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SELECTIVE INSURANCE GROUP INC - Quarter Report: 2013 June (Form 10-Q)

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
 
FORM 10-Q
(Mark One)
 
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended: June 30, 2013
or
 
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from_____________________________to_____________________________
 
Commission File Number: 001-33067
 
SELECTIVE INSURANCE GROUP, INC.
(Exact Name of Registrant as Specified in Its Charter)
 
New Jersey
 
22-2168890
(State or Other Jurisdiction of Incorporation or Organization)
 
(I.R.S. Employer Identification No.)
 
 
 
40 Wantage Avenue
 
 
Branchville, New Jersey
 
07890
(Address of Principal Executive Offices)
 
(Zip Code)
 
(973) 948-3000
(Registrant’s Telephone Number, Including Area Code)
 
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)
 
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
Yesx           No o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yesx           No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
 
Accelerated filer o
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).                                                              Yeso          Nox
As of June 30, 2013, there were 55,728,510 shares of common stock, par value $2.00 per share, outstanding. 


Table of Contents

 
SELECTIVE INSURANCE GROUP, INC.
 
 
Table of Contents
 
 
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Federal Income Taxes
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Table of Contents

PART I. FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS
 
SELECTIVE INSURANCE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
 
Unaudited
 
 
($ in thousands, except share amounts)
 
June 30, 2013
 
December 31, 2012
ASSETS
 
 

 
 

Investments:
 
 

 
 

Fixed maturity securities, held-to-maturity – at carrying value (fair value:  $507,625 – 2013; $594,661 – 2012)
 
$
479,507

 
554,069

Fixed maturity securities, available-for-sale – at fair value (amortized cost: $3,363,994 – 2013; $3,130,683 – 2012)
 
3,419,811

 
3,296,013

Equity securities, available-for-sale – at fair value (cost:  $142,434 – 2013; $132,441 – 2012)
 
172,064

 
151,382

Short-term investments (at cost which approximates fair value)
 
186,499

 
214,479

Other investments
 
109,077

 
114,076

Total investments (Note 5)
 
4,366,958

 
4,330,019

Cash
 
154

 
210

Interest and dividends due or accrued
 
36,376

 
35,984

Premiums receivable, net of allowance for uncollectible accounts of:  $4,478 – 2013; $3,906 – 2012
 
568,523

 
484,388

Reinsurance recoverables, net
 
552,488

 
1,421,109

Prepaid reinsurance premiums
 
140,833

 
132,637

Current federal income tax
 
1,904

 
2,569

Deferred federal income tax
 
135,886

 
119,136

Property and equipment – at cost, net of accumulated depreciation and amortization of:
$174,226 – 2013; $169,428 – 2012
 
48,841

 
47,131

Deferred policy acquisition costs
 
165,078

 
155,523

Goodwill
 
7,849

 
7,849

Other assets
 
87,737

 
57,661

Total assets
 
$
6,112,627

 
6,794,216

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 

 
 

Liabilities:
 
 

 
 

Reserve for loss and loss expenses
 
$
3,270,114

 
4,068,941

Unearned premiums
 
1,048,011

 
974,706

Notes payable (Note 9)
 
392,400

 
307,387

Accrued salaries and benefits
 
102,223

 
152,396

Other liabilities
 
200,834

 
200,194

Total liabilities
 
$
5,013,582

 
5,703,624

 
 
 
 
 
Stockholders’ Equity:
 
 

 
 

Preferred stock of $0 par value per share:
 
$

 

Authorized shares 5,000,000; no shares issued or outstanding
 
 
 
 
Common stock of $2 par value per share:
 
 
 
 
Authorized shares 360,000,000
 
 
 
 
Issued: 98,910,399 – 2013; 98,194,224 – 2012
 
197,821

 
196,388

Additional paid-in capital
 
282,014

 
270,654

Retained earnings
 
1,158,861

 
1,125,154

Accumulated other comprehensive income (Note 11)
 
19,278

 
54,040

Treasury stock – at cost
(shares:  43,181,889 – 2013; 43,030,776 – 2012)
 
(558,929
)
 
(555,644
)
Total stockholders’ equity
 
1,099,045

 
1,090,592

Commitments and contingencies (Note 14)
 


 


