses on the sale of investments are determined on the basis of the cost of the specific investments sold. Proceeds from the sale of AFS securities were $71.8 million in First Quarter 2012 and $71.7 million in First Quarter 2011. In addition to calls and maturities, the realized gain, excluding OTTI charges, in First Quarter 2012 was driven primarily by the sale of AFS equity securities for proceeds of $57.5 million with realized gains of $4.3 million due to a rebalancing of securities within the equity securities portfolio.

 

Net realized gains, excluding OTTI charges, in First Quarter 2011 was driven by the sale of AFS equity securities for proceeds of $56.8 million with realized gains of $6.2 million due to a reallocation of the equity securities portfolio into a high dividend yield equities strategy.

 

 

NOTE 7. Fair Value Measurements

The following table presents the carrying amounts and estimated fair values of our financial instruments as of March 31, 2012 and December 31, 2011:

 

		March 31, 2012								December 31, 2011
		Carrying				Fair				Carrying				Fair
($ in thousands)		Amount				Value				Amount				Value
Financial Assets
Fixed maturity securities:
HTM		$	667,192				711,731				712,348				758,043
AFS			3,034,511				3,034,511				2,897,373				2,897,373
Equity securities, AFS			152,986				152,986				157,355				157,355
Short-term investments			174,472				174,472				217,044				217,044
Receivable for proceeds related to sale of Selective HR Solutions (“Selective HR”)			2,989				2,989				3,212				3,212
Financial Liabilities
Notes payable:
7.25% Senior Notes			49,909				59,814				49,908				51,111
6.70% Senior Notes			99,457				113,261				99,452				113,195
7.50% Junior Notes			100,000				100,520				100,000				100,360
2.90% borrowings from FHLBI			13,000				13,725				13,000				13,759
1.25% borrowings from FHLBI			45,000				44,688				45,000				44,629
Total notes payable		$	307,366				332,008				307,360				323,054

 

The techniques used to value our financial assets are as follows:

·

For valuations of securities in our equity securities portfolio and U.S. Treasury notes held in our fixed maturity securities portfolio, we receive prices from an independent pricing service that are based on observable market transactions. We validate these prices against a second external pricing service, and if established market value comparison thresholds are breached, further analysis is performed, in conjunction with our external investment managers, to determine the price to be used. These securities are classified as Level 1 in the fair value hierarchy.

 

·

For approximately 95% of our fixed maturity securities portfolio, we utilize a market approach, using primarily matrix pricing models prepared by external pricing services. Matrix pricing models use mathematical techniques to value debt securities by relying on the securities relationship to other benchmark quoted securities, and not relying exclusively on quoted prices for specific securities, as the specific securities are not always frequently traded. As a matter of policy, we consistently use one pricing service as our primary source and secondary pricing services if prices are not available from the primary pricing service. In conjunction with our external investment portfolio managers, fixed maturity securities portfolio pricing is reviewed for reasonableness in the following ways: (i) comparing positions traded directly by the external investment portfolio managers to prices received from the third-party pricing services; (ii) comparing the primary vendor pricing to other third-party pricing services as well as benchmark indexed pricing; (iii) comparing market value fluctuations between months for reasonableness; and (iv) reviewing stale prices. If further analysis is needed, a challenge is sent to the primary pricing service for review and confirmation of the price. In addition to the tests described above, management also selects a sample of prices for a comparison to a secondary price source. Historically, we have not experienced significant variances in prices, and therefore, we have consistently used our primary pricing service. These prices are typically Level 2 in the fair value hierarchy.

 

·

For the small portion of our fixed maturity securities portfolio that we cannot price using our primary service, we typically use non-binding broker quotes. These prices are from various broker/dealers that utilize bid or ask prices, or benchmarks to indices, in measuring the fair value of a security. In conjunction with our external investment portfolio managers, broker quotes are reviewed for reasonableness. This review includes an analysis of price fluctuations between months with variances over established thresholds being analyzed further. These prices are generally classified as Level 3 in the fair value hierarchy, as the inputs cannot be corroborated by observable market data.

 

·

Short-term investments are carried at cost, which approximates fair value. Given the liquid nature of our short-term investments, we generally validate their fair value by way of active trades within approximately one week of the financial statement close. These securities are classified as Level 1 in the fair value hierarchy.

 

·

Our investments in other miscellaneous securities are generally accounted for under the equity method. Investments in tax credits are carried under the effective yield method of accounting.

 

·

The fair value of the receivable for proceeds related to the 2009 sale of Selective HR Solutions operations (“Selective HR”) is estimated using a discounted cash flow analysis, which includes our judgment regarding future worksite life generation and retention assumptions. These assumptions are derived based on our historical experience modified to reflect current and anticipated future trends. Proceeds related to the sale are scheduled to be received over a 10-year period based on the ability of the purchaser to retain and generate new worksite lives though our independent agency distribution channel. We have concluded that these proceeds are not directly related to the operations of Selective HR since we have no continuing involvement with the operations of this company and have no continuing cash flows other than these proceeds. This receivable is classified as Level 3 in the fair value hierarchy.

 

The techniques used to value our financial liabilities are as follows:

·

The fair values of the 7.25% Senior Notes due November 15, 2034, the 6.70% Senior Notes due November 1, 2035, and the 7.50% Junior Subordinated Notes due September 27, 2066 are based on quoted market prices. These prices are typically Level 1 in the fair value hierarchy.

  

·

The fair value of the 2.90% and 1.25% borrowings from the FHLBI are estimated using a discounted cash flow analysis based on a current borrowing rate provided by the FHLBI consistent with the remaining term of the borrowing. These prices are typically Level 2 in the fair value hierarchy.

