SELECTIVE INSURANCE GROUP INC - Annual Report: 2009 (Form 10-K)
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-K
(Mark
One)
x
|
ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
1934
|
For the
fiscal year ended December 31, 2009
OR
¨
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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 1-33067
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.)
|
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40
Wantage Avenue, Branchville, New Jersey
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07890
|
|
(Address
of Principal Executive Office)
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(Zip
Code)
|
|
Registrant’s
telephone number, including area code:
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(973)
948-3000
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Securities
registered pursuant to Section 12(b) of the Act:
|
||
Title of Each Class
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Name of Each Exchange on Which
Registered
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Common
Stock, par value $2 per share
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NASDAQ
Global Select Market
|
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7.5%
Junior Subordinated Notes due September 27, 2066
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New
York Stock Exchange
|
|
Securities
registered pursuant to Section 12(g) of the
Act: None
|
Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.
x Yes
¨ No
Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.
¨ Yes
x No
Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months, (or for such shorter period that the registrant was
required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days.
x Yes
¨ No
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Website, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).
¨ Yes ¨ No
Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained here in, and will not be contained, to the best
of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K.
¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company. See definitions of “large accelerated filer,” “accelerated
filer” and “smaller reporting company” in Rule 12b-2 of the Exchange
Act.
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 Act).
¨ Yes x No
The
aggregate market value of the voting company common stock held by non-affiliates
of the registrant, based on the closing price on the NASDAQ Global Select
Market, was $663,122,319 on June 30, 2009. As of February 12, 2010,
the registrant had outstanding 53,173,723 shares of common stock.
DOCUMENTS
INCORPORATED BY REFERENCE
Portions
of the registrant’s definitive Proxy Statement for the 2010 Annual Meeting of
Stockholders to be held on April 28, 2010 are incorporated by reference into
Part III of this report.
SELECTIVE
INSURANCE GROUP, INC.
Table of
Contents
Page No.
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PART I.
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Item
1. Business
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3
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Item
1A. Risk Factors
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23
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Item
1B. Unresolved Staff Comments
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36
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Item
2. Properties
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36
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Item
3. Legal
Proceedings
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36
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Item
4. Submission of Matters to a
Vote of Security Holders
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36
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PART II
|
|
Item
5. Market For Registrant’s Common
Equity, Related Stockholder Matters and
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|
Issuer
Purchases of Equity Securities
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37
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Item
6. Selected Financial
Data
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39
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Item
7. Management’s Discussion and
Analysis of Financial Condition and
|
|
Results
of Operations
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41
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Forward-looking
Statements
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41
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Introduction
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41
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Critical
Accounting Policies and Estimates
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42
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Financial
Highlights of Results for Years Ended December 31, 2009,
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|
2008,
and 2007
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52
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Results
of Operations and Related Information by Segment
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54
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Federal
Income Taxes
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70
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Financial
Condition, Liquidity and Capital Resources
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70
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Pending
Accounting Pronouncements
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74
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Item
7A. Quantitative and Qualitative Disclosures
About Market Risk
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75
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Item
8. Financial Statements and
Supplementary Data
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81
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Consolidated
Balance Sheets as of December 31, 2009 and 2008
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82
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Consolidated
Statements of Income for the Years Ended
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|
December
31, 2009, 2008, and 2007
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83
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Consolidated
Statements of Stockholders’ Equity for the Years Ended
|
|
December
31, 2009, 2008, and 2007
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84
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Consolidated
Statements of Cash Flows for the Years Ended
|
|
December
31, 2009, 2008, and 2007
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85
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Notes
of Consolidated Financial Statements
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86
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Item
9. Changes in and
Disagreements With Accountants on Accounting
|
|
And
Financial Disclosure
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132
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Item
9A. Controls and
Procedures
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132
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Item
9B. Other Information
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134
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PART III.
|
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Item
10. Directors, Executive
Officers and Corporate Governance
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134
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Item
11. Executive
Compensation
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134
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Item
12. Security Ownership of
Certain Beneficial Owners and Management
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|
and
Related Stockholder Matters
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134
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Item
13. Certain Relationships
and Related Transactions, and Director Independence
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134
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Item
14. Principal Accountant
Fees and Services
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134
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Part IV.
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Item
15. Exhibits and Financial
Statement Schedules
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135
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2
PART
I
Item
1. Business.
Overview
Selective
Insurance Group, Inc. is a holding company for seven insurance subsidiaries
(collectively referred to as “we,” “us,” or “our”) that principally offer
property and casualty insurance products and services in the East and Midwest of
the United States. We are a New Jersey corporation formed in 1977,
and our headquarters are in Branchville, New Jersey. Our common stock
is traded on the NASDAQ Global Select Market under the symbol
“SIGI.” In 2009, we were ranked as the 48th largest
property and casualty group in the United States in A.M. Best and Company’s
annual list of “Top 200 U.S. Property/Casualty Groups.”
In 2009,
we classified our business into two operating segments:
|
·
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Insurance
Operations, which sells property and casualty insurance policies and
products; and
|
|
·
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Investment
Operations, which invests the premiums collected by the Insurance
Operations.
|
We
eliminated our third operating segment, Diversified Insurance Services in two
steps in 2009: In the first quarter, we reclassified our federal
flood insurance administrative services (“Flood”) business into Insurance
Operations because of changes in the way we managed the business; and (ii) in
the fourth quarter, we sold our human resource administration outsourcing (“HR
Outsourcing”) business. See Note 13. “Discontinued Operations” of
this Form 10-K for additional information.
We derive
substantially all of our income in three ways:
|
·
|
Underwriting Income
from the Insurance Operations. Underwriting income is
comprised of both revenues and expenses. The Insurance
Operations revenues are the premiums earned on its insurance products and
services. The gross premiums billed insureds are direct premium
written (“DPW”) plus premiums assumed from other
insurers. Gross premiums billed less premium ceded to
reinsurers, is net premium written (“NPW”). Net Premiums Earned
(“NPE”) is NPW recognized as revenue ratably over the policy’s
term. The Insurance Operations expenses are categorized into
three main categories: (i) losses associated with claims and various loss
expenses incurred for adjusting claims (referred to as “loss and loss
expenses”); (ii) expenses related to insurance policy issuance, such as
agent commissions, premium taxes, reinsurance, and other expenses incurred
in issuing and maintaining policies, including employee compensation and
benefits (referred to as “underwriting expenses”); and (iii) policyholder
dividends.
|
|
·
|
Net Investment Income
from the Investment Operations. From the time we collect
insurance premiums until the time we pay loss and loss expenses;
underwriting expenses; and policyholder dividends; we invest the premiums
and generate investment income. Net investment income consists
primarily of interest earned on fixed maturity investments, dividends
earned on equity securities, and other income that is primarily generated
from our alternative investment portfolio. Interest on fixed
maturity investments, dividends earned on equity investments, and other
income on alternative investments are recorded as net investment
income.
|
|
·
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Net realized gains and
losses on investment securities from the Investment Operations (including
the investment portfolios of our seven insurance subsidiaries (“Insurance
Subsidiaries” and our insurance holding
company). Realized gains and losses from the investment
portfolio are typically the result of sales, maturities, calls, and
redemptions. They also include write downs from
other-than-temporary impairments
(“OTTI”).
|
We
measure the performance of our Insurance Operations by its combined
ratio. Under generally accepted accounting principles in the United
States (“GAAP”), the combined ratio is calculated by adding the loss and loss
adjustment expense ratio, which is the ratio of incurred loss and loss
adjustment expense to NPE and the expense ratio, which is the ratio of policy
acquisition and other underwriting expenses to NPE. A combined ratio
under 100% generally indicates an underwriting profit and a combined ratio over
100% generally indicates an underwriting loss. The statutory combined
ratio does not reflect investment income, federal income taxes, or other
non-operating income or expense.
We
measure the performance of our Investment Operations by its pre- and after-tax
investment income, as well as its associated return on invested
assets. Our investment philosophy includes setting certain return and
risk objectives for the fixed maturity and equity portfolios. We
generally measure our performance by comparing our returns for each of these
components of our portfolio to a weighted-average benchmark of comparable
indices.
3
Our
Insurance Operations and Investment Operations are heavily regulated by the
departments of insurance in the states in which our Insurance Subsidiaries are
organized and licensed. Each insurance subsidiary is required to file
financial statements with such states, prepared in accordance with statutory
accounting principles (“SAP”). SAP have been promulgated by the
National Association of Insurance Commissioners (“NAIC”) and adopted by the
various states. The purpose of state insurance regulation is to
protect the policyholders, focusing on solvency and liquidation
value. GAAP, which we are required to use as a holding company,
focuses more on the potential for profit than liquidation. There are
significant differences between SAP and GAAP. However, we use SAP to
manage our Insurance Operations and discuss these differences further under
“Measure of Insurance
Operations Profitability.”
Insurance
Operations
Overview
We derive
substantially all of our Insurance Operations revenue from selling insurance
products and services to businesses and individuals in exchange for
premium. Sales to businesses, non-profit organizations, and local
government entities, which are called Commercial Lines, represent about 84% of
our revenue. Sales to individuals, which are called Personal Lines,
represent about 16% of our revenue. The bulk of our sales are annual
insurance policies. Commercial Lines sales are seasonally heaviest in
January and July and lowest during the fourth quarter of the year.
Insurance Operations
Products and Services
The types
of insurance we sell in our Insurance Operations fall into three broad
categories:
|
·
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Property
insurance, which generally covers the financial consequences of accidental
loss of an insured’s real and/or personal property. Property
claims are generally reported and settled in a relatively short period of
time;
|
|
·
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Casualty
insurance, which generally covers the financial consequences of employee
injuries in the course of employment and bodily injury and/or property
damage to a third party as a result of an insured’s negligent acts,
omissions, or legal liabilities. Some casualty claims may take
several years to be reported and settled;
and
|
|
·
|
Package
insurance, which is a combination of property and
casualty. Package claims mirror the reporting and settlement
time of the underlying portion of
coverage.
|
The main
Commercial Lines we underwrite and insure primarily through traditional
insurance and, to a lesser extent, through alternative risk management products,
such as retrospective rating plans, self-insured group retention programs, or
individual self-insured accounts, are as follows:
Type
of Policy
|
Category
of Insurance
|
Commercial
Property
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Property
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Commercial
Automobile
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Package
|
General
Liability (including Excess Liability/Umbrella)
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Casualty
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Workers
Compensation
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Casualty
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Business
Owners Policy (“BOP”)
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Package
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Bonds
(Fidelity and Surety)
|
Casualty
|
The main
Personal Lines we underwrite and insure are as follows:
Type
of Policy
|
Category
of Insurance
|
Homeowners
|
Package
|
Personal
Automobile
|
Package
|
4
Product Development and
Pricing
Our
Insurance Operations policies are contracts that specify our coverages – what we
will pay to or for an insured upon specified losses. We develop our
coverages internally and by adopting and modifying forms and statistical data
licensed from third party aggregators, notably Insurance Services Office, Inc.
(“ISO”). Determining the price to charge for our coverages is
complicated. At the time we underwrite and issue a policy, we do not
know what our actual costs for the policy will be in the future. To
calculate and project future costs, we examine and analyze historical
statistical data and factor in expected changes in loss trends. In
the last five years, we have also developed predictive models for our Insurance
Operations. Predictive models analyze historical statistical data
regarding our insureds and their loss experience and, applying and analyzing
that information to risks of current insureds and prospective insureds, provide
us with an analysis and prediction of the likely profitability of the
account. The model’s predictive capabilities are limited by the
amount and quality of the statistical data available. As a regional
insurance group, our Insurance Operations’ loss experience is not large enough
in all circumstances to analyze and project future costs. We use data
from ISO to supplement ours. Also, by using ISO’s policy language,
policy writing rules, prospective loss cost information, and rates, our
Insurance Operations ensure compliance with all applicable legal and regulatory
requirements.
Customers and Customer
Markets
Commercial
Lines customers represent 84% of our total DPW. The following
provides a breakdown of these customers by policy size:
Market
|
Premium
Account Size
|
%
of DPW
|
Small
Business
|
<$25,000
|
51%
|
Middle
Market
|
≥$25,000
to $250,000
|
43%
|
Large
Accounts
|
>$250,000
|
6%
|
Approximately
20% of the Large Account premium includes alternative risk transfer
mechanisms. Personal Lines customers represent 16% our total direct
premiums. We do not sub-divide our Personal Lines customers by size
or class. No one customer accounts for 10% or more of our
premium.
Geographic
Markets
Our
Insurance Operations only do business in the United States, of which we
currently operate in 22 states. We primarily market our products and services in
the East and Midwest regions of the country. We believe that this
geographic diversification lessens our exposure to regulatory, competitive, and
catastrophic risk. The principal states where we conduct business and
their respective percentage of our total NPW over the last three fiscal years is
shown in the following table:
Year
Ended December 31,
|
||||||||||||
Net
Premiums Written
|
2009
|
2008
|
2007
|
|||||||||
New
Jersey
|
26.9 | % | 28.6 | 30.0 | ||||||||
Pennsylvania
|
14.0 | 14.5 | 14.1 | |||||||||
New
York
|
10.1 | 10.2 | 10.8 | |||||||||
Maryland
|
7.1 | 7.4 | 7.6 | |||||||||
Illinois
|
5.6 | 4.8 | 4.4 | |||||||||
Virginia
|
5.4 | 5.7 | 6.0 | |||||||||
Indiana
|
4.1 | 3.7 | 3.5 | |||||||||
North
Carolina
|
3.5 | 4.0 | 4.0 | |||||||||
Georgia
|
3.5 | 3.7 | 3.5 | |||||||||
Michigan
|
2.7 | 2.3 | 2.0 | |||||||||
South
Carolina
|
2.6 | 2.7 | 2.8 | |||||||||
Ohio
|
2.3 | 2.0 | 1.8 | |||||||||
Other
states
|
12.2 | 10.4 | 9.5 | |||||||||
Total
|
100.0 | % | 100.0 | 100.0 |
Distribution and
Marketing
We sell
and distribute our Insurance Operations products and services exclusively
through independent insurance agents. As of December 31, 2009, we had
appointed and entered into agency agreements with approximately 960 independent
agencies. As these agencies often have multiple offices, we have
approximately 2,000 independent agency offices selling our products and
services. We pay our agencies commissions and other consideration for
business placed with us (and we do not authorize our agencies to receive other
monies for our insurance). We seek to compensate our agencies fairly and
consistent with market practices. No one agency is responsible for 10% or
more of our Insurance Operations premium.
5
Independent
insurance agents and brokers write approximately 80% of commercial property and
casualty insurance and approximately 35% of the personal lines insurance
business in the United States according to a study released in 2009 by the
Independent Insurance Agents and Brokers of America. We believe that
independent insurance agents will remain a significant force in overall
insurance industry premium production because they represent more than one
insurance group and can provide insureds with a wider choice of Commercial Lines
and Personal Lines insurance products than if they represented only one
insurer. Because our agencies also generally represent several of our
competitors and we face competition within our distribution channel, it is
sometimes difficult to develop brand recognition among our customers, who do not
always differentiate between insurance carriers and insurance coverages because
of their reliance on their independent insurance agent. Our primary
marketing strategy with agents is to:
·
|
Develop
close relationships with each agency and its principals by
(i) soliciting their feedback on products and services, (ii) advising
them concerning company developments, and (iii) investing significant time
with them professionally and
socially;
|
·
|
Develop
with each agency, and then carefully monitor, annual goals regarding (i)
types and mix of risks placed with us, (ii) amounts of premium or numbers
of policies placed with us, (iii) customer service levels, and (iv)
profitability of business placed with us;
and
|
·
|
Use
a business model that gives them close geographic proximity to
underwriting decision-makers and broad, competitive coverages and
services.
|
We
received an overall satisfaction score of 8.5 out of 10 for the second
consecutive year from our agent survey, which demonstrates that our field model
and technology makes it easier for our agents to do business with
us.
Field and Technology
Strategies Supporting Independent Agent Distribution
We use
the service mark “High-Tech x High-Touch = HT2 SM” to
describe our Insurance Operations business strategy. “High-Tech”
refers to our advanced technology that we use to make it easy for our
independent insurance agents and customers to do business with
us. “High-Touch” refers to the close relationships that we have with
our independent insurance agents and customers due to our field business model
that places underwriters, claims representatives, technical staff, and safety
management representatives near our agents and customers.
Employees
To
support our independent agents, we employ a field model in both underwriting and
claims. The field model places various employees in the field,
usually working from home offices near our agents. We believe that we
build better and stronger relationships with our agents because of the close
proximity of our field employees to our agents and the resulting direct and
regular interaction with our agents and our customers.
6
At
December 31, 2009, we had approximately 1,900 employees. Our
employees that work primarily from the field as of December 31, 2009 are shown
on the following table:
Field Position
|
Responsibility
|
No. of Employees
|
||
Agency
Management Specialist (“AMS”) and Large Account Managers
|
Commercial
Lines.
|
104
|
||
Personal
Lines Territory Manager (“TM”)
|
Personal
Lines.
|
15
|
||
Field
Technology Specialists
|
Train
agents on our technology systems in order to streamline the processing of
our insurance products and obtain agent feedback on areas for technology
improvement.
|
16
|
||
Safety
Management Specialists (“SMS”)
|
Survey
and assess insured and prospective risks from a risk/safety standpoint and
provide ongoing safety management services to certain
insureds.
|
72
|
||
Claims
Management Specialists (“CMS”)
|
|
Like
AMSs, CMSs live in the geographic vicinity of our appointed agents and
generally work from offices in their homes. CMSs, because of
their geographic location, are able to conduct on-site inspections of
losses and resolve claims faster, more accurately, and with higher levels
of customer satisfaction. As a result, CMSs also obtain
knowledge about potential exposures that they can share with
AMSs.
|
|
125
|
We
support our field model with our corporate headquarters in Branchville, New
Jersey, and five regional branch offices (“Regions”). As of December
31, 2009, the Regions and their office locations were as follows:
Region
|
Office Location
|
|
Heartland
|
Carmel,
Indiana
|
|
New
Jersey
|
Hamilton,
New Jersey
|
|
Northeast
|
Branchville,
New Jersey
|
|
Mid-Atlantic
|
Allentown,
Pennsylvania and Hunt Valley, Maryland
|
|
Southern
|
|
Charlotte,
North
Carolina
|
Underwriting Process
Involving Agents and Field Model
Our
underwriting process requires communication and interaction among:
|
·
|
Our
independent agents, who act as front-line underwriters, and our
AMSs;
|
|
·
|
Our
strategic business units (“SBUs”), located in our corporate headquarters,
which are organized by product and customer type and develop our pricing
and underwriting guidelines in conjunction with the
Regions;
|
|
·
|
Our
Regions establish: (i) annual premium and pricing goals in
consultation with the SBUs; (ii) agency new business targets; and (iii)
agency profit improvement plans;
and
|
|
·
|
Our
Actuarial Department, located in our corporate headquarters, which assists
in the determination of rate and pricing levels, while also monitoring
pricing and profitability.
|
We also
have an underwriting service center (“USC”) located in Richmond,
Virginia. The USC assists our independent agents by servicing
Personal Lines and Commercial Lines Small Business and Middle Market
accounts. At the USC, our employees are licensed agents who respond
to customer inquiries about insurance coverage, billing transactions, and other
matters. For the convenience of using the USC and not having to
handle certain transactions, our independent agents agree to receive a slightly
lower than standard commission for the premium associated with the
USC. As of December 31, 2009, our USC was servicing Commercial Lines
NPW of $54 million and Personal Lines NPW of $32 million. The $86
million total serviced by the USC represents 6% of our total
NPW.
7
We
believe that our field underwriting model has a distinct advantage in its
ability to provide a wide range of front-line safety management services focused
on improving an insured’s safety and risk management programs, as expressed by
its service mark “Safety Management: Solutions for a safer
workplace®”. Safety
management services include: (i) risk evaluation and improvement
surveys intended to evaluate potential exposures and provide solutions for
mitigation; (ii) Internet-based safety management educational resources,
including a large library of coverage-specific safety materials, videos and on
line courses, such as defensive driving and employee educational safety courses;
(iii) thermographic infrared surveys aimed at identifying electrical hazards;
and (iv) OSHA construction and general industry certification
training. Risk improvement efforts for existing customers are
designed to improve loss experience and policyholder retention through valuable
ongoing consultative service. Our safety management goal is to
partner with our insureds to identify and eliminate potential loss
exposures.
Claims Management and Field
Claims Model
Effective,
fair, and timely claims management is one of the most important services that we
provide our customers and agents. It also is one of the critical
factors in achieving underwriting profitability. We have structured
our claims organization to emphasize (i) cost-effective delivery of claims
services and control of loss and loss expenses and (ii) maintenance of timely
and adequate claims reserves. We believe that we can achieve lower
claims expenses through our field model and locating claims representatives in
close proximity to our customers and independent agents. In 2009, we
undertook a number of initiatives to reduce claim cycle times and improve
workflows, including: (i) claims automation; (ii) enhancement of
claims quality and control; (iii) litigation management; (iv) compliance
enhancement and bill review; (v) enhancement of workers compensation review; and
(vi) enhancement of salvage and subrogation review. We expect these
initiatives to accelerate the timing of the establishment and inflate the
severity of reserves, although we expect lower loss costs to be ultimately
realized through reduced legal and loss adjustment expenses and a more efficient
claims process.
CMSs are
primarily responsible for investigating and settling a significant portion of
our claims directly with insureds and claimants. By promptly and
personally investigating claims, we believe CMSs are able to provide better
customer and agent service and quickly resolve claims within their
authority. In the rare circumstances where we have insufficient claim
volume to justify the placement of a CMS or when a particular claim expertise is
required, we use independent adjusters. All workers compensation
claims are handled in the Regions. Because of the special nature of
property claims, CMSs refer those claims above certain amounts to our general
property adjusters for consultation. All environmental claims are
referred to our specialized corporate environmental unit.
We also
have a claims service center (“CSC”), co-located with the USC, in Richmond,
Virginia. The CSC receives all first notices of loss from our
insureds. The CSC is designed to: (i) reduce the claims settlement
time on first-and third-party automobile property damage claims; (ii) increase
our use of body shops, glass repair shops, and car rental agencies that have
contracted with us at discounted rates; (iii) handle and settle small property
claims; and (iv) investigate and negotiate auto liability
claims. Upon receipt of a claim, the CSC, as appropriate, will assign
the matter to the appropriate Region or the specialized area in the corporate
headquarters.
We have a
special investigations unit (“SIU”) that investigates potential insurance fraud
and abuse, and supports efforts by regulatory bodies and trade associations to
curtail the cost of fraud. The SIU adheres to uniform internal
procedures to improve detection and take action on potentially fraudulent
claims. It is our practice to notify the proper authorities of its
findings. This practice sends a clear message that we will not
tolerate fraudulent activity committed against us or our
customers. The SIU also supervises anti-fraud training for CMSs and
other employees, including AMSs.
Technology
We try to
do as much of our business as possible with technology. In recent
years, we have made significant investments in information technology platforms,
integrated systems, Internet-based applications, and predictive modeling
initiatives. We did this to provide:
|
§
|
Our
independent agents and customers with access to accurate business
information and the ability to process certain transactions from their
locations seamlessly integrating those transactions into our systems;
and
|
|
§
|
Our
underwriters with targeted pricing tools to enhance profitability while
growing the business.
|
In 2009,
for the second consecutive year, we received the Interface Partner Award from
Applied Systems Client Network, an automated solutions provider to independent
insurance agents, for promoting efficient communication between insurance
carriers and independent agents. The award recognized our leadership
and innovation, specifically citing our commitment to providing agents with
download, real-time inquiry, and real-time rating.
8
We manage
our information technology projects through a project management office
(“EPMO”). The EPMO is staffed by certified individuals who apply
methodologies to: (i) communicate project management standards; (ii)
provide project management training and tools; (iii) review project status and
cost; and (iv) provide non-technology project management consulting services to
the rest of the organization. Our senior management meets
periodically with the EPMO to review all major projects and receive reports on
the status of other projects. We believe that the EPMO is a factor in
the success of our technology implementation and is a competitive
advantage. Our technology operations are located in Branchville, New
Jersey and Glastonbury, Connecticut. We also have agreements with two
consulting and information technology services companies from India that have a
significant presence in the United States to provide supplemental staffing
services to our information technology operation. Together, they
provide approximately 25% of our total capacity for skilled technology
resources. However, we retain all management oversight of projects
and ongoing information technology production operations. We also
believe we would be able to manage an efficient transition to new vendors and
not experience significant impact to our operations if we terminated either
vendor.
Insurance Operations
Competition
Market
Competition
The
property and casualty market is highly competitive and few companies have
significant market share. We compete with three types of companies,
primarily on the basis of price, coverage terms, claims service, safety
management services, ease of technology, and financial ratings:
|
·
|
Regional
insurers, such as Cincinnati Financial Corporation, The Hanover
Insurance Group, Inc., and Harleysville Group, Inc., which offer
Commercial Lines and Personal Lines products and
services;
|
|
·
|
National
insurers, such as Liberty Mutual Group, Travelers Companies, Inc.,
The Hartford Financial Services Group, Inc. and Zurich Financial Services
Group, which offer Commercial Lines and Personal Lines products and
services; and
|
|
·
|
Direct
insurers, such as GEICO and The Progressive Corporation, which
primarily offer Personal Lines coverage and market through the
Internet.
|
Some of
these competitors are public companies and some are mutual
companies. Some, like us, rely solely on independent insurance agents
for distribution of their products and services and have competition within
their distribution channel. Others employ their own agents who only
represent one insurance group. Others use a combination of
independent and captive agents.
We also
face competition, primarily in Commercial Lines, from entities that self-insure
their own risks. From time-to-time, some of our customers and
potential customers evaluate the benefits and risks of alternative risk
mechanisms, such as self-insurance. Generally, only large entities
have the capacity to self-insure. However, in the public sector some
small and mid-sized public entities do have the opportunity to partially
self-insure their risks through the use of risk pools or joint insurance funds
that are generally created by legislative act.
Financial
Ratings
Because
agent and customer concerns about our ability to pay claims in the future are
such an important factor in our competitiveness, our financial ratings are
important to our ability to compete. Major financial rating agencies
evaluated us on our financial strength, operating performance, strategic
position, and ability to meet policyholder obligations. We believe
that our ability to write insurance business is most significantly influenced by
our rating from A.M. Best & Company (“A.M. Best”). We have had
our current rating of “A+ (Superior)” for the last 48 years. A.M.
Best uses its highest Financial Strength Rating of “Secure,” and a descriptor of
“Superior,” for its “A+” rating, which it defines as, “assigned to companies
that have, in our opinion, a superior ability to meet their ongoing obligations
to policyholders.” It is the second highest of 15
ratings. Only approximately 10% of commercial and personal insurance
companies carry an “A+” or better rating from A.M. Best.
Our A.M.
Best Financial Strength Rating of “A+ (Superior)” was most recently reaffirmed
in the second quarter of 2009, at which time our outlook was revised to
“negative” from “stable.” In taking their rating action regarding our
outlook, A.M. Best cited our risk-adjusted capitalization deterioration in 2008
from investment losses and impairment charges and our ability to improve
operating results in the current challenging commercial lines
environment.
We
believe our A.M. Best rating is a competitive advantage in the marketplace and
influences where independent insurance agents place their business. A
downgrade from A.M. Best to a rating below “A-” could affect our ability to
write new business with customers and/or agents, some of whom are required
(under various third party agreements) to maintain insurance with a carrier that
maintains a minimum A.M. Best rating; usually an “A-.”
9
Our
ratings by other major rating agencies are as follows:
Rating
Agency
|
Financial
Strength Rating
|
Outlook
|
S&P
Insurance Rating Services
|
A
|
Negative
|
Moody’s
|
A2
|
Stable
|
Fitch
Ratings
|
A+
|
Negative
|
While
customers and agents may be aware of our S&P and Moody’s financial strength
ratings, these ratings are not as important in insurance
decision-making. They do, however, affect our ability to access
capital markets. For further discussion on this, please see the
“Financial Condition, Liquidity and Capital Resources” section of Item 7.
“Management’s Discussion and Analysis of Financial Condition and Results of
Operations.” of this Form 10-K.
Other
factors that might impact our competitiveness are discussed in Item 1A. “Risk
Factors,” of this Form 10-K.
Reinsurance
We use
reinsurance to protect our capital resources and insure us against losses on
property and casualty risks that we underwrite. We use two main
reinsurance vehicles: (i) a reinsurance pooling agreement between our
Insurance Subsidiaries in which each company agrees to share in premiums and
losses based on certain specified percentages; and (ii) reinsurance contracts
and arrangements that cover various policies that our Insurance Operations issue
to insureds.
Reinsurance Pooling
Agreement
The
primary purposes of the reinsurance pooling agreement between our Insurance
Subsidiaries are the following;
|
·
|
Pool
or share proportionately the underwriting profit and loss results of
property and casualty underwriting operations through
reinsurance;
|
|
·
|
Prevent
any insurance subsidiary from suffering undue
loss;
|
|
·
|
Reduce
administration expenses; and
|
|
·
|
Permit
all of the Insurance Subsidiaries to obtain a uniform rating from A.M.
Best.
|
Under the
Pooling Agreement, all of the Insurance Subsidiaries mutually reinsure all
insurance risks written by them pursuant to the respective percentage set forth
opposite each Insurance Subsidiary’s name on the table below:
Insurance Subsidiary
|
Respective Percentage
|
|||
SICA
|
49.5 | % | ||
SWIC
|
21.0 | % | ||
SICSC
|
9.0 | % | ||
SICSE
|
7.0 | % | ||
SICNY
|
7.0 | % | ||
SAICNJ
|
6.0 | % | ||
SICNE
|
0.5 | % |
Reinsurance Treaties and
Arrangements
By
entering reinsurance treaties and arrangements, we are able to increase
underwriting capacity and accept larger risks and a larger number of risks
without directly increasing capital or surplus. All of our
reinsurance treaties are for traditional reinsurance; we do not purchase finite
reinsurance. Under our reinsurance treaties, the reinsurer generally
assumes a portion of the losses we cede to them in exchange for a portion of the
premium. Amounts not reinsured are known as
retention. Reinsurance does not legally discharge us from liability
under the terms and limits of our policies, but it does make our reinsurer
liable to us for the amount of liability we cede to
them. Accordingly, we have counterparty credit risk to our
reinsurers. We attempt to mitigate this credit risk by: (i) pursuing
relationships in most cases with reinsurers rated “A-” or higher; and (ii)
requiring collateral to secure reinsurance obligations. Some of our
reinsurance contracts include provisions that permit us to terminate or commute
the reinsurance treaty if the reinsurer’s financial condition or rating
deteriorates. We continuously monitor the financial condition of our
reinsurers. We also continuously review the quality of reinsurance
recoverables and reserves for uncollectible reinsurance.
10
We
primarily use the following three reinsurance treaty and arrangement types for
property and casualty insurance:
|
·
|
Treaty
reinsurance, under which certain types of policies are automatically
reinsured without prior approval by the reinsurer of the underlying
individual insured risks;
|
|
·
|
Facultative
reinsurance, under which an individual insurance policy or a specific risk
is reinsured with the prior approval of the reinsurer. We use
facultative reinsurance for policies with limits greater than those
available under our treaty reinsurance;
and
|
|
·
|
Protection
provided under the Terrorism Risk Insurance Act of 2002 as modified and
extended through December 31, 2014 by the Terrorism Risk Insurance Program
Reauthorization Act of 2007 (collectively referred to as
“TRIA”). TRIA requires private insurers and the United States
government to share the risk of loss on future acts of terrorism that are
certified by the U.S. Secretary of the Treasury. All insurers
with Commercial Lines DPW in the United States are required to participate
in TRIA, and TRIA applies to almost every line of commercial
insurance. Under TRIA, terrorism coverage is mandatory for all
primary workers compensation policies. Insureds with
non-workers compensation commercial policies, however, have the option to
accept or decline our terrorism coverage or negotiate with us for other
terms. TRIA rescinded all previously approved coverage
exclusions for terrorism. Under TRIA, each participating
insurer is responsible for paying a deductible of specified losses before
federal assistance is available. This deductible is based on a
percentage of the prior year’s applicable commercial lines
DPW. In 2009, the deductible would have been approximately $189
million. For losses above the deductible, the federal
government will pay 85% and the insurer retains 15%. Although
TRIA’s provisions will mitigate our loss exposure to a large-scale
terrorist attack, our deductible is substantial. In 2009,
approximately 87% of our Commercial Lines non-workers compensation
policyholders purchased terrorism coverage. Also in 2009, 45%
or 10 of the 22 primary states in which we underwrite commercial property
coverage mandated the coverage of fire following an act of
terrorism.
|
The
following is a summary of our property reinsurance treaties and arrangements
covering our Insurance Subsidiaries:
PROPERTY REINSURANCE
|
||||
Treaty Name
|
Reinsurance Coverage
|
Terrorism Coverage
|
||
Property
Excess of Loss
|
$28
million above $2 million retention in two layers. Losses other
than TRIA certified losses are subject to the following reinstatements and
annual aggregate limits:
·
$8 million in excess of $2 million layer provides unlimited
reinstatements, no annual aggregate limit; and
·
$20 million in excess of $10 million layer provides three
reinstatements
|
All
nuclear, biological, chemical, and radioactive (“NBCR”) losses are
excluded regardless of whether or not they are certified under
TRIA. For non-NBCR losses, the treaty distinguishes between
acts certified under TRIA and those that are not. The treaty
provides annual aggregate limits for TRIA certified (other than NBCR) acts
of $24 million for the first layer and $40 million for the second
layer. Non-certified terrorism losses (other than NBCR) are
subject to the normal limits under the treaty.
|
||
Property
Catastrophe Excess of Loss
|
95%
of $310 million above $40 million retention in three layers:
·
95% of losses in excess of $40 million up to $100
million;
·
95% of losses in excess of $100 million up to $200 million;
and
·
95% of losses in excess of $200 million up to $350
million.
The
treaty provides one reinstatement per layer, $589 million annual aggregate
limit, net of the Insurance Subsidiaries’
co-participation.
|
All
nuclear, biological, and chemical (NBC) losses are excluded regardless of
whether or not they are certified under TRIA. TRIA losses
related to foreign acts of terrorism are excluded from the
treaty. Domestic terrorism is included regardless of whether it
is certified under TRIA or not. Please see Item 1A. “Risk
Factors” of this Form 10-K for further discussion regarding changes in
TRIA.
|
||
Flood
|
|
100%
reinsurance by the federal government’s write-your-own (“WYO”)
Program.
|
|
None
|
11
The
following is a summary of our casualty reinsurance treaties and arrangements
covering our Insurance Subsidiaries:
CASUALTY REINSURANCE
|
||||
Treaty Name
|
Reinsurance Coverage
|
Terrorism Coverage
|
||
Casualty
Excess of Loss
|
The
1st
layer of $3 million in excess of $2 million is covered at
85%. The 2nd
through 6th
layers are covered at 100%. Losses other than terrorism losses
are subject to the following reinstatements and annual aggregate
limits:
·
85% of $3 million in excess of $2 million layer provides up to $2.6
million of per occurrence coverage net of co-participation with 23
reinstatements, $61 million net annual aggregate limit;
·
$7 million in excess of $5 million layer provides three
reinstatements, $28 million annual aggregate limit;
·
$9 million in excess of $12 million layer provides two
reinstatements, $27 million annual aggregate limit;
·
$9 million in excess of $21 million layer provides one
reinstatement, $18 million annual aggregate limit;
·
$20 million in excess of $30 million layer provides one
reinstatement, $40 million annual aggregate limit; and
·
$40 million in excess of $50 million layer provides with one
reinstatement, $80 million in net annual aggregate limit.
|
All
NBCR losses are excluded. All other losses stemming from the
acts of terrorism are subject to the following reinstatements and annual
aggregate limits:
·
85% of $3 million in excess of $2 million layer provides up to $2.6
million of per occurrence coverage net of co-participation with four
reinstatements for terrorism losses, $13 million net annual aggregate
limit;
·
$7 million in excess of $5 million layer provides two
reinstatements for terrorism losses, $21 million annual aggregate
limit;
·
$9 million in excess of $12 million layer provides two
reinstatements for terrorism losses, $27 million annual aggregate
limit;
·
$9 million in excess of $21 million layer provides one
reinstatement for terrorism losses, $18 million annual aggregate
limit;
·
$20 million in excess of $30 million layer provides one
reinstatement for terrorism losses, $40 million annual aggregate limit;
and
·
$40 million in excess of $50 million layer provides one
reinstatement for terrorism losses, $80 million in net annual aggregate
limit.
|
||
National
Workers Compensation Reinsurance Pool (“NWCRP”)
|
|
100%
quota share up to a maximum ceded combined ratio cap of
141%. Provides up to 5 points in pool participant insolvency
assessment protection.
|
|
Provides
full terrorism coverage including
NBCR.
|
We also
have other smaller reinsurance treaties, such as our Surety and Fidelity Excess
of Loss Reinsurance Treaty and our Equipment Breakdown Coverage Reinsurance
Treaty. For further discussion on reinsurance, see the “Reinsurance”
section of Item 7. “Management’s Discussion and Analysis of Financial Condition
and Results of Operations.” of this Form 10-K.
12
Claims
Reserves
Net Loss and Loss Expense
Reserves
We
establish loss and loss expense reserves that are estimates of the amounts we
will need to pay in the future for claims and related expenses for insured
losses that have already occurred. Estimating reserves as of any date
involves a considerable degree of judgment by management and is inherently
uncertain. We regularly review our reserving techniques and our
overall amount of reserves. We also review:
|
·
|
Information
regarding each claim for losses, including potential extra-contractual
liabilities, or amounts paid in excess of the policy limits, which may not
be covered by our contracts with
reinsurers;
|
|
·
|
Our
loss history and the industry’s loss
history;
|
|
·
|
Legislative
enactments, judicial decisions and legal developments regarding
damages;
|
|
·
|
Changes
in political attitudes; and
|
|
·
|
Trends
in general economic conditions, including
inflation.
|
See
“Critical Accounting Policies and Estimates” in Item 7. “Management’s
Discussion and Analysis of Financial Condition and Results for Operations.” of
this Form 10-K for full discussion regarding our loss reserving
process.
Our loss
and loss expense reserve development over the preceeding 10 years is shown on
the following table, which has five parts:
|
·
|
Section
I shows the estimated liability recorded at the end of each indicated year
for all current and prior accident year’s unpaid loss and loss
expenses. The liability represents the estimated amount of loss
and loss expenses for unpaid claims, including incurred but not reported
(“IBNR”) reserves. In accordance with GAAP, the liability for
unpaid loss and loss expenses is recorded gross of the effects of
reinsurance. An estimate of reinsurance recoverables is
reported separately as an asset. The net balance represents the
estimated amount of unpaid loss and loss expenses outstanding reduced by
estimates of amounts recoverable under reinsurance
contracts.
|
|
·
|
Section
II shows the re-estimated amount of the previously recorded net liability
as of the end of each succeeding year. Estimates of the
liability of unpaid loss and loss expenses are increased or decreased as
payments are made and more information regarding individual claims and
trends, such as overall frequency and severity patterns, becomes
known.
|
|
·
|
Section
III shows the cumulative amount of net loss and loss expenses paid
relating to recorded liabilities as of the end of each succeeding
year.
|
|
·
|
Section
IV shows the re-estimated gross liability and re-estimated reinsurance
recoverables through December 31,
2009.
|
|
·
|
Section
V shows the cumulative net (deficiency)/redundancy representing the
aggregate change in the liability from the original balance sheet dates
and the re-estimated liability through December 31,
2009.
|
This
table does not present accident or policy year development
data. Conditions and trends that have affected past reserve
development may not necessarily occur in the future. As a result,
extrapolating redundancies or deficiencies based on this table is inherently
uncertain.
13
($
in millions)
|
1999
|
2000
|
2001
|
2002
|
2003
|
2004
|
2005
|
2006
|
2007
|
2008
|
2009
|
|||||||||||||||||||||||||||||||||
I. Gross
reserves for unpaid losses and loss expenses at December
31
|
$ | 1,273.8 | 1,272.7 | 1,298.3 | 1,403.4 | 1,587.8 | 1,835.2 | 2,084.0 | 2,288.8 | 2,542.5 | 2,641.0 | 2,745.8 | ||||||||||||||||||||||||||||||||
Reinsurance
recoverables on unpaid losses and loss expenses at December
31
|
$ | (192.0 | ) | (160.9 | ) | (166.5 | ) | (160.4 | ) | (184.6 | ) | (218.8 | ) | (218.2 | ) | (199.7 | ) | (227.8 | ) | (224.2 | ) | (271.6 | ) | |||||||||||||||||||||
Net
reserves for unpaid losses and loss expenses at December
31
|
$ | 1,081.8 | 1,111.8 | 1,131.8 | 1,243.1 | 1,403.2 | 1,616.4 | 1,865.8 | 2,089.0 | 2,314.7 | 2,416.8 | 2,474.2 | ||||||||||||||||||||||||||||||||
II. Net
Reserves estimate as of:
|
||||||||||||||||||||||||||||||||||||||||||||
One
year later
|
$ | 1,080.7 | 1,125.5 | 1,151.7 | 1,258.1 | 1,408.1 | 1,621.5 | 1,858.5 | 2,070.2 | 2,295.4 | 2,387.4 | |||||||||||||||||||||||||||||||||
Two
years later
|
1,088.2 | 1,152.7 | 1,175.8 | 1,276.3 | 1,452.3 | 1,637.3 | 1,845.1 | 2,024.0 | 2,237.8 | |||||||||||||||||||||||||||||||||||
Three
years later
|
1,115.6 | 1,181.9 | 1,210.7 | 1,344.6 | 1,491.1 | 1,643.7 | 1,825.2 | 1,982.4 | ||||||||||||||||||||||||||||||||||||
Four
years later
|
1,134.4 | 1,220.2 | 1,290.2 | 1,371.5 | 1,522.9 | 1,649.8 | 1,808.9 | |||||||||||||||||||||||||||||||||||||
Five
years later
|
1,156.0 | 1,278.3 | 1,306.8 | 1,413.8 | 1,529.2 | 1,653.6 | ||||||||||||||||||||||||||||||||||||||
Six
years later
|
1,194.6 | 1,287.5 | 1,349.6 | 1,420.8 | 1,538.4 | |||||||||||||||||||||||||||||||||||||||
Seven
years later
|
1,203.2 | 1,325.5 | 1,357.6 | 1,428.7 | ||||||||||||||||||||||||||||||||||||||||
Eight
years later
|
1,238.2 | 1,332.8 | 1,363.4 | |||||||||||||||||||||||||||||||||||||||||
Nine
years later
|
1,243.5 | 1,338.6 | ||||||||||||||||||||||||||||||||||||||||||
Ten
years later
|
1,246.7 | |||||||||||||||||||||||||||||||||||||||||||
Cumulative
net redundancy (deficiency)
|
$ | (165.0 | ) | (226.8 | ) | (231.6 | ) | (185.7 | ) | (135.2 | ) | (37.1 | ) | 56.9 | 106.6 | 77.0 | 29.4 | |||||||||||||||||||||||||||
III. Cumulative
amount of net reserves paid through:
|
||||||||||||||||||||||||||||||||||||||||||||
One
year later
|
$ | 348.2 | 399.2 | 377.1 | 384.0 | 414.5 | 422.4 | 468.6 | 469.4 | 579.4 | 584.5 | |||||||||||||||||||||||||||||||||
Two
years later
|
600.3 | 649.1 | 627.3 | 653.3 | 691.4 | 729.5 | 775.0 | 841.3 | 945.5 | |||||||||||||||||||||||||||||||||||
Three
years later
|
767.5 | 815.3 | 807.2 | 836.3 | 903.7 | 942.4 | 1,026.9 | 1,080.0 | ||||||||||||||||||||||||||||||||||||
Four
years later
|
870.8 | 930.9 | 926.9 | 966.2 | 1,033.5 | 1,101.0 | 1,174.2 | |||||||||||||||||||||||||||||||||||||
Five
years later
|
933.6 | 1,002.4 | 1,003.3 | 1,044.6 | 1,128.4 | 1,189.2 | ||||||||||||||||||||||||||||||||||||||
Six
years later
|
974.6 | 1,046.3 | 1,053.8 | 1,110.0 | 1,184.5 | |||||||||||||||||||||||||||||||||||||||
Seven
years later
|
1,001.1 | 1,081.7 | 1,100.3 | 1,151.8 | ||||||||||||||||||||||||||||||||||||||||
Eight
years later
|
1,029.0 | 1,115.9 | 1,133.9 | |||||||||||||||||||||||||||||||||||||||||
Nine
years later
|
1,055.2 | 1,143.6 | ||||||||||||||||||||||||||||||||||||||||||
Ten
years later
|
1,078.3 | |||||||||||||||||||||||||||||||||||||||||||
IV. Re-estimated
gross liability
|
$ | 1,548.1 | 1,608.5 | 1,646.1 | 1,685.5 | 1,816.7 | 1,939.0 | 2,106.5 | 2,238.8 | 2,487.3 | 2,635.9 | |||||||||||||||||||||||||||||||||
Re-estimated
reinsurance recoverables
|
$ | (301.4 | ) | (269.9 | ) | (282.7 | ) | (256.8 | ) | (278.3 | ) | (285.4 | ) | (297.6 | ) | (256.4 | ) | (249.5 | ) | (248.5 | ) | |||||||||||||||||||||||
Re-estimated
net liability
|
$ | 1,246.7 | 1,338.6 | 1,363.4 | 1,428.7 | 1,538.4 | 1,653.6 | 1,808.9 | 1,982.4 | 2,237.8 | 2,387.4 | |||||||||||||||||||||||||||||||||
V. Cumulative
gross redundancy
(deficiency)
|
$ | (274.3 | ) | (335.9 | ) | (347.7 | ) | (282.1 | ) | (228.9 | ) | (103.8 | ) | (22.4 | ) | 49.9 | 55.3 | 5.1 | ||||||||||||||||||||||||||
Cumulative
net redundancy (deficiency)
|
$ | (165.0 | ) | (226.8 | ) | (231.6 | ) | (185.7 | ) | (135.2 | ) | (37.1 | ) | 56.9 | 106.6 | 77.0 | 29.4 |
Note: some
amounts may not foot due to rounding.
14
We
experienced favorable prior year loss and loss expense reserve development in
2009, 2008, and 2007:
|
·
|
The
primary drivers of 2009’s favorable development of $29.4 million were the
following:
|
|
o
|
Our
workers compensation line experienced favorable development of
approximately $11 million. Accident years 2005 to 2007 had
favorable development of approximately $36 million from the impact of a
series of underwriting improvement strategies in that period that was
partially offset by approximately $22 million of adverse development due
to higher than expected severity in accident year
2008.
|
|
o
|
Our
commercial automobile line experienced favorable development of
approximately $10 million from lower than anticipated severity emergence
primarily in accident year 2007.
|
|
o
|
Our
general liability line had favorable development of approximately $8
million. We had favorable loss emergence in accident years 2004
through 2007 in our premises coverage business that was partially offset
by adverse development in our products/completed operations
business.
|
|
·
|
The
primary drivers of 2008’s favorable development of $19.3 million were the
following:
|
|
o
|
Our
workers compensation line experienced favorable prior year development of
approximately $24 million. This was primarily driven by
favorable development in accident years 2004 to 2006 of approximately $28
million attributable to underwriting improvements, better than expected
medical trends, and the redesign and re-contracting of our managed care
process. However, accident year 2007 had adverse prior year
development of approximately $6 million from higher
severity.
|
|
o
|
Our
general liability line experienced adverse development of approximately $3
million that reflected normal volatility for this line of
business.
|
|
o
|
Our
remaining lines of business collectively contributed approximately $2
million of adverse development. Individually, none reflect any
significant trends related to prior year
development.
|
|
·
|
The
primary drivers of 2007’s favorable development of $18.8 million were the
following:
|
|
o
|
Our
commercial automobile line experienced favorable development of
approximately $19 million. This was driven by lower than
expected severity in accident years 2004 through
2006.
|
|
o
|
Our
personal automobile line experienced favorable development of
approximately $10 million. This primarily related to lower than
expected loss emergence for accident years 2005 and prior of approximately
$18 million after we re-evaluated the impact of a 2005 adverse New Jersey
Supreme Court ruling eliminating the application of the serious life
impact standard under the verbal tort threshold of New Jersey’s Automobile
Insurance Cost Reduction Act. However, this was partially
offset by higher severity that we experienced in accident year 2006 of
approximately $8 million.
|
|
o
|
Our
workers compensation line experienced favorable development of
approximately $4 million. The implementation of a series of
underwriting improvement strategies in recent accident years were
reflected in this development, but this was partially offset by an
increase in the tail factor related to medical inflation and general
development trends.
|
|
o
|
The
homeowners line experienced adverse development of approximately $6
million. The main cause was unfavorable trends in claims for
groundwater contamination from leaking underground oil storage
tanks.
|
|
o
|
The
personal excess line experienced adverse development of approximately $4
million in 2007 related to the impact of several significant losses on a
relatively small line of business.
|
|
o
|
Our
remaining lines of business collectively contributed approximately $4
million of adverse development. Individually, none of these
lines reflected any significant trends related to prior year
development.
|
The
significant cumulative loss and loss expense reserve net deficiencies seen
between 1999 and 2003 reflect the property and casualty industry’s soft market
pricing during those years – with 1999 seeing its lowest pricing
levels. As a whole, the property and casualty industry underestimated
reserves and loss trends and created intense pricing
competition.
15
The
following table reconciles losses and loss expense reserves under SAP and GAAP
at December 31 as follows:
($ in thousands)
|
2009
|
2008
|
||||||
Statutory
losses and loss expense reserves
|
$ | 2,471,833 | 2,414,743 | |||||
Provision
for uncollectible reinsurance
|
2,500 | 2,470 | ||||||
Other
|
(144 | ) | (432 | ) | ||||
GAAP
losses and loss expense reserves – net
|
2,474,189 | 2,416,781 | ||||||
Reinsurance
recoverables on unpaid losses and loss expenses
|
271,610 | 224,192 | ||||||
GAAP
losses and loss expense reserves – gross
|
$ | 2,745,799 | 2,640,973 |
Environmental
Reserves
Our
general liability and excess liability reserves include exposure to
environmental claims, which include asbestos claims and non-asbestos
claims. Our exposure to environmental liability is primarily due to:
(i) policies written prior to the absolute pollutions endorsement in the mid
1980’s; and (ii) underground storage tank leaks mainly form New Jersey
homeowners’ policies. Our environmental claims stem primarily from
insured exposures in municipal government, small non-manufacturing commercial
risks, and homeowners policies. The emergence of these claims is slow
and highly unpredictable.
“Asbestos
claims” are claims for bodily injury alleged to have occurred from exposure to
asbestos-containing products. In the past, we were the insurer of
various distributors of asbestos and/or asbestos-containing products, and, in
some cases, the manufacturers of these products. Over the last 20
years, an increasing number of asbestos claims have been made against the
insurance industry. While most of our claims are the result of
incidental exposure, we insure a former manufacturer of asbestos related
products, which comprises approximately half of our outstanding
claims. Favorable emergence on our reported claims resulted in a
reduction in incurred losses in 2009 of approximately $2.9 million, net of
reinsurance. At December 31, 2009, asbestos claims constituted 22% of
our $41.6 million net environmental reserves compared to 29% of $44.1 million
net environmental reserves at December 31, 2008.
“Non-asbestos
claims” are claims alleging bodily injury or property damage from pollution or
other environmental contaminants other than asbestos. These claims
primarily include landfills and leaking underground storage tanks. In
past years, landfill claims have accounted for a significant portion of our
environmental claim unit’s litigation costs. Over the past few years,
we have been experiencing adverse development in our homeowners line of business
due to unfavorable trends in claims for groundwater contamination from leaking
underground heating oil storage tanks in New Jersey. During 2009,
claims related to leaking underground heating oil storage tanks began to
stabilize.
Our
environmental claims are handled in our centralized and specialized
environmental claim unit. Environmental reserves are evaluated on a
claims-by-claims basis. The ability to assess potential exposure
often improves as an environmental claim develops, including judicial
determinations of coverage issues. As a result, reserves are adjusted
accordingly.
Estimating
IBNR reserves for environmental claims is difficult because, in addition to
other factors, there are significant uncertainties associated with estimating
critical assumptions, such as average clean-up costs, third-party costs,
potentially responsible party shares, allocation of damages, litigation and
coverage defense costs, and potential state and federal legislative
changes. Normal historically based actuarial approaches are difficult
to apply to environmental claims because past loss history is not indicative of
future potential environmental losses. In addition, while models can
be applied, such models can produce significantly different results with small
changes in assumptions. As a result, we do not calculate a specific
environmental loss range. Historically, our environmental claims have
been significantly less volatile and uncertain than other competitors in the
commercial lines industry. In part, this is due to the fact that we
are the primary insurance carrier on the majority of our environmental
exposures, thus providing more certainty in our reserve position compared to the
insurance marketplace.
Measure of Insurance
Operations Profitability
We manage
and evaluate the performance and profitability of our Insurance Operations in
accordance with SAP, which differs from GAAP. We base our incentive
compensation to our employees and our independent agents on the SAP results of
our Insurance Operations. In addition, our rating agencies use SAP
information to evaluate our performance, including against our industry
peers.
16
We
measure our statutory underwriting performance by four different
ratios:
|
1.
|
Loss
and loss expense ratio, which is calculated by dividing incurred loss and
loss expenses by NPE;
|
|
2.
|
Underwriting
expense ratio, which is calculated by dividing all expenses related to the
issuance of insurance policies by
NPW;
|
|
3.
|
Dividend
ratio, which is calculated by dividing policyholder dividends by NPE;
and
|
|
4.
|
Combined
ratio, which is the sum of the loss and loss expense ratio, the
underwriting expense ratio, and the dividend
ratio.
|
SAP
differs in several ways from GAAP, under which we report our financial results
to shareholders and the Securities Exchange Commission (“SEC”):
|
·
|
With regard to the
underwriting expense ratio, NPE is the denominator for GAAP;
whereas NPW is the denominator for
SAP.
|
|
·
|
With regard to
income:
|
|
·
|
Underwriting
expenses are deferred and amortized to expense over the life of the policy
under GAAP; whereas they are recognized when incurred under
SAP.
|
|
o
|
Deferred
taxes are recognized in our Consolidated Statements of Income as either a
deferred tax expense or a deferred tax benefit under GAAP; whereas they
are recorded directly to surplus under
SAP.
|
|
o
|
Changes
in the fair value of our alternative investments, which are part of our
other investment portfolio on our Consolidated Balance sheets, are
recognized in income under GAAP; whereas they are recorded directly to
surplus under SAP.
|
|
·
|
With regard to equity
under GAAP and statutory surplus under
SAP:
|
|
o
|
The
timing difference in income due to the GAAP/SAP differences in expense
recognition creates a difference between GAAP equity and SAP statutory
surplus.
|
|
o
|
Regarding
unrealized gains and losses on fixed maturity
securities:
|
|
§
|
Under
GAAP, unrealized gains and losses on available-for-sale (“AFS”) fixed
maturity securities are recognized in equity; but they are not recognized
in equity on purchased held-to-maturity (“HTM”)
securities. Unrealized gains and losses on HTM securities
transferred from an AFS designation are amortized from equity as a yield
adjustment.
|
|
§
|
Under
SAP, unrealized gains and losses on fixed maturity securities assigned
certain National Association of Insurance Commissioners Security Valuation
Office ratings (specifically designations of one or two) are not
recognized in statutory surplus. However, fixed maturity securities that
have a designation of three or higher must recognize changes in unrealized
gains and losses as an adjustment to statutory
surplus.
|
|
o
|
Certain
assets designated under insurance regulations as “non-admitted,” including
but not limited to, certain deferred tax assets, overdue premium
receivables, furniture and equipment, and prepaid expenses, and as such,
are excluded from statutory surplus under SAP; whereas these assets are
recorded in the balance sheet net of applicable allowances under GAAP;
and
|
|
o
|
Regarding
recognition of pension liability:
|
|
§
|
Under
GAAP, the liability is recognized in an amount equal to the excess of the
projected benefit obligation over the fair value of the pension assets,
and any changes in this balance not in income are recognized in equity as
a component of other comprehensive income
(“OCI”).
|
|
§
|
Under
SAP, the liability is recognized in an amount equal to the excess of the
vested accumulated benefit obligation over the fair value of the pension
plan assets, and any changes in this balance not recognized in income are
recognized in statutory
surplus.
|
17
Our
Insurance Operations statutory results for the last three completed fiscal years
are shown on the following table:
Year Ended December 31,
|
||||||||||||
($ in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Insurance
Operations Results
|
||||||||||||
NPW
|
$ | 1,422,655 | 1,492,938 | 1,562,728 | ||||||||
NPE
|
$ | 1,431,047 | 1,504,387 | 1,525,163 | ||||||||
Losses
and loss expenses incurred
|
972,041 | 1,011,700 | 997,230 | |||||||||
Net
underwriting expenses incurred
|
459,757 | 471,629 | 494,944 | |||||||||
Policyholders’
dividends
|
3,640 | 5,211 | 7,202 | |||||||||
Underwriting
(loss) profit
|
$ | (4,391 | ) | 15,847 | 25,787 | |||||||
Ratios:
|
||||||||||||
Losses
and loss expense ratio
|
67.9 | % | 67.2 | 65.4 | ||||||||
Underwriting
expense ratio
|
32.3 | % | 31.7 | 31.6 | ||||||||
Policyholders’
dividends ratio
|
0.3 | % | 0.3 | 0.5 | ||||||||
Combined
ratio
|
100.5 | % | 99.2 | 97.5 | ||||||||
GAAP
combined ratio1
|
99.8 | % | 100.0 | 98.0 |
Our
statutory combined ratio has been lower than that of the property and casualty
insurance industry for three of the past five years and we have outperformed the
industry average during that period by 1.6 points. A comparison of
certain statutory ratios for our Insurance Operations and our industry are shown
on the following table:
Simple
Average of
All Periods
Presented
|
2009
|
2008
|
2007
|
2006
|
2005
|
|||||||||||||||||||
Insurance
Operations Ratios:1
|
||||||||||||||||||||||||
Loss
and loss expense
|
65.5 | 67.9 | 67.2 | 65.4 | 63.7 | 63.5 | ||||||||||||||||||
Underwriting
expense
|
31.5 | 32.3 | 31.7 | 31.6 | 31.3 | 30.7 | ||||||||||||||||||
Policyholders’
dividends
|
0.4 | 0.3 | 0.3 | 0.5 | 0.4 | 0.4 | ||||||||||||||||||
Statutory
combined ratio
|
97.4 | 100.5 | 99.2 | 97.5 | 95.4 | 94.6 | ||||||||||||||||||
Growth
in net premiums written
|
0.9 | (4.7 | ) | (4.5 | ) | 1.4 | 5.3 | 6.9 | ||||||||||||||||
Industry
Ratios:1,
2
|
||||||||||||||||||||||||
Loss
and loss expense
|
71.6 | 72.5 | 77.0 | 67.7 | 65.4 | 75.3 | ||||||||||||||||||
Underwriting
expense
|
26.7 | 27.5 | 27.1 | 27.1 | 26.1 | 25.4 | ||||||||||||||||||
Policyholders’
dividends
|
0.7 | 0.6 | 0.7 | 0.7 | 0.9 | 0.5 | ||||||||||||||||||
Statutory
combined ratio
|
99.0 | 100.6 | 104.7 | 95.6 | 92.4 | 101.2 | ||||||||||||||||||
Growth
in net premiums written
|
(0.6 | ) | (4.2 | ) | (0.8 | ) | (0.8 | ) | 4.0 | 0.0 | ||||||||||||||
Favorable
(Unfavorable) to Industry:
|
||||||||||||||||||||||||
Statutory
combined ratio
|
1.6 | 0.1 | 5.5 | (1.9 | ) | (3.0 | ) | 6.6 | ||||||||||||||||
Growth
in net premiums written
|
1.5 | (0.5 | ) | (3.7 | ) | 2.2 | 1.3 | 6.9 |
1The
ratios and percentages are based on SAP prescribed or permitted by state
insurance departments in the states in which each company is
domiciled.
2Source: A.M.
Best. The industry ratios for 2009 have been estimated by A.M.
Best.
Insurance
Regulation
Primary Oversight from the
States in Which We Operate
Our
Insurance Operations are heavily regulated. The primary public policy
behind insurance regulation is the protection of policyholders and claimants
over all other constituencies, including shareholders. By virtue of
the McCarran-Ferguson Act, Congress has largely delegated insurance regulation
to the various states. For our seven insurance subsidiaries, the
primary regulators of their business and financial condition are the departments
of insurance in the states in which they are organized and are
licensed. The broad regulatory, administrative, and supervisory
powers of the various departments of insurance include:
|
·
|
Related
to our financial condition, review and approval of such matters as minimum
capital and surplus requirements, standards of solvency, security
deposits, methods of accounting, form and content of financial statements,
reserves for unpaid loss and LAE, reinsurance, payment of dividends and
other distributions to shareholders, periodic financial examinations and
annual and other report filings;
and
|
|
·
|
Related
to our general business, review and approval of such matters as
certificates of authority and other insurance company licenses, licensing
of agents, premium rates (which may not be excessive, inadequate, or
unfairly discriminatory), policy forms, policy terminations, reporting of
statistical information regarding our premiums and losses, unfair trade
practices, and periodic market conduct
examinations.
|
18
|
·
|
Related
to our ownership of our seven insurance subsidiaries, we are required to
register as an insurance holding company system and report information
concerning all of our operations that may materially affect the
operations, management, or financial condition of the
insurers. As an insurance holding company, the appropriate
state regulatory may: (i) examine us or our insurance
subsidiaries at any time; (ii) require disclosure or prior approval of
material transactions of any of the insurance subsidiaries with us or each
other; and (iii) require prior approval or notice of certain transactions,
such as payment of dividends or distributions to
us.
|
The
various state departments of insurance that regulate us are members of the
National Association of Insurance Commissioners (“NAIC”). The NAIC is
the organization that has codified SAP and other accounting reporting formats
and drafts model insurance laws and regulations governing insurance
companies. An NAIC model only becomes law when the various state
legislatures enact it. The adoption of certain NAIC model laws and
regulations, however, is a key aspect of the NAIC Financial Regulations
Standards and Accreditation Program, which also sets forth minimum staffing and
resource levels for state insurance departments.
IRIS, RBC, and the Model
Audit Rule
Among the
various financial regulatory initiatives of the NAIC that are material to the
regulators in which our seven insurance subsidiaries are organized are the
following:
|
·
|
The
Insurance Regulatory Information System (“IRIS”). IRIS
identifies 11 industry financial ratios and specifies “usual values” for
each ratio. Departure from the usual values on four or more of
the financial ratios can lead to inquiries from individual state insurance
departments about certain aspects of the insurer’s
business. Our insurance subsidiaries have consistently met the
majority of the IRIS ratio tests.
|
|
·
|
Risk
Based Capital. Risk-based capital is measured by the four major
areas of risk to which property and casualty insurers are
exposed: (i) asset risk; (ii) credit risk; (iii) underwriting
risk; and (iv) off-balance sheet risk. Insurers with total
adjusted capital that is less than two times their calculated “Authorized
Control Level,” are subject to different levels of regulatory intervention
and action. Based upon the unaudited 2009 statutory financial
statements, the total adjusted capital for each of our seven insurance
subsidiaries substantially exceeded two times their Authorized Control
Level.
|
|
·
|
Annual
Financial Reporting Regulation (referred to as the “Model Audit
Rule”). Effective January 1, 2010, the regulators of all seven
of our insurance subsidiaries adopted this regulation, modeled closely on
the Sarbanes-Oxley Act, concerning (i) auditor independence; (ii)
corporate governance; and (iii) internal control over financial
reporting. As permitted under the regulation, our Audit
Committee of the Board of Directors also serves as the audit committee of
each of our seven insurance
subsidiaries.
|
Federal
Regulation
Although
the federal government does not directly regulate insurance, federal legislation
and administrative policies do affect the insurance industry. Among
the most notable are TRIA and various privacy laws that apply to us because we
have personal non-public information, including the Gramm-Leach-Bliley Act, the
Fair Credit Reporting Act, the Drivers Privacy Protection Act, and the Health
Insurance Portability and Accountability Act. Like all businesses, we
also are required to enforce the economic and trade sanctions of the Office of
Foreign Assets Control (“OFAC”).
As a
result of the financial markets crises in 2008 and 2009, there have been a
number of legislative proposals discussed and introduced in Congress that could
result in the federal government becoming directly involved in the regulation of
insurance. Among the most notable are proposals to require the federal
government to regulate the solvency of insurers in light of the AIG scandal and
to repeal the McCarran-Ferguson Act. While proposals for
McCarran-Ferguson Act repeal recently have been primarily directed at health
insurers, if enacted and applicable to all insurers, such repeal would
significantly reduce our ability to compete because we rely on the anti-trust
exemptions the law provides to obtain historical loss data from third party
aggregators such as ISO to develop loss costs. We expect the debate
about the role of the federal government in regulating insurance to
continue. We cannot predict whether one proposal or another will be
adopted, or what impact, if any, such proposals or, if enacted, such laws, could
have on our business, financial condition or results of
operations.
19
Investment
Operations
Our
Investments Operations are based primarily in Parsippany, New Jersey, while
certain segments of the portfolio are managed by external investment portfolio
managers. Like many other property and casualty insurance companies,
we depend on income from our investment portfolio for a significant portion of
our revenues and earnings. We are exposed to significant financial
and capital markets risks, primarily relating to interest rates, credit spreads,
equity price risks and the change in market value of our alternative investment
portfolio. A decline in both income and our investment portfolio
asset values could occur as a result of, among other things, a decrease in
market liquidity, fluctuations in interest rates, decreased dividend payment
rates, negative market perception of credit risk with respect to types of
securities in our portfolio, a decline in the performance of the underlying
collateral of our structured securities, reduced returns on our alternative
investment portfolio, or general market conditions.
Our
Investment Operations invest the premiums collected by the Insurance Operations
and generate investment income and earnings. At December 31, 2009,
our investment portfolio consisted of the following:
Category
of Investment
|
Amount Invested
|
%
of Investment Portfolio
|
||||
Fixed
maturities
|
$ |
3,346.3
million
|
88 | % | ||
Equities
|
$ |
80.3
million
|
2 | % | ||
Short-term
investments
|
$ |
213.8
million
|
6 | % | ||
Other
investments, including alternative investments
|
$ |
140.7
million
|
4 | % | ||
Total
|
$ |
3,781.1
million
|
100 | % |
Our
investment philosophy includes setting certain return and risk objectives for
the fixed maturity and equity 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. The equity
portfolio return objective is to meet or exceed a weighted-average benchmark of
public equity indices. The risk objectives for our portfolios are
focused on: (i) asset diversification; (ii) investment quality; (iii)
liquidity, particularly to coincide with cash obligations of the Insurance
Operations; (iv) consideration of taxes; and (v) preservation of
capital. Our overall philosophy is to invest with a long-term horizon
along with a “buy-and-hold” principle; however, yield and income generation
remain the key drivers to our investment strategy.
For
further information regarding our risks associated with the overall investment
portfolio, see Item 7A. “Quantitative and Qualitative Disclosures about Market
Risk.” and Item 1A. “Risk Factors.” of this Form 10-K. For additional
information about investments, see the section entitled, “Investments,” in Item
7. “Management’s Discussion and Analysis of Financial Condition and Results of
Operations.” and Item 8. “Financial Statements and Supplementary Data.” Note 5.
of this Form 10-K.
20
Our
Executive Officers
Biographical
information about our Chief Executive Officer and other executive officers is as
follows:
Name,
Age, Title
|
Occupation and Background | ||
Gregory E. Murphy,
54
|
·
|
Present
position since May 2000
|
|
Chairman,
President, and
|
·
|
President,
Chief Executive Officer, and Director, Selective, 1999 –
2000
|
|
Chief
Executive Officer
|
·
|
President,
Chief Operating Officer, and Director, Selective, 1997 –
1999
|
|
·
|
Other
senior executive, management, and operational positions, Selective, since
1980
|
||
·
|
Certified
Public Accountant (New Jersey) (Inactive)
|
||
·
|
Director,
Newton Memorial Hospital Foundation, Inc., since 1999
|
||
·
|
Director,
Property Casualty Insurers Association of America, since
2008
|
||
·
|
Director,
Insurance Information Institute, since 2000
|
||
·
|
Director,
American Insurance Association (AIA), 2002 to 2006
|
||
·
|
Trustee,
the American Institute for CPCU (AICPCU) and the Insurance Institute of
America (IIA), since June 2001
|
||
·
|
Graduate
of Boston College (B.S. Accounting)
|
||
·
|
Harvard
University (Advanced Management Program)
|
||
·
|
M.I.T.