Total liabilities and stockholders’ equity
 
$
6,112,627

 
6,794,216


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

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Table of Contents

SELECTIVE INSURANCE GROUP, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in thousands, except per share amounts)
 
2013
 
2012
 
2013
 
2012
Revenues:
 
 

 
 

 
 
 
 
Net premiums earned
 
$
426,252

 
392,212

 
847,192

 
771,041

Net investment income earned
 
34,003

 
34,006

 
66,873

 
66,634

Net realized gains:
 
 

 
 

 


 


Net realized investment gains
 
5,709

 
272

 
11,013

 
5,051

Other-than-temporary impairments
 
(508
)
 
(40
)
 
(2,427
)
 
(297
)
Other-than-temporary impairments on fixed maturity securities recognized in other comprehensive income
 
(47
)
 
(54
)
 
(77
)
 
(218
)
Total net realized gains
 
5,154

 
178

 
8,509

 
4,536

Other income
 
3,536

 
2,511

 
6,320

 
6,044

Total revenues
 
468,945

 
428,907

 
928,894

 
848,255

 
 
 
 
 
 
 
 
 
Expenses:
 
 

 
 

 
 
 
 
Loss and loss expense incurred
 
279,594

 
287,903

 
549,443

 
540,809

Policy acquisition costs
 
143,728

 
131,219

 
283,256

 
259,177

Interest expense
 
5,570

 
4,723

 
11,401

 
9,423

Other expenses
 
3,852

 
5,754

 
19,725

 
16,347

Total expenses
 
432,744

 
429,599

 
863,825

 
825,756

 
 
 
 
 
 
 
 
 
Income (loss) from continuing operations, before federal income tax
 
36,201

 
(692
)
 
65,069

 
22,499

 
 
 
 
 
 


 
 
Federal income tax expense (benefit):
 
 

 
 

 


 
 
Current
 
6,221

 
(500
)
 
13,674

 
6,678

Deferred
 
2,858

 
(480
)
 
1,968

 
(2,560
)
Total federal income tax expense (benefit)
 
9,079

 
(980
)
 
15,642

 
4,118

 
 
 
 
 
 
 
 
 
Net income from continuing operations
 
27,122

 
288

 
49,427

 
18,381

 
 
 
 
 
 
 
 
 
Loss on disposal of discontinued operations, net of tax of $(538)
 

 

 
(997
)
 

 
 
 
 
 
 
 
 
 
Net income
 
$
27,122

 
288

 
48,430

 
18,381

 
 
 
 
 
 


 
 
Earnings per share:
 
 

 
 

 
 
 
 
Basic net income from continuing operations
 
$
0.49

 
0.01

 
0.89

 
0.34

Basic net loss from discontinued operations
 

 

 
(0.02
)
 

Basic net income
 
$
0.49

 
0.01

 
0.87

 
0.34

 
 
 
 
 
 


 
 
Diluted net income from continuing operations
 
$
0.48

 
0.01

 
0.88

 
0.33

Diluted net loss from discontinued operations
 

 

 
(0.02
)
 

Diluted net income
 
$
0.48

 
0.01

 
0.86

 
0.33

 
 
 
 
 
 
 
 
 
Dividends to stockholders
 
$
0.13

 
0.13

 
0.26

 
0.26

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


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SELECTIVE INSURANCE GROUP, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in thousands)
 
2013
 
2012
 
2013
 
2012
Net income
 
$
27,122

 
288

 
48,430

 
18,381

 
 
 
 
 
 
 
 
 
Other comprehensive income, net of tax:
 
 

 
 

 
 
 
 
Unrealized (losses) gains on investment securities:
 
 

 
 

 
 
 
 
Unrealized holding (losses) gains arising during period
 
(59,353
)
 
5,101

 
(56,959
)
 
17,974

Non-credit portion of other-than-temporary impairments recognized in other comprehensive income
 
31

 
35

 
50

 
142

  Amount reclassified into net income:
 
 
 
 
 
 
 
 
Held-to-maturity securities
 
(399
)
 
(456
)
 
(865
)
 
(1,017
)
Non-credit other-than-temporary impairment
 
3

 
39

 
8

 
171

Realized gains on available for sale securities
 
(3,438
)
 
(128
)
 
(7,322
)
 
(2,917
)
Total unrealized (losses) gains on investment securities
 
(63,156
)
 