 

The following tables provide quantitative disclosures of our financial assets that were measured at fair value at March 31, 2012 and December 31, 2011:

 

 

March 31, 2012						Fair Value Measurements Using
						Quoted Prices in
		Assets				Active Markets for				Significant Other				Significant
		Measured at				Identical Assets/				Observable				Unobservable
		Fair Value				Liabilities				Inputs				Inputs
($ in thousands)		at 3/31/12				(Level 1) 1				(Level 2) 1				(Level 3)
Description
Measured on a recurring basis:
U.S. government and government agencies2		$	335,180				130,189				183,768				21,223
Foreign government			37,817				-				37,817				-
Obligations of states and political subdivisions			669,073				-				669,073				-
Corporate securities			1,294,945				-				1,292,433				2,512
ABS			94,742				-				94,742				-
CMBS			112,048				-				111,667				381
RMBS			490,706				-				490,706				-
Total AFS fixed maturity securities			3,034,511				130,189				2,880,206				24,116
Equity securities			152,986				152,986				-				-
Short-term investments			174,472				174,472				-				-
Receivable for proceeds related to sale of Selective HR			2,989				-				-				2,989
Total assets		$	3,364,958				457,647				2,880,206				27,105

 

 

December 31, 2011						Fair Value Measurements Using
						Quoted Prices in
		Assets				Active Markets for				Significant Other				Significant
		Measured at				Identical Assets/				Observable				Unobservable
		Fair Value				Liabilities				Inputs				Inputs
($ in thousands)		at 12/31/11				(Level 1)				(Level 2)				(Level 3)
Description
Measured on a recurring basis:
U.S. government and government agencies2		$	353,796				126,475				205,580				21,741
Foreign government			34,173				-				34,173				-
Obligations of states and political subdivisions			622,659				-				622,659				-
Corporate securities			1,213,310				-				1,210,707				2,603
ABS			78,949				-				78,949				-
CMBS			112,598				-				112,244				354
RMBS			481,888				-				481,888				-
Total AFS fixed maturity securities			2,897,373				126,475				2,746,200				24,698
Equity securities			157,355				157,355				-				-
Short-term investments			217,044				217,044				-				-
Receivable for proceeds related to sale of Selective HR			3,212				-				-				3,212
Total assets		$	3,274,984				500,874				2,746,200				27,910

 

¹ There were no transfers of securities between Level 1 and Level 2 in First Quarter 2012.

² U.S. government includes corporate securities fully guaranteed by the FDIC.

 

The following tables provide a summary of the changes in the fair value of securities measured using Level 3 inputs and related quantitative information as of March 31, 2012:

 

($ in thousands)		Government				Corporate				CMBS				Receivable for Proceeds Related to Sale of Selective HR				Total
Fair value, December 31, 2011		$	21,741				2,603				354				3,212				27,910
Total net (losses) gains for the period included in:
OCI1			105				99				27				-				231
Net income2,3			(46	)			-				-				64				18
Purchases			-				-				-				-				-
Sales			-				-				-				-				-
Issuances			-				-				-				-				-
Settlements			(577	)			(190	)			-				(287	)			(1,054	)
Transfers into Level 3			-				-				-				-				-
Transfers out of Level 3			-				-				-				-				-
Fair value, March 31, 2012		$	21,223				2,512				381				2,989				27,105

 

1	Amounts are reported in “Unrealized holding gains (losses) arising during period” on the Consolidated Statements of Comprehensive Income.
2	Amounts are reported in “Net realized gains (losses)” for realized gains and losses and “Net investment income earned” for amortization of securities on the Consolidated Statements of Income.
3	Amounts are reported in “Other income” for the receivable related to the sale of Selective HR on the Consolidated Statements of Income  and are related to interest accretion on the receivable.

 

As discussed above, the fair value of our Level 3 fixed maturity securities are typically obtained through non-binding broker quotes, which we review for reasonableness. The receivable related to the sale of Selective HR is also a Level 3 fair value measurement using unobservable inputs, the most significant of which is our assumption regarding the retention of business. If this assumption were to change by +/-10%, the value of this receivable would increase/decrease by approximately $0.1 million.

 

 

The following table provides a summary of the changes in the fair value of securities measured using Level 3 inputs in 2011:

 

2011														Receivable for Proceeds Related to Sale
($ in thousands)		Government				Corporate				CMBS				of Selective HR				Total
Fair value, December 31, 2010		$	-				-				185				5,002				5,187
Total net (losses) gains for the period included in:
OCI1			-				-				507				-				507
Net income2,3			-				-				(322	)			(638	)			(960	)
Purchases			-				-				-				-				-
Sales			-				-				-				-				-
Issuances			-				-				-				-				-
Settlements			-				-				(16	)			(1,152	)			(1,168	)
Transfers into Level 3			21,741				2,603				-				-				24,344
Transfers out of Level 3			-				-				-				-				-
Fair value, December 31, 2011		$	21,741				2,603				354				3,212				27,910

  

1	Amounts are reported in “Other net unrealized gains on investment securities, net of deferred income tax” on the Consolidated Statements of Stockholders’ Equity in our 2011 Annual Report.
2	Amounts are reported in “Net realized gains (losses)” for realized gains and losses and “Net investment income earned” for amortization for the CMBS securities on the Consolidated Statements of Income in our 2011 Annual Report.
3	Amounts are reported in either “Loss on disposal of discontinued operations, net of tax” or “Other income” for the receivable related to the sale of Selective HR on the Consolidated Statements of Income.  Amounts in “Loss on disposal of discontinued operations, net of tax” related to charges to reduce the fair value of our receivable, and amounts in “Other income” related to interest accretion on the receivable in our 2011 Annual Report.

 

The transfers of the government and corporate securities into level 3 classification at December 31, 2011 were primarily the result of broker-priced securities being transferred from an HTM to an AFS designation in 2011.

 

The following tables provide quantitative information regarding our financial assets and liabilities that were disclosed at fair value at March 31, 2012:

 

March 31, 2012						Fair Value Measurements Using
		Assets/				Quoted Prices in
		Liabilities				Active Markets for				Significant Other				Significant
		Disclosed at				Identical Assets/				Observable				Unobservable
		Fair Value				Liabilities				Inputs				Inputs
($ in thousands)		at 3/31/12				(Level 1)				(Level 2)				(Level 3)
Financial Assets
HTM:
Foreign government		$	5,455				-				5,455				-
Obligations of states and political subdivisions			612,293				-				612,293				-
Corporate securities			69,063				-				63,280				5,783
ABS			7,863				-				6,188				1,675
CMBS			17,057				-				14,366				2,691
Total HTM fixed maturity securities		$	711,731				-				701,582				10,149
Financial Liabilities
Notes payable:
7.25% Senior Notes		$	59,814				59,814				-				-
6.70% Senior Notes			113,261				113,261				-				-
7.50% Junior Notes			100,520				100,520				-				-
2.90% borrowings from FHLBI			13,725				-				13,725				-
1.25% borrowings from FHLBI			44,688				-				44,688				-
Total notes payable		$	332,008				273,595				58,413				-

 

 

NOTE 8. Reinsurance

The following table contains a listing of direct, assumed, and ceded reinsurance amounts for premiums written, premiums earned, and losses and loss expenses incurred. For more information concerning reinsurance, refer to Note 8. “Reinsurance” in Item 8. “Financial Statements and Supplementary Data.” in our 2011 Annual Report.