Sloan School of Management
|
||
Richard F. Connell,
64
|
·
|
Present
position since October 2007
|
|
Senior
Executive Vice
|
·
|
Senior
Executive Vice President and Chief Information Officer, Selective, 2006 –
2007
|
|
President
and Chief
|
·
|
Executive
Vice President and Chief Information Officer, Selective 2000 –
2006
|
|
Administrative
Officer
|
·
|
Chief
Technology Officer, Liberty Mutual, 1998 – 2000
|
|
·
|
Central
Connecticut State University (B.S. Marketing)
|
||
Kerry A. Guthrie,
52
|
·
|
Present
position since February 2005
|
|
Executive
Vice President
|
·
|
Senior
Vice President and Chief Investment Officer, Selective, 2002 –
2005
|
|
and
Chief Investment
|
·
|
Various
investment positions, Selective, 1987 – 2002
|
|
Officer
|
·
|
Chartered
Financial Analyst
|
|
·
|
Certified
Public Accountant (New Jersey) (Inactive)
|
||
·
|
Member,
New York Society of Security Analysts
|
||
·
|
Siena
College (B.S. Accounting)
|
||
·
|
Fairleigh
Dickinson University (M.B.A. Finance)
|
||
Dale A. Thatcher,
48
|
·
|
Present
position since February 2003
|
|
Executive
Vice President,
|
·
|
Senior
Vice President, Chief Financial Officer and Treasurer, Selective, 2000 –
2003
|
|
Chief
Financial Officer
|
·
|
Certified
Public Accountant (Ohio) (Inactive)
|
|
and
Treasurer
|
·
|
Chartered
Property and Casualty Underwriter
|
|
·
|
Chartered
Life Underwriter
|
||
·
|
Member,
American Institute of Certified Public Accountants
|
||
·
|
Member,
Ohio Society of Certified Public Accountants
|
||
·
|
Member,
Financial Executives Initiative
|
||
·
|
Member,
Insurance Accounting and Systems Association
|
||
·
|
University
of Cincinnati (B.B.A. Accounting; M.B.A. Finance)
|
||
·
|
Harvard
University (Advanced Management
Program)
|
21
Name,
Age, Title
|
Occupation and Background | ||
Ronald J. Zaleski,
55
|
·
|
Present
position since February 2003
|
|
Executive
Vice
|
·
|
Senior
Vice President and Chief Actuary, Selective, 2000 –
2003
|
|
President
and Chief
|
·
|
Vice
President and Chief Actuary, Selective, 1999 – 2000
|
|
Actuary
|
·
|
Fellow
of Casualty Actuarial Society
|
|
·
|
Member,
American Academy of Actuaries
|
||
·
|
Loyola
College (B.A. Mathematics)
|
||
Steven B. Woods,
50
|
·
|
Present
position since January 2009
|
|
Executive
Vice President,
Human Resources
|
·
|
Vice
President, Human Resources, Corporate Affairs, Administration and Vice
President, International for Crayola, LLC, 2000 – 2009
|
|
|
·
|
Southeastern
Massachusetts University (B.S.)
|
|
|
·
|
Old
Dominion University (Ph.D., M.S.)
|
|
Michael H. Lanza,
48
|
·
|
Present
position since October 2007
|
|
Executive
Vice
|
·
|
Senior
Vice President and General Counsel, Selective, 2004 –
2007
|
|
President,
General
|
·
|
Corporate
advisor and legal consultant, 2003 – 2004
|
|
Counsel,
and Chief
|
·
|
Executive
Vice President and Corporate Secretary, QuadraMed Corporation, 2000 –
2003
|
|
Compliance
Officer
|
·
|
Member,
Society of Corporate Secretaries and Corporate Governance
Professionals
|
|
·
|
Member,
National Investor Relations Institute
|
||
·
|
University
of Connecticut (B.A.)
|
||
·
|
University
of Connecticut School of Law (J.D.)
|
||
John J. Marchioni,
40
|
·
|
Present
position since October 2008
|
|
Executive
Vice President,
|
·
|
Executive
Vice President, Chief Field Operations Officer, Selective 2007 –
2008
|
|
Chief
Underwriting and
|
·
|
Senior
Vice President, Director of Personal Lines, Selective 2005 –
2007
|
|
Field
Operations Officer
|
·
|
Various
insurance operation and government affairs positions, Selective, 1998 –
2005
|
|
|
·
|
Chartered
Property Casualty Underwriter (CPCU)
|
|
·
|
Princeton
University (B.A. History)
|
||
·
|
Harvard
University (Advanced Management
Program)
|
Information
about our Board of Directors (the “Board”) is in our definitive Proxy Statement
for the 2010 Annual Meeting of Stockholders to be held on April 28, 2010 in
“Information About Proposal 2, Election of Directors,” and is also incorporated
by reference into Part III of this Form 10-K.
Reports
to Security Holders
We file
with the United States Securities and Exchange Commission (“SEC”) all required
disclosures, including our Annual Report on Form 10-K, Quarterly Reports on Form
10-Q, Current Reports on Form 8-K, Proxy Statements, and other required
information under Sections 13(a) or 15(d) of the Securities Exchange Act of 1934
(“Exchange Act”). We also provide access to these filed materials on
our Internet website, www.selective.com.
You may read and copy any of these
filed materials at the SEC’s Public Reference Room at 100 F Street, N.E.,
Washington, DC 20549. You may obtain information on the operation of
the Public Reference Room by calling the SEC at 1-800-SEC-0330. The
SEC also maintains an Internet site, www.sec.gov, which contains reports, proxy and
information statements, and other information regarding issuers, including
ourselves, that file electronically with the SEC.
22
Item
1A. Risk Factors
Any of
the following risk factors could cause our actual results to differ materially
from historical or anticipated results. They also could have a
significant impact on our business, liquidity, capital resources, results of
operations and financial condition. These risk factors also might
affect, alter, or change actions that we might take in executing our long-term
capital strategy, including but not limited to, contributing capital to any or
all of the Insurance Subsidiaries, issuing additional debt and/or equity
securities, repurchasing our shares of common stock, or increasing or decreasing
stockholders’ dividends. The following list of risk factors is not
exhaustive, and others may exist.
Risks Related to Insurance
Operations
The failure of our risk management
strategies could have a material adverse effect on our financial condition or
results of operations.
We employ
a number of risk management strategies to reduce our exposure to risk that
include, but are not limited to the following:
§
|
Being
disciplined in our underwriting
practices.
|
§
|
Being
prudent in our claims management practices and establishing adequate loss
and loss expense reserves.
|
§
|
Continuing
to develop and implement predictive models to analyze historical
statistical data regarding our insureds and their loss experience and to
apply that information to risks of current insureds and prospective
insureds so we can better predict the likely profitability of the
account.
|
§
|
Purchasing
reinsurance.
|
All of
these strategies have inherent limitations. We cannot be certain that
an event or series of unanticipated events will not occur and result in losses
greater than we expect and have a material adverse effect on our liquidity,
capital resources, results of operations, and financial condition.
Our loss reserves
may not be adequate to cover actual losses and expenses.
We are
required to maintain loss reserves for our estimated liability for losses and
loss expenses associated with reported and unreported insurance
claims. Our estimates of reserve amounts are based on facts and
circumstances that we know, including our expectations of the ultimate
settlement and claim administration expenses, predictions of future events,
trends in claims severity and frequency, and other subjective factors relating
to our insurance policies in force. There is no method for precisely
estimating the ultimate liability for settlement of claims. From
time-to-time, we adjust reserves and increase them if they are inadequate or
reduce them if they are redundant. We cannot be certain that the
reserves we establish are adequate or will be adequate in the
future. An increase in reserves: (i) reduces net income
and stockholders’ equity for the period in which the deficiency in reserves is
identified; and (ii) could have a material adverse effect on our results of
operations, liquidity, financial condition, and financial strength and debt
ratings.
We
are subject to losses from catastrophic events.
Our
results are subject to losses from natural and man-made catastrophes, including
but not limited to; hurricanes, tornadoes, windstorms, earthquakes, hail,
terrorism, explosions, severe winter weather, floods and fires, some of which
may be related to climate changes. The frequency and severity of these
catastrophes are inherently unpredictable. One year may be relatively
free of such events while another may have numerous events. For
further discussion regarding man-made catastrophes that relate to terrorism see
the risk factor directly below this one regarding the potential for significant
losses from acts of terrorism. Furthermore, scientists, legislators,
and regulators are among a broad spectrum of the public which have a heightened
interest in the effect that greenhouse gas emissions have on our environment in
particular to a change in climate. If greenhouse gases continue to
shift our climate, more devastating catastrophic events may
occur. Catastrophe losses are determined by the severity of the event
and the total amount of insured exposures in the area affected by the
event. Our insurance operations business is concentrated
geographically in the Eastern and Midwestern regions of the U.S. New
Jersey accounted for 27% of our total NPW during the year ended December 31,
2009 and therefore catastrophes in these areas could adversely impact our
business more so than in other geographic areas. Although
catastrophes can cause losses in a variety of property and casualty lines, most
of our historic catastrophe-related claims have been from commercial property
and homeowners coverages. In an effort to reduce our exposure to
catastrophe losses we purchase catastrophe reinsurance. Despite
acquiring this protection, reinsurance could prove inadequate if: (i) the
modeling software we use to analyze the Insurance Subsidiaries’ risk results in
an inadequate purchase of reinsurance by us; (ii) a major catastrophe loss
exceeds the reinsurance limit or the reinsurers’ financial capacity; and (iii)
the frequency of catastrophe losses results in the Insurance Subsidiaries
exceeding their one reinstatement. Even after considering our
reinsurance protection, our exposure to catastrophe risks could have a material
adverse effect on our results of operations or financial
condition.
23
We
are subject to potential significant losses from acts of terrorism.
TRIA
requires private insurers and the United States government to share the risk of
loss on future acts of terrorism that are certified by the U.S. Secretary of the
Treasury. As a Commercial Lines writer, we are required to
participate in TRIA. Under TRIA, terrorism coverage is mandatory for
all primary workers compensation policies. However, insureds with
non-workers compensation commercial policies have the option to accept or
decline our terrorism coverage or negotiate with us for other
terms. In 2009, approximately 87% of our Commercial Lines non-workers
compensation policyholders purchased terrorism coverage.
TRIA
rescinded all previously approved coverage exclusions for
terrorism. Many of the states in which we write commercial property
insurance, however, mandate that we cover fire following an act of
terrorism. Under TRIA, each participating insurer is responsible for
paying a deductible of specified losses before federal assistance is
available. This deductible is based on a percentage of the prior
year’s applicable commercial lines premiums. In 2009, the deductible
would have been approximately $189 million. For losses above the
deductible, the federal government will pay 85%, up to an industry limit of $100
billion, and the insurer retains 15%. Although TRIA’s provisions will
mitigate our loss exposure to a large-scale terrorist attack, our deductible is
substantial and could have a material adverse effect on our results of
operations or financial condition.
TRIA
legislation is in effect through December 31, 2014. Currently, the
Obama Administration’s proposed budget includes provisions to scale back TRIA by
removing coverage for domestically inspired acts of terrorism, increasing
private insurer deductibles and co-payments, and allowing the program to expire
at the end of 2014.
Our
ability to reduce our risk exposure depends on the availability and cost of
reinsurance.
We
transfer a portion of our underwriting risk exposure to reinsurance
companies. Through our reinsurance arrangements, a specified portion
of our losses and loss adjustment expenses are assumed by the reinsurer in
exchange for a specified portion of premiums. The availability,
amount, and cost of reinsurance depend on market conditions, which may vary
significantly. While reinsurance agreements generally bind our
reinsurers for the cost of reinsurance on existing business reinsured, market
conditions beyond our control determine the availability and cost of the
reinsurance for new business. In certain circumstances, the price of
reinsurance for business already reinsured may also increase. Any
decrease in the amount of our reinsurance will increase our risk of
loss. Any increase in the cost of reinsurance will, absent a decrease
in the amount of reinsurance, reduce our earnings. Accordingly, we
may be forced to incur additional expenses for reinsurance or may not be able to
obtain sufficient reinsurance on acceptable terms. Either could
adversely affect our ability to write future business or result in the
assumption of more risk with respect to those policies we issue.
We are exposed to credit
risk.
We are
exposed to credit risk in several areas of our Insurance Operations business,
including from:
·
|
Our
reinsurers, who are obligated to us under our reinsurance
agreements. The relatively small size of the reinsurance market
and our objective to maintain an average weighted rating of “A” by A.M.
Best on our current reinsurance programs constrains our ability to
diversify our exposure to “single issuer” credit
risk. However, some of our reinsurance credit risk
is collateralized.
|
·
|
Some
of our independent agents, who collect premiums from insureds and are
required to remit the collected premium to
us.
|
·
|
Our
pension plan investments, which partially serve to fund the Insurance
Operations liability associated with this plan. To the extent
that credit risk adversely impacts the valuation and performance of the
invested assets within our pension plan, the funded status of the pension
plan could be adversely impacted and as result could increase the cost of
the plan to our insurance
operations.
|
It is possible that current economic conditions could increase our credit risk. Our exposure to credit risk could have a material adverse effect on our results of operations or financial condition.
24
The
property and casualty insurance industry is subject to general economic
conditions and is cyclical.
The
property and casualty insurance industry has experienced significant
fluctuations in its historic results due to competition, occurrence or severity
of catastrophic events, levels of capacity, general economic conditions,
interest rates, and other factors. Demand for insurance is influenced
significantly by prevailing general economic conditions. The supply
of insurance is related to prevailing prices, the levels of insured losses and
the levels of industry surplus which, in turn, may fluctuate in response to
changes in rates of return on investments being earned in the insurance
industry. As a result, the insurance industry historically has been a
cyclical industry characterized by periods of intense price competition due to
excessive underwriting capacity as well as periods when shortages of capacity
permitted favorable premium levels. For example, competitors pricing
business below technical levels could force us to reduce our profit margin in
order to protect our best business.
The
following is an example of pricing and loss trends on the statutory combined
ratio: Taking a pure price decline of 1.4% and removing the expense that
directly varies with premium volume yields an adverse combined ratio impact of
approximately one point. In addition, a claims inflation increase of
3% will cause the loss and loss adjustment expense ratio to increase
approximately two points, all else remaining equal. The combination
of claims inflation and price decreases could raise the combined ratio
approximately three points in this example, absent any initiatives targeted to
address these trends.
The
industry’s profitability also is affected by unpredictable developments,
including:
|
·
|
Natural
and man-made disasters;
|
|
·
|
Fluctuations
in interest rates and other changes in the investment environment that
affect investment returns;
|
|
·
|
Inflationary
pressures (medical and economic) that affect the size of
losses;
|
|
·
|
Judicial,
regulatory, legislative, and legal decisions that affect insurers’
liabilities;
|
|
·
|
Changes
in the frequency and severity of
losses;
|
|
·
|
Pricing
and availability of reinsurance in the marketplace;
and
|
|
·
|
Weather-related
impacts due to the effects of climate
changes.
|
Any of
the above developments could cause the supply or demand for insurance to change,
which could adversely affect our results of operations and financial
condition.
Difficult
conditions in global capital markets and the economy may adversely affect our
revenue and profitability and harm our business, and these conditions may not
improve in the near future.
General
conditions in the United States and world economies and volatility in financial
and insurance markets materially affect our results of
operations. Concerns over such issues as the availability and cost of
credit, the stability of the U.S. mortgage market, declining real estate
markets, increased unemployment, volatile energy and commodity prices, and
geopolitical issues, also have led to declines in business and consumer
confidence and precipitated an economic slowdown.
Factors
such as consumer spending, business investment, government spending, the
volatility and strength of the capital markets, and inflation all affect the
business and economic environment and, indirectly, the amount and profitability
of our business. In an economic downturn characterized by higher
unemployment, lower family income, lower corporate earnings, lower business
investment, and lower consumer spending, the demand for insurance products could
be adversely affected. In addition, we are impacted by the recent
decrease in commercial and new home construction and home ownership in 2009
because 39% of direct premiums written in our Commercial Lines business were
generated through contractors business. In addition, 36% of direct
premiums written in our Commercial Lines business is based on payroll/sales of
our underlying insureds. The impact of the economic downturn on
Commercial Lines can be seen in the approximately $73 million of audit and
endorsement premium we have returned to our insureds during
2009. Further unfavorable economic developments could adversely
affect our earnings if our customers have less need for insurance coverage,
cancel existing insurance policies, modify coverage or choose not renew with
us. These circumstances could have a material adverse effect on our
business, results of operations and financial condition. Challenging
economic conditions also may impair the ability of our customers to pay premiums
as they come due. We are unable to predict the likely duration and
severity of the current economic conditions in the U.S. and other countries,
which may have an adverse effect on us.
25
A
downgrade or a potential downgrade in our financial strength or credit ratings
could result in a loss of business and could have a material adverse effect on
our financial condition and results of operations.
We are
rated on our financial strength, primarily our ability to pay claims, by various
Nationally Recognized Statistical Rating Organizations
(“NRSROs”). The financial strength ratings on the Insurance
Subsidiaries are as follows:
NRSRO
|
Financial Strength Rating
|
Outlook
|
A.M.
Best and Company
|
“A+”
|
Negative
|
Standard
& Poor’s
|
“A”
|
Negative
|
Fitch
|
“A+”
|
Negative
|
Moody’s
Investor Service
|
“A2”
|
Stable
|
A
significant rating downgrade, particularly from A.M. Best, could: (i)
affect our ability to write new business with customers, some of whom are
required under various third party agreements to maintain insurance with a
carrier that maintains a specified minimum rating; or (ii) be an event of
default under our line of credit with Wachovia Bank, National Association (“Line
of Credit”). The Line of Credit requires our insurance subsidiaries
to maintain an A.M. Best rating of at least “A-“ (two levels below our current
rating) and a default could lead to acceleration of any outstanding
principal. Such an event also could trigger default provisions under
certain of our other debt instruments and negatively impact our ability to
borrow in the future. As a result any significant downgrade in
ratings could have a material adverse effect on our financial condition and
results of operations.
NRSROs
also rate our long-term debt creditworthiness. Credit ratings
indicate the ability of debt issuers to meet debt obligations in a timely manner
and are important factors in our overall funding profile and ability to access
certain types of liquidity. Our current credit ratings are as
follows:
NRSRO
|
Credit Rating
|
Long Term Credit Outlook
|
A.M.
Best and Company
|
“a-”
|
Negative
|
Standard
& Poor’s
|
“BBB”
|
Negative
|
Fitch
|
“A-”
|
Negative
|
Moody’s
Investor Services
|
“Baa2”
|
Stable
|
Downgrades
in our credit ratings could have a material adverse effect on our financial
condition and results of operations in many ways, including making it more
expensive for us to access capital markets.
Because
of the difficulties recently experienced by many financial institutions,
including insurance companies, and the public criticism of NRSROs, we believe it
is possible that the NRSROs: (i) will heighten their level of
scrutiny of financial institutions; (ii) will increase the frequency and scope
of their reviews; and (iii) may adjust upward the capital and other requirements
employed in their models for maintaining certain rating levels. We
cannot predict possible actions NRSROs may take regarding our ratings that could
adversely affect our business or the possible actions we may take in response to
any such action.
Our
industry is very competitive and we have many competitors and potential
competitors.
The
insurance industry is highly competitive. The current economic
environment has only served to further increase competition. We
compete with regional, national, and direct-writer property and casualty
insurance companies for customers, agents, and employees. Some
competitors are public companies and some are mutual companies. Many
competitors are larger and may have lower operating costs or lower costs of
capital. They may have the ability to absorb greater risk while
maintaining their financial strength ratings. Consequently, they may
be able to price their products more competitively. These competitive
pressures could result in increased pricing pressures on a number of our
products and services, particularly as competitors seek to win market share, and
may impair our ability to maintain or increase our profitability. We
also face competition, primarily in Commercial Lines, from entities that
self-insure their own risks. Because of its relatively low cost of
entry, the Internet has also emerged as a significant place of new competition,
both from existing competitors and new competitors. It is also
possible that reinsurers, who have significant knowledge of the primary property
and casualty business because they reinsure it, could enter the market to
diversify their operations. New competition could cause changes in
the supply or demand for insurance and adversely affect our
business.
26
We
have less loss experience data than our larger competitors.
We
believe that insurance companies are competing and will continue to compete on
their ability to use reliable data about their insureds and loss experience in
complex analytics and predictive models to select profitable
risks. With the consistent expansion of computing power and the
asymmetric decline in its cost, we believe that data and analytics use will
increase and become more complex and accurate. As a regional
insurance group, the loss experience from our Insurance Operations is not large
enough in all circumstances to analyze and project our future
costs. We use data from ISO to obtain sufficient industry loss
experience data. While statistically relevant, that data is not
specific to the performance of risks we have underwritten. Larger
competitors, particularly national carriers, have sufficient data regarding the
performance of risks that they have underwritten. Their analytics of
their loss experience data may be more predictive of profitability of their
underwritten risks than our analysis using, in part, general industry loss
experience. For the same reason, should Congress repeal the
McCarran-Ferguson Act and we are unable to access data from ISO, we will be at a
competitive disadvantage to larger insurers who have more sufficient loss
experience data on their own insureds.
We
depend on independent insurance agents.
We market
and sell our insurance products exclusively through independent insurance agents
who are not our employees. We believe that independent insurance
agents will remain a significant force in overall insurance industry premium
production because they can provide insureds with a wider choice of insurance
products than if they represented only one insurer. That, however,
creates competition in our distribution channel and we must market our products
and services to our agents before they sell them to our mutual
customers. Our financial condition and results of operations are tied
to the successful marketing and sales efforts of our products by our
agents.
We
face risks regarding our Flood business because of uncertainties regarding the
funding of the NFIP program.
We are
the seventh largest insurance group participating in the WYO arrangement of the
NFIP, which is managed by the Mitigation Division of FEMA in the U.S. Department
of Homeland Security. For WYO participation, we receive an expense
allowance, or servicing fee, for policies written and claims
serviced. Currently, the expense allowance is 30% of direct written
premiums.
The NFIP
is funded by Congress. In the last several years, funding of the
program has continued through short extensions as part of continuing resolutions
to temporarily maintain current spending. At present, the funding for
the program is set to expire on February 28, 2010, although we expect Congress
to extend the program past this date. Some members of Congress have
expressed a desire to explore a comprehensive revision of the program, its
costs, and its administration. We are actively monitoring
developments in Washington regarding reform proposals to the NFIP, particularly
regarding any changes to the fee structure. We cannot predict whether
proposals will be adopted or, if adopted, what impact their adoption could have
on our business, financial condition or results of operations.
We
are heavily regulated and changes in regulation may reduce our profitability and
limit our growth.
Our
Insurance Operations are heavily regulated and subject to extensive laws and
regulations that are subject to change. By virtue of the
McCarran-Ferguson Act, Congress has largely ceded insurance regulation to the
various states. We, however, are subject to federal regulators, such
as the SEC, for securities issues, and the Federal Trade Commission, for privacy
issues. We also are subject to non-governmental regulators, such as
the NASDAQ Stock Market and the New York Stock Exchange, where we list our
securities. Many of these regulators, to some degree, have overlap
with each other on various matters. They also have different
regulations on the same legal issus that are subject to their individual
interpretative discretion. Consequently, we have the risk that one
regulator’s position may conflict with another regulator’s position on the same
issue. As compliance is generally reviewed in hindsight, we also are
subject to the risk that interpretations will change over time.
The
primary public policy behind insurance regulation is the protection of
policyholders and claimants over all other constituencies, including
shareholders. By virtue of the McCarran-Ferguson Act, Congress has
largely delegated insurance regulation to the various states. For
Insurance Subsidiaries, the primary regulators of their business and financial
condition are the departments of insurance in the states in which they are
organized and are licensed. The broad regulatory, administrative, and
supervisory powers of the various departments of insurance include:
|
·
|
Related
to our financial condition, review and approval of such matters as minimum
capital and surplus requirements, standards of solvency, security
deposits, methods of accounting, form and content of statutory financial
statements, reserves for unpaid loss and LAE, reinsurance, payment of
dividends and other distributions to shareholders, periodic financial
examinations and annual and other report
filings.
|
27
|
·
|
Related
to our general business, review and approval of such matters as
certificates of authority and other insurance company licenses, licensing
and compensation of agents, premium rates (which may not be excessive,
inadequate, or unfairly discriminatory), policy forms, policy
terminations, reporting of statistical information regarding our premiums
and losses, periodic market conduct examinations, unfair trade practices,
participation in mandatory shared market mechanisms, such as assigned risk
pools and reinsurance pools, participation in mandatory state guaranty
funds, and mandated continuing workers compensation coverage
post-termination of employment.
|
|
·
|
Related
to our ownership of the Insurance Subsidiaries, we are required to
register as an insurance holding company system and report information
concerning all of our operations that may materially affect the
operations, management, or financial condition of the
insurers. As an insurance holding company, the appropriate
state regulatory authority may: (i) examine us or our insurance
subsidiaries at any time; (ii) require disclosure or prior approval of
material transactions of any of the insurance subsidiaries with us or each
other; and (iii) require prior approval or notice of certain transactions,
such as payment of dividends or distributions to
us.
|
Although
the federal government does not directly regulate insurance, federal legislation
and administrative policies do affect us, including TRIA, OFAC, and various
privacy laws, including the Gramm-Leach-Bliley Act, the Fair Credit Reporting
Act, the Drivers Privacy Protection Act, and the Health Insurance Portability
and Accountability Act. As a result of issuing workers compensation
policies, we also are subject to Mandatory Medicare Secondary Payer Reporting
under the Medicare, Medicaid and SCHIP Extension Act of 2007.
We
believe that we are in compliance with all laws and regulations that have a
material effect on our results of operations, but the cost of complying with
changes in laws and regulation could have a material affect on our results of
operations and financial condition.
We
are subject to the risk that legislation will be passed significantly changing
insurance regulation and adversely impacting our business, our financial
condition, and our results of operations.
As a
result of the financial markets crises in 2008 and 2009, the issues regarding
the AIG scandal, and public concerns over health insurance, there have been a
number of legislative proposals discussed and introduced in Congress that could
result in the federal government becoming directly involved in the regulation of
insurance:
|
·
|
Repeal of the
McCarran-Ferguson Act. While proposals for
McCarran-Ferguson Act repeal recently have been primarily directed at
health insurers, if enacted and applicable to property and casualty
insurers, such repeal would significantly reduce our ability to compete
and materially affect our results of operations because we rely on the
anti-trust exemptions the law provides to obtain loss data from third
party aggregators such as ISO to predict future
losses.
|
|
·
|
Changes in Oversight
of Financial Solvency. There have been proposals
introduced to place the responsibility for the solvency oversight of
certain insurance companies and insurance holding companies in the
Department of Treasury or another federal agency. Some of these
proposals also have left supervision of day-to-day insurance regulatory
issues, such as rate and form filing approvals, with the various state
departments of insurance. We believe that, should such a
proposal become law and the regulatory roles for such responsibilities be
split, that it would be conceivable that the federal regulator could
require that we increase our capital position and that the state regulator
could deny rate filings necessary to accomplish the federal
directive.
|
|
·
|
National Catastrophe
Funds. Various legislative proposals have been
introduced that would establish a federal reinsurance catastrophic fund as
a federal backstop for future natural disasters. These bills
generally encourage states to create catastrophe funds by creating a
federal backstop for states that create the funds. While
homeowners' insurance is primarily handled at the state level, there are
important roles for the federal government to play, including the
establishment of a national catastrophic
fund.
|
|
·
|
Reform of the
NFIP. There have been legislative proposals to reform
the NFIP by: (i) expanding coverage to include coverage for
losses from wind damage; and (ii) forgiving the nearly $20 billion in debt
amassed by the NFIP from the catastrophic storms of 2004 and
2005. We believe that the expansion of coverage to include wind
losses would significantly increase the cost and availability of NFIP
insurance.
|
We expect
the debate about the role of the federal government in regulating insurance to
continue. We cannot predict whether any of these or any related
proposal will be adopted, or what impact, if any, such proposals, could have on
our business, financial condition or results of operations if
enacted.
28
Class
action litigation could affect our business practices and financial
results.
Our
industries have been the target of class action litigation in areas including
the following:
|
·
|
After-market
parts;
|
|
·
|
Urban
homeowner insurance underwriting
practices;
|
|
·
|
Credit
scoring and predictive modeling
pricing;
|
|
·
|
Investment
disclosure;
|
|
·
|
Managed
care practices;
|
|
·
|
Timing
and discounting of personal injury protection claims
payments;
|
|
·
|
Direct
repair shop utilization practices;
and
|
|
·
|
Shareholder
class action suits.
|
Changes
in accounting guidance could impact the results of our operations and financial
condition.
The
Financial Accounting Standards Board (“FASB”) currently is reviewing proposed
changes to existing accounting regarding the treatment of costs associated with
acquiring or renewing insurance contracts. We currently defer these
expenses, which include commissions, premium taxes, fees, and certain other
costs of underwriting policies, and amortize them into expense over the period
in which the premium is earned. If FASB changes this accounting
treatment, depending on the provisions of such guidance, it could have a
material impact on our results of operations.
FASB also
is involved with the International Accounting Standards Board in a joint project
that could significantly impact today’s insurance model. Potential
changes include, but are not limited to: (i) redefining the revenue
recognition process; and (ii) requiring loss reserve discounting. As
indicated in Note 2. “Summary of Significant Accounting Policies” in Item 8.
“Financial Statements and Supplementary Data.” of this Form 10-K, our premiums
are earned over the period that coverage is provided and we do not discount our
loss reserves. Final guidance from this joint project could have a
material impact on our operations.
Risks Related to Our
Investment Operations
The failure of our risk management
strategies could have a material adverse effect on our financial condition or
results of operations.
We employ
a number of risk management strategies to reduce our exposure to risk that
include, but are not limited to the following:
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·
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Being
prudent in establishing our investment policy and appropriately
diversifying our investments.
|
|
·
|
Using
complex financial and investment models to analyze historic investment
performance and to predict future investment performance under a variety
of scenarios using asset concentration, asset volatility, asset
correlation, and systematic risk.
|
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·
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Closely
monitor investment performance, general economic and financial conditions,
and other relevant factors.
|
All of
these strategies have inherent limitations. We cannot be certain that
an event or series of unanticipated events will not occur and result in losses
greater than we expect and have a material adverse effect on our liquidity,
capital resources, results of operations, and financial
condition.
Difficult
conditions in global capital markets and the economy may adversely affect our
revenue and profitability and harm our business, and these conditions may not
improve in the near future.
Our
results of operations are materially affected by conditions in the global
capital markets and the economy generally, in both the U.S. and
abroad. Concerns over the availability and cost of credit, the U.S.
mortgage market, a declining real estate market in the U.S., increased
unemployment, volatile energy and commodity prices and geopolitical issues,
among other factors, have contributed to increased volatility for the economy
and the financial and insurance markets. These concerns have also led
to declines in business and consumer confidence, which have precipitated an
economic slowdown.
In
addition, the market for fixed income securities has experienced decreased
liquidity, increased price volatility, credit downgrade events, and increased
probability of default. Securities that are less liquid are more
difficult to value and may be hard to sell. Domestic and
international equity markets have also been experiencing heightened volatility
and turmoil, with issuers (such as our company) exposed to the mortgage
securities and credit markets particularly affected. These factors
and the continuing market disruption may have an adverse effect on our
investment portfolio, revenues, and profit margins.
29
We
are exposed to risk in our investment portfolio.
The market
for fixed income securities has experienced decreased liquidity, increased price
volatility, credit downgrade events, and increased probability of
default. Securities that are less liquid are more difficult to value
and may be hard to sell. Domestic and international equity markets
have also been experiencing heightened volatility and turmoil, with issuers
(such as our company) exposed to the mortgage securities and credit markets
particularly affected. These factors and the continued potential for
market disruption may have an adverse effect on our investment portfolio,
revenues, and profit margins.
Credit
risk
We are
exposed to credit risk in our investment portfolio from issuers of securities,
insurers of certain securities and certain other investment portfolio
counterparties. The value of our investment portfolio is subject to
credit risk from the issuers and/or guarantors of the securities in the
portfolio, other counterparties in certain transactions and, for certain
securities, insurers that guarantee specific issuer’s
obligations. Defaults by the issuer and, where applicable, an
issuer’s guarantor, insurer or other counterparties regarding any of our
investments could reduce our net investment income and net realized investment
gains or result in investment losses.
Interest
rate risk
Our
exposure to interest rate risk relates primarily to the market price (and cash
flow variability) associated with changes in interest rates. A rise
in interest rates may decrease the fair value of our existing fixed maturity
investments and declines in interest rates may result in an increase in the fair
value of our existing fixed maturity investments. Our fixed income
investment portfolio, which currently has a duration of 3.5 years, contains
interest rate sensitive instruments that may be adversely affected by changes in
interest rates resulting from governmental monetary policies, domestic and
international economic and political conditions, and other factors beyond our
control. A rise in interest rates would decrease the net unrealized
gain position of the investment portfolio, offset by our ability to earn higher
rates of return on funds reinvested in new investments. Conversely, a
decline in interest rates would increase the net unrealized gain position of the
investment portfolio, offset by lower rates of return on funds reinvested and
new investments. We seek to mitigate our interest rate risk
associated with holding fixed maturity investments by monitoring and maintaining
the average duration of our portfolio with a view toward achieving an adequate
after-tax return without subjecting the portfolio to an unreasonable level of
interest rate risk. Although we take measures to manage the economic
risks of investing in a changing interest rate environment, we may not be able
to mitigate the interest rate risk of our assets relative to our
liabilities.
Our
statutory surplus may be materially affected by rating downgrades on investments
held in our portfolio.
We are
exposed to significant financial and capital markets risks, primarily relating
to interest rates, credit spreads, equity price risks and the change in market
value of our alternative investment portfolio. A decline in both
income and our investment portfolio asset values could occur as a result of,
among other things, a decrease in market liquidity, falling interest rates,
decreased dividend payment rates, negative market perception of credit risk with
respect to types of securities in our portfolio, a decline in the performance of
the underlying collateral of our structured securities, reduced returns on our
alternative investment portfolio, or general market conditions.
With
economic uncertainty, the credit quality and ratings of securities in our
portfolio could be adversely affected. The NAIC could potentially
apply a lower class code on a security than was originally assigned which could
adversely affect statutory surplus because securities with NAIC class codes 3
through 6 require securities to be marked-to-market for statutory accounting
purposes as compared to securities with NAIC class codes of 1 or 2 that are
carried at amortized cost.
We are
also subject to the risk that the issuers, or guarantors, of fixed maturity
securities we own may default on principal and interest payments due under the
terms of the securities. At December 31, 2009, our fixed maturity
securities portfolio represented approximately 88% of our total invested
assets. Approximately 66% of our fixed maturity securities are state,
municipality, or U.S. Government obligations. The occurrence of a
major economic downturn, acts of corporate malfeasance, widening credit spreads,
budgetary deficits, or other events that adversely affect the issuers or
guarantors of these securities could cause the value of our fixed maturity
securities portfolio and our net income to decline and the default rate of our
fixed maturity securities portfolio to increase. With economic
uncertainty, credit quality of issuers or guarantors could be adversely affected
and a ratings downgrade of the issuers or guarantors of the securities in our
portfolio could also cause the value of our fixed maturity securities portfolio
and our net income to decrease. For example, rating agency downgrades
of monoline insurance companies during 2009 contributed to a decline in the
carrying value and the market liquidity of our municipal bond investment
portfolio. A reduction in the value of our investment portfolio could
have a material adverse effect on our business, results of operations and
financial condition. Levels of write down are impacted by our
assessment of the impairment, including a review of the underlying collateral of
structured securities, and our intent and ability to hold securities which have
declined in value until recovery. If we determine to reposition or
realign portions of the portfolio where we determine not to hold certain
securities in an unrealized loss position to recovery, then we will incur an
other-than-temporary impairment (“OTTI”) charge.
30
The
current economic crisis has also raised the possibility of future legislative
and regulatory actions, in addition to the enactment of Emergency Economic
Stabilization Act of 2008 (the “EESA”), which could further impact our
business. We discuss government action further in this
section. We cannot predict whether or when such actions may occur, or
what impact, if any, such actions could have on our business, results of
operations and financial condition.
Deterioration
in the public debt and equity markets, as well as in the private investment
marketplace, could lead to investment losses, which may adversely affect our
results of operations, financial condition and liquidity.
Like many
other property and casualty insurance companies, we depend on income from our
investment portfolio for a significant portion of our revenue and
earnings. We are exposed to significant financial and capital markets
risks, primarily relating to interest rates, credit spreads, equity price risks,
and the changes in market value of our alternative investment
portfolio. A decline could occur as a results of, among other things,
a decrease in market liquidity, falling interest rates, decreased dividend
payment rates, negative market perception of credit risk with respect to types
of securities in our portfolio, a decline in the performance of the underlying
collateral of our structured securities, reduced returns on our other
investments, including our portfolio of alternative investments, or general
market conditions.
Our note
payable and line of credit are subject to certain debt-to-capitalization
restrictions and net worth covenants, which could also be impacted by a
significant decline in investment value, and further OTTI charges could be
necessary if there is a future significant decline in investment
values. Depending on market conditions going forward, and in the
event of extreme prolonged market events, such as the global credit crisis, we
could incur additional realized and unrealized losses in future periods, which
could have an adverse impact on our results of operations, financial condition,
debt and financial strength ratings, and our ability to access capital markets
as a result of realized losses, impairments and changes in unrealized
positions.
For more
information regarding market interest rate, credit and equity price risk, see
Item 7A. “Quantitative and Qualitative Disclosures About Market Risk” in this
Form 10-K.
There
can be no assurance that the actions of the U.S. Government, Federal Reserve and
other governmental and regulatory bodies to try to stabilize the financial
markets will achieve their intended effect.
In the
second quarter of 2009, the Obama Administration released its Financial
Regulatory Reform plan which outlines certain proposed changes to regulatory
oversight on financial institutions provisions. The plan calls for,
among other things, heightened supervision and regulation on financial
institutions, stipulations to strengthen capital levels, scrutiny on executive
incentive compensation practices, potential changes to accounting standards, and
tightened oversight on credit rating agencies. More particular to our
industry, the plan calls for the possibility of federal regulation and potential
changes to capital and liquidity requirements. It is presently
unclear as to what impact this legislation, if enacted, would have on our
operations.
Since the
introduction of the Obama Administration’s Financial Regulatory Reform plan,
Congress has been debating the plan in relation to financial service
organizations to determine the level of federal oversight of these institutions
related to the “too big to fail” risk for financial entities and whether or not
this measure should be applied to certain insurance-related organizations.
The U.S. House of Representatives passed H.R. 4173 in December of 2009
containing various changes to the federal regulatory structure. It is
currently unclear as to the final content this reform will take after the Senate
conducts its review. The insurance impact will be measured by the extent,
if any, of the federal oversight on financial and solvency standards, currently
a state function, to evaluate the “too-big-to-fail” test and the state’s
regulatory oversight on forms and rate filings.
However,
the failure to effectively implement legislation and related actions, or
ineffectiveness of the legislation and actions, could result in a crisis of
investor confidence in the U.S. economy and financial markets, which could
increase constraints on the liquidity available in the banking system and
financial markets and increase pressure on the price of our fixed income and
equity portfolios. These results could materially and adversely
affect our results of operations, financial condition, liquidity and the trading
price of the Parent’s common stock. In the event of future material
deterioration in business conditions, we may need to raise additional capital or
consider other transactions to manage our capital position and
liquidity.
31
In
addition, we are subject to extensive laws and regulations that are administered
and enforced by a number of different governmental authorities and
non-governmental self-regulatory agencies. In light of the current
economic conditions, some of these authorities have implemented, or may in the
future implement, new or enhanced regulatory requirements intended to restore
confidence in financial institutions and reduce the likelihood of similar
economic events in the future. These authorities may also seek to
exercise their supervisory and enforcement authority in new or more robust
ways. Such events could affect the way we conduct our business and
manage our capital, and may require us to satisfy increased capital
requirements. These developments, if they occurred could materially
affect our results of operations, financial conditions and
liquidity.
We
are subject to the types of risks inherent in making alternative investments in
private limited partnerships.
Our other
investments include alternative investments in private limited partnerships that
invest in various strategies such as private equity, mezzanine debt, distressed
debt, and real estate. As of December 31, 2009, these types of
investments represented 4% of our total invested assets. The amount
and timing of income from these partnerships tends to be variable as a result of
the performance and investment state of the underlying
investments. The timing of the distributions from the partnerships,
which depends on particular events relating to the underlying investments, as
well as the partnerships’ schedules for making distributions and their need for
cash, can be difficult to predict. As a result, the amount of income
that we record from these investments can vary substantially from
quarter-to-quarter. Pursuant to the various limited partnership
agreements of these partnerships, we are committed for the full life of each
fund and cannot redeem our investment with the general
partner. Liquidation is only triggered by certain clauses within the
limited partnership agreements or at the funds’ stated end date, at which time
we will receive our final allocation of capital and any earned appreciation of
the underlying investments. In addition, we also are subject to
potential future capital calls in the aggregate amount of approximately $103
million as of December 31, 2009.
We are
also subject to the risks arising from the fact that the determination of the
fair value of these types of investments is inherently
subjective. The general partner of each of these partnerships
generally reports the change in the fair value of the interests in the
partnership on a one quarter lag because of the nature of the underlying assets
or liabilities. Since these partnerships’ underlying investments
consist primarily of assets or liabilities for which there are no quoted prices
in active markets for the same or similar assets, the valuation of interests in
these partnerships are subject to a higher level of subjectivity and
unobservable inputs than substantially all of our other
investments. Pursuant to guidance under the FASB Accounting Standards
Codification each of these general partners are required to determine fair value
by the price obtainable for the sale of the interest at the time of
determination. Valuations based on unobservable inputs are subject to
greater scrutiny and reconsideration from one reporting period to the next and
therefore, the changes in the fair value of these investments may be subject to
significant fluctuations which could lead to significant decreases in their fair
value from one reporting period to the next. Since we record our
investments in these various partnerships under the equity method of accounting,
any decreases in the valuation of these investments would negatively impact our
results of operations.
The
valuation of our investments include methodologies, estimations and assumptions
which are subject to differing interpretations and could result in changes to
investment valuations that may adversely affect our results of operations or
financial condition.
Fixed
maturity, equity, and short-term investments, which are reported at fair value
on the consolidated balance sheet, represented the majority of our total cash
and invested assets as of December 31, 2009. As required under
accounting rules, we have categorized these securities into a three-level
hierarchy, based on the priority of the inputs to the respective valuation
technique. The fair value hierarchy gives the highest priority to
quoted prices in active markets for identical assets or liabilities (Level 1),
the next priority to quoted prices in markets that are not active or inputs that
are observable either directly or indirectly, including quoted prices for
similar assets or liabilities or in markets that are not active and other inputs
that can be derived principally from, or corroborated by, observable market data
for substantially the full term of the assets or liabilities (Level 2) and the
lowest priority to unobservable inputs supported by little or no market activity
and that reflect the reporting entity’s own assumptions about the exit price,
including assumptions that market participants would use in
pricing the asset or liability (Level 3). An asset or
liability’s classification within the fair value hierarchy is based on the
lowest level of significant input to its valuation. We generally use
a combination of independent pricing services and broker quotes to price our
investment securities. At December 31, 2009, approximately 18% and
82% of these securities represented Level 1 and Level 2,
respectively. However, prices provided by independent pricing
services and independent broker quotes can vary widely even for the same
security. Rapidly changing and unprecedented credit and equity market
conditions could materially impact the valuation of securities as reported
within our consolidated financial statements and the period-to-period changes in
value could vary significantly. Decreases in value may have a
material adverse effect on our financial condition and may result in an increase
in non-cash OTTI charges.
32
The
determination of the amount of impairments taken on our investment is highly
subjective and could materially impact our results of operations or financial
position.
The
determination of the amount of impairments taken on our investments is based on
our periodic evaluation and assessment of our investments and known and inherent
risks associated with the various asset classes. Such evaluations and
assessments are revised as conditions change and new information becomes
available. Management updates its evaluations regularly and reflects
changes in impairments as such evaluations are revised. There can be
no assurance that our management has accurately assessed the level of
impairments taken as reflected in our financial
statements. Furthermore, additional impairments may need to be taken
in the future. Historical trends may not be indicative of future
impairments.
An
investment in a fixed maturity or equity security, is impaired if its fair value
falls below its carrying value and the decline is considered to be
other-than-temporary. We regularly review our entire investment
portfolio for declines in value. Management’s assessment of a decline
in value includes, but is not limited to, current judgment as to the financial
position and future prospects of the security issuer as well as general market
conditions. For fixed maturity securities, if we believe that a
decline in the value of a particular investment is temporary, and we do not have
the intent to sell these securities and do not believe we will be required to
sell these securities before recovery, we record the decline as an unrealized
loss in accumulated other comprehensive income for those securities that are
designated as available-for-sale. Our assessment of whether an equity
security is other-than-temporarily-impaired also includes our intent-to-hold the
security in the near term. If we believe the decline is
other-than-temporary we write down the carrying value of the investment and
record a realized loss in our consolidated statements of income. For
further information regarding our evaluation and considerations for determining
whether a security is other-than-temporarily impaired, please refer to “Critical
Accounting Policies and Estimates” in Item. 7. “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” of this Form
10-K.
Additionally,
our management considers a wide range of factors about the security issuer and
uses their best judgment in evaluating the cause of the decline in the estimate
fair value of the security and in assessing the prospects for near-term
recovery. Inherent in management’s evaluation of the security are
assumptions and estimates about the operations of the issuer and its future
earnings potential. Consideration in the impairment evaluation
process include, but are not limited to: (i) whether the decline
appears to be issuer or industry specific; (ii) the relationship of market
prices per share to book value per share at the date of acquisition and date of
evaluation; (iii) the price-earnings ratio at the time of acquisition and date
of evaluation; (iv) the financial condition and near-term prospects of the
issuer, including any specific events that may influence the issuer’s
operations; (v) the recent income or loss of the issuer; (vi) the independent
auditors’ report on the issuer’s recent financial statements; (vii) the dividend
policy of the issuer at the date of acquisition and the date of evaluation;
(viii) any buy/hold/sell recommendations or price projections published by
outside investment advisors; (ix) any rating agency announcements; (x) the
length of time and the extent to which the fair value has been less than
cost/amortized cost; and (xi) the evaluation of projected cash flows under
various economic and default scenarios.
Changes
in tax laws impacting marginal tax rates and/or the preferred tax treatment of
municipal obligations could adversely impact our business.
Tax
legislation which changes the tax preference of municipal obligations under
current law could adversely affect the market value of municipal
obligations. At December 31, 2009, 40% of our investment portfolio
was invested in tax-exempt municipal obligations; as such, the value of our
investment portfolio could be adversely affected by any such
legislation. Additionally, any such changes in tax law could reduce
the difference between tax-exempt interest rates and taxable
rates.
33
Risks Related to Our General
Operations
Operational
risks, including human or systems failures, are inherent in our
business.
Operational
risks and losses can result from, among other things, fraud, errors, failure to
document transactions properly or to obtain proper internal authorization,
failure to comply with regulatory requirements, information technology failures
or external events.
We
believe that our modeling, underwriting and information technology and
application systems are critical to our business. We expect our
information technology and application systems to remain an important part of
our underwriting process and our ability to compete successfully. We have
also licensed certain systems and data from third parties. We cannot be
certain that we will have access to these, or comparable, service providers, or
that our information technology or application systems will continue to operate
as intended. A major defect or failure in our internal controls or
information technology and application systems could result in management
distraction; harm our reputation, or increases in expenses. We believe
appropriate controls and mitigation procedures are in place to prevent
significant risk of defect in our internal controls, information technology and
application systems, but internal controls provide only a reasonable, not
absolute, assurance as to the absence of errors or irregularities and any
ineffectiveness of such controls and procedures could have a significant and
negative effect on our business.
We
depend on key personnel.
To a
large extent, the success of our businesses is dependent on our ability to
attract and retain key employees, in particular our senior officers, key
management, sales, information systems, underwriting, claims, and corporate
personnel. Competition to attract and retain key personnel is
intense. While we have employment agreements with a number of key
managers, all of our employees are at-will employees and we cannot ensure that
we will be able to attract and retain key personnel. As of December
31, 2009, our workforce had an average age of approximately 46 and approximately
20% of our workforce was retirement eligible under our retirement and benefit
plans.
If we experience difficulties with
outsourcing relationships, our ability to conduct our business might be
negatively impacted.
We
outsource certain business and administrative functions to third parties and may
do so increasingly in the future. If we fail to develop and implement
our outsourcing strategies or our third party providers fail to perform as
anticipated, we may experience operational difficulties, increased costs and a
loss of business that may have a material adverse effect on our results of
operations or financial condition. By outsourcing certain business
and administrative functions to third parties, we may be exposed to enhanced
risk of data security breaches. Any breach of data security could
damage our reputation and/or result in monetary damages, which, in turn, could
have a material adverse effect on our results of operations or financial
condition.
We
are subject to a variety of modeling risks which could have a material adverse
impact on our business results.
We rely
on complex financial models, such as predictive modeling, Risk Management
Solutions, Enterprise Risk Management, and the ALGO risk tool, which have been
developed internally or by third parties to analyze historical loss costs and
pricing, trends in claims severity and frequency, the occurrence of catastrophe
losses, investment performance and portfolio risk. Flaws in these
financial models and/or faulty assumptions used by these financial models, could
lead to increased losses. For example, the ALGO risk tool uses
value-at-risk (“VaR”) as a method to evaluate portfolio risk. VaR is
a probabilistic method of measuring the potential loss in portfolio value over a
given time period and for a given distribution of historical
returns. Portfolio risk, as measured by VaR, is affected by four
primary risk factors: asset concentration, asset volatility, asset
correlation and systematic risk. While VaR models are relatively
sophisticated, the quantitative market risk information generated is limited by
the assumptions and parameters established in creating the related
models. We believe that statistical models alone do not provide a
reliable method of monitoring and controlling market risk. Therefore,
such models are tools and do not substitute for the experience or judgment of
senior management.
We
have significant deferred tax assets which we may be unable to use if we do not
generate sufficient future taxable income.
We have
no net operating loss carryforward, capital loss carryforward and tax credit
carryforward as of December 31, 2009. We have sufficient capital
loss carryback capacity as of December 31, 2009 to absorb the current realized
capital losses. In the future, we would be required to establish a
valuation allowance if: (i) we run out of capital loss carryback
capacity; (ii) there are no valid tax planning strategies to generate taxable
income of the appropriate character (i.e. ordinary loss or capital loss); and
(iii) it is determined that it is more likely than not that sufficient future
income of the appropriate character will be generated. The establishment
of a valuation allowance would have an adverse effect on our financial condition
and results of operations.
34
Risks Related to Our
Corporate Structure and Governance
We
are a holding company and our ability to declare dividends to our shareholders
and pay indebtedness may be limited because our insurance subsidiaries are
regulated.
Restrictions
on the ability of the Insurance Subsidiaries to pay dividends, loans, or
advances to us may materially affect our ability to pay dividends on our common
stock or repay our indebtedness.
Dividends,
loans, or advances to us from our insurance subsidiaries are subject to the
approval and/or review of the insurance regulators in the states where the
subsidiaries are organized. The standards for review of such
transactions are whether: (i) the terms and charges are fair and
reasonable; and (ii) after the transaction, the insurance subsidiary’s surplus
for policyholders is reasonable in relation to its outstanding liabilities and
financial needs. Although dividends and loans to us from our
insurance subsidiaries historically have been approved, we can make no assurance
that future dividends and loans will be approved.
Because
we are an insurance holding company and a New Jersey corporation, potential
acquirers may be discouraged and the value of our common stock could be
adversely affected.
Because
we are an insurance holding company that owns insurance subsidiaries, anyone who
seeks to acquire 10% or more of our stock must seek prior approval from the
insurance regulators in the states in which our subsidiaries are organized and
file extensive information regarding their business operations and
finances.
Because
we are organized under New Jersey law, provisions in our certificate of
incorporation (as amended) also may discourage, delay, or prevent us from being
acquired, including:
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·
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Supermajority
voting requirements and fair price to approve business
combinations;
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·
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Supermajority
voting requirements to amend the foregoing provisions;
and
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·
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The
ability of the Board to issue “blank check” preferred
stock.
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Under the
New Jersey Shareholders’ Protection Act, we may not engage in specified business
combinations with a shareholder having indirect or direct beneficial ownership
of 10% or more of the voting power of our outstanding stock (an “interested
shareholder”) for a period of five years after the date the shareholder became
an interested shareholder, unless the business combination is approved by our
Board before the date they became an interested shareholder. We also
may never engage in any business combination with any interested shareholder
except: (i) a business combination approved by the Board prior to the
date they became an interested shareholder; (ii) a business combination approved
by two-thirds of our shareholders (other than the interested shareholder); or
(iii) a business combination that satisfies certain price criteria.
These
provisions of our certificate of incorporation and New Jersey law could have the
effect of depriving our stockholders of an opportunity to receive a premium over
our common stock’s prevailing market price in the event of a hostile takeover
and may adversely affect the value of our common stock.
35
Item
1B. Unresolved Staff Comments.
None.
Item
2. Properties.
Our main
office is located in Branchville, New Jersey, on a site owned by a subsidiary
with approximately 114 acres and 315,000 square feet of operational
space. We lease all of our other facilities. The principal
office locations related to our two business segments are described in the
“Field Strategy,” and “Investments Segment,” sections of Item 1.
“Business.” We believe our facilities provide adequate space for our
present needs and that additional space, if needed, would be available on
reasonable terms.
Item
3. Legal Proceedings.
In the
ordinary course of conducting business, we are named as defendants in various
legal proceedings. Most of these proceedings are claims litigation
involving the Insurance Subsidiaries as either: (i) liability
insurers defending or providing indemnity for third-party claims brought against
insureds; or (ii) 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.
From time
to time, the Insurance Subsidiaries are also involved in other legal actions,
some of which assert claims for substantial amounts. These actions
include, among others, putative state class actions seeking certification of a
state or national class. Such putative class actions have alleged,
for example, improper reimbursement of medical providers paid under workers
compensation and personal and commercial automobile insurance
policies. The Insurance Subsidiaries are also from time-to-time
involved in individual actions in which extra-contractual damages, punitive
damages, or penalties are sought, such as claims alleging bad faith in the
handling of insurance claims. We believe that we have valid defenses
to these cases and 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
4. Submission of Matters to a Vote of Security Holders.
No
matters were submitted to a vote of security holders, through the solicitation
of proxies or otherwise, during the fourth quarter of 2009.
36
PART
II
Item
5. Market For Registrant’s Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities.
(a)
Market Information
The
Parent’s common stock is traded on the NASDAQ Global Select Market under the
symbol “SIGI.” The following table sets forth the high and low sales
prices, as reported on the NASDAQ Global Select market, for the Parent’s common
stock for each full quarterly period within the two most recent fiscal
years:
2009
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2008
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High
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Low
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High
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Low
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|||||||||||||
First
Quarter
|
$ | 23.28 | 10.06 | 27.03 | 20.78 | |||||||||||
Second
Quarter
|
15.30 | 11.46 | 26.22 | 18.74 | ||||||||||||
Third
Quarter
|
17.54 | 12.15 | 30.40 | 17.81 | ||||||||||||
Fourth
Quarter
|
17.17 | 14.84 | 26.49 | 16.33 |
On
February 19, 2010, the closing price of the Parent’s common stock as reported on
the NASDAQ Global Select Market was $16.29.
(b)
Holders
As of
February 12, 2010, there were approximately 2,490 holders of record of the
Parent’s common stock, including beneficial holders whose securities were held
in the name of the registered clearing agency or its nominee.
(c)
Dividends
Dividends
on shares of the Parent’s common stock are declared and paid at the discretion
of the Board based on our operations results, financial condition, capital
requirements, contractual restrictions, and other relevant
factors. The following table provides information on the dividends
declared for each quarterly period within our two most recent fiscal
years:
Dividend per share
|
2009
|
2008
|
||||||
First
Quarter
|
$ | 0.13 | $ | 0.13 | ||||
Second
Quarter
|
0.13 | 0.13 | ||||||
Third
Quarter
|
0.13 | 0.13 | ||||||
Fourth
Quarter
|
0.13 | 0.13 |
Our
ability to declare dividends is restricted by covenants contained in our 8.87%
senior notes that we issued on May 4, 2000. See Note 10.
“Indebtedness” in Item 8. “Financial Statements and Supplementary Data.” of this
Form 10-K. All such covenants were met during 2009 and
2008. At December 31, 2009, the amount available for dividends to
holders of our common shares under such restrictions was $303.6 million for the
8.87% Senior Notes.
Our
ability to receive dividends, loans, or advances from the Insurance Subsidiaries
is subject to the approval and/or review of the insurance regulators in the
respective domiciliary states of the Insurance Subsidiaries. Such
approval and review is made under the respective domiciliary states’ insurance
holding company acts, which generally require that any transaction between
related companies be fair and equitable to the insurance company and its
policyholders. Although our dividends have historically been met with
regulatory approval, there is no assurance that future dividends will be
approved given current market conditions. We currently expect to
continue to pay quarterly cash dividends on shares of the Parent’s common stock
in the future.
(d)
Securities Authorized for Issuance Under Equity Compensation Plans
The
following table provides information about the Parent’s common stock authorized
for issuance under equity compensation plans as of December 31,
2009.
(a)
|
(b)
|
(c)
|
||||||
Number of
|
||||||||
securities remaining
|
||||||||
Number of
|
available for
|
|||||||
securities to be
|
future issuance under
|
|||||||
issued upon
|
Weighted-average
|
equity compensation
|
||||||
exercise of
|
exercise price of
|
plans (excluding
|
||||||
outstanding options,
|
outstanding options,
|
securities reflected in
|
||||||
Plan Category
|
warrants and rights
|
warrants and rights
|
column (a))
|
|||||
Equity
compensation plans approved by security
holders
|
|
1,381,350
|
|
$
|
17.90
|
|
5,843,8681
|
1
|
Includes
1,404,195 shares available for issuance under the Employee Stock Purchase
Plan, 2,494,901 shares available for issuance under
the Stock Purchase Plan for Independent Insurance Agencies, and 1,944,772
shares available for issuance under the Selective Insurance Group,
Inc. 2005
Omnibus Stock Plan. Future grants under this plan can be made,
among other things, as stock options, restricted stock units, or
restricted stock.
|
37
(e)
Performance Graph
The
following chart, produced by Research Data Group, Inc., depicts our performance
for the period beginning December 31, 2004 and ending December 31, 2009, as
measured by total stockholder return on the Parent’s common stock compared with
the total return of the NASDAQ Composite Index and a select group of peer
companies comprised of NASDAQ-listed companies in SIC Code 6330-6339, Fire,
Marine, and Casualty Insurance.
![](https://www.sec.gov/Archives/edgar/data/0000230557/000114420410009710/chart1.jpg)
This
performance graph is not incorporated into any other filing we have made with
the SEC and will not be incorporated into any future filing we may make with the
SEC unless we so specifically incorporate it by reference. This
performance graph also shall not be deemed to be “soliciting material” or to be
“filed” with the SEC unless we specifically request so or specifically
incorporate it by reference in any filing we make with the SEC.
(f)
Purchases of Equity Securities by the Issuer and Affiliated
Purchasers
During
the year, the Company had an authorized share repurchase program for up to 4
million shares. No shares were repurchased under this program during
2009, which expired in July.
The
following table provides information regarding our purchases of the Parent’s
common stock in the fourth quarter of 2009:
Average
price
|
||||||||
Total
number of
|
paid
|
|||||||
Period
|
shares purchased1
|
per share
|
||||||
October
1-31, 2009
|
1,257 | $ | 15.97 | |||||
November
1 – 30, 2009
|
6,800 | 15.41 | ||||||
December
1 – 31, 2009
|
10,864 | 16.21 | ||||||
Total
|
18,921 | $ | 15.91 |
1
|
During
the fourth quarter of 2009, 15,049 shares were purchased from employees in
connection with the vesting of restricted stock and 3,872 shares were
purchased from employees in connection with stock option
exercises. These repurchases were made in connection with
satisfying tax withholding obligations with respect to those
employees. These shares were not purchased as part of the
publicly announced program. The shares that were purchased in
connection with the vesting of restricted stock were purchased at the
closing price on the dates of purchase. The shares purchased in
connection with the option exercises were purchased at the current market
prices of the Parent’s common stock on the dates the options were
exercised.
|
38
Item
6. Selected Financial Data.
Eleven-Year
Financial Highlights1
(All presentations are in accordance with
|
||||||||||||||||||||
GAAP unless noted otherwise, number of
|
||||||||||||||||||||
weighted average shares and dollars in
|
||||||||||||||||||||
thousands, except per share amounts)
|
2009
|
2008
|
2007
|
2006
|
2005
|
|||||||||||||||
Net
premiums written
|
$ | 1,422,665 | 1,492,738 | 1,562,450 | 1,540,645 | 1,462,605 | ||||||||||||||
Net
premiums earned
|
1,431,047 | 1,504,187 | 1,524,889 | 1,504,348 | 1,421,144 | |||||||||||||||
Net
investment income earned
|
118,471 | 131,032 | 174,144 | 156,802 | 135,950 | |||||||||||||||
Net
realized (losses) gains
|
(45,970 | ) | (49,452 | ) | 33,354 | 35,479 | 14,464 | |||||||||||||
Total
revenues
|
1,514,018 | 1,589,939 | 1,739,315 | 1,703,083 | 1,576,517 | |||||||||||||||
Underwriting
profit (loss)
|
2,385 | 132 | 30,966 | 71,077 | 80,458 | |||||||||||||||
Net income from
continuing operations2
|
44,658 | 44,101 | 143,636 | 160,175 | 144,822 | |||||||||||||||
Total discontinued
operations, net of tax2
|
(8,260 | ) | (343 | ) | 2,862 | 3,399 | 3,176 | |||||||||||||
Cumulative
effect of change in accounting principle, net of tax
|
- | - | - | - | 495 | |||||||||||||||
Net
income
|
36,398 | 43,758 | 146,498 | 163,574 | 148,493 | |||||||||||||||
Comprehensive
income (loss)
|
126,984 | (136,741 | ) | 131,940 | 159,802 | 112,078 | ||||||||||||||
Total
assets
|
5,114,827 | 4,945,556 | 5,007,158 | 4,772,528 | 4,375,625 | |||||||||||||||
Notes
payable and debentures
|
274,606 | 273,878 | 295,067 | 362,602 | 339,409 | |||||||||||||||
Stockholders’
equity
|
1,002,375 | 890,493 | 1,076,043 | 1,077,227 | 981,124 | |||||||||||||||
Statutory
premiums to surplus ratio
|
1.5 | 1.7 | 1.5 | 1.5 | 1.6 | |||||||||||||||
Statutory
combined ratio
|
100.5 | 99.2 | 97.5 | 95.4 | 94.6 | |||||||||||||||
Combined
ratio
|
99.8 | 100.0 | 98.0 | 95.3 | 94.3 | |||||||||||||||
Yield
on investment, before tax
|
3.2 | 3.6 | 4.8 | 4.6 | 4.6 | |||||||||||||||
Debt
to capitalization
|
21.5 | 23.5 | 21.5 | 25.2 | 25.7 | |||||||||||||||
Return
on average equity
|
3.8 | 4.5 | 13.6 | 15.9 | 15.9 | |||||||||||||||
Non-GAAP
measures3:
|
||||||||||||||||||||
Operating
income (loss)
|
74,538 | 76,245 | 121,956 | 137,113 | 135,421 | |||||||||||||||
Operating
return on average equity
|
7.9 | 7.8 | 11.3 | 13.3 | 14.5 | |||||||||||||||
Per
share data:
|
||||||||||||||||||||
Net
income from continuing operations2:
|
||||||||||||||||||||
Basic
|
$ | 0.84 | 0.85 | 2.75 | 2.92 | 2.68 | ||||||||||||||
Diluted
|
0.83 | 0.83 | 2.54 | 2.60 | 2.30 | |||||||||||||||
Net
income:
|
||||||||||||||||||||
Basic
|
$ | 0.69 | 0.84 | 2.80 | 2.98 | 2.74 | ||||||||||||||
Diluted
|
0.68 | 0.82 | 2.59 | 2.65 | 2.35 | |||||||||||||||
Dividends
to stockholders
|
$ | 0.52 | 0.52 | 0.49 | 0.44 | 0.40 | ||||||||||||||
Stockholders’
equity
|
$ | 18.83 | 16.84 | 19.81 | 18.81 | 17.34 | ||||||||||||||
Price
range of common stock:
|
||||||||||||||||||||
High
|
$ | 23.28 | 30.40 | 29.07 | 29.18 | 29.64 | ||||||||||||||
Low
|
10.06 | 16.33 | 19.04 | 24.89 | 20.88 | |||||||||||||||
Close
|
16.45 | 22.93 | 22.99 | 28.65 | 26.55 | |||||||||||||||
Number
of weighted average shares:
|
||||||||||||||||||||
Basic
|
$ | 52,630 | 52,104 | 52,382 | 54,986 | 54,342 | ||||||||||||||
Diluted
|
53,397 | 53,319 | 57,165 | 62,542 | 64,708 |
1
|
See
the Glossary of Terms attached to this Form 10-K as Exhibit
99.1
|
2
|
In
2002, we sold our ownership interest in PDA Software Services, Inc., in
2005, we sold our ownership interest in CHN Solutions (Alta
Services, LLC and Consumer Health Network Plus, LLC), and in 2009, we sold
our ownership interest in Selective
HR.
|
3
|
Operating
income (loss) is a non-GAAP measure. Operating return on
average equity is a profitability measure calculated by dividing operating
income (loss)
by average equity. See the “Financial Highlights” section in
Item 7. of this Form 10-K for a reconciliation of operating income to net
income.
|
39
Eleven-Year
Financial Highlights1
(All presentations are in accordance with
|
||||||||||||||||||||||||
GAAP unless noted otherwise, number of
|
||||||||||||||||||||||||
weighted average shares and dollars in
|
||||||||||||||||||||||||
thousands, except per share amounts)
|
2004
|
2003
|
2002
|
2001
|
2000
|
1999
|
||||||||||||||||||
Net
premiums written
|
1,367,717 | 1,211,192 | 1,055,314 | 927,035 | 844,935 | 812,484 | ||||||||||||||||||
Net
premiums earned
|
1,320,959 | 1,135,103 | 990,095 | 884,663 | 822,596 | 799,872 | ||||||||||||||||||
Net
investment income earned
|
120,540 | 114,748 | 103,067 | 96,767 | 99,495 | 96,351 | ||||||||||||||||||
Net
realized (losses) gains
|
24,587 | 12,842 | 3,294 | 6,816 | 4,191 | 29,377 | ||||||||||||||||||
Total
revenues
|
1,470,907 | 1,267,510 | 1,101,274 | 992,254 | 931,007 | 928,743 | ||||||||||||||||||
Underwriting
profit (loss)
|
50,098 | (18,816 | ) | (34,352 | ) | (58,217 | ) | (61,746 | ) | (50,042 | ) | |||||||||||||
Net
income from continuing operations2.
|
125,655 | 64,547 | 41,091 | 28,344 | 24,272 | 52,889 | ||||||||||||||||||
Total discontinued
operations, net of tax2
|
2,984 | 1,797 | 878 | (2,651 | ) | 2,263 | 828 | |||||||||||||||||
Cumulative
effect of change in accounting principle, net of
tax
|
- | - | - | - | - | - | ||||||||||||||||||
Net
income
|
128,639 | 66,344 | 41,969 | 25,693 | 26,535 | 53,717 | ||||||||||||||||||
Comprehensive
income (loss)
|
134,723 | 99,362 | 59,366 | 24,405 | 49,166 | 16,088 | ||||||||||||||||||
Total
assets
|
3,912,414 | 3,424,923 | 3,017,147 | 2,674,073 | 2,590,903 | 2,507,940 | ||||||||||||||||||
Notes
payable and debentures
|
264,350 | 238,621 | 262,768 | 156,433 | 163,634 | 81,585 | ||||||||||||||||||
Stockholders’
equity
|
882,018 | 749,784 | 652,102 | 591,160 | 577,797 | 569,964 | ||||||||||||||||||
Statutory
premiums to surplus ratio
|
1.7 | 1.8 | 1.9 | 1.8 | 1.7 | 1.6 | ||||||||||||||||||
Statutory
combined ratio
|
95.9 | 101.5 | 103.2 | 106.7 | 108.2 | 105.7 | ||||||||||||||||||
Combined
ratio
|
96.2 | 101.7 | 103.5 | 106.6 | 107.5 | 106.3 | ||||||||||||||||||
Yield
on investment, before tax
|
4.7 | 5.1 | 5.4 | 5.4 | 5.8 | 5.6 | ||||||||||||||||||
Debt
to capitalization
|
23.1 | 24.1 | 28.7 | 21.0 | 22.1 | 12.5 | ||||||||||||||||||
Return
on average equity
|
15.8 | 9.5 | 6.8 | 4.4 | 4.6 | 9.1 | ||||||||||||||||||
Non-GAAP
measures3:
|
||||||||||||||||||||||||
Operating
income (loss
|
109,674 | 56,200 | 38,950 | 23,914 | 21,548 | 33,794 | ||||||||||||||||||
Operating
return on average equity
|
13.4 | 8.0 | 6.3 | 4.1 | 3.8 | 5.7 | ||||||||||||||||||
Per
share data:
|
||||||||||||||||||||||||
Net
income from continuing operations2:
|
||||||||||||||||||||||||
Basic
|
2.35 | 1.24 | 0.81 | 0.58 | 0.49 | 0.97 | ||||||||||||||||||
Diluted
|
1.99 | 1.07 | 0.75 | 0.54 | 0.47 | 0.93 | ||||||||||||||||||
Net
income:
|
||||||||||||||||||||||||
Basic
|
2.41 | 1.27 | 0.83 | 0.53 | 0.54 | 0.99 | ||||||||||||||||||
Diluted
|
2.04 | 1.10 | 0.77 | 0.49 | 0.51 | 0.94 | ||||||||||||||||||
Dividends
to stockholders
|
0.35 | 0.31 | 0.30 | 0.30 | 0.30 | 0.30 | ||||||||||||||||||
Stockholders’
equity
|
15.79 | 13.74 | 12.26 | 11.58 | 11.46 | 10.73 | ||||||||||||||||||
Price
range of common stock:
|
||||||||||||||||||||||||
High
|
22.98 | 16.50 | 15.74 | 14.11 | 12.94 | 11.25 | ||||||||||||||||||
Low
|
15.86 | 10.91 | 9.68 | 9.97 | 7.32 | 8.25 | ||||||||||||||||||
Close
|
22.12 | 16.18 | 12.59 | 10.87 | 12.13 | 8.60 | ||||||||||||||||||
Number
of weighted average shares:
|
||||||||||||||||||||||||
Basic
|
53,462 | 52,262 | 50,602 | 49,166 | 49,814 | 54,162 | ||||||||||||||||||
Diluted
|
64,756 | 63,206 | 55,990 | 52,848 | 53,144 | 57,754 |
1
|
See
the Glossary of Terms attached to this Form 10-K as Exhibit
99.1
|
2
|
In
2002, we sold our ownership interest in PDA Software Services, Inc., in
2005, we sold our ownership interest in CHN Solutions (Alta
Services, LLC and Consumer Health Network Plus, LLC), and in 2009, we sold
our ownership interest in Selective
HR.
|
3
|
Operating
income (loss) is a non-GAAP measure. Operating return on
average equity is a profitability measure calculated by dividing operating
income (loss)
by average equity. See the “Financial Highlights” section in
Item 7. of this Form 10-K for a reconciliation of operating income to net
income.
|
40
Item
7. Management’s Discussion and Analysis of Financial Condition and
Results of Operations.