4,591

 
(65,088
)
 
14,353

 
 
 
 
 
 
 
 
 
Defined benefit pension and post-retirement plans:
 
 

 
 

 
 
 
 
Net actuarial gain
 

 

 
28,600

 

Amounts reclassified into net income:
 
 
 
 
 
 
 
 
Net actuarial loss
 
513

 
905

 
1,709

 
1,808

Prior service cost
 

 
24

 
6

 
49

Curtailment expense
 

 

 
11

 

  Total defined benefit pension and post-retirement plans
 
513

 
929

 
30,326

 
1,857

Other comprehensive (loss) income
 
(62,643
)
 
5,520

 
(34,762
)
 
16,210

Comprehensive (loss) income
 
$
(35,521
)
 
5,808

 
13,668

 
34,591

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


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SELECTIVE INSURANCE GROUP, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
 
Six Months ended June 30,
($ in thousands)
 
2013
 
2012
Common stock:
 
 

 
 

Beginning of year
 
$
196,388

 
194,494

Dividend reinvestment plan (shares:  33,514 – 2013; 46,603 – 2012)
 
67

 
93

Stock purchase and compensation plans (shares:  682,661 – 2013; 667,500 – 2012)
 
1,366

 
1,334

End of period
 
197,821

 
195,921

 
 
 
 
 
Additional paid-in capital:
 
 

 
 

Beginning of year
 
270,654

 
257,370

Dividend reinvestment plan
 
703

 
712

Stock purchase and compensation plans
 
10,657

 
7,647

End of period
 
282,014

 
265,729

 
 
 
 
 
Retained earnings:
 
 

 
 

Beginning of year
 
1,125,154

 
1,116,319

Net income
 
48,430

 
18,381

Dividends to stockholders ($0.26 per share – 2013 and 2012)
 
(14,723
)
 
(14,557
)
End of period
 
1,158,861

 
1,120,143

 
 
 
 
 
Accumulated other comprehensive income:
 
 

 
 

Beginning of year
 
54,040

 
42,294

Other comprehensive (loss) income
 
(34,762
)
 
16,210

End of period
 
19,278

 
58,504

 
 
 
 
 
Treasury stock:
 
 

 
 

Beginning of year
 
(555,644
)
 
(552,149
)
Acquisition of treasury stock (shares:  151,113 – 2013; 173,620– 2012)
 
(3,285
)
 
(3,102
)
End of period
 
(558,929
)
 
(555,251
)
Total stockholders’ equity
 
$
1,099,045

 
1,085,046

 
Selective Insurance Group, Inc. also has authorized, but not issued, 5,000,000 shares of preferred stock, without par value, of which 300,000 shares have been
designated Series A junior preferred stock, without par value.
  
The accompanying notes are an integral part of these unaudited interim consolidated financial statements.
 


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SELECTIVE INSURANCE GROUP, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF CASH FLOW
 
Six Months ended June 30,
($ in thousands)
 
2013
 
2012
Operating Activities
 
 

 
 

Net income
 
$
48,430

 
18,381

 
 
 
 
 
Adjustments to reconcile net income to net cash provided by operating activities:
 
 

 
 

Depreciation and amortization
 
23,103

 
19,550

Loss on disposal of discontinued operations
 
997

 

Stock-based compensation expense
 
6,189

 
5,160

Undistributed losses of equity method investments
 
419

 
496

Net realized gains
 
(8,509
)
 
(4,536
)
Retirement income plan curtailment expense
 
16

 

 
 
 
 
 
Changes in assets and liabilities:
 
 

 
 

Increase in reserve for losses and loss expenses, net of reinsurance recoverables
 
69,790

 
19,802

Increase in unearned premiums, net of prepaid reinsurance and advance premiums
 
65,225

 
75,172

Increase (decrease) in net federal income taxes
 
3,171

 
(3,058
)
Increase in premiums receivable
 
(84,135
)
 
(57,294
)
Increase in deferred policy acquisition costs
 
(9,555
)
 
(16,638
)
Increase in interest and dividends due or accrued
 
(1,066
)
 
(500
)
Decrease in accrued salaries and benefits
 
(6,173
)
 
(5,699
)
Decrease in accrued insurance expenses
 
(5,478
)
 
(4,500
)
Other-net
 
(4,526
)
 