  

		Quarter ended
		March 31,
($ in thousands)		2012				2011
Premiums written:
Direct		$	475,966				423,342
Assumed			21,989				5,653
Ceded			(77,783	)			(67,160	)
Net		$	420,172				361,835
Premiums earned:
Direct		$	451,988				412,879
Assumed			15,049				5,889
Ceded			(88,208	)			(67,425	)
Net		$	378,829				351,343
Losses and loss expenses incurred:
Direct		$	252,203				269,404
Assumed			10,599				3,833
Ceded			(9,896	)			(24,031	)
Net		$	252,906				249,206

 

Direct premium written (“DPW”) for First Quarter 2012 was $52.6 million higher than First Quarter 2011 due to the following: (i) our E&S operations that generated DPW of $13.2 million; (ii) Commercial Lines renewal pure price increases of 5.1% coupled with a three-point increase in retention to 83%; (iii) Personal Lines filed rate increases that were effective for the quarter that averaged 5.9% while retention improved one point from a year ago to 87%; (iv) an increase in direct new business premiums of $21.8 million; and (v) audit and endorsement additional premium of $5.7 million compared to return premium of $4.0 million. Direct premium earned increases in First Quarter 2012 were consistent with the fluctuation in DPW for the twelve-month period ended March 31, 2012 as compared to the twelve-month period ended March 31, 2011.

 

Assumed premiums written and earned for First Quarter 2012 was $16.3 million and $9.2 million higher, respectively, than First Quarter 2011 primarily due to the August 2011 E&S renewal rights acquisition.

 

The ceded premiums and losses related to our involvement with the National Flood Insurance Program (“NFIP”), in which all of our Flood premiums, losses, and loss expenses are ceded to the NFIP, are as follows:

 

National Flood Insurance Program		Quarter ended
		March 31,
($ in thousands)		2012				2011
Ceded premiums written		$	(51,724	)			(48,314	)
Ceded premiums earned			(51,905	)			(47,948	)
Ceded losses and loss expenses incurred		$	14,922				(14,540	)

 

 

NFIP ceded losses and loss expenses incurred in First Quarter 2012 were $29.5 million lower than First Quarter 2011. This decrease was a direct result of Hurricane Irene and Lee claims from August and September 2011 being settled in First Quarter 2012 for roughly $15 million less than their original estimates. On an overall company basis, this decrease was partially offset by ceded loss activity related to our E&S business.

 

 

NOTE 9. Segment Information
We have classified our operations into two segments, the disaggregated results of which are reported to and used by senior management to manage our operations:

 

·

Insurance Operations, which is evaluated based on statutory underwriting results (net premiums earned, incurred losses and loss expenses, policyholders dividends, policy acquisition costs, and other underwriting expenses) and statutory combined ratios; and

·

Investments, which is evaluated based on net investment income and net realized gains and losses.

 

Our Insurance Operations segment has historically reflected the results of our standard market insurance products. In 2011, through our acquisition activities, we began writing E&S business. This business has not met the quantitative thresholds for individual segment reporting, as our E&S operations share various economic, regulatory, and production-related characteristics with our standard market insurance products, we have aggregated their results into our Insurance Operations segment.

 

In computing the results of each segment, we do not make adjustments for interest expense, net general corporate expenses, or federal income taxes. We do not maintain separate investment portfolios for the segments, and therefore, do not allocate assets to the segments.

 

The following summaries present revenue (net investment income and net realized gain (loss) on investments in the case of the Investments segment) and pre-tax income for the individual segments:

 

Revenue by Segment		Quarter ended
		March 31,
($ in thousands)		2012				2011
Insurance Operations:
Net premiums earned:
Commercial automobile		$	70,484				69,670
Workers compensation			65,811				62,526
General liability			90,143				82,566
Commercial property			49,371				48,193
Business owners’ policies			16,857				16,485
Bonds			4,663				4,767
Other			12,891				2,556
Total commercial lines			310,220				286,763
Personal automobile			37,456				36,962
Homeowners			27,958				24,555
Other			3,195				3,063
Total personal lines			68,609				64,580
Total net premiums earned			378,829				351,343
Miscellaneous income			3,457				2,770
Total Insurance Operations revenues			382,286				354,113
Investments:
Net investment income			32,628				43,473
Net realized gain on investments			4,358				5,760
Total investment revenues			36,986				49,233
Total all segments			419,272				403,346
Other income			76				110
Total revenues		$	419,348				403,456

 

  

Income Before Federal Income Tax		Quarter ended
		March 31,
($ in thousands)		2012				2011
Insurance Operations:
Commercial lines underwriting		$	(4,484	)			(6,192	)
Personal lines underwriting			3,121				(6,506	)
Underwriting loss, before federal income tax			(1,363	)			(12,698	)
GAAP combined ratio			100.4	%			103.6
Statutory combined ratio			99.1	%			102.6
Investments:
Net investment income		$	32,628				43,473
Net realized gain on investments			4,358				5,760
Total investment income, before federal income tax			36,986				49,233
Total all segments			35,623				36,535
Interest expense			(4,700	)			(4,557	)
General corporate and other expenses			(7,732	)			(5,820	)
Income before federal income tax		$	23,191				26,158

 

NOTE 10. Retirement Plans

The following tables show the costs of the Retirement Income Plan for Selective Insurance Company of America (“Retirement Income Plan”) and the retirement life insurance component (“Retirement Life Plan”) of the Selective Insurance Company of America Welfare Benefits Plan. For more information concerning these plans, refer to Note 16. “Retirement Plans” in Item 8. “Financial Statements and Supplementary Data.” of our 2011 Annual Report.