Forward-looking
Statements
Certain
statements in this report, including information incorporated by reference, are
“forward-looking statements” as that term is defined in the Private Securities
Litigation Reform Act of 1995 (“PSLRA”). The PSLRA provides a safe
harbor under the Securities Act of 1933 and the Exchange Act for forward-looking
statements. These statements relate to our intentions, beliefs,
projections, estimations or forecasts of future events or future financial
performance and involve known and unknown risks, uncertainties and other factors
that may cause us or the industry’s actual results, levels of activity, or
performance to be materially different from those expressed or implied by the
forward-looking statements. In some cases, forward-looking statements
may be identified by use of the words such as “may,” “will,” “could,” “would,”
“should,” “expect,” “plan,” “anticipate,” “target,” “project,” “intend,”
“believe,” “estimate,” “predict,” “potential,” “pro forma,” “seek,” “likely” or
“continue” or other comparable terminology. These statements are only
predictions, and we can give no assurance that such expectations will prove to
be correct. We undertake no obligation, other than as may be required
under the federal securities laws, to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.
Factors
that could cause our actual results to differ materially from those we have
projected, forecasted or estimated in forward-looking statements are discussed
in further detail in Item 1A. “Risk Factors.” These risk factors may
not be exhaustive. We operate in a continually changing business
environment, and new risk factors emerge from time-to-time. We can
neither predict such new risk factors nor can we assess the impact, if any, of
such new risk factors on our businesses or the extent to which any factor or
combination of factors may cause actual results to differ materially from those
expressed or implied in any forward-looking statements in this
report. In light of these risks, uncertainties and assumptions, the
forward-looking events discussed in this report might not occur.
Introduction
We offer
property and casualty insurance products through our various
subsidiaries. We classify our businesses into two operating
segments: (i) Insurance Operations, which consists of commercial
lines (“Commercial Lines”) and personal lines, including our flood line of
business (“Personal Lines”) and (ii) Investments. These segments
reflect a change from our historical segments of: Insurance
Operations, Investments, and Diversified Insurance Services (which included
federal flood insurance administrative services (“Flood”) and human resource
administration outsourcing (“HR Outsourcing”)). In the process of
periodically reviewing our operating segments, we reclassified our Flood
operations in the first quarter of 2009 to be included within our Insurance
Operations segment, which reflects the way we are now managing this
business. We believe these reporting changes better enable investors
to view us the way our management views our operations and provide more
consistency with how our peers report their business. During the
third quarter of 2009, we entered into a plan to dispose of our HR Outsourcing
segment, which caused the elimination of this operating segment. The
sale of this business was completed in Fourth Quarter 2009. Our
revised segments are reflected throughout this report for all periods
presented. See Note 13. “Discontinued Operations” in Item 8. “Financial
Statements and Supplementary Data.” of this Form 10-K for additional
information.
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.
In the
MD&A, we will discuss and analyze the following:
·
|
Critical
Accounting Policies and Estimates;
|
·
|
Financial
Highlights of Results for Years Ended December 31, 2009, 2008, and
2007;
|
·
|
Results
of Operations and Related Information by
Segment;
|
·
|
Federal
Income Taxes;
|
·
|
Financial
Condition, Liquidity, and Capital
Resources;
|
·
|
Off-Balance
Sheet Arrangements;
|
·
|
Contractual
Obligations and Contingent Liabilities and
Commitments;
|
·
|
Ratings;
and
|
·
|
Adoption
of Accounting Pronouncements.
|
41
Critical
Accounting Policies and Estimates
We have
identified the policies and estimates described below as critical to our
business operations and the understanding of the results of our
operations. Our preparation of the Consolidated Financial Statements
requires us to make estimates and assumptions that affect the reported amount of
assets and liabilities, disclosure of contingent assets and liabilities at the
date of our Consolidated Financial Statements, and the reported amounts of
revenue and expenses during the reporting period. There can be no
assurance that actual results will not differ from those
estimates. Those estimates that were most critical to the preparation
of the Consolidated Financial Statements involved the following: (i)
reserve for losses and loss expenses; (ii) deferred policy acquisition costs;
(iii) pension and post-retirement benefit plan actuarial assumptions; (iv) OTTI;
and (v) reinsurance.
Reserves
for Losses and Loss Expenses
Significant
periods of time can elapse between the occurrence of an insured loss, the
reporting of the loss to the insurer, and the insurer’s payment of that
loss. To recognize liabilities for unpaid losses and loss expenses,
insurers establish reserves as balance sheet liabilities representing an
estimate of amounts needed to pay reported and unreported net losses and loss
expense. As of December 31, 2009, we had accrued $2.7 billion of
gross loss and loss expense reserves compared to $2.6 billion at December 31,
2008.
How
reserves are established
When a
claim is reported to an insurance subsidiary, claims personnel establish a “case
reserve” for the estimated amount of the ultimate payment. The amount
of the reserve is primarily based upon a case by case evaluation of the type of
claim involved, the circumstances surrounding each claim, and the policy
provisions relating to the type of losses. The estimate reflects the
informed judgment of such personnel based on their knowledge, experience, and
general insurance reserving practices. Until the claim is resolved,
these estimates are revised as deemed appropriate by the responsible claims
personnel based on subsequent developments and periodic reviews of the
case.
In
addition to case reserves, we maintain estimates of reserves for losses and loss
expenses that have been incurred but not reported to us (referred to as
“IBNR”). Using generally accepted actuarial reserving techniques, we
project our estimate of ultimate losses and loss expenses at each reporting
date. The difference between: (i) the projected ultimate
loss and loss expense reserves; and (ii) the case loss reserves and the loss
expenses reserved thereon is carried as the IBNR reserve. The
actuarial techniques used are part of a comprehensive reserving process that
included two primary components. The first component is a detailed
quarterly reserve analysis performed by our internal actuarial
staff. In completing this analysis, the actuaries are required to
make numerous assumptions including, for example, the selection of loss
development factors and the weight to be applied to each individual actuarial
indication. These indications include paid and incurred versions for
the following actuarial methodologies: loss development,
Bornhuetter-Ferguson, Berquist-Sherman, and frequency/severity
modeling. Additionally, the actuaries must gather substantially
similar data in sufficient volume to ensure the statistical credibility of the
data. The second component of the analysis is the projection of the
expected ultimate loss ratio for each line of business for the current accident
year. This projection is part of our planning process wherein we
review and update expected loss ratios each quarter. This review
includes actual versus expected pricing changes, loss trend assumptions, and
updated prior period loss ratios from the most recent quarterly reserve
analysis.
In
addition to the most recent loss trends, a range of possible IBNR reserves is
determined annually and continually considered, among other factors, in
establishing IBNR for each reporting period. Loss trends include, but
are not limited to, large loss activity, environmental claim activity, large
case reserve additions or reductions for prior accident years, and reinsurance
recoverable issues. We also consider factors such as: (i)
per claim information; (ii) company and industry historical loss experience;
(iii) legislative enactments, judicial decisions, legal developments in the
imposition of damages, and changes in political attitudes; and (iv) trends in
general economic conditions, including the effects of
inflation. Based on the consideration of the range of possible IBNR
reserves, recent loss trends, uncertainty associated with actuarial assumptions
and other factors, IBNR is established and the ultimate net liability for losses
and loss expenses is determined. Such an assessment requires
considerable judgment given that it is frequently not possible to determine
whether a change in the data is an anomaly until some time after the
event. Even if a change is determined to be permanent, it is not
always possible to reliably determine the extent of the change until some time
later. There is no precise method for subsequently evaluating the
impact of any specific factor on the adequacy of reserves because the eventual
deficiency or redundancy is affected by many factors. The changes in
these estimates, resulting from the continuous review process and the
differences between estimates and ultimate payments, are reflected in the
consolidated statements of income for the period in which such estimates are
changed. Any changes in the liability estimate may be material to the
results of operations in future periods.
42
Major
trends by line of business creating additional loss and loss expense reserve
uncertainty
The
Insurance Subsidiaries are multi-state, multi-line property and casualty
insurance companies and, as such, are subject to reserve uncertainty stemming
from a variety of sources. These uncertainties are considered at each
step in the process of establishing loss and loss expense
reserves. However, as market conditions change, certain trends are
identified that management believes create an additional amount of
uncertainty. A discussion of recent trends, by line of business, that
have been recognized by management follows:
Workers
Compensation
At
December 31, 2009, our workers compensation line of business recorded reserves,
net of reinsurance, of $843 million, or 34% of our total net
reserves. In addition to the uncertainties associated with actuarial
assumptions and methodologies described above, the workers compensation line of
business can be impacted by a variety of issues such as unexpected changes in
medical cost inflation, higher than anticipated claim severity, changes in
overall economic conditions, and Company specific initiatives. From
2005 through 2009, we experienced an unusual amount of volatility associated
with our workers compensation medical costs. In addition, uncertainty
regarding future medical inflation creates the potential for additional
volatility in our reserves. In 2009, overall economic conditions were
extremely unstable. High levels of unemployment could impact both the
severity and frequency of our workers compensation claims. There is
potential for an increase in severity if the longevity of workers compensation
claims increase. Injured workers could have less incentive to return
to work when their company is in financial distress or injured workers could be
laid off while on workers compensation. There is potential for a
decrease in frequency if workers are reluctant to file claims or have less work
and less exposure to injury. Additionally, the economy could impact
the frequency and severity of claims in ways unanticipated by
management. In 2009 and 2008, we have experienced an unusually high
amount of audit activity in which we have return premium of $29.0 million and
$10.7 million, respectively, a trend which may continue into the
future. This could impact our reserves in ways not yet
determined. The result could be favorable development if the
reduction in payroll is truly a reduction in exposure. The result
could be adverse development if the reduction in payroll indicates that
remaining workers are now overworked and more prone to
accidents. Finally, in the past few years, the company implemented a
multi-faceted workers compensation strategy which incorporated knowledge
management and predictive modeling initiatives. The ongoing impact of
these initiatives is a potential source of uncertainty in the
future. If the ongoing impact of these strategies exceed our
expectations, the result could be favorable development in the
future. If our internal strategies are less effective than
anticipated and we experience higher than expected claim severity, the result
could be adverse development in the future.
General
Liability
At
December 31, 2009, our general liability line of business had recorded reserves,
net of reinsurance of $948 million, which represented 38% of our total net
reserves. This line of business includes excess policies which
provide additional limits above underlying automobile and general liability
coverages. While prior year development in recent years has been
relatively minor, we have been growing the number of our commercial excess
policies at a greater rate than the rest of our commercial lines of business
which could create additional volatility in our results. In 2008 and
2009, we have lowered the net retention of our reinsurance covering these
policies, which should mitigate some of the potential volatility.
Commercial
Automobile
At
December 31, 2009, our commercial automobile line of business had recorded
reserves, net of reinsurance, of $370 million, which represented 15% of our
total net reserves. This line of business experienced favorable prior
year loss development from 2005 to 2009 which was driven by a downward trend in
frequency of large claims. The number of large claims has a high
degree of volatility from year to year and, therefore, requires a longer period
before true trends are recognized and can be acted upon. We
experienced lower than expected severity in accident years 2002 through 2006
which did not continue into the 2007 and 2008 accident years. At this
early stage, accident year 2009 is showing positive signs of having lower than
expected severity. While management has not identified any specific
trends related to this line, the volatility of large claims does create
additional uncertainty in our analysis for our most recent accident
years.
General Liability and
Commercial Automobile (Impact of Claims Initiatives and
Inflation)
In
addition to the line of business specific issues mentioned above, both of these
lines of business have been impacted by a number of initiatives undertaken by
our claims department which have resulted in volatility in the average case
reserves. This change in the average level of case reserves increases
the uncertainty in the short run, but the longer term benefit is a more refined
management of the claims process. Additionally, inflationary
pressures are perceived to be more likely in the current economic
environment. Uncertainty regarding future inflation or deflation
creates the potential for additional volatility in our reserves for both of
these lines of business.
43
Personal
Automobile
At
December 31, 2009, our personal automobile line of business had recorded
reserves, net of reinsurance, of $138 million, which represented 6% of our total
net reserves. The majority of the reserves are from business written
in New Jersey, where the judicial and regulatory environment has been subject to
significant changes over the past few decades. Over the past several
years we have been decreasing the amount of business written in New Jersey while
increasing the amount of business written in other states. We review
the reserves for states other than New Jersey on a combined basis so that there
is a sufficient volume of data to ensure statistical
credibility. However, the state mix changes over
time. Both the change in state mix and the change in the New Jersey
judicial and regulatory environment increases the uncertainty surrounding our
personal automobile reserves since much of the historical information used to
make assumptions has been rendered less effective as a basis for projecting
future results.
Other Lines of
Business
At
December 31, 2009, no other individual line of business had recorded reserves of
more than $79 million, net of reinsurance. We have not identified any
recent trends that would create additional significant reserve uncertainty for
these other lines of business.
The
following tables provide case and IBNR reserves for losses, reserves for loss
expenses, and reinsurance recoverable on unpaid losses and loss expenses as of
December 31, 2009 and 2008:
As of December 31, 2009
|
Reinsurance
|
|||||||||||||||||||||||
Recoverable
|
||||||||||||||||||||||||
On Unpaid
|
||||||||||||||||||||||||
Loss Reserves
|
Loss
|
Losses and
|
||||||||||||||||||||||
Case
|
IBNR
|
Expense
|
Loss
|
|||||||||||||||||||||
($ in thousands)
|
Reserves
|
Reserves
|
Total
|
Reserves
|
Expenses
|
Net Reserves
|
||||||||||||||||||
Commercial automobile
|
$ | 125,576 | 216,860 | 342,436 | 37,145 | 9,224 | 370,357 | |||||||||||||||||
Workers
compensation
|
434,922 | 410,783 | 845,705 | 107,415 | 110,015 | 843,105 | ||||||||||||||||||
General
liability
|
191,890 | 605,309 | 797,199 | 200,546 | 49,336 | 948,409 | ||||||||||||||||||
Commercial
property
|
28,467 | (288 | ) | 28,179 | 3,933 | 1,592 | 30,520 | |||||||||||||||||
Business
owners’ policies
|
27,011 | 46,800 | 73,811 | 12,531 | 7,470 | 78,872 | ||||||||||||||||||
Bonds
|
3,474 | 4,581 | 8,055 | 2,222 | 390 | 9,887 | ||||||||||||||||||
Other
|
811 | 1,210 | 2,021 | 3 | 617 | 1,407 | ||||||||||||||||||
Total
commercial lines
|
812,151 | 1,285,255 | 2,097,406 | 363,795 | 178,644 | 2,282,557 | ||||||||||||||||||
Personal
automobile
|
116,625 | 57,831 | 174,456 | 30,487 | 67,124 | 137,819 | ||||||||||||||||||
Homeowners
|
17,303 | 23,873 | 41,176 | 5,820 | 942 | 46,054 | ||||||||||||||||||
Other
|
13,171 | 16,710 | 29,881 | 2,778 | 24,900 | 7,759 | ||||||||||||||||||
Total
personal lines
|
147,099 | 98,414 | 245,513 | 39,085 | 92,966 | 191,632 | ||||||||||||||||||
Total
|
$ | 959,250 | 1,383,669 | 2,342,919 | 402,880 | 271,610 | 2,474,189 |
As of December 31, 2008
|
Reinsurance
|
|||||||||||||||||||||||
Recoverable
|
||||||||||||||||||||||||
On Unpaid
|
||||||||||||||||||||||||
Loss Reserves
|
Loss
|
Losses and
|
||||||||||||||||||||||
Case
|
IBNR
|
Expense
|
Loss
|
|||||||||||||||||||||
($ in thousands)
|
Reserves
|
Reserves
|
Total
|
Reserves
|
Expenses
|
Net Reserves
|
||||||||||||||||||
Commercial automobile
|
$ | 131,038 | 187,804 | 318,842 | 36,868 | 9,351 | 346,359 | |||||||||||||||||
Workers
compensation
|
396,345 | 431,549 | 827,894 | 103,952 | 81,556 | 850,290 | ||||||||||||||||||
General
liability
|
203,487 | 538,591 | 742,078 | 185,434 | 36,978 | 890,534 | ||||||||||||||||||
Commercial
property
|
39,570 | 1,978 | 41,548 | 3,669 | 2,214 | 43,003 | ||||||||||||||||||
Business
owners’ policies
|
25,988 | 35,309 | 61,297 | 10,073 | 5,256 | 66,114 | ||||||||||||||||||
Bonds
|
2,135 | 4,314 | 6,449 | 2,215 | 387 | 8,277 | ||||||||||||||||||
Other
|
719 | 1,323 | 2,042 | - | 686 | 1,356 | ||||||||||||||||||
Total
commercial lines
|
799,282 | 1,200,868 | 2,000,150 | 342,211 | 136,428 | 2,205,933 | ||||||||||||||||||
Personal
automobile
|
123,964 | 62,141 | 186,105 | 35,239 | 62,699 | 158,645 | ||||||||||||||||||
Homeowners
|
18,589 | 22,729 | 41,318 | 4,628 | 883 | 45,063 | ||||||||||||||||||
Other
|
13,730 | 15,026 | 28,756 | 2,566 | 24,182 | 7,140 | ||||||||||||||||||
Total
personal lines
|
156,283 | 99,896 | 256,179 | 42,433 | 87,764 | 210,848 | ||||||||||||||||||
Total
|
$ | 955,565 | 1,300,764 | 2,256,329 | 384,644 | 224,192 | 2,416,781 |
44
Range
of reasonable reserves
We
established a range of reasonably possible reserves for net claims of
approximately $2,312 million to $2,608 million at December 31, 2009 and $2,267
million to $2,545 million at December 31, 2008. A low and high
reasonable reserve selection was derived primarily by considering the range of
indications calculated using generally accepted actuarial
techniques. Such techniques assume that past experience, adjusted for
the effects of current developments and anticipated trends, are an appropriate
basis for predicting future events. Although this range reflects
likely scenarios, it is possible that the final outcomes may fall above or below
these amounts. Based on internal stochastic modeling, we feel that a
reasonable estimate of the likelihood that the final outcome falls within the
current range is approximately 78%. This range does not include a
provision for potential increases or decreases associated with environmental
reserves. Our best estimate is consistent with the actuarial best
estimate. We do not discount to present value that portion of our
loss reserves expected to be paid in future periods; however, the loss reserves
take into account anticipated recoveries for salvage and subrogation
claims.
Sensitivity
Analysis: Potential impact on reserve volatility due to changes in
key assumptions
Our
process to establish reserves includes a variety of key assumptions, including,
but not limited to, the following:
|
·
|
The
selection of loss development
factors;
|
|
·
|
The
weight to be applied to each individual actuarial
indication;
|
|
·
|
Projected
future loss trends; and
|
|
·
|
Expected
ultimate loss ratios for the current accident
year.
|
The
importance of any single assumption depends on several considerations, such as
the line of business and the accident year. If the actual experience
emerges differently than the assumptions used in the process to establish
reserves, changes in our reserve estimate are possible and may be material to
the results of operations in future periods. Set forth below is a
discussion of the potential impact of using certain key assumptions that differ
from those used in our latest reserve analysis. It is important to
note that the following discussion considers each assumption individually,
without any consideration of correlation between lines of business and accident
years, and therefore, does not constitute an actuarial range. While
the following discussion represents possible volatility from variations in key
assumptions as identified by management, there is no assurance that the future
emergence of our loss experience will be consistent with either our current or
alternative set of assumptions. By the very nature of the insurance
business, loss development patterns have a certain amount of normal
volatility.
Workers
Compensation
In
addition to the normal amount of volatility, the combination of the sensitivity
of workers compensation results to medical inflation, economic conditions
including unemployment, and changes in underwriting could lead to actual
experience emerging differently than the assumptions used in the process to
establish reserves. In our judgment, it is possible that actual
medical loss development factors could range from 6% below to 9% above those
selected in our latest reserve analysis and expected loss ratios could range
from 5% below to 8% above those selected in our latest reserve
analysis. The combination of reducing the assumptions for medical
loss development by 6% and the expected loss ratio by 5% could decrease our
indicated workers compensation reserves by approximately $63 million for
accident years 2008 and prior. Alternatively, the combination of
increasing the medical loss development factors by 9% and the expected loss
ratio by 8% could increase our indicated workers compensations reserves by
approximately $101 million for accident years 2008 and prior.
General
Liability
In
addition to the normal amount of volatility, general liability loss development
factors have greater uncertainty due to the complexity of the coverages and the
possibly significant periods of time that can elapse between the occurrence of
an insured loss, the reporting of the loss to the insurer, and the insurer’s
payment of that loss. In our judgment, it is possible that general
liability loss development factors could be +/- 5% from those actually selected
in our latest reserve analysis. If the loss development assumptions
were changed by +/- 5% that would increase/decrease our indicated general
liability reserves by approximately $83 million for accident years 2008 and
prior.
45
Commercial
Automobile
In
addition to the normal amount of volatility, our commercial automobile line of
business has realized significant favorable development in 2005 to
2009. This favorable development was driven in large part by a
reduction in our bodily injury large loss experience. The actual
number of large claims has a high degree of volatility from year to year in
terms of timing and ultimate final emergence. Even if ultimate large
losses are ultimately consistent from year to year, if they are identified at
different times than previous years, traditional loss development factors may
overstate or understate actuarial indications. If the timing of large
losses is significantly variable, it is our judgment that actual loss
development factors could be +/- 5% different from those selected in our reserve
review, which would increase/decrease our indicated commercial auto reserves by
approximately $52 million for accident years 2008 and prior.
Claims Initiatives Impact on
General Liability and Commercial Automobile
As
discussed in the major trend section above, the claims initiatives and
inflationary uncertainty could impact reserves for the general liability and
commercial automobile lines of business. In our judgment, it is
possible that the selected reserves for these lines of business in our latest
reserve review could increase by $72 million or decrease by $51 million due to
the combination of case reserve volatility in accident years 2008 and 2009 and
unexpected inflation or deflation.
Personal
Automobile
In
addition to a normal amount of volatility, the uncertainty of personal
automobile loss development factors is greater than usual due to the number of
judicial and regulatory changes in the New Jersey personal automobile market
over the years as well as the change in our state mix for business written in
states other than New Jersey. In our judgment, it is possible that
personal auto bodily injury loss development factors could range from 4% below
those actually selected in our latest reserve analysis to 3% above those
selected in our latest reserve analysis. If the loss development
assumptions were reduced by 4%, that would decrease our indicated personal
automobile reserves by approximately $34 million for accident years 2008 and
prior. Alternatively, if the loss development factors were increased
by 3% that would increase our indicated personal automobile reserves by
approximately $25 million for accident years 2008 and prior.
Current Accident
Year
For the
2009 accident year, the expected ultimate loss ratio by line of business is a
key assumption. This assumption is based upon a large number of
inputs that are assessed periodically, such as historical loss ratios, projected
future loss trend, and planned pricing amounts. In our judgment, it
is possible that the actual ultimate loss ratio for the 2009 accident year could
be +/-7% from the one selected in our latest reserve analysis for each of our
four major long-tailed lines of business. The table below summarizes
the possible impact on our reserves of varying our expected loss ratio
assumption by +/-7% by line of business for the 2009 accident year.
Reserve Impact of Changing
Current year Expected Ultimate Loss Ratio Assumption
($ in millions)
|
If Assumption Was
Reduced by 7%
|
If Assumption Was
Raised by 7%
|
||||||
Workers
Compensation
|
(18 | ) | 18 | |||||
General
Liability
|
(25 | ) | 25 | |||||
Commercial
Automobile Liability
|
(17 | ) | 17 | |||||
Personal
Automobile Liability
|
(7 | ) | 7 |
Prior
year reserve development
In light
of the many uncertainties associated with establishing the estimates and making
the assumptions necessary to establish reserve levels, we review our reserve
estimates on a regular basis as described above and make adjustments in the
period that the need for such adjustment is determined. These reviews
could result in the identification of information and trends that would require
us to increase some reserves and/or decrease other reserves for prior periods
and could also lead to additional increases in loss and loss adjustment expense
reserves, which could have a material adverse effect on our results of
operations, equity, business, insurer financial strength, and debt
ratings. In 2009, we experienced favorable loss development of
approximately $67 million in accident years 2004 through 2007 partially offset
by unfavorable loss development in the 2008 accident year, as well as accident
years prior to 2003, of approximately $38 million, netting to favorable prior
year development of $29 million. In 2008, we experienced favorable
loss development in accident years 2006 and prior of $46.2 million partially
offset by unfavorable loss development in accident year 2007 of $26.9 million,
netting to total favorable prior year development of $19.3 million and in 2007,
we experienced net favorable prior year development of $18.8
million. For further discussion on the prior year development in loss
and loss expense reserves, see the discussion on “Net Loss and Loss Expense
Reserves” in Item 1. “Business” and Note 9 of Item
8. “Financial Statements and Supplementary Data” of this Form
10-K.
46
Asbestos
and Environmental Reserves
Included
in our loss and loss expense reserves are amounts for environmental claims, both
asbestos and non-asbestos. Carried net loss and loss expense reserves
for environmental claims were $41.6 million as of December 31, 2009 and $44.1
million as of December 31, 2008. Our asbestos and non-asbestos
environmental claims have arisen primarily from insured exposures in municipal
government, small commercial risks, and homeowners policies. The
emergence of these claims is slow and highly unpredictable. Over the
past few years, we also experienced adverse development in our homeowners line
of business as a result of unfavorable trends in claims for groundwater
contamination caused by leakage of certain underground heating oil storage tanks
in New Jersey. In addition, certain landfill sites are included on
the National Priorities List (“NPL”) by the United States Environmental
Protection Agency (“USEPA”). Once on the NPL, the USEPA determines an
appropriate remediation plan for these sites. A landfill can remain
on the NPL for many years until final approval for the removal of the site is
granted from the USEPA. The USEPA also has the authority to re-open
previously closed sites and return them to the NPL. We currently have
reserves for several claims related to sites on the NPL, one of which has been
reopened in 2009 relative to a natural resources claim.
IBNR
reserve estimation for environmental claims is often difficult because, in
addition to other factors, there are significant uncertainties associated with
critical assumptions in the estimation process, such as average clean-up costs,
third-party costs, potentially responsible party shares, allocation of damages,
insurer litigation costs, insurer coverage defenses, and potential changes to
state and federal statutes.
However,
we are not aware of any emerging trends that could result in future reserve
adjustments. Moreover, normal historically-based actuarial approaches
are difficult to apply because relevant history is not
available. While models can be applied, such models can produce
significantly different results with small changes in assumptions. As
a result, we do not calculate a specific environmental loss range, as we believe
it would not be meaningful.
The table
below summarizes the number of asbestos and non-asbestos claims outstanding at
December 31, 2009, 2008, and 2007. For additional information about
our environmental reserves, see Item 1. “Business,” and Item 8. “Financial
Statements and Supplementary Data,” Note 9. to the Consolidated Financial
Statements.
Environmental Claims Activity
|
||||||||||||
2009
|
2008
|
2007
|
||||||||||
Asbestos Related Claims1
|
||||||||||||
Claims
at beginning of year
|
2,037 | 2,177 | 2,273 | |||||||||
Claims
received during year
|
129 | 124 | 114 | |||||||||
Claims
closed during year2
|
(1,030 | ) | (264 | ) | (210 | ) | ||||||
Claims
at end of year
|
1,136 | 2,037 | 2,177 | |||||||||
Average
gross loss settlement on closed claims
|
$ | 54 | 32 | 81 | ||||||||
Gross
amount paid to administer closed claims
|
$ | 88,645 | 110,582 | 51,868 | ||||||||
Net
survival ratio3
|
9 | 15 | 16 | |||||||||
Non-Asbestos
Related Claims1
|
||||||||||||
Claims
at beginning of year
|
325 | 271 | 302 | |||||||||
Claims
received during year
|
186 | 269 | 108 | |||||||||
Claims
closed during year2
|
(281 | ) | (215 | ) | (139 | ) | ||||||
Claims
at end of year
|
230 | 325 | 271 | |||||||||
Average
gross loss settlement on closed claims
|
$ | 4,293 | 14,803 | 4,149 | ||||||||
Gross
amount paid to administer closed claims
|
$ | 411,855 | 115,562 | 62,874 | ||||||||
Net
survival ratio3
|
6 | 6 | 14 |
1 The
number of environmental claims includes all multiple claimants who are
associated with the same site or incident.
2 Includes
claims dismissed, settled, or otherwise resolved.
3 The net
survival ratio was calculated using a three-year average for the net losses and
expenses paid.
Annually
we perform a focused review on all of our asbestos claims with our defense
counsel, confirming our participation in the claims and the number of claims
that were open. During the 2009 review, coupled with a focused effort
on resolving certain claims, a significant number of claim files were
closed.
47
Deferred
Policy Acquisition Costs
Policy
acquisition costs, which include commissions, premium taxes, fees, and certain
other costs of underwriting policies, are deferred and amortized over the same
period in which the related premiums are earned. Deferred policy
acquisition costs are limited to the estimated amounts recoverable after
providing for losses and loss expenses that are expected to be incurred, based
upon historical and current experience. Anticipated investment income
is considered in determining whether a premium deficiency exists. The
methods of making such estimates and establishing the deferred costs are
continually reviewed, and any adjustments are made in the accounting period in
which the adjustment arose.
We
regularly conduct reviews for potential premium deficiencies at a level
consistent with that used for our segment reporting in that we group our
policies at the Insurance Operations level, considering the
following:
|
·
|
Our
marketing efforts for all of our product lines within our Insurance
Operations revolve around independent agencies and their touch points with
our shared customers, the
policyholders.
|
|
·
|
We
service our agency distribution channel through our field model, which
includes agency management specialists, loss control representatives,
claim management specialists and our Underwriting and Claims Service
Centers, all of which service the entire population of insurance contracts
acquired through each agency.
|
|
·
|
We
measure the profitability of our business at the Insurance Operations
level, which is evident in, among other items, the structure of our
incentive compensation programs. We measure the profitability
of our agents and calculate their compensation based on overall insurance
results and all of our employees, including senior management, are
incented based on overall insurance
results.
|
We had
deferred policy acquisition costs of $218.6 million at December 31, 2009
compared to $212.3 million at December 31, 2008. Currently, the
Financial Accounting Standards Board is reviewing proposed changes to existing
accounting guidance regarding accounting for costs associated with acquiring or
renewing insurance contracts. Depending on the outcome of their
review, changes in this guidance could materially impact our results of
operations.
Pension
and Post-retirement Benefit Plan Actuarial Assumptions
Our
pension and post-retirement life benefit obligations and related costs are
calculated using actuarial methods, within the framework of U.S. generally
accepted accounting principles. Two key assumptions, the discount
rate and the expected return on plan assets, are important elements of expense
and/or liability measurement. We evaluate these key assumptions
annually. Other assumptions involve demographic factors such as
retirement age, mortality, turnover, and rate of compensation
increases.
The
discount rate enables us to state expected future cash flows at their present
value on the measurement date. The guideline for setting this rate is
a high-quality long-term corporate bond rate. A lower discount rate
increases the present value of benefit obligations and increases pension
expense. We decreased our discount rate to 5.93% for 2009, from 6.24%
for 2008 to reflect market interest rate conditions. To determine the
expected long-term rate of return on the plan assets, we consider the current
and expected asset allocation, as well as historical and expected returns on
each plan asset class. A lower expected rate of return on pension
plan assets would increase pension expense. Our long-term expected
return on plan assets was 8.00% in 2009 and 2008. We had a pension
and post-retirement benefit plan obligation of $205.5 million at December 31,
2009 compared to $188.0 million at December 31, 2008.
In 2009,
the financial markets experienced some degree of recovery which was reflected in
the 19% increase in our pension assets, ending the year at $139.7 million up
from $117.3 million at the end of 2008. Volatility in the
marketplace, coupled with changes in the discount rate assumption could
materially impact our pension valuation in the future.
For
additional information regarding our pension and post-retirement benefit plan
obligations, see Item 8. “Financial Statements and Supplementary Data,” Note
16(c) of this Form 10-K.
Other-Than-Temporary
Investment Impairments
When the
fair value of any investment is lower than its cost/amortized cost, an
assessment is made to determine if the decline is other than
temporary. We regularly review our entire investment portfolio for
declines in fair value. If we believe that a decline in the value of
an available-for-sale (“AFS”) security is temporary, we record the decline as an
unrealized loss in other comprehensive income (“OCI”). Temporary
declines in the value of a held-to-maturity (“HTM”) security are not recognized
in the financial statements. Our assessment of a decline in fair
value includes judgment as to the financial positions and future prospects of
the entity that issued the investment security, as well as a review of the
security’s underlying collateral. Broad changes in the overall market
or interest rate environment generally will not lead to a
write-down.
48
Fixed
Maturity Securities and Short-Term Investments
Our
evaluation for OTTI of a fixed maturity security or a short-term investment
includes, but is not limited to, the evaluation of the following
factors:
·
|
Whether
the decline appears to be issuer or industry
specific;
|
·
|
The
degree to which the issuer is current or in arrears in making principal
and interest payments on the fixed maturity
security;
|
·
|
The
issuer’s current financial condition and ability to make future scheduled
principal and interest payments on a timely
basis;
|
·
|
Evaluation
of projected cash flows under various economic and default
scenarios;
|
·
|
Buy/hold/sell
recommendations published by outside investment advisors and analysts;
and
|
·
|
Relevant
rating history, analysis and guidance provided by rating agencies and
analysts.
|
Prior to
April 1, 2009, when the decline in fair value below amortized cost of a fixed
maturity security was deemed to be other than temporary, the investment was
written down to fair value and the amount of the write-down was charged to
income as a realized loss. A decline in fair value on a fixed
maturity security was deemed to be other than temporary if we did not have the
intent and ability to hold the security to its anticipated
recovery. Effective April 1, 2009 with the adoption of revised OTTI
accounting guidance, unless we have the intent to sell, or it is more likely
than not that we may be required to sell, a fixed maturity security, an other
than temporary impairment is only recognized as a realized loss to the extent it
is credit related. If there is a decline in fair value to below
amortized cost of a fixed maturity security that we intend to sell or,
more-likely-than-not, may be required to sell, the impairment is considered
other than temporary and the security is written down to fair value with the
amount of the write-down charged to earnings as a component of realized
losses.
In order
to determine if an impairment is other than temporary, we perform additional
impairment assessments for our fixed maturity portfolio including, but not
limited to commercial mortgage-backed securities (“CMBS”), residential
mortgage-backed securities (“RMBS”), asset-backed securities (“ABS”),
collateralized debt obligations (“CDOs”), and corporate debt
securities. This assessment takes into consideration the length of
time for which the security has been in an unrealized loss position, but
primarily focuses on evaluation of future cash flows, which involves subjective
judgments and estimates determined by management
including: performance of the underlying collateral under various
economic and default scenarios, the nature and realizable value of such
collateral, and the ability of the security to make scheduled
payments.
For
structured securities, including CMBS, RMBS, ABS, and CDOs, we project the
future cash flows using various expected default, severity, and prepayment
assumptions based on security type and vintage, taking into consideration
information from credit agencies, historical performance, and other relevant
economic and performance factors.
Based on
these projections, we determine expected recovery values to be generated by the
collateral for each security. Prior to April 1, 2009, if these
projections indicated an other-than-temporary impairment, the shortfall between
the amortized cost of the security and the fair value was charged to earnings as
a component of realized losses. Subsequent to April 1, 2009, if these
projections indicate an impairment, we perform a discounted cash flow analysis
to determine the present value of future cash flows to be generated by the
underlying collateral of the security. Additionally, we perform a
discounted cash flow analysis on all previously other-than-temporarily impaired
securities and all structured securities that are not of high-credit quality at
the date of purchase.
Any
shortfall in the expected present value of the future cash flows, based on the
discounted cash flow analysis, from the amortized cost basis of a security is
considered a “credit impairment,” with the remaining decline in fair value of a
security considered as a “non-credit impairment.” Credit impairments
are charged to earnings as a component of realized losses, while non-credit
impairments are recorded to OCI as a component of unrealized
losses.
Discounted
Cash Flow Assumptions
The
discount rate we use in this present value calculation is the effective interest
rate implicit in the security at the date of acquisition for those structured
securities that were not of high-credit quality at acquisition. For
all other securities, we use a discount rate that equals the current yield,
excluding the impact of previous OTTI charges, used to accrete the beneficial
interest.
49
We use a
conditional default rate assumption in the present value calculation to estimate
future defaults. The conditional default rate is the proportion of
all loans outstanding in a security at the beginning of a time period that is
expected to default during that period. Our assumption of this rate
takes into consideration the uncertainty of future defaults as well as whether
or not these securities have experienced significant cumulative losses or
delinquencies to date. We use the conditional default rates used
during our initial cash flow testing for each security as a reference point, but
we may ultimately use rates at more elevated levels in the discounted cash flow
analysis in order to determine our best estimate of the present value of future
cash flows.
Conditional
default rate assumptions apply at the total collateral pool level held in the
securitization trust. Generally, collateral conditional default rates
will “ramp-up” over time as the collateral seasons, the performance begins to
weaken and losses begin to surface. As time passes, depending on the
collateral type and vintage, losses will peak and performance will begin to
improve as weaker borrowers are removed from the pool through delinquency
resolutions. In the later years of a collateral pool’s life,
performance is generally materially better as the resulting favorable selection
of the portfolio improves the overall quality and performance. While
“ramped up” assumptions are sometimes used in our discounted cash flow analysis
of our CMBS portfolio, we typically apply a more conservative approach and do
not apply a “ramp” of our conditional default rate assumptions in our initial
evaluations. Instead, we assume the cash flows for the next period
will experience defaults at the higher end of the range and then remain at that
level for the life of the position, due to the current uncertainty surrounding
the magnitude of potential future defaults on CMBS.
We use a
loan loss severity assumption in our discounted cash flow analysis that is
applied at the loan level of the collateral pool. The loan loss
severity assumptions represent the estimated percentage loss on the
loan-to-value exposure for a particular security. If the current
loan-to-value ratio of a security is not available, we assume a 50% loan loss
severity. However, certain of the securities have lower current
loan-to-value ratios, which in our opinion results in a severity assumption of
50% being overly conservative. Where we have current loan-to-value
information and the loan-to-value ratio is lower than 80%, we adjust the
severity assumption to reflect the fact that the loan-to-value ratio is
lower.
For
purposes of our initial evaluations, the loan loss severity assumption is held
constant and is derived in either one of two ways:
|
(i)
|
Applying
an estimated loss on exposure percentage to the current loan-to-value
ratio of a particular security; or
|
|
(ii)
|
Using
an assumed 50% in those instances where current loan-to-value ratios were
not available at the time of our
assessment.
|
Equity
Securities
Evaluation
for OTTI of an equity security, includes, but is not limited to, the evaluation
of the following factors:
·
|
Whether
the decline appears to be issuer or industry
specific;
|
·
|
The
relationship of market prices per share to book value per share at the
date of acquisition and date of
evaluation;
|
·
|
The
price-earnings ratio at the time of acquisition and date of
evaluation;
|
·
|
The
financial condition and near-term prospects of the issuer, including any
specific events that may influence the issuer’s operations, coupled with
our intention to hold the securities in the near
term;
|
·
|
The
recent income or loss of the
issuer;
|
·
|
The
independent auditors’ report on the issuer’s recent financial
statements;
|
·
|
The
dividend policy of the issuer at the date of acquisition and the date of
evaluation;
|
·
|
Buy/hold/sell
recommendations or price projections published by outside investment
advisors;
|
·
|
Rating
agency announcements;
|
·
|
The
length of time and the extent to which the fair value has been less than
cost; and
|
·
|
Our
expectation of when the cost of the security will be
recovered.
|
If there
is a decline in the fair value on an equity security that we do not intend to
hold, or if we determine the decline is other-than-temporary, we will write down
the carrying value of the investment and record the charge through earnings as a
component of realized losses.
50
Other
Investments
Our
evaluation for OTTI of an other investment (i.e., an alternative investment)
includes, but is not limited to, conversations with the management of the
alternative investment concerning the following:
·
|
The
current investment strategy;
|
·
|
Changes
made or future changes to be made to the investment
strategy;
|
·
|
Emerging
issues that may affect the success of the strategy;
and
|
·
|
The
appropriateness of the valuation methodology used regarding the underlying
investments.
|
If there
is a decline in fair value on an other investment that we do not intend to hold,
or if we determine the decline is other than temporary, we write down the cost
of the investment and record the charge through earnings as a component of
realized losses.
Reinsurance
Reinsurance
recoverables on paid and unpaid losses and loss expenses represent estimates of
the portion of such liabilities that will be recovered from
reinsurers. Each reinsurance contract is analyzed to ensure that the
transfer of risk exists to properly record the transactions in the financial
statements. Amounts recovered from reinsurers are recognized as
assets at the same time and in a manner consistent with the paid and unpaid
losses associated with the reinsurance policies. An allowance for
estimated uncollectible reinsurance is recorded based on an evaluation of
balances due from reinsurers and other available information. This
allowance totaled $2.5 million at December 31, 2009 and December 31,
2008. We continually monitor developments that may impact
recoverability from our reinsurers and have available to us contractually
provided remedies if necessary. For further information regarding
reinsurance, see Note 8. “Reinsurance” in Item 8. “Financial Statements and
Supplementary Data.” of this Form 10-K.
51
Financial
Highlights of Results for Years Ended December 31, 2009, 2008, and 20071
($ in thousands, except per share amounts)
|
2009
|
2008
|
2009 vs.
2008
|
2007
|
2008 vs.
2007
|
|||||||||||||||
GAAP
measurements:
|
||||||||||||||||||||
Revenues
|
$ | 1,514,018 | 1,589,939 | (5 | )% | 1,739,315 | (9 | )% | ||||||||||||
Pre-tax
net investment income
|
118,471 | 131,032 | (10 | ) | 174,144 | (25 | ) | |||||||||||||
Pre-tax
net income
|
26,253 | 39,386 | (33 | ) | 192,758 | (80 | ) | |||||||||||||
Net
income
|
36,398 | 43,758 | (17 | ) | 146,498 | (70 | ) | |||||||||||||
Diluted
net income per share
|
0.68 | 0.82 | (17 | ) | 2.59 | (68 | ) | |||||||||||||
Diluted
weighted-average outstanding shares
|
53,397 | 53,319 | - | 57,165 | (7 | ) | ||||||||||||||
GAAP
combined ratio
|
99.8 | % | 100.0 |
(0.2
|
)pts | 98.0 |
2.0
|
pts | ||||||||||||
Statutory
combined ratio
|
100.5 | % | 99.2 | 1.3 | 97.5 | 1.7 | ||||||||||||||
Return
on average equity
|
3.8 | % | 4.5 | (0.7 | ) | 13.6 | (9.1 | ) | ||||||||||||
Non-GAAP
measurements:
|
||||||||||||||||||||
Operating
income2
|
$ | 74,538 | 76,245 | (2.2 | )% | 121,956 | (37.5 | )% | ||||||||||||
Diluted operating
income per share2
|
1.39 | 1.43 | (2.8 | ) | 2.16 | (33.8 | ) | |||||||||||||
Operating return on
average equity2
|
7.9 | % | 7.8 |
0.1
|
pts | 11.3 |
(3.5
|
)pts |
1 Refer to
the Glossary of Terms attached to this Form 10-K as Exhibit 99.1 for definitions
of terms used in this financial review.
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 OTTI charges that are charged to earnings, and the results of
discontinued operations, could distort the analysis of trends. See
below for a reconciliation of operating income to net income in accordance with
generally accepted accounting principles.
Pre-tax
net income decreased in 2009 compared to 2008 and 2007 as seen in the table
above. On a pre-tax basis, net income decreased by $13.1 million in
2009 and $153.4 million in 2008 compared to the respective prior
years. These fluctuations were driven by the following:
|
·
|
Pre-tax
net investment income earned decreased $12.6 million, to $118.5 million,
in 2009 and $43.1 million, to $131.0 million, in 2008. The
decrease from 2008 to 2009 was driven by: (i) an increase in
losses of $9.1 million on our alternative investments; (ii) a decrease in
interest income of approximately $7.7 million on our fixed maturity and
short-term investment portfolios due to lower purchase yields; and (iii)
lower dividend income of $3.3 million due to our reduced equity
portfolio. Although our alternative investments began
stabilizing in the second half of 2009, these losses, which amounted to
$21.7 million on a pre-tax basis, were driven by the unprecedented
volatility in the global capital markets that occurred during the second
half of 2008 and continued through the first half of 2009. This
volatility resulted in a decline in asset values, of which 57% was
attributable to our real estate strategy and 30% was attributable to our
private equity/private equity secondary market strategies. Our
alternative investments, which are accounted for under the equity method,
primarily consist of investments in limited partnerships that primarily
report results to us on a one quarter lag. For additional
information on our other investment portfolio and a discussion of the
related strategies associated with this portfolio, refer to the
“Investments” section below. This was partially offset by
offset by the effect of the elimination of our trading portfolio in the
first quarter of 2009. During 2008, unrealized losses of $8.1
million on the trading portfolio negatively impacted investment
income.
|
The
decrease in net investment income, before tax, of $43.1 million for 2008
compared to 2007 was due to: (i) decreased returns of $31.9 million on the
alternative investment portion of our other investments portfolio; and (ii) $8.1
million of reductions in the fair value of our equity trading portfolio due to
the sell off in the equity markets, as well as the collapse in commodity prices
in the second half of 2008.
|
·
|
Net
realized losses, pre-tax, were $46.0 million in 2009 compared to a pre-tax
loss of $49.5 million in 2008 and a pre-tax gain of $33.4 million in
2007. The level of net realized losses experienced in 2009 and
2008 were driven by pre-tax non-cash OTTI charges of $55.4 million and
$53.1 million, respectively. For details regarding these
charges see Note 5. “Investments” in Item. 8 “Financial Statements and
Supplementary Data.” of this Form 10-K or “Investments”
below.
|
|
·
|
Underwriting
profits were $2.4 million in 2009 compared to $0.1 million in 2008 and
$31.0 million in 2007. The decrease in 2008 is primarily
attributable to higher catastrophe losses and reduced
NPE. Catastrophe losses increased to $31.7 million in 2008
compared to $14.9 million in 2007 driven by storm activity in the southern
and mid-western states. Also in 2008, NPE decreased 1%
reflecting pricing pressure stemming from a highly competitive insurance
marketplace and the slowing
economy.
|
52
|
·
|
Taxes
from continuing operations were a benefit of $5.5 million in 2009 compared
to a benefit of $3.9 million in 2008 and an expense of $45.1 million in
2007. These decreases are primarily driven by the decreases in
pre-tax investment income discussed
above.
|
|
·
|
Also
included in net income are the results of the discontinuance of our Human
Resources Outsourcing segment. We entered into a plan to
dispose of Selective HR Solutions, Inc. in the third quarter of 2009, the
sale of which was finalized with an after-tax loss on disposal of $1.2
million in the fourth quarter of 2009. The after-tax loss on
the operating results of Selective HR Solutions, Inc. of $7.1 million for
2009 is primarily due to an after-tax goodwill impairment charge in the
third quarter of 2009 of $7.9 million, resulting from our near-term
projections for this segment not being sufficient to support its carrying
value. A similar impairment charge of $2.6 million was recorded
in 2008 for this segment. See Note 13 “Discontinued Operations”
in Item 8. “Financial Statements and Supplementary Data.” of this Form
10-K for additional information.
|
The
following table reconciles operating income and net income for the periods
presented above:
($ in thousands, except per share amounts)
|
2009
|
2008
|
2007
|
|||||||||
Operating
income
|
$ | 74,538 | 76,245 | 121,956 | ||||||||
Net
realized (losses) gains, net of tax
|
(29,880 | ) | (32,144 | ) | 21,680 | |||||||
(Loss)
income from discontinued operations, net of tax
|
(7,086 | ) | (343 | ) | 2,862 | |||||||
Loss
on disposal of discontinued operations, net of tax
|
(1,174 | ) | - | - | ||||||||
Net
income
|
$ | 36,398 | 43,758 | 146,498 | ||||||||
Diluted
operating income per share
|
$ | 1.39 | 1.43 | 2.16 | ||||||||
Diluted
net realized (losses) gains per share
|
(0.56 | ) | (0.60 | ) | 0.38 | |||||||
Diluted
net (loss) income from discontinued operations per share
|
(0.13 | ) | (0.01 | ) | 0.05 | |||||||
Diluted
loss on disposal of discontinued operations per share
|
(0.02 | ) | - | - | ||||||||
Diluted
net income per share
|
$ | 0.68 | 0.82 | 2.59 |
On a
pre-tax basis, operating income was $85.2 million in 2009, $89.6 million in
2008, and $155.4 million in 2007. The decrease in operating income is
primarily attributable to the decrease in net investment income as discussed
above. Refer to Exhibit 99.1 of this Form 10-K for a definition of
operating income.
53
Results
of Operations and Related Information by Segment
Insurance
Operations
Our
Insurance Operations segment writes property and casualty insurance business
through seven insurance subsidiaries (the “Insurance
Subsidiaries”). Our Insurance Operations segment sells property and
casualty insurance products and services primarily in 22 states in the Eastern
and Midwestern U.S. through approximately 960 independent insurance
agencies. Our Insurance Operations segment consists of two
components: (i) Commercial Lines, which markets primarily to
businesses and represents approximately 84% of net premium written (“NPW”); and
(ii) Personal Lines, including Flood, which markets primarily to individuals and
represents approximately 16% of NPW. The underwriting performance of
these lines is generally measured by four different statutory
ratios: (i) loss and loss expense ratio; (ii) underwriting expense
ratio; (iii) dividend ratio; and (iv) combined ratio.
Summary
of Insurance Operations
All Lines
|
||||||||||||||||||||
2009
|
2008
|
|||||||||||||||||||
($ in thousands)
|
2009
|
2008
|
vs. 2008
|
2007
|
vs. 2007
|
|||||||||||||||
GAAP
Insurance Operations Results:
|
||||||||||||||||||||
NPW
|
$ | 1,422,655 | 1,492,738 | (5 | )% | 1,562,450 | (4 | )% | ||||||||||||
NPE
|
1,431,047 | 1,504,187 | (5 | ) | 1,524,889 | (1 | ) | |||||||||||||
Less:
|
||||||||||||||||||||
Losses
and loss expenses incurred
|
971,905 | 1,011,544 | (4 | ) | 997,812 | 1 | ||||||||||||||
Net
underwriting expenses incurred
|
453,117 | 487,300 | (7 | ) | 488,909 | - | ||||||||||||||
Dividends
to policyholders
|
3,640 | 5,211 | (30 | ) | 7,202 | (28 | ) | |||||||||||||
Underwriting
income
|
$ | 2,385 | 132 | 1,707 | % | 30,966 | (100 | )% | ||||||||||||
GAAP
Ratios:
|
||||||||||||||||||||
Loss
and loss expense ratio
|
67.9 | % | 67.2 | % |
0.7
|
pts | 65.4 |
1.8
|
pts | |||||||||||
Underwriting
expense ratio
|
31.6 | 32.5 | (0.9 | ) | 32.1 | 0.4 | ||||||||||||||
Dividends
to policyholders ratio
|
0.3 | 0.3 | - | 0.5 | (0.2 | ) | ||||||||||||||
Combined
ratio
|
99.8 | 100.0 | (0.2 | ) | 98.0 | 2.0 | ||||||||||||||
Statutory
Ratios:
|
||||||||||||||||||||
Loss
and loss expense ratio
|
67.9 | 67.2 | 0.7 | 65.4 | 1.8 | |||||||||||||||
Underwriting
expense ratio
|
32.3 | 31.7 | 0.6 | 31.6 | 0.1 | |||||||||||||||
Dividends
to policyholders ratio
|
0.3 | 0.3 | - | 0.5 | (0.2 | ) | ||||||||||||||
Combined
ratio
|
100.5 | % | 99.2 |
1.3
|
pts | 97.5 |
1.7
|
pts |
|
·
|
Despite
2009 being the first year since 2004 that we were able to achieve a
Commercial Lines renewal pure price increase, which was 0.9%, NPW still
decreased compared to 2008 primarily due to economic
conditions. We have experienced the most significant NPW
decreases in our workers compensation and general liability lines of
businesses driven by reduced levels of exposure given the reduction in
payroll and sales of our insureds, which is reflective of the current
unemployment level resulting from the economic slowdown. These
factors are evidenced by the
following:
|
|
o
|
Reductions
in endorsement and audit activity of $50.4 million, to a net return
premium of $72.7 million; and
|
|
o
|
Reductions
in net renewals of $19.4 million, to $1.2 billion including a reduction in
Commercial Lines retention of one point to 76% in
2009.
|
The
decrease in 2008 compared to 2007 was also largely attributable to economic
factors of which were illustrated in our audit and endorsement return premium of
$22.3 million in 2008 compared to additional audit and endorsement premiums of
$15.8 million in 2007. Also contributing to the decline in 2008 was a
decline in new business and Commercial Lines renewal pure pricing decrease of
3.1% as compared to 2009 wherein we experienced positive Commercial Lines
renewal pure pricing of 0.9%. New business in 2009 was up 3% and was
driven by growth in Personal Lines.
|
·
|
NPE
decreases in 2009 compared to 2008 and 2007 are consistent with the
fluctuation in NPW. These decreases were primarily driven by a
decrease in exposure coupled with premiums written in 2008, which
experienced a decrease in pure price of 3.1% in 2008, earning in over the
course of 2009.
|
54
|
·
|
The
increase in the GAAP loss and loss expense ratio in 2009 compared to 2008
was primarily attributable to casualty loss costs that have outpaced
premiums in the current accident year, coupled with non-catastrophe
property losses that were $205.4 million, or 14.4 points, compared to
$192.2 million, or 12.8 points, in 2008. Partially offsetting
these increases were:
|
|
o
|
Favorable
prior year development of $29 million, or 2.1 points, in 2009 compared to
favorable prior year development of $19 million, or 1.3 points, in
2008. Favorable development in 2007 was approximately $19
million, or 1.2 points. For more information on the favorable
prior year development on our commercial lines of business, please refer
to the “Review of Underwriting Results by Lines of Business” below;
and
|
|
o
|
Catastrophe
losses that were 0.6 points, or $8.5 million, compared to 2.1 points, or
$31.7 million, in 2008.
|
|
·
|
Decreases
in the GAAP underwriting expense ratio in 2009 were primarily attributable
to several expense initiatives implemented in 2008 and during the first
quarter of 2009. These initiatives included, but were not
limited to:
|
|
o
|
Workforce
reductions in 2008 that resulted in a pre-tax charge of $4.5 million in
2008;
|
|
o
|
The
re-domestication of two of the Insurance Subsidiaries to Indiana in June
2008;
|
|
o
|
Targeted
changes to agency commissions that were implemented in most states in July
2008;
|
|
o
|
The
consolidation of our purchasing power with fewer vendors and their desire
to lock up longer-term contracts;
and
|
|
o
|
The
elimination of retiree life insurance benefits for current employees
amounting to a total benefit of $4.2 million, pre-tax, in the first
quarter of 2009.
|
Partially
offsetting these actions is the impact of reduced NPE and corresponding impact
it has had on the expense ratio.
The GAAP
underwriting expense ratio increased in 2008 compared to 2007 primarily as the
result of the pre-tax workforce restructuring charge of $4.5 million discussed
above. Absent this charge, the expense ratio remained relatively
flat, reflecting a 1% decrease in NPE partially offset by lower overall
underwriting expenses year over year. These reduced expenses were the
result of lower than expected payments of profit-based incentives to our agents
and employees, reflecting lower NPW and underwriting results during 2008, and
benefits realized from our 2008 cost containment initiatives discussed
above.
Insurance Operations
Outlook
Historically,
the results of the property and casualty insurance industry have experienced
significant fluctuations due to competition, economic conditions, interest
rates, loss cost trends, and other factors. During 2009, the
Insurance Operations segment outperformed both A.M. Best and Fitch Ratings
(“Fitch”) industry wide projections of 100.6% and 101%, respectively, with a
statutory combined ratio of 100.5%. Our Commercial Lines business
reported a statutory combined ratio of 99.8% and our Personal Lines business
reported a statutory combined ratio of 104.4% for the year.
We
continued to see a trend toward higher Commercial Lines and Personal Lines
pricing in our Insurance Operations segment. The Commercial Lines
Insurance Pricing Survey (“CLIPS”) third quarter 2009 report indicated that
industry pricing remained flat during the quarter whereas we experienced a pure
price increase over that period of 1.5%. Fitch has indicated that the
industry is now solidly entrenched in the soft phase of the market cycle and
that a material improvement in pricing does not appear imminent. In
this light, the price increase of 2.7% we obtained during the fourth quarter of
2009, the largest quarterly price increase of 2009, and the overall 2009 pure
price increase of 0.9%, both achieved while maintaining a delicate balance with
retention, demonstrates the overall strength of the relationships that we have
with our independent agents, even in difficult economic and competitive
times. As for our Personal Lines operations, we have seen an increase
in 2009 NPW driven by: (i) 28 rate increases that went into effect during
2009; (ii) new business premium increases of $11.8 million; and (iii) net
renewal premium increases of $5.1 million.
In
addition, our focus for 2009 included the following:
|
·
|
Deploying
second generation Commercial Lines predictive modeling tools that give our
underwriters superior information, enabling them to make better decisions
regarding individual account underwriting. It also ensures that
we price our business with precision, giving our agents the ability to
compete for the most attractive accounts, furthering our focus on
maintaining insurance operations profitability. Going forward,
we believe that the use of this tool will enable us to maintain our
competitive pricing for the best accounts while driving a meaningful
improvement in the loss ratio.
|
55
|
·
|
Putting
into effect the Personal Lines rate increases mentioned above, which we
believe will generate $6.7 million in additional premium. We
accomplished this while losing only one point of retention and increasing
new policy counts by 51% in 2009.
|
|
·
|
Claims
Strategic Program underway with a focus on enhancing areas
of: (i) workers compensation best practices and targeted case
management; (ii) litigation management; (iii) enhanced potential fraud and
recovery recognition through use of advanced systems analytics; (iv)
advanced claims automation; and (v) enhanced vendor
management. We believe that these initiatives will allow us to
maintain our reputation for superior claims service while enabling us to
leverage our current resources to increase the effectiveness and
efficiency of the claims area.
|
|
·
|
Sales
management efforts, including our market planning tools and leads
program. Our market planning tools allow us to identify and
strategically appoint additional independent agencies and hire or redeploy
agency management specialists (“AMS”) in under-penetrated
territories. We have continued to expand our independent agency
count, which now stands at approximately 960 agencies across our
footprint. These independent insurance agencies are serviced by
approximately 94 field-based AMSs who make hands-on underwriting decisions
on a daily basis. In addition, we use our predictive modeling
and business analytics to build tools that help agents identify potential
new customers.
|
|
·
|
Expense
management initiatives over the past year, which include the elimination
of retiree life insurance benefits for current employees and ongoing
controlled hiring practices, along with several initiatives taken in 2008,
such as our workforce reduction initiatives, changes to agent commission
programs, and the re-domestication of two of the Insurance Subsidiaries to
Indiana. These expense management initiatives served to benefit
our expense ratio this year, and the ongoing impact of these initiatives
will continue to benefit expenses going
forward.
|
|
·
|
Technology
that allows agents and our field teams to input business seamlessly into
our systems, including our One & Done®
small business system and our xSELerate®
straight-through processing system. Average premiums of
approximately $294,000 per workday were processed through our One &
Done®
small business system during 2009, up 7% from 2008. These
technology-based systems complement our existing underwriting group,
giving them more time to focus on more technical underwriting
accounts.
|
|
·
|
Strategically
expanding our business in our footprint states, including Tennessee, where
we began operations in June 2008. In the first full year of
operations in this state, we wrote premium of approximately $14.6
million.
|
|
·
|
Continued
diversification of our territory/footprint
states.
|
The
overall outlook on the industry for 2010 from key rating agencies is as
follows:
|
·
|
A.M.
Best – A.M. Best is maintaining a stable outlook on the industry
looking forward as they project that balance sheet strength and liquidity
will remain adequate in 2010. They expect that although
commercial line’s underwriting results and loss reserve adequacy will
continue to deteriorate, this line of business is in a reasonably solid
position to confront these challenges. They cite that with
economic uncertainty expected to continue, commercial line managers should
remain prudent in pricing, reserving, and deployment of
capital. For 2010, A.M. Best expects a small decline in NPW
driven by an anticipated sluggish economic recovery, coupled with an
increase in catastrophe-related losses, will lead to a combined ratio of
101.7%.
|
|
·
|
Fitch
Ratings (“Fitch”) – In Fitch’s
“Review and Outlook 2009-2010” December 2009 report, they are maintaining
the negative outlook over the next 12 to 18 months, reflecting lingering
economic and financial uncertainty. In addition, Fitch projects
an industry-wide statutory combined ratio of 104.0% for 2010, reflecting
their belief that underwriting results will not improve significantly as
they project premiums will have insignificant growth. They
anticipate that underwriting results will be impacted by higher expense
ratios and less favorable reserve development, partially offset by a
return to historical average catastrophe loss
experience.
|
|
·
|
Standard
& Poor’s (“S&P”) – S&P recently reiterated their
negative outlook on the industry citing that the increase in cost of
capital may not be able to be passed along to the insureds in its
entirety, as well as the expectation that future investment returns will
be relatively modest in the near term. S&P believes that
rating downgrades will exceed upgrades for the industry over the next six
months.
|
We will
continue to manage our book of business in 2010 by: (i) balancing
anticipated Commercial Lines pure price increases with retention; and (ii) as
discussed above, we expect the 2010 rate changes, will generate an additional
$14.1 million in premium over the course of the next year in Personal
Lines. We continue to believe that the cycle management tools we have
in place are performing as we intended in the current market
conditions. These tools protect us from writing business that we
believe will ultimately be unprofitable and, over the long run as pricing and
exposures improve, will better position us to return to targeted return on
equity levels.
56
We are
providing 2010 guidance that includes a combined ratio of approximately 101.5%
on both a GAAP and statutory basis reflecting catastrophe losses of 1.6
points. These combined ratios do not include any assumptions for
reserve development, favorable or unfavorable. Weighted average
shares at year-end 2010 are expected to be approximately 54
million.
Review
of Underwriting Results by Lines of Business
Commercial
Lines
2009
|
2008
|
|||||||||||||||||||
($ in thousands)
|
2009
|
2008
|
vs. 2008
|
2007
|
vs. 2007
|
|||||||||||||||
GAAP
Insurance Operations Results:
|
||||||||||||||||||||
NPW
|
$ | 1,194,796 | 1,279,553 | (7 | )% | 1,358,381 | (6 | )% | ||||||||||||
NPE
|
1,214,952 | 1,294,244 | (6 | ) | 1,321,585 | (2 | ) | |||||||||||||
Less:
|
||||||||||||||||||||
Losses
and loss expenses incurred
|
809,430 | 852,697 | (5 | ) | 838,577 | 2 | ||||||||||||||
Net
underwriting expenses incurred
|
387,494 | 425,521 | (9 | ) | 429,052 | (1 | ) | |||||||||||||
Dividends
to policyholders
|
3,640 | 5,211 | (30 | ) | 7,202 | (28 | ) | |||||||||||||
Underwriting
income
|
$ | 14,388 | 10,815 | 33 | % | 46,754 | (77 | )% | ||||||||||||
GAAP
Ratios:
|
||||||||||||||||||||
Loss
and loss expense ratio
|
66.6 | % | 65.9 |
0.7
|
pts | 63.5 |
2.4
|
pts | ||||||||||||
Underwriting
expense ratio
|
31.9 | 32.9 | (1.0 | ) | 32.5 | 0.4 | ||||||||||||||
Dividends
to policyholders ratio
|
0.3 | 0.4 | (0.1 | ) | 0.5 | (0.1 | ) | |||||||||||||
Combined
ratio
|
98.8 | 99.2 | (0.4 | ) | 96.5 | 2.7 | ||||||||||||||
Statutory
Ratios:
|
||||||||||||||||||||
Loss
and loss expense ratio
|
66.6 | 65.9 | 0.7 | 63.4 | 2.5 | |||||||||||||||
Underwriting
expense ratio
|
32.9 | 32.2 | 0.7 | 32.0 | 0.2 | |||||||||||||||
Dividends
to policyholders ratio
|
0.3 | 0.4 | (0.1 | ) | 0.5 | (0.1 | ) | |||||||||||||
Combined
ratio
|
99.8 | % | 98.5 |
1.3
|
pts | 95.9 |
2.6
|
pts |
|
·
|
Despite
2009 being the first year since 2004 that we were able to achieve a
Commercial Lines renewal pure price increase, which was 0.9%, NPW still
decreased compared to 2008 primarily due to the economic
recession. We have experienced the most significant decreases
in our workers compensation and general liability lines of businesses due
to reduced levels of exposure given the reduction in payroll and sales,
which is reflective of the current unemployment level resulting from the
economic slowdown. These factors are evidenced by the
following:
|
|
o
|
Reductions
in endorsement and audit activity of $49.5 million, to a net return
premium of $72.6 million, in 2009;
|
|
o
|
Reductions
in net renewals of $24.5 million, to $1.1 billion, in 2009 including
reductions in retention of one point in 2009 from 2008;
and
|
|
o
|
Reductions
in direct new business of $1.5 million, to $265.7 million, in
2009.
|
The
decrease in 2008 compared to 2007 was also largely due to economic factors of
which were illustrated in our audit and endorsement return premium of $23.2
million in 2008 compared to additional audit and endorsement premiums of $14.5
million in 2007. Also contributing to the decline in 2008 was a
decline in direct new business of $46.1 million compared to 2007 and a 3.1%
decrease in renewal pure pricing.
|
·
|
NPE
decreases in 2009 compared to 2008 and 2007 are consistent with the
fluctuation in NPW discussed above. These decreases were
primarily driven by a decrease in exposure coupled with premiums written
in 2008, which experienced a decrease in renewal pure price of 3.1% in
2008 as mentioned above, earning in over the course of
2009.
|
|
·
|
The
increase in the GAAP loss and loss expense ratio in 2009 compared to 2008
was primarily attributable to an increase in casualty loss costs that have
outpaced premium in the current accident year coupled with non-catastrophe
property losses that increased $4.2 million, or 1.0
points. Partially offsetting these increases
were:
|
|
o
|
Increase
in favorable prior year development of approximately $13
million. This development of $28 million, or 2.3 points in 2009
was primarily driven by our workers compensation, commercial auto, and
general liability lines of business while favorable prior year development
of $15 million, or 1.1 points in 2008 was primarily driven by our workers
compensation line of business. Favorable development in 2007
was approximately $20 million, or 1.5 points, driven by our commercial
automobile line of business; and
|
|
o
|
Catastrophe
losses that were 0.5 points, or $5.8 million, compared to 2.1, points or
$27.0 million, in 2008.
|
57
|
·
|
Improvements
in the GAAP underwriting expense ratio in 2009 compared to 2008 were
primarily attributable to the expense initiatives that we implemented over
the last couple of years as mentioned
above.
|
The
following is a discussion on our most significant commercial lines of
business:
General
Liability
2009
|
2008
|
|||||||||||||||||||
($
in thousands)
|
2009
|
2008
|
vs.