5,823

Net adjustments
 
49,468

 
33,778

Net cash provided by operating activities
 
97,898

 
52,159

 
 
 
 
 
Investing Activities
 
 

 
 

Purchase of fixed maturity securities, available-for-sale
 
(530,402
)
 
(426,346
)
Purchase of equity securities, available-for-sale
 
(42,546
)
 
(40,430
)
Purchase of other investments
 
(4,393
)
 
(6,355
)
Purchase of short-term investments
 
(1,116,873
)
 
(795,707
)
Purchase of subsidiary
 

 
255

Sale of subsidiary
 
1,225

 
445

Sale of fixed maturity securities, available-for-sale
 
6,851

 
37,699

Sale of short-term investments
 
1,144,853

 
876,928

Redemption and maturities of fixed maturity securities, held-to-maturity
 
48,186

 
57,152

Redemption and maturities of fixed maturity securities, available-for-sale
 
286,905

 
197,199

Sale of equity securities, available-for-sale
 
42,206

 
58,176

Distributions from other investments
 
6,077

 
8,443

Purchase of property and equipment
 
(6,761
)
 
(6,793
)
Net cash used in investing activities
 
(164,672
)
 
(39,334
)
 
 
 
 
 
Financing Activities
 
 

 
 

Dividends to stockholders
 
(13,668
)
 
(13,442
)
Acquisition of treasury stock
 
(3,285
)
 
(3,102
)
Net proceeds from stock purchase and compensation plans
 
3,769

 
2,225

Proceeds from issuance of notes payable, net of debt issuance costs
 
178,435

 

Repayment of notes payable
 
(100,000
)
 

Excess tax benefits from share-based payment arrangements
 
1,467

 
873

Net cash provided by (used in) financing activities
 
66,718

 
(13,446
)
Net decrease in cash
 
(56
)
 
(621
)
Cash, beginning of year
 
210

 
762

Cash, end of period
 
$
154

 
141

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

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NOTES TO UNAUDITED INTERIM CONSOLIDATED FINANCIAL STATEMENTS

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

We classify our business into three operating segments:
Our Standard Insurance Operations segment, which is comprised of both commercial lines ("Commercial Lines") and personal lines ("Personal Lines") business, sells property and casualty insurance products and services in the standard market, including flood insurance through the National Flood Insurance Program's ("NFIP") write-your-own ("WYO") program;
Our E&S Insurance Operations segment, which is comprised of Commercial Lines property and casualty insurance products and services that are unavailable in the standard market due to market conditions or characteristics of the insured that are caused by the insured's claim history or the characteristics of their business; and
Our Investments segment - invests the premiums collected by our Standard and E&S Insurance Operations, as well as amounts generated through our capital management strategies, which may include the issuance of debt and equity securities.

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

Certain amounts in our prior years' Financial Statements and related notes have been reclassified to conform to the 2013 presentation. Such reclassifications had no effect on our net income, stockholders' equity, or cash flows.
 
These Financial Statements reflect all adjustments that, in our opinion, are normal, recurring, and necessary for a fair presentation of our results of operations and financial condition. The Financial Statements cover the second quarters ended June 30, 2013 (“Second Quarter 2013”) and June 30, 2012 (“Second Quarter 2012”) and the six-month periods ended June 30, 2013 ("Six Months 2013") and June 30, 2012 ("Six Months 2012"). The Financial Statements do not include all of the information and disclosures required by GAAP and the SEC for audited financial statements. Results of operations for any interim period are not necessarily indicative of results for a full year. Consequently, the Financial Statements should be read in conjunction with the consolidated financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2012 (“2012 Annual Report”).
 
NOTE 3. Adoption of Accounting Pronouncements 
In February 2013, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income ("ASU 2013-02"), which adds new disclosure requirements for items reclassified out of Accumulated Other Comprehensive Income ("AOCI"). ASU 2013-02 requires entities to disclose additional information about reclassification adjustments, including: (i) changes in AOCI balances by component; and (ii) significant items reclassified out of AOCI. Prospective application of ASU 2013-02 was effective for fiscal years, and interim periods within those years, beginning after December 15, 2012. We have included the disclosures required by ASU 2013-02 in the notes to our Financial Statements, as required.