 

		Retirement Income Plan								Retirement Life Plan
		Quarter ended March 31,								Quarter ended March 31,
($ in thousands)		2012				2011				2012				2011
Components of Net Periodic Benefit Cost:
Service cost		$	2,154				2,173				-				-
Interest cost			3,230				3,155				74				77
Expected return on plan assets			(3,547	)			(3,482	)			-				-
Amortization of unrecognized prior service cost			38				37				-				-
Amortization of unrecognized net loss			1,383				1,101				7				4
Net periodic cost		$	3,258				2,984				81				81
Weighted-Average Expense Assumptions for the years ended December 31:
Discount rate			5.16	%			5.55				5.16	%			5.55
Expected return on plan assets			7.75	%			8.00				-	%			-
Rate of compensation increase			4.00	%			4.00				-	%			-

 

We presently anticipate contributing $8.4 million to the Retirement Income Plan in 2012, $2.4 million of which has been funded as of March 31, 2012.

 

 

NOTE 11. Comprehensive Income
The components of comprehensive income, both gross and net of tax, for First Quarter 2012 and 2011 are as follows:

 

 

First Quarter 2012
($ in thousands)		Gross				Tax				Net
Net income		$	23,191				5,098				18,093
Components of OCI:
Unrealized gains on securities:
Unrealized holding gains during the period			19,804				6,931				12,873
Portion of OTTI recognized in OCI			367				129				238
Amortization of net unrealized gains on HTM securities			(794	)			(278	)			(516	)
Reclassification adjustment for gains included in net income			(4,359	)			(1,526	)			(2,833	)
Net unrealized gains			15,018				5,256				9,762
Defined benefit pension and post-retirement plans:
Reversal of amortization items:
Net actuarial loss			1,390				487				903
Prior service cost			38				13				25
Defined benefit pension and post-retirement plans			1,428				500				928
Comprehensive income		$	39,637				10,854				28,783

 

 

First Quarter 2011
($ in thousands)		Gross				Tax				Net
Net income		$	26,158				5,658				20,500
Components of OCI:
Unrealized losses on securities:
Unrealized holding losses during the period			(933	)			(327	)			(606	)
Portion of OTTI recognized in OCI			180				63				117
Amortization of net unrealized gains on HTM securities			(1,175	)			(411	)			(764	)
Reclassification adjustment for gains included in net income			(5,749	)			(2,012	)			(3,737	)
Net unrealized losses			(7,677	)			(2,687	)			(4,990	)
Defined benefit pension and post-retirement plans:
Reversal of amortization items:
Net actuarial loss			1,105				387				718
Prior service cost			37				13				24
Defined benefit pension and post-retirement plans			1,142				400				742
Comprehensive income		$	19,623				3,371				16,252

  

The balances of, and changes in, each component of AOCI (net of taxes) as of March 31, 2012 are as follows:

  

March 31, 2012														Defined
		Net Unrealized Gain (Loss)												Benefit
		OTTI				HTM				All				Pension and Post- Retirement				Total Accumulated
($ in thousands)		Related				Related				Other				Plans				OCI
Balance, December 31, 2011		$	(3,500	)			4,622				96,125				(54,953	)			42,294
Changes in component during period			238				(585	)			10,109				928				10,690
Balance, March 31, 2012		$	(3,262	)			4,037				106,234				(54,025	)			52,984

 

Note 12. Commitments and Contingencies

At March 31, 2012, we had contractual obligations that expire at various dates through 2022 to invest up to an additional $54.3 million in alternative and other investments. There is no certainty that any such additional investment will be required.

  

 

Note 13. Litigation

In the ordinary course of conducting business, we are named as defendants in various legal proceedings. Most of these proceedings are claims litigation involving our eight insurance subsidiaries (the “Insurance Subsidiaries”) as either: (a) liability insurers defending or providing indemnity for third-party claims brought against insureds; or (b) insurers defending first-party coverage claims brought against them. We account for such activity through the establishment of unpaid loss and loss adjustment expense reserves. We expect that the ultimate liability, if any, with respect to such ordinary course claims litigation, after consideration of provisions made for potential losses and costs of defense, will not be material to our consolidated financial condition, results of operations, or cash flows.

 

Our Insurance Subsidiaries are also from time-to-time involved in other legal actions, some of which assert claims for substantial amounts. These actions include, among others, putative class actions seeking certification of a state or national class. Such putative class actions have alleged, for example, improper reimbursement of medical providers paid under workers compensation and personal and commercial automobile insurance policies. Our Insurance Subsidiaries also are involved from time-to-time in individual actions in which extra-contractual damages, punitive damages, or penalties are sought, such as claims alleging bad faith in the handling of insurance claims. We believe that we have valid defenses to these cases. We expect that the ultimate liability, if any, with respect to such lawsuits, after consideration of provisions made for estimated losses, will not be material to our consolidated financial condition. Nonetheless, given the large or indeterminate amounts sought in certain of these actions, and the inherent unpredictability of litigation, an adverse outcome in certain matters could, from time-to-time, have a material adverse effect on our consolidated results of operations or cash flows in particular quarterly or annual periods.

 

 

ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Forward-Looking Statements
In this Quarterly Report on Form 10-Q, we discuss and make statements regarding our intentions, beliefs, current expectations, and projections regarding our company’s future operations and performance. Such statements are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are often identified by words such as “anticipates,” “believes,” “expects,” “will,” “should,” and “intends” and their negatives. We caution prospective investors that such forward-looking statements are not guarantees of future performance. Risks and uncertainties are inherent in our future performance. Factors that could cause actual results to differ materially from those indicated by such forward-looking statements include, but are not limited to, those discussed under Item 1A. “Risk Factors” below in Part II “Other Information”. 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. We make forward-looking statements based on currently available information and assume no obligation to update these statements due to changes in underlying factors, new information, future developments, or otherwise.

  

Introduction

We classify our business into two operating segments:

·

Insurance Operations, which sells property and casualty insurance products and services; and

·

Investments, which invests the premiums collected by our insurance operations.

 

Our Insurance Operations offers standard market insurance products and services through seven insurance subsidiaries and, in 2011, we began offering excess and surplus lines (“E&S”) insurance products through one insurance subsidiary as the result of the following acquisition activity:

·

The purchase of the renewal rights to an E&S book of business in August 2011; and

·

The purchase of Montpelier U.S. Insurance Company (now known as Mesa Underwriters Specialty Insurance Company) (“MUSIC”) in December 2011.

Our eight insurance subsidiaries are collectively referred to as the “Insurance Subsidiaries”.