2008
|
2007
|
vs.
2007
|
|||||||||||||||
Statutory
NPW
|
$ | 352,336 | 393,012 | (10 | )% | 420,388 | (7 | )% | ||||||||||||
Statutory
NPE
|
362,479 | 396,066 | (8 | ) | 410,024 | (3 | ) | |||||||||||||
Statutory
combined ratio
|
102.9 | % | 102.0 |
0.9
|
pts | 98.8 |
3.2
|
pts | ||||||||||||
%
of total statutory commercial NPW
|
29 | % | 31 | 31 |
NPW for
this line of business decreased in 2009 compared to 2008, and in 2008 compared
to 2007. The decrease in 2009, compared to 2008 was driven
by: (i) a $19.5 million decrease in audit and endorsement activity,
to a return premium of $27.2 million; (ii) a $14.9 million, or 4%, decrease in
net renewals; and (iii) a $3.6 million, or 5%, decrease in new business for
2009. The decrease in 2008, compared to 2007 was driven
by: (i) a $17.7 million decrease in audit and endorsement activity,
to a return premium of $7.8 million; and (ii) a decrease in direct voluntary new
business premiums of $15.7 million, or 17%. The decreases in both
2009 and 2008 were primarily driven by the effects of the economic recession
that has been ongoing since the middle of 2008. Approximately 56% of
our premium as of December 31, 2009 and 58% as of December 31, 2008 is subject
to audit, wherein actual exposure units (usually sales or payroll) are compared
to estimates and a return premium or additional premium transaction
occurs.
Our
renewal pure price increase was 1.6% in 2009 compared to decreases of 2.0% in
2008 and 4.5% in 2007. We achieved these increases while increasing
policy counts 1% and losing only one point in retention in 2009 compared to
2008. We continue to concentrate on our long-term strategies of
improving profitability by focusing on diversifying our mix of business by
writing more non-contractor classes of business. In 2009,
non-contractor new business comprised 51% of our total new business, up from 46%
in 2008. This business typically experiences lower volatility during
economic cycles.
The
increase in the statutory combined ratio for 2009 compared to 2008 and 2008
compared to 2007 was driven by: (i) increased loss and loss expense
costs in the current accident years that have outpaced premiums, leading to a
higher combined ratio; and (ii) an increase in the expense ratio caused by
premium declines, particularly in audit and endorsements, that have outpaced
expense reductions resulting from our various expense
initiatives. The 2009 increase was partially offset by favorable
prior year development of approximately $8 million, or 2.3 points, in 2009
compared to adverse prior year development of approximately $4 million, or 0.9
points, in 2008. Favorable development in the general liability line
of business is often times volatile year-to-year and, therefore, requires a
longer period of time before true trends are recognized and can be acted
upon. The favorable development in 2009 was driven by favorable loss
emergence for accident years 2004 to 2007. The increase in the
statutory combined ratio for 2008 compared to 2007 reflected higher estimated
losses due to loss trends that have outpaced pricing.
Workers
Compensation
2009
|
2008
|
|||||||||||||||||||
($
in thousands)
|
2009
|
2008
|
vs.
2008
|
2007
|
vs.
2007
|
|||||||||||||||
Statutory
NPW
|
$ | 251,121 | 303,783 | (17 | )% | 336,189 | (10 | )% | ||||||||||||
Statutory
NPE
|
263,490 | 308,618 | (15 | ) | 325,657 | (5 | ) | |||||||||||||
Statutory
combined ratio
|
107.6 | % | 96.1 |
11.5
|
pts
|
101.6 |
(5.5
|
)pts | ||||||||||||
%
of total statutory commercial NPW
|
21 | % | 24 | 25 |
In 2009,
NPW on this line decreased compared to 2008, due primarily to: (i) a
$26.4 million decrease in audit and endorsement activity, to a return premium of
$39.9 million, reflecting the impact of the economic recession and reduced
levels of exposure consistent with the current unemployment level; (ii) a $17.9
million, or 7%, decrease in net renewals; and (iii) a two point decrease in
retention, to 76%, due to initiatives that have allowed us to target price
increases for our worst performing business and competitive pressure from
monoline carriers and competitors willing to write workers compensation policies
mainly on the upper end of our middle market business and our large account
business. These decreases were partially offset by a 0.6% increase in
renewal pure price 2009 compared to a 2.1% decrease 2008. The
decrease in NPW in 2008 compared to 2007 was driven by the aforementioned
impacts on pricing and exposure due to the economic recession, which we began to
experience in 2008, and the competitive marketplace.
58
The
increase in the statutory combined ratio on this line for 2009 compared to 2008
was primarily attributable to higher loss costs in the current accident year
coupled with the following: (i) higher audit return premium in 2009
that added 11.1 points to the combined ratio compared to audit return premium in
2008 that added 3.3 points; and (ii) prior year favorable development in 2009 of
approximately $10 million, or 3.9 points, primarily driven by accident years
2005 to 2007 reflecting the on-going impact from a series of improvement
strategies for this line in recent years, partially offset by adverse severity
in accident year 2008. In 2008, favorable prior year development was
approximately $23 million, or 7.6 points, related to accident years 2004 to
2006, as a result of our improvement initiatives on this line, partially offset
by adverse development in the 2007 accident year driven by higher than expected
severity. The improvement in the statutory combined ratio in 2008
compared to 2007 reflects the aforementioned favorable prior year development in
2008 compared to $3 million, or 0.8 points, in 2007, partially offset by higher
estimated losses due to loss trends that have outpaced pricing.
Commercial
Automobile
2009
|
2008
|
|||||||||||||||||||
($
in thousands)
|
2009
|
2008
|
vs.
2008
|
2007
|
vs.
2007
|
|||||||||||||||
Statutory
NPW
|
$ | 298,036 | 300,391 | (1 | )% | 319,176 | (6 | )% | ||||||||||||
Statutory
NPE
|
300,562 | 307,388 | (2 | ) | 315,259 | (2 | ) | |||||||||||||
Statutory
combined ratio
|
98.2 | % | 99.7 |
(1.5
|
)pts
|
88.1 |
11.6
|
pts
|
||||||||||||
%
of total statutory commercial NPW
|
25 | % | 23 | 23 |
NPW for
this line of business decreased in 2009 compared to 2008, and in 2008 compared
to 2007, due to the ongoing effects of the economic recession. The
decrease in 2009 was primarily attributable to: (i) net renewal premiums down
$4.8 million; or 2%; and (ii) a two-point decrease in retention, to
77%. This was partially offset by new business that increased 4%, to
$54.2 million in 2009 compared to 2008 and renewal pure price increases of 1.1%
in 2009 compared to decreases of 5.0% in 2008. The decrease in
premium for 2008 compared to 2007 was driven by direct voluntary new business
premiums, which were down $9.2 million, or 15%, from 2007 and the aforementioned
renewal pure price decreases.
The 1.5
point decrease in the statutory combined ratio for 2009, compared to 2008, was
driven primarily by: (i) favorable casualty prior year development in
2009 of approximately $10 million, or 3.2 points, driven by lower than
anticipated severity primarily in accident year 2007 compared to insignificant
development in 2008; and (ii) physical damage losses that were $4.5 million, or
approximately 1.2 points, lower in 2009 compared to 2008. These items
were partially offset by higher estimated losses due to loss trends that have
outpaced pricing.
The
increase in the statutory combined ratio in 2008 compared to 2007 is primarily
due to: (i) insignificant prior year development in 2008 compared to
favorable prior year statutory development in 2007 of approximately $19 million
due to improved severity trends; (ii) physical damage losses that were $6.2
million, or 2.3 points, higher in 2008; and (iii) pure price decreases in 2008
as discussed above.
Commercial
Property
2009
|
2008
|
|||||||||||||||||||
($
in thousands)
|
2009
|
2008
|
vs.
2008
|
2007
|
vs.
2007
|
|||||||||||||||
Statutory
NPW
|
$ | 199,707 | 194,550 | 3 | % | 198,903 | (2 | )% | ||||||||||||
Statutory
NPE
|
197,665 | 196,189 | 1 | 190,681 | 3 | |||||||||||||||
Statutory
combined ratio
|
83.9 | % | 92.9 |
(9
|
)pts
|
92.7 |
0.2
|
pts | ||||||||||||
%
of total statutory commercial NPW
|
17 | % | 15 | 15 |
NPW for
this line of business increased in 2009 compared to 2008, while declining for
2008 compared to 2007. The increases in 2009 were primarily due
to: (i) net renewal premium increases of 4%, to $171.3 million; (ii)
total policy count increases of 3% in 2009; and (iii) renewal pure price
increases of 0.3% in 2009 compared to decreases of 4.1% in 2008. The
decrease in 2008 compared to 2007 was due to: (i) a reduction in new
business premium of $2.4 million; (ii) the aforementioned renewal pure price
decreases of 4.1%; and (iii) an one point reduction in retention to
76%.
The
improvement in the statutory combined ratio in 2009 was driven by a decrease in
catastrophe losses of $18.7 million, or 9.5 points, partially offset by an
increase in non-catastrophe property losses of $3.0 million, or 1.0 points,
compared to 2008. The increased levels of total property losses
during 2008 were mainly due to weather-related activity such as water damage and
claims resulting from freezing pipes, as well as fire losses.
59
Personal
Lines
2009
|
2008
|
|||||||||||||||||||
($ in thousands)
|
2009
|
2008
|
vs. 2008
|
2007
|
vs. 2007
|
|||||||||||||||
GAAP
Insurance Operations Results:
|
||||||||||||||||||||
NPW
|
$ | 227,859 | 213,185 | 7 | % | 204,069 | 4 | % | ||||||||||||
NPE
|
216,095 | 209,943 | 3 | 203,304 | 3 | |||||||||||||||
Less:
|
||||||||||||||||||||
Losses
and loss expenses incurred
|
162,475 | 158,847 | 2 | 159,235 | - | |||||||||||||||
Net
underwriting expenses incurred
|
65,623 | 61,779 | 6 | 59,857 | 3 | |||||||||||||||
Underwriting
loss
|
$ | (12,003 | ) | (10,683 | ) | (12 | )% | (15,788 | ) | 32 | % | |||||||||
GAAP
Ratios:
|
||||||||||||||||||||
Loss
and loss expense ratio
|
75.2 | % | 75.7 | (0.5 | )Pts | 78.3 | (2.6 | )Pts | ||||||||||||
Underwriting
expense ratio
|
30.4 | 29.4 | 1.0 | 29.4 | - | |||||||||||||||
Combined
ratio
|
105.6 | 105.1 | 0.5 | 107.7 | (2.6 | ) | ||||||||||||||
Statutory
Ratios:
|
||||||||||||||||||||
Loss
and loss expense ratio
|
75.2 | 75.7 | (0.5 | ) | 78.2 | (2.5 | ) | |||||||||||||
Underwriting
expense ratio
|
29.2 | 28.0 | 1.2 | 29.7 | (1.7 | ) | ||||||||||||||
Combined
ratio
|
104.4 | % | 103.7 | 0.7 | Pts | 107.9 | (4.2 | )Pts |
|
·
|
The
increase in NPW in 2009 compared to 2008 is primarily due
to:
|
|
o
|
Approximately
28 rate increases that generated $6.7 million in annual premium, that went
into effect across our Personal Lines footprint during 2009;
and
|
|
o
|
New
business premium increases of $11.8 million to $55.2 million in
2009.
|
Our rate
increases were partially offset by a decline in retention of approximately one
point, to 80%, on our overall Personal Lines book. In addition, the number of
automobiles that we insure in New Jersey decreased by approximately 9,000 to
56,000 cars, at December 31, 2009.
The
increase in NPW in 2008 compared to 2007 is primarily due to the impact of rate
actions that became effective during the year. These rate actions resulted in an
overall rate increase of 7.7% in Personal Lines, comprised of 11.1% in our
personal automobile line of business and 1.1% in our homeowners line of
business. Specific to our New Jersey personal automobile business, we have
received rate increases of 6.8% effective in May 2008 and 6.5% effective in
October 2008.
|
·
|
NPE
increases in 2009 compared to 2008 and 2007 are consistent with the
fluctuation in NPW increase in 2009 compared to 2008 and 2007 as discussed
below.
|
|
·
|
The
improvement in the GAAP loss and loss expense ratio for 2009 compared to
2008 was driven by: (i) increased rate on this book of business that is
favorably impacting NPE and outpacing loss costs; and (ii) a decrease in
catastrophe losses of $2.0 million, or 1.0 points. Partially offsetting
these items was increased non-catastrophe property losses of $8.9 million,
or 3.4 points.
|
The
improvement in the GAAP loss and loss expense ratio in 2008 compared to 2007 is
primarily driven by the 3% increase in NPE, coupled with favorable prior year
development in our casualty lines of approximately $5 million, or 2.2 points, in
2008, compared to unfavorable prior year development of approximately $1
million, or 0.4 points, in 2007. The 2008 development reflected a better quality
of business being written through our MATRIXSM pricing
system, coupled with normal volatility, while the 2007 development included the
impact of unfavorable trends in groundwater contamination caused by the leakage
of certain underground oil storage tanks in our homeowners line of business.
This improvement in the loss and loss expense ratio was partially offset by
increases in: (i) catastrophe losses of $1.9 million to $4.7 million in 2008;
and (ii) non-catastrophe property losses of $4.5 million to $56.5 million in
2008.
|
·
|
The
higher GAAP underwriting expense ratio in 2009 compared to 2008 was
primarily attributable to increased commissions resulting from the mix of
premium. Additionally, although to a lesser degree, commissions on our
Flood business reduced the expense ratio by 8.6 points in 2009 compared to
8.9 points in 2008. Partially offsetting these items were the expense
initiatives that we implemented in 2008 and 2009, including a $0.5 million
total benefit related to the elimination of retiree life insurance
benefits recognized in the first quarter of 2009, combined with the $0.5
million restructuring charge in the first quarter of
2008.
|
60
The
increases in new business and net premiums written are attributable, among other
things, to our ability to continue to increase quote volume through the
following: (i) improved marketing and communication strategies; (ii) strong
representation across our footprint; and (iii) providing the excellent service
that our policyholders and agents demand. We are now participating in several
programs that allow our agents to compare our personal auto rates to those of
other insurance companies through a system known as “comparative raters,” which
has increased our quote volume by 66% during 2009 compared to 2008. Starting in
first quarter 2010, we will be adding our homeowners line of business to the
comparative raters system, with New Jersey as the first state in production. In
addition, New Jersey automobile new business is now written under our
60-territory structure, which provides more adequate pricing in territories that
historically have not been profitable for us. Price increases for renewal
business are capped at 10% as we reclassify these policies into the new
territory definitions.
We
believe the various rate increases taken over the last three years illustrated
below will help us achieve our goal of being profitable in this line of
business.
Implemented Rate Filings
|
||||||||
Direct Premium
Written Increase
|
Additional Premium
Generated on In-Force Policies
|
|||||||
2008
|
7.1%
|
$15 million
|
||||||
2009
|
3.1%
|
$7 million
|
||||||
20101
|
6.0%
|
$14 million
|
1 Includes
a New Jersey automobile increase of 6%.
Reinsurance
We have
reinsurance contracts that cover both property and casualty
business. We use traditional forms of reinsurance and do not utilize
finite risk reinsurance. Available reinsurance can be segregated into
the following key categories:
|
·
|
Property Reinsurance –
includes our Property Excess of Loss treaty purchased for
protection against large individual property losses and our Property
Catastrophe treaty purchased to provide protection for the overall
property portfolio against severe catastrophic
events. Facultative reinsurance is also used for property risks
that are in excess of our treaty
capacity.
|
|
·
|
Casualty Reinsurance –
purchased to provide protection for both individual large casualty losses
and catastrophic casualty losses involving multiple claimants or
insureds. Facultative reinsurance is also used for casualty
risks that are in excess of our treaty
capacity.
|
|
·
|
Terrorism Reinsurance –
available as a federal backstop related to terrorism losses as provided
under the TRIA. For further information regarding this
legislation, see Item 1A. “Risk Factors.” of this Form
10-K.
|
|
·
|
Flood Reinsurance – as
a servicing carrier in the WYO Program, we receive a fee for writing flood
business, for which the related premiums and losses are ceded to the
federal government.
|
|
·
|
Other Reinsurance –
includes smaller treaties, such as our Surety and Fidelity Excess of Loss,
NWCRP and our Equipment Breakdown Coverage treaties, which do not fall
within the categories above.
|
Information
regarding the terms and related coverage associated with each of our categories
of reinsurance above can be found in Item 1. “Business.” of this Form
10-K.
We
regularly reevaluate our overall reinsurance program and try to develop the most
effective ways to manage our risk. Our analysis is based on a comprehensive
process that includes periodic analysis of modeling results, aggregation of
exposures, exposure growth, diversification of risks, limits written, projected
reinsurance costs, financial strength of reinsurers and projected impact on
earnings and statutory surplus. We strive to balance sometimes opposing
considerations of reinsurer credit quality, price, terms, and our appetite for
retaining a certain level of risk.
Property
Reinsurance
The
Property Catastrophe treaty renewed effective January 1, 2010 with an 8%
decrease in premium. The current treaty structure remains the same providing per
occurrence coverage for 95% of $310.0 million in excess of $40.0 million
retention. The annual aggregate limit net of our co-participation is $589.0
million.
In 2008,
we managed our hurricane exposures through the implementation of a Catastrophe
(“CAT”) strategy initiative. It focused on policies with high Annual Average
Loss (“AAL”) to premium ratios which were targeted for increases in deductibles
and premium, and in certain cases non-renewals. The strategy led to the
implementation of a variety of underwriting system tools that provide CAT
management information to the underwriters for a more granular portfolio
management of our property book of business. The July 2009 modeling results
included a 9.5% reduction in gross AAL, while insured values increased 7.6% when
compared to June 2008, clearly showing that the strategy has taken
hold.
61
We
continue to assess our property catastrophe exposure aggregations, modeled
results and effects of growth on our property portfolio and strive to manage our
exposure to individual large events balanced against the cost of reinsurance
protections.
The
following table presents Risk Management Solutions, Inc.’s (“RMS”) v. 9.0
modeled hurricane losses based on the Insurance Subsidiaries’ property book of
business as of July 2009:
($ in thousands)
|
Historical Basis
|
Near Term Basis
|
||||||||||||||||||||||
Occurrence Exceedence
Probability
|
Gross Losses
RMS v.9.0
|
Net
Losses1
|
Net Losses
as a
Percent of
Equity2
|
Gross
Losses RMS
v.9.0
|
Net
Losses1
|
Net Losses
as a
Percent of
Equity2
|
||||||||||||||||||
4.0%
(1 in 25 year event)
|
$ | 46,707 | 26,632 | 3 | % | $ | 59,973 | 27,882 | 3 | % | ||||||||||||||
2.0%
(1 in 50 year event)
|
99,518 | 31,610 | 3 | 121,433 | 33,126 | 3 | ||||||||||||||||||
1.0%
(1 in 100 year event)
|
192,560 | 38,007 | 4 | 223,867 | 39,809 | 4 | ||||||||||||||||||
0.40%
(1 in 250 year event)
|
400,310 | 79,336 | 8 | 447,196 | 109,811 | 11 |
1 Losses
are after tax and include applicable reinstatement premium.
2 Equity
as of December 31, 2009
RMS v.9.0
allows modeling based on the long-term averages (historic view) and modeling
based on a near-term view that includes an assumption of elevated hurricane
activity in the North Atlantic Basin in the short to medium-term. Results of
both models are provided above for select probabilities. Our current catastrophe
program provides protection for a 1 in 209 year event, or an event with 0.5%
probability according to the RMS v.9.0 historic model, and for a 1 in 179 year
event, or an event with 0.6% probability according to RMS v.9.0 near term
model.
The
Property Excess of Loss treaty (“Property Treaty”) was renewed on July 1, 2009
and is effective through June 30, 2010, with the same terms as the expiring
treaty. This treaty provides a per risk coverage of $28.0 million in excess of a
$2.0 million retention.
|
·
|
The
per occurrence cap on the total program is $64.0
million.
|
|
·
|
The
first layer continues to have unlimited reinstatements. The annual
aggregate limit for the second, $20.0 million in excess of $10.0 million,
layer remains at $80.0 million.
|
|
·
|
Consistent
with the prior year treaty, the Property Treaty excludes nuclear,
biological, chemical, and radiological terrorism
losses.
|
|
·
|
The
renewal treaty rate increased by
2.8%.
|
Casualty
Reinsurance
The
Casualty Excess of Loss treaty (“Casualty Treaty”) was renewed on July 1, 2009.
The current program provides the following coverage:
|
·
|
The
first layer provides coverage for 85% of up to $3.0 million in excess of a
$2.0 million retention. The placement of this layer was increased from 65%
in the expiring treaty.
|
|
·
|
The
next four layers provide coverage for 100% of up to $45.0 million in
excess of a $5.0 million retention.
|
|
·
|
The
sixth layer provides coverage for 100% of up to $40.0 million in excess of
a $50.0 million retention. The placement of this layer was increased from
75% in the expiring treaty.
|
|
·
|
Consistent
with the prior year, the Casualty Treaty excludes nuclear, biological,
chemical and radiological terrorism losses. Annual aggregate terrorism
limits, net of co-participation, increased to $198.8 million due to
increased placement percentages for the fifth and sixth
layers.
|
|
·
|
The
renewal treaty rate increased by
6.1%.
|
Other
Reinsurance
Our
Surety and Fidelity Excess of Loss treaty was renewed effective January 1, 2010,
with essentially no changes in coverage and a 0.9% decrease in the rate
partially offset by an increase in projected subject premium.
Effective
January 1, 2010, we renewed the NWCRP treaty which covers our participation in
the involuntary National Council of Compensation Insurance (“NCCI”) pool, a
residual workers compensation market, and essentially keeps the same coverage as
the expiring treaty. The NWCRP treaty provides 100% Quota Share coverage,
including terrorism coverage, assumed business from the NCCI and has an
aggregate combined ratio limit of approximately 141% for the 2010 underwriting
year. The 2010 treaty is placed with three carriers with ratings of “A” by A.M.
Best. We believe that the continued protection provided within this treaty for
residual market business is especially beneficial given current market
conditions and the expected deterioration in the experience of the NCCI
pool.
62
Investments
During
the first half of 2009, the economy continued to be impacted by the dislocation
of the credit markets brought on by the financial crisis that began in the
latter part of 2008. However, during the second half of 2009, credit spreads
rallied, outperforming the “safe haven” government and agency bond markets as
capital flowed back to risk sectors. Virtually all sectors of the credit markets
saw a return to more normal functioning and stability, accompanied by much
reduced credit spread levels. Improved market confidence and positive sentiments
continue to feed a recovery in valuations of fixed maturity securities.
Consistent with these conditions, we saw our overall investment portfolio go
from a unrealized loss position at December 31, 2008 to an overall unrealized
gain position at December 31, 2009, reflecting a $133.2 million improvement in
valuations. Credit quality of our fixed maturity portfolio continues to remain
high, with an average S&P rating of “AA+.” This is primarily due to the
large allocation of the fixed income portfolio to high quality municipal bonds,
agency RMBS, and government and agency obligations. Exposure to non-investment
grade bonds remains low, composing approximately 1% of the total fixed maturity
portfolio. We have 20 non-investment grade rated securities in the portfolio
with a fair value of $34.9 million and an unrealized loss of $17.9
million.
Our
investment philosophy includes certain return and risk objectives for the fixed
maturity and equity portfolios. The primary fixed maturity portfolio return
objective is to maximize after-tax investment yield and income while balancing
risk. A secondary objective is to meet or exceed a weighted-average benchmark of
public fixed income indices. The equity portfolio return objective is to meet or
exceed a weighted-average benchmark of public equity indices. Although yield and
income generation remain the key drivers to our investment strategy, our overall
philosophy is to invest with a long-term horizon along with a “buy-and-hold”
principle.
The
following table presents information regarding our investment
portfolio:
2009
|
2008
|
|||||||||||||||||||
($ in thousands)
|
2009
|
2008
|
vs. 2008
|
2007
|
vs. 2007
|
|||||||||||||||
Total
invested assets
|
$ | 3,781,051 | 3,540,309 | 7 | % | $ | 3,733,029 | (5 | )% | |||||||||||
Net
investment income – before tax
|
118,471 | 131,032 | (10 | ) | 174,144 | (25 | ) | |||||||||||||
Net
investment income – after tax
|
95,725 | 105,039 | (9 | ) | 133,669 | (21 | ) | |||||||||||||
Unrealized
gain (loss) during the period – before tax
|
133,160 | (219,515 | ) | 161 | (31,214 | ) | (603 | ) | ||||||||||||
Unrealized
gain (loss) during the period – after tax
|
86,554 | (142,685 | ) | 161 | (20,289 | ) | (603 | ) | ||||||||||||
Net
realized (losses) gains – before tax
|
(45,970 | ) | (49,452 | ) | 7 | 33,354 | (248 | ) | ||||||||||||
Net
realized (losses) gains – after tax
|
(29,880 | ) | (32,144 | ) | 7 | 21,680 | (248 | ) | ||||||||||||
Effective
tax rate
|
19.2 | % | 19.8 | (0.6 | )Pts | 23.2 | % | (3.4 | )Pts | |||||||||||
Annual
after-tax yield on fixed maturity securities
|
3.3 | 3.6 | (0.3 | ) | 3.6 | - | ||||||||||||||
Annual
after-tax yield on investment portfolio
|
2.6 | 2.9 | (0.3 | ) | 3.6 | (0.7 | ) |
Total
Invested Assets
Our
portfolio totaled $3.8 billion at December 31, 2009, an increase of 7% compared
to $3.5 billion at December 31, 2008. The increase in invested assets was
primarily due to pre-tax unrealized gains of $133.2 million during 2009 as
discussed above. Our investment portfolio as of December 31, 2009 was comprised
of 88% fixed maturity securities, 2% equities, 6% short term investment and 4%
other investments.
We have
continued to strive to 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. In an effort to
preserve capital and further reduce the risk in our investment portfolio, we
took certain actions during 2009, which included the following:
|
·
|
Reduced
our equity position from approximately $135 million at December 31, 2008
to approximately $80 million at December 31,
2009.
|
|
·
|
Reduced
our non-agency commercial mortgage-backed securities (“CMBS”) exposure
from a carrying value of $154 million at December 31, 2008, or 4% of
invested assets, to $74 million, or 2% of invested
assets;
|
|
·
|
Reduced
our non-agency RMBS, Home Equity ABS and Alternative-A securities
(“Alt-A”) exposure from a carrying value of $127 million at December 31,
2008, or 4% of invested assets, to $63 million, or 2%, of invested
assets;
|
|
·
|
Increased
our position in U.S. government obligations by $368.2 million, raising our
allocation from 7% to 16% as a percentage of invested assets;
and
|
|
·
|
Reclassified
approximately $1.9 billion of our fixed maturity portfolio from an AFS
classification to a HTM classification. As a result of this transfer,
coupled with activity during the year, our HTM portfolio has a carrying
value of $1.7 billion as of December 31,
2009.
|
63
HTM fixed
maturity securities are reported on the Consolidated Balance Sheets at carrying
value, which represents either: (i) amortized cost reduced by unrealized
non-credit OTTI amounts that are reflected in accumulated OCI; or (ii) for those
securities that have been reclassified into an HTM designation, fair value at
the time of transfer adjusted for subsequent accretion or amortization. AFS
fixed maturity and equity securities, as well as our short-term investments are
reported at fair value on the Consolidated Balance Sheets. These fair values are
categorized into a three-level hierarchy, based on the priority of the inputs to
the respective valuation technique. At December 31, 2009, all of our securities
were priced using Level 1 or Level 2 inputs. For additional information see Note
2(e). “Summary of Significant Accounting Policies” and Note 7. “Fair Value
Measurements” of Item 8. “Financial Statements and Supplementary Data.” of this
Form 10-K.
As
mentioned above, our portfolio continues to have a weighted average credit
rating of “AA+.” The following table presents the credit ratings of our fixed
maturities portfolios:
Unaudited
|
Unaudited
|
|||||||
Fixed Maturity
|
December 31,
|
December 31,
|
||||||
Rating
|
2009
|
2008
|
||||||
Aaa/AAA
|
57 | % | 52 | % | ||||
Aa/AA
|
25 | % | 34 | % | ||||
A/A
|
14 | % | 10 | % | ||||
Baa/BBB
|
3 | % | 4 | % | ||||
Ba/BB
or below
|
1 | % |
<1
|
% | ||||
Total
|
100 | % | 100 | % |
To manage
and mitigate exposure, we perform our analysis on mortgage-backed securities
both at the time of the purchase and as part of the ongoing portfolio
evaluation. This analysis may include loan level reviews of average FICO® scores,
loan-to-value ratios, geographic spread of the assets securing the bond,
delinquencies in payments for the underlying mortgages, gains/losses on sales,
evaluations of projected cash flows under various economic and default
scenarios, as well as other information that aids in determination of the health
of the underlying assets. We also consider overall credit environment, economic
conditions, total projected return on the investment, and overall asset
allocation of the portfolio in our decisions to purchase or sell structured
securities. For additional information regarding credit risk associated with our
portfolio see Item 7A. “Quantitative and Qualitative Disclosures About Market
Risk.” of this Form 10-K.
Net
Investment Income
Net
investment income, before tax, decreased to $118.5 million in 2009 from $131.0
million in 2008 due to: (i) an increase in losses of $9.1 million on our
alternative investments; (ii) a decrease in interest income of approximately
$7.7 million on our fixed maturity and short-term investment portfolios
resulting from lower purchase yields; and (iii) lower dividend income of $3.3
million due to our reduced equity portfolio. Although our alternative
investments began stabilizing in the second half of 2009, these losses, which
amounted to $21.7 million on a pre-tax basis, were driven by the unprecedented
volatility in the global capital markets that occurred during the second half of
2008 and continued through the first half of 2009. This volatility resulted in a
decline in asset values, of which 57% was attributable to our real estate
strategy and 30% was attributable to our private equity/private equity secondary
market strategies. As 2009 progressed, the improvements in the credit markets
and increasing stability in the financial markets were reflected in our returns
on this portfolio, which improved from a $29.4 million loss in the first half of
the year to a $7.7 million gain in the second half of the year. Our alternative
investments primarily consist of investments in limited partnerships that
primarily report results to us on a one quarter lag. Unlike AFS securities, our
limited partnerships are accounted for under the equity method of accounting,
with changes in the valuation of these investments being reflected in net
investment income, rather than in OCI. This was partially offset by the effect
of the elimination of our trading portfolio in the first quarter of 2009. During
2008, unrealized losses of $8.1 million on the trading portfolio negatively
impacted investment income.
The
decrease in net investment income, before tax, of $43.1 million for 2008
compared to 2007 was due to: (i) decreased returns of $31.9 million on the
alternative investment portion of our other investments portfolio; and (ii) $8.1
million of reductions in the fair value of our equity trading portfolio due to
the sell off in the equity markets, as well as the collapse in commodity prices
in the second half of 2008.
As of
December 31, 2009, alternative investments represented 4% of our total invested
assets. In addition to the capital that we have already invested to date, we are
contractually obligated to invest up to an additional $102.9 million in these
alternative investments through commitments that currently expire at various
dates through 2023.
64
The
following table outlines a summary of our other investment portfolio by strategy
and the remaining commitment amount associated with each strategy:
Other Investments
|
2009
|
|||||||||||
Carrying Value
|
Remaining
|
|||||||||||
($ in thousands)
|
December 31, 2009
|
December 31, 2008
|
Commitment
|
|||||||||
Alternative
Investments
|
||||||||||||
Energy/Power
Generation
|
$ | 32,996 | 35,839 | 11,014 | ||||||||
Private
Equity
|
21,525 | 22,846 | 17,965 | |||||||||
Secondary
Private Equity
|
20,936 | 24,077 | 25,104 | |||||||||
Mezzanine
Financing
|
20,323 | 23,166 | 28,619 | |||||||||
Distressed
Debt
|
19,201 | 29,773 | 4,611 | |||||||||
Real
Estate
|
16,856 | 23,446 | 13,543 | |||||||||
Venture
Capital
|
5,752 | 5,870 | 2,000 | |||||||||
Total
Alternative Investments
|
137,589 | 165,017 | 102,856 | |||||||||
Other
Securities
|
3,078 | 7,040 | - | |||||||||
Total
Other Investments
|
$ | 140,667 | 172,057 | 102,856 |
Our seven
alternative investment strategies employ low or moderate levels of leverage and
generally use hedging only to reduce foreign exchange or interest rate
volatility. At this time, our alternative investment strategies do not invest in
hedge funds.
For
further discussion of our alternative investment strategies, see Note 5.
“Investments” in Item 8. “Financial Statements and Supplementary Data.” of this
Form 10-K.
Realized
Gains and Losses
Realized Gains and Losses
(excluding OTTI)
Realized
gains and losses, by type of security excluding OTTI charges, are determined on
the basis of the cost of specific investments sold and are credited or charged
to income. The components of net realized (losses) gains were as
follows:
Realized gains (losses) excluding OTTI
|
||||||||||||
($ in thousands)
|
2009
|
2008
|
2007
|
|||||||||
HTM
fixed maturity securities
|
||||||||||||
Gains
|
$ | 225 | 27 | - | ||||||||
Losses
|
(1,049 | ) | (2 | ) | - | |||||||
AFS
fixed maturity securities
|
||||||||||||
Gains
|
20,899 | 1,777 | 445 | |||||||||
Losses
|
(13,889 | ) | (14,259 | ) | (2,260 | ) | ||||||
AFS
equity securities
|
||||||||||||
Gains
|
33,355 | 34,582 | 50,254 | |||||||||
Losses
|
(28,056 | ) | (14,677 | ) | (9,359 | ) | ||||||
Other
investments
|
||||||||||||
Gains
|
- | 1,356 | 847 | |||||||||
Losses
|
(2,039 | ) | (5,156 | ) | (1,683 | ) | ||||||
Total
other net realized investment gains (losses)
|
9,446 | 3,648 | 38,244 | |||||||||
Total
OTTI charges recognized in earnings
|
(55,416 | ) | (53,100 | ) | (4,890 | ) | ||||||
Total
net realized (losses) gains
|
$ | (45,970 | ) | (49,452 | ) | 33,354 |
For
further discussion of realized gains and losses, see Note 5. “Investments” in
Item 8. “Financial Statements and Supplementary Data.” of this Form
10-K.
65
The
following table presents the period of time that securities sold at a loss were
continuously in an unrealized loss position prior to sale:
Period of time in an
|
2009
|
2008
|
2007
|
|||||||||||||||||||||
unrealized loss position
|
Fair
|
Fair
|
Fair
|
|||||||||||||||||||||
Value on
|
Realized
|
Value on
|
Realized
|
Value on
|
Realized
|
|||||||||||||||||||
($ in thousands)
|
Sale Date
|
Loss
|
Sale Date
|
Loss
|
Sale Date
|
Loss
|
||||||||||||||||||
Fixed
maturities:
|
||||||||||||||||||||||||
0 –
6 months
|
$ | 54,287 | 6,951 | 40,467 | 8,259 | 28,994 | 671 | |||||||||||||||||
7 –
12 months
|
38,292 | 3,424 | 11,415 | 567 | 31,639 | 464 | ||||||||||||||||||
Greater
than 12 months
|
39,241 | 3,420 | 9,359 | 3,627 | 10,167 | 203 | ||||||||||||||||||
Total
fixed maturities
|
131,820 | 13,795 | 61,241 | 12,453 | 70,800 | 1,338 | ||||||||||||||||||
Equities:
|
||||||||||||||||||||||||
0 –
6 months
|
29,567 | 20,620 | 30,062 | 13,383 | 59,975 | 8,903 | ||||||||||||||||||
7 –
12 months
|
8,230 | 7,436 | 3,838 | 618 | 1,600 | 360 | ||||||||||||||||||
Greater
than 12 months
|
- | - | 1,628 | 675 | 323 | 95 | ||||||||||||||||||
Total
equity securities
|
37,797 | 28,056 | 35,258 | 14,676 | 61,898 | 9,358 | ||||||||||||||||||
Other
Investments:
|
||||||||||||||||||||||||
0 –
6 months
|
- | - | 8,996 | 4,306 | 5,317 | 1,683 | ||||||||||||||||||
7 –
12 months
|
4,816 | 1,189 | - | - | - | - | ||||||||||||||||||
Total
other investments
|
4,816 | 1,189 | 8,996 | 4,306 | 5,317 | 1,683 | ||||||||||||||||||
Total
|
$ | 174,433 | 43,040 | 105,765 | 31,435 | 138,015 | 12,379 |
During
2009 and 2008, we sold certain securities that were in an unrealized loss
position immediately prior to their sale as a result of financial and tax
planning strategies. Despite these losses, we believe that we have a high
quality and liquid investment portfolio. The sale of securities that produced
net realized gains/losses, or impairment charges that produced realized losses,
did not change the overall liquidity of the investment portfolio. The duration
of the fixed maturity portfolio as of December 31, 2009, including short-term
investments, was an average 3.3 years compared to the Insurance Subsidiaries’
liability duration of approximately 3.6 years which was relatively consistent
with last year. The current duration of the fixed maturities is within our
historical range and is monitored and managed to maximize yield and limit
interest rate risk. We manage the duration mismatch between our assets and
liabilities 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. Our general philosophy for sales of securities is
to reduce our exposure to securities and sectors based upon economic evaluations
and when the fundamentals for that security or sector have deteriorated. We
typically have a long investment time horizon and every purchase or sale is made
with the intent of improving future investment returns while balancing capital
preservation.
Other-than-Temporary
Impairments
The
following table provides information regarding our OTTI charges recognized in
earnings:
($ in thousands)
|
2009
|
2008
|
2007
|
|||||||||
HTM
securities
|
||||||||||||
ABS
|
$ | 2,482 | - | - | ||||||||
CMBS
|
11,777 | - | - | |||||||||
Total
HTM securities
|
14,259 | - | - | |||||||||
AFS
securities
|
||||||||||||
Corporate
securities
|
1,271 | 10,200 | - | |||||||||
ABS
|
- | 16,420 | 4,890 | |||||||||
CMBS
|
- | 9,725 | - | |||||||||
RMBS
|
37,779 | 5,357 | - | |||||||||
Total
fixed maturity AFS securities
|
39,050 | 41,702 | 4,890 | |||||||||
Equity
securities
|
2,107 | 6,613 | - | |||||||||
Total
AFS securities
|
41,157 | 48,315 | 4,890 | |||||||||
Other
securities
|
||||||||||||
Other
securities
|
- | 4,785 | - | |||||||||
Total
other securities
|
- | 4,785 | - | |||||||||
Total
OTTI charges recognized in earnings
|
$ | 55,416 | 53,100 | 4,890 |
66
We
regularly review our entire investment portfolio for declines in fair value. If
we believe that a decline in the value of a particular investment is other than
temporary, we record it as an other-than-temporary impairment, through realized
losses in earnings for the credit-related portion and through unrealized losses
in OCI for the non-credit related portion. Under previously existing accounting
guidance, a decline in fair value on a fixed maturity security was deemed to be
other than temporary if we did not have the intent and ability to hold the
security to its anticipated recovery.
For a
discussion of our OTTI methodology, see Note 2. “Summary of Significant
Accounting Policies” in Item 8, “Financial Statements and Supplementary Data.”
of this Form 10-K. In addition, for significant inputs used to measure OTTI and
qualitative information regarding these charges, see Note 5. “Investments” in
Item 8. “Financial Statements and Supplementary Data.” of this Form
10-K.
Unrealized/Unrecognized
Losses
The
following table summarizes the aggregate fair value and gross pre-tax
unrealized/unrecognized losses recorded, by asset class and by length of time,
for all securities that have continuously been in an unrealized/unrecognized
loss position at December 31, 2009 and December 31, 2008:
December 31, 2009
|
0 – 6 months1
|
7 – 11 months1
|
12 months or longer 1
|
|||||||||||||||||||||
($ in thousands)
|
Fair
Value
|
Net
Unrecognized
Unrealized
(Losses)
|
Fair
Value
|
Net
Unrecognized
Unrealized
(Losses)
|
Fair
Value
|
Net
Unrecognized
Unrealized
(Losses)
|
||||||||||||||||||
AFS securities
|
||||||||||||||||||||||||
U.S.
government and government agencies
|
$ | 187,283 | (1,210 | ) | - | - | - | - | ||||||||||||||||
Obligations
of states and political subdivisions
|
8,553 | (120 | ) | - | - | 3,059 | (17 | ) | ||||||||||||||||
Corporate
securities
|
74,895 | (829 | ) | - | - | 10,550 | (417 | ) | ||||||||||||||||
ABS
|
2,983 | (17 | ) | - | - | 3,960 | (40 | ) | ||||||||||||||||
CMBS
|
36,447 | (637 | ) | - | - | - | - | |||||||||||||||||
RMBS
|
77,674 | (493 | ) | 654 | (21 | ) | 53,607 | (20,198 | ) | |||||||||||||||
Total
fixed maturity securities
|
387,835 | (3,306 | ) | 654 | (21 | ) | 71,176 | (20,672 | ) | |||||||||||||||
Equity
securities
|
3,828 | (214 | ) | - | - | 5,932 | (396 | ) | ||||||||||||||||
Sub-total
|
$ | 391,663 | (3,520 | ) | 654 | (21 | ) | 77,108 | (21,068 | ) | ||||||||||||||
HTM securities
|
||||||||||||||||||||||||
U.S.
government and government agencies
|
$ | 19,746 | (29 | ) | 9,713 | (288 | ) | - | - | |||||||||||||||
Obligations
of states and political subdivisions
|
40,904 | (332 | ) | 5,767 | (181 | ) | 74,360 | (2,684 | ) | |||||||||||||||
Corporate
securities
|
6,124 | (102 | ) | - | - | 19,233 | (1,310 | ) | ||||||||||||||||
ABS
|
- | - | - | - | 13,343 | (2,496 | ) | |||||||||||||||||
CMBS
|
- | - | 316 | (728 | ) | 22,044 | (16,194 | ) | ||||||||||||||||
RMBS
|
5,068 | (146 | ) | - | - | 5,892 | (935 | ) | ||||||||||||||||
Sub-total
|
$ | 71,842 | (609 | ) | 15,796 | (1,197 | ) | 134,872 | (23,619 | ) | ||||||||||||||
Total
|
$ | 463,505 | (4,129 | ) | 16,450 | (1,218 | ) | 211,980 | (44,687 | ) |
1 The
month count for aging of unrealized losses was reset back to historical
unrealized loss month counts for securities impacted by the adoption of OTTI
accounting guidance issued in 2009.
67
December 31, 2008
|
0 – 6 months1
|
7 – 11 months1
|
12 months or longer1
|
|||||||||||||||||||||
($ in thousands)
|
Fair
Value
|
Unrealized
(Losses)
|
Fair
Value
|
Unrealized
(Losses)
|
Fair
Value
|
Unrealized
(Losses)
|
||||||||||||||||||
AFS securities
|
||||||||||||||||||||||||
U.S.
government and government agencies
|
$ | - | - | - | - | - | - | |||||||||||||||||
Obligations
of states and political subdivisions
|
198,172 | (3,430 | ) | 156,443 | (8,135 | ) | 128,130 | (8,682 | ) | |||||||||||||||
Corporate
Securities
|
87,880 | (7,811 | ) | 74,459 | (12,298 | ) | 30,087 | (10,018 | ) | |||||||||||||||
ABS
|
21,355 | (1,794 | ) | 20,787 | (5,975 | ) | 15,336 | (7,577 | ) | |||||||||||||||
CMBS
|
76,758 | (2,246 | ) | 31,868 | (2,654 | ) | 40,691 | (29,935 | ) | |||||||||||||||
RMBS
|
18,012 | (2,812 | ) | 54,507 | (20,391 | ) | 56,338 | (36,399 | ) | |||||||||||||||
Total
fixed maturity securities
|
402,177 | (18,093 | ) | 338,064 | (49,453 | ) | 270,582 | (92,611 | ) | |||||||||||||||
Equity
securities
|
53,461 | (14,291 | ) | 7,686 | (4,370 | ) | - | - | ||||||||||||||||
Other
securities
|
4,528 | (1,478 | ) | - | - | - | - | |||||||||||||||||
Total
AFS Securities
|
$ | 460,166 | (33,862 | ) | 345,750 | (53,823 | ) | 270,582 | (92,611 | ) |
1 2008 HTM
securities are not presented in this table, as their fair value was
approximately $1.2 million and therefore not material.
Unrealized
losses decreased as compared to December 31, 2008, primarily driven by
improvement in the overall marketplace related to our fixed maturity portfolio
coupled with a reduction in our equity portfolio during the year. As of December
31, 2009, 173 fixed maturity securities and six equity securities were in an
unrealized loss position.
We have
reviewed these securities in accordance with our OTTI policy as discussed
previously in “Critical Accounting Policies and Estimates” “Other-Than-Temporary
Investment Impairments.” For qualitative information regarding this conclusion,
see Note 5. “Investments,” in Item 8. “Financial Statements and Supplementary
Data.” of this Form 10-K.
In
addition, the following table presents information regarding securities in our
portfolio with the five largest unrealized/unrecognized balances as of December
31, 2009:
Cost/
|
Unrealized/
|
|||||||||||
Amortized
|
Fair
|
Unrecognized
|
||||||||||
($ in thousands)
|
Cost
|
Value
|
Losses
|
|||||||||
GS
Mortgage Securities Corp II
|
$ | 6,858 | 3,110 | 3,748 | ||||||||
GSAA
Home Equity Trust
|
10,000 | 6,969 | 3,031 | |||||||||
ACT
Depositor Corp
|
2,815 | 253 | 2,562 | |||||||||
Wells
Fargo Mtg Backed Sec
|
3,385 | 1,001 | 2,384 | |||||||||
Mach
One Trust
|
4,424 | 2,212 | 2,212 |
In
performing our assessment on the five individual securities in our portfolio
with the largest unrealized loss balances, we evaluated the securities in the
table above under various scenarios. Based on our analysis at December 31, 2009,
GS Mortgage Securities Corp II was deemed to be other-than-temporarily impaired
and the $3.7 million unrealized balance in the table above represents the
non-credit portion of this impairment. The $2.4 million unrealized balance
related to the Wells Fargo Mortgage Backed Security reflects the non-credit
portion of an OTTI charge that was recorded in the third quarter of 2009. For
the remainder of the securities, no OTTI charge was necessary at year-end as,
under each of the modeled scenarios, the securities did not show signs of
impairment. ACT Depositor Corp and Mach One Trust showed no signs of loss when
modeling a conditional default rate of 3.0 and a loss severity of 55%. Both are
well-seasoned securities with debt service coverage ratios of 1.6x and 1.8x,
respectively. Both securities are also well collateralized. Mach One Trust has
seen no actual losses to date with low delinquencies. GSAA Home Equity Trust has
a reasonably short weighted average life, delinquencies have been stable for
quite some time, and our timeline can withstand conditional default rates and
loss severities in excess of 9.7 and 54.6%, respectively, without any signs of
loss. The current loan-to-value ratio was only 72%.
The
following table presents amortized cost and fair value regarding our AFS fixed
maturities that were in an unrealized loss position at December 31, 2009 by
contractual maturity:
Contractual Maturities
|
Amortized
|
Fair
|
||||||
($ in thousands)
|
Cost
|
Value
|
||||||
One
year or less
|
$ | 105,120 | 100,943 | |||||
Due
after one year through five years
|
276,762 | 262,875 | ||||||
Due
after five years through ten years
|
89,274 | 83,568 | ||||||
Due
after ten years through fifteen years
|
12,508 | 12,279 | ||||||
Total
|
$ | 483,664 | 459,665 |
68
The
following table presents information regarding our HTM fixed maturities that
were in an unrealized loss position at December 31, 2009 by contractual
maturity:
Contractual Maturities
|
Carrying
|
Fair
|
||||||
($ in thousands)
|
Value
|
Value
|
||||||
One
year or less
|
$ | 22,854 | 22,749 | |||||
Due
after one year through five years
|
97,432 | 101,518 | ||||||
Due
after five years through ten years
|
86,199 | 88,896 | ||||||
Due
after ten years through fifteen years
|
3,518 | 4,279 | ||||||
Due
after fifteen years
|
5,215 | 5,068 | ||||||
Total
|
$ | 215,218 | 222,510 |
Investments
Outlook
During
the latter part of 2009, the credit markets witnessed a broad rally, fueled not
only by an improving economic outlook, but also by renewed risk taking with
investors moving away from lower risk-free yields. As capital flowed back to
risk sectors, virtually all sectors of the credit markets saw a return to more
normal functioning and stability, accompanied by much reduced credit spread
levels. Additionally, residential housing may be stabilizing, which may further
help to maintain positive momentum for the U.S. economic outlook. Although the
consensus expects 2010 to see moderate economic growth, the economy still faces
significant challenges. U.S. unemployment rates will probably not see a
meaningful reduction and consumer spending will remain modest, which will
continue to have a dampening effect on the growth potential of the Gross
Domestic Product. Furthermore, mortgage delinquencies and foreclosures continue
to rise, while underwriting remains tight.
Our fixed
income strategy will be centered on maintaining sufficient liquidity while
maximizing yield within acceptable risk tolerances. We will continue to invest
in high quality instruments, while striving to reduce risk, including additions
to high-grade corporate bonds with targeted maturities of approximately five
years to lessen incremental interest rate risk.
We will
continue our disciplined equity investment strategy by investing in companies
that we believe have attractive long-term value, characterized by: (i) strong
balance sheets; (ii) sufficient cash levels to meet liability obligations; (iii)
cash generating capacity to support attractive dividend yields; (iv) high
returns on capital; and (v) strong management.
Our
long-term outlook for the alternative investment strategy continues to be
positive despite the volatility in investment income over the past two years.
Although investment activity continues to be slow due to current market
conditions, the merger and acquisitions environment continues to improve as
financing has become available. However, in the near term, we continue to be
cautious and limit our exposure in the alternative investment
class.
69
Federal
Income Taxes
The
following table presents our taxable income, pre-tax financial statement income,
and net deferred tax asset:
($ in millions)
|
2009
|
2008
|
2007
|
|||||||||
Current
taxable income from continuing operations
|
$ | 11.9 | 69.6 | 154.6 | ||||||||
Pre-tax
income from continuing operations
|
39.2 | 40.2 | 188.8 | |||||||||
Net
deferred tax asset
|
111.0 | 150.8 | 27.1 | |||||||||
Federal
income tax benefit (expense)
|
5.5 | 3.9 | (45.1 | ) | ||||||||
Effective
tax rate
|
(14.0 | )% | (9.8 | )% | 23.9 | % |
Our
effective tax rate from continuing operations differs from the federal corporate
rate of 35% primarily as a result of tax-advantaged investment income. For a
reconciliation of our effective tax rate to the statutory rate of 35%, see Note
15. “Federal Income Tax” in Item 8. “Financial Statement and Supplementary
Data.” of this Form 10-K.
We have a
net deferred tax asset of $111.0 million at December 31, 2009 compared with a
deferred tax asset of $150.8 million at December 31, 2008. The decrease of $39.8
million is primarily due to a reduction in unrealized losses in our investment
portfolio.
Financial
Condition, Liquidity, and Capital Resources
Capital
resources and liquidity reflect our ability to generate cash flows from business
operations, borrow funds at competitive rates, and raise new capital to meet
operating and growth needs.
Liquidity
We manage
liquidity with a focus on generating sufficient cash flows to meet the
short-term and long-term cash requirements of our business operations. Our cash
and short-term investment position was $215 million at December 31, 2009
primarily comprised of $48 million at the Parent and $167 million at the
Insurance Subsidiaries.
We
continually evaluate our liquidity levels in light of market conditions and,
given the financial market volatility that occurred during the latter half of
2008 through the first half of 2009, we continue to maintain higher than
historical cash and short-term investment balances. All short-term investments
are maintained in AAA-rated money market funds approved by the
NAIC.
Sources
of cash for the Parent have historically consisted of dividends from the
Insurance Subsidiaries, borrowings under its line of credit and loan agreements
with the Indiana Subsidiaries, and the issuance of stock and debt securities. We
continue to monitor these sources, giving consideration to our long-term
liquidity and capital preservation strategies. The Parent had no private or
public issuances of stock or debt during 2009. In addition there were no
borrowings under its lines of credit.
The
Insurance Subsidiaries paid $24.5 million of dividends to the Parent in 2009,
all of which was paid through December 2009, compared to our allowable ordinary
dividend amount of approximately $102 million. Any dividends to the Parent
continue to be subject to the approval and/or review of the insurance regulators
in the respective domiciliary states under insurance holding company acts, and
are generally payable only from earned surplus as reported in the statutory
annual statements of those subsidiaries as of the preceding December 31.
Although past dividends have historically been met with regulatory approval,
there is no assurance that future dividends that may be declared will be
approved given current conditions. For additional information regarding dividend
restrictions, refer to Note 10. “Indebtedness” and Note 11. “Stockholders’
Equity” in Item 8. “Financial Statements and Supplementary Data.” of this Form
10-K.
During
the third quarter of 2009 the Parent terminated its previously existing line of
credit and entered into a new syndicated line of credit agreement on August 25,
2009. The new $30 million line of credit is syndicated between Wachovia Bank
N.A., a subsidiary of Wells Fargo & Company, as administrative agent and
Branch Banking and Trust Company (“Line of Credit”) and allows us to increase
our borrowings to $50 million with the approval of both lending parties. We
continue to monitor current news regarding the banking industry, in general, and
our lending partners, in particular, as, according to the syndicated line of
credit agreement, the obligations of the lenders to make loans and to make
payments are several and not joint. There were no balances outstanding under
this credit facility as of December 31, 2009.
The Line
of Credit agreement contains representations, warranties and covenants that are
customary for credit facilities of this type, including, without limitation,
financial covenants under which we are obligated to maintain a minimum
consolidated net worth, minimum combined statutory surplus, and maximum ratio of
consolidated debt to total capitalization, and covenants limiting our ability
to: (i) merge or liquidate; (ii) incur debt or liens; (iii) dispose of assets;
(iv) make investments and acquisitions; (v) repurchase common stock; and (vi)
engage in transactions with affiliates.
70
The table
below outlines information regarding certain of the covenants in the Line of
Credit:
As of December 31, 2009
|
Required as of
December 31, 2009
|
Actual as of
December 31, 2009
|
|||
Consolidated
net worth
|
$777
million
|
$1.0
billion
|
|||
Statutory
Surplus
|
not
less than $700 million
|
$982
million
|
|||
Debt-to-capitalization
ratio
|
Not
to exceed 30%
|
21.5%
|
|||
A.M.
Best financial strength rating
|
Minimum
of A-
|
A+
|
In the
first quarter of 2009, the Indiana Subsidiaries joined and invested in the
Federal Home Loan Bank of Indianapolis (“FHLBI”), which provides these companies
with access to additional liquidity. The Indiana Subsidiaries’ aggregate
investment of $0.7 million provides them with the ability to borrow up to 20
times the total amount of the FHLBI common stock purchased, at comparatively low
borrowing rates. The new Line of Credit permits collateralized borrowings by the
Indiana Subsidiaries from the FHLBI so long as the aggregate amount borrowed
does not exceed 10% of the respective Indiana Subsidiary’s admitted assets from
the preceding calendar year. All borrowings from FHLBI are required to be
secured by certain investments. The Indiana Department of Insurance has approved
lending agreements from the Indiana Subsidiaries to the Parent. In the fourth
quarter of 2009, the Indiana Subsidiaries accessed the FHLBI for $13 million in
fixed rate borrowings after pledging the required collateral. These funds have
been loaned to the Parent under the approved lending agreements.
The
Insurance Subsidiaries also generate liquidity through insurance float, which is
created by collecting premiums and earning investment income before losses are
paid. The period of the float can extend over many years. While current market
conditions have limited the liquidity in our fixed maturity investments
regarding sales, our laddered portfolio, in which some issues are always
maturing, continues to provide a source of cash flows for claim payments in the
ordinary course of business. The duration of the fixed maturity portfolio,
including short-term investments, was 3.3 years as of December 31, 2009, while
the liabilities of the Insurance Subsidiaries have a duration of 3.6 years. In
addition, the Insurance Subsidiaries purchase reinsurance coverage for
protection against any significantly large claims or catastrophes that may occur
during the year.
The
liquidity generated from the sources discussed above is used, among other
things, to pay dividends to our shareholders. Dividends on shares of the
Parent’s common stock are declared and paid at the discretion of the Board of
Directors (the “Board”) based on our operating results, financial condition,
capital requirements, contractual restrictions, and other relevant factors. Our
ability to declare dividends is restricted by covenants contained in our 8.87%
Senior Notes, of which $12.3 million was outstanding as of December 31, 2009.
All such covenants were met during 2009 and 2008. At December 31, 2009, the
amount available for dividends to holders of the Parent’s common stock, in
accordance with the restrictions of the 8.87% Senior Notes, was $303.6 million.
For further information regarding our notes payable and the related covenants,
see Note 10. “Indebtedness,” included in Item 8. “Financial Statements and
Supplementary Data.” of this Form 10-K.
Our
ability to meet our interest and principal repayment obligations on our debt, as
well as our ability to continue to pay dividends to our stockholders is
dependent on liquidity at the Parent coupled with the ability of the Insurance
Subsidiaries to pay dividends, if necessary, and/or the availability of other
sources of liquidity to the Parent. Our next principal repayments are $12.3
million in 2010 and $13 million due in 2014 with the next principal repayment
occurring beyond that in 2034. Restrictions on the ability of the Insurance
Subsidiaries to declare and pay dividends, without alternative liquidity
options, could materially affect our ability to service our debt and pay
dividends on common stock.
Capital
Resources
Capital
resources provide protection for policyholders, furnish the financial strength
to support the business of underwriting insurance risks, and facilitate
continued business growth. At December 31, 2009, we had statutory surplus of
$981.9 million and GAAP stockholders’ equity of $1.0 billion. We had total debt
of $274.6 million at December 31, 2009, which equates to a debt-to-capital ratio
of approximately 21.5%.
Our cash
requirements include, but are not limited to, principal and interest payments on
various notes payable and dividends to stockholders, payment of claims, payment
of commitments under limited partnership agreements and capital expenditures, as
well as other operating expenses, which include agents’ commissions, labor
costs, premium taxes, general and administrative expenses, and income taxes. For
further details regarding our cash requirements, refer to the section below
entitled “Contractual Obligations and Contingent Liabilities and
Commitments.”
71
We
continually monitor our cash requirements and the amount of capital resources
that we maintain at the holding company and operating subsidiary levels. As part
of our long-term capital strategy, we strive to maintain a 25% debt-to-capital
ratio and a premiums-to-surplus ratio sufficient to maintain an “A+” (Superior)
financial strength A.M. Best rating for the Insurance Subsidiaries. Based on our
analysis and market conditions, we may take a variety of actions, including, but
not limited to, contributing capital to our subsidiaries in our Insurance
Operations, issuing additional debt and/or equity securities, repurchasing
shares of the Parent’s common stock, and increasing stockholders’ dividends. In
2009, the Parent made a capital contribution of $20.0 million to one of its
Insurance Subsidiaries, thereby increasing liquidity and the statutory surplus
of that Insurance Subsidiary.
Although
the financial markets appear to have begun stabilizing towards the end of 2009,
we continue to maintain liquidity at the Insurance Subsidiary levels and during
2009, did not purchase stock under our authorized share repurchase program,
which expired on July 26, 2009. In 2008, we purchased 1.8 million shares at a
cost of $40.5 million under this program. Our capital management strategy is
intended to protect the interests of the policyholders of the Insurance
Subsidiaries and our stockholders, while enhancing our financial strength and
underwriting capacity.
Book
value per share increased to $18.83 as of December 31, 2009 from $16.84 as of
December 31, 2008, primarily driven by: (i) unrealized gains on our investment
portfolio, which led to an increase in book value per share of $1.63; and (ii)
net income, which led to an increase in book value per share of $0.69. Partially
offsetting these increases was the impact of dividends paid to our shareholders,
which resulted in decreases in book value per share of $0.53.
Off-Balance
Sheet Arrangements
At
December 31, 2009 and, 2008, we did not have any relationships with
unconsolidated entities or financial partnerships, such as entities often
referred to as structured finance or special purpose entities, which would have
been established for the purpose of facilitating off-balance sheet arrangements
or for other contractually narrow or limited purposes. As such, we are not
exposed to any financing, liquidity, market, or credit risk that could arise if
we had engaged in such relationships.
Contractual
Obligations and Contingent Liabilities and Commitments
As
discussed in “Net Loss and Loss Expense Reserves” in Item 1. “Business.” of this
Form 10-K, we maintain case reserves and estimates of reserves for losses and
loss expense IBNR, in accordance with industry practice. Using generally
accepted actuarial reserving techniques, we project our estimate of ultimate
losses and loss expenses at each reporting date. Included within the estimate of
ultimate losses and loss expenses are case reserves, which are analyzed on a
case-by-case basis by the type of claim involved, the circumstances surrounding
each claim, and the policy provisions relating to the type of losses. The
difference between: (i) projected ultimate loss and loss expense reserves; and
(ii) case loss reserves and loss expense reserves thereon are carried as the
IBNR reserve. A range of possible reserves is determined annually and considered
in addition to the most recent loss trends and other factors in establishing
reserves for each reporting period. Based on the consideration of the range of
possible reserves, recent loss trends and other factors, IBNR is established and
the ultimate net liability for losses and loss expenses is determined. Such an
assessment requires considerable judgment given that it is frequently not
possible to determine whether a change in the data is an anomaly until sometime
after the event. Even if a change is determined to be permanent, it is not
always possible to reliably determine the extent of the change until sometime
later. As a result, there is no precise method for subsequently evaluating the
impact of any specific factor on the adequacy of reserves because the eventual
deficiency or redundancy is affected by many factors.
Given
that the loss and loss expense reserves are estimates as described above and in
more detail under the “Critical Accounting Policies and Estimates” section of
Item 7. “Management’s Discussion and Analysis of Financial Condition and Results
of Operations.” of this Form 10-K, the payment of actual losses and loss
expenses is generally not fixed as to amount or timing. Due to this uncertainty,
financial accounting standards prohibit us from discounting these reserves to
their present value. Additionally, estimated losses as of the financial
statement date do not consider the impact of estimated losses from future
business. Therefore, the projected settlement of the reserves for net loss and
loss expenses will differ, perhaps significantly, from actual future
payments.
The
projected paid amounts in the table below by year are estimates based on past
experience, adjusted for the effects of current developments and anticipated
trends, and include considerable judgment. There is no precise method for
evaluating the impact of any specific factor on the projected timing of when
loss and loss expense reserves will be paid and as a result, the timing and
amounts of the actual payments will be affected by many factors. Care must be
taken to avoid misinterpretation by those unfamiliar with this information or
familiar with other data commonly reported by the insurance
industry.
72
Our
future cash payments associated with contractual obligations pursuant to
operating leases for office space and equipment, notes payable, interest on debt
obligations, and loss and loss expenses as of December 31, 2009 are summarized
below:
Contractual obligations
|
Payment due by period
|
|||||||||||||||||||
Less than
|
1-3
|
3-5
|
More than
|
|||||||||||||||||
($ in millions)
|
Total
|
1 year
|
years
|
years
|
5 years
|
|||||||||||||||
Operating
leases
|
$ | 24.1 | 9.2 | 10.6 | 3.9 | 0.4 | ||||||||||||||
Notes
payable
|
275.3 | 12.3 | - | 13.0 | 250.0 | |||||||||||||||
Interest
on debt obligations
|
693.0 | 18.8 | 36.4 | 36.4 | 601.4 | |||||||||||||||
Subtotal
|
992.4 | 40.3 | 47.0 | 53.3 | 851.8 | |||||||||||||||
Gross
loss and loss expense payments
|
2,745.8 | 704.4 | 860.4 | 428.5 | 752.5 | |||||||||||||||
Ceded
loss and loss expense payments
|
271.6 | 56.3 | 60.6 | 28.6 | 126.1 | |||||||||||||||
Net
loss and loss expense payments
|
2,474.2 | 648.1 | 799.8 | 399.9 | 626.4 | |||||||||||||||
Total
|
3,466.6 | 688.4 | 846.8 | 453.2 | 1,478.2 |
See the
“Liquidity” section above for a discussion of our syndicated line of credit
agreement.
At
December 31, 2009, we also have contractual obligations that expire at various
dates through 2023 that may require us to invest up to an additional $102.9
million in alternative investments. There is no certainty that any such
additional investment will be required. We have issued no material guarantees on
behalf of others and have no trading activities involving non-exchange traded
contracts accounted for at fair value. We have no material transactions with
related parties other than those disclosed in Note 18. “Related Party
Transactions” included in Item 8. “Financial Statements and Supplementary Data.”
of this Form 10-K.
Ratings
We are
rated by major rating agencies, which issue opinions on our financial strength,
operating performance, strategic position, and ability to meet policyholder
obligations. We believe that our ability to write insurance business is most
influenced by our rating from A.M. Best, which was reaffirmed in the second
quarter of 2009 as “A+ (Superior),” their second highest of 15 ratings, while
our outlook was revised to “negative” from “stable.” They cited our
risk-adjusted capitalization deterioration as a result of investment losses and
impairment charges in 2008 as well as our ability to improve operating results
in the current challenging commercial lines environment. We have been rated “A”
or higher by A.M. Best for the past 79 years, with our current rating of “A+
(Superior)” being in place for the last 48 consecutive years. The financial
strength reflected by our A.M. Best rating is a competitive advantage in the
marketplace and influences where independent insurance agents place their
business. A downgrade from A.M. Best, could: (i) affect our ability to write new
business with customers and/or agents, some of whom are required (under various
third party agreements) to maintain insurance with a carrier that maintains a
specified A.M. Best minimum rating; or (ii) be an event of default under our
line of credit.
Our
ratings by other major rating agencies are as follows:
|
·
|
S&P
Insurance Rating Services — Our financial strength rating was revised to
“A” from “A+” in the third quarter of 2009. S&P cited our strong
competitive position in Mid-Atlantic markets, well-developed predictive
modeling capabilities, strong financial flexibility and consistent
recognition by third-party agent satisfaction surveys as a superior
regional carrier. Mitigating the strengths and precipitating the rating
change was a decline in capital adequacy and operating results, relative
to historically strong levels. S&P noted the decline in statutory
surplus was largely attributed to realized and unrealized losses from the
investment portfolio at the end of 2008 and the first quarter of 2009.
S&P’s outlook of “negative” reflects continued commercial lines
pricing competition and reduced investment
income.
|
|
·
|
Moody’s
— Our “A2” financial strength rating was reaffirmed in the third quarter
of 2008, citing our strong regional franchise with good independent agency
support, along with our conservative balance sheet, moderate financial
leverage, and consistent profitability. At the same time, Moody’s revised
our outlook from “positive” to “stable” reflecting an increasingly
competitive commercial lines market and continued weakness in our personal
lines book of business.
|
|
·
|
Fitch
Ratings — Our “A+” rating was reaffirmed in the first quarter of 2009,
citing our disciplined underwriting culture, conservative balance sheet,
strong independent agency relationships, and improved diversification
through our continued efforts to reduce our concentration in New Jersey.
Fitch revised our outlook from “stable” to “negative” citing a
deterioration of recent underwriting performance on an absolute basis and
relative to our rating category. To a lesser extent, the negative outlook
also reflects Fitch’s concern about further declines in our capitalization
tied to investment losses.
|
73
Our
S&P and Moody’s financial strength ratings affect our ability to access
capital markets. In addition, our interest rate under our line of credit varies
based on the Parent’s debt ratings from S&P and Moody’s. There can be no
assurance that our ratings will continue for any given period of time or that
they will not be changed. It is possible that positive or negative ratings
actions by one or more of the rating agencies may occur in the future. We review
our financial debt agreements for any potential rating triggers that could
dictate a material change in terms if our credit ratings were to
change.