In July 2013, the FASB issued ASU No. 2013-11, Income Taxes, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus of the FASB Emerging Issues Task Force) ("ASU 2013-11"), which states that an unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except to the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets.

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This ASU applies to all entities that have unrecognized tax benefits when a net operating loss carryforward, a similar tax loss, or a tax credit carryforward exists at the reporting date. The amendments in ASU 2013-11 are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. The adoption of this guidance will not impact our financial condition or results of operation.

NOTE 4. Statements of Cash Flow
Cash paid during Six Months 2013 and 2012 for interest and federal income taxes was as follows:
 
 
Six Months ended June 30,
($ in thousands)
 
2013
 
2012
Cash paid during the period for:
 
 

 
 

Interest
 
$
10,295

 
9,389

Federal income tax
 
11,000

 
6,300

 
At June 30, 2013, included in "Other assets" on the Consolidated Balance Sheets was $13.6 million of cash received from the NFIP which is restricted to pay flood claims under the WYO program.

NOTE 5. Investments
(a) The amortized cost, net unrealized gain and losses, carrying value, unrecognized holding gains and losses, and fair values of held-to-maturity (“HTM”) fixed maturity securities as of June 30, 2013 and December 31, 2012 were as follows:
 
June 30, 2013
 
 
 
 
 
 
 
 
 
 
 
 
($ in thousands)
 
Amortized Cost
 
Net
 Unrealized Gains
 (Losses)
 
Carrying
Value
 
Unrecognized
 Holding
Gains
 
Unrecognized Holding
 Losses
 
Fair
Value
Foreign government
 
$
5,292

 
172

 
5,464

 
194

 

 
5,658

Obligations of state and political subdivisions
 
421,460

 
4,947

 
426,407

 
20,520

 
(34
)
 
446,893

Corporate securities
 
35,983

 
(643
)
 
35,340

 
3,541

 

 
38,881

Asset-backed securities (“ABS”)
 
6,536

 
(824
)
 
5,712

 
868

 

 
6,580

Commercial mortgage-backed securities (“CMBS”)
 
7,623

 
(1,039
)
 
6,584

 
3,029

 

 
9,613

Total HTM fixed maturity securities
 
$
476,894

 
2,613

 
479,507

 
28,152

 
(34
)
 
507,625


December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
($ in thousands)
 
Amortized Cost
 
Net
 Unrealized Gains
 (Losses)
 
Carrying
Value
 
Unrecognized
 Holding
Gains
 
Unrecognized Holding
 Losses
 
Fair
Value
Foreign government
 
$
5,292

 
212

 
5,504

 
367

 

 
5,871

Obligations of state and political subdivisions
 
491,180

 
6,769

 
497,949

 
28,996

 
(23
)
 
526,922

Corporate securities
 
38,285

 
(812
)
 
37,473

 
4,648

 

 
42,121

ABS
 
6,980

 
(1,052
)
 
5,928

 
1,170

 

 
7,098

CMBS
 
8,406

 
(1,191
)
 
7,215

 
5,434

 

 
12,649

Total HTM fixed maturity securities
 
$
550,143

 
3,926

 
554,069

 
40,615

 
(23
)
 
594,661

 
Unrecognized holding gains and losses of HTM securities are not reflected in the Financial Statements, as they represent fair value fluctuations from the later of: (i) the date a security is designated as HTM; or (ii) the date that an other-than-temporary impairment (“OTTI”) charge is recognized on an HTM security, through the date of the balance sheet. Our HTM securities had an average duration of 2.3 years as of June 30, 2013.
 
During Six Months 2013, ten securities with a carrying value of $22.9 million and a net unrecognized gain position of $1.1 million were reclassified from an HTM designation to an available-for-sale (“AFS”) designation due to credit rating downgrades by Moody’s Investors Services ("Moody's") and/or Standard and Poor's Financial Services (“S&P”). These

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unexpected rating downgrades raised concerns about the issuers’ credit worthiness, which changed our intention to hold these securities to maturity.