 

For additional information regarding our recent acquisitions, refer to Note 13. “Business Combinations” in Item 8. “Financial Statements and Supplementary Data.” of our Annual Report on Form 10-K for the year ended December 31, 2011 (“2011 Annual Report”).

 

The purpose of the Management’s Discussion and Analysis (“MD&A”) is to provide an understanding of the consolidated results of operations and financial condition and known trends and uncertainties that may have a material impact in future periods. Consequently, investors should read the MD&A in conjunction with the consolidated financial statements in our 2011 Annual Report.

  

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

·

Critical Accounting Policies and Estimates;

·

Financial Highlights of Results for First Quarter 2012 and 2011;

·

Results of Operations and Related Information by Segment;

·

Financial Condition, Liquidity, Short-term Borrowings, and Capital Resources;

·

Ratings;

·

Off-balance Sheet Arrangements; and

·

Contractual Obligations, Contingent Liabilities, and Commitments.

 

 

Critical Accounting Policies and Estimates

These unaudited interim consolidated financial statements include amounts based on our informed estimates and judgments for those transactions that are not yet complete. Such estimates and judgments affect the reported amounts in the consolidated financial statements. Those estimates and judgments most critical to the preparation of the consolidated financial statements involve the following: (i) reserves for losses and loss expenses; (ii) deferred policy acquisition costs; (iii) premium audit; (iv) pension and post-retirement benefit plan actuarial assumptions; (v) other-than-temporary investment impairments; and (vi) reinsurance. These estimates and judgments require the use of assumptions about matters that are highly uncertain and, therefore, are subject to change as facts and circumstances develop. If different estimates and judgments had been applied, materially different amounts might have been reported in the financial statements. For additional information regarding our critical accounting policies, refer to our 2011 Annual Report, pages 47 through 56.

 

Financial Highlights of Results for First Quarter 2012 and 2011¹

 

		Unaudited
		Quarter Ended
		March 31,
($ and shares in thousands)		2012				2011				Change
GAAP measures:
Revenues		$	419,348				403,456				4	%
Pre-tax net investment income			32,628				43,473				(25	)
Pre-tax net income			23,191				26,158				(11	)
Net income			18,093				20,500				(12	)
Diluted net income per share			0.33				0.37				(11	)
Diluted weighted-average outstanding shares			55,605				55,054				1
GAAP combined ratio			100.4	%			103.6				(3.2	) pts
Statutory combined ratio			99.1	%			102.6				(3.5	)
Return on average equity			6.8	%			8.0				(1.2	)
Non-GAAP measures:
Operating income2		$	15,260				16,756				(9	)%
Diluted operating income per share2			0.28				0.30				(7	)
Operating return on average equity2			5.7	%			6.5				(0.8	) pts

 

¹ Refer to the Glossary of Terms attached to our 2011 Annual Report as Exhibit 99.1 for definitions of terms used in this Form 10-Q.

² Operating income is used as an important financial measure by us, analysts, and investors, because the realization of investment gains and losses on sales in any given period is largely discretionary as to timing. In addition, these realized investment gains and losses, as well as other-than-temporary impairments (“OTTI”) that are charged to earnings could distort the analysis of trends. See below for a reconciliation of operating income to net income in accordance with U.S. generally accepted accounting principles (“GAAP”). Operating return on average equity is calculated by dividing annualized operating income by average stockholders’ equity.

 

Our pre-tax net income decreased by $3.0 million in the first quarter of 2012 (“First Quarter 2012”) as compared to the first quarter of 2011 (“First Quarter 2011”), primarily due to a reduction in net investment income of $10.8 million partially offset by improved underwriting operations. The net income fluctuation between 2012 and 2011 is consistent with these pre-tax income changes.

 

The following table reconciles operating income and net income for the periods presented above:

 

		Quarter ended  March 31,
($ in thousands, except per share amounts)		2012				2011
Operating income		$	15,260				16,756
Net realized gains, net of tax			2,833				3,744
Net income		$	18,093				20,500
Diluted operating income per share		$	0.28				0.30
Diluted net realized gains per share			0.05				0.07
Diluted net income per share		$	0.33				0.37

 

The variances in operating income are reflective of the results discussed above.

 

 

Results of Operations and Related Information by Segment

 

Insurance Operations

 

Our standard market insurance products and services are sold primarily in 22 states in the Eastern and Midwestern U.S. through approximately 1,000 independent insurance agencies. Our recent E&S acquisitions provide us the opportunity to write contract binding authority E&S business in all 50 states and the District of Columbia through approximately 100 wholesale agents across the entire country.

 

Our Insurance Operations segment consists of two components: (i) Commercial Lines, which markets primarily to businesses and represents approximately 82% of net premiums written (“NPW”); and (ii) Personal Lines, which markets primarily to individuals and represents approximately 18% of NPW. Our E&S operations write exclusively commercial lines of business, and for purposes of this MD&A, this business is included within Commercial Lines. The underwriting performance of these lines is generally measured by four different statutory ratios: (i) the loss and loss expense ratio; (ii) the underwriting expense ratio; (iii) the dividend ratio; and (iv) the combined ratio.

 

Summary of Insurance Operations

 

All Lines		Quarter ended								Change
		March 31,								% or
($ in thousands)		2012				2011				Points
GAAP Insurance Operations Results:
NPW			420,172				361,835				16
Net premiums earned (“NPE”)			378,829				351,343				8
Less:
Losses and loss expenses incurred			252,906				249,206				1
Net underwriting expenses incurred			126,372				113,549				11
Dividends to policyholders			914				1,286				(29	)
Underwriting loss		$	(1,363	)			(12,698	)			89	%
GAAP Ratios:
Loss and loss expense ratio			66.8	%			70.9				(4.1	) pts
Underwriting expense ratio			33.4				32.3				1.1
Dividends to policyholders ratio			0.2				0.4				(0.2	)
Combined ratio			100.4				103.6				(3.2	)
Statutory Ratios:
Loss and loss expense ratio			66.7				70.9				(4.2	)
Underwriting expense ratio			32.2				31.3				0.9
Dividends to policyholders ratio			0.2				0.4				(0.2	)
Combined ratio			99.1	%			102.6				(3.5	) pts

 

Overall NPW increased by 16% in First Quarter 2012 compared to First Quarter 2011, 7.1 points of which were attributable to our E&S operations that generated NPW of $25.8 million. The remainder of the increase was attributable to our standard market business due to the following: (i) Commercial Lines renewal pure price increases of 5.1% coupled with a three-point increase in retention to 83%; (ii) Personal Lines filed rate increases that were effective for the quarter that averaged 5.9% while retention improved one point from a year ago to 87%; (iii) an overall increase in direct new business premiums of $21.8 million; and (iv) audit and endorsement additional premium of $5.7 million compared to return premium of $4.0 million in First Quarter 2011.