Pending
Accounting Pronouncements
Currently,
the Financial Accounting Standards Board (“FASB”) is reviewing proposed changes
to existing accounting regarding the treatment of costs associated with
acquiring or renewing insurance contracts. We currently defer these expenses,
which include commissions, premium taxes, fees, and certain other costs of
underwriting policies and amortize them into expense over the same period in
which the premium is earned. Changes in this accounting treatment resulting from
issuance of final guidance on this topic could, depending on the provisions of
such guidance, have a material impact to our results of operations.
In
addition, the FASB is involved in a joint project with the International
Accounting Standards Board that could significantly impact today’s insurance
model. These potentially include, but are not limited to: (i) redefining the
revenue recognition process; and (ii) requiring loss reserve discounting. As
indicated in Note 2. “Summary of Significant Accounting Policies” in Item 8.
“Financial Statements and Supplementary Data.” of this Form 10-K, our premiums
are earned over the period that coverage is provided and we do not discount our
loss reserves. Final guidance resulting from this joint project, may or may not
have a material impact on our operations.
For
information regarding our adoption of current accounting pronouncements see Note
3. “Adoption of Accounting Pronouncements” in Item 8. “Financial Statements and
Supplementary Data.” of this Form 10-K.
74
Item
7A. Quantitative and Qualitative Disclosures About Market Risk.
Market
Risk
The fair
value of our assets and liabilities are subject to market risk, primarily
interest rate, credit spreads, and equity price risk related to our investment
portfolio as well as fluctuations in the value of our alternative investment
portfolio. Our investment portfolio is currently comprised of securities
categorized as available for sale and held to maturity. We do not hold
derivative or commodity investments. Foreign investments are made on a limited
basis, and all fixed maturity transactions are denominated in U.S. currency. We
have minimal foreign currency fluctuation risk on certain equity
securities.
Our
investment philosophy includes setting certain return objectives relating to the
equity and fixed maturity portfolios as well as risk objectives relating to the
overall portfolio. The return objective of our equity portfolio is to meet or
exceed a weighted-average benchmark of public equity indices. The primary return
objective of our fixed maturity portfolio is to maximize after-tax investment
yield and income while balancing certain risk objectives, with a secondary
objective of meeting or exceeding a weighted-average benchmark of public fixed
income indices. The risk objectives for our portfolios are to ensure investments
are being structured conservatively, focusing on: (i) asset diversification;
(ii) investment quality; (iii) liquidity, particularly to meet the cash
obligations of the insurance operations; (iv) consideration of taxes; and (v)
preservation of capital. 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 a “buy-and-hold” principle. The current allocation
of our portfolio is 88% fixed maturity securities, 2% equity securities, 6%
short-term investments, and 4% other investments as of December 31, 2009;
however, we do plan to make further additions to our high grade bonds with a
focus on modestly increasing the allocation of our fixed maturity securities to
corporate securities, while slightly decreasing our allocation to government
securities.
We manage
our investment portfolio to mitigate risks associated with various financial
market scenarios. We will, however, take prudent risk to enhance our overall
long-term results while managing a conservative, well-diversified investment
portfolio to support our underwriting activities.
Interest
Rate Risk
In
connection with the Insurance Subsidiaries, we invest in interest rate-sensitive
securities, mainly fixed maturity securities. Our fixed maturity portfolio is
comprised of primarily investment grade (investments receiving S&P or an
equivalent rating of BBB- or above) corporate securities, U.S. government and
agency securities, municipal obligations, and mortgage-backed securities. Our
strategy to manage interest rate risk is to purchase intermediate-term fixed
maturity investments that are attractively priced in relation to perceived
credit risks. Our fixed maturity securities include both AFS and HTM securities.
Fixed maturity securities that are not classified as either HTM securities or
trading securities are classified as AFS securities and reported at fair value,
with unrealized gains and losses excluded from earnings and reported as a
separate component of stockholders’ equity. Those fixed maturity securities that
we have the ability and positive intent to hold to maturity are classified as
HTM and carried at either: (i) amortized cost; or (ii) market value at the date
the security was transferred into the HTM category, adjusted for subsequent
amortization.
Our
exposure to interest rate risk relates primarily to the market price and cash
flow variability associated with changes in interest rates. A rise in interest
rates may decrease the fair value of our existing fixed maturity investments and
declines in interest rates may result in an increase in the fair value of our
existing fixed maturity investments. However, new and reinvested money used to
purchase fixed maturity securities would benefit from rising interest rates and
would be negatively impacted by falling interest rates. Our fixed income
investment portfolio contains interest rate-sensitive instruments that may be
adversely affected by changes in interest rates resulting from governmental
monetary policies, domestic and international economic and political conditions,
and other factors beyond our control. We seek to mitigate our interest rate risk
associated with holding fixed maturity investments by monitoring and maintaining
the average duration of our portfolio with a view toward achieving an adequate
after-tax return without subjecting the portfolio to an unreasonable level of
interest rate risk. The fixed maturity portfolio duration of December 31, 2009
was 3.5 years compared to 3.8 years a year ago. The current duration of the
fixed maturities is within our historical range and is monitored and managed to
maximize yield and limit interest rate risk. Duration of the investment
portfolio was shortened to further reduce interest rate risk and the volatility
of the portfolio. The insurance subsidiaries liability duration is approximately
3.6. We manage the slight duration mismatch between our assets and liabilities
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.
75
Based on
our fixed maturity securities asset allocation and security selection process,
we believe that our fixed maturity portfolio is not overly prone to prepayment
or extension risk. Although we take measures to manage the economic risks of
investing in a changing interest rate environment, we may not be able to
mitigate the interest rate risk of our assets relative to our
liabilities.
We use
interest rate sensitivity analysis to measure the potential loss or gain in
future earnings, fair values, or cash flows of market sensitive fixed maturity
securities. The sensitivity analysis hypothetically assumes an instant parallel
200 basis point shift in interest rates up and down in 100 basis point
increments from the date of the Consolidated Financial Statements. We use fair
values to measure the potential loss. This analysis is not intended to provide a
precise forecast of the effect of changes in market interest rates and equity
prices on our income or stockholders’ equity. Further, the calculations do not
take into account any actions we may take in response to market
fluctuations.
The
following table presents the sensitivity analysis of each component of market
risk as of December 31, 2009:
2009
|
||||||||||||||||||||
Interest Rate Shift in Basis Points
|
||||||||||||||||||||
($ in millions)
|
-200
|
-100
|
0
|
100
|
200
|
|||||||||||||||
HTM
fixed maturity securities
|
||||||||||||||||||||
Fair
value of HTM fixed maturity securities portfolio
|
1,894,717 | 1,814,509 | 1,740,211 | 1,671,545 | 1,608,077 | |||||||||||||||
Fair
value change
|
154,506 | 74,298 | (68,666 | ) | (132,134 | ) | ||||||||||||||
Fair
value change from base (%)
|
8.88 | % | 4.27 | % | (3.95 | )% | (7.59 | )% | ||||||||||||
AFS
fixed maturity securities
|
||||||||||||||||||||
Fair
value of AFS fixed maturity securities portfolio
|
1,773,868 | 1,704,351 | 1,635,869 | 1,570,379 | 1,508,607 | |||||||||||||||
Fair
value change
|
137,999 | 68,482 | (65,490 | ) | (127,262 | ) | ||||||||||||||
Fair
value change from base (%)
|
8.44 | % | 4.19 | % | (4.00 | )% | (7.78 | )% |
In 2009,
the impact of interest rate risk on our portfolio and our stockholders’ equity
was partially mitigated by the fact that we transferred $1.9 billion of our AFS
securities to a HTM designation. Our HTM portfolio consists of the following at
December 31, 2009: $1.2 billion of state and municipal obligations, $236.3
million of mortgage backed securities, $144.8 million of government securities,
$98.8 million of corporate securities, and $29.0 million of asset backed
securities. This portfolio has an unrealized/unrecognized gain position of $39.7
million as of December 31, 2009.
Credit
Risk
During
the first half of 2009, the economy continued to be impacted by the dislocation
of the credit markets brought on by the financial crisis that began in the
latter part of 2008. However, during the second half of 2009, credit spreads
rallied, outperforming the “safe haven” government and agency bond markets as
capital flowed back to risk sectors. Virtually all sectors of the credit markets
saw a return to more normal functioning and stability, accompanied by much
reduced credit spread levels. Much improved market confidence and positive
sentiments continue to feed a recovery in valuations of fixed maturity
securities. Given these conditions, we saw our overall investment portfolio go
from an unrealized loss position at December 31, 2008 to an overall unrealized
gain position at December 31, 2009, reflecting $133 million improvement in
valuations. Furthermore, credit quality of our fixed maturity portfolio
continues to remain high, with an average S&P rating of “AA+.” This is
primarily due to the large allocation of the fixed income portfolio to
highly-rated and high quality municipal bonds, agency RMBS, and government and
agency obligations. Exposure to non-investment grade bonds remains at a low
absolute level, comprising approximately 1% of the total fixed maturity
portfolio. We only have 20 non-investment grade rated securities in the
portfolio with a fair value of $34.9 million and an unrealized loss of $17.9
million.
76
The
following table summarizes the fair values, unrealized gain (loss) balances, and
the weighted average credit qualities of our AFS fixed maturity securities at
December 31, 2009 and December 31, 2008:
December 31, 2009
|
December 31, 2008
|
|||||||||||||||||||||
Fair
|
Unrealized
|
Credit
|
Fair
|
Unrealized
|
Credit
|
|||||||||||||||||
($ in millions)
|
Value
|
Gain (Loss)
|
Quality
|
Value
|
Gain (Loss)
|
Quality
|
||||||||||||||||
AFS
Fixed Maturity Portfolio:
|
||||||||||||||||||||||
U.S. government
obligations1
|
$ | 475.6 | 1.8 |
AAA
|
$ | 252.2 | 16.6 |
AAA
|
||||||||||||||
State
and municipal obligations
|
379.8 | 20.3 |
AA+
|
1,758.0 | 18.6 |
AA+
|
||||||||||||||||
Corporate
securities
|
379.6 | 14.1 |
A+
|
366.5 | (22.9 | ) |
A
|
|||||||||||||||
Mortgaged-backed-securities
|
373.9 | (17.2 | ) |
AA+
|
596.2 | (86.1 | ) |
AA+
|
||||||||||||||
ABS
|
27.0 | 0.4 |
AA
|
61.4 | (15.3 | ) |
AA
|
|||||||||||||||
Total
AFS portfolio
|
$ | 1,635.9 | 19.4 |
AA+
|
$ | 3,034.3 | (89.1 | ) |
AA+
|
|||||||||||||
State
and Municipal Obligations:
|
||||||||||||||||||||||
General
obligations
|
$ | 222.6 | 11.0 |
AA+
|
$ | 574.1 | 16.2 |
AA+
|
||||||||||||||
Special
revenue obligations
|
157.2 | 9.3 |
AA+
|
1,183.9 | 2.4 |
AA+
|
||||||||||||||||
Total
state and municipal obligations
|
$ | 379.8 | 20.3 |
AA+
|
$ | 1,758.0 | 18.6 |
AA+
|
||||||||||||||
Corporate
Securities:
|
||||||||||||||||||||||
Financial
|
$ | 67.4 | 3.0 |
AA-
|
$ | 101.0 | (13.1 | ) |
A+
|
|||||||||||||
Industrials
|
46.6 | 2.2 |
A
|
67.7 | (2.1 | ) |
A-
|
|
||||||||||||||
Utilities
|
18.9 | 0.9 |
A-
|
47.6 | (0.8 | ) |
A
|
|||||||||||||||
Consumer
discretion
|
26.3 | 1.3 |
A-
|
33.9 | (1.5 | ) |
A-
|
|||||||||||||||
Consumer
staples
|
51.6 | 1.4 |
A
|
42.0 | 0.5 |
A
|
||||||||||||||||
Healthcare
|
52.8 | 1.7 |
AA-
|
22.7 | 0.7 |
A+
|
||||||||||||||||
Materials
|
20.7 | 0.8 |
A-
|
13.2 | (3.7 | ) |
BBB+
|
|||||||||||||||
Energy
|
42.4 | 1.3 |
AA-
|
19.1 | (0.2 | ) |
A-
|
|||||||||||||||
Information
technology
|
10.8 | 0.1 |
AA
|
10.1 | (1.9 | ) |
BBB
|
|||||||||||||||
Telecommunications
services
|
14.6 | 0.5 |
A
|
9.2 | (0.8 | ) |
A-
|
|||||||||||||||
Other
|
27.5 | 0.9 |
A
|
- | - |
-
|
||||||||||||||||
Total
corporate securities
|
$ | 379.6 | 14.1 |
A+
|
$ | 366.5 | (22.9 | ) |
A
|
|||||||||||||
Mortgage-backed
Securities:
|
||||||||||||||||||||||
Government
guaranteed agency CMBS
|
$ | 94.6 | 1.1 |
AAA
|
$ | 56.3 | 2.2 |
AAA
|
||||||||||||||
Other
agency CMBS
|
- | - |
-
|
16.6 | 0.6 |
AAA
|
||||||||||||||||
Non-agency
CMBS
|
- | - |
-
|
154.3 | (34.8 | ) |
AAA
|
|||||||||||||||
Government
guaranteed agency RMBS
|
105.2 | 0.1 |
AAA
|
84.6 | 0.7 |
AAA
|
||||||||||||||||
Other
agency RMBS
|
119.8 | 1.9 |
AAA
|
160.9 | 3.5 |
AAA
|
||||||||||||||||
Non-agency
RMBS
|
30.2 | (12.8 | ) |
A-
|
74.3 | (28.4 | ) |
AA+
|
||||||||||||||
Alternative-A
(“Alt-A”) RMBS
|
24.1 | (7.5 | ) |
A-
|
49.2 | (29.9 | ) |
AA+
|
||||||||||||||
Total
mortgage-backed securities
|
$ | 373.9 | (17.2 | ) |
AA+
|
$ | 596.2 | (86.1 | ) |
AA+
|
||||||||||||
ABS:
|
||||||||||||||||||||||
ABS
|
$ | 27.0 | 0.4 |
AA
|
$ | 59.3 | (15.1 | ) |
AA+
|
|||||||||||||
Alt-A
ABS
|
- | - |
-
|
0.9 | - |
B
|
||||||||||||||||
Sub-prime ABS2
|
- | - |
-
|
1.2 | (0.2 | ) |
A
|
|||||||||||||||
Total
ABS
|
$ | 27.0 | 0.4 |
AA
|
$ | 61.4 | (15.3 | ) |
AA
|
1U.S.
government includes corporate securities fully guaranteed by the
FDIC.
2We define
sub-prime exposure as exposure to direct and indirect investments in non-agency
residential mortgages with average FICO® scores
below 650.
77
The
following table provides information regarding our HTM fixed maturity securities
and their credit qualities at December 31, 2009:
December 31, 2009
($ in millions)
|
Fair
Value
|
Carry
Value
|
Unrecognized
Holding Gain
(Loss)
|
Unrealized
Gain (Loss) in
Accumulated
OCI
|
Total
Unrealized/
Unrecognized
Gain (Loss)
|
Average
Credit
Quality
|
|||||||||||||||||
HTM Fixed Maturity
Portfolio1:
|
|||||||||||||||||||||||
U.S.
government obligations
|
$ | 146.0 | 144.8 | 1.2 | 5.6 | 6.8 |
AAA
|
||||||||||||||||
State
and municipal obligations
|
1,210.8 | 1,201.4 | 9.4 | 33.9 | 43.3 |
AA
|
|||||||||||||||||
Corporate
securities
|
107.5 | 98.8 | 8.7 | (6.0 | ) | 2.7 |
A-
|
||||||||||||||||
MBS
|
242.8 | 236.4 | 6.4 | (17.6 | ) | (11.2 | ) |
AA+
|
|||||||||||||||
ABS
|
33.1 | 29.0 | 4.1 | (6.0 | ) | (1.9 | ) |
AA-
|
|||||||||||||||
Total
HTM portfolio
|
$ | 1,740.2 | 1,710.4 | 29.8 | 9.9 | 39.7 |
AA+
|
||||||||||||||||
State
and Municipal Obligations:
|
|||||||||||||||||||||||
General
obligations
|
$ | 301.5 | 300.8 | 0.7 | 14.7 | 15.4 |
AA+
|
||||||||||||||||
Special
revenue obligations
|
909.3 | 900.6 | 8.7 | 19.2 | 27.9 |
AA
|
|||||||||||||||||
Total
state and municipal obligations
|
$ | 1,210.8 | 1,201.4 | 9.4 | 33.9 | 43.3 |
AA
|
||||||||||||||||
Corporate
Securities:
|
|||||||||||||||||||||||
Financial
|
$ | 35.4 | 31.8 | 3.6 | (4.0 | ) | (0.4 | ) |
A
|
||||||||||||||
Industrials
|
29.1 | 25.7 | 3.4 | (2.0 | ) | 1.4 |
A-
|
||||||||||||||||
Utilities
|
16.5 | 16.3 | 0.2 | (0.1 | ) | 0.1 |
A-
|
||||||||||||||||
Consumer
discretion
|
6.3 | 6.0 | 0.3 | - | 0.3 |
BBB+
|
|||||||||||||||||
Consumer
staples
|
14.6 | 13.9 | 0.7 | 0.5 | 1.2 |
AA-
|
|||||||||||||||||
Materials
|
2.1 | 1.9 | 0.2 | (0.1 | ) | 0.1 |
BBB-
|
||||||||||||||||
Energy
|
3.5 | 3.2 | 0.3 | (0.3 | ) | - |
BB+
|
||||||||||||||||
Total
corporate securities
|
$ | 107.5 | 98.8 | 8.7 | (6.0 | ) | 2.7 |
A-
|
|||||||||||||||
Mortgage-backed
Securities:
|
|||||||||||||||||||||||
Government
guaranteed agency CMBS
|
$ | 11.1 | 10.8 | 0.3 | - | 0.3 |
AAA
|
||||||||||||||||
Other
agency CMBS
|
3.8 | 3.8 | - | 0.1 | 0.1 |
AAA
|
|||||||||||||||||
Non-agency
CMBS
|
77.6 | 74.4 | 3.2 | (18.9 | ) | (15.7 | ) |
AA+
|
|||||||||||||||
Government
guaranteed agency RMBS
|
4.2 | 3.9 | 0.3 | (0.2 | ) | 0.1 |
AAA
|
||||||||||||||||
Other
agency RMBS
|
140.2 | 137.7 | 2.5 | 2.5 | 5.0 |
AAA
|
|||||||||||||||||
Non-agency
RMBS
|
5.9 | 5.8 | 0.1 | (1.1 | ) | (1.0 | ) |
AAA
|
|||||||||||||||
Total
mortgage-backed securities
|
$ | 242.8 | 236.4 | 6.4 | (17.6 | ) | (11.2 | ) |
AA+
|
||||||||||||||
ABS:
|
|||||||||||||||||||||||
ABS
|
$ | 30.2 | 27.0 | 3.2 | (5.1 | ) | (1.9 | ) |
AA
|
||||||||||||||
Alt-A
ABS
|
1.8 | 1.0 | 0.8 | (0.5 | ) | 0.3 |
CC
|
||||||||||||||||
Sub-prime
ABS2
|
1.1 | 1.0 | 0.1 | (0.4 | ) | (0.3 | ) |
A
|
|||||||||||||||
Total
ABS
|
$ | 33.1 | 29.0 | 4.1 | (6.0 | ) | (1.9 | ) |
AA-
|
1 2008 HTM
securities are not presented in this table, as their fair value was
approximately $1.2 million and therefore not material.
2 We define sub-prime exposure as
exposure to direct and indirect investments in non-agency residential mortgages
with average FICO® scores below 650.
A portion
of our AFS and HTM municipal bonds contain insurance
enhancements. The following table provides information regarding
these insurance-enhanced securities as of December 31, 2009:
Insurers of Municipal Bond Securities
|
Ratings
|
Ratings
|
||||||
with
|
without
|
|||||||
($ in thousands)
|
Fair Value
|
Insurance
|
Insurance
|
|||||
MBIA
Inc.
|
$ | 264,165 |
AA-
|
A+
|
||||
Assured
Guaranty
|
221,100 |
AA+
|
AA
|
|||||
Financial
Guaranty Insurance Company
|
140,412 |
AA-
|
AA-
|
|||||
Ambac
Financial Group, Inc.
|
114,842 |
AA-
|
AA-
|
|||||
Other
|
8,125 |
AA+
|
A
|
|||||
Total
|
$ | 748,644 |
AA
|
AA-
|
To manage
and mitigate exposure, we perform analyses on mortgage-backed securities both at
the time of purchase and as part of the ongoing portfolio evaluation. This
analysis includes review of average FICO®
scores, loan-to-value ratios, geographic spread of the assets securing
the bond, delinquencies in payments for the underlying mortgages, gains/losses
on sales, evaluations of projected cash flows under various economic and default
scenarios, as well as other information that aids in determination of the health
of the underlying assets. We also consider overall credit environment, economic
conditions, total projected return on the investment, and overall asset
allocation of the portfolio in our decisions to purchase or sell structured
securities.
78
The
following table details the top 10 state exposures of the municipal bond portion
of our fixed maturity portfolio at December 31, 2009:
State
Exposures of Municipal Bonds
|
General
|
Special
|
Fair
|
Average Credit
|
||||||||||
($
in thousands)
|
Obligation
|
Revenue
|
Value
|
Quality
|
||||||||||
Texas
|
$ | 116,803 | 86,326 | 203,129 |
AA+
|
|||||||||
Washington
|
47,639 | 47,562 | 95,201 |
AA+
|
||||||||||
Florida
|
531 | 88,971 | 89,502 |
AA-
|
||||||||||
Arizona
|
6,802 | 73,605 | 80,407 |
AA+
|
||||||||||
New
York
|
- | 78,112 | 78,112 |
AA+
|
||||||||||
Illinois
|
21,151 | 43,898 | 65,049 |
AA+
|
||||||||||
Ohio
|
21,495 | 39,318 | 60,813 |
AA+
|
||||||||||
Colorado
|
34,668 | 22,595 | 57,263 |
AA
|
||||||||||
Minnesota
|
41,131 | 15,707 | 56,838 |
AA+
|
||||||||||
Other
|
209,696 | 528,732 | 738,428 |
AA+
|
||||||||||
$ | 499,916 | 1,024,826 | 1,524,742 |
AA+
|
||||||||||
Advanced
refunded/escrowed to maturity bonds
|
24,236 | 41,617 | 65,853 |
AA+
|
||||||||||
Total
|
524,152 | 1,066,443 | $ | 1,590,595 |
AA+
|
While the
nature of special revenue fixed income securities of municipalities (referred to
as “special revenue bonds”) generally do not have the “full faith and credit”
backing of the municipal or state governments as do general obligation bonds,
special revenue bonds have a dedicated revenue stream for repayment which can,
in many instances, provide a higher quality credit profile than general
obligation bonds. As such, we believe our special revenue bond
portfolio is appropriate for the current environment. The following
table provides further quantitative details on our special revenue
bonds:
December 31, 2009
($ in thousands)
|
Market
Value
|
% of Special
Revenue
Bonds
|
Average
Rating
|
||||||||
Essential
Services:
|
|||||||||||
Transportation
|
$ | 210,931 | 21 | % |
AA
|
||||||
Water
and Sewer
|
188,944 | 18 | % |
AA+
|
|||||||
Electric
|
113,707 | 11 | % |
AA
|
|||||||
Total
Essential Services
|
513,582 | 50 | % |
AA+
|
|||||||
Education
|
151,690 | 15 | % |
AA+
|
|||||||
Special
Tax
|
127,798 | 12 | % |
AA
|
|||||||
Housing
|
119,157 | 12 | % |
AA+
|
|||||||
Other:
|
|||||||||||
Leasing
|
45,273 | 4 | % |
AA
|
|||||||
Hospital
|
20,847 | 2 | % |
AA-
|
|||||||
Other
|
46,479 | 5 | % |
AA-
|
|||||||
Total
Other
|
112,599 | 11 | % |
AA-
|
|||||||
Total
Special Revenue Bonds
|
$ | 1,024,826 | 100 | % |
AA+
|
Essential
Services
A large
portion of our special revenue bond portfolio is, by design, invested in sectors
that are conventionally deemed as “essential services” and thus are not
considered cyclical in nature. The essential services category (as reflected in
the above table) is comprised of transportation, water and sewer, and
electric.
Education
The
education portion of the portfolio includes higher education as well as
state-wide university systems – both of which are not cyclical in nature.
Special
Tax
This
group includes special revenue bonds with a wide range of attributes. However,
similar to other revenue bonds, these are backed by a dedicated lien on a tax or
other revenue repayment source.
Housing
Despite
the turmoil in the housing sector, these bonds continue to be highly rated, much
of it with the support of U.S. Housing Agencies. The need for affordable housing
continues to grow, especially in light of current delinquencies and defaults,
and as such, political support for these programs remains high. These
attributes, when combined, tend to mute this sector’s cyclicality.
79
Based on
the above attributes, we remain confident in the collectability of our special
revenue bond portfolio and have not acquired any bond insurance in the secondary
market covering any of our special revenue bonds.
We
continue to evaluate underlying credit quality within this portfolio and believe
that current fair value fluctuations are reflective of temporary market
dislocation. As long-term, income-oriented investors, we remain
comfortable with the credit risk in these securities.
Equity
Price Risk
Our
equity securities are classified as available for sale. Our equity
securities portfolio is exposed to equity price risk arising from potential
volatility in equity market prices. We attempt to minimize the
exposure to equity price risk by maintaining a diversified portfolio and
limiting concentrations in any one company or industry. The following
table presents the hypothetical increases and decreases in 10% increments in
market value of the equity portfolio as of December 31, 2009:
Change
in Equity Values in Percent
|
||||||||||||||||||||||||||||
($
in millions)
|
-30%
|
-20%
|
-10%
|
0%
|
10%
|
20%
|
30%
|
|||||||||||||||||||||
Fair
value of AFS equity portfolio
|
56,185 | 64,211 | 72,238 | 80,264 | 88,290 | 96,317 | 104,343 | |||||||||||||||||||||
Fair
value change
|
(24,079 | ) | (16,053 | ) | (8,026 | ) | - | 8,026 | 16,053 | 24,079 |
In
addition to our equity securities, we invest in certain other investments that
are also subject to price risk. Our other investments include
alternative investments in private limited partnerships that invest in various
strategies such as private equity, mezzanine debt, distressed debt, and real
estate. As of December 31, 2009, these types of investments
represented 4% of our total invested assets and 14% of our stockholders’
equity. These investments are subject to the risks arising from the
fact that the determination of their value is inherently
subjective. The general partner of each of these partnerships usually
reports the change in the value of the interests in the partnership on a one
quarter lag because of the nature of the underlying assets or
liabilities. Since these partnerships' underlying investments consist
primarily of assets or liabilities for which there are no quoted prices in
active markets for the same or similar assets, the valuation of interests in
these partnerships are subject to a higher level of subjectivity and
unobservable inputs than substantially all of our other
investments. Each of these general partners are required to determine
fair value by the price obtainable for the sale of the interest at the time of
determination. Valuations based on unobservable inputs are subject to
greater scrutiny and reconsideration from one reporting period to the next and
therefore, the changes in the fair value of these investments may be subject to
significant fluctuations which could lead to significant decreases in their fair
value from one reporting period to the next. Since we record our
investments in these various partnerships under the equity method of accounting,
any decreases in the valuation of these investments would negatively impact our
results of operations.
For
additional information regarding these alternative investment strategies, see
Note 5, “Investments” in Item 8.”Financial Statements and Supplementary Data.”
of this Form 10-K.
Indebtedness
(a)
Long-Term Debt. As of December 31, 2009, the Parent had outstanding long-term
debt of $274.6 million that mature as shown on the following table:
2009
|
||||||||||
Year
of
|
Carrying
|
Fair
|
||||||||
($
in thousands)
|
Maturity
|
Amount
|
Value
|
|||||||
Financial
liabilities
|
||||||||||
Notes
payable
|
||||||||||
8.87%
Senior Notes Series B
|
2010
|
$ | 12,300 | $ | 12,300 | |||||
7.25%
Senior Notes
|
2034
|
49,900 | 49,505 | |||||||
6.70%
Senior Notes
|
2035
|
99,406 | 90,525 | |||||||
7.50%
Junior Subordinated Notes
|
2066
|
100,000 | 83,680 | |||||||
Borrowings
from FHLBI
|
2014
|
13,000 | 13,000 | |||||||
Total
notes payable
|
$ | 274,606 | $ | 249,010 |
The
weighted average effective interest rate for the Parent's outstanding long-term
debt is 7.01%. The Parent is not exposed to material changes in interest rates
because the interest rates are fixed on its long-term indebtedness.
(b)
Short-Term Debt. During the third quarter of 2009, the Parent terminated its
previously existing line of credit and entered into a new syndicated line of
credit agreement on August 25, 2009. This new $30 million line of
credit is syndicated between Wachovia Bank N.A., a subsidiary of Wells Fargo
& Company, as administrative agent and Branch Banking and Trust Company and
allows us to increase our borrowings to $50 million with the approval of both
lending parties. We continue to monitor current news regarding the
banking industry in general, and our lending partners in particular, as,
according to the syndicated line of credit agreement, the obligations of the
lenders to make loans and to make payments are several and not
joint. The Parent did not access the facility during 2009 and, as
such, at December 31, 2009, no balances were outstanding.
80
Item
8. Financial Statements and Supplementary Data.
Report of Independent
Registered Public Accounting Firm
The Board
of Directors and Stockholders
Selective
Insurance Group, Inc.:
We have
audited the accompanying consolidated balance sheets of Selective Insurance
Group, Inc. and its subsidiaries as of December 31, 2009 and 2008, and the
related consolidated statements of income, stockholders' equity, and cash flows
for each of the years in the three-year period ended December 31, 2009. In
connection with our audits of the consolidated financial statements, we also
have audited financial statement schedules I to V. These consolidated
financial statements and financial statement schedules are the responsibility of
the Company's management. Our responsibility is to express an opinion
on these consolidated financial statements and financial statement schedules
based on our audits.
We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatements. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Selective Insurance Group,
Inc. and its subsidiaries as of December 31, 2009 and 2008, and the results of
their operations and their cash flows for each of the years in the three-year
period ended December 31, 2009, in conformity with U.S. generally accepted
accounting principles. Also in our opinion, the related financial
statement schedules, when considered in relation to the basic consolidated
financial statements taken as a whole, present fairly, in all material respects,
the information set forth therein.
As
discussed in Note 3 and Note 5. to the consolidated financial statements, the
Company changed its method of evaluating other-than-temporary impairments of
fixed maturity securities due to the adoption of new accounting requirements
issued by the Financial Accounting Standards Board as of April 1,
2009.
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the
effectiveness of Selective Insurance Group, Inc.'s internal control over
financial reporting as of December 31, 2009, based on criteria established in
Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO), and our report dated February 24, 2010 expressed an
unqualified opinion on the effectiveness of the Company's internal control over
financial reporting.
/s/ KPMG
LLP
New York,
New York
February
24, 2010
81
Consolidated
Balance Sheets
|
||||||||
December
31,
|
||||||||
($
in thousands, except share amounts)
|
2009
|
2008
|
||||||
ASSETS
|
||||||||
Investments:
|
||||||||
Fixed
maturity securities, held-to-maturity – at carry value
|
||||||||
(fair
value: $1,740,211 – 2009; $1,178 – 2008)
|
$ | 1,710,403 | 1,163 | |||||
Fixed
maturity securities, available-for-sale – at fair value
|
||||||||
(amortized
cost: $1,616,456 – 2009; $3,123,346 – 2008)
|
1,635,869 | 3,034,278 | ||||||
Equity
securities, available-for-sale – at fair value
|
||||||||
(cost
of: $64,390 – 2009; $125,947 – 2008)
|
80,264 | 132,131 | ||||||
Short-term
investments (at cost which approximates fair value)
|
213,848 | 198,111 | ||||||
Equity
securities, trading – at fair value
|
- | 2,569 | ||||||
Other
investments
|
140,667 | 172,057 | ||||||
Total
investments (Note 5)
|
3,781,051 | 3,540,309 | ||||||
Cash
|
811 | 3,606 | ||||||
Interest
and dividends due or accrued
|
34,651 | 36,538 | ||||||
Premiums
receivable, net of allowance for uncollectible
|
||||||||
accounts
of: $5,880 – 2009; $4,237 – 2008
|
446,577 | 480,894 | ||||||
Reinsurance
recoverable on paid losses and loss expenses
|
4,408 | 6,513 | ||||||
Reinsurance
recoverable on unpaid losses and loss expenses (Note 8)
|
271,610 | 224,192 | ||||||
Prepaid
reinsurance premiums (Note 8)
|
105,522 | 96,617 | ||||||
Current
federal income tax (Note 15)
|
17,662 | 26,593 | ||||||
Deferred
federal income tax (Note 15)
|
111,038 | 150,759 | ||||||
Property
and Equipment – at cost, net of accumulated
|
||||||||
depreciation
and amortization of: $141,251 – 2009; $129,333 –
2008
|
46,287 | 51,580 | ||||||
Deferred
policy acquisition costs (Note 2j)
|
218,601 | 212,319 | ||||||
Goodwill
(Note 2k, 12)
|
7,849 | 7,849 | ||||||
Assets
of discontinued operations (Note 13)
|
- | 56,468 | ||||||
Other
assets
|
68,760 | 51,319 | ||||||
Total
assets
|
$ | 5,114,827 | 4,945,556 | |||||
LIABILITIES
AND STOCKHOLDERS’ EQUITY
|
||||||||
Liabilities:
|
||||||||
Reserve
for losses (Note 9)
|
$ | 2,342,919 | 2,256,329 | |||||
Reserve
for loss expenses (Note 9)
|
402,880 | 384,644 | ||||||
Unearned
premiums
|
844,847 | 844,334 | ||||||
Notes
payable (Note 10)
|
274,606 | 273,878 | ||||||
Commissions
payable
|
49,237 | 48,560 | ||||||
Accrued
salaries and benefits
|
103,802 | 118,422 | ||||||
Liabilities
of discontinued operations (Note 13)
|
- | 34,138 | ||||||
Other
liabilities
|
94,161 | 94,758 | ||||||
Total
liabilities
|
$ | 4,112,452 | 4,055,063 | |||||
Stockholders’
Equity:
|
||||||||
Preferred
stock of $0 par value per share:
|
||||||||
Authorized
shares 5,000,000; no shares issue or outstanding
|
$ | - | - | |||||
Common
stock of $2 par value per share
|
||||||||
Authorized
shares: 360,000,000 (Note 11)
|
||||||||
Issued: 95,822,959
– 2009; 95,263,508 – 2008
|
191,646 | 190,527 | ||||||
Additional
paid-in capital
|
231,933 | 217,195 | ||||||
Retained
earnings
|
1,138,978 | 1,128,149 | ||||||
Accumulated
other comprehensive loss (Note 6)
|
(12,460 | ) | (100,666 | ) | ||||
Treasury
stock – at cost (shares: 42,578,779 – 2009; 42,386,921 –
2008)
|
(547,722 | ) | (544,712 | ) | ||||
Total
stockholders’ equity (Note 11)
|
1,002,375 | 890,493 | ||||||
Commitments
and contingencies (Notes 19 and 20)
|
||||||||
Total
liabilities and stockholders’ equity
|
$ | 5,114,827 | 4,945,556 |
See
accompanying notes to consolidated financial statements.
82
Consolidated
Statements of Income
|
||||||||||||
December
31,
|
||||||||||||
($
in thousands, except share amounts)
|
2009
|
2008
|
2007
|
|||||||||
Revenues:
|
||||||||||||
Net
premiums written
|
$ | 1,422,655 | 1,492,738 | 1,562,450 | ||||||||
Net
decrease (increase) in unearned premiums and prepaid reinsurance
premiums
|
8,392 | 11,449 | (37,561 | ) | ||||||||
Net
premiums earned
|
1,431,047 | 1,504,187 | 1,524,889 | |||||||||
Net
investment income earned
|
118,471 | 131,032 | 174,144 | |||||||||
Net
realized (losses) gains:
|
||||||||||||
Net
realized investment gains
|
9,446 | 3,648 | 38,244 | |||||||||
Other-than-temporary
impairments
|
(64,184 | ) | (53,100 | ) | (4,890 | ) | ||||||
Other-than-temporary
impairments on fixed maturity securities recognized in other comprehensive
income
|
8,768 | - | - | |||||||||
Total
net realized (losses) gains
|
(45,970 | ) | (49,452 | ) | 33,354 | |||||||
Other
income
|
10,470 | 4,172 | 6,928 | |||||||||
Total
revenues
|
1,514,018 | 1,589,939 | 1,739,315 | |||||||||
Expenses:
|
||||||||||||
Losses
incurred
|
798,363 | 845,656 | 829,524 | |||||||||
Loss
expenses incurred
|
173,542 | 165,888 | 168,288 | |||||||||
Policy
acquisition costs
|
457,424 | 485,702 | 491,235 | |||||||||
Dividends
to policyholders
|
3,640 | 5,211 | 7,202 | |||||||||
Interest
expense
|
19,386 | 20,508 | 23,795 | |||||||||
Other
expenses
|
22,477 | 26,807 | 30,507 | |||||||||
Total
expenses
|
1,474,832 | 1,549,772 | 1,550,551 | |||||||||
Income
from continuing operations, before federal income tax
|
39,186 | 40,167 | 188,764 | |||||||||
Federal
income tax (benefit) expense:
|
||||||||||||
Current
|
3,585 | 21,995 | 42,557 | |||||||||
Deferred
|
(9,057 | ) | (25,929 | ) | 2,571 | |||||||
Total
federal income tax (benefit) expense
|
(5,472 | ) | (3,934 | ) | 45,128 | |||||||
Net
income from continuing operations
|
44,658 | 44,101 | 143,636 | |||||||||
(Loss)
income from discontinued operations, net of tax of $(4,042) –
2009;
|
||||||||||||
$(438)
– 2008; $1,132 – 2007
|
(7,086 | ) | (343 | ) | 2,862 | |||||||
Loss
on disposal of discontinued operations, net of tax of $(631) –
2009
|
(1,174 | ) | - | - | ||||||||
Total
discontinued operations, net of tax
|
(8,260 | ) | (343 | ) | 2,862 | |||||||
Net
income
|
36,398 | 43,758 | 146,498 | |||||||||
Earnings
per share:
|
||||||||||||
Basic
net income from continuing operations
|
0.84 | 0.85 | 2.75 | |||||||||
Basic
net (loss) income from discontinued operations
|
(0.15 | ) | (0.01 | ) | 0.05 | |||||||
Basic
net income
|
$ | 0.69 | 0.84 | 2.80 | ||||||||
Diluted
net income from continuing operations
|
$ | 0.83 | 0.83 | 2.54 | ||||||||
Diluted
net (loss) income from discontinued operations
|
(0.15 | ) | (0.01 | ) | 0.05 | |||||||
Diluted
net income
|
0.68 | 0.82 | 2.59 | |||||||||
Dividends
to stockholders
|
$ | 0.52 | 0.52 | 0.49 |
See
accompanying notes to consolidated financial statements.
83
Consolidated
Statements of Stockholders’ Equity
|
||||||||||||||||||||||||
December
31,
|
||||||||||||||||||||||||
($
in thousands, except share amounts)
|
2009
|
2008
|
2007
|
|||||||||||||||||||||
Common
stock:
|
||||||||||||||||||||||||
Beginning
of year
|
$ | 190,527 | 189,306 | 183,124 | ||||||||||||||||||||
Dividend
reinvestment plan
|
||||||||||||||||||||||||
(shares: 123,880
– 2009; 81,200 – 2008;
|
||||||||||||||||||||||||
78,762
– 2007)
|
248 | 162 | 158 | |||||||||||||||||||||
Convertible
debentures
|
||||||||||||||||||||||||
(shares: 45,759
– 2008; 2,074,067 – 2007)
|
- | 92 | 4,148 | |||||||||||||||||||||
Stock
purchase and compensation plans
|
||||||||||||||||||||||||
(shares: 435,571
– 2009; 483,619 – 2008;
|
||||||||||||||||||||||||
937,835
–2007)
|
871 | 967 | 1,876 | |||||||||||||||||||||
End
of year
|
191,646 | 190,527 | 189,306 | |||||||||||||||||||||
Additional
paid-in capital:
|
||||||||||||||||||||||||
Beginning
of year
|
217,195 | 192,627 | 153,246 | |||||||||||||||||||||
Dividend
reinvestment plan
|
1,514 | 1,677 | 1,708 | |||||||||||||||||||||
Convertible
debentures
|
- | 645 | 9,806 | |||||||||||||||||||||
Stock
purchase and compensation plans
|
13,224 | 22,246 | 27,867 | |||||||||||||||||||||
End
of year
|
231,933 | 217,195 | 192,627 | |||||||||||||||||||||
Retained
earnings:
|
||||||||||||||||||||||||
Beginning
of year
|
1,128,149 | 1,105,946 | 986,017 | |||||||||||||||||||||
Cumulative-effect
adjustment due to fair value election
|
||||||||||||||||||||||||
under
ASC 825, net of deferred income tax effect of $3,344
|
- | 6,210 | - | |||||||||||||||||||||
Cumulative-effect
adjustment due to adoption of other-
|
||||||||||||||||||||||||
than-temporary
impairment guidance under ASC 320,
|
||||||||||||||||||||||||
net
of deferred income tax effect of $1,282
|
2,380 | - | - | |||||||||||||||||||||
Net
income
|
36,398 | 36,398 | 43,758 | 43,758 | 146,498 | 146,498 | ||||||||||||||||||
Cash
dividends to stockholders ($0.52 per share – 2009;
|
||||||||||||||||||||||||
$0.52
per share – 2008; and $0.49 per share – 2007)
|
(27,949 | ) | (27,765 | ) | (26,569 | ) | ||||||||||||||||||
End
of year
|
1,138,978 | 1,128,149 | 1,105,946 | |||||||||||||||||||||
Accumulated
other comprehensive (loss) income:
|
||||||||||||||||||||||||
Beginning
of year
|
(100,666 | ) | 86,043 | 100,601 | ||||||||||||||||||||
Cumulative-effect
adjustment due to fair value election
|
||||||||||||||||||||||||
under
ASC 825, net of deferred income tax effect of
|
||||||||||||||||||||||||
$(3,344)
|
- | (6,210 | ) | - | ||||||||||||||||||||
Cumulative-effect
adjustment due to adoption of other-
|
||||||||||||||||||||||||
than-temporary
impairment guidance under ASC 320,
|
||||||||||||||||||||||||
net
of deferred income tax effect of $(1,282)
|
(2,380 | ) | - | - | ||||||||||||||||||||
Other
comprehensive income (loss), increase (decrease) in:
|
||||||||||||||||||||||||
Unrealized
(losses) gains on investment securities:
|
||||||||||||||||||||||||
Non-credit
portion of other-than-temporary
|
||||||||||||||||||||||||
impairment
losses recognized in other
|
||||||||||||||||||||||||
comprehensive
income, net of deferred income tax
|
||||||||||||||||||||||||
effect
of $(3,030)
|
(5,629 | ) | - | - | ||||||||||||||||||||
Other
net unrealized gains (losses) on investment
|
||||||||||||||||||||||||
securities,
net of deferred income tax effect of
|
||||||||||||||||||||||||
$49,637
– 2009; $(76,831) – 2008;
|
||||||||||||||||||||||||
and
$(10,925) – 2007
|
92,183 | (142,685 | ) | (20,289 | ) | |||||||||||||||||||
Total
unrealized gains (losses) on investment
|
||||||||||||||||||||||||
securities
|
86,554 | 86,554 | (142,685 | ) | (142,685 | ) | (20,289 | ) | (20,289 | ) | ||||||||||||||
Defined
benefit pension plans, net of deferred income
|
||||||||||||||||||||||||
tax effect
of: $2,171 – 2009; $(20,362) – 2008;
|
||||||||||||||||||||||||
$3,086
– 2007
|
4,032 | 4,032 | (37,814 | ) | (37,814 | ) | 5,731 | 5,731 | ||||||||||||||||
End
of year
|
(12,460 | ) | (100,666 | ) | 86,043 | |||||||||||||||||||
Comprehensive
income (loss)
|
126,984 | (136,741 | ) | 131,940 | ||||||||||||||||||||
Treasury
stock:
|
||||||||||||||||||||||||
Beginning
of year
|
(544,712 | ) | (497,879 | ) | (345,761 | ) | ||||||||||||||||||
Acquisition
of treasury stock
|
||||||||||||||||||||||||
(shares: 191,858
– 2009; 2,039,027 – 2008;
|
||||||||||||||||||||||||
6,057,920
– 2007)
|
(3,010 | ) | (46,833 | ) | (152,118 | ) | ||||||||||||||||||
End
of year
|
(547,722 | ) | (544,712 | ) | (497,879 | ) | ||||||||||||||||||
Total
stockholders’ equity
|
$ | 1,002,375 | 890,493 | 1,076,043 |
The
Company 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.
See
accompanying notes to consolidated financial statements.
84
Consolidated
Statements of Cash Flows
|
||||||||||||
December
31,
|
||||||||||||
($
in thousands, except share amounts)
|
2009
|
2008
|
2007
|
|||||||||
Operating
Activities
|
||||||||||||
Net
Income
|
$ | 36,398 | 43,758 | 146,498 | ||||||||
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
||||||||||||
Depreciation
and amortization
|
28,593 | 28,552 | 29,139 | |||||||||
Loss
on disposal of discontinued operations
|
1,174 | - | - | |||||||||
Stock-based
compensation expense
|
11,036 | 17,215 | 20,992 | |||||||||
Undistributed
losses (income) of equity method investments
|
21,726 | 13,753 | (4,281 | ) | ||||||||
Net
realized losses (gains)
|
45,970 | 49,452 | (33,354 | ) | ||||||||
Postretirement
life curtailment benefit
|
(4,217 | ) | - | - | ||||||||
Deferred
tax (benefit) expense
|
(9,057 | ) | (26,665 | ) | 3,214 | |||||||
Unrealized
(gain) loss on trading securities
|
(262 | ) | 8,129 | - | ||||||||
Goodwill
impairment on discontinued operations
|
12,214 | 4,000 | - | |||||||||
Changes
in assets and liabilities:
|
||||||||||||
Increase
in reserves for losses and loss expenses, net of reinsurance
recoverable
|
||||||||||||
on
unpaid losses and loss expenses
|
58,514 | 102,100 | 227,749 | |||||||||
(Decrease)
increase in unearned premiums, net of prepaid reinsurance and advance
premiums
|
(8,028 | ) | (10,766 | ) | 38,346 | |||||||
Decrease
(increase) in net federal income tax recoverable
|
5,339 | (22,092 | ) | (3,767 | ) | |||||||
Decrease
(increase) in premiums receivable
|
34,317 | 15,469 | (37,911 | ) | ||||||||
(Increase)
decrease in deferred policy acquisition costs
|
(6,282 | ) | 14,115 | (8,331 | ) | |||||||
Decrease
(increase) in interest and dividends due or accrued
|
1,918 | (431 | ) | (1,331 | ) | |||||||
Decrease
(increase) in reinsurance recoverable on paid losses and loss
expenses
|
2,105 | 916 | (2,736 | ) | ||||||||
Decrease
in accrued salaries and benefits
|
(15,020 | ) | (3,100 | ) | (3,266 | ) | ||||||
Increase
(decrease) in accrued insurance expenses
|
2,240 | (15,880 | ) | 6,370 | ||||||||
Purchase
of trading securities
|
- | (6,587 | ) | - | ||||||||
Sale
of trading securities
|
2,831 | 21,002 | - | |||||||||
Other-net
|
6,050 | 8,233 | 8,957 | |||||||||
Net
adjustments
|
191,161 | 197,415 | 239,790 | |||||||||
Net
cash provided by operating activities
|
227,559 | 241,173 | 386,288 | |||||||||
Investing
Activities
|
||||||||||||
Purchase
of fixed maturity securities, held-to-maturity
|
(158,827 | ) | - | - | ||||||||
Purchase
of fixed maturity securities, available-for-sale
|
(1,041,277 | ) | (587,430 | ) | (580,864 | ) | ||||||
Purchase
of equity securities, available-for-sale
|
(79,455 | ) | (70,651 | ) | (148,569 | ) | ||||||
Purchase
of other investments
|
(16,298 | ) | (53,089 | ) | (80,147 | ) | ||||||
Purchase
of short-term investments
|
(1,956,164 | ) | (2,204,107 | ) | (2,198,362 | ) | ||||||
Sale
of subsidiary
|
(12,538 | ) | - | - | ||||||||
Sale
of fixed maturity securities, held-to-maturity
|
5,820 | - | - | |||||||||
Sale
of fixed maturity securities, available-for-sale
|
538,769 | 152,655 | 102,613 | |||||||||
Sale
of short-term investments
|
1,940,427 | 2,196,162 | 2,205,194 | |||||||||
Redemption
and maturities of fixed maturity securities,
held-to-maturity
|
282,310 | 4,652 | 4,051 | |||||||||
Redemption
and maturities of fixed maturity securities,
available-for-sale
|
122,403 | 294,342 | 319,118 | |||||||||
Sale
of equity securities, available-for-sale
|
137,244 | 102,313 | 187,259 | |||||||||
Proceeds
from other investments
|
25,596 | 26,164 | 40,115 | |||||||||
Purchase
of property and equipment
|
(8,207 | ) | (8,083 | ) | (14,511 | ) | ||||||
Net
cash used in investment activities
|
(220,197 | ) | (147,072 | ) | (164,103 | ) | ||||||
Financing
Activities
|
||||||||||||
Dividends
to stockholders
|
(26,296 | ) | (25,804 | ) | (24,464 | ) | ||||||
Acquisition
of treasury stock
|
(3,010 | ) | (46,833 | ) | (152,118 | ) | ||||||
Principal
payment of notes payable
|
(12,300 | ) | (12,300 | ) | (18,300 | ) | ||||||
Proceeds
from borrowings
|
13,000 | - | - | |||||||||
Net
proceeds from stock purchase and compensation plans
|
4,612 | 8,222 | 8,609 | |||||||||
Excess
tax benefits from share-based payment arrangements
|
(1,200 | ) | 1,628 | 3,484 | ||||||||
Borrowings
under line of credit agreement
|
- | - | 6,000 | |||||||||
Repayment
of borrowings under line of credit agreement
|
- | - | (6,000 | ) | ||||||||
Principal
payments of convertible bonds
|
- | (8,754 | ) | (37,456 | ) | |||||||
Net
cash used in financing activities
|
(25,194 | ) | (83,841 | ) | (220,245 | ) | ||||||
Net
(decrease) increase in cash and cash equivalents
|
(17,832 | ) | 10,260 | 1,940 | ||||||||
Net
(decrease) increase in cash and cash equivalents from discontinued
operations
|
(15,037 | ) | 8,619 | 921 | ||||||||
Net
(decrease) increase in cash from continuing operations
|
(2,795 | ) | 1,641 | 1,019 | ||||||||
Cash
from continuing operations, beginning of year
|
3,606 | 1,965 | 946 | |||||||||
Cash
from continuing operations, end of year
|
$ | 811 | 3,606 | 1,965 |
See
accompanying notes to consolidated financial statements.
85
Notes
to Consolidated Financial Statements
December
31, 2009, 2008, and 2007
Note 1.
Organization
Selective
Insurance Group, Inc., through its subsidiaries, (collectively referred to as
“we,” “us,” or “our”) offers 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 primarily in 22 states in the Eastern and Midwestern U.S.;
and
|
|
·
|
Investments
|
These
segments reflect a change from our historical segments of: Insurance
Operations, Investments, and Diversified Insurance Services (which included
federal flood insurance administrative services (“Flood”) and human resource
administration outsourcing (“HR Outsourcing”)):
|
·
|
In
the process of periodically reviewing our operating segments, we
reclassified our Flood operations in the first quarter of 2009 to be
included within our Insurance Operations segment, reflecting the way we
are now managing this business. We believe this change better
enables investors to view us the way our management views our
operations.
|
|
·
|
During
the fourth quarter of 2009 we disposed of Selective HR Solutions, Inc.
(“Selective HR”), which comprised our HR Outsourcing segment, causing the
elimination of this operating segment. See Note 13.
“Discontinued Operations” for additional
information.
|
Our
revised segments are reflected throughout this report for all periods
presented.
Note 2. Summary of
Significant Accounting Policies
(a)
Principles of Consolidation
The
accompanying consolidated financial statements ("Financial Statements") include
the accounts we have 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"). All significant
intercompany accounts and transactions are eliminated in
consolidation.
(b) Use
of Estimates
The
preparation of our Financial Statements in conformity with GAAP requires
management to make estimates and assumptions that affect the reported financial
statement balances, as well as the disclosure of contingent assets and
liabilities. Actual results could differ from those
estimates.
(c)
Reclassifications
Certain
amounts in our prior years' consolidated financial statements and related notes
have been reclassified to conform to the 2009 presentation. Such
reclassifications had no effect on our net income, stockholders' equity, or cash
flows.
86
(d)
Investments
Fixed
maturity securities may include bonds, redeemable preferred stocks, and mortgage
and asset-backed securities. Fixed maturity securities classified as
available-for-sale are reported at fair value. Those fixed maturity
securities that we have the ability and positive intent to hold to maturity are
classified as held-to-maturity (“HTM”) and are carried at either: (i)
amortized cost; or (ii) market value at date of transfer into the HTM category,
adjusted for subsequent amortization. The amortized cost of fixed
maturity securities is adjusted for amortization of premiums and accretion of
discounts over the expected life of the security using the effective interest
method. Premiums and discounts arising from the purchase of
mortgage-backed securities are amortized over the expected life of the security
based on future principal payments, and considering
prepayments. These prepayments are estimated based upon historical
and projected cash flows. Prepayment assumptions are reviewed
quarterly and adjusted to reflect actual prepayments and changes in
expectations. Future amortization of any premium and/or discount is
also adjusted to reflect the revised assumptions. Interest income, as
well as amortization and accretion, is included in "Net investment income
earned" on our Consolidated Statements of Income. The carrying value
of fixed maturity securities is written down to fair value when a decline in
value is considered to be other than temporary. See the discussion
below on realized investment gains and losses for a description of the
accounting for impairments. Unrealized gains and losses on fixed
maturities classified as available-for-sale, net of tax are included in
accumulated other comprehensive income (loss) ("AOCI").
Equity
securities, which are classified as available-for-sale, may include common
stocks and non-redeemable preferred stocks and are carried at fair
value. Dividend income on these securities is included in "Net
investment income earned." The associated unrealized gains and
losses, net of tax are included in AOCI. The cost of equity
securities is written down to fair value when a decline in value is considered
to be other than temporary. See the discussion below on realized
investment gains and losses for a description of the accounting for
impairments. Certain equity securities managed by an external
portfolio manager that were disposed of in 2009, were classified as trading
securities. Trading securities are recorded at fair value with
subsequent changes in fair value recognized in net investment
income.
Short-term
investments may include certain money market instruments, savings accounts,
commercial paper, other debt issues purchased with a maturity of less than one
year, and variable rate demand notes. These investments are carried
at cost, which approximates fair value. The associated income is
included in "Net investment income earned."
Other
investments may include alternative investments and other miscellaneous
securities. Alternative investments are accounted for using the
equity method. Our share of distributed and undistributed net income
from alternative investments is included in "Net investment income
earned." Investments in other miscellaneous securities are generally
carried at estimated fair value, because our interests are so minor that we
exercise virtually no influence over operating and financial policies of the
investees. Our distributed share of net income from other
miscellaneous investments is included in "Net investment income
earned." Any changes in estimated fair value associated with these
other miscellaneous investments are recorded as an unrealized gain or loss, of
which these items, net of tax, are included in AOCI.
Realized
gains and losses on the sale of investments are determined on the basis of the
cost of the specific investments sold and are credited or charged to
income. Also included in realized gains and losses are the
other-than-temporary impairment ("OTTI") charges recognized in earnings, which
are discussed below.
When the
fair value of any investment is lower than its cost/amortized cost, an
assessment is made to determine if the decline is other than
temporary. We regularly review our entire investment portfolio for
declines in fair value. If we believe that a decline in the value of
an available-for-sale (“AFS”) security is temporary, we record the decline as an
unrealized loss in AOCI. Temporary declines in the value of a HTM
security are not recognized in the financial statements. Our
assessment of a decline in fair value includes judgment as to the financial
position and future prospects of the entity that issued the investment security,
as well as a review of the security’s underlying collateral. Broad
changes in the overall market or interest rate environment generally will not
lead to a write-down.
87
Fixed
Maturity Securities and Short-Term Investments
Our
evaluation for OTTI of a fixed maturity security or a short-term investment
includes, but is not limited to, the evaluation of the following
factors:
·
|
Whether
the decline appears to be issuer or industry
specific;
|
·
|
The
degree to which the issuer is current or in arrears in making principal
and interest payments on the fixed maturity
security;
|
·
|
The
issuer’s current financial condition and ability to make future scheduled
principal and interest payments on a timely
basis;
|
·
|
Evaluations
of projected cash flows under various economic and default
scenarios;
|
·
|
Buy/hold/sell
recommendations published by outside investment advisors and analysts;
and
|
·
|
Relevant
rating history, analysis and guidance provided by rating agencies and
analysts.
|
Prior to
April 1, 2009, when the decline in fair value below amortized cost of a fixed
maturity security was deemed to be other than temporary, the investment was
written down to fair value and the amount of the write-down was charged to
income as a realized loss. A decline in fair value on a fixed
maturity security was deemed to be other than temporary if we did not have the
intent and ability to hold the security to its anticipated
recovery. Effective April 1, 2009 with the adoption of revised OTTI
accounting guidance, see Note 3., unless we have the intent to sell, or it is
more likely than not that we may be required to sell, a fixed maturity security,
an other-than-temporary impairment is only recognized as a realized loss to the
extent it is credit related. If there is a decline in fair value
below amortized cost on a fixed maturity security that we intend to sell or,
more-likely-than-not, may be required to sell, the impairment is considered
other than temporary, and the security is written down to fair value with the
amount of the write-down charged to earnings as a component of realized
losses.
In order
to determine if an impairment is other than temporary, we perform impairment
assessments for our fixed maturity portfolio including, but not limited to
commercial mortgage-backed securities (“CMBS”), residential mortgage-backed
securities (“RMBS”), asset-backed securities (“ABS”), collateralized debt
obligations (“CDOs”), and corporate debt securities. This assessment
takes into consideration the length of time for which the security has been in
an unrealized loss position, but primarily focuses on an evaluation of future
cash flows, which involve subjective judgments and estimates determined by
management including: performance of the underlying collateral under
various economic and default scenarios, the nature and realizable value of such
collateral, and the ability of the security to make scheduled
payments.
For
structured securities, including CMBS, RMBS, ABS, and CDOs, we project the
future cash flows using various expected default, severity, and prepayment
assumptions based on security type and vintage, taking into consideration
information from credit agencies, historical performance, and other relevant
economic and performance factors.
Based on
these projections, we determine expected recovery values to be generated by the
collateral for each security. Prior to April 1, 2009, if these
projections indicated an other-than-temporary impairment, the shortfall between
the amortized cost of the security and the fair value was charged to earnings as
a component of realized losses. Subsequent to April 1, 2009, if these
projections indicate an impairment, we perform a discounted cash flow analysis
to determine the present value of future cash flows to be generated by the
underlying collateral of the security. Additionally, we perform a
discounted cash flow analysis on all previously other-than-temporarily impaired
securities and all structured securities that are not of high-credit quality at
the date of purchase.
Any
shortfall in the expected present value of the future cash flows, based on the
discounted cash flow analysis, from the amortized cost basis of a security is
considered a “credit impairment,” with the remaining decline in fair value of a
security considered as a “non-credit impairment.” Credit impairments
are charged to earnings as a component of realized losses, while non-credit
impairments are recorded to OCI as a component of unrealized
losses.
Discounted Cash Flow
Assumptions
The
discount rate we use in this present value calculation is the effective interest
rate implicit in the security at the date of acquisition for those structured
securities that were not of high-credit quality at acquisition. For
all other securities, we use a discount rate that equals the current yield,
excluding the impact of previous OTTI charges, used to accrete the beneficial
interest.
88
We use a
conditional default rate assumption in the present value calculation to estimate
future defaults. The conditional default rate is the proportion of
all loans outstanding in a security at the beginning of a time period that is
expected to default during that period. Our assumption of this rate
takes into consideration the uncertainty of future defaults as well as whether
or not these securities have experienced significant cumulative losses or
delinquencies to date. We use the conditional default rates used
during our initial evaluation for each security as a reference point, but we may
ultimately use rates at more elevated levels in the discounted cash flow
analysis in order to determine our best estimate of the present value of future
cash flows.
Conditional
default rate assumptions apply at the total collateral pool level held in the
securitization trust. Generally, collateral conditional default rates
will “ramp-up” over time as the collateral seasons, the performance begins to
weaken and losses begin to surface. As time passes, depending on the
collateral type and vintage, losses will peak and performance will begin to
improve as weaker borrowers are removed from the pool through delinquency
resolutions. In the later years of a collateral pool’s life,
performance is generally materially better as the resulting favorable selection
of the portfolio improves the overall quality and performance. While
“ramped up” assumptions are sometimes used in our discounted cash flow analysis
of our CMBS portfolio, we typically apply a more conservative approach and do
not apply a “ramp” of our conditional default rate assumptions in our initial
evaluations. Instead, we assume the cash flows for the next period
will experience defaults at the higher end of the range and then remain at that
level for the life of the position, due to the current uncertainty surrounding
the magnitude of potential future defaults on CMBS.
We use a
loan loss severity assumption in our discounted cash flow analysis that is
applied at the loan level of the collateral pool. The loan loss
severity assumptions represent the estimated percentage loss on the
loan-to-value exposure for a particular security. If the current
loan-to-value ratio of a security is not available, we assume a 50% loan loss
severity. However, certain of the securities have lower current
loan-to-value ratios, which in our opinion results in a severity assumption of
50% being overly conservative. Where we have current loan-to-value
information and the loan-to-value ratio is lower than 80%, we adjust the
severity assumption to reflect the fact that the loan-to-value ratio is
lower.
For
purposes of our initial evaluations, the loan loss severity assumption is held
constant and is derived in either one of two ways:
|
(i)
|
Applying
an estimated loss on exposure percentage to the current loan-to-value
ratio of a particular security; or
|
|
(ii)
|
Using
an assumed 50% in those instances where current loan-to-value ratios were
not available at the time of our
assessment.
|
Equity
Securities
Evaluation
for OTTI of an equity security includes, but is not limited to, the evaluation
of the following factors:
|
·
|
Whether
the decline appears to be issuer or industry
specific;
|
|
·
|
The
relationship of market prices per share to book value per share at the
date of acquisition and date of
evaluation;
|
|
·
|
The
price-earnings ratio at the time of acquisition and date of
evaluation;
|
|
·
|
The
financial condition and near-term prospects of the issuer, including any
specific events that may influence the issuer's operations, coupled with
our intention to hold the securities in the
near-term;
|
|
·
|
The
recent income or loss of the
issuer;
|
|
·
|
The
independent auditors' report on the issuer's recent financial
statements;
|
|
·
|
The
dividend policy of the issuer at the date of acquisition and the date of
evaluation;
|
|
·
|
Buy/hold/sell
recommendations or price projections published by outside investment
advisors;
|
|
·
|
Rating
agency announcements;
|
|
·
|
The
length of time and the extent to which the fair value has been less than
its cost; and
|
|
·
|
Our
expectation of when the cost of the security will be
recovered.
|
If there
is a decline in fair value on an equity security that we do not intend to hold,
or if we determine the decline is other than temporary, we write down the cost
of the investment to its fair value and record the charge through earnings as a
component of realized losses.
89
Other
Investments
Our
evaluation for OTTI of an other investment (i.e., an alternative investment)
includes, but is not limited to, conversations with the management of the
alternative investment concerning the following:
|
·
|
The
current investment strategy;
|
|
·
|
Changes
made or future changes to be made to the investment
strategy;
|
|
·
|
Emerging
issues that may affect the success of the strategy;
and
|
|
·
|
The
appropriateness of the valuation methodology used regarding the underlying
investments.
|
If there
is a decline in fair value on an other investment that we do not intend to hold,
or if we determine the decline is other than temporary, we write down the cost
of the investment and record the charge through earnings as a component of
realized losses.
(e) Fair
Values of Financial Instruments
Assets
The fair
values of our investment portfolio are generated using various valuation
techniques and are placed into the fair value hierarchy considering the
following: (i) the highest priority is given to quoted prices in
active markets for identical assets (Level 1); (ii) the next highest priority is
given to quoted prices in markets that are not active or inputs that are
observable either directly or indirectly, including quoted prices for similar
assets in markets that are not active and other inputs that can be derived
principally from, or corroborated by, observable market data for substantially
the full term of the assets (Level 2); and (iii) the lowest priority is given to
unobservable inputs supported by little or no market activity and that reflect
our assumptions about the exit price, including assumptions that market
participants would use in pricing the asset (Level 3). An asset’s
classification within the fair value hierarchy is based on the lowest level of
significant input to its valuation.
The
techniques used to value our investment portfolio are as follows:
|
·
|
For
valuations of securities in our equity portfolio and U.S. Treasury notes
held in our fixed maturity portfolio, we utilize a market approach,
wherein we use quoted prices in an active market for identical
assets. The source of these prices is one primary external
pricing service, which we validate against a second external pricing
service. Significant variances between pricing from the two
pricing services are challenged with the respective pricing service, the
resolution of which determines the price utilized. These
securities are classified as Level 1 in the fair value
hierarchy.
|
|
·
|
For
the majority of our fixed maturity portfolio, approximately 98%, we also
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. We
utilize up to two pricing services in order to obtain prices on our fixed
maturity portfolio. As a matter of policy, we consistently use
one of the pricing services as our primary source and we use the second
pricing service in certain circumstances where prices were not available
from the primary pricing service. We validate the prices
utilized for reasonableness in one of two ways: (i) randomly
sampling the population and verifying the price to a separate third party
source; or (ii) analytically validating the entire portfolio against a
third pricing service. Historically, we have not experienced
significant variances in prices and therefore we have consistently used
either our primary or secondary pricing service. These prices
are typically Level 2 in the fair value
hierarchy.
|
For
approximately 1% of our fixed maturity portfolio, we are unable to obtain a
price from either our primary or secondary pricing service; therefore, we obtain
non-binding broker quotes for such securities. These quotes are
reviewed for reasonableness by internal investment professionals and are
generally classified as Level 2 in the fair value hierarchy as the brokers are
generally using market information to determine the quotes.
|
·
|
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 a week of the financial statement close. These
securities are Level 1 in the fair value
hierarchy.
|
|
·
|
Our
investments in other miscellaneous securities are generally accounted for
at fair value based on net asset value and included in Level 2 in the fair
value hierarchy. Investments in tax credits are carried under
the effective interest method of
accounting.
|
90
Liabilities
The
techniques used to value our notes payable are as follows:
|
·
|
The
fair values of the 1.6155% Senior Convertible Notes due September 24,
2032, the 7.25% Senior Notes due November 15, 2034, the 6.70% Senior Notes
due November 1, 2035, and the 7.5% Junior Subordinated Notes due September
27, 2066, are based on quoted market
prices.
|
|
·
|
The
fair value of the 8.87% Senior Notes due May 4, 2010 is estimated to be
its carrying value due to its maturity being approximately 120 days from
the balance sheet date.
|
|
·
|
The
fair value of our borrowing from the Federal Home Loan Bank of
Indianapolis (“FHLBI”) is estimated to be its carrying value due to the
close proximity to December 31, 2009 when the borrowing took
place.
|
See Note
7. “Fair Value Measurements” for a summary table of the fair value and related
carrying amounts of financial instruments.
(f)
Allowance for Doubtful Accounts
We
estimate an allowance for doubtful accounts on our premiums
receivable. This allowance is based on historical write-off
percentages adjusted for the effects of current and anticipated
trends.
(g)
Share-Based Compensation
Share-based
compensation consists of all share-based payment transactions in which an entity
acquires goods or services by issuing (or offering to issue) its shares, share
units, share options, or other equity instruments. The cost resulting
from all share-based payment transactions are recognized in the consolidated
financial statements, based on the fair value of both equity and liability
awards. The fair value is measured at grant date for equity awards,
whereas the fair value for liability awards are remeasured at each reporting
period. Both the fair value of equity and liability awards is
recognized over the requisite service period. The requisite service
period is typically the lesser of the vesting period or the period of time from
the grant date to the date of retirement eligibility. The expense
recognized for share-based awards, which, in some cases, contain performance
criteria, is based on the number of shares/units expected to be issued at the
end of the performance period.