(b) The cost/amortized cost, unrealized gains and losses, and fair value of AFS securities as of June 30, 2013 and December 31, 2012 were as follows:
 
June 30, 2013
 
 
 
 
 
 
 
 
($ in thousands)
 
Cost/
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
U.S. government and government agencies
 
$
165,844

 
12,519

 
(369
)
 
177,994

Foreign government
 
28,802

 
995

 
(127
)
 
29,670

Obligations of states and political subdivisions
 
884,615

 
28,521

 
(18,818
)
 
894,318

Corporate securities
 
1,491,837

 
46,984

 
(14,850
)
 
1,523,971

ABS
 
155,338

 
999

 
(911
)
 
155,426

CMBS1
 
137,048

 
2,318

 
(3,782
)
 
135,584

Residential mortgage-backed
securities (“RMBS”)2
 
500,510

 
8,906

 
(6,568
)
 
502,848

AFS fixed maturity securities
 
3,363,994

 
101,242

 
(45,425
)
 
3,419,811

AFS equity securities
 
142,434

 
30,395

 
(765
)
 
172,064

Total AFS securities
 
$
3,506,428

 
131,637

 
(46,190
)
 
3,591,875

 
December 31, 2012
 
 
 
 
 
 
 
 
($ in thousands)
 
Cost/
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
U.S. government and government agencies
 
$
241,874

 
17,219

 
(1
)
 
259,092

Foreign government
 
28,813

 
1,540

 
(124
)
 
30,229

Obligations of states and political subdivisions
 
773,953

 
44,398

 
(327
)
 
818,024

Corporate securities
 
1,368,954

 
81,696

 
(402
)
 
1,450,248

ABS
 
126,330

 
2,319

 
(9
)
 
128,640

CMBS1
 
133,763

 
4,572

 
(1,216
)
 
137,119

RMBS2
 
456,996

 
15,961

 
(296
)
 
472,661

AFS fixed maturity securities
 
3,130,683

 
167,705

 
(2,375
)
 
3,296,013

AFS equity securities
 
132,441

 
19,400

 
(459
)
 
151,382

Total AFS securities
 
$
3,263,124

 
187,105

 
(2,834
)
 
3,447,395


1 CMBS includes government guaranteed agency securities with a fair value of $39.9 million at June 30, 2013 and $48.9 million at December 31, 2012.
2 RMBS includes government guaranteed agency securities with a fair value of $72.2 million at June 30, 2013 and $91.0 million at December 31, 2012.
 
Unrealized gains and losses of AFS securities represent fair value fluctuations from the later of: (i) the date a security is designated as AFS; or (ii) the date that an OTTI charge is recognized on an AFS security, through the date of the balance sheet. These unrealized gains and losses are recorded in AOCI on the Consolidated Balance Sheets.
 


8

Table of Contents

(c) The following tables summarize, for all securities in a net unrealized/unrecognized loss position at June 30, 2013 and December 31, 2012, 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:

June 30, 2013
 
Less than 12 months
 
12 months or longer
($ in thousands)
 
Fair Value
 
Unrealized
Losses1
 
Fair Value
 
Unrealized
Losses1
AFS securities
 
 

 
 

 
 

 
 

U.S. government and government agencies
 
$
16,151

 
(369
)
 

 

Foreign government
 
1,058

 
(10
)
 
2,880

 
(117
)
Obligations of states and political subdivisions
 
393,204

 
(18,818
)
 

 

Corporate securities
 
431,753

 
(14,699
)
 
2,952

 
(151
)
ABS
 
98,136

 
(911
)
 

 

CMBS
 
67,456

 
(3,340
)
 
2,158

 
(442
)
RMBS
 
220,814

 
(6,387
)
 
1,626

 
(181
)
Total fixed maturity securities
 
1,228,572

 
(44,534
)
 
9,616

 
(891
)
Equity securities
 
16,948

 
(765
)
 

 

Subtotal
 
$
1,245,520

 
(45,299
)
 
9,616

 
(891
)
 
 
 
Less than 12 months
 
12 months or longer
($ in thousands)
 
Fair
Value
 
Unrealized
Losses1
 
Unrecognized
Gains2
 
Fair
Value
 
Unrealized
Losses1
 
Unrecognized
Gains2
HTM securities
 
 

 
 

 
 

 
 

 
 

 
 

Obligations of states and political subdivisions
 
$
180

 
(3
)
 
3

 
702

 
(28
)
 
20

ABS
 

 

 

 
2,803

 
(709
)
 
647

Subtotal
 
$
180


(3
)
 
3

 
3,505

 
(737
)
 
667

Total AFS and HTM
 
$
1,245,700

 
(45,302
)
 