 

·

NPE increases in First Quarter 2012 were consistent with the fluctuation in NPW for the twelve-month period ended March 31, 2012 as compared to the twelve-month period ended March 31, 2011.

 

 

·

The GAAP loss and loss expense ratio decreased in First Quarter 2012 compared to the same quarter in the prior year primarily attributable to a decrease in non-catastrophe property losses of $9.3 million, or 3.7 points, to $51.9 million coupled with growth in NPE that has outpaced loss cost trends. Catastrophe losses of $6.9 million in First Quarter 2012 were comparable to catastrophe losses of $6.8 million in First Quarter 2011.

 

·

The GAAP underwriting expense ratio in First Quarter 2012 increased by 1.1 points compared to First Quarter 2011 primarily driven by expenses of $7.2 million associated with our E&S business. As MUSIC unearned premiums as of the acquisition date were fully ceded, our underwriting expense ratio will be under pressure going forward until the premiums that we write subsequent to the purchase are earned to support the ongoing expenses of these operations.

 

Insurance Operations Outlook  

The insurance industry continues to demonstrate higher levels for pricing and underwriting discipline, in part due to the extreme levels of catastrophe losses in 2011. However, until a sustained hard market has been established, the industry is expected to remain unprofitable as evidenced by A.M. Best’s industry combined ratio projection of 102.0% for 2012, including approximately 2 points of favorable prior year reserve development. Our Insurance Operations segment reported a statutory combined ratio of 99.1% for First Quarter 2012 as compared to 102.6% in First Quarter 2011. Our full year 2012 expectation remains at a statutory combined ratio of 101.5%.

 

A.M Best continues to maintain its negative outlook on the commercial lines sector as widespread pricing improvements have not yet materialized. A recent report from the Commercial Lines Insurance Pricing Survey showed that industry pricing increased by 3.3% during the fourth quarter of 2011. While industry pricing continues to improve, we are on our twelfth consecutive quarter of Commercial Lines renewal pure price increases with 5.1% in First Quarter 2012 while retention continues to be strong at 83%, an increase of three points as compared to the prior year. The price increases that we have obtained demonstrate the overall strength of the relationships that we have with our independent agents, even in difficult economic times.

 

The personal lines market continues to be more receptive to price increases, and A.M. Best has continued to maintain a stable outlook for the sector, citing that capitalization will continue to be strong and rating actions will generally be affirmations. Our Personal Lines operations continue to experience NPW growth driven by ongoing rate increases that went into effect over the past several years. Personal Lines filed rate increases that were effective for the quarter that averaged 5.9% while retention improved one point from a year ago to 87%. As we achieve rate increases in excess of loss trends, we expect profitability in this line to improve

 

In First Quarter 2012, some positive variances in underwriting results and some negative variances in investments led to overall earnings within expectations.  We are maintaining the 2012 guidance as follows:

 

·

A statutory combined ratio of 101.5% and a GAAP combined ratio of 102.5%, which do not include any additional reserve development assumptions, either favorable or unfavorable, and catastrophe losses of 2.5 points – about a point higher than the historical average to reflect the more severe weather patterns;

·

Investment income expected to be approximately flat with 2011 levels; and

·

Weighted average shares outstanding of 55.6 million.

 

 

Review of Underwriting Results by Line of Business

 

Commercial Lines

 

Commercial Lines		Quarter ended								Change
		March 31,								% or
($ in thousands)		2012				2011				Points
GAAP Insurance Operations Results:
NPW		$	354,626				300,334				18	%
NPE			310,220				286,763				8
Less:
Losses and loss expenses incurred			205,273				196,022				5
Net underwriting expenses incurred			108,517				95,647				14
Dividends to policyholders			914				1,286				(29	)
Underwriting loss		$	(4,484	)			(6,192	)			28	%
GAAP Ratios:
Loss and loss expense ratio			66.2	%			68.4				(2.2	) pts
Underwriting expense ratio			34.9				33.4				1.5
Dividends to policyholders ratio			0.3				0.4				(0.1	)
Combined ratio			101.4				102.2				(0.8	)
Statutory Ratios:
Loss and loss expense ratio			66.1				68.4				(2.3	)
Underwriting expense ratio			32.8				31.8				1.0
Dividends to policyholders ratio			0.3				0.4				(0.1	)
Combined ratio			99.2	%			100.6				(1.4	) pts

 

·

Overall NPW increased by 18% in First Quarter 2012 compared to First Quarter 2011, including $25.8 million, or 8.6 points, from our E&S operations. The remainder of the increases were attributable to our standard market Commercial Lines business, which reflects the following:

o

Renewal pure price increases of 5.1% coupled with a three-point increase in retention to 83%;

o

Increase in direct new business of 48%, or $22.7 million, to $69.9 million; and

o

Audit and endorsement additional premium of $5.7 million in First Quarter 2012, compared to return premium of $4.1 million in First Quarter 2011.

 

·

NPE increases in First Quarter 2012 compared to First Quarter 2011 are consistent with the fluctuation in NPW for the twelve-month period ended March 31, 2012 as compared to the twelve-month period ended March 31, 2011.

 

·

The 2.2-point decrease in the GAAP loss and loss expense ratio from First Quarter 2011 primarily reflects the reduction in non-catastrophe property losses of $2.1 million, or 1.6 points. In addition, the loss and loss expense ratio reflects: (i) a reduction in catastrophe losses of 0.5 points, or $1.1 million, to $3.9 million in First Quarter 2012; and (ii) growth in NPE that has outpaced cost trends.

 

·

The increase in the GAAP underwriting expense ratio of 1.5 points in First Quarter 2012 compared to First Quarter 2011 was driven by underwriting expenses of $7.2 million associated with our E&S business, which added 1.3 points for the First Quarter 2012. As MUSIC unearned premiums as of the acquisition date were fully ceded, our underwriting expense ratio will be under pressure going forward until the premiums that we write subsequent to the purchase are earned to support the ongoing expenses of these operations.