(h)
Reinsurance
Reinsurance
recoverable on paid and unpaid losses and loss expenses represent estimates of
the portion of such liabilities that will be recovered from
reinsurers. Generally, amounts recoverable from reinsurers are
recognized as assets at the same time and in a manner consistent with the paid
and unpaid losses associated with the reinsured policies. An
allowance for estimated uncollectible reinsurance is recorded based on an
evaluation of balances due from reinsurers and other available
information.
(i)
Property and Equipment
Property
and equipment used in operations, including certain costs incurred to develop or
obtain computer software for internal use, are capitalized and carried at cost
less accumulated depreciation. Depreciation is calculated using the
straight-line method over the estimated useful lives of the assets, which range
up to 40 years.
(j) Deferred
Policy Acquisition Costs
Policy
acquisition costs directly related to the writing of insurance policies are
deferred and amortized over the life of the policies. These costs
include labor costs, commissions, premium taxes and assessments, boards, bureaus
and dues, travel, and other underwriting expenses incurred in the acquisition of
premium. The deferred policy acquisition costs are limited to the sum
of unearned premiums and anticipated investment income less anticipated losses
and loss expenses, policyholder dividends and other expenses for maintenance of
policies in force.
91
We
regularly conduct reviews for potential premium deficiencies at a level
consistent with that used for our segment reporting in that we group our
policies at the Insurance Operations level, considering the
following:
|
·
|
Our
marketing efforts for all of our product lines within our Insurance
Operations revolve around independent agencies and their touch points with
our shared customers, the
policyholders.
|
|
·
|
We
service our agency distribution channel through our field model, which
includes agency management specialists, loss control representatives,
claim management specialists and our Underwriting and Claims Service
Centers, all of which service the entire population of insurance contracts
acquired through each agency.
|
|
·
|
We
measure the profitability of our business at the Insurance Operations
level, which is evident in, among other items, the structure of our
incentive compensation programs. We measure the profitability
of our agents and calculate their compensation based on overall insurance
results and all of our employees, including senior management, are
incented based on overall insurance
results.
|
There
were no premium deficiencies for any of the reported years as the sum of the
anticipated losses and loss expenses, policyholder dividends, and other expenses
for our Insurance Operations segment did not exceed the related unearned premium
and anticipated investment income. The investment yields assumed in
the premium deficiency assessment for each reporting period, which are based
upon our actual average investment yield before tax as of the calculation date
on September 30, were 2.9% for 2009, 4.1% for 2008, and 4.6% for
2007. Deferred policy acquisition costs amortized to expense were
$428.6 million for 2009, $454.8 million for 2008, and $460.2 million for
2007.
(k)
Goodwill
Goodwill
results from business acquisitions where the cost of assets and liabilities
acquired exceeds the fair value of those assets and
liabilities. Goodwill is tested for impairment annually or more
frequently if events or changes in circumstances indicate that goodwill may be
impaired. Goodwill is allocated to the reporting units for the
purposes of the impairment test.
(l)
Reserves for Losses and Loss Expenses
Reserves
for losses and loss expenses are made up of both case reserves and reserves for
claims incurred but not yet reported ("IBNR"). Case reserves result
from claims that have been reported to our seven insurance subsidiaries (the
"Insurance Subsidiaries") and are estimated at the amount of ultimate
payment. IBNR reserves are established based on generally accepted
actuarial techniques. Such techniques assume that past experience,
adjusted for the effects of current developments and anticipated trends, are an
appropriate basis for predicting future events. In applying generally
accepted actuarial techniques, we also consider a range of possible loss and
loss adjustment expense reserves in establishing IBNR.
The
internal assumptions considered by us in the estimation of the IBNR amounts for
both environmental and non-environmental reserves at our reporting dates are
based on: (i) an analysis of both paid and incurred loss and loss
expense development trends; (ii) an analysis of both paid and incurred claim
count development trends; (iii) the exposure estimates for reported claims; (iv)
recent development on exposure estimates with respect to individual large claims
and the aggregate of all claims; (v) the rate at which new
environmental claims are being reported; and (vi) patterns of events observed by
claims personnel or reported to them by defense counsel. External
factors identified by us in the estimation of IBNR for both environmental and
non-environmental IBNR reserves include: (i) legislative enactments;
(ii) judicial decisions; (iii) legal developments in the determination of
liability and the imposition of damages; and (iv) trends in general economic
conditions, including the effects of inflation. Adjustments to IBNR
are made periodically to take into account changes in the volume of business
written, claims frequency and severity, the mix of business, claims processing,
and other items that are expected by management to affect our reserves for
losses and loss expenses over time.
By using
both individual estimates of reported claims and generally accepted actuarial
reserving techniques, we estimate the ultimate net liability for losses and loss
expenses. While the ultimate actual liability may be higher or lower
than reserves established, we believe the reserves to be
adequate. Any changes in the liability estimate may be material to
the results of operations in future periods. We do not discount to
present value that portion of our loss reserves expected to be paid in future
periods; however, our loss reserves include anticipated recoveries for salvage
and subrogation claims.
92
Reserves
are reviewed for adequacy on a periodic basis. As part of the
periodic review, we consider the range of possible loss and loss expense
reserves, determined at the beginning of the year, in evaluating reserve
adequacy. When reviewing reserves, we analyze historical data and
estimate the impact of various factors such as: (i) per claim
information; (ii) our and the industry's historical loss experience; (iii)
legislative enactments, judicial decisions, legal developments in the imposition
of damages, and changes in political attitudes; and (iv) trends in general
economic conditions, including the effects of inflation. This process
assumes that past experience, adjusted for the effects of current developments
and anticipated trends, is an appropriate basis for predicting future
events. However, there is no precise method for subsequently
evaluating the impact of any specific factor on the adequacy of reserves because
the eventual deficiency or redundancy is affected by many
factors. Based upon such reviews, we believe that the estimated
reserves for losses and loss expenses are adequate to cover the ultimate cost of
claims. The changes in these estimates, resulting from the continuous
review process and the differences between estimates and ultimate payments, are
reflected in the consolidated statements of income for the period in which such
estimates are changed.
(m)
Revenue Recognition
The
Insurance Subsidiaries' net premiums written include direct insurance policy
writings plus reinsurance assumed and estimates of premiums earned but unbilled
on the workers compensation and general liability lines of insurance, less
reinsurance ceded. Premiums written are recognized as revenue over
the period that coverage is provided using the semi-monthly pro-rata
method. Unearned premiums and prepaid reinsurance premiums represent
that portion of premiums written that are applicable to the unexpired terms of
policies in force.
(n)
Dividends to Policyholders
We
establish reserves for dividends to policyholders on certain policies, most
significantly workers compensation policies. These dividends are
based on the policyholders' loss experience. The dividend reserves
are established based on past experience, adjusted for the effects of current
developments and anticipated trends. The expense for these dividends
is recognized over a period that begins at policy inception and ends with the
payment of the dividend. We do not issue policies that entitle the
policyholder to participate in the earnings or surplus of the Insurance
Subsidiaries.
(o)
Federal Income Tax
We use
the asset and liability method of accounting for income
taxes. Deferred federal income taxes arise from the recognition of
temporary differences between financial statement carrying amounts and the tax
basis of assets and liabilities. A valuation allowance is established
when it is more likely than not that some portion of the deferred tax asset will
not be realized. The effect of a change in tax rates is recognized in
the period of enactment.
(p)
Leases
We have
various operating leases for office space and equipment. Rental
expense for such leases is recorded on a straight-line basis over the lease
term. If a lease has a fixed and determinable escalation clause, or
periods of rent holidays, the difference between rental expense and rent paid is
included in "Other liabilities" as deferred rent in the Consolidated Balance
Sheets.
(q)
Pension
Our
pension and post-retirement life benefit obligations and related costs are
calculated using actuarial methods, within the framework of U.S. generally
accepted accounting principles. Two key assumptions, the discount
rate and the expected return on plan assets, are important elements of expense
and/or liability measurement. We evaluate these key assumptions
annually. Other assumptions involve demographic factors such as
retirement age, mortality, turnover, and rate of compensation
increases. The discount rate enables us to state expected future cash
flows at their present value on the measurement date. The guideline
for setting this rate is a high-quality long-term corporate bond
rate. To determine the expected long-term rate of return on the plan
assets, we consider the current and expected asset allocation, as well as
historical and expected returns on each plan asset class.
Note 3. Adoption of
Accounting Pronouncements
In June
2007, the Financial Accounting Standards Board ("FASB") issued guidance under
Accounting Standards Codification (“ASC”) 718, Compensation – Stock
Compensation, which was formerly referred to as EITF Issue No. 06-11,
Accounting for Income Tax
Benefits of Dividends on Share-Based Payment Awards ("EITF
06-11"). This guidance requires that the tax benefit from dividends
or dividend equivalents that are charged to retained earnings and are paid to
employees for equity classified non-vested equity shares, non-vested equity
share units, and outstanding equity share options be recognized as an increase
to additional paid-in capital. This guidance was effective on a
prospective basis beginning with dividends declared in fiscal years beginning
after December 15, 2007, and we adopted it in the first quarter of
2008. The adoption of the guidance did not have a material impact on
our results of operations or financial condition.
93
In
February 2008, the FASB issued guidance under ASC 820, Fair Value Measurements and
Disclosures (“ASC 820”), which was formerly referred to as FASB Staff
Position (“FSP”) FAS 157-2, Effective Date of FASB Statement No.
157. This guidance delayed the previously issued fair value
guidance until January 1, 2009 for non-financial assets and non-financial
liabilities, except those that are recognized or disclosed at fair value in the
consolidated financial statements on a recurring basis. The adoption
of this guidance did not have an impact on our results of operations or
financial condition.
In May
2008, the FASB issued guidance under ASC 944, Financial Services – Insurance
(“ASC 944”), which was formerly referred to as FASB Statement of
Financial Accounting Standards No. 163, Accounting for Financial Guarantee
Insurance Contracts - an interpretation of FASB Statement No.
60. This guidance applies to financial guarantee insurance and
reinsurance contracts that are: (i) issued by enterprises that are
included within the scope of ASC 944; and (ii) not accounted for as derivative
instruments. This guidance is effective for financial statements
issued for fiscal years beginning after December 15, 2008, and interim periods
within those fiscal years. The adoption of this guidance did not have
an impact on our results of operations or financial condition.
In May
2008, the FASB issued guidance under ASC 470, Debt, which was formerly
referred to as FSP No. APB 14-1, Accounting for Convertible Debt
Instruments that may be Settled in Cash upon Conversion (Including Partial Cash
Settlement). This guidance applies to convertible debt
instruments that, by their stated terms, may be completely or partially settled
in cash (or other assets) upon conversion, unless the embedded conversion option
is required to be separately accounted for as a derivative under FASB ASC
815, Derivatives and
Hedging. This guidance is effective for financial statements
issued for fiscal years beginning after December 15, 2008, and interim periods
within those fiscal years. The adoption of this guidance did not have
a material impact on our financial condition or results of operations for any
period presented.
In June
2008, the FASB issued guidance under ASC 260, Earnings Per Share, which was
formerly referred to as FSP No. EITF 03-6-1, Determining Whether Instruments
Granted in Share-Based Payment Transactions are Participating
Securities. This guidance addresses the treatment of unvested
share-based payment awards containing non-forfeitable rights to dividends or
dividend equivalents in the calculation of earnings per share and is effective
for financial statements issued for fiscal years beginning after December 15,
2008, and interim periods within those years. The adoption of this
guidance did not have a material impact on our calculation of earnings per share
for any period presented.
In
December 2008, the FASB issued guidance under ASC 715, Compensation – Retirement Benefits,
which was formerly referred to as FSP FAS 132(R)-1, an amendment to FASB
Statement No. 132 (revised 2003), Employers' Disclosures about
Pensions and Other Post-retirement Benefits, to provide guidance on an
employer's disclosures about plan assets of a defined benefit pension or other
postretirement plan. This guidance requires employers of public and
nonpublic entities to disclose more information about the
following:
|
·
|
How
investment allocation decisions are made (including investment policies
and strategies, as well as the company’s strategy for funding the benefit
obligations);
|
|
·
|
The
major categories of plan assets, including cash and cash equivalents;
equity securities (segregated by industry type, company size, or
investment objective); debt securities (segregated by those issued by
national, state, and local governments); corporate debt securities;
asset-backed securities; structured debt; derivatives (segregated by the
type of underlying risk in the contract); investment funds (segregated by
type of fund); and real estate;
|
|
·
|
Fair-value
measurements, and the fair-value techniques and inputs used to measure
plan assets (i.e.: Level 1, 2 & 3);
and
|
|
·
|
Significant
concentrations of risk within plan
assets.
|
The
disclosure requirements are effective for years ending after December 15,
2009. We have included the required disclosures in Note 16.
“Retirement Plans” of this Form 10-K.
In
January 2009, FASB issued OTTI guidance under ASC 325 Investments, pertaining to
structured securities that were not of high-credit quality at the date of
purchase. Under the previously existing guidance for these
securities, a company was required to use market participant assumptions about
future cash flows. This requirement could not be overcome by
management's judgment as to the probability of collecting all projected cash
flows. This guidance amends this requirement in that companies are
not required to place exclusive reliance on market participant assumptions about
future cash flows and instead management is permitted to use reasonable judgment
when considering the probability of collection of all future cash flows due in
determining whether an OTTI charge exists. This guidance, which was
effective for reporting periods ending after December 15, 2008, did not have a
material impact on our operations.
94
In April
2009, the FASB issued guidance under ASC 820, which was formerly referred to as
FSP FAS 157-4, Determining
Fair Value When the Volume and Level of Activity for the Asset or Liability Have
Significantly Decreased and Identifying Transactions That Are Not
Orderly. This guidance addresses the factors that determine
whether there has been a significant decrease in the volume and level of
activity for an asset or liability when compared to the normal market
activity. Under this guidance, if the reporting entity has determined
that the volume and level of activity has significantly decreased and
transactions are not orderly, further analysis is required and significant
adjustments to the quoted prices or transactions may be needed. This
guidance was effective for interim and annual reporting periods ending after
June 15, 2009 and our adoption on April 1, 2009 did not have a material impact
on our financial condition or results of operations. We have included
the required disclosures in the following notes to the consolidated financial
statements where applicable.
In April
2009, the FASB issued guidance under ASC 320, Investments – Debt and Equity
Securities, which was formerly referred to as FSP FAS 115-2 and FSP FAS
124-2, Recognition and
Presentation of Other-Than-Temporary Impairments. This
guidance introduces the concept of credit and non-credit OTTI charges on fixed
maturity securities. Under this guidance, when an OTTI of a fixed
maturity security has occurred, the amount of the OTTI charge recognized in
earnings depends on whether a company: (i) intends to sell the
security; or (ii) will more likely than not will be required to sell the
security before recovery of its amortized cost basis. If the debt
security meets either of these two criteria, the OTTI recognized in earnings is
equal to the entire difference between the security’s amortized cost basis and
its fair value at the impairment measurement date. For impairments of
fixed maturity securities that do not meet these two criteria, the net amount
recognized in earnings is equal to the difference between the amortized cost of
the debt security and its projected net present value of future cash flows
(referred to as the “credit impairment”). Any difference between the
fair value and the projected net present value of future cash flows at the
impairment measurement date is recorded in OCI (referred to as the “non-credit
impairment”). Prior to our adoption of this guidance on April 1,
2009, an OTTI recognized in earnings for fixed maturity securities was equal to
the total difference between its amortized cost and fair value at the time of
impairment. We were also required to analyze securities held as of
the adoption date which have had past OTTI charges in order to quantify a
cumulative effect adjustment to the opening balance of retained earnings with a
corresponding adjustment to AOCI upon adoption. This cumulative
effect adjustment amounted to $2.4 million, net of deferred tax, which decreased
AOCI and increased retained earnings. Also upon adoption, we
increased the amortized cost of these securities by $3.7 million, representing
non-credit related impairments recognized in earnings prior to the adoption of
this guidance. This guidance was effective for interim and annual
reporting periods ending after June 15, 2009. See Note 5.
“Investments” for information regarding our credit and non-credit OTTI
charges. In addition, we have included the required disclosures in
the notes to the consolidated financial statements where
applicable.
In April
2009, the FASB issued guidance under ASC 825, Financial Instruments, which
was formerly referred to as FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value
of Financial Instruments to provide guidance on additional disclosures
surrounding fair value of financial instruments required when a publicly traded
company issues financial information for interim reporting
periods. The disclosure requirements are effective for interim
reporting periods ending after June 15, 2009. We have included the
required disclosures of this guidance for interim reporting
purposes.
In June
2009, the FASB issued an update to ASC 855, Subsequent Events, which was
formerly referred to as FASB Statement of Financial Accounting Standards No.
165, Subsequent
Events. Under this guidance, we are required to disclose that
we have analyzed subsequent events through February 24, 2010, the date on which
these Financial Statements are issued. Requirements concerning the
accounting and disclosure of subsequent events under this guidance are not
significantly different from those contained in existing auditing standards and,
as a result, our adoption of the guidance did not have a material impact on our
financial condition or results of operations
In June
2009, the FASB issued guidance under ASC 105, Generally Accepted Accounting
Principles, which was formerly referred to as FASB Statement of Financial
Accounting Standards No. 168,
FASB Accounting Standards Codification and the Hierarchy of Generally Accepted
Accounting Principles – A Replacement of FASB Statement No.
162. This guidance establishes the FASB Accounting Standards
Codification (the “Codification”) as the source of authoritative GAAP for
nongovernmental entities. The Codification supercedes all existing
non-SEC accounting and reporting standards. Rules and interpretive
releases of the SEC under authority of federal security laws remain
authoritative GAAP for SEC registrants. This guidance and the
Codification are effective for financial statements issued for interim and
annual periods ending after September 15, 2009. As the Codification
did not change existing GAAP, the adoption did not have an impact on our
financial condition or results of operations.
95
In August
2009, the FASB issued ASC Update 2009-05, Fair Value Measurements and
Disclosures (Topic 820) – Measuring Liabilities at Fair Value, which
provides guidance on the fair value measurement of liabilities that are traded
as assets in the marketplace (i.e. debt obligations). In
circumstances in which the quoted price in an active market is not available for
an identical liability, a company should measure fair value using one or more of
the following valuation techniques: (i) quoted price of the identical
liability when traded as an asset; (ii) quoted prices for similar liabilities
when traded as an asset; or (iii) a valuation technique that is based on the
amount that the company would pay or receive to transfer an identical
liability. This guidance was effective for the first reporting period
beginning after August 26, 2009. The adoption did not have a material
impact on our financial condition or results of operations.
In
September 2009, the FASB issued ASC Update 2009-12, Fair Value Measurements and
Disclosures (Topic 820) - Investment in Certain Entities that Calculate Net
Asset Value per Share (or Its Equivalent). This update
provides guidance in estimating the fair value of a company’s investments in
investment companies when the investment does not have a readily determinable
fair value. It permits the use of the investment’s net asset value as
a practical expedient to determine fair value. This guidance also
required additional disclosure of the attributes of these investments such
as: (i) the nature of any restrictions on the reporting entity’s
ability to redeem its investment; (ii) unfunded commitments; and (iii)
investment strategies of the investees. This guidance is effective
for periods ending after December 15, 2009. The adoption did not have
a material impact on our financial condition or results of
operations.
Pronouncements
to be effective in the future
In
December 2009, the FASB issued ASC Update 2009-16, Transfers and Servicing (Topic 860)
– Accounting for Transfers of Financial Assets. This
guidance: (i) eliminates the concept of a qualifying “special-purpose
entity” (“SPE”); (ii) alters the requirements for transferring assets off of the
reporting company’s balance sheet; (iii) requires additional disclosure about a
transferor’s involvement in transferred assets; and (iv) eliminates special
treatment of guaranteed mortgage securitizations. This guidance is
effective for fiscal years beginning after November 15, 2009. We do
not expect that the adoption of this guidance will have a material impact on our
financial condition or results of operations.
In
December 2009, the FASB issued ASC Update 2009-17, Consolidations (Topic 810) –
Improvements to Financial Reporting by Enterprises Involved with Variable
Interest Entities. This guidance requires the reporting entity
to perform a qualitative analysis that results in a variable interest entity
(“VIE”) being consolidated if the reporting entity: (i) has the power
to direct activities of the VIE that significantly impact the VIE’s financial
performance; and (ii) has an obligation to absorb losses or receive benefits
that may be significant to the VIE. This guidance further requires
enhanced disclosures, including disclosure of significant judgments and
assumptions as to whether a VIE must be consolidated, and how involvement with a
VIE affects the company’s financial statements. This guidance is
effective for fiscal years beginning after November 15, 2009. We do
not expect that the adoption of this guidance will have a material impact on our
financial condition or results of operations.
NOTE 4. Statement of Cash
Flows
Cash paid
or received during the year for interest and federal income taxes, as well as
non-cash financing activities, was as follows for the years ended 2009, 2008,
and 2007:
($
in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Cash
paid (received) during the period for:
|
||||||||||||
Interest
|
$ | 19,462 | 20,647 | 25,311 | ||||||||
Federal
income tax
|
(1,000 | ) | 42,750 | 43,809 | ||||||||
Supplemental
schedule of non-cash financing transactions:
|
||||||||||||
Conversion
of convertible debentures
|
- | 169 | 12,066 |
96
NOTE 5.
Investments
(a) Net
unrealized gains (losses) on investments included in other comprehensive income
(loss) by asset class are as follows:
($
in thousands)
|
2009
|
2008
|
2007
|
|||||||||
AFS
securities:
|
||||||||||||
Fixed
maturity securities
|
$ | 19,413 | (89,068 | ) | 23,634 | |||||||
Equity
securities
|
15,874 | 6,184 | 114,315 | |||||||||
Other
investments
|
- | (1,478 | ) | 6,758 | ||||||||
Total
AFS securities
|
35,287 | (84,362 | ) | 144,707 | ||||||||
HTM
securities:
|
||||||||||||
Fixed
maturity securities
|
9,849 | - | - | |||||||||
Total
HTM securities
|
9,849 | - | - | |||||||||
Total
net unrealized gains (losses)
|
45,136 | (84,362 | ) | 144,707 | ||||||||
Deferred
income tax (expense) benefit
|
(15,797 | ) | 29,527 | (50,647 | ) | |||||||
Net
unrealized gains (losses), net of deferred income tax
|
$ | 29,339 | (54,835 | ) | 94,060 | |||||||
Unrealized
adjustments not in other comprehensive income:
|
||||||||||||
Cumulative
effect adjustment due to adoption of OTTI accounting
|
||||||||||||
guidance,
net of deferred income tax
|
2,380 | - | - | |||||||||
Cumulative
effect adjustment due to adoption of fair value option, net of
tax
|
- | 6,210 | - | |||||||||
Net
unrealized gains (losses), in other comprehensive income, net of deferred
income
tax
|
$ | 31,719 | (48,625 | ) | 94,060 | |||||||
Increase
(decrease) in net unrealized gains (losses) in other comprehensive income,
net
of deferred income tax
|
$ | 86,554 | (142,685 | ) | (20,289 | ) |
(b) The
carrying value, unrecognized holding gains and losses, and fair values of HTM
fixed maturity securities were as follows:
2009
|
Net
|
|||||||||||||||||||||||
Unrealized
|
Unrecognized
|
Unrecognized
|
||||||||||||||||||||||
Amortized
|
Gains
|
Carrying
|
Holding
|
Holding
|
Fair
|
|||||||||||||||||||
($
in thousands)
|
Cost
|
(Losses)
|
Value
|
Gains
|
Losses
|
Value
|
||||||||||||||||||
U.S.
government and government agencies
|
$ | 139,278 | 5,555 | 144,833 | 1,694 | (549 | ) | 145,978 | ||||||||||||||||
Obligations
of state and political
|
||||||||||||||||||||||||
subdivisions
|
1,167,461 | 33,951 | 1,201,412 | 14,833 | (5,450 | ) | 1,210,795 | |||||||||||||||||
Corporate
securities
|
104,854 | (6,028 | ) | 98,826 | 9,665 | (913 | ) | 107,578 | ||||||||||||||||
Asset-backed
securities (“ABS”)
|
35,025 | (6,042 | ) | 28,983 | 4,195 | (82 | ) | 33,096 | ||||||||||||||||
Commercial
mortgage-backed
|
||||||||||||||||||||||||
securities
(“CMBS”)1
|
107,812 | (18,836 | ) | 88,976 | 7,132 | (3,658 | ) | 92,450 | ||||||||||||||||
Residential
mortgage-backed
|
||||||||||||||||||||||||
securities
(“RMBS”)2
|
146,124 | 1,249 | 147,373 | 3,153 | (212 | ) | 150,314 | |||||||||||||||||
Total
HTM fixed maturity securities
|
$ | 1,700,554 | 9,849 | 1,710,403 | 40,672 | (10,864 | ) | 1,740,211 |
1 CMBS
includes government guaranteed agency securities with a carrying value of $10.8
million.
2 RMBS
includes government guaranteed agency securities with a carrying value of $3.9
million.
2008
|
Net
|
|||||||||||||||||||||||
Unrealized
|
Unrecognized
|
Unrecognized
|
||||||||||||||||||||||
Amortized
|
Gains
|
Carrying
|
Holding
|
Holding
|
Fair
|
|||||||||||||||||||
($
in thousands)
|
Cost
|
(Losses)
|
Value
|
Gains
|
Losses
|
Value
|
||||||||||||||||||
Obligations
of state and political subdivisions
|
$ | 1,146 | - | 1,146 | 71 | (58 | ) | 1,159 | ||||||||||||||||
Mortgage-backed
securities (“MBS”)
|
17 | - | 17 | 2 | - | 19 | ||||||||||||||||||
Total
HTM fixed maturity securities
|
$ | 1,163 | - | 1,163 | 73 | (58 | ) | 1,178 |
The
increase in our HTM securities in 2009 was primarily attributable to a $1.9
billion transfer of previously designated AFS securities to a HTM designation in
the first quarter of 2009. We reassess the classification designation
of each security we hold at each balance sheet date. The
reclassification of these securities was permitted because we determined that we
have the ability and the intent to hold these securities as an investment until
maturity or call. We transferred these previously designated AFS
securities to a HTM designation to preserve capital. Upon transfer
from AFS to HTM, the difference between par value and fair value at the date of
transfer is reflected as an unrealized gain or loss that is amortized as a yield
adjustment over the expected life of the security. These unrealized
gains or losses are reflected in AOCI on the Consolidated Balance Sheet, net of
subsequent amortization.
97
Unrecognized
holding gains/losses of HTM securities are not reflected in the financial
statements, as they represent market value fluctuations from the later
of: (i) the date of security is designated as HTM; or (ii) the date
that an OTTI charge is recognized on a HTM security, through the date of the
balance sheet. Our HTM securities had an average duration of 3.5
years as of December 31, 2009.
(c) The
cost/amortized cost, fair values, and unrealized gains (losses) of AFS
securities were as follows:
2009
|
||||||||||||||||
Cost/
|
||||||||||||||||
Amortized
|
Unrealized
|
Unrealized
|
Fair
|
|||||||||||||
($
in thousands)
|
Cost
|
Gains
|
Losses
|
Value
|
||||||||||||
U.S.
government and government agencies1
|
$ | 473,750 | 2,994 | (1,210 | ) | 475,534 | ||||||||||
Obligations
of states and political subdivisions
|
359,517 | 20,419 | (137 | ) | 379,799 | |||||||||||
Corporate
securities
|
365,500 | 15,330 | (1,246 | ) | 379,584 | |||||||||||
ABS
|
26,638 | 466 | (57 | ) | 27,047 | |||||||||||
CMBS2
|
93,514 | 1,746 | (637 | ) | 94,623 | |||||||||||
RMBS3
|
297,537 | 2,457 | (20,712 | ) | 279,282 | |||||||||||
AFS
fixed maturity securities
|
1,616,456 | 43,412 | (23,999 | ) | 1,635,869 | |||||||||||
AFS
equity securities
|
64,390 | 16,484 | (610 | ) | 80,264 | |||||||||||
Total
AFS securities
|
$ | 1,680,846 | 59,896 | (24,609 | ) | 1,716,133 |
1 U.S.
government includes corporate securities fully guaranteed by the FDIC with a
fair value of $136.2 million
2 CMBS are
made up of government guaranteed agency securities.
3 RMBS
includes government guaranteed agency securities with a fair value of $105.2
million.
2008
|
||||||||||||||||
Cost/
|
||||||||||||||||
Amortized
|
Unrealized
|
Unrealized
|
Fair
|
|||||||||||||
($
in thousands)
|
Cost
|
Gains
|
Losses
|
Value
|
||||||||||||
U.S.
government and government agencies1
|
$ | 235,540 | 16,611 | - | 252,151 | |||||||||||
Obligations
of states and political subdivisions
|
1,739,349 | 38,863 | (20,247 | ) | 1,757,965 | |||||||||||
Corporate
securities
|
389,386 | 7,277 | (30,127 | ) | 366,536 | |||||||||||
ABS
|
76,758 | 6 | (15,346 | ) | 61,418 | |||||||||||
MBS
|
682,313 | 8,332 | (94,437 | ) | 596,208 | |||||||||||
AFS
fixed maturity securities
|
3,123,346 | 71,089 | (160,157 | ) | 3,034,278 | |||||||||||
AFS
equity securities
|
125,947 | 24,845 | (18,661 | ) | 132,131 | |||||||||||
Total
AFS securities
|
$ | 3,249,293 | 95,934 | (178,818 | ) | 3,166,409 |
1U.S.
government includes corporate securities fully guaranteed by the FDIC with a
fair value of $34.3 million.
Unrealized
gains/losses represent market value fluctuations from the later
of: (i) the date of security is designated as AFS; or (ii) the date
that an OTTI charge is recognized on an AFS security, through the date of the
balance sheet. These unrealized gains and losses are recorded in AOCI
on the Consolidated Balance Sheets.
98
(d) The
following tables summarize, for all securities in a net unrealized/unrecognized
loss position at December 31, 2009 and December 31, 2008, the fair value and
gross pre-tax net unrealized/unrecognized loss by asset class and by length of
time those securities have been in a net loss position:
December
31, 2009
|
Less than 12
months1
|
12 months or
longer1
|
||||||||||||||
($
in thousands)
|
Fair
Value
|
Unrealized
(Losses)2
|
Fair
Value
|
Unrealized
(Losses)2
|
||||||||||||
AFS
securities
|
||||||||||||||||
U.S. government and
government agencies4
|
$ | 187,283 | (1,210 | ) | - | - | ||||||||||
Obligations
of states and political subdivisions
|
8,553 | (120 | ) | 3,059 | (17 | ) | ||||||||||
Corporate
securities
|
74,895 | (829 | ) | 10,550 | (417 | ) | ||||||||||
ABS
|
2,983 | (17 | ) | 3,960 | (40 | ) | ||||||||||
CMBS
|
36,447 | (637 | ) | - | - | |||||||||||
RMBS
|
78,328 | (514 | ) | 53,607 | (20,198 | ) | ||||||||||
Total
fixed maturity securities
|
388,489 | (3,327 | ) | 71,176 | (20,672 | ) | ||||||||||
Equity
securities
|
3,828 | (214 | ) | 5,932 | (396 | ) | ||||||||||
Subtotal
|
$ | 392,317 | (3,541 | ) | 77,108 | (21,068 | ) |
Less
than 12 months1
|
12
months or longer1
|
|||||||||||||||||||||||
Unrecognized
|
Unrecognized
|
|||||||||||||||||||||||
($
in thousands)
|
Fair
Value
|
Unrealized
(Losses)2
|
Gains
(Losses)3
|
Fair
Value
|
Unrealized
(Losses)2
|
Gains
(Losses)3
|
||||||||||||||||||
HTM securities
|
||||||||||||||||||||||||
U.S.
government and government agencies4
|
$ | 29,459 | - | (317 | ) | - | - | - | ||||||||||||||||
Obligations
of states and political subdivisions
|
46,671 | (598 | ) | 85 | 74,360 | (4,315 | ) | 1,631 | ||||||||||||||||
Corporate
securities
|
6,124 | (1,170 | ) | 1,068 | 19,233 | (4,751 | ) | 3,441 | ||||||||||||||||
ABS
|
- | - | - | 13,343 | (4,968 | ) | 2,472 | |||||||||||||||||
CMBS
|
316 | (538 | ) | (190 | ) | 22,044 | (15,315 | ) | (879 | ) | ||||||||||||||
RMBS
|
5,068 | - | (146 | ) | 5,892 | (1,062 | ) | 127 | ||||||||||||||||
Subtotal
|
$ | 87,638 | (2,306 | ) | 500 | 134,872 | (30,411 | ) | 6,792 | |||||||||||||||
Total
|
$ | 479,955 | (5,847 | ) | 500 | 211,980 | (51,479 | ) | 6,792 |
1 The
month count for aging of unrealized losses was reset back to historical
unrealized loss month counts for securities impacted by the adoption of OTTI
guidance in the second quarter 2009 and for securities that were transferred
from an AFS to HTM category.
2 Gross
unrealized gains/(losses) include non-OTTI unrealized amounts and OTTI losses
recognized in AOCI at December 31, 2009. In addition, this column
includes remaining unrealized gain or loss amounts on securities that were
transferred to a HTM designation in the first quarter of 2009 for those
securities that are in a net unrealized/unrecognized loss position at December
31, 2009.
3
Unrecognized holding gains/(losses) represent market value fluctuations from the
later of: (i) the date of a security is designated as HTM; or (ii)
the date that an OTTI charge is recognized on a HTM security.
4 U.S.
government includes corporate securities fully guaranteed by the
FDIC.
99
December
31, 20081
|
Less
than 12 months
|
12
months or longer
|
||||||||||||||
Fair
|
Unrealized
|
Fair
|
Unrealized
|
|||||||||||||
($
in thousands)
|
Value
|
(Losses)
|
Value
|
(Losses)
|
||||||||||||
AFS securities
|
||||||||||||||||
U.S.
government and government agencies2
|
$ | - | - | - | - | |||||||||||
Obligations
of states and political subdivisions
|
354,615 | (11,565 | ) | 128,130 | (8,682 | ) | ||||||||||
Corporate
securities
|
162,339 | (20,109 | ) | 30,087 | (10,018 | ) | ||||||||||
ABS
|
42,142 | (7,769 | ) | 15,336 | (7,577 | ) | ||||||||||
Agency
MBS
|
2,910 | (8 | ) | 6,092 | (1,241 | ) | ||||||||||
Non-agency
MBS
|
178,235 | (28,095 | ) | 90,937 | (65,093 | ) | ||||||||||
Total
fixed maturity securities
|
740,241 | (67,546 | ) | 270,582 | (92,611 | ) | ||||||||||
Equity
securities
|
61,147 | (18,661 | ) | - | - | |||||||||||
Other
investments
|
4,528 | (1,478 | ) | - | - | |||||||||||
Total
securities in a temporary unrealized loss position
|
$ | 805,916 | (87,685 | ) | 270,582 | (92,611 | ) |
1 2008 HTM
securities are not presented in this table, as their fair value was
approximately $1.2 million and therefore not material.
2 U.S.
government includes corporate securities fully guaranteed by the
FDIC.
Unrealized
losses decreased compared to December 31, 2008, primarily because of the general
improvement in the overall marketplace for our fixed maturity portfolio and the
reduction in our equity portfolio as discussed below. As of December
31, 2009, 173 fixed maturity securities and six equity securities were in an
unrealized loss position. At December 31, 2008, 355 fixed maturity
securities, 45 equity securities, and one other investment security were in an
unrealized loss position. As of December 31, 2009, the overall
Standard and Poor’s credit quality rating of our fixed maturity securities was
“AA+” and these securities are performing according to their contractual
terms.
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”
above. In determining the loss severity applied within the scenarios,
we use a current, or estimated, loan-to-value ratio multiplied by an estimated
65% loss on that exposure. We typically use conditional default rates
on our CMBS portfolio of 2.5, but these rates may exceed 2.5 based on our
judgment regarding the facts surrounding the securities. Generally
the range of the conditional default rate assumptions for our other structured
securities is as follows:
·
|
Alternative-A
securities (“Alt-A”) fixed structured securities:
|
0.50
– 6.00
|
·
|
Alt-A
hybrid structured securities:
|
1.00
– 7.00
|
·
|
All
other fixed structured securities:
|
0.07
– 1.00
|
·
|
All
other hybrid structured securities:
|
0.33
– 1.50
|
Given the
range of conditional default rates assumptions for our Alt-A fixed structured
and hybrid structured securities above, the following is a further outline of
these assumptions by vintage year:
Vintage Years
|
|||||||||
2004 & Prior
|
2005
|
2006
|
|||||||
Alt-A
fixed structured securities
|
0.50 – 1.25
|
1.00 – 3.00
|
1.00 – 6.00
|
||||||
Alt-A
hybrid structured securities
|
1.00 – 3.00
|
1.00 – 6.00
|
3.00 – 7.00
|
The
discussion that follows will focus on fixed maturity securities in an unrealized
loss position for more than 12 months, which amounted to $44.3
million. Specifically, we will focus on the following
categories:
|
·
|
AFS
RMBS with an unrealized/unrecognized loss balance of $20.2
million;
|
|
·
|
HTM
CMBS with an unrealized/unrecognized loss balance of $16.2 million;
and
|
|
·
|
All
other fixed maturity securities with an unrealized/unrecognized loss
balance of $7.9 million.
|
AFS
RMBS
Unrealized
losses on our AFS RMBS that have been in an unrealized loss position for more
than 12 months amounted to $20.2 million at December 31, 2009. These
losses can be categorized as follows:
|
·
|
$3.8
million of non-credit OTTI charges that have been recognized in
AOCI. These non-credit impairment charges were generated
concurrently with related credit charges. Prior to impairment,
these securities had a decline in fair value of 57%, or $4.4 million, as
compared to their amortized cost.
|
|
·
|
$16.4
million in unrealized losses not related to OTTI charges (referred to as
“traditional unrealized losses” in the discussion that
follows). These securities had a decline in fair value of 24%,
or $16.4 million, as compared to their amortized
cost.
|
100
Of the
$16.4 million in traditional unrealized, $11.3 million, or approximately 70%,
related to 10 securities, four of which were Alt-A securities with a related
unrealized balance of $6.1 million. The weighted average life of
these 10 securities was two years at December 31, 2009 and all principal and
interest payments have been received to date. The evaluations
performed utilized the following assumptions:
|
·
|
Loss
severities that generally ranged from approximately 35% to 49% with a
weighted average of 45%;
|
|
·
|
Loan-to-value
ratios that generally ranged from 54% to 75%, with a weighted average of
70%;
|
|
·
|
Conditional
default rates that generally ranged from 1.0 to 1.3 for those securities
that were not Alt-As; and
|
|
·
|
Conditional
default rates that generally ranged from 3.0 to 7.0 for Alt-A securities,
with a weighted average of 6.2.
|
Under all
scenarios performed, these securities did not indicate that the impairment is
other than temporary.
HTM
CMBS
Unrealized
losses on our HTM CMBS that have been in a loss position for more than 12 months
amounted to $16.2 million at December 31, 2009. These losses can be
categorized as follows:
|
·
|
$7.1
million of non-credit OTTI charges that have been recognized in
AOCI. These non-credit impairment charges were generated
concurrently with related credit charges. Prior to impairment,
these securities had a decline in fair value of 78%, or $19.1 million, as
compared to their amortized cost.
|
|
·
|
$9.1
million in unrealized/unrecognized losses not related to OTTI charges
(referred to as “traditional unrealized losses” in the discussion that
follows). These securities had a decline in fair value of 35%,
as compared to their amortized
cost.
|
Of the
$9.1 million in traditional unrealized losses, $6.8 million, or 75%, related to
three securities. The weighted average remaining contractual life of
these securities was approximately two years as of December 31, 2009, and all
scheduled principal and interest payments have been received to
date. The evaluations performed used the following
assumptions:
|
·
|
Loss
severities that generally ranged from approximately 24% to 55% with a
weighted average of 30%;
|
|
·
|
Loan-to-value
ratios with a weighted average of 37%;
and
|
|
·
|
Conditional
default rates of 3.0.
|
As a
comparison, recent industry publications indicated a weighted average historical
conditional default rate of 0.9 for CMBS, which is based on vintage years dating
back to the mid-1990’s.
Under all
scenarios performed, the underlying cash flows did not indicate that the
impairment is other than temporary.
All
Other Securities
The
remaining $7.9 million of unrealized/unrecognized losses was comprised of 66
securities with fair values that were, on average, 95% of their amortized
costs. Given the number of securities and the close proximity of
amortized cost and fair value, we have concluded that these securities are not
other-than-temporarily impaired under our OTTI policy.
Based on
the above, coupled with the fact that we do not have the intent to sell any of
the securities discussed above, nor do we believe we will be required to sell
these securities, we have concluded that they are not other-than-temporarily
impaired as of December 31, 2009. This conclusion reflects our
current judgment as to the financial position and future prospects of the entity
that issued the investment security and underlying collateral. If our
judgment about an individual security changes in the future, we may ultimately
record a credit loss after having originally concluded that one did not exist,
which could have a material impact on our net income and financial position in
future periods.
(e)
Fixed-maturity securities at December 31, 2009, by contractual maturity are
shown below. Mortgage-backed securities are included in the maturity
tables using the estimated average life of each security. Expected
maturities may differ from contractual maturities because issuers may have the
right to call or prepay obligations with or without call or prepayment
penalties.
Listed
below are HTM fixed maturity securities at December 31, 2009:
($
in thousands)
|
Carrying Value
|
Fair Value
|
||||||
Due
in one year or less
|
$ | 246,802 | 249,351 | |||||
Due
after one year through five years
|
825,613 | 847,803 | ||||||
Due
after five years through 10 years
|
611,042 | 614,723 | ||||||
Due
after 10 years through 15 years
|
21,731 | 23,265 | ||||||
Due
after 15 years
|
5,215 | 5,069 | ||||||
Total
HTM fixed maturity securities
|
$ | 1,710,403 | 1,740,211 |
101
Listed
below are AFS fixed maturity securities at December 31, 2009:
($
in thousands)
|
Fair Value
|
|||
Due
in one year or less
|
$ | 214,399 | ||
Due
after one year through five years
|
924,579 | |||
Due
after five years through 10 years
|
481,786 | |||
Due
after 10 years through 15 years
|
15,105 | |||
Total
AFS fixed maturity securities
|
$ | 1,635,869 |
(f) 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
|
2009
|
||||||||||
December 31,
|
December 31,
|
Remaining
|
||||||||||
($ in thousands)
|
2009
|
2008
|
Commitment
|
|||||||||
Alternative
Investments
|
||||||||||||
Energy/Power
Generation
|
$ | 32,996 | 35,839 | 11,014 | ||||||||
Private
Equity
|
21,525 | 22,846 | 17,965 | |||||||||
Secondary
Private Equity
|
20,936 | 24,077 | 25,104 | |||||||||
Mezzanine
Financing
|
20,323 | 23,166 | 28,619 | |||||||||
Distressed
Debt
|
19,201 | 29,773 | 4,611 | |||||||||
Real
Estate
|
16,856 | 23,446 | 13,543 | |||||||||
Venture
Capital
|
5,752 | 5,870 | 2,000 | |||||||||
Total
Alternative Investments
|
137,589 | 165,017 | 102,856 | |||||||||
Other
Securities
|
3,078 | 7,040 | - | |||||||||
Total
Other Investments
|
$ | 140,667 | 172,057 | 102,856 |
The
decrease in other investments of $31.4 million for 2009 compared to 2008 was
primarily due to the $21.7 million decrease in the value of our alternative
investments, combined with $5.7 million in distributions net of additional
investments. The distributions include the sale of one of our limited
partnerships for $12.1 million. The decrease in value was driven by
general volatility in the capital markets and the slowdown of merger and
acquisition activity that began in 2008. As 2009 progressed, the
improvements in the credit markets and increasing stability in the financial
markets were reflected in our returns on this portfolio, which improved from a
$29.4 million loss in the first half of the year to a $7.7 million gain in the
second half of the year.
The
following is a description of our alternative investment
strategies:
Energy / Power
Generation
This
strategy invests primarily in cash flow generating assets in the coal, natural
gas, power generation, and electric and gas transmission and distribution
industries.
Private
Equity
This
strategy makes private equity investments primarily in established large and
middle market companies across diverse industries in North America, Europe and
Asia.
Secondary Private
Equity
This
strategy purchases seasoned private equity funds from investors desiring
liquidity prior to normal fund termination. Investments are made
across all sectors of the private equity market, including leveraged buyouts,
venture capital, distressed securities, mezzanine financing, real estate, and
infrastructure.
Mezzanine
Financing
This
strategy provides privately negotiated fixed income securities, generally with
an equity component, to leveraged buyout (“LBO”) firms and private and publicly
traded large, mid and small-cap companies to finance LBOs, recapitalizations,
and acquisitions.
Distressed
Debt
This
strategy makes direct and indirect investments in debt and equity securities of
companies that are experiencing financial and/or operational
distress. Investments include buying indebtedness of bankrupt or
financially-troubled companies, small balance loan portfolios, special
situations and capital structure arbitrage trades, commercial real estate
mortgages and similar non-U.S. securities and debt obligations. This
strategy also includes a fund of funds component.
The fund
of funds component of our distressed debt strategy, which makes up approximately
$7.4 million of our distressed debt strategy, encompasses a number of strategies
that generally fall into one of the following broad categories:
102
Distressed
Debt Funds – Trading-Focused
These
funds focus on buying and selling debt of distressed companies (“Distressed
Debt”).
Distressed
Debt Funds - Restructuring-Focused
These
funds focus on acquiring Distressed Debt with the intent of converting it into
equity in a restructuring and taking control of the company.
Special
Situations Funds
These
funds pursue strategies that seek to take advantage of dislocations or
opportunities in the market that are often related to, or are derivatives of,
distressed investing. Special situations are often event-driven and
characterized by complexity, market inefficiency, and excess risk
premiums.
Private
Equity Funds - Turnaround-Focused
These
funds are a subset of private equity funds focused on investing in
under-performing or distressed companies. These funds generally
create value by acquiring the equity of these companies, in certain cases out of
bankruptcy, and effecting operational turnarounds or financial
restructuring.
Real
Estate
This
strategy invests opportunistically in real estate in North America, Europe, and
Asia via direct property ownership, joint ventures, mortgages, and investments
in equity and debt instruments.
Venture
Capital
In
general, these investments are venture capital investments made principally by
investing in equity securities of privately held corporations, for long-term
capital appreciation. This strategy also makes private equity
investments in growth equity and buyout partnerships.
Our seven
alternative investment strategies employ low or moderate levels of leverage and
generally use hedging only to reduce foreign exchange or interest rate
volatility. At this time, our alternative investment strategies do
not include hedge funds. We are committed for the full life of each
fund and cannot redeem our investment with the general partner. Once
liquidation is triggered by clauses within the limited partnership agreements or
at the funds’ stated end date, we will receive our final allocation of capital
and any earned appreciation of the underlying investments. Management
does not intend to sell these investments in the secondary market in the
near-term. We currently receive distributions from these alternative
investments through the realization of the underlying investments in the limited
partnerships. We anticipate that the general partners of these
alternative investments will liquidate their underlying investment portfolios up
through 2023. At December 31, 2009, we have contractual obligations
that expire at various dates through 2023 to further invest up to $102.9 million
in alternative investments. There is no certainty that any such
additional investment will be required.
(g) The
components of net investment income earned were as follows:
($
in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Fixed
maturity securities
|
$ | 141,882 | 146,555 | 140,383 | ||||||||
Equity
securities, dividend income
|
2,348 | 5,603 | 8,626 | |||||||||
Trading
securities, change in fair value
|
262 | (8,129 | ) | - | ||||||||
Short-term
investments
|
1,273 | 4,252 | 8,563 | |||||||||
Other
investments
|
(21,383 | ) | (12,336 | ) | 21,828 | |||||||
Investment
expenses
|
(5,911 | ) | (4,913 | ) | (5,256 | ) | ||||||
Net
investments earned
|
$ | 118,471 | 131,032 | 174,144 |
Net
investment income, before tax, decreased to $118.5 million in 2009 from $131.0
million in 2008 due to: (i) an increase in losses on our alternative
investments of $9.1 million; (ii) a decrease in interest income of approximately
$7.7 million on our fixed maturity and short-term investment portfolios
resulting from lower purchase yields; and (iii) lower dividend income of $3.3
million due to our reduced equity portfolio. Alternative investment
losses, which amounted to $21.7 million on a pre-tax basis, were driven by the
unprecedented volatility in the global capital markets that occurred during the
second half of 2008 and continued through the first half of
2009. This volatility resulted in a decline in asset values, of which
57% was attributable to our real estate strategy and 30% was attributable to our
private equity/private equity secondary market
strategies. Alternative investment income made a sound recovery in
the latter half of 2009 as equity markets rebounded and credit markets eased, in
turn allowing the merger and acquisition environment to
improve. These decreases were partially offset by the effect of the
elimination of our trading portfolio in the first quarter of
2009. During 2008, unrealized losses of $8.1 million on the trading
portfolio negatively impacted investment income.
103
The
decrease in net investment income of $43.1 million for 2008 compared to 2007 was
due to: (i) decrease returns of $31.9 million on the alternative
investment portion of our other investments portfolio; and (ii) $8.1 million of
reductions in the fair value of our equity trading portfolio due to the sell off
in the equity markets, as well as the collapse in commodity prices in
2008.
(h) The
following tables summarize OTTI by asset type for the periods
indicated:
Year
ended December 31, 2009
|
Recognized in
|
|||||||||||
($
in thousands)
|
Gross
|
Included
in OCI
|
earnings
|
|||||||||
Fixed
maturity securities
|
||||||||||||
Corporate
securities
|
$ | 1,271 | - | 1,271 | ||||||||
ABS
|
1,190 | (1,292 | ) | 2,482 | ||||||||
CMBS
|
18,865 | 7,088 | 11,777 | |||||||||
RMBS
|
40,751 | 2,972 | 37,779 | |||||||||
Total
fixed maturity securities
|
62,077 | 8,768 | 53,309 | |||||||||
Equity
Securities
|
2,107 | - | 2,107 | |||||||||
OTTI
losses
|
$ | 64,184 | 8,768 | 55,416 |
Year
ended December 31, 2008
|
Recognized in
|
|||||||||||
($
in thousands)
|
Gross
|
Included
in OCI
|
earnings
|
|||||||||
Fixed
maturity securities
|
||||||||||||
Corporate
securities
|
$ | 10,200 | - | 10,200 | ||||||||
ABS
|
16,420 | - | 16,420 | |||||||||
CMBS
|
9,725 | - | 9,725 | |||||||||
RMBS
|
5,357 | - | 5,357 | |||||||||
Total
fixed maturity securities
|
41,702 | - | 41,702 | |||||||||
Equity
Securities
|
6,613 | - | 6,613 | |||||||||
Other
|
4,785 | - | 4,785 | |||||||||
OTTI
losses
|
$ | 53,100 | - | 53,100 |
Year
ended December 31, 2007
|
Recognized in
|
|||||||||||
($
in thousands)
|
Gross
|
Included
in OCI
|
earnings
|
|||||||||
Fixed
maturity securities
|
||||||||||||
ABS
|
$ | 4,890 | - | 4,890 | ||||||||
OTTI
losses
|
$ | 4,890 | - | 4,890 |
The
following tables sets forth, as of the dates 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:
($
in thousands)
|
Gross
|
|||
Balance,
March 31, 2009
|
$ | - | ||
Credit
losses remaining in retained earnings after adoption of OTTI accounting
guidance
|
9,395 | |||
Addition
for the amount related to credit loss for which an OTTI was not previously
recognized
|
10,579 | |||
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
|
- | |||
Additional
increases to the amount related to credit loss for which an OTTI was
previously recognized
|
2,718 | |||
Accretion
of credit loss impairments previously recognized due to an increase in
cash flows expected to be collected
|
- | |||
Balance,
December 31, 2009
|
$ | 22,692 |
The
following is a discussion surrounding the credit-related OTTI charges taken
during 2009 as outlined in the table above:
|
·
|
$37.8
million of RMBS credit OTTI charges during 2009. These charges
taken during the year related to securities that experienced reductions in
the cash flows of their underlying collateral. These
securities, on average, showed signs of loss at conditional default rates
of 0.33 and had declines in fair value of 65% as compared to their
amortized cost. As a result, we do not believe it is probable
that we will receive all contractual cash flows for these
securities.
|
|
·
|
$11.8
million of CMBS credit OTTI charges during 2009. These charges
taken during the year related to reductions in the related cash flows of
the underlying collateral of these securities. These
securities, on average, showed signs of loss at conditional default rates
between 2.5 to 3.0 and had declines in fair value of 77% as compared to
their amortized cost. As a result, we do not believe it is
probable that we will receive all contractual cash flows for these
securities.
|
104
|
·
|
$2.5
million of ABS credit OTTI charges during 2009. These charges
related primarily to two bonds from the same issuer, who is currently in
technical default, that were previously written
down.
|
|
·
|
$1.3
million of corporate debt credit OTTI charges during 2009. In
assessing corporate debt securities for OTTI, we evaluate, among other
things, the issuer’s ability to meet its debt obligations, the value of
the company, and, if applicable, the value of specific collateral securing
the position. The charge taken in 2009 was related to a
financial institution issuer that was on the verge of bankruptcy at the
end of the second quarter of 2009. This security was sold
subsequent to the charge at an additional loss of $1.1 million in the
third quarter of 2009.
|
|
·
|
$2.1 million of equity charges
during 2009 related to seven equity securities. These seven
securities were comprised of two banks, one bank exchange traded fund, one
energy company, a membership warehouse chain of stores, and two healthcare
companies. We believe the share price weakness of these
securities is more reflective of general overall financial market
conditions, as we are not aware of any significant deterioration in the
fundamentals of these four companies. However, the length of
time these securities have been in an unrealized loss position, and the
overall distressed trading levels of these stocks make a recovery to our
cost basis unlikely in the near
term.
|
(i) The
components of net realized (losses) gains, excluding OTTI charges, were as
follows:
($
in thousands)
|
2009
|
2008
|
2007
|
|||||||||
HTM
fixed maturity securities
|
||||||||||||
Gains
|
$ | 225 | 27 | - | ||||||||
Losses
|
(1,049 | ) | (2 | ) | - | |||||||
AFS
fixed maturity securities
|
||||||||||||
Gains
|
20,899 | 1,777 | 445 | |||||||||
Losses
|
(13,889 | ) | (14,259 | ) | (2,260 | ) | ||||||
AFS
equity securities
|
||||||||||||
Gains
|
33,355 | 34,582 | 50,254 | |||||||||
Losses
|
(28,056 | ) | (14,677 | ) | (9,359 | ) | ||||||
Other
investments
|
||||||||||||
Gains
|
- | 1,356 | 847 | |||||||||
Losses
|
(2,039 | ) | (5,156 | ) | (1,683 | ) | ||||||
Total
other net realized investment gains (losses)
|
9,446 | 3,648 | 38,244 | |||||||||
Total
OTTI charges recognized in earnings
|
(55,416 | ) | (53,100 | ) | (4,890 | ) | ||||||
Total
net realized (losses) gains
|
$ | (45,970 | ) | (49,452 | ) | 33,354 |
Proceeds
from the sale of AFS securities were $676.0 million during 2009, $255.0 million
during 2008, and $289.9 million during 2007. Of the $13.9 million of
realized losses incurred from sales of AFS fixed maturity securities during
2009, $5.8 million was attributable to five securities on which we had taken
previous OTTI charges as we had the intention to sell these
securities. Additionally sales of AFS fixed maturity securities that
resulted in realized losses were driven by further declines in the issuers’
credit worthiness and liquidity.
In
addition to calls and maturities on HTM securities, we sold one HTM security
with a carrying value of $6.0 million for a loss of $0.2 million during the
second quarter of 2009. This security had experienced significant
deterioration in the issuer’s credit worthiness.
We sold
equity securities during 2009 with realized gains of $33.4 million and realized
losses of $28.1 million. This activity included the
following:
|
·
|
The
sale of certain equity securities in the first quarter of 2009, resulting
in a net realized loss of approximately $0.2 million, comprised of $19.7
million in realized gains and $19.0 million in realized losses, in an
effort to reduce overall portfolio risk. The decision to sell
these equity positions was in response to an overall year-to-date market
decline of approximately 24% by the end of the first week of
March. In addition, the Parent's market capitalization at that
time had decreased more than 50% since the latter part of January 2009,
which we believe to be due partially to investment community views of our
equity and equity-like investments. Our equity-like investments
include alternative investments, many of which report results to us on a
one quarter lag. Consequently, we believed the investment
community would wait to evaluate our results based on the knowledge they
had of the previous quarter's general market conditions. As a
result, we determined it was prudent to mitigate a portion of our overall
equity exposure. In determining which securities were to be
sold, we contemplated, among other things, security-specific
considerations with respect to downward earnings trends corroborated by
recent analyst reports, primarily in the energy, commodity, and
pharmaceutical sectors.
|
105
|
·
|
The
sale of certain equity securities in the second quarter of
2009. A.M. Best changed our ratings outlook from "Stable" to
"Negative" due, in part, to concerns over the risk in our investment
portfolio. To reduce this risk, we sold $31.1 million of equity
securities for a net loss of $0.6 million, which included gross gains of
$7.7 million and gross losses of $8.3
million.
|
Note 6. Comprehensive Income
(Loss)
The
components of comprehensive income (loss), both gross and net of tax, for 2009,
2008, and 2007 are as follows:
2009
|
||||||||||||
($
in thousands)
|
Gross
|
Tax
|
Net
|
|||||||||
Net
income
|
$ | 26,253 | (10,145 | ) | 36,398 | |||||||
Components
of other comprehensive income:
|
||||||||||||
Unrealized
gains on securities:
|
||||||||||||
Unrealized
holding gains during the period
|
102,514 | 35,880 | 66,634 | |||||||||
Portion
of OTTI recognized in OCI
|
(8,659 | ) | (3,030 | ) | (5,629 | ) | ||||||
Amortization
of net unrealized gains on HTM securities
|
914 | 320 | 594 | |||||||||
Reclassification adjustment for losses included in net
income
|
38,392 | 13,437 | 24,955 | |||||||||
Net
unrealized gains
|
133,161 | 46,607 | 86,554 | |||||||||
Defined
benefit pension and post-retirement plans:
|
||||||||||||
Net
actuarial gain
|
2,824 | 988 | 1,836 | |||||||||
Reversal
of amortization items:
|
||||||||||||
Net
actuarial loss
|
5,274 | 1,846 | 3,428 | |||||||||
Curtailment
gain
|
(1,387 | ) | (485 | ) | (902 | ) | ||||||
Prior
service credit
|
(508 | ) | (178 | ) | (330 | ) | ||||||
Defined
benefit pension and post-retirement plans
|
6,203 | 2,171 | 4,032 | |||||||||
Comprehensive
income
|
$ | 165,617 | 38,633 | 126,984 |
2008
|
||||||||||||
($
in thousands)
|
Gross
|
Tax
|
Net
|
|||||||||
Net
income
|
$ | 39,386 | (4,372 | ) | 43,758 | |||||||
Components
of other comprehensive income:
|
||||||||||||
Unrealized
gains on securities:
|
||||||||||||
Unrealized
holding gains during the period
|
(268,993 | ) | (94,148 | ) | (174,845 | ) | ||||||
Reclassification adjustment for losses included in net
income
|
49,477 | 17,317 | 32,160 | |||||||||
Net
unrealized losses
|
(219,516 | ) | (76,831 | ) | (142,685 | ) | ||||||
Defined
benefit pension and post-retirement plans:
|
||||||||||||
Net
actuarial loss
|
(60,272 | ) | (21,095 | ) | (39,177 | ) | ||||||
Prior
service credit
|
1,985 | 695 | 1,290 | |||||||||
Reversal
of amortization items:
|
||||||||||||
Net
actuarial loss
|
136 | 47 | 89 | |||||||||
Prior
service credit
|
(25 | ) | (9 | ) | (16 | ) | ||||||
Defined
benefit pension and post-retirement plans
|
(58,176 | ) | (20,362 | ) | (37,814 | ) | ||||||
Comprehensive
loss
|
$ | (238,306 | ) | (101,565 | ) | (136,741 | ) |
2007
|
||||||||||||
($
in thousands)
|
Gross
|
Tax
|
Net
|
|||||||||
Net
income
|
$ | 192,758 | 46,260 | 146,498 | ||||||||
Components
of other comprehensive income:
|
||||||||||||
Unrealized
gains on securities:
|
||||||||||||
Unrealized
holding gains during the period
|
2,140 | 749 | 1,391 | |||||||||
Reclassification adjustment for losses included in net
income
|
(33,354 | ) | (11,674 | ) | (21,680 | ) | ||||||
Net
unrealized losses
|
(31,214 | ) | (10,925 | ) | (20,289 | ) | ||||||
Defined
benefit pension and post-retirement plans:
|
||||||||||||
Net
actuarial gain
|
8,003 | 2,801 | 5,202 | |||||||||
Reversal
of amortization items:
|
||||||||||||
Net
actuarial loss
|
696 | 244 | 452 | |||||||||
Prior
service cost
|
118 | 41 | 77 | |||||||||
Defined
benefit pension and post-retirement plans
|
8,817 | 3,086 | 5,731 | |||||||||
Comprehensive
income
|
$ | 170,361 | 38,421 | 131,940 |
106
The
balances of and changes in each component of AOCI as of December 31, 2009 are as
follows (net of taxes):
2009
|
Defined
|
|||||||||||||||||||
Benefit
|
||||||||||||||||||||
Pension
|
||||||||||||||||||||
Net
Unrealized Gain (Loss)
|
and
Post
|
Total
|
||||||||||||||||||
OTTI
|
HTM
|
All
|
Retirement
|
Accumulated
|
||||||||||||||||
($
in thousands)
|
Related
|
Related
|
Other
|
Plans
|
OCI
|
|||||||||||||||
Balance,
December 31, 2008
|
$ | - | - | (54,836 | ) | (45,830 | ) | (100,666 | ) | |||||||||||
Adoption
of OTTI accounting guidance
|
(2,380 | ) | - | - | - | (2,380 | ) | |||||||||||||
2009
comprehensive income
|
(5,629 | ) | 11,937 | 80,246 | 4,032 | 90,586 | ||||||||||||||
Balance,
December 31, 2009
|
$ | (8,009 | ) | 11,937 | 25,410 | (41,798 | ) | (12,460 | ) |
Note 7. Fair Values
Measurements
The
following table presents the carrying amounts and estimated fair values of our
financial instruments as of December 31, 2009 and 2008:
December
31, 2009
|
December
31, 2008
|
|||||||||||||||
Carrying
|
Fair
|
Carrying
|
Fair
|
|||||||||||||
($
in thousands)
|
Amount
|
Value
|
Amount
|
Value
|
||||||||||||
Financial
Assets
|
||||||||||||||||
Fixed
maturity securities:
|
||||||||||||||||
HTM
|
$ | 1,710,403 | 1,740,211 | 1,163 | 1,178 | |||||||||||
AFS
|
1,635,869 | 1,635,869 | 3,034,278 | 3,034,278 | ||||||||||||
Equity
securities:
|
||||||||||||||||
AFS
|
80,264 | 80,264 | 132,131 | 132,131 | ||||||||||||
Trading
|
- | - | 2,569 | 2,569 | ||||||||||||
Short-term
investments
|
213,848 | 213,848 | 198,111 | 198,111 | ||||||||||||
Other
securities
|
- | - | 7,040 | 7,040 | ||||||||||||
Financial
Liabilities
|
||||||||||||||||
Notes
payable:1
|
||||||||||||||||
8.87%
Senior Notes Series B
|
12,300 | 12,300 | 24,600 | 25,592 | ||||||||||||
7.25%
Senior Notes
|
49,900 | 49,505 | 49,895 | 42,221 | ||||||||||||
6.70%
Senior Notes
|
99,406 | 90,525 | 99,383 | 72,000 | ||||||||||||
7.50%
Junior Notes
|
100,000 | 83,680 | 100,000 | 59,680 | ||||||||||||
Borrowings
from Federal Home Loan Bank
|
||||||||||||||||
of
Indianapolis (“FHLBI”)
|
13,000 | 13,000 | - | - | ||||||||||||
Total
notes payable
|
$ | 274,606 | 249,010 | 273,878 | 199,493 |
1 Our
notes payable are subject to certain debt covenants that were met in their
entirety in 2009 and 2008. For further discussion regarding the debt
covenants, refer to Note 10, “Indebtedness” in this Form 10-K.
For
further discussion regarding the fair value valuation techniques for our
financial instruments portfolio, refer to Note 2. “Summary of Significant
Accounting Policies” of this Form 10-K.
107
The
following tables provide quantitative disclosures of our financial assets that
were measured at fair value at December 31, 2009 and 2008:
December
31, 2009
|
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 12/31/09
|
(Level 1)
|
(Level
2)
|
(Level
3)
|
||||||||||||
Description
|
||||||||||||||||
U.S.
government and government agencies1
|
$ | 475,534 | 52,361 | 423,173 | - | |||||||||||
Obligations
of states and political subdivisions
|
379,799 | - | 379,799 | - | ||||||||||||
Corporate
securities
|
379,584 | - | 379,584 | - | ||||||||||||
ABS
|
27,047 | - | 27,047 | - | ||||||||||||
CMBS
|
94,623 | - | 94,623 | - | ||||||||||||
RMBS
|
279,282 | - | 279,282 | - | ||||||||||||
Total
fixed maturity securities
|
1,635,869 | 52,361 | 1,583,508 | - | ||||||||||||
Equity
securities
|
80,264 | 80,264 | - | - | ||||||||||||
Short-term
investments
|
213,848 | 213,848 | - | - | ||||||||||||
Measured
on a non-recurring basis:
|
||||||||||||||||
ABS
|
2,412 | - | 2,412 | - | ||||||||||||
CMBS
|
5,400 | - | 5,400 | - | ||||||||||||
Total
assets
|
$ | 1,937,793 | 346,473 | 1,591,320 | - | |||||||||||
1
U.S. government includes corporate securities fully guaranteed by the
FDIC.
|
December
31, 2008
|
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 12/31/08
|
(Level 1)
|
(Level 2)
|
(Level 3)
|
||||||||||||
Description
|
||||||||||||||||
Trading
securities:
|
||||||||||||||||
Equity
securities
|
$ | 2,569 | 2,569 | - | - | |||||||||||
AFS
securities:
|
||||||||||||||||
Fixed
maturity securities
|
3,034,278 | 94,811 | 2,939,467 | - | ||||||||||||
Equity
securities
|
132,131 | 132,131 | - | - | ||||||||||||
Short-term
investments
|
198,111 | 198,111 | - | - | ||||||||||||
Other
investments
|
7,040 | - | 7,040 | - | ||||||||||||
Measured
on a non-recurring basis:
|
||||||||||||||||
Goodwill
|
21,788 | - | - | 21,788 | ||||||||||||
Total
assets
|
$ | 3,395,917 | 427,622 | 2,946,507 | 21,788 |
As of
December 31, 2009, as the result of our OTTI analysis, we impaired approximately
$7.8 million of HTM securities down to fair value, which are typically not
carried at fair value. These securities consisted of: (i)
one ABS security, fair valued at $2.4 million; and (ii) six CMBS, fair valued at
$5.4 million. All of these fair values were determined using Level 2
pricing.
Certain
assets are measured at fair value on a nonrecurring basis. Due to the
economic deterioration that occurred during 2008 and 2009 in the U.S., our
near-term financial projections for our HR Outsourcing reporting unit were not
sufficient to support its carrying value during the fourth quarter of
2008. As a result, a pre-tax goodwill impairment loss of $4.0 million
was recognized for this reporting unit, which is included in “Loss from
discontinued operations, net of tax” in our Consolidated Statements of
Income. Fair value was determined using various inputs including, but
not limited to expected present value of future cash flows, comparison to
similar companies, and market multiples.
Fair
Value Option Election
On
January 1, 2008, we adopted the Fair Value Option of ASC Topic
825. This topic provides companies with an option to report selected
financial assets and liabilities at fair value (“fair value
option”). We elected to apply the fair value option to certain
securities that were being managed by an external manager at the time of
adoption. The securities for which we elected the fair value option
were previously held as AFS securities and were classified as trading securities
as of December 31, 2008. As of December 31, 2009, we no longer hold
equities classified as trading securities.