3

 
13,121

 
(1,628
)
 
667


December 31, 2012
 
Less than 12 months
 
12 months or longer
($ in thousands)
 
Fair
Value
 
Unrealized
Losses1
 
Fair Value
 
Unrealized
Losses1
AFS securities
 
 

 
 

 
 

 
 

U.S. government and government agencies
 
$
518

 
(1
)
 

 

Foreign government
 

 

 
2,871

 
(124
)
Obligations of states and political subdivisions
 
32,383

 
(327
)
 

 

Corporate securities
 
50,880

 
(402
)
 

 

ABS
 
9,137

 
(9
)
 

 

CMBS
 
7,637

 
(19
)
 
11,830

 
(1,197
)
RMBS
 
8,710

 
(59
)
 
5,035

 
(237
)
Total fixed maturity securities
 
109,265

 
(817
)
 
19,736

 
(1,558
)
Equity securities
 
15,901

 
(459
)
 

 

Subtotal
 
$
125,166

 
(1,276
)
 
19,736

 
(1,558
)
 

9

Table of Contents


 
 
Less than 12 months
 
12 months or longer
($ in thousands)
 
Fair
Value
 
Unrealized
Losses1
 
Unrecognized
Gains2
 
Fair
Value
 
Unrealized
Losses1
 
Unrecognized
Gains2
HTM securities
 
 

 
 

 
 

 
 

 
 

 
 

Obligations of states and political subdivisions
 
$
1,218

 
(33
)
 
29

 
1,108

 
(47
)
 
38

ABS
 

 

 

 
2,860

 
(840
)
 
753

Subtotal
 
1,218

 
(33
)
 
29

 
3,968

 
(887
)
 
791

Total AFS and HTM
 
$
126,384

 
(1,309
)
 
29

 
23,704

 
(2,445
)
 
791

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

As evidenced by the table below, our net unrealized/unrecognized loss positions increased by $43.3 million as of June 30, 2013 compared to December 31, 2012 as follows:

($ in thousands)
 
 
June 30, 2013
 
December 31, 2012
Number of
Issues
% of Market/Book
Unrealized/
Unrecognized Loss
 
Number of
Issues
% of
Market/Book
Unrealized/
Unrecognized
Loss
504

80% - 99%
$
46,022

 
100

80% - 99%
2,701

1

60% - 79%
238

 
1

60% - 79%
233


40% - 59%

 

40% - 59%


20% - 39%

 

20% - 39%


0% - 19%

 

0% - 19%

 

 
$
46,260

 
 

 
2,934

 
We have reviewed the securities in the tables above in accordance with our OTTI policy, as described in Note 2. “Summary of Significant Accounting Policies” in Item 8. “Financial Statements and Supplementary Data.” of our 2012 Annual Report.
  
At June 30, 2013, we had 505 securities in an aggregate unrealized/unrecognized loss position of $46.3 million, $1.0 million of which have been in a loss position for more than 12 months. During Second Quarter 2013, interest rates on the 10 year U.S. Treasury Note rose by 64 basis points. This interest rate movement has negatively impacted our fixed maturity securities portfolio's valuation, thus increasing the number of securities in a loss position and the corresponding dollar amount of unrealized losses. The increase in the unrealized losses does not correspond to any issuer specific credit concerns, rather just interest rate movements. For a discussion regarding the sensitivity of interest rate movements and the related impacts on the fixed maturity securities portfolio, refer to Item 7A. "Quantitative and Qualitative Disclosures About Market Risk" in our 2012 Annual Report.
  
At December 31, 2012, we had 101 securities in an aggregate unrealized/unrecognized loss position of $2.9 million, $1.7 million of which had been in a loss position for more than 12 months. Securities that have had non-credit OTTI impairments comprised $0.9 million of the $1.7 million balance. The remainder of the $1.7 million balance is related to securities that were, on average, 5% impaired compared to their amortized cost.
 
We do not intend to sell any securities in an unrealized/unrecognized loss position, nor do we believe we will be required to sell these securities, and therefore we have concluded that they are temporarily impaired as of June 30, 2013. 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.
 