 

 

The following is a discussion of our most significant standard market commercial lines of business:

 

General Liability

 

		Quarter ended								Change
		March 31,								% or
($ in thousands)		2012				2011				Points
Statutory NPW		$	100,628				88,772				13	%
Statutory NPE			90,143				82,566				9
Statutory combined ratio			100.2	%			100.3				(0.1	) pts
% of total statutory commercial NPW			28	%			30

 

We continue to see improvements in pricing in this line as our renewal pure price increase was 5.8% in First Quarter 2012. Along with our ability to achieve price increases, we are seeing premium improvement in this line compared to First Quarter 2011 as evidenced by the following:

o

New business up 49%, or $6.2 million, to $19.1 million compared to First Quarter 2011;

o

A three-point improvement in retention compared to First Quarter 2011 to approximately 83%; and

o

Audit and endorsement premium of $2.0 million in First Quarter 2012, compared to return premium of $3.0 million in First Quarter 2011.

 

The statutory combined ratio for First Quarter 2012 was flat compared to the same period last year. While there was no prior year development in First Quarter 2012, First Quarter 2011 was impacted by favorable prior year development of approximately $3 million, or 3.5 points. The prior year development was driven by 2008 and prior accident years partially offset by adverse development in the 2010 accident year.

 

Workers Compensation

 

		Quarter ended								Change
		March 31,								% or
($ in thousands)		2012				2011				Points
Statutory NPW		$	73,188				67,768				8	%
Statutory NPE			65,811				62,526				5
Statutory combined ratio			110.9	%			122.8				(11.9	) pts
% of total statutory commercial NPW			21	%			23

 

In First Quarter 2012, we achieved renewal pure price increases of 6.9%. In addition, improvements in NPW include the following:

o

New business up 36%, or $4.1 million, to $15.4 million compared to First Quarter 2011;

o

A one-point improvement in retention compared to First Quarter 2011 to approximately 80%; and

o

Audit and endorsement additional premium of $2.8 million in First Quarter 2012, compared to $2.9 million of return premium in First Quarter 2011.

 

The decrease in the statutory combined ratio of this line reflects no net prior year development in First Quarter 2012, compared to $6 million, or 9.6 points, of unfavorable development related to the 2010 accident year for First Quarter 2011.

 

 

Commercial Automobile

  

		Quarter ended								Change
		March 31,								% or
($ in thousands)		2012				2011				Points
Statutory NPW		$	75,838				71,729				6	%
Statutory NPE			70,484				69,670				1
Statutory combined ratio			96.6	%			92.3				4.3	pts
% of total statutory commercial NPW			21	%			24

 

NPW increased 6% on this line of business in First Quarter 2012 compared to the same period last year driven by: (i) new business growth of 48%, or $4.8 million, to $14.6 million; (ii) renewal pure price increases of 4.0%; and (iii) a three-point improvement in retention to 83%.

 

The increase in the statutory combined ratio was primarily driven by lower favorable casualty prior year development in First Quarter 2012 compared to First Quarter 2011. Prior year casualty development was as follows:

o

2012: $1 million, or 1.4 points, of favorable development; and

o

2011: $5 million, or 6.5 points of favorable development, driven by accident years 2006 through 2009.

 

Commercial Property

 

		Quarter ended								Change
		March 31,								% or
($ in thousands)		2012				2011				Points
Statutory NPW		$	53,027				48,331				10	%
Statutory NPE			49,371				48,193				2
Statutory combined ratio			83.9	%			86.8				(2.9	) pts
% of total statutory commercial NPW			15	%			16

 

NPW for this line of business increased in First Quarter 2012 compared to First Quarter 2011 primarily due to: 

o

New business, which was up 73%, or $5.4 million, to $12.7 million;

o

An increase in retention of three points, to 82%; and

o

Renewal pure price increases of 3.9%.

 

The improvement in the statutory combined ratio was driven by a decrease in catastrophe losses of $2.3 million, or 4.9 points, compared to First Quarter 2011. Partially offsetting the catastrophe losses were non-catastrophe property losses that increased by 1.2 points for First Quarter 2012 compared to First Quarter 2011.

 

 

Personal Lines

 

Personal Lines		Quarter ended								Change
		March 31,								% or
($ in thousands)		2012				2011				Points
GAAP Insurance Operations Results:
NPW		$	65,546				61,501				7	%
NPE			68,609				64,580				6
Less:
Losses and loss expenses incurred			47,633				53,184				(10	)
Net underwriting expenses incurred			17,855				17,902				-
Underwriting gain (loss)		$	3,121				(6,506	)			148	%
GAAP Ratios:
Loss and loss expense ratio			69.4	%			82.4				(13.0	) pts
Underwriting expense ratio			26.1				27.7				(1.6	)
Combined ratio			95.5				110.1				(14.6	)
Statutory Ratios:
Loss and loss expense ratio			69.4				82.2				(12.8	)
Underwriting expense ratio			28.3				29.3				(1.0	)
Combined ratio			97.7	%			111.5				(13.8	) pts

 

·

NPW increased in First Quarter 2012 compared to First Quarter 2011 primarily due to:

o

Filed rate increases that were effective for the quarter that averaged 5.9%; and

o

Improved retention of one point to 87%.

 

·

NPE increases in First Quarter 2012, compared to the same period last year, are consistent with the fluctuation in NPW for the 12-month period ended March 31, 2012 as compared to the 12-month period ended March 31, 2011.

 

·

The 13-point decrease in the GAAP loss and loss expense ratio in First Quarter 2012 compared to First Quarter 2011 was primarily attributable to: (i) a decrease in non-catastrophe property losses of $7.1 million, or 12.7 points, to $18.4 million; and (ii) growth in NPE that has outpaced loss trends. Catastrophe losses slightly offset this decrease with $3.0 million, or 4.4 points in First Quarter 2012 compared to $1.8 million, or 2.8 points, in First Quarter 2011.

 

·

The decrease in the GAAP underwriting expense ratio in First Quarter 2012 compared to First Quarter 2011 reflects the impact of premiums outpacing expenses last year. On a statutory basis, the impact of this trend is recognized immediately in the expense ratio, while on a GAAP basis, the impact is recognized over the policy period.