108
The
following table provides information regarding the reclassification and
corresponding cumulative-effect adjustment on retained earnings resulting from
the initial application of this topic for this portfolio:
Pre-Adoption
|
Impact of
|
Post-Adoption
|
||||||||||
Carrying/Fair
|
Fair Value
|
Carrying/Fair
|
||||||||||
Value at
|
Election
|
Value at
|
||||||||||
($ in thousands)
|
January 1, 2008
|
Adoption
|
January 1, 2008
|
|||||||||
Equity
securities:
|
||||||||||||
Available-for-sale
securities
|
$ | 274,705 | (25,113 | ) | 249,592 | |||||||
Trading
securities
|
- | 25,113 | 25,113 | |||||||||
Total
equity securities
|
$ | 274,705 | - | 274,705 |
Accumulated
|
||||||||||||
Other
|
||||||||||||
Retained
|
Comprehensive
|
|||||||||||
($ in thousands)
|
Earnings
|
Income
|
Total
|
|||||||||
Beginning
balance at January 1, 2008
|
$ | 1,105,946 | 86,043 | 1,191,989 | ||||||||
Pre-tax
cumulative effect of adoption of fair value option
|
9,554 | (9,554 | ) | - | ||||||||
Deferred
tax impact
|
(3,344 | ) | 3,344 | - | ||||||||
Adjusted
beginning balance at January 1, 2008
|
$ | 1,112,156 | 79,833 | 1,191,989 |
Note 8.
Reinsurance
Our
consolidated financial statements reflect the effects of assumed and ceded
reinsurance transactions. Assumed reinsurance refers to the
acceptance of certain insurance risks that other insurance entities have
underwritten. Ceded reinsurance involves transferring certain
insurance risks (along with the related written and earned premiums) that we
have underwritten to other insurance companies that agree to share these
risks. The primary purpose of ceded reinsurance is to protect our
company from potential losses in excess of the amount it is prepared to
accept.
The
Insurance Subsidiaries remain liable to policyholders to the extent that any
reinsurer becomes unable to meet our contractual obligations. We
evaluate and monitor the financial condition of our reinsurers under voluntary
reinsurance arrangements to minimize our exposure to significant losses from
reinsurer insolvencies. On an ongoing basis, we review amounts
outstanding, length of collection period, changes in reinsurer credit ratings
and other relevant factors to determine collectability of reinsurance
recoverables. The allowance for reinsurance recoverables on paid and
unpaid losses and loss expenses was $2.5 million at both December 31, 2009 and
December 31, 2008.
The
following table represents our total reinsurance balances segregated by
reinsurer to depict our concentration of risk throughout our reinsurance
portfolio:
As
of December 31, 2009
|
As
of December 31, 2008
|
|||||||||||||||
($
in thousands)
|
%
of Net
|
%
of Net
|
||||||||||||||
Reinsurance
|
Unsecured
|
Reinsurance
|
Unsecured
|
|||||||||||||
Balances
|
Reinsurance
|
Balances
|
Reinsurance
|
|||||||||||||
Total
Reinsurance Recoverables
|
$ | 276,018 | $ | 230,705 | ||||||||||||
Total
Prepaid Reinsurance Premiums
|
105,522 | 96,617 | ||||||||||||||
Less:
Collateral1
|
(59,885 | ) | (52,167 | ) | ||||||||||||
Net
Unsecured Reinsurance Balances
|
321,655 | 275,155 | ||||||||||||||
Federal and State
Pools2:
|
||||||||||||||||
NJ
Unsatisfied Claim Judgment Fund
|
65,347 | 20 | % | 60,716 | 22 | % | ||||||||||
National
Flood Insurance Program (“NFIP”)
|
119,245 | 37 | 111,466 | 41 | ||||||||||||
Other
|
5,695 | 2 | 6,081 | 2 | ||||||||||||
Total Federal and State
Pools
|
190,287 | 59 | 178,263 | 65 | ||||||||||||
Remaining
Unsecured Reinsurance
|
131,368 | 41 | 96,892 | 35 | ||||||||||||
Hannover
Ruckversicherungs AG (A.M. Best Rated “A”)
|
28,273 | 9 | 17,283 | 6 | ||||||||||||
Munich
Re Group (A.M. Best Rated “A+”)
|
28,659 | 9 | 22,083 | 8 | ||||||||||||
Swiss
Re Group (A.M. Best Rated “A”)
|
21,915 | 7 | 16,336 | 6 | ||||||||||||
All
other reinsurers
|
52,521 | 16 | 41,190 | 15 | ||||||||||||
Total
|
$ | 131,368 | 41 | % | $ | 96,892 | 35 | % | ||||||||
1
Includes letters of credit, trust funds, and funds
withheld.
|
||||||||||||||||
2
Considered to have minimal risk of default.
|
||||||||||||||||
Note:
Some amounts may not foot due to rounding
|
109
Under our
reinsurance arrangements, which are prospective in nature, reinsurance premiums
ceded are recorded as prepaid reinsurance and amortized over the remaining
contract period in proportion to the reinsurance protection provided, or
recorded periodically, as per the terms of the contract, in a direct
relationship to the gross premium recording. Reinsurance recoveries
are recognized as gross losses are incurred.
($
in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Premiums
written:
|
||||||||||||
Direct
|
$ | 1,657,142 | 1,702,147 | 1,736,740 | ||||||||
Assumed
|
22,784 | 22,463 | 30,018 | |||||||||
Ceded
|
(257,271 | ) | (231,872 | ) | (204,308 | ) | ||||||
Net
|
$ | 1,422,655 | 1,492,738 | 1,562,450 | ||||||||
Premiums
earned:
|
||||||||||||
Direct
|
$ | 1,657,911 | 1,694,510 | 1,685,167 | ||||||||
Assumed
|
21,501 | 27,115 | 31,783 | |||||||||
Ceded
|
(248,365 | ) | (217,438 | ) | (192,061 | ) | ||||||
Net
|
$ | 1,431,047 | 1,504,187 | 1,524,889 | ||||||||
Losses
and loss expenses incurred:
|
||||||||||||
Direct
|
$ | 1,065,594 | 1,113,416 | 1,084,541 | ||||||||
Assumed
|
14,794 | 17,852 | 22,595 | |||||||||
Ceded
|
(108,483 | ) | (119,724 | ) | (109,324 | ) | ||||||
Net
|
$ | 971,905 | 1,011,544 | 997,812 |
Assumed
premiums written remained flat in 2009 compared to 2008 and decreased in 2008
compared to 2007 primarily due to reduction in mandatory and voluntary pool
assumptions. Assumed premiums earned decreased in 2009 compared to
2008 and in 2008 compared to 2007, reflecting the assumed premiums written
changes mentioned above. Assumed losses decreased in each period
primarily due to a reduction in mandatory pool assumptions.
The
fluctuation in ceded premium (written and earned) and ceded losses were
primarily attributable charges in our Flood book of business, which is 100%
ceded to the NFIP. The associated amounts are as
follows:
($
in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Ceded
premiums written
|
$ | (178,934 | ) | (166,649 | ) | (143,404 | ) | |||||
Ceded
premiums earned
|
(171,941 | ) | (153,883 | ) | (132,041 | ) | ||||||
Ceded
losses and loss expenses incurred
|
(35,597 | ) | (91,257 | ) | (51,032 | ) |
Note 9. Reserves for Losses
and Loss Expenses
The table
below provides a roll forward of reserves for losses and loss expenses for
beginning and ending reserve balances:
($
in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Gross
reserves for losses and loss expenses, at beginning of
year
|
$ | 2,640,973 | 2,542,547 | 2,288,770 | ||||||||
Less:
reinsurance recoverable on unpaid loss and loss expenses, at beginning of
year
|
224,192 | 227,801 | 199,738 | |||||||||
Net
reserves for losses and loss expenses, at beginning of
year
|
2,416,781 | 2,314,746 | 2,089,032 | |||||||||
Incurred
losses and loss expenses for claims occurring in the:
|
||||||||||||
Current
year
|
1,001,333 | 1,030,852 | 1,016,656 | |||||||||
Prior
years
|
(29,428 | ) | (19,308 | ) | (18,844 | ) | ||||||
Total
incurred losses and loss expenses
|
971,905 | 1,011,544 | 997,812 | |||||||||
Paid
losses and loss expenses for claims occurring in the:
|
||||||||||||
Current
year
|
330,006 | 330,158 | 302,727 | |||||||||
Prior
years
|
584,491 | 579,351 | 469,371 | |||||||||
Total
paid losses and loss expenses
|
914,497 | 909,509 | 772,098 | |||||||||
Net
reserves for losses and loss expenses, at end of year
|
2,474,189 | 2,416,781 | 2,314,746 | |||||||||
Add: Reinsurance
recoverable on unpaid loss and loss expenses, at end of
year
|
271,610 | 224,192 | 227,801 | |||||||||
Gross
reserves for losses and loss expenses at end of year
|
$ | 2,745,799 | 2,640,973 | 2,542,547 |
The net
loss and loss expense reserves increased by $57.4 million in 2009, $102.0
million in 2008, and $225.7 million in 2007. The loss reserves
include anticipated recoveries for salvage and subrogation claims, which
amounted to $58.8 million for 2009, $55.9 million for 2008, and $52.3 million in
2007. The changes in the net loss and loss expense reserves were the
result of growth in exposures, anticipated loss trends, changes in reinsurance
retentions, as well as normal reserve development inherent in the uncertainty in
establishing reserves for losses and loss expenses. As additional
information is collected in the loss settlement process, reserves are adjusted
accordingly. These adjustments are reflected in the consolidated
statements of income in the period in which such adjustments are
recognized. These changes could have a material impact on the results
of operations of future periods when the adjustments are made.
110
In 2009,
we experienced favorable loss development of approximately $29 million, which
was primarily driven by favorable loss development in accident years 2007 and
prior, which was partially offset by unfavorable loss development in accident
year 2008 of $29 million. The main driver of this development was
favorable prior year development in our workers compensation, commercial
automobile and general liability lines of business. Workers
compensation experienced favorable prior year development of approximately $11
million primarily driven by favorable development of $36 million in accident
years 2005 to 2007 reflecting the on-going impact from a series of improvement
strategies for this line in recent years, partially offset by adverse
development of approximately $22 million due to higher than expected severity in
accident year 2008. Commercial automobile experienced favorable
development of approximately $10 million driven by lower than anticipated
severity emergence primarily in accident year 2007. General liability
experienced favorable development of approximately $8 million driven by
favorable loss emergence for accident years 2004 through 2007, partially offset
by adverse development in our products/completed operations
business.
In 2008,
we experienced favorable loss development of $19.3 million, which was primarily
driven by favorable loss development in accident years 2002 through 2006 of
$54.2 million partially offset by unfavorable loss development in accident year
2007 of $26.9 million as well as unfavorable development in accident years 2001
and prior of $8.0 million. The main driver of this development was
favorable prior year development in our workers compensation line of business,
partially offset by adverse prior year development in the general liability line
of business. Workers compensation experienced favorable prior year
development of $24 million primarily driven by favorable development in accident
years 2004 to 2006 as a result of the implementation of improvement strategies
for this line, partially offset by adverse prior year development in accident
year 2007. Prior year development for the commercial automobile line
of business was only minimally favorable reflecting the leveling off of
improvements in severity trends. Partially offsetting the favorable
loss development, the general liability line of business experienced adverse
prior year development of approximately $3 million reflecting normal volatility
in this line of business. The remaining lines of business, which
collectively contributed approximately $2 million of adverse development, do not
individually reflect any significant trends related to prior year
development.
In 2007,
we experienced favorable loss development in accident years 2002 through 2006 of
$61.7 million partially offset by unfavorable loss development in accident years
2001 and prior of $42.9 million, netting to total favorable prior year
development of $18.8 million. This development was primarily driven
by favorable prior year development in our commercial automobile, personal
automobile, and workers compensation lines of business partially offset by
adverse development in our homeowners and personal excess lines of
business. The commercial automobile line of business experienced
favorable prior year loss and loss expense reserve development of approximately
$19 million, which was primarily driven by lower than expected severity in
accident years 2004 through 2006. The personal automobile line of
business experienced favorable prior year development of approximately $10
million, due to lower than expected loss emergence for accident years 2005 and
prior, partially offset by higher severity in accident year 2006. The
workers compensation line of business experienced favorable prior year
development of approximately $4 million reflecting the implementation of a
series of improvement strategies for this line in recent accident years
partially offset by an increase in the tail factor related to medical inflation
and general development trends. The homeowners line of business
experienced adverse prior year loss and loss expense reserve development of
approximately $6 million driven by unfavorable trends in claims for groundwater
contamination caused by the leakage of certain underground oil storage
tanks. The personal excess line of business experienced adverse prior
year loss and loss expense reserve development of approximately $4 million in
2007, which was due to the impact of several significant losses on this small
line. The remaining lines of business, which collectively contributed
approximately $4 million of adverse development, do not individually reflect any
significant trends related to prior year development.
Reserves
established for liability insurance include exposure to environmental claims,
both asbestos and non-asbestos. These claims have arisen primarily
from insured exposures in municipal government, small non-manufacturing
commercial risk, and homeowners policies. The emergence of these
claims is slow and highly unpredictable. There are significant
uncertainties in estimating our exposure to environmental claims (for both case
and IBNR reserves) resulting from lack of historical data, long reporting
delays, uncertainty as to the number and identity of claimants and complex legal
and coverage issues. Legal issues that arise in environmental cases
include federal or state venue, choice of law, causation, admissibility of
evidence, allocation of damages and contribution among joint defendants,
successor and predecessor liability, and whether direct action against insurers
can be maintained. Coverage issues that arise in environmental cases
include the interpretation and application of policy exclusions, the
determination and calculation of policy limits, the determination of the
ultimate amount of a loss, the extent to which a loss is covered by a policy, if
at all, the obligation of an insurer to defend a claim and the extent to which a
party can prove the existence of coverage. Courts have reached
different and sometimes inconsistent conclusions on these legal and coverage
issues. We do not discount to present value that portion of our loss
reserves expected to be paid in future periods.
111
At
December 31, 2009, our reserves for environmental claims amounted to $50.5
million on a gross basis (including case reserves of $16.5 million and IBNR
reserves of $34.0 million) and $41.6 million on a net basis (including case
reserves of $11.4 million and IBNR reserves of $30.2 million). There
are a total of 1,366 environmental claims. Of these, 1,136 are
asbestos related, of which 440 are with 27 insureds in the wholesale and/or
retail of plumbing, electrical, and other building supplies with related case
reserves of $1.1 million. In addition, 647 asbestos claims are with
one insured, an asbestos gasket manufacturer with related case reserves of $0.9
million. During 2009, 1,030 asbestos claims were closed, which
accounted for approximately $0.1 million of the total asbestos paid of $0.8
million. The total case reserves for asbestos related claims amounted
to $2.9 million on a gross basis and $2.3 million on a net
basis. About 51 of the total environmental claims involve nine
landfill sites. The landfill sites account for case reserves of $8.1
million on a gross and $4.0 million on a net basis, and include reserves for
several sites that are currently listed on the National Priorities
List. The remaining claims, which account for $5.5 million of case
reserves on a gross and $5.0 million on a net basis, involve leaking underground
heating oil storage tanks and other latent environmental exposures.
The
following table details our exposures to various environmental
claims:
2009
|
||||||||
($
in millions)
|
Gross
|
Net
|
||||||
Asbestos
|
$ | 11.1 | 9.2 | |||||
Landfill
sites
|
21.6 | 16.3 | ||||||
Other1
|
17.8 | 16.1 | ||||||
Total
|
$ | 50.5 | 41.6 |
1 Consists
of leaking underground storage tanks, and other latent environmental
exposures.
IBNR
reserve estimation is often difficult because, in addition to other factors,
there are significant uncertainties associated with critical assumptions in the
estimation process such as average clean-up costs, third-party costs,
potentially responsible party shares, allocation of damages, insurer litigation
costs, insurer coverage defenses and potential changes to state and federal
statutes. Moreover, normal historically based actuarial approaches
are difficult to apply because relevant history is not available. In addition,
while models can be applied, such models can produce significantly different
results with small changes in assumptions.
The
following table provides a roll forward of gross and net environmental incurred
losses and loss expenses and related reserves thereon:
2009
|
2008
|
2007
|
||||||||||||||||||||||
($
in thousands)
|
Gross
|
Net
|
Gross
|
Net
|
Gross
|
Net
|
||||||||||||||||||
Asbestos
|
||||||||||||||||||||||||
Reserves
for losses and loss expenses at beginning of
year
|
$ | 14,269 | 12,969 | 14,955 | 13,655 | 14,164 | 12,863 | |||||||||||||||||
Incurred
losses and loss expenses
|
(2,418 | ) | (2,930 | ) | 672 | 579 | 1,943 | 1,845 | ||||||||||||||||
Less:
losses and loss expenses paid
|
(795 | ) | (795 | ) | (1,358 | ) | (1,265 | ) | (1,152 | ) | (1,053 | ) | ||||||||||||
Reserves
for losses and loss expenses at the end of
year
|
$ | 11,056 | 9,244 | 14,269 | 12,969 | 14,955 | 13,655 | |||||||||||||||||
Non-Asbestos
|
||||||||||||||||||||||||
Reserves
for losses and loss expenses at beginning of
year
|
$ | 37,246 | 31,124 | 43,741 | 37,716 | 36,547 | 33,615 | |||||||||||||||||
Incurred
losses and loss expenses
|
8,115 | 6,405 | 3,222 | 2,754 | 10,496 | 7,128 | ||||||||||||||||||
Less:
losses and loss expenses paid
|
(5,943 | ) | (5,171 | ) | (9,717 | ) | (9,346 | ) | (3,302 | ) | (3,027 | ) | ||||||||||||
Reserves
for losses and loss expenses at the end of year
|
$ | 39,418 | 32,358 | 37,246 | 31,124 | 43,741 | 37,716 | |||||||||||||||||
Total
Environmental Claims
|
||||||||||||||||||||||||
Reserves
for losses and loss expenses at beginning of
year
|
$ | 51,515 | 44,093 | 58,696 | 51,371 | 50,711 | 46,478 | |||||||||||||||||
Incurred
losses and loss expenses
|
5,697 | 3,475 | 3,894 | 3,333 | 12,439 | 8,973 | ||||||||||||||||||
Less:
losses and loss expenses paid
|
(6,738 | ) | (5,966 | ) | (11,075 | ) | (10,611 | ) | (4,454 | ) | (4,080 | ) | ||||||||||||
Reserves
for losses and loss expenses at the end of year
|
$ | 50,474 | 41,602 | 51,515 | 44,093 | 58,696 | 51,371 |
112
Note 10.
Indebtedness
(a) Notes
Payable
(1) On
September 25, 2006, we issued $100 million aggregate principal amount of 7.5%
Junior Subordinated Notes due 2066 ("Junior Notes"). The Junior Notes
will pay interest, subject to our right to defer interest payments for up to 10
years, on March 15, June 15, September 15, and December 15 of each year,
beginning December 15, 2006, and ending on September 27, 2066. On or
after September 26, 2011, the Junior Notes may be called at any time, in whole
or in part, at their aggregate principal amount, together with any accrued and
unpaid interest. The net proceeds of $96.8 million from the issuance
were used for general corporate purposes. There are no attached
financial debt covenants to which we are required to comply in regards to the
Junior Notes.
(2) On
November 3, 2005, we issued $100 million of 6.70% Senior Notes due
2035. These notes were issued at a discount of $0.7 million resulting
in an effective yield of 6.754% and pay interest on May 1 and November 1 each
year commencing on May 1, 2006. Net proceeds of approximately $50
million were used to fund an irrevocable trust to provide for certain payment
obligations in respect of our outstanding debt. The remainder of the
proceeds were used for general corporate purposes. The agreements
covering these notes contain a standard default cross-acceleration provision
that provides the 6.70% Senior Notes will enter a state of default upon the
failure to pay principal when due or upon any event or condition that results in
an acceleration of principal of any other debt instrument in excess of $10
million which we have outstanding concurrently with the 6.70% Senior
Notes. There are no attached financial debt covenants to which we are
required to comply in regards to these notes.
(3) On
November 15, 2004, we issued $50 million of 7.25% Senior Notes due
2034. These notes were issued at a discount of $0.1 million,
resulting in an effective yield of 7.27% and pay interest on May 15 and November
15 each year. We contributed $25.0 million of the bond proceeds to
the Insurance Subsidiaries as capital. The remainder of the proceeds
were used for general corporate purposes. The agreements covering
these notes contain a standard default cross-acceleration provision that
provides the 7.25% Senior Notes will enter a state of default upon the failure
to pay principal when due or upon any event or condition that results in an
acceleration of principal of any other debt instrument in excess of $10 million
which we have outstanding concurrently with the 7.25% Senior
Notes. There are no attached financial debt covenants to which we are
required to comply in regards to these notes.
(4) On
May 4, 2000, we entered into a $61.5 million note purchase agreement with
various private lenders covering the 8.87% Senior Notes. We have paid
$49.2 million in principal to date, in addition to accrued interest thereon, for
these notes. The final principal payment of $12.3 million is due on
May 4, 2010. The unpaid principal amount of the 8.87% Senior Notes,
which was $12.3 million at December 31, 2009 and $24.6 million at December 31,
2008, accrues interest and is payable semiannually on May 4 and November 4 of
each year, until the principal is paid in full. The agreements
covering these notes contain a standard default cross-acceleration provision
that provides the 8.87% Senior Notes will enter a state of default upon the
failure to pay principal when due or upon any event or condition that results in
an acceleration of principal, the election of directors to the Board, or a
mandatory repurchase of any other debt instrument in excess of $1 million which
we have outstanding concurrently with the 8.87% Senior Notes. In
addition to the above cross-acceleration provision covenants, the note purchase
agreement covering the 8.87% Senior Notes also contains financial debt covenants
that are reviewed quarterly. They include, but are not limited to, a
limitation on indebtedness, restricted ability to declare dividends, and net
worth maintenance. All of the covenants were met during 2009 and
2008. At December 31, 2009, the amount available for dividends to
stockholders under such restrictions was $303.6 million.
(5) In
the first quarter of 2009, Selective Insurance Company of the Southeast and
Selective Insurance Company of South Carolina (“Indiana Subsidiaries”) joined
and invested in the FHLBI, which provides them with access to additional
liquidity. The Indiana Subsidiaries’ aggregate investment is $0.7
million and this investment provides the ability to borrow up to 20 times the
total amount of the FHLBI common stock purchased with additional collateral, at
comparatively low borrowing rates. All borrowings from FHLBI are
required to be secured by certain investments. On December 15, 2009,
the Indiana Subsidiaries borrowed $9 million and $4 million, respectively, from
the FHLBI. The unpaid principal amount accrues interest of 2.9% and
is paid on the 15th of
every month. The principal amount is due on December 15,
2014.
The funds
borrowed by the Indiana Subsidiaries have been loaned to the Parent as of
December 31, 2009 and are being used for general corporate
purposes.
113
(b)
Short-Term Debt
During
the third quarter of 2009, the Parent terminated its previously existing line of
credit and entered into a new syndicated line of credit agreement on August 25,
2009. This new $30 million line of credit is syndicated between
Wachovia Bank N.A., a subsidiary of Wells Fargo & Company, as administrative
agent and Branch Banking and Trust Company (“Line of Credit”) and allows us to
increase our borrowings to $50 million with the approval of both lending
parties. We continue to monitor current news regarding the banking
industry, in general, and our lending partners, in particular, as, according to
the syndicated line of credit agreement, the obligations of the lenders to make
loans and to make payments are several and not joint. There were no
balances outstanding under this credit facility as of December 31,
2009.
The Line
of Credit agreement contains representations, warranties and covenants that are
customary for credit facilities of this type, including, without limitation,
financial covenants under which we are obligated to maintain a minimum
consolidated net worth, minimum combined statutory surplus, and maximum ratio of
consolidated debt to total capitalization, and covenants limiting our ability
to: (i) merge or liquidate; (ii) incur debt or liens; (iii) dispose
of assets; (iv) make investments and acquisitions; (v) repurchase common stock;
and (vi) engage in transactions with affiliates. The Line of Credit
permits collateralized borrowings by the Indiana Subsidiaries from the FHLBI so
long as the aggregate amount borrowed does not exceed 10% of the respective
Indiana Subsidiary’s admitted assets from the preceding calendar
year.
The table
below outlines information regarding certain of the covenants in the Line of
Credit:
As
of December 31, 2009
|
Required
as of
December
31, 2009
|
Actual
as of
December
31, 2009
|
||||
Consolidated
net worth
|
$777
million
|
$1.0
billion
|
||||
Statutory
Surplus
|
not
less than $700 million
|
$982
million
|
||||
Debt-to-capitalization
ratio
|
Not
to exceed 30%
|
21.5%
|
||||
A.M.
Best financial strength rating
|
Minimum
of A-
|
A+
|
In
addition to the above requirements, the syndicated line of credit agreement
contains a cross-default provision that provides that the line of credit will be
in default if we fail to comply with any condition, covenant or agreement
(including payment of principal and interest when due on any debt with an
aggregate principal amount of at least $10.0 million), which causes, or permits,
the acceleration of principal.
Note 11. Stockholders'
Equity
As of
December 31, 2009, we had 10.8 million shares reserved for various stock
compensation and purchase plans, retirement plans and dividend reinvestment
plans. As part of our ongoing capital management strategy, we
repurchase the Parent's stock from time-to-time. The following table
provides information regarding the purchase of the Parent's common stock during
the 2007-2009 reporting periods:
($
in thousands)
|
||||||||||||||||
Shares Purchased
|
Cost of Shares Purchased
|
|||||||||||||||
in Connection with
|
in Connection with
|
Shares Purchased
|
Cost of Shares Purchased
|
|||||||||||||
Restricted Stock Vestings
|
Restricted Stock Vestings
|
as Part of Publicly
|
as Part of Publicly
|
|||||||||||||
Period
|
And Stock Option
Exercises |
And Stock Option
Exercises |
Announced Plans
or Programs
|
Announced Plans
or Programs
|
||||||||||||
2009
|
191,858 | $ | 3,010 | - | $ | - | ||||||||||
2008
|
268,493 | $ | 6,290 | 1,770,534 | $ | 40,543 | ||||||||||
2007
|
354,456 | $ | 8,813 | 5,703,464 | $ | 143,305 |
Our
previously-authorized stock repurchase program expired on July 26,
2009.
On
January 30, 2007, the Board of Directors (the "Board") of the Parent declared a
two-for-one stock split of the Parent's common stock, par value $2.00 per share
in the form of a share dividend of one additional share of the Parent's common
stock for each outstanding share of the Parent's common stock issued by us (the
"Share Dividend"). The Share Dividend was paid on February 20, 2007
to shareholders of record as of the close of business on February 13,
2007.
114
Our
ability to declare and pay dividends on the Parent's common stock is dependent
on liquidity at the Parent coupled with the ability of the Insurance
Subsidiaries to declare and pay dividends, if necessary, and/or the availability
of other sources of liquidity to the Parent. Restrictions on the
ability of the Insurance Subsidiaries to pay dividends, without alternative
liquidity options, could materially affect our ability to pay dividends on
common stock. The dividends from the Insurance Subsidiaries are
subject to the regulatory limitations of the states in which the Insurance
Subsidiaries are domiciled: New Jersey, New York, Indiana, or
Maine. Based on the unaudited 2009 statutory financial statements,
the maximum ordinary dividends that can be paid to the Parent by the Insurance
Subsidiaries in 2010 are as follows:
($
in millions)
|
||||
Selective
Insurance Company of America
|
$ | 48.9 | ||
Selective
Way Insurance Company
|
20.0 | |||
Selective
Insurance Company of South Carolina
|
10.2 | |||
Selective
Insurance Company of the Southeast
|
6.9 | |||
Selective
Insurance Company of New York
|
7.3 | |||
Selective
Insurance Company of New England
|
1.3 | |||
Selective
Auto Insurance Company of New Jersey
|
6.4 | |||
Total
|
$ | 101.0 |
The
statutory capital and surplus of the Insurance Subsidiaries in excess of these
ordinary dividend amounts must remain with the Insurance Subsidiaries in the
absence of the approval of a request for an extraordinary
dividend. In each such jurisdiction, domestic insurers are prohibited
from paying "extraordinary dividends" without approval of the insurance
commissioner of the respective state. Additionally, New Jersey and
Indiana require notice of the declaration of any ordinary or extraordinary
dividend distribution. During the notice period, the relevant state
regulatory authority may disallow all or part of the proposed dividend if it
determines that the insurer's surplus, with regard to policyholders, is not
reasonable in relation to the insurer's outstanding liabilities and adequate for
our financial needs.
Note 12. 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 are subject to certain geographic
concentration. Approximately 27% of net premiums written are related
to insurance policies written in New Jersey.
Our
commercial and personal lines property and casualty insurance products are sold
through independent insurance agents.
As
discussed in Note 1. “Organization,” we revised our segments as follows in
2009:
|
·
|
During
the first quarter of 2009, we realigned our Flood operations to be part of
our Insurance Operations segment, which reflects how senior management
evaluates our results.
|
|
·
|
During
the fourth quarter of 2009, we disposed of Selective HR, which comprised
our HR Outsourcing segment. The results of Selective HR
operations are included in “Loss from discontinued operations, net of tax”
in our Consolidated Statements of Income. See Note 13.
“Discontinued Operations” for additional information on the
disposal.
|
We do not
aggregate any of our operating segments. All historical data
presented has been restated to reflect our current operating
segments. Our goodwill balance for our operating segments was $7.8
million at December 31, 2009 and December 31, 2008 related to our Insurance
Operations segment. The goodwill balance for our discontinued
operation was $21.8 million at December 31, 2008 and is reflected in “Assets
from discontinued operations” on the Consolidated Balance Sheets. See
Note 13. “Discontinued Operations” for information regarding the goodwill
impairment charge recognized in 2009.
We also
provide services to each other in the normal course of
business. These transactions, including transactions with our
discontinued operations, Selective HR, totaled $9.0 million in 2009, $13.8
million in 2008, and $17.8 million in 2007. These transactions were
eliminated in all consolidated statements. In computing the results
of each segment, we do not make adjustments for interest expense, net general
corporate expenses, or federal income taxes. We do not maintain
separate investment portfolios for the segments and therefore, do not allocate
assets to the segments.
115
The
following summaries present revenues from continuing operations (net investment
income and net realized gains on investments in the case of the Investments
segment) and pre-tax income from continuing operations for the individual
segments:
Revenue
from continuing operations by segment
|
||||||||||||
Years
ended December 31,
|
||||||||||||
($
in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Insurance
Operations:
|
||||||||||||
Net
premiums earned:
|
||||||||||||
Commercial
automobile
|
$ | 300,562 | 307,388 | 315,259 | ||||||||
Workers
compensation
|
263,490 | 308,618 | 325,636 | |||||||||
General
liability
|
362,479 | 396,066 | 410,024 | |||||||||
Commercial
property
|
197,665 | 196,189 | 190,681 | |||||||||
Business
owners’ policies
|
62,638 | 57,858 | 52,677 | |||||||||
Bonds
|
18,455 | 18,831 | 19,036 | |||||||||
Other
|
9,663 | 9,294 | 8,272 | |||||||||
Total
Commercial Lines
|
1,214,952 | 1,294,244 | 1,321,585 | |||||||||
Personal
automobile
|
133,320 | 132,845 | 132,944 | |||||||||
Homeowners
|
73,076 | 68,088 | 62,280 | |||||||||
Other
|
9,699 | 9,010 | 8,080 | |||||||||
Total
Personal Lines
|
216,095 | 209,943 | 203,304 | |||||||||
Total
net premiums earned
|
1,431,047 | 1,504,187 | 1,524,889 | |||||||||
Miscellaneous
income
|
10,440 | 2,610 | 5,833 | |||||||||
Total
Insurance Operations revenues
|
1,441,487 | 1,506,797 | 1,530,722 | |||||||||
Investments:
|
||||||||||||
Net
investment income
|
118,471 | 131,032 | 174,144 | |||||||||
Net
realized (losses) gains on investments
|
(45,970 | ) | (49,452 | ) | 33,354 | |||||||
Total
investment revenues
|
72,501 | 81,580 | 207,498 | |||||||||
Total
all segments
|
1,513,988 | 1,588,377 | 1,738,220 | |||||||||
Other
income
|
30 | 1,562 | 1,095 | |||||||||
Total
revenues from continuing operations
|
$ | 1,514,018 | 1,589,939 | 1,739,315 |
Income
from continuing operations, before federal income tax
|
||||||||||||
Years
ended December 31,
|
||||||||||||
($
in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Insurance
Operations:
|
||||||||||||
Commercial
lines underwriting income
|
$ | 14,388 | 10,815 | 46,754 | ||||||||
Personal
lines underwriting loss
|
(12,003 | ) | (10,683 | ) | (15,788 | ) | ||||||
Underwriting
income, before federal income tax
|
2,385 | 132 | 30,966 | |||||||||
GAAP
combined ratio
|
99.8 | % | 100.0 | 98.0 | ||||||||
Statutory
combined ratio
|
100.5 | % | 99.2 | 97.5 | ||||||||
Investments:
|
||||||||||||
Net
investment income
|
118,471 | 131,032 | 174,144 | |||||||||
Net
realized (losses) gains on investments
|
(45,970 | ) | (49,452 | ) | 33,354 | |||||||
Total
investment income, before federal income tax
|
72,501 | 81,580 | 207,498 | |||||||||
Total
all segments
|
74,886 | 81,712 | 238,464 | |||||||||
Interest
expense
|
(19,386 | ) | (20,508 | ) | (23,795 | ) | ||||||
General
corporate and other expenses
|
(16,314 | ) | (21,037 | ) | (25,905 | ) | ||||||
Income
from continuing operations, before federal income tax
|
$ | 39,186 | 40,167 | 188,764 |
116
Note 13. Discontinued
Operations
In the
fourth quarter of 2009, we sold 100% of our interest in Selective HR, which had
historically comprised the HR Outsourcing segment of our
operations. We sold our interest in Selective HR for proceeds to be
received over a 10-year period in the amount of $12.3 million, based on the
ability of the purchaser to retain and generate new worksite lives though the
independent agents who currently distribute the HR Outsourcing
products. The sale resulted in an after-tax loss of $1.2 million,
which is included in discontinued operations on the Consolidated Statements of
Income. Also included in discontinued operations on the Consolidated
Statements of Income are $7.1 million and $0.3 million of after-tax losses in
2009 and 2008, respectively and $2.9 million of after-tax profit in 2007,
reflecting the results of Selective HR’s operations prior to
divestiture. Included in the 2009 after-tax loss, is the impact of a
goodwill impairment charge of $7.9 million, after-tax, recognized in the third
quarter of 2009 which was the result of Selective HR’s estimated fair value
being not sufficient enough to support its carrying value.
We have
reclassified prior period amounts on the consolidated financial statements to
present the assets, liabilities, and operating results of Selective HR as a
discontinued operation.
Operating
results of discontinued operations are as follows:
($
in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Net
revenue
|
$ | 44,508 | 53,147 | 59,109 | ||||||||
Pre-tax
(loss) profit
|
(11,128 | ) | (781 | ) | 3,994 | |||||||
After-tax
(loss) profit
|
(7,086 | ) | (343 | ) | 2,862 |
Intercompany
transactions related to the discontinued operations are as follows:
($
in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Net
revenue
|
$ | 9,016 | 12,793 | 16,713 |
Assets of
discontinued operations are comprised of the following:
($
in thousands)
|
2008
|
|||
Cash
and cash equivalents
|
$ | 15,037 | ||
Other
trade receivables, net of allowance for uncollectible accounts of $164 -
2008
|
18,922 | |||
Property
and equipment – at cost, net of accumulated depreciation and amortization
of $3,276 - 2008
|
117 | |||
Goodwill
|
21,788 | |||
Other
assets
|
604 | |||
Total
assets from discontinued operations
|
$ | 56,468 |
Liabilities
of discontinued operations are comprised of the following:
($
in thousands)
|
2008
|
|||
Accrued
salaries and benefits
|
$ | 28,628 | ||
Other
liabilities
|
1,286 | |||
Current
federal income tax
|
266 | |||
Deferred
federal income tax
|
3,958 | |||
Total
liabilities from discontinued operations
|
$ | 34,138 |
117
Note 14. Earnings per
Share
The
following table provides a reconciliation of the numerators and denominators of
the basic and diluted earnings per share
("EPS")
computations of net income for the year ended:
2009
|
Income
|
Shares
|
Per
Share
|
|||||||||
($
in thousands, except per share amounts)
|
|
(Numerator)
|
(Denominator)
|
Amount
|
||||||||
Basic
EPS:
|
||||||||||||
Net
income from continuing operations
|
$ | 44,658 | 52,630 | $ | 0.84 | |||||||
Net
loss from discontinued operations
|
(7,086 | ) | 52,630 | (0.13 | ) | |||||||
Net
loss on disposal of discontinued operations
|
(1,174 | ) | 52,630 | (0.02 | ) | |||||||
Net
income available to common stockholders
|
$ | 36,398 | 52,630 | $ | 0.69 | |||||||
Effect
of dilutive securities:
|
||||||||||||
Restricted
stock
|
- | 302 | ||||||||||
Restricted
stock units
|
- | 171 | ||||||||||
Stock
options
|
- | 114 | ||||||||||
Deferred
shares
|
- | 180 | ||||||||||
Diluted
EPS:
|
||||||||||||
Net
income from continuing operations
|
$ | 44,658 | 53,397 | $ | 0.83 | |||||||
Net
loss from discontinued operations
|
(7,086 | ) | 53,397 | (0.13 | ) | |||||||
Net
loss on disposal of discontinued operations
|
(1,174 | ) | 53,397 | (0.02 | ) | |||||||
Net
income available to common stockholders and assumed
conversions
|
$ | 36,398 | 53,397 | $ | 0.68 |
2008
|
Income
|
Shares
|
Per
Share
|
|||||||||
($
in thousands, except per share amounts)
|
(Numerator)
|
(Denominator)
|
Amount
|
|||||||||
Basic
EPS:
|
||||||||||||
Net
income from continuing operations
|
$ | 44,101 | 52,104 | $ | 0.85 | |||||||
Net
loss from discontinued operations
|
(343 | ) | 52,104 | (0.01 | ) | |||||||
Net
income available to common stockholders
|
$ | 43,758 | 52,104 | $ | 0.84 | |||||||
Effect
of dilutive securities:
|
||||||||||||
Restricted
stock
|
- | 727 | ||||||||||
Restricted
stock units
|
- | 53 | ||||||||||
Stock
options
|
- | 247 | ||||||||||
Deferred
shares
|
- | 188 | ||||||||||
Diluted
EPS:
|
||||||||||||
Net
income from continuing operations
|
$ | 44,101 | 53,319 | $ | 0.83 | |||||||
Net
loss from discontinued operations
|
(343 | ) | 53,319 | (0.01 | ) | |||||||
Net
income available to common stockholders and assumed
conversions
|
$ | 43,758 | 53,319 | $ | 0.82 |
2007
|
Income
|
Shares
|
Per
Share
|
|||||||||
($
in thousands, except per share amounts)
|
(Numerator)
|
(Denominator)
|
Amount
|
|||||||||
Basic
EPS:
|
||||||||||||
Net
income from continuing operations
|
$ | 143,636 | 52,382 | $ | 2.75 | |||||||
Net
income from discontinued operations
|
2,862 | 52,382 | 0.05 | |||||||||
Net
income available to common stockholders
|
$ | 146,498 | 52,382 | $ | 2.80 | |||||||
Effect
of dilutive securities:
|
||||||||||||
Restricted
stock
|
- | 1,158 | ||||||||||
8.75%
convertible subordinated debentures
|
25 | 128 | ||||||||||
4.25%
senior convertible notes
|
1,268 | 2,931 | ||||||||||
Stock
options
|
- | 385 | ||||||||||
Deferred
shares
|
- | 181 | ||||||||||
Diluted
EPS:
|
||||||||||||
Net
income from continuing operations
|
$ | 144,929 | 57,165 | $ | 2.54 | |||||||
Net
income from discontinued operations
|
2,862 | 57,165 | 0.05 | |||||||||
Net
income available to common stockholders and assumed
conversions
|
$ | 147,791 | 57,165 | $ | 2.59 |
118
Note 15. Federal Income
Tax
(a) A
reconciliation of federal income tax on pre-tax earnings at the corporate rate
to the effective tax rate is as follows:
($
in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Tax
at statutory rate of 35%
|
$ | 13,715 | 14,058 | 66,067 | ||||||||
Tax-advantaged
interest
|
(18,205 | ) | (18,947 | ) | (19,246 | ) | ||||||
Dividends
received deduction
|
(513 | ) | (922 | ) | (1,213 | ) | ||||||
Nonqualified
deferred compensation
|
(721 | ) | 1,563 | (351 | ) | |||||||
Other
|
252 | 314 | (129 | ) | ||||||||
Federal
income tax (benefit) expense from continuing operations
|
$ | (5,472 | ) | (3,934 | ) | 45,128 |
(b) The
tax effects of the significant temporary differences that give rise to deferred
tax assets and liabilities are as follows:
($
in thousands)
|
2009
|
2008
|
||||||
Deferred
tax assets:
|
||||||||
Net
loss reserve discounting
|
$ | 97,655 | 95,444 | |||||
Net
unearned premiums
|
51,751 | 52,297 | ||||||
Employee
benefits
|
27,346 | 27,556 | ||||||
Long-term
incentive compensation plans
|
8,601 | 12,347 | ||||||
Unrealized
loss on available-for-sale securities
|
- | 29,527 | ||||||
Temporary
investment write-downs
|
10,595 | 12,811 | ||||||
Other
|
13,992 | 9,031 | ||||||
Total
deferred tax assets
|
209,940 | 239,013 | ||||||
Deferred
tax liabilities:
|
||||||||
Deferred
policy acquisition costs
|
76,227 | 74,156 | ||||||
Unrealized
gains on available-for-sale securities
|
13,044 | - | ||||||
Accelerated
depreciation and amortization
|
7,100 | 8,809 | ||||||
Other
|
2,531 | 5,289 | ||||||
Total
deferred tax liabilities
|
98,902 | 88,254 | ||||||
Net
deferred federal income tax asset
|
$ | 111,038 | 150,759 |
Based on
our federal tax loss carryback availability, expected levels of pre-tax
financial statement income and federal taxable income, we believe it is more
likely than not that the existing deductible temporary differences will reverse
during periods in which we generate net federal taxable income or have adequate
federal carryback availability. As a result, we have no valuation
allowance recognized for federal deferred tax assets at December 31, 2009 and
2008.
Stockholders'
equity reflects tax benefits related to compensation expense deductions for
stock options exercised of $17.4 million at December 31, 2009, $18.6 million at
December 31, 2008, and $17.0 million at December 31, 2007.
We have
analyzed our deferred tax positions in all open tax years, which as of December
31, 2009 were 2006, 2007 and 2008. Based on this analysis, we do not
have unrecognized tax benefits as of December 31, 2009. We believe
our tax positions will more likely than not be sustained upon examination,
including related appeals or litigation. In the event we had a tax
position that did not meet the more likely than not criteria, any tax, interest,
and penalties incurred related to such a position would be reflected in "Federal
income tax expense" on our Consolidated Statements of Income.
Note 16. Retirement
Plans
(a)
Retirement Savings Plan
Selective
Insurance Company of America ("SICA") offers a voluntary defined contribution
401(k) retirement savings plan to employees who meet eligibility
requirements. Participants, other than highly compensated employees
(“HCEs”) as defined by the IRS can contribute up to 50% of their defined
compensation to the Retirement Savings Plan. SICA limits the
contributions of HCEs. We match 65% of participant contributions up
to a maximum of 7% of defined compensation. Effective January 1, 2006, the
Selective Insurance Retirement Savings Plan ("Retirement Savings Plan") was
amended to include additional enhanced matching contributions and non-elective
contributions for otherwise eligible employees who, because of a date of hire
after December 31, 2005, are not eligible for the Retirement Income Plan for
Selective Insurance Company of America ("Retirement Income
Plan"). For those employees, following one year of service, we match,
dollar for dollar, up to 2% of the employee's defined
compensation. In addition, we make non-elective contributions to the
Retirement Savings Plan equal to 2% of the employee's defined
compensation. Employees age 50 or older who are contributing the
maximum may also make additional contributions not to exceed the additional
amount permitted by the IRS. Employer contributions plan amounted to
$6.0 million in 2009, $6.4 million in 2008, and $5.4 million in
2007.
119
The
Retirement Savings Plan allows employees to make voluntary contributions to a
number of diversified investment options on a before and/or after-tax
basis. The Parent’s common stock fund had been an investment option
but as of March 10, the Parent common stock fund was closed to new
contributions. Shares of the Parent's common stock issued under this
plan were 13,983 during 2009, 27,920 during 2008, and 29,214 during
2007.
(b)
Deferred Compensation Plan
SICA
offers a nonqualified deferred compensation plan ("Deferred Compensation Plan")
to a group of management or highly compensated employees (the "Participants") as
a method of recognizing and retaining such employees. The Deferred
Compensation Plan provides the Participants the opportunity to elect to defer
receipt of specified portions of compensation and to have such deferred amounts
deemed to be invested in specified investment options. A Participant
in the Deferred Compensation Plan may elect to defer compensation or awards to
be received, including up to: (i) 50% of annual base salary; (ii) 100% of annual
bonus; and/or (iii) a percentage of other compensation as otherwise designated
by the Administrator of the Deferred Compensation Plan.
In
addition to the deferrals elected by the Participants, we may also choose to
make matching contributions to the deferral accounts of some or all Participants
to the extent a Participant did not receive the maximum matching contribution
permissible under our Retirement Savings Plan due to limitations under the
Internal Revenue Code or the Retirement Savings Plan. We may also
choose at any time to make discretionary contributions to the deferral account
of any Participant in our sole discretion. No discretionary
contributions were made in 2009, 2008, or 2007. We contributed $0.1
million in 2009, $0.2 million in 2008, and $0.1 million 2007 to the Deferred
Compensation Plan.
(c)
Retirement Income and Post-retirement Plans
The
Retirement Income Plan is a noncontributory defined benefit retirement income
plan covering all SICA employees who meet eligibility requirements prior to
January 1, 2006. At such date, the plan was amended to eliminate
eligibility for plan participation by employees first hired on or after January
1, 2006. If otherwise qualified, these employees will, however, be
eligible for enhanced matching and non-elective contributions from SICA under
the Retirement Savings Plan as discussed above.
The
funding policy provides that payments to the pension trust shall be equal to the
minimum funding requirements of the Employee Retirement Income Security Act,
plus additional amounts that the Board of the plan sponsor, may approve from
time to time.
The
Retirement Income Plan was amended as of July 1, 2002 to provide for different
calculations based on service with the company as of that
date. Monthly benefits payable under the Retirement Income Plan and
Supplemental Excess Retirement Plan at normal retirement age are computed under
the terms of those agreements. The earliest retirement age is age 55
with 10 years of service or the attainment of 70 points (age plus years of
service). If a participant chooses to begin receiving benefits before
their 65th
birthday, the amount of their monthly benefit would be reduced in accordance
with the provisions of the plan. At retirement, participants receive
monthly pension payments and may choose among four joint and survivor payment
options.
Prior to
April 1, 2009, SICA provided a life insurance benefit (postretirement benefits)
for employees who terminated employment and met the age and service requirements
to otherwise be eligible for a benefit under the Retirement Income Plan
(“Retirees”). Retirees who terminated employment with SICA prior to
March 31, 2009 are eligible for a maximum life insurance benefit, depending upon
the Retiree’s date of termination ranging from $10,000 to
$100,000. On March 31, 2009, SICA eliminated the benefits under the
Retirement Life Plan to active employees. This elimination resulted
in a curtailment to the plan, the benefit of which was $4.2 million in the year
and was composed of: (i) a $2.8 million reversal of the Retirement
Life Plan liability; and (ii) a $1.4 million reversal of prior service credits
and net actuarial losses included in Accumulated Other Comprehensive
Loss.
120
The
funded status of these plans was recognized on the Consolidated Balance Sheets
for 2009 and 2008, the details of which are as follows:
December
31, 2009
|
Retirement Income Plan
|
Post-retirement Plan
|
||||||||||||||
($ in thousands)
|
2009
|
2008
|
2009
|
2008
|
||||||||||||
Change
in Benefit Obligation:
|
||||||||||||||||
Benefit
obligation, beginning of year
|
$ | 180,341 | 152,252 | 7,644 | 8,986 | |||||||||||
Service
cost
|
7,078 | 6,966 | 32 | 122 | ||||||||||||
Interest
cost
|
10,944 | 10,039 | 361 | 473 | ||||||||||||
Plan
amendments
|
- | - | - | (1,985 | ) | |||||||||||
Actuarial
losses
|
6,539 | 15,352 | 646 | 364 | ||||||||||||
Benefits
paid
|
(4,861 | ) | (4,268 | ) | (350 | ) | (316 | ) | ||||||||
Liability
gain due to curtailment
|
- | - | (2,830 | ) | - | |||||||||||
Benefit
obligation, end of year
|
$ | 200,041 | 180,341 | 5,503 | 7,644 | |||||||||||
Change
in Fair Value of Assets:
|
||||||||||||||||
Fair
value of assets, beginning year
|
$ | 117,258 | 147,995 | - | - | |||||||||||
Actual
return on plan assets, net of expenses
|
19,223 | (32,689 | ) | - | - | |||||||||||
Contributions
by the employer to funded plans
|
8,000 | 6,145 | - | - | ||||||||||||
Contributions
by the employer to unfunded plans
|
129 | 75 | - | - | ||||||||||||
Benefits
paid
|
(4,861 | ) | (4,268 | ) | - | - | ||||||||||
Fair
value of assets, end of year
|
$ | 139,749 | 117,258 | - | - | |||||||||||
Funded
status
|
(60,292 | ) | (63,083 | ) | (5,503 | ) | (7,644 | ) | ||||||||
Amounts
Recognized in the Consolidated Balance Sheet:
|
||||||||||||||||
Liabilities
|
(60,292 | ) | (63,083 | ) | (5,503 | ) | (7,644 | ) | ||||||||
Net
pension liability, end of year
|
$ | (60,292 | ) | (63,083 | ) | (5,503 | ) | (7,644 | ) | |||||||
Amounts
Recognized in Accumulated Other
|
||||||||||||||||
Comprehensive
(Loss) Income:
|
||||||||||||||||
Prior
service cost (credit)
|
$ | 476 | 626 | - | (2,045 | ) | ||||||||||
Net
actuarial loss
|
63,185 | 71,315 | 646 | 614 | ||||||||||||
Total
|
$ | 63,661 | 71,941 | 646 | (1,431 | ) | ||||||||||
Other
Information as of December 31:
|
||||||||||||||||
Accumulated
benefit obligation
|
$ | 171,552 | 152,744 | - | - | |||||||||||
Weighted-Average
Liability Assumptions as of
|
||||||||||||||||
December
31:
|
||||||||||||||||
Discount
rate
|
5.93 | 6.24 | % | 5.93 | 6.24 | |||||||||||
Rate
of compensation increase
|
4.00 | 4.00 | % | 4.00 | 4.00 |
121
Retirement
Income Plan
|
Post-retirement
Plan
|
|||||||||||||||||||||||
($
in thousands)
|
2009
|
2008
|
2007
|
2009
|
2008
|
2007
|
||||||||||||||||||
Components
of Net Periodic Benefit Cost and
|
||||||||||||||||||||||||
Other
Amounts Recognized in Other
|
||||||||||||||||||||||||
Comprehensive
Loss (Income):
|
||||||||||||||||||||||||
Net
Periodic Benefit Cost:
|
||||||||||||||||||||||||
Service
cost
|
$ | 7,078 | 6,966 | 7,454 | 32 | 122 | 317 | |||||||||||||||||
Interest
cost
|
10,944 | 10,039 | 8,963 | 361 | 473 | 495 | ||||||||||||||||||
Expected
return on plan assets
|
(9,214 | ) | (11,867 | ) | (11,092 | ) | - | - | - | |||||||||||||||
Amortization
of unrecognized prior service cost (credit)
|
150 | 150 | 150 | (44 | ) | (175 | ) | (32 | ) | |||||||||||||||
Amortization
of unrecognized actuarial loss
|
4,660 | 136 | 696 | - | - | - | ||||||||||||||||||
Special
termination benefits
|
- | - | 900 | - | - | 100 | ||||||||||||||||||
Curtailment
income
|
- | - | - | (4,217 | ) | - | - | |||||||||||||||||
Net
periodic cost
|
13,618 | 5,424 | 7,071 | (3,868 | ) | 420 | 880 | |||||||||||||||||
Other
Changes in Plan Assets and Benefit
|
||||||||||||||||||||||||
Obligations
Recognized in Other
|
||||||||||||||||||||||||
Comprehensive
Loss (Income):
|
||||||||||||||||||||||||
Net
actuarial loss (gain)
|
$ | (3,470 | ) | 59,908 | (7,728 | ) | 646 | 364 | (275 | ) | ||||||||||||||
Prior
service credit
|
- | - | - | - | (1,985 | ) | - | |||||||||||||||||
Reversal
of amortization of net actuarial loss
|
(4,660 | ) | (136 | ) | (696 | ) | (614 | ) | - | - | ||||||||||||||
Reversal
of amortization of prior service (cost) credit
|
(150 | ) | (150 | ) | (150 | ) | 2,045 | 175 | 32 | |||||||||||||||
Total
recognized in other comprehensive loss (income)
|
(8,280 | ) | 59,622 | (8,574 | ) | 2,077 | (1446 | ) | (243 | ) | ||||||||||||||
Total
recognized in net periodic benefit cost and
|
||||||||||||||||||||||||
other
comprehensive loss (income)
|
$ | 5,338 | 65,046 | (1,503 | ) | (1,791 | ) | (1,026 | ) | 637 |
In the
second quarter of 2007, we restructured our personal lines
department. As part of this restructuring, an early retirement
enhancement option was offered to eligible employees. The present
value of the enhancement to be made in conjunction with this early retirement
option was equal to $0.9 million for the Retirement Income Plan and $0.1 million
for the Post-retirement Plan.
The
amortization of prior service cost related to the Retirement Income Plan and
Post-retirement Plan is determined using a straight-line amortization of the
cost over the average remaining service period of employees expected to receive
benefits under the Plans.
The
estimated net actuarial loss and prior service cost for the Retirement Income
Plan that will be amortized from accumulated other comprehensive (loss) income
into net periodic benefit cost during the 2010 fiscal year are $3.7 million and
$0.2 million, respectively.
Retirement Income Plan
|
Post-retirement Plan
|
|||||||||||||||||||||||
($ in thousands)
|
2009
|
2008
|
2007
|
2009
|
2008
|
2007
|
||||||||||||||||||
Weighted-Average
Expense Assumptions for the years ended December 31:
|
||||||||||||||||||||||||
Discount
rate
|
6.24 | % | 6.50 | 5.90 | 6.24 | 6.50 | 5.90 | |||||||||||||||||
Expected
return on plan assets
|
8.00 | % | 8.00 | 8.00 | - | - | - | |||||||||||||||||
Rate
of compensation increase
|
4.00 | % | 4.00 | 4.00 | 4.00 | 4.00 | 4.00 |
Our
measurement date was December 31, 2009 and our expected return on plan assets
was 8.0%, which was based primarily on the Retirement Income Plan's long-term
historical returns. Our expected return approximates our actual 7.2%
annualized return achieved since plan inception for all plan
assets. We have kept our expected return on plan assets at 8.0% after
examining recent market conditions and trends. In addition to the
plan's historical returns, we consider long-term historical rates of return on
the respective asset classes.
Our 2009
discount rate used to value the liability is 5.93% for both the Retirement
Income Plan and the Post-retirement Plan. We determined the most
appropriate discount rate in comparison to our expected pay out patterns of the
plans' obligations.
122
Plan
Assets
Assets of
the Retirement Income Plan shall be invested to ensure that principal is
preserved and enhanced over time. In addition, the Retirement Income
Plan is expected to perform above average relative to comparable funds without
assuming undue risk, and to add value through active management. Our
return objective is to meet or exceed the returns of the plan's policy index,
which is the return the plan would have earned if the assets were invested
according to the target asset class weightings and earned index
returns. The Retirement Income Plan's exposure to a concentration of
credit risk is limited by the diversification of investments across varied
financial instruments, including common stocks, mutual funds, non-publicly
traded stocks, investments in limited partnerships, fixed income securities, and
short-term investments.
The
plan's allocated target and ranges by investment categories are as
follows:
Investment Category
|
Target
|
Range
|
||||||
Equity
|
||||||||
Large
Capitalization
|
24%
|
17%
- 31%
|
||||||
Small
and Mid Capitalization
|
10%
|
6%
- 14%
|
||||||
International
|
10%
|
6%
- 14%
|
||||||
Alternative
Investments
|
27%
|
20%
- 34%
|
||||||
Fixed
income
|
||||||||
Domestic
Core
|
16%
|
0%
- 21%
|
||||||
Global
Emerging Markets
|
13%
|
0%
- 18%
|
||||||
Liability
Driven Investments
|
12%
|
0%
- 45%
|
||||||
Cash
and Short-term Investments
|
0%
|
0%
- 5%
|
The fair
value of our Retirement Income Plan investments is generated using various
valuation techniques. We follow the methodology discussed in Note 2.
“Summary of Significant Accounting Policies,” regarding pricing and
valuation techniques, as well as the fair value hierarchy of equity and fixed
maturity securities held in the Retirement Income Plan. The remaining
assets, which primarily consist of investments in limited liability companies
and limited partnerships, are carried at fair value based on net asset
value. The majority of the net asset values are reported to us on a
one quarter lag. We assess whether these reported net asset values
are indicative of market activity that has occurred since the date of their
valuation by the investees by: (i) reviewing the overall market
fluctuation and whether a material impact to our investments' valuation could
have occurred; and (ii) routine conversations had with the underlying funds'
general partners/managers discussing, among other things, conditions or events
having significant impacts to their portfolio assets that have occurred
subsequent to the reported date, if any. The majority of these
investments cannot be redeemed with the investee as we are required to hold the
investments for the duration of the underlying funds' lives. As such,
these funds have been fair valued using Level 3 inputs as of December
31, 2009 using the net asset value of our ownership interest in partners'
capital. The Retirement Income Plan has one investment in a hedge
fund which can be redeemed semi-annually provided a 30 day notification of
intent to redeem. The net asset value is reported to us on a one
quarter lag, thus we are unable to redeem these investments at the net asset
value reported to us on December 31, 2009. However, management has
determined the time between reporting periods is not significant enough to allow
for a drastic change in fair value indications. As such these funds
have been fair valued using Level 2 inputs as of December 31, 2009 using the net
asset value of our ownership interest in partners' capital.
123
The
following tables provide quantitative disclosures of our pension plan assets
that are measured at fair value on a recurring basis:
December
31, 2009
|
Fair
Value Measurements at 12/31/09 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 12/31/09
|
(Level 1)
|
(Level 2)
|
(Level 3)
|
||||||||||||
Description
|
||||||||||||||||
Equities:
|
||||||||||||||||
Large
Capitalization
|
$ | 27,699 | 18,102 | 9,597 | - | |||||||||||
Small
and Mid Capitalization
|
13,139 | 13,139 | - | - | ||||||||||||
International
Equities
|
12,666 | 12,666 | - | - | ||||||||||||
Total
equity securities:
|
53,504 | 43,907 | 9,597 | - | ||||||||||||
Fixed
Income securities:
|
||||||||||||||||
Domestic
Core
|
26,883 | 26,883 | - | - | ||||||||||||
Global
Emerging Markets
|
21,490 | 21,490 | - | - | ||||||||||||
Liability
Driven Investment
|
10,383 | 10,383 | - | - | ||||||||||||
Total
fixed income securities
|
58,756 | 58,756 | - | - | ||||||||||||
Alternative
Investments:
|
||||||||||||||||
Equity
Long/Short Hedge
|
1,680 | - | 1,680 | |||||||||||||
Private
Equity
|
15,691 | - | - | 15,691 | ||||||||||||
Real
Estate
|
3,073 | - | - | 3,073 | ||||||||||||
Total
Alternative Investments
|
20,444 | - | 1,680 | 18,764 | ||||||||||||
Cash
and Short-term Investments
|
7,045 | 7,045 | - | - | ||||||||||||
Total
assets
|
$ | 139,749 | 109,708 | 11,277 | 18,764 |
The
following table provides a summary of the changes in fair value of securities
using significant unobservable inputs (Level 3):
December
31, 2009
|
Private
|
Real
|
||||||
($ in thousands)
|
Equity
|
Estate
|
||||||
Fair
Value, December 31, 2008
|
$ | 16,378 | 4,742 | |||||
Actual
return on plan assets:
|
||||||||
Related
to assets still held at December 31, 2009
|
(889 | ) | (2,419 | ) | ||||
Related
to assets sold during 2009
|
- | - | ||||||
Purchases,
sales, issuances, and settlements (net)
|
202 | 750 | ||||||
Transfers
in and/or out of Level 3
|
- | - | ||||||
Fair
Value, December 31, 2009
|
$ | 15,691 | 3,073 |
The
following table outlines a summary of our alternative investment portfolio by
strategy and the remaining commitment amount associated with each
strategy:
Alternative
Investments
|
Carrying
Value
|
2009
|
||||||||||
December
31,
|
December
31,
|
Remaining
|
||||||||||
($ in millions)
|
2009
|
2008
|
Amount
|
|||||||||
Equity
Long/Short Hedge
|
$ | 1.7 | 15.3 | - | ||||||||
Private
Equity
|
15.7 | 16.4 | 7.8 | |||||||||
Real
Estate
|
3.1 | 4.7 | 1.2 | |||||||||
Total
Alternative Investments
|
$ | 20.5 | 36.4 | 9.0 |
For a
description of our private equity and real estate strategies, refer to Note 5.
Investments. Our Equity Long/Short Hedge strategy invests
opportunistically in equities and equity-related instruments in companies
generally in the financial services sector. Investments within this
strategy are permitted to be sold short in order to: (i)
prospectively benefit from a correction in overvalued equities; and (ii)
partially hedge portfolio assets due to the strategy’s heavy weighting toward
the financial sector.
124
At this
time, the Retirement Income Plan’s alternative investment portfolio includes one
hedge fund. Redemption from this investment is permitted
semi-annually on June 30th and
December 31st subject
to a 30-day notice of intent to redeem. Management currently does not
intend to redeem its investment in this strategy in the near
term. For the remainder of the alternative investments, we are
currently committed for the full life of each fund and cannot redeem our
investment with the general partner. Once liquidation is triggered by
clauses within the limited partnership agreements or at the funds' stated end
date, we will receive our final allocation of capital and any earned
appreciation of the underlying investments. Management does not
intend to sell these investments in the secondary market in the near
term. At December 31, 2009, we have contractual obligations that
expire at various dates through 2022 to further invest up to $9.0 million in
alternative investments. There is no certainty that any such
additional investment will be required. We currently receive
distributions from these alternative investments through the realization of the
underlying investments in the limited partnerships. We anticipate
that the general partners of these alternative investments will liquidate their
underlying investment portfolios up through 2022.
Additionally,
the portfolio may not contain investments in any one security or
issuer greater than 5% of the portfolio value, regardless of the number of
differing issues, except for U.S. Treasury and agency obligations, as well as
sovereign debt issues rated A through AAA. The use of leverage is
prohibited and the fund managers are prohibited from investing in certain types
of securities.
The
weighted average asset allocation by percentage of the Retirement Income Plan at
December 31 is as follows:
2009
|
2008
|
|||||||
Equities:
|
||||||||
Large
Capitalization
|
20 | % | 19 | |||||
Small
and Mid Capitalization
|
9 | 7 | ||||||
International
|
9 | 8 | ||||||
Fixed
income:
|
||||||||
Domestic
Core
|
19 | 20 | ||||||
Global
Emerging Markets
|
15 | 14 | ||||||
Liability
Driven Funds
|
8 | |||||||
Alternative
Investments
|
15 | 31 | ||||||
Cash
and Short-term Investments
|
5 | 1 | ||||||
Total
|
100 | % | 100 |
The
Retirement Income Plan had no investments in the Parent’s common stock as of
December 31, 2009 and 2008.
Contributions
We
presently anticipate contributing $8.0 million to the Retirement Income Plan in
2010, none of which represents minimum required contribution
amounts.
($ in thousands)
|
Retirement Income Plan
|
Post-retirement Plan
|
||||||
Benefits
Expected to be Paid in Future
|
||||||||
Fiscal
Years:
|
||||||||
2010
|
$ | 5,610 | 324 | |||||
2011
|
6,518 | 343 | ||||||
2012
|
7,117 | 351 | ||||||
2013
|
7,837 | 360 | ||||||
2014
|
8,583 | 368 | ||||||
2015-2019
|
57,295 | 1,945 |
Note 17. Share-Based
Payments
The
following is a brief description of each of our share-based compensation
plans:
2005 Omnibus Stock
Plan
The
Parent's 2005 Omnibus Stock Plan ("Stock Plan") was adopted and approved by the
Board effective as of April 1, 2005, and approved by stockholders on April 27,
2005. With the Stock Plan's approval, no further grants are available
under the: (i) Parent's Stock Option Plan III, as amended ("Stock
Option Plan III"); (ii) Parent's Stock Option Plan for Directors, as amended
("Stock Option Plan for Directors"); or (iii) Parent's Stock Compensation Plan
for Non-employee Directors, as amended ("Stock Compensation Plan for
Non-employee Directors"), but awards outstanding under these plans and the Stock
Option Plan II, under which future grants ceased being available on May 22,
2002, shall continue in effect according to the terms of those plans and any
applicable award agreements.
125
Under the
Stock Plan, the Board's Salary and Employee Benefits Committee ("SEBC") may
grant stock options, stock appreciation rights ("SARs"), restricted stock,
restricted stock units ("RSUs"), phantom stock, stock bonuses, and other awards
in such amounts and with such terms and conditions as it shall determine,
subject to the provisions of the Stock Plan. Each award granted under
the Stock Plan (except unconditional stock bonuses and the cash component of
Director compensation) shall be evidenced by an agreement containing such
restrictions as the SEBC may, in its sole discretion, deem necessary or
desirable and which are not in conflict with the terms of the Stock
Plan. The maximum exercise period for an option grant under this plan
is ten years from the date of the grant. During 2009, we granted, net
of forfeitures, 520,011 RSUs, and experienced net restricted stock forfeitures
of 7,168 shares. During 2008, we granted, net of forfeitures, 382,521
RSUs, and experienced net restricted stock forfeitures of
45,240. During 2007, we granted, net of forfeitures, 478,862 shares
of restricted stock. We also granted options to purchase 313,811
shares during 2009, 191,568 shares during 2008, and 158,435 shares during
2007. As of December 31, 2009, 2,688,518 shares of the Parent's
common stock remain available for issuance pursuant to outstanding stock options
and restricted stock awards granted under the Stock Plan.
During
the vesting period, dividend equivalent units ("DEUs") are earned on the
RSUs. The DEUs are reinvested in the Parent's common stock at fair
value on each dividend payment date. We accrued 32,088 and 8,667 DEUs
in relation to the RSUs granted in 2009 and 2008, respectively. The
DEUs are subject to the same vesting period and conditions set forth in the
award agreement for the RSUs.
Cash Incentive
Plan
The
Parent's Cash Incentive Plan was adopted and approved by the Board effective
April 1, 2005 and approved by stockholders on April 27, 2005. Under
the Cash Incentive Plan, the Board's SEBC may grant cash incentive units in such
amounts and with such terms and conditions as it shall determine, subject to the
provisions of the Cash Incentive Plan. The initial dollar value of
these grants will be adjusted to reflect the percentage increase or decrease in
the total shareholder return on the Parent's common stock over a specified
performance period. In addition, for certain grants, the number of
units granted will be adjusted to reflect our performance on specified
indicators as compared to targeted peer companies. Each award granted
under the Cash Incentive Plan shall be evidenced by an agreement containing such
restrictions as the SEBC may, in its sole discretion, deem necessary or
desirable and which are not in conflict with the terms of the Cash Incentive
Plan. During 2009, we issued, net of forfeitures, 46,349 cash units,
48,890 cash units during 2008, and 38,681 cash units during 2007.
Stock Option Plan
II
As of
December 31, 2009, 400,742 shares of the Parent's common stock remain available
for issuance pursuant to outstanding stock options and restricted stock awards
granted under Stock Option Plan II, under which future grants ceased being
available on May 22, 2002. Under Stock Option Plan II, employees were
granted qualified and nonqualified stock options, with or without SARs, and
restricted or unrestricted stock: (i) at not less than fair value on
the date of grant and (ii) subject to certain vesting periods as determined by
the SEBC. Restricted stock awards also could be subject to the
achievement of performance objectives as determined by the SEBC. The
maximum exercise period for an option grant under this plan is ten years from
the date of the grant.
During
the vesting period, dividends are earned on the restricted shares and held in
escrow subject to the same vesting period and conditions set forth in the award
agreement. Effective September 3, 1996, dividends earned on the
restricted shares were reinvested in the Parent's common stock at fair
value. We experienced net forfeitures of 679 restricted shares from
Dividend Reinvestment Plan (“DRP”) reserves during 2009. We issued,
net of forfeitures, 255 restricted shares from the DRP reserves during 2008 and
539 restricted shares from the DRP reserves during 2007.
Stock Option Plan
III
As of
December 31, 2009, there were 426,212 shares of the Parent's common stock
available for issuance pursuant to outstanding stock options and restricted
stock awards granted under Stock Option Plan III, under which future grants
ceased being available with the approval of the Stock Plan. Under
Stock Option Plan III, employees were granted qualified and nonqualified stock
options, with or without SARs, and restricted or unrestricted
stock: (i) at not less than fair value on the date of grant and (ii)
subject to certain vesting restrictions determined by the
SEBC. Restricted stock awards also could be subject to achievement of
performance objectives as determined by the SEBC. The maximum
exercise period for an option grant under this plan is 10 years from the date of
the grant.
126
We
experienced restricted stock forfeitures of 1,924 shares during 2009, 21,532
shares during 2008 and 25,128 shares during 2007. During the vesting
period, dividends earned on restricted shares are reinvested in the Parent's
common stock at fair value. We experienced net forfeitures of 23,285
restricted shares from the DRP reserve during 2009. We issued, net of
forfeitures, 1,017 restricted shares during 2008, and 11,694 restricted shares
during 2007 from the DRP reserve.
Stock Option Plan for
Directors
As of
December 31, 2009, 336,000 shares of the Parent's common stock were available
for issuance pursuant to outstanding stock option awards under the Stock Option
Plan for Directors, under which future grants ceased being available with the
approval of the Stock Plan. All non-employee directors participated
in this plan and automatically received an annual nonqualified option to
purchase 6,000 shares of the Parent's common stock at not less than fair value
on the date of grant, which was on March 1. Options under this plan
vested on the first anniversary of the grant and must be exercised by the tenth
anniversary of the grant.
Stock Compensation Plan-for
Non-employee Directors
As of
December 31, 2009, there were 94,290 shares of the Parent's common stock
available for issuance pursuant to outstanding stock option awards under the
Stock Compensation Plan for Non-employee Directors, under which future grants
ceased being available with the approval of the Stock Plan. Under the
Stock Compensation Plan for Non-employee Directors, Directors could elect to
receive a portion of their annual compensation in shares of the Parent's common
stock. We issued 960 shares during 2009. There were no
issuances under this plan in 2008 and 2007.
Employee Stock Purchase
Savings Plan
On April
29, 2009, our stockholders’ approved the Employee Stock Purchase plan (2009)
(“ESPP”). This plan replaced the previous employee stock purchase
savings plan under which no further purchases could be made as of July 1,
2009. Under ESPP, there were 1,404,195 shares of the Parent's common
stock available for purchase as of December 31, 2009. The ESPP is
available to all employees who meet the plan's eligibility
requirements. The ESPP provides for the issuance of options to
purchase shares of common stock. The purchase price is the lower
of: (i) 85% of the closing market price at the time the option is
granted or (ii) 85% of the closing price at the time the option is
exercised. Shares are generally issued on June 30 and December 31 of
each year. Collectively, under the current and prior plans, we issued
190,845 shares to employees during 2009, 134,561 shares during 2008, and 108,062
shares during 2007.
Agent Stock Purchase
Plan
On April
26, 2006, our stockholders approved the Stock Purchase Plan for Independent
Insurance Agencies ("Agent Plan"). This plan replaced the previous
agent purchase plan under which no further purchases could be made as of July 1,
2006. Under the Agent Plan, there were 2,494,901 shares of common
stock available for purchase as of December 31, 2009. The Agent Plan
provides for quarterly offerings in which independent insurance agencies and
certain eligible persons associated with the agencies with contracts with the
Insurance Subsidiaries can purchase the Parent's common stock at a 10% discount
with a one year restricted period during which the shares purchased cannot be
sold or transferred. Under the Agent Plan, we issued to agents
146,570 shares in 2009, 137,264 shares in 2008 and 157,375 shares in 2007 and
charged to expense $0.2 million in 2009, $0.3 million in 2008, and $0.4 million
in 2007, with a corresponding income tax benefit of $0.1 million in each
year.
A summary
of the stock option transactions under our share-based payment plans is as
follows:
Weighted
|
||||||||||||||||
Weighted
|
Average
|
|||||||||||||||
Average
|
Remaining
|
Aggregate
|
||||||||||||||
Number
|
Exercise
|
Contractual
|
Intrinsic
Value
|
|||||||||||||
of Shares
|
Price
|
Life in Years
|
($ in thousands)
|
|||||||||||||
Outstanding
at December 31, 2008
|
1,158,847 | $ | 18.73 | |||||||||||||
Granted
2009
|
313,811 | 13.43 | ||||||||||||||
Exercised
2009
|
57,757 | 8.87 | ||||||||||||||
Forfeited
or expired 2009
|
33,551 | 20.41 | ||||||||||||||
Outstanding
at December 31, 2009
|
1,381,350 | $ | 17.90 | 5.70 | $ | 2,982 | ||||||||||
Exercisable
at December 31, 2009
|
1,028,709 | $ | 18.63 | 4.62 | $ | 2,126 |
The total
intrinsic value of options exercised was $0.4 million during December 31, 2009,
$2.8 million during December 31, 2008, and $1.9 million during December 31,
2007.
127
A summary
of the restricted stock and RSU transactions under our share-based payment plans
is as follows:
Weighted
|
||||||||
Average
|
||||||||
Number
|
Exercise
|
|||||||
of Shares
|
Price
|
|||||||
Unvested
restricted stock and RSU awards at January 1, 2009
|
1,120,033 | $ | 24.67 | |||||
Granted
2009
|
528,942 | 14.22 | ||||||
Vested
2009
|
508,476 | 24.59 | ||||||
Forfeited
2009
|
18,023 | 22.14 | ||||||
Unvested
restricted stock and RSU awards at December 31, 2009
|
1,122,476 | $ | 19.83 |
As of
December 31, 2009, total unrecognized compensation cost related to non-vested
restricted stock and RSU awards granted under our stock plans was $4.7
million. That cost is expected to be recognized over a
weighted-average period of 1.7 years. The total fair value of
restricted stock and RSU vested was $7.9 million for 2009, $14.2 million for
2008, and $22.7 million for 2007. In connection with the restricted
stock vestings, the total fair value of the DRP shares that also vested was $0.6
million during 2008 and $1.1 million during 2007.
At
December 31, 2009, the liability recorded in connection with our Cash Incentive
Plan was $6.0 million. The fair value of the liability is re-measured
at each reporting period through the settlement date of the awards, which is
three years from the date of grant based on an amount expected to be
paid. A Monte Carlo simulation is performed to determine the fair
value of the cash incentive units that, in accordance with the Cash Incentive
Plan, are adjusted to reflect our performance on specified indicators as
compared to targeted peer companies. The remaining cost associated
with the cash incentive units is expected to be recognized over a weighted
average period of 1.5 years. During 2009, the cash incentive payment
made was $7.0 million. In 2008 and 2007, no cash incentive unit
payments were made.
In
determining expense to be recorded for stock options granted under our
share-based compensation plans, the fair value of each option award is estimated
on the date of grant using the Black Scholes option valuation model ("Black
Scholes"). The following are the significant assumptions used in
applying Black Scholes: (i) risk-free interest rate, which is the
implied yield currently available on U.S. Treasury zero-coupon issues with an
equal remaining term; (ii) expected term, which is based on historical
experience of similar awards; (iii) dividend yield, which is determined by
dividing the expected per share dividend during the coming year by the grant
date stock price; and (iv) expected volatility, which is based on the volatility
of the Parent's stock price over a historical period comparable to the expected
term. In applying Black Scholes, we use the weighted average
assumptions illustrated in the following table:
Employee Stock Purchase
Plan
|
All Other Option Plans
|
|||||||||||||||||||||||
2009
|
2008
|
2007
|
2009
|
2008
|
2007
|
|||||||||||||||||||
Risk-free
interest rate
|
0.31 | % | 2.77 | % | 5.11 | % | 1.85 | % | 2.97 | % | 4.67 | % | ||||||||||||
Expected
term
|
6
months
|
6
months
|
6
months
|
5
years
|
6
years
|
6
years
|
||||||||||||||||||
Dividend
yield
|
3.4 | % | 2.5 | % | 1.7% | % | 3.9 | % | 2.2% | % | 1.8 | % | ||||||||||||
Expected
volatility
|
64 | % | 38 | % | 17 | % | 32 | % | 25 | % | 23 | % |
The
expense recorded for restricted stock awards and stock compensation for
non-employee directors is determined using the number of awards granted and the
grant date fair value and is amortized over the requisite service
period.
The
weighted-average fair value of options and stock, including restricted stock and
RSUs granted per share for the Parent's stock plans, during 2009, 2008, and 2007
is as follows:
($ in millions)
|
2009
|
2008
|
2007
|
|||||||||
Stock
options
|
$ | 2.68 | 5.43 | 7.02 | ||||||||
Restricted
stock and RSUs
|
14.22 | 23.11 | 27.30 | |||||||||
Directors’
stock compensation plan
|
15.11 | 22.70 | 25.57 | |||||||||
Employee
stock purchase plan (ESPP):
|
||||||||||||
Six
month option
|
2.51 | 2.02 | 1.47 | |||||||||
15%
of grant date market value
|
2.49 | 2.83 | 3.72 | |||||||||
Total
ESPP
|
5.00 | 4.85 | 5.19 | |||||||||
Agent
stock purchase plan:
|
||||||||||||
Discount
of grant date market value
|
1.39 | 2.24 | 2.40 |
128
Share-based
compensation expense charged against net income before tax was $10.8 million for
the year ended December 31, 2009 with a corresponding income tax benefit of $3.4
million. Share-based compensation expense that was charged against
net income before tax was $16.9 million for the year ended December 31, 2008 and
$20.6 million for the year ended December 31, 2007 with a corresponding income
tax benefit of $5.5 million and $6.8 million, respectively.
Note 18. Related Party
Transactions
William
M. Rue, a Director of the Parent, is President of, and owns more than 10% of the
equity of, Chas. E. Rue & Sons, Inc.
t/a Rue Insurance, a general independent insurance agency ("Rue
Insurance"). Rue Insurance is an appointed independent agent of the
Insurance Subsidiaries and of the recently discontinued operations of Selective
HR, on terms and conditions similar to those of our other agents. Rue
Insurance also places insurance for our business operations. Our
relationship with Rue Insurance has existed since 1928.
The
following is a summary of transactions with Rue Insurance:
|
·
|
Rue
Insurance placed insurance policies with the Insurance
Subsidiaries. Direct premiums written associated with these
policies were $7.6 million in 2009, $8.3 million in 2008, and $9.9 million
in 2007. In return, the Insurance Subsidiaries paid commissions
to Rue Insurance of $1.4 million in 2009, $1.7 million in 2008 and
2007.
|
|
·
|
Rue
Insurance placed human resource outsourcing contracts with Selective HR
resulting in revenues to Selective HR of approximately $77,000 in 2009,
$79,000 in 2008, and $69,000 in 2007. In return, Selective HR
paid commissions to Rue Insurance of approximately $10,000 in 2009,
$12,000 in 2008, and $15,000 in 2007. These revenues are
reflected in “(Loss) income from discontinued operations, net of tax” in
the Consolidated Statements of
Income.
|
|
·
|
Rue
Insurance placed insurance coverage for us with other insurance companies
for which Rue Insurance was paid commission pursuant to its agreements
with those carriers. We paid premiums for such insurance
coverage of $0.5 million in 2009, 2008, and
2007.
|
|
·
|
We
paid reinsurance commissions of $0.2 million in 2008 and 2007 to PL,
LLC. There were no reinsurance commissions paid to PL, LLC
during 2009. PL, LLC is an insurance fund administrator that
places reinsurance through an Insurance Subsidiary. As of
December 31, 2008, Rue Insurance owned 33.33% of PL,
LLC.
|
In 2005,
a private foundation, The Selective Group Foundation (the "Foundation"), was
established by us under Section 501(c)(3) of the Internal Revenue
Code. The Board of Directors of the Foundation is comprised of some
of the Parent's officers. We made contributions to the Foundation in
the amount of $0.4 million in 2009, $0.5 million in 2008, and $0.4 million in
2007.
In August
1998, certain officers of our company purchased stock on the open market with
proceeds advanced by us. These officers gave our company promissory
notes totaling $1.8 million. The promissory notes bore interest at
2.5% and were secured by the purchased shares of the Parent's common
stock. The promissory notes were full recourse and subject to certain
employment requirements. The principal amount outstanding was fully
repaid in March 2009 and was $0.1 million at December 31, 2008 and $0.2 million
at December 31, 2007.
Note 19. Commitments and
Contingencies
(a) We
purchase annuities from life insurance companies to fulfill obligations under
claim settlements which provide for periodic future payments to
claimants. As of December 31, 2009, we had purchased such annuities
in the amount of $10.4 million for settlement of claims on a structured basis
for which we are contingently liable. To our knowledge, none of the
issuers of such annuities have defaulted in their obligations
thereunder.
(b) We
have various operating leases for office space and equipment. Such
lease agreements, which expire at various times, are generally renewed or
replaced by similar leases. Rental expense under these leases
amounted to $11.5 million in 2009, $11.9 million in 2008, and $11.2 million in
2007. See Note 2(p) for information on our accounting policy
regarding leases.
129
In
addition, certain leases for rented premises and equipment are non-cancelable,
and liability for payment will continue even though the space or equipment may
no longer be in use. At
December 31, 2009, the total future minimum rental commitments under
non-cancelable leases were $24.1 million and such yearly amounts are as
follows:
($ in millions)
|
||||
2010
|
$ | 9.2 | ||
2011
|
6.6 | |||
2012
|
4.0 | |||
2013
|
2.5 | |||
2014
|
1.4 | |||
After
2014
|
0.4 | |||
Total
minimum payment required
|
$ | 24.1 |
(c) At
December 31, 2009, we have contractual obligations that expire at various dates
through 2023 to invest up to an additional $102.9 million in alternative
investments. There is no certainty that any such additional
investment will be required. For additional information regarding
these investments, see item (f) of Note 5. "Investments."
Note 20.
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 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
us. 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.
The
Insurance Subsidiaries are also from time to time involved in other legal
actions, some of which assert claims for substantial amounts. These
actions include, among others, putative state class actions seeking
certification of a state or national class. Such putative class
actions have alleged, for example, improper reimbursement of medical providers
paid under workers compensation and personal and commercial automobile insurance
policies. The Insurance Subsidiaries are also from time-to-time
involved in individual actions in which extra-contractual damages, punitive
damages, or penalties are sought, such as claims alleging bad faith in the
handling of insurance claims. We believe that we have valid defenses to these
cases. Our management expects that the ultimate liability, if any,
with respect to such lawsuits, after consideration of provisions made for
estimated losses, will not be material to 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.
Note 21. Statutory Financial
Information
The
Insurance Subsidiaries prepare their statutory financial statements in
accordance with accounting principles prescribed or permitted by the various
state insurance departments of domicile. Prescribed statutory
accounting principles include state laws, regulations, and general
administrative rules, as well as a variety of publications of the National
Association of Insurance
Commissioners (“NAIC"). Permitted statutory accounting principles
encompass all accounting principles that are not prescribed; such principles
differ from state to state, may differ from company to company within a state
and may change in the future. The Insurance Subsidiaries do not
utilize any permitted statutory accounting principles that materially affect the
determination of statutory surplus, statutory net income, or risk-based capital
("RBC"). As of December 31, 2009, the various state insurance
departments of domicile have adopted the March 2009 version of the NAIC
Accounting Practices and Procedures manual in its entirety, as a component of
prescribed or permitted practices.
The
combined statutory capital and surplus of the Insurance Subsidiaries was $981.9
million (unaudited) in 2009 and $884.4 million in 2008. The combined
statutory net income of the Insurance Subsidiaries was $69.8 million (unaudited)
in 2009, $104.3 million in 2008, and $167.6 million in 2007.
The
Insurance Subsidiaries are required to maintain certain minimum amounts of
statutory surplus to satisfy their various state insurance departments of
domicile. RBC requirements for property and casualty insurance
companies are designed to assess capital adequacy and to raise the level of
protection that statutory surplus provides for policyholders. Based
upon the Insurance Subsidiaries' 2009 unaudited statutory financial statements,
their combined total adjusted capital exceeded the authorized control level RBC
by 4.7:1, as defined by the NAIC.
130
Note 22. Quarterly Financial
Information1
(unaudited,
$ in thousands,
|
First
Quarter
|
Second
Quarter
|
Third
Quarter
|
Fourth
Quarter
|
||||||||||||||||||||||||||||
except
per share data)
|
2009
|
2008
|
2009
|
2008
|
2009
|
2008
|
2009
|
2008
|
||||||||||||||||||||||||
Net
premiums written
|
$ | 375,783 | 391,954 | 365,263 | 389,394 | 376,718 | 402,739 | 304,891 | 308,651 | |||||||||||||||||||||||
Net
premiums earned
|
363,873 | 383,387 | 358,311 | 377,254 | 355,906 | 374,708 | 352,957 | 368,838 | ||||||||||||||||||||||||
Net
investment income earned
|
15,717 | 37,866 | 26,368 | 38,515 | 36,585 | 36,134 | 39,801 | 18,517 | ||||||||||||||||||||||||
Net
realized (losses) gains
|
(24,025 | ) | 1,515 | (11,294 | ) | 1,923 | (4,983 | ) | (22,577 | ) | (5,668 | ) | (30,313 | ) | ||||||||||||||||||
Underwriting
(loss) profit
|
(2,963 | ) | 1,799 | 6,032 | 934 | (142 | ) | (1,194 | ) | (542 | ) | (1,407 | ) | |||||||||||||||||||
Net (loss) income
from continuing operations2
|
(12,950 | ) | 19,996 | 15,358 | 28,044 | 20,606 | 8,240 | 21,644 | (12,179 | ) | ||||||||||||||||||||||
Income (loss) from
discontinued operations, net of tax2
|
73 | 507 | 330 | 607 | (7,599 | ) | 752 | (1,064 | ) | (2,209 | ) | |||||||||||||||||||||
Net
(loss) income
|
(12,877 | ) | 20,503 | 15,688 | 28,651 | 13,007 | 8,992 | 20,580 | (14,388 | ) | ||||||||||||||||||||||
Other
comprehensive income (loss)
|
37,246 | (26,628 | ) | 23,613 | (37,935 | ) | 31,049 | (46,289 | ) | (1,322 | ) | (69,647 | ) | |||||||||||||||||||
Comprehensive
income (loss)
|
24,369 | (6,125 | ) | 39,301 | (9,284 | ) | 44,056 | (37,297 | ) | 19,258 | (84,035 | ) | ||||||||||||||||||||
Net
(loss) income per share:
|
||||||||||||||||||||||||||||||||
Basic
|
(0.25 | ) | 0.39 | 0.30 | 0.55 | 0.25 | 0.17 | 0.39 | (0.28 | ) | ||||||||||||||||||||||
Diluted
|
(0.25 | ) | 0.38 | 0.29 | 0.54 | 0.24 | 0.17 | 0.38 | (0.28 | ) | ||||||||||||||||||||||
Dividends to
stockholders3
|
0.13 | 0.13 | 0.13 | 0.13 | 0.13 | 0.13 | 0.13 | 0.13 | ||||||||||||||||||||||||
Price range of common
stock:4
|
||||||||||||||||||||||||||||||||
High
|
23.28 | 27.03 | 15.30 | 26.22 | 17.54 | 30.40 | 17.17 | 26.49 | ||||||||||||||||||||||||
Low
|
10.06 | 20.78 | 11.46 | 18.74 | 12.15 | 17.81 | 14.84 | 16.33 |
The
addition of all quarters may not agree to annual amounts on the consolidated
financial statements due to rounding.
1
Refer to the Glossary of Terms attached to this Form 10-K as
Exhibit 99.1.
|
4
These ranges of high and low prices of the Parent’s common stock, as
reported by the NASDAQ Global Select Market, represent actual
transactions. All price quotations do not include retail markups,
markdowns and commissions. The range of high and low prices for common
stock for the period beginning January 4, 2010 and ending February 19,
2010 was $16.92 to $15.01.
|
2
See Note 13. to the consolidated financial statements for a discussion
of discontinued operations.
|
|
3
See Note 10. and Note 11. to the consolidated financial statements for or
a discussion of dividend
restrictions.
|
131
Item
9. Changes in and Disagreements With Accountants on Accounting and Financial
Disclosure.
None.
Item
9A. Controls and Procedures.
Our
management, with the participation of our Chief Executive Officer and Chief
Financial Officer, has evaluated the effectiveness of our disclosure controls
and procedures (as such term is defined in Rules 13a-15(e) and 15d- 15(e) under
the Securities Exchange Act of 1934, as amended (the "Exchange Act")) as of the
end of the period covered by this report. Based on such evaluation,
our Chief Executive Officer and Chief Financial Officer have concluded that, as
of the end of such period, our disclosure controls and procedures
are: (i) effective in recording, processing, summarizing, and
reporting information on a timely basis that we are required to disclose in the
reports that we file or submit under the Exchange Act; and (ii) effective in
ensuring that information that we are required to disclose in the reports that
we file or submit under the Exchange Act is accumulated and communicated to our
management, including our Chief Executive Officer and Chief Financial Officer,
as appropriate, to allow timely decisions regarding required
disclosure.
Management's
Report on Internal Control Over Financial Reporting
Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting. Internal control over financial
reporting (as defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act) is
a process designed by, or under the supervision of, a company's principal
executive and principal financial officers and effected by the Board, management
and other personnel to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles and
includes those policies and procedures that:
|
·
|
Pertain
to the maintenance of records that in reasonable detail accurately and
fairly reflect the transactions and dispositions of the assets of the
company;
|
|
·
|
Provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures
of the company are being made only in accordance with
authorizations of management and directors of the company;
and
|
|
·
|
Provide
reasonable assurance regarding prevention or timely detection of
unauthorized acquisition, use or disposition of the company's assets that
could have a material effect on the financial
statements.
|
Our
management assessed the effectiveness of our internal control over financial
reporting as of December 31, 2009. In making this assessment,
management used the criteria set forth by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO) in Internal Control-Integrated
Framework.
Based on
its assessment, our management believes that, as of December 31, 2009, our
internal control over financial reporting is effective.
No
changes in our internal control over financial reporting (as such term is
defined in Rule 13a-15(f) of the Exchange Act) occurred during the fourth
quarter of 2009 that materially affected, or are reasonably likely to materially
affect, our internal
control
over financial reporting.
Attestation
Report of the Registered Public Accounting Firm
Our
independent registered public accounting firm, KPMG, LLP has issued their
attestation report on our internal control over financial reporting which is set
forth below.
132
Report of Independent
Registered Public Accounting Firm
The Board
of Directors and Stockholders
Selective
Insurance Group, Inc.:
We have
audited Selective Insurance Group, Inc.’s and subsidiaries' ("the Company")
internal control over financial reporting as of December 31, 2009, based on
criteria established in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission
(COSO). The Company's management is responsible for maintaining
effective internal control over financial reporting and for its assessment of
the effectiveness of internal control over financial reporting, included in the
accompanying Management's Report on Internal Control Over Financial Reporting.
Our responsibility is to express an opinion on Selective Insurance Group, Inc.'s
internal control over financial reporting based on our audit.
We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was maintained in all
material respects. Our audit included obtaining an understanding of
internal control over financial reporting, assessing the risk that a material
weakness exists, and testing and evaluating the design and operating
effectiveness of internal control based on the assessed risk. Our
audit also included performing such other procedures as we considered necessary
in the circumstances. We believe that our audit provides a reasonable basis for
our opinion.
A
company's internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company's internal
control over financial reporting includes those policies and procedures that (1)
pertain to the maintenance of records that, in reasonable detail, accurately and
fairly reflect the transactions and dispositions of the assets of the company;
(2) provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition,
use, or disposition of the company's assets that could have a material effect on
the financial statements.
Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation
of effectiveness to future periods are subject to the risk that controls may
become inadequate because of changes in conditions, or that the degree of
compliance with the policies or procedures may deteriorate.
In our
opinion, Selective Insurance Group, Inc. and subsidiaries maintained, in all
material respects, effective internal control over financial reporting as of
December 31, 2009, based on criteria established in Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO).
We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of Selective
Insurance Group, Inc. and subsidiaries as of December 31, 2009 and 2008, and the
related consolidated statements of income, stockholders' equity, and cash flows
for each of the years in the three-year period ended December 31, 2009, and our
report dated February 24, 2010 expressed an unqualified opinion on those
consolidated financial statements.
/s/ KPMG
LLP
New York,
New York
February
24, 2010
133
Item
9B. Other Information.
There is
no other information that was required to be disclosed in a report on Form 8-K
during the fourth quarter of 2009 that we did not report.
PART
III
Because
we will file a Proxy Statement within 120 days after the end of the fiscal year
ending December 31, 2009, this Annual Report on Form 10-K omits certain
information required by Part III and incorporates by reference certain
information included in the Proxy Statement.
Item
10. Directors, Executive Officers and Corporate
Governance.
Information
regarding our executive officers appears in Item 1. "Business." of this Form
10-K under "Management." Information about the Board and all other matters
required to be disclosed in Item 10. "Directors, Executive Officers and
Corporate Governance." appears under "Election of Directors" in the Proxy
Statement. That portion of the Proxy Statement is hereby incorporated by
reference.
Section
16(a) Beneficial Ownership Reporting Compliance
Information
about compliance with Section 16(a) of the Exchange Act appears under "Section
16(a) Beneficial Ownership Reporting Compliance" in the "Election of Directors"
section of the Proxy Statement and is hereby incorporated by reference.
Item
11. Executive Compensation.
Information
about compensation of our named executive officers appears under "Executive
Compensation" in the "Election of Directors" section of the Proxy Statement and
is hereby incorporated by reference. Information about compensation
of the Board appears under "Director Compensation" in the "Election of
Directors" section of the Proxy Statement and is hereby incorporated by
reference.
Item
12. Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters.
Information
about security ownership of certain beneficial owners and management appears
under "Security Ownership of Management and Certain Beneficial Owners" in the
"Election of Directors" section of the Proxy Statement and is hereby
incorporated by reference.
Item
13. Certain Relationships and Related Transactions, and Director
Independence.
Information
about certain relationships and related transactions, and director independence
appears under "Certain Relationships and Related Transactions" in the "Election
of Directors" section of the Proxy Statement and is hereby incorporated by
reference.
Item
14. Principal Accountant Fees and Services.
Information
about the fees and services of our principal accountants appears under "Audit
Committee Report" and "Fees of Independent Public Accountants" in the
"Ratification of Appointment of Independent Public Accountants" section of the
Proxy Statement and is hereby incorporated by reference.
134
PART
IV
Item
15. Exhibits and Financial Statement Schedules.
(a) The
following documents are filed as part of this report:
(1)
Financial Statements:
The
consolidated financial statements listed below are included in Item 8.
"Financial Statements and Supplementary Data."
Form
10-K
|
|
Page
|
|
Consolidated
Balance Sheets as of December 31, 2009 and 2008
|
82
|
Consolidated
Statements of Income for the Years ended December 31, 2009, 2008 and
2007
|
83
|
Consolidated
Statements of Stockholders' Equity for the Years ended December 31, 2009,
2008 and 2007
|
84
|
Consolidated
Statements of Cash Flows for the Years ended December 31, 2009, 2008 and
2007
|
85
|
Notes
to Consolidated Financial Statements, December 31, 2009, 2008 and
2007
|
86
|
(2) Financial Statement
Schedules:
The
financial statement schedules, with Independent Auditors' Report thereon,
required to be filed are listed below by page number as filed in this
report. All other schedules are omitted as the information required
is inapplicable, immaterial, or the information is presented in the consolidated
financial statements or related notes.
Form
10-K
|
||
Page
|
||
Schedule
I
|
Condensed
Financial Information of Registrant at December 31, 2009 and 2008 and
for
|
|
the
years ended December 31, 2009, 2008 and 2007
|
138
|
|
Schedule
II
|
Allowance
for Uncollectible Premiums and Other Receivables for the years
ended
|
|
December
31, 2009, 2008 and 2007
|
141
|
|
Schedule
III
|
Summary
of Investments – Other than Investments in Related Parties
at
|
|
December
31, 2009
|
142
|
|
Schedule
IV
|
Supplementary
Insurance Information for the years ended December 31, 2009,
2008
|
|
and
2007
|
143
|
|
Schedule
V
|
Reinsurance
for the years ended December 31, 2009, 2008 and 2007
|
146
|
135
(3) Exhibits:
The
exhibits required by Item 601 of Regulation S-K are listed in the Exhibit Index,
which is incorporated by reference and immediately precedes the exhibits filed
with or incorporated by reference in this Form 10-K.
SIGNATURES
Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this Report to be signed on its behalf by
the undersigned, thereunto duly authorized.
SELECTIVE
INSURANCE GROUP, INC.
By: /s/ Gregory E. Murphy
|
February
24, 2010
|
|
Gregory
E. Murphy
|
||
Chairman
of the Board, President and Chief Executive Officer
|
||
By: /s/ Dale A. Thatcher
|
February
24, 2010
|
|
Dale
A. Thatcher
|
||
Executive
Vice President, Chief Financial Officer and Treasurer
|
||
(principal
accounting officer and principal financial officer)
|
Pursuant
to the requirements of the Securities Exchange Act of 1934, this Report has been
signed below by the following persons on behalf of the Registrant and in the
capacities and on the date indicated.
By: /s/ Gregory E.
Murphy
|
February
24, 2010
|
|
Gregory
E. Murphy
|
||
Chairman
of the Board, President and Chief Executive Officer
|
||
*
|
February
24, 2010
|
|
Paul
D. Bauer
|
||
Director
|
||
*
|
February
24, 2010
|
|
W.
Marston Becker
|
||
Director
|
||
*
|
February
24, 2010
|
|
A.
David Brown
|
||
Director
|
||
*
|
February
24, 2010
|
|
John
C. Burville
|
||
Director
|
||
*
|
February
24, 2010
|
|
Joan
M. Lamm-Tennant
|
||
Director
|
||
*
|
February
24, 2010
|
|
S.
Griffin McClellan III
|
||
Director
|
||
*
|
February
24, 2010
|
|
Michael
J. Morrissey
|
||
Director
|
136
*
|
February
24, 2010
|
|
Cynthia
S. Nicholson
|
||
Director
|
*
|
February
24, 2010
|
||
Ronald
L. O’Kelley
|
|||
Director
|
|||
*
|
February
24, 2010
|
||
J.
Brian Thebault
|
|||
Director
|
|||
* |
By: /s/ Dale A. Thatcher
|
February
24, 2010
|
|
Dale
A. Thatcher
|
|||
Attorney-in-fact
|
137
SCHEDULE
I
SELECTIVE
INSURANCE GROUP, INC.
(Parent
Corporation)
Balance
Sheets
December
31,
|
||||||||
($ in thousands, except share
amounts)
|
2009
|
2008
|
||||||
Assets
|
||||||||
Fixed
maturity securities, held-to-maturity – at carry value (fair
value: $1,339 – 2009)
|
$ | 1,313 | - | |||||
Fixed
maturity, securities, available-for-sale – at fair value (amortized cost:
$1,542 – 2008)
|
- | 1,535 | ||||||
Short-term
investments
|
47,867 | 60,208 | ||||||
Cash
|
77 | - | ||||||
Investment
in subsidiaries
|
1,256,163 | 1,081,229 | ||||||
Current
federal income tax
|
16,006 | 14,225 | ||||||
Deferred
federal income tax
|
10,309 | 14,014 | ||||||
Other
assets
|
18,787 | 9,755 | ||||||
Total
assets
|
$ | 1,350,522 | 1,180,966 | |||||
Liabilities
and Stockholders’ Equity
|
||||||||
Liabilities:
|
||||||||
Notes
payable
|
$ | 261,606 | 273,878 | |||||
Intercompany
notes payable
|
75,408 | - | ||||||
Other
liabilities
|
11,133 | 16,595 | ||||||
Total
liabilities
|
348,147 | 290,473 | ||||||
Stockholders’
Equity:
|
||||||||
Preferred
stock at $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: 95,822,959
– 2009; 95,263,508 – 2008
|
191,646 | 190,527 | ||||||
Additional
paid-in capital
|
231,933 | 217,195 | ||||||
Retained
earnings
|
1,138,978 | 1,128,149 | ||||||
Accumulated
other comprehensive loss
|
(12,460 | ) | (100,666 | ) | ||||
Treasury
stock – at cost (shares: 42,578,779 – 2009; 42,386,921 –
2008)
|
(547,722 | ) | (544,712 | ) | ||||
Total
stockholders’ equity
|
1,002,375 | 890,493 | ||||||
Total
liabilities and stockholders’ equity
|
$ | 1,350,522 | 1,180,966 |
Information
should be read in conjunction with the Notes to Consolidated Financial
Statements of Selective Insurance Group, Inc. and its Subsidiaries in Item 8.
“Financial Statements and Supplementary Data.” of the Company’s Form
10-K.
138
SCHEDULE
I (continued)
SELECTIVE
INSURANCE GROUP, INC.
(Parent
Corporation)
Statements
of Income
Year
ended December 31,
|
||||||||||||
($ in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Revenues:
|
||||||||||||
Dividends
from subsidiaries
|
$ | 24,518 | 77,045 | 139,649 | ||||||||
Net
investment income earned
|
315 | 1,206 | 3,529 | |||||||||
Other
income
|
- | 3 | 63 | |||||||||
Total
revenues
|
24,833 | 78,254 | 143,241 | |||||||||
Expenses:
|
||||||||||||
Interest
expense
|
21,377 | 20,508 | 23,795 | |||||||||
Other
expenses
|
16,410 | 20,990 | 25,588 | |||||||||
Total
expenses
|
37,787 | 41,498 | 49,383 | |||||||||
(Loss)
income from continuing operations, before federal income
tax
|
(12,954 | ) | 36,756 | 93,858 | ||||||||
Federal
income tax benefit:
|
||||||||||||
Current
|
(16,381 | ) | (12,611 | ) | (14,969 | ) | ||||||
Deferred
|
3,701 | (1,106 | ) | (861 | ) | |||||||
Total
federal income tax benefit
|
(12,680 | ) | (13,717 | ) | (15,830 | ) | ||||||
Net
(loss) income from continuing operations before equity in undistributed
income of subsidiaries
|
(274 | ) | 50,473 | 109,688 | ||||||||
Equity
in undistributed income of continuing subsidiaries, net of
tax
|
44,932 | 2 | 33,948 | |||||||||
Dividends
in excess of continuing subsidiaries’ current year
earnings
|
- | (6,374 | ) | - | ||||||||
Net
income from continuing operations
|
44,658 | 44,101 | 143,636 | |||||||||
Dividends
from discontinued operations, net of tax
|
- | 2,079 | 3,094 | |||||||||
Dividends
in excess of discontinued operations current year earnings
|
- | (2,079 | ) | (232 | ) | |||||||
Equity
in (loss) undistributed earnings of subsidiaries, net of
tax
|
(7,086 | ) | (343 | ) | - | |||||||
Loss
on disposal of discontinued operations, net of tax
|
(1,174 | ) | - | - | ||||||||
Total
discontinued operations, net of tax
|
(8,260 | ) | (343 | ) | 2,862 | |||||||
Net
income
|
$ | 36,398 | 43,758 | 146,498 |
Information
should be read in conjunction with the Notes to Consolidated Financial
Statements of Selective Insurance Group, Inc. and its Subsidiaries in Item 8.
“Financial Statements and Supplementary Data.” of the Company’s Form
10-K.
139
SCHEDULE
I (continued)
SELECTIVE
INSURANCE GROUP, INC.
(Parent
Corporation)
Statements
of Cash Flows
Year
ended December 31,
|
||||||||||||
($
in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Operating
Activities:
|
||||||||||||
Net
income
|
$ | 36,398 | 43,758 | 146,498 | ||||||||
Adjustments
to reconcile net income to net cash provided by operating
activities:
|
||||||||||||
Equity
in undistributed income of subsidiaries, net of tax
|
(37,846 | ) | 341 | (33,948 | ) | |||||||
Dividends
in excess of subsidiaries’ current year income
|
- | 8,453 | 232 | |||||||||
Stock-based
compensation expense
|
11,036 | 17,215 | 20,992 | |||||||||
Loss
on disposition of discontinued operations
|
1,174 | - | - | |||||||||
Deferred
income tax expense (benefit)
|
3,701 | (1,106 | ) | (861 | ) | |||||||
Amortization
– other
|
208 | 269 | 1,306 | |||||||||
Changes
in assets and liabilities:
|
||||||||||||
Decrease
in accrued salaries and benefits
|
(7,007 | ) | - | - | ||||||||
(Increase)
decrease in net federal income tax recoverable
|
(956 | ) | 4,228 | (3,611 | ) | |||||||
Other,
net
|
3,478 | (7,105 | ) | 4,208 | ||||||||
Net
adjustments
|
(26,212 | ) | 22,295 | (11,682 | ) | |||||||
Net
cash provided by operating activities
|
10,186 | 66,053 | 134,816 | |||||||||
Investing
Activities:
|
||||||||||||
Redemption
and maturities of fixed maturity securities,
available-for-sale
|
236 | 12,463 | 33,619 | |||||||||
Purchase
of short-term investments
|
(232,823 | ) | (363,827 | ) | (381,775 | ) | ||||||
Sale
of short-term investments
|
245,165 | 368,111 | 432,615 | |||||||||
Capital
contribution to subsidiaries
|
(20,000 | ) | - | - | ||||||||
Sale
of subsidiary
|
(581 | ) | - | - | ||||||||
Distributions
of capital by subsidiaries
|
680 | 960 | 980 | |||||||||
Net
cash (used) provided in investing activities
|
(7,323 | ) | 17,707 | 85,439 | ||||||||
Financing
Activities:
|
||||||||||||
Dividends
to stockholders
|
(26,296 | ) | (25,804 | ) | (24,464 | ) | ||||||
Acquisition
of treasury stock
|
(3,010 | ) | (46,833 | ) | (152,118 | ) | ||||||
Principal
payment on notes payable
|
(12,300 | ) | (12,300 | ) | (18,300 | ) | ||||||
Net
proceeds from stock purchase and compensation plans
|
4,612 | 8,222 | 8,609 | |||||||||
Excess
tax benefits from share-based payment arrangements
|
(1,200 | ) | 1,628 | 3,484 | ||||||||
Borrowings
under line of credit agreement
|
- | - | 6,000 | |||||||||
Repayment
of borrowings under line of credit agreement
|
- | - | (6,000 | ) | ||||||||
Borrowings
from subsidiaries
|
36,000 | - | - | |||||||||
Principal
payment of borrowings from subsidiaries
|
(592 | ) | - | - | ||||||||
Principal
payments of convertible debt
|
- | (8,754 | ) | (37,456 | ) | |||||||
Net
cash used in financing activities
|
(2,786 | ) | (83,841 | ) | (220,245 | ) | ||||||
Net
increase (decrease) in cash
|
77 | (81 | ) | 10 | ||||||||
Cash,
beginning of year
|
- | 81 | 71 | |||||||||
Cash,
end of year
|
$ | 77 | - | 81 |
Information should
be read in conjunction with the Notes to Consolidated Financial Statements
of Selective Insurance Group, Inc. and its Subsidiaries
in Item 8. “Financial Statements and Supplementary Data.” of the Company’s
Form
10-K.
|
140
SCHEDULE
II
SELECTIVE
INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
ALLOWANCE
FOR UNCOLLECTIBLE PREMIUMS AND OTHER RECEIVABLES
Years
ended December 31, 2009, 2008 and 2007
($
in thousands)
|
2009
|
2008
|
2007
|
|||||||||
Balance,
January 1
|
$ | 7,006 | 6,899 | 6,656 | ||||||||
Additions
|
6,535 | 4,283 | 3,625 | |||||||||
Deductions
|
(5,161 | ) | (4,176 | ) | (3,382 | ) | ||||||
Balance,
December 31
|
$ | 8,380 | 7,006 | 6,899 |
141
SCHEDULE
III
SELECTIVE
INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
SUMMARY
OF INVESTMENTS-OTHER THAN INVESTMENTS IN RELATED PARTIES
December
31, 2009
Types
of investment
|
Amortized Cost
|
Fair
|
Carrying
|
|||||||||
($
in thousands)
|
or Cost
|
Value
|
Amount
|
|||||||||
Fixed
maturity securities:
|
||||||||||||
Held-to-maturity
|
||||||||||||
U.S.
government and government agencies
|
$ | 139,278 | 145,978 | 144,833 | ||||||||
Obligations
of states and political subdivisions
|
1,167,461 | 1,210,795 | 1,201,412 | |||||||||
Corporate
securities
|
104,854 | 107,578 | 98,826 | |||||||||
Asset-backed
securities
|
35,025 | 33,096 | 28,983 | |||||||||
Commercial
mortgage-backed securities
|
107,812 | 92,450 | 88,976 | |||||||||
Residential
mortgage-backed securities
|
146,124 | 150,314 | 147,373 | |||||||||
Total
fixed maturity securities, held-to-maturity
|
1,700,554 | 1,740,211 | 1,710,403 | |||||||||
Available-for-sale:
|
||||||||||||
U.S.
government and government agencies
|
473,750 | 475,534 | 475,534 | |||||||||
Obligations
of states and political subdivisions
|
359,517 | 379,799 | 379,799 | |||||||||
Corporate
securities
|
365,500 | 379,584 | 379,584 | |||||||||
Asset-backed
securities
|
26,638 | 27,047 | 27,047 | |||||||||
Commercial
mortgage-backed securities
|
93,514 | 94,623 | 94,623 | |||||||||
Residential
mortgage-backed securities
|
297,537 | 279,282 | 279,282 | |||||||||
Total
fixed maturity securities, available-for-sale
|
1,616,456 | 1,635,869 | 1,635,869 | |||||||||
Equity
securities:
|
||||||||||||
Common
Stock:
|
||||||||||||
Banks,
trust and insurance companies
|
4,399 | 4,366 | 4,366 | |||||||||
Industrial,
miscellaneous and all other
|
59,991 | 75,898 | 75,898 | |||||||||
Total
equity securities, available-for-sale
|
64,390 | 80,264 | 80,264 | |||||||||
Short-term
investments
|
213,848 | 213,848 | ||||||||||
Other
investments
|
140,667 | 140,667 | ||||||||||
Total
investments
|
$ | 3,735,915 | 3,781,051 |
142
SCHEDULE
IV
SELECTIVE
INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
SUPPLEMENTARY
INSURANCE INFORMATION
Year
ended December 31, 2009
Amortization
|
||||||||||||||||||||||||||||||||||||
Deferred
|
Reserve
|
Losses
|
of
deferred
|
|||||||||||||||||||||||||||||||||
policy
|
for
losses
|
Net
|
Net
|
and
loss
|
policy
|
Other
|
Net
|
|||||||||||||||||||||||||||||
acquisition
|
and
loss
|
Unearned
|
premiums
|
investment
|
expenses
|
acquisition
|
operating
|
premiums
|
||||||||||||||||||||||||||||
($ in thousands)
|
costs
|
expenses1
|
premiums
|
earned
|
income2
|
incurred3
|
costs4
|
expenses4
|
written
|
|||||||||||||||||||||||||||
Insurance
Operations Segment
|
$ | 218,601 | 2,745,799 | 844,847 | 1,431,047 | - | 971,905 | 428,554 | 28,202 | 1,422,655 | ||||||||||||||||||||||||||
Investment
Segment
|
- | - | - | - | 72,501 | - | - | - | - | |||||||||||||||||||||||||||
Total
|
$ | 218,601 | 2,745,799 | 844,847 | 1,431,047 | 72,501 | 971,905 | 428,554 | 28,202 | 1,422,655 |
1
|
Includes
“Reserve for losses” and “Reserve for loss expenses” on the Consolidated
Balance Sheets.
|
|
2
|
Includes
“Net investment income earned” and “Net realized investment (losses)
gains” on the Consolidated Statements of Income.
|
|
3
|
Includes
“Losses incurred” and “Loss expenses incurred” on the Consolidated
Statements of Income.
|
|
4
|
The
total of “Amortization of deferred policy acquisition costs” of $428,554
and “Other operating expenses” of $28,202 reconciles
|
|
to
the Consolidated Statement of Income as
follows:
|
Policy
acquisition costs
|
$ | 457,424 | ||
Dividends
to policyholders
|
3,640 | |||
Other
income5
|
(10,440 | ) | ||
Other
expenses5
|
6,132 | |||
Total
|
$ | 456,756 |
5
In addition to
amounts related to the Insurance Operations segment, “Other income” and
“Other expense” on the Consolidated Statement of
Income includes holding company income and expense amounts of $30 and
$16,345,
respectively.
|
143
SCHEDULE
IV (continued)
SELECTIVE
INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
SUPPLEMENTARY
INSURANCE INFORMATION
Year
ended December 31, 2008
Amortization
|
||||||||||||||||||||||||||||||||||||
Deferred
|
Reserve
|
Losses
|
of
deferred
|
|||||||||||||||||||||||||||||||||
policy
|
for
losses
|
Net
|
Net
|
and
loss
|
policy
|
Other
|
Net
|
|||||||||||||||||||||||||||||
acquisition
|
and
loss
|
Unearned
|
premiums
|
investment
|
expenses
|
acquisition
|
operating
|
premiums
|
||||||||||||||||||||||||||||
($ in thousands)
|
costs
|
expenses1
|
premiums
|
earned
|
income2
|
incurred3
|
costs4
|
expenses4
|
written
|
|||||||||||||||||||||||||||
Insurance
Operations Segment
|
$ | 212,319 | 2,640,973 | 844,334 | 1,504,187 | - | 1,011,544 | 454,826 | 37,686 | 1,492,738 | ||||||||||||||||||||||||||
Investment
Segment
|
- | - | - | - | 81,580 | - | - | - | - | |||||||||||||||||||||||||||
Total
|
$ | 212,319 | 2,640,973 | 844,334 | 1,504,187 | 81,580 | 1,011,544 | 454,826 | 37,686 | 1,492,738 |
1
|
Includes
“Reserve for losses” and “Reserve for loss expenses” on the Consolidated
Balance Sheets.
|
|
2
|
Includes
“Net investment income earned” and “Net realized (losses) gains” on the
Consolidated Statements of Income.
|
|
3
|
Includes
“Losses incurred” and “Loss expenses incurred” on the Consolidated
Statements of Income.
|
|
4
|
The
total of “Amortization of deferred policy acquisition costs” of $454,826
and “Other operating expenses” of $37,686 reconciles
|
|
to
the Consolidated Statement of Income as
follows:
|
Policy
acquisition costs
|
$ | 485,702 | ||
Dividends
to policyholders
|
5,211 | |||
Other
income5
|
(2,610 | ) | ||
Other
expenses5
|
4,209 | |||
Total
|
$ | 492,512 |
5
In addition to
amounts related to the Insurance Operations segment, “Other income” and
“Other expense” on the Consolidated Statement of
Income includes holding company income and expense amounts of $1,562 and
$22,598, respectively.
|
|
144
SCHEDULE
IV (continued)
SELECTIVE
INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
SUPPLEMENTARY
INSURANCE INFORMATION
Year
ended December 31, 2007
Amortization
|
||||||||||||||||||||||||||||||||||||
Deferred
|
Reserve
|
Losses
|
of
deferred
|
|||||||||||||||||||||||||||||||||
policy
|
for
losses
|
Net
|
Net
|
and
loss
|
policy
|
Other
|
Net
|
|||||||||||||||||||||||||||||
acquisition
|
and
loss
|
Unearned
|
premiums
|
investment
|
expenses
|
acquisition
|
operating
|
premiums
|
||||||||||||||||||||||||||||
($ in thousands)
|
costs
|
expenses1
|
premiums
|
earned
|
income2
|
incurred3
|
costs4
|
expenses4
|
written
|
|||||||||||||||||||||||||||
Insurance
Operations Segment
|
$ | 226,434 | 2,542,547 | 841,348 | 1,524,889 | - | 997,812 | 460,167 | 35,944 | 1,562,450 | ||||||||||||||||||||||||||
Investment
Segment
|
- | - | - | - | 207,498 | - | - | - | - | |||||||||||||||||||||||||||
Total
|
$ | 226,434 | 2,542,547 | 841,348 | 1,524,889 | 207,498 | 997,812 | 460,167 | 35,944 | 1,562,450 |
1
|
Includes
“Reserve for losses” and “Reserve for loss expenses” on the Consolidated
Balance Sheets.
|
|
2
|
Includes
“Net investment income earned” and “Net realized (losses) gains” on the
Consolidated Statements of Income.
|
|
3
|
Includes
“Losses incurred” and “Loss expenses incurred” on the Consolidated
Statements of Income.
|
|
4
|
The
total of “Amortization of deferred policy acquisition costs” of $460,167
and “Other operating expenses” of $35,944 reconciles
|
|
to
the Consolidated Statement of Income as
follows:
|
Policy
acquisition costs
|
$ | 491,235 | ||
Dividends
to policyholders
|
7,202 | |||
Other
income5
|
(5,833 | ) | ||
Other
expenses5
|
3,507 | |||
Total
|
$ | 496,111 |
5
In addition to
amounts related to the Insurance Operations segment, “Other income” and
“Other expense” on the Consolidated Statement of
Income includes holding company income and expense amounts of $1,095 and
$27,000,
respectively.
|
145
SCHEDULE
V
SELECTIVE
INSURANCE GROUP, INC. AND CONSOLIDATED SUBSIDIARIES
REINSURANCE
Years
ended December 31, 2009, 2008 and 2007
%
of
|
||||||||||||||||||||
Assumed
|
Ceded
|
Amount
|
||||||||||||||||||
Direct
|
From
Other
|
To
Other
|
Assumed
|
|||||||||||||||||
($
thousands)
|
Amount
|
Companies
|
Companies
|
Net
Amount
|
To
Net
|
|||||||||||||||
2009
|
||||||||||||||||||||
Premiums
earned:
|
||||||||||||||||||||
Accident
and health insurance
|
$ | 70 | - | 70 | - | - | ||||||||||||||
Property
and liability insurance
|
1,657,841 | 21,501 | 248,295 | 1,431,047 | 2 | % | ||||||||||||||
Total
premiums earned
|
1,657,911 | 21,501 | 248,365 | 1,431,047 | 2 | % | ||||||||||||||
2008
|
||||||||||||||||||||
Premiums
earned:
|
||||||||||||||||||||
Accident
and health insurance
|
$ | 80 | - | 80 | - | - | ||||||||||||||
Property
and liability insurance
|
1,694,430 | 27,115 | 217,358 | 1,504,187 | 2 | % | ||||||||||||||
Total
premiums earned
|
1,694,510 | 27,115 | 217,438 | 1,504,187 | 2 | % | ||||||||||||||
2007
|
||||||||||||||||||||
Premiums
earned:
|
||||||||||||||||||||
Accident
and health insurance
|
$ | 80 | - | 80 | - | - | ||||||||||||||
Property
and liability insurance
|
1,685,087 | 31,783 | 191,981 | 1,524,889 | 2 | % | ||||||||||||||
Total
premiums earned
|
1,685,167 | 31,783 | 192,061 | 1,524,889 | 2 | % |
146
EXHIBIT
INDEX
Exhibit
Number
|
||
3.1
|
Restated
Certificate of Incorporation of Selective Insurance Group, Inc., dated
August 4, 1977, as amended (incorporated by reference to Exhibit 3.1 of
the Company’s Annual Report on Form 10-K for the year ended December 31,
2007, File No. 001-33067).
|
|
3.2
|
By-Laws
of Selective Insurance Group, Inc., effective October 24, 2006
(incorporated by reference herein to Exhibit 3.1 to the Company's Current
Report on Form 8-K filed October 24, 2006, File No.
001-33067).
|
|
4.1
|
Indenture
dated as of September 24, 2002, between Selective Insurance Group, Inc.
and National City Bank, as Trustee, relating to the Company's 1.6155%
Senior Convertible Notes due September 24, 2032 (incorporated by reference
herein to Exhibit 4.1 of the Company's Registration Statement on Form S-3
No. 333-101489).
|
|
4.2
|
Indenture,
dated as of November 16, 2004, between Selective Insurance Group, Inc. and
Wachovia Bank, National Association, as Trustee, relating to the Company's
7.25% Senior Notes due 2034 (incorporated by reference herein to Exhibit
4.1 of the Company's Current Report on Form 8-K filed November 18, 2004,
File No. 0-8641).
|
|
4.3
|
Indenture,
dated as of November 3, 2005, between Selective Insurance Group, Inc. and
Wachovia Bank, National Association, as Trustee, relating to the Company’s
6.70% Senior Notes due 2035 (incorporated by reference herein to Exhibit
4.1 of the Company’s Current Report on Form 8-K filed November 9, 2005,
File No. 0-8641).
|
|
4.4
|
Registration
Rights Agreement, dated as of November 16, 2004, between Selective
Insurance Group, Inc. and Keefe, Bruyette & Woods, Inc. (incorporated
by reference herein to Exhibit 4.2 of the Company’s Current Report on Form
8-K filed November 18, 2004, File No. 001-33067).
|
|
4.5
|
Registration
Rights Agreement, dated as of November 3, 2005, between Selective
Insurance Group, Inc. and Keefe, Bruyette & Woods, Inc. (incorporated
by reference herein to Exhibit 4.2 of the Company’s Current Report on Form
8-K filed November 9, 2005, File No. 001-33067).
|
|
4.6
|
Form
of Junior Subordinated Debt Indenture between Selective Insurance Group,
Inc. and U.S. Bank National Association (incorporated by reference herein
to Exhibit 4.3 of the Company’s Registration Statement on Form S-3 No.
333-137395).
|
|
4.7
|
First
Supplemental Indenture, dated as of September 25, 2006, between Selective
Insurance Group, Inc. and U.S. Bank National Association, as Trustee,
relating to the Company’s 7.5% Junior Subordinated Notes due 2066
(incorporated by reference herein to Exhibit 4.1 of the Company’s Current
Report on Form 8-K filed September 27, 2006, File No.
0-8641).
|
|
10.1
|
Selective
Insurance Supplemental Pension Plan, As Amended and Restated Effective
January 1, 2005 (incorporated by reference herein to Exhibit 10.1 of the
Company’s Quarterly Report on 10-Q for the quarter ended September 30,
2008, File No. 001-33067).
|
|
10.2
|
Selective
Insurance Company of America Deferred Compensation Plan (2005)
(incorporated by reference herein to Exhibit 10.1 of the Company’s Current
Report on Form 8-K filed September 21, 2007, File No.
001-33067).
|
|
*10.2a
|
Amendment
No. 1 to Selective Insurance Company of America Deferred Compensation Plan
(2005)
|
147
Exhibit
Number
|
||
10.3
|
Selective
Insurance Stock Option Plan II, as amended (incorporated by reference
herein to Exhibit 10.13b to the Company’s Annual Report on Form 10-K for
the year ended December 31, 1999, File No. 0-8641).
|
|
10.3a
|
Amendment
to the Selective Insurance Stock Option Plan II, as amended, effective as
of July 26, 2006 (incorporated by reference herein to Exhibit 10.4 to the
Company’s Quarterly Report on Form 10-Q for the quarter ended June 30,
2006, File No. 0-8641).
|
|
10.4
|
Selective
Insurance Stock Option Plan III (incorporated by reference herein to
Exhibit A to the Company’s Definitive Proxy Statement for its 2002 Annual
Meeting of Stockholders filed April 1, 2002, File No.
0-8641).
|
|
10.4a
|
Amendment
to the Selective Insurance Stock Option Plan III, effective as of July 26,
2006 (incorporated by reference herein to Exhibit 10.5 to the Company’s
Quarterly Report on Form 10-Q for the quarter ended June 30, 2006, File
No. 0-8641).
|
|
10.5
|
Selective
Insurance Group, Inc. 2005 Omnibus Stock Plan (incorporated by reference
herein to Appendix A of the Company’s Definitive Proxy Statement for its
2005 Annual Meeting of Stockholders filed April 6, 2005, File No.
0-8641).
|
|
10.5a
|
Amendment
to the Selective Insurance Group, Inc. 2005 Omnibus Stock
Plan (incorporated by reference herein to Exhibit 10.3 to the
Company’s Quarterly Report on Form 10-Q for the quarter ended June 30,
2005, File No. 0-8641).
|
|
10.5b
|
Amendment
No. 2 to the Selective Insurance Group, Inc. 2005 Omnibus Stock Plan
(incorporated by reference herein to Exhibit 10.5b of the Company’s Annual
Report on Form 10-K for the year ended December 31, 2005, File No.
0-8641).
|
|
10.5c
|
Amendment
No. 3 to the Selective Insurance Group, Inc. 2005 Omnibus Stock Plan
(incorporated by reference herein to Exhibit 10.5c of the Company’s Annual
Report on Form 10-K for the year ended December 31, 2005, File No.
0-8641).
|
|
10.5d
|
Amendment
No. 4 to the Selective Insurance Group, Inc. 2005 Omnibus Stock Plan
Amendment (incorporated by reference herein to Exhibit 10.5d of the
Company’s Annual Report on Form 10-K for the year ended December 31, 2006,
File No. 001-33067).
|
|
10.5e
|
Amendment
No. 5 to the Selective Insurance Group, Inc. 2005 Omnibus Stock Plan
Amendment (incorporated by reference herein to Exhibit 10.5e of the
Company’s Annual Report on Form 10-K for the year ended December 31, 2007,
File No. 001-33067).
|
|
10.5f
|
Amendment
No. 6 to the Selective Insurance Group, Inc. 2005 Omnibus Stock Plan
Amendment (incorporated by reference herein to Exhibit 10.5f of the
Company’s Annual Report on Form 10-K for the year ended December 31, 2008,
File No. 001-33067).
|
|
10.6
|
Selective
Insurance Group, Inc. 2005 Omnibus Stock Plan Stock Option Agreement
(incorporated by reference herein to Exhibit 10.2 to the Company’s
Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, File
No. 0-8641).
|
|
10.7
|
Selective
Insurance Group, Inc. 2005 Omnibus Stock Plan Director Restricted Stock
Agreement (incorporated by reference herein to Exhibit 10.8 of the
Company’s Annual Report on Form 10-K for the year ended December 31, 2005,
File No. 0-8641).
|
|
*10.8
|
Selective
Insurance Group, Inc. 2005 Omnibus Stock Plan Director Restricted Stock
Unit Agreement.
|
148
Exhibit
Number
|
||
10.9
|
Selective
Insurance Group, Inc. 2005 Omnibus Stock Plan Director Stock Option
Agreement (incorporated by reference herein to Exhibit 10.9 of the
Company’s Annual Report on Form 10-K for the year ended December 31, 2005,
File No. 0-8641).
|
|
10.10
|
Selective
Insurance Group, Inc. 2005 Omnibus Stock Plan Restricted Stock Agreement
(incorporated by reference herein to Exhibit 10.3 to the Company’s
Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, File
No. 0-8641).
|
|
10.11
|
Selective
Insurance Group, Inc. 2005 Omnibus Stock Plan Restricted Stock Agreement
(incorporated by reference herein to Exhibit 10.4 to the Company’s
Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, File
No. 0-8641).
|
|
*10.12
|
Selective
Insurance Group, Inc. 2005 Omnibus Stock Plan Restricted Stock Unit
Agreement.
|
|
*10.13
|
Selective
Insurance Group, Inc. 2005 Omnibus Stock Plan Restricted Stock Unit
Agreement.
|
|
10.14
|
Selective
Insurance Group, Inc. 2005 Omnibus Stock Plan Automatic Director Stock
Option Agreement (incorporated by reference herein to Exhibit 2 of the
Company’s Definitive Proxy Statement for its 2005 Annual Meeting of
Stockholders filed April 6, 2005, File No. 0-8641).
|
|
10.15
|
Deferred
Compensation Plan for Directors (incorporated by reference herein to
Exhibit 10.5 to the Company’s Annual Report on Form 10-K for the year
ended December 31, 1993, File No. 0-8641).
|
|
10.16
|
Selective
Insurance Group, Inc. Employee Stock Purchase Plan (2009) (incorporated by
reference herein to Appendix A to the Company’s Definitive Proxy Statement
for its 2009 Annual Meeting of Stockholders filed March 26, 2009, File No.
001-33067).
|
|
10.17
|
Selective
Insurance Group, Inc. Cash Incentive Plan (incorporated by reference
herein to Appendix B to the Company’s Definitive Proxy Statement for its
2005 Annual Meeting of Stockholders filed April 6, 2005, File No.
0-8641).
|
|
10.17a
|
Amendment
No. 1 to the Selective Insurance Group, Inc. Cash Incentive Plan
(incorporated by reference herein to Exhibit 10.1 to the Company’s
Quarterly Report on Form 10-Q for the quarter ended March 31, 2006, File
No. 0-8641).
|
|
10.17b
|
Amendment
No. 2 to the Selective Insurance Group, Inc. Cash Incentive Plan
(incorporated by reference herein to Exhibit 10.14b of the Company’s
Annual Report on Form 10-K for the year ended December 31, 2007, File No.
001-33067).
|
|
10.18
|
Selective
Insurance Group, Inc. Cash Incentive Plan Cash Incentive Unit Award
Agreement (incorporated by reference herein to Exhibit 10.14c of the
Company’s Annual Report on Form 10-K for the year ended December 31, 2007,
File No. 001-33067).
|
|
10.19
|
Selective
Insurance Group, Inc. Cash Incentive Plan Cash Incentive Unit Award
Agreement (incorporated by reference herein to Exhibit 10.14d of the
Company’s Annual Report on Form 10-K for the year ended December 31, 2007,
File No. 001-33067).
|
|
10.20
|
Selective
Insurance Group, Inc. Stock Purchase Plan for Independent Insurance
Agencies, effective July 1, 2006 (incorporated by reference herein to
Appendix A of the Company’s Definitive Proxy Statement for its 2006 Annual
Meeting of Stockholders filed March 28, 2006, File No.
0-8641).
|
149
Exhibit
Number
|
||
10.20a
|
Amendment
No. 1 to the Selective Insurance Group, Inc. Stock Purchase Plan for
Independent Insurance Agencies (incorporated by reference to Exhibit
10.15a of the Company’s Annual Report on Form 10-K for the year ended
December 31, 2006, File No. 001-33067).
|
|
10.20b
|
Amendment
No. 2 to the Selective Insurance Group, Inc. Stock Purchase Plan for
Independent Insurance Agencies (incorporated by reference to Exhibit 10.1
of the Company’s Quarterly Report on Form 10-Q for the quarter ended
September 30, 2007, File No. 001-33067).
|
|
10.20c
|
Amendment
No. 3 to the Selective Insurance Group, Inc. Stock Purchase Plan for
Independent Insurance Agencies (incorporated by reference to Exhibit 10.1
of the Company’s Quarterly Report on Form 10-Q for the quarter ended
September 30, 2009, File No. 001-33067).
|
|
10.21
|
Selective
Insurance Group, Inc. Stock Option Plan for Directors (incorporated by
reference herein to Exhibit B of the Company’s Definitive Proxy Statement
for its 2000 Annual Meeting of Stockholders filed March 31, 2000, File No.
0-8641).
|
|
10.21a
|
Amendment
to the Selective Insurance Group, Inc. Stock Option Plan for Directors, as
amended, effective as of July 26, 2006, (incorporated by reference herein
to Exhibit 10.3 to the Company’s Quarterly Report on Form 10-Q for the
quarter ended June 30, 2006, File No. 0-8641).
|
|
10.22
|
Selective
Insurance Group, Inc. Stock Compensation Plan for Nonemployee Directors,
as amended (incorporated by reference herein to Exhibit A to the Company’s
Definitive Proxy Statement for its 2000 Annual Meeting of Stockholders
filed March 31, 2000, File No. 0-8641).
|
|
10.22a
|
Amendment
to Selective Insurance Group, Inc. Stock Compensation Plan for Nonemployee
Directors, as amended (incorporated by reference to Exhibit 10.22a of the
Company’s Annual Report on Form 10-K for the year ended December 31, 2008,
File No. 001-33067).
|
|
10.23
|
Employment,
Termination and Severance Agreements.
|
|
10.23a
|
Employment
Agreement between Selective Insurance Company of America and Gregory E.
Murphy, dated as of December 23, 2008 (incorporated by reference herein to
Exhibit 10.1 to the Company’s Current Report on Form 8-K filed December
30, 2009, File No. 001-33067).
|
|
10.23b
|
Employment
Agreement between Selective Insurance Company of America and Dale A.
Thatcher, dated as of December 23, 2008 (incorporated by reference herein
to Exhibit 10.2 to the Company’s Current Report on Form 8-K filed December
30, 2008, File No. 001-33067).
|
|
10.23c
|
Employment
Agreement between Selective Insurance Company of America and Richard F.
Connell, dated as of December 23, 2008 (incorporated by reference herein
to Exhibit 10.3 to the Company’s Current Report on Form 8-K filed December
30, 2008, File No. 001-33067).
|
|
10.23d
|
Employment
Agreement between Selective Insurance Company of America and Kerry A.
Guthrie, dated as of December 23, 2008 (incorporated by reference herein
to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed December
30, 2008, File No. 001-33067).
|
|
10.23e
|
Employment
Agreement between Selective Insurance Company of America and Michael H.
Lanza, dated as of December 23, 2008 (incorporated by reference to Exhibit
10.23e of the Company’s Annual Report on Form 10-K for the year ended
December 31, 2008, File No.
001-33067).
|
150
Exhibit
Number
|
||
10.23f
|
Employment
Agreement between Selective Insurance Company of America and John J.
Marchioni, dated as of December 23, 2008 (incorporated by reference to
Exhibit 10.23f of the Company’s Annual Report on Form 10-K for the year
ended December 31, 2008, File No. 001-33067).
|
|
10.23g
|
Employment
Agreement between Selective Insurance Company of America and Steven B.
Woods, dated as of February 20, 2009 (incorporated by reference to Exhibit
10.23h of the Company’s Annual Report on Form 10-K for the year ended
December 31, 2008, File No. 001-33067).
|
|
10.23h
|
Employment
Agreement between Selective Insurance Company of America and Ronald J.
Zaleski, dated as of December 23, 2008 (incorporated by reference to
Exhibit 10.23i of the Company’s Annual Report on Form 10-K for the year
ended December 31, 2008, File No. 001-33067).
|
|
10.24
|
Credit
Agreement among Selective Insurance Group, Inc., the Lenders Named Therein
and Wachovia Bank, National Association, as Administrative Agent, dated as
of August 25, 2009 (incorporated by reference herein to Exhibit 10.1 to
the Company’s Current Report on Form 8-K filed August 26, 2009, File No.
001-33067).
|
|
10.25
|
Form
of Indemnification Agreement between Selective Insurance Group, Inc. and
each of its directors and executive officers, as adopted on May 19, 2005
(incorporated by reference herein to Exhibit 10.1 to the Company’s Current
Report on Form 8-K filed May 20, 2005, File No.
000-08641)
|
|
10.26
|
Stock
and Asset Purchase Agreement, dated as of October 27, 2009, by and among
Selective Insurance Group, Inc., Selective HR Solutions, Inc. and its
subsidiaries, and AlphaStaff Group, Inc. and certain of its subsidiaries
(incorporated by reference herein to Exhibit 2.1 to the Company’s Current
Report on Form 8-K filed October 30, 2009, File No.
001-33067).
|
|
*10.26a
|
Amendment
No. 1 to the Stock Purchase Agreement.
|
|
*10.27
|
Selective
Insurance Group, Inc. Non-Employee Directors’ Deferred Compensation
Plan.
|
|
*21
|
Subsidiaries
of Selective Insurance Group, Inc.
|
|
*23.1
|
Consent
of KPMG LLP.
|
|
*24.1
|
Power
of Attorney of Paul D. Bauer.
|
|
*24.2
|
Power
of Attorney of W. Marston Becker.
|
|
*24.3
|
Power
of Attorney of A. David Brown.
|
|
*24.4
|
Power
of Attorney of John C. Burville.
|
|
*24.5
|
Power
of Attorney of Joan M. Lamm-Tennant.
|
|
*24.6
|
Power
of Attorney of S. Griffin McClellan III.
|
|
*24.7
|
Power
of Attorney of Michael J. Morrissey.
|
|
*24.8
|
Power
of Attorney of Cynthia S. Nicholson.
|
|
*24.9
|
Power
of Attorney of Ronald L.
O'Kelley.
|
151
Exhibit
Number
|
||
*24.10
|
Power
of Attorney of William M. Rue.
|
|
*24.11
|
Power
of Attorney of J. Brian Thebault.
|
|
*31.1
|
Certification
of Chief Executive Officer in accordance with Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
*31.2
|
Certification
of Chief Financial Officer in accordance with Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
*32.1
|
Certification
of Chief Executive Officer in accordance with Section 906 of the
Sarbanes-Oxley Act of 2002.
|
|
*32.2
|
Certification
of Chief Financial Officer in accordance with Section 906 of the
Sarbanes-Oxley Act of 2002.
|
|
*99.1
|
Glossary
of Terms.
|
* Filed
herewith.
152