 

 

Investments

Our investment philosophy includes certain return and risk objectives for the fixed maturity, equity, and other investment portfolios. The primary fixed maturity portfolio return objective is to maximize after-tax investment yield and income while balancing risk. A secondary objective is to meet or exceed a weighted-average benchmark of public fixed income indices. Within the equity portfolio, the high dividend yield equities strategy is designed to generate consistent dividend income while maintaining a minimal tracking error to the Standard & Poor’s (“S&P”) 500 Index. Additional equity security strategies are focused on meeting or exceeding strategy specific benchmarks of public equity indices. Although yield and income generation remain the key drivers to our investment strategy, our overall philosophy is to invest with a long-term horizon along with predominately a “buy-and-hold” approach. The return objective of the other investment portfolio, which includes alternative investments, is to meet or exceed the S&P 500 Index.

 

Total Invested Assets

 

($ in thousands)		March 31, 2012				December 31, 2011				Change %
Total invested assets		$	4,154,301				4,112,421				1	%
Unrealized gain – before tax			164,630				149,612				10
Unrealized gain – after tax			107,009				97,248				10

 

The increase in our investment portfolio compared to year-end 2011 was driven primarily by: (i) operating cash flows generated from Insurance Operations; and (ii) valuation improvements on securities in our available-for-sale (“AFS”) portfolio. The cash generated from our Insurance Operations in First Quarter 2012 was used to invest primarily in corporate securities within our fixed income portfolio.

 

We structure our portfolio conservatively with a focus on: (i) asset diversification; (ii) investment quality; (iii) liquidity, particularly to meet the cash obligations of our Insurance Operations segment; (iv) consideration of taxes; and (v) preservation of capital. We believe that we have a high quality and liquid investment portfolio. The breakdown of our investment portfolio is as follows:

 

		March 31,				December 31,
		2012				2011
U.S. government obligations			8	%			9	%
Foreign government obligations			1				1
State and municipal obligations			30				30
Corporate securities			33				31
Mortgage-backed securities (“MBS”)			15				15
Asset-backed securities (“ABS”)			2				2
Total fixed maturity securities			89				88
Equity securities			4				4
Short-term investments			4				5
Other investments			3				3
Total			100	%			100	%

 

 

Fixed Maturity Securities 

The average duration of the fixed maturity securities portfolio as of March 31, 2012 was 3.3 years compared to the Insurance Subsidiaries’ liability duration of approximately 3.8 years, which was relatively consistent with the prior year. The current duration of the fixed maturity securities portfolio is within our historical range, and is monitored and managed to maximize yield and limit interest rate risk. We are currently experiencing pressure on our yields within our fixed maturity securities portfolio, as higher yielding bonds that are either maturing or have been sold are being replaced with the lower yielding bonds that are currently available in the marketplace. We manage liquidity with a laddered maturity structure and an appropriate level of short-term investments to avoid liquidation of AFS fixed maturities in the ordinary course of business. We typically have a long investment time horizon, and every purchase or sale is made with the intent of maximizing risk adjusted investment returns in the current market environment while balancing capital preservation. In First Quarter 2012, we continued to migrate to investment-grade corporate bonds as part of our overall investment strategy, due to the more attractive risk/return characteristics of the corporate sector. We also invested in high credit quality municipal bonds and MBS.

 

Our fixed maturity securities portfolio maintains a weighted average credit rating of “AA-” as of March 31, 2012. The following table presents the credit ratings of our fixed maturity securities portfolio:

 

 

Fixed Maturity		March 31,				December 31,
Security Rating		2012				2011
Aaa/AAA			15	%			14	%
Aa/AA			50				52
A/A			25				24
Baa/BBB			9				9
Ba/BB or below			1				1
Total			100	%			100	%

 

 

The following table summarizes the fair value, unrealized gain (loss) balances, and the weighted average credit qualities of our AFS fixed maturity securities at March 31, 2012 and December 31, 2011:

 

		March 31, 2012												December 31, 2011
										Average												Average
			Fair				Unrealized			Credit					Fair				Unrealized			Credit
($ in millions)			Value				Gain (Loss)			Quality					Value				Gain (Loss)			Quality
AFS Fixed Maturity Portfolio:
U.S. government obligations1		$	335.2				18.7				AA+				353.8				20.3				AA+
Foreign government obligations			37.8				0.9				AA				34.2				0.5				AA
State and municipal obligations			669.1				40.1				AA				622.7				44.4				AA
Corporate securities			1,294.9				58.0				A				1,213.3				44.9				A
MBS			602.8				17.9				AA				594.5				19.2				AA
ABS			94.7				1.4				AAA				78.9				1.2				AAA
Total AFS fixed maturity portfolio		$	3,034.5				137.0				AA-				2,897.4				130.5				AA-
State and Municipal Obligations:
General obligations		$	304.2				20.0				AA+				282.6				22.1				AA+
Special revenue obligations			364.9				20.1				AA				340.1				22.3				AA
Total state and municipal obligations		$	669.1				40.1				AA				622.7				44.4				AA
Corporate Securities:
Financial		$	420.6				12.9				A				379.0				3.7				A
Industrials			86.3				6.8				A-				86.9				6.1				A-
Utilities			82.5				3.8				BBB+				75.6				3.5				BBB+
Consumer discretion			113.0				5.6				A-				104.3				4.9				BBB+
Consumer staples			141.8				7.3				A				137.3				6.9				A
Healthcare			153.0				8.6				AA-				145.0				8.3				AA-
Materials			69.4				3.3				A-				66.5				2.5				A-
Energy			82.7				3.6				A-				77.9				3.3				A-
Information technology			80.0				2.8				A				74.3				2.6				A
Telecommunications services			54.3				2.0				BBB+				50.9				1.5				BBB+
Other			11.3				1.3				AA+				15.6				1.6				AA+
Total corporate securities		$	1,294.9				58.0				A				1,213.3				44.9				A
MBS:
Government guaranteed agency commercial MBS (“CMBS”)		$	68.4				3.4				AA+				72.9				5.0				AA+
Non-agency CMBS			43.7				(1.3	)			A				39.7				(0.3	)			A-
Government guaranteed agency residential MBS (“RMBS”)			102.8				4.8				AA+				98.2				4.7				AA+
Other agency RMBS			340.1				10.6				AA+				339.1				10.8				AA+
Non-agency RMBS			40.7				0.3				BBB+				37.1				(1.0	)			BBB
Alternative-A (“Alt-A”) RMBS			7.1