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Table of Contents

(d) Fixed maturity securities at June 30, 2013, by contractual maturity, are shown below. Mortgage-backed securities ("MBS") 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 June 30, 2013:
($ in thousands)
 
Carrying Value
 
Fair Value
Due in one year or less
 
$
93,387

 
96,086

Due after one year through five years
 
348,188

 
369,227

Due after five years through 10 years
 
35,044

 
38,777

Due after 10 years
 
2,888

 
3,535

Total HTM fixed maturity securities
 
$
479,507

 
507,625

 
Listed below are AFS fixed maturity securities at June 30, 2013:
($ in thousands)
 
Fair Value
Due in one year or less
 
$
326,454

Due after one year through five years
 
1,840,956

Due after five years through 10 years
 
1,202,597

Due after 10 years
 
49,804

Total AFS fixed maturity securities
 
$
3,419,811

  
(e) The following table summarizes our other investment portfolio by strategy and the remaining commitment amount associated with each strategy:
Other Investments
 
Carrying Value
 
June 30,
2013
($ in thousands)
 
June 30,
2013
 
December 31,
2012
 
Remaining Commitment
Alternative Investments
 
 

 
 

 
 

  Secondary private equity
 
$
26,489

 
28,032

 
7,527

  Energy/power generation
 
18,417

 
18,640

 
7,825

  Private equity
 
17,809

 
18,344

 
11,542

  Mezzanine financing
 
12,868

 
12,692

 
19,712

  Real estate
 
12,149

 
11,751

 
10,290

  Distressed debt
 
12,106

 
12,728

 
2,929

  Venture capital
 
7,378

 
7,477

 
400

Total alternative investments
 
107,216

 
109,664

 
60,225

Other securities
 
1,861

 
4,412

 
1,289

Total other investments
 
$
109,077

 
114,076

 
61,514

 
For a description of our seven alternative investment strategies, as well as information regarding redemption, restrictions, and fund liquidations, refer to Note 5. “Investments” in Item 8. “Financial Statements and Supplementary Data.” of our 2012 Annual Report.
 

11

Table of Contents

The following table sets forth aggregated summarized financial information for the partnerships in our alternative and other investments carried under the equity method of accounting. The last line of the table below reflects our share of the aggregate income, which is the portion included in our Financial Statements. As the majority of these investments report results to us on a quarter lag, the summarized financial statement information for the six-month periods ended March 31 is as follows:

Income Statement Information
 
Quarter ended March 31,
 
Six Months ended March 31,
($ in millions)
 
2013
 
2012
 
2013
 
2012
Net investment income
 
$
46.8

 
54.0

 
255.0

 
90.1

Realized (losses) gains
 
(22.1
)
 
234.6

 
599.7

 
985.3

Net change in unrealized depreciation
 
378.8

 
53.4

 
(18.9
)
 
(434.0
)
Net income
 
$
403.5

 
342.0

 
835.8

 
641.4

Selective’s insurance subsidiaries’ other investments income
 
$
3.9

 
3.0

 
7.5

 
5.0

 
(f) At June 30, 2013, we had 32 fixed maturity securities, with a carrying value of $62.2 million, that were pledged as collateral for our outstanding borrowing of $58.0 million with the Federal Home Loan Bank of Indianapolis (“FHLBI”).  This outstanding borrowing is included in “Notes payable” on the Consolidated Balance Sheets.  In accordance with the terms of our agreement with the FHLBI, we retain all rights regarding these securities, which are included in the “U.S. government and government agencies,” “RMBS,” and “CMBS” classifications of our AFS fixed maturity securities portfolio.

In addition, certain bonds with a carrying value of $27.1 million were on deposit with various state and regulatory agencies to comply with insurance laws. We retain all rights regarding these securities, which are primarily included in the "U.S. government and government agencies" classification of our AFS fixed maturity securities portfolio.
 
(g) The components of net investment income earned for the periods indicated were as follows:
 
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in thousands)
 
2013
 
2012
 
2013
 
2012
Fixed maturity securities
 
$
30,298


31,759

 
60,387

 
63,109

Equity securities
 
1,874


1,280

 
3,081

 
2,517

Short-term investments
 
29


29

 
81

 
67

Other investments
 
3,869


2,963

 
7,471

 
4,963

Miscellaneous income
 


25

 

 
64

Investment expenses
 
(2,067
)

(2,050
)
 
(4,147
)
 
(4,086
)
Net investment income earned
 
$
34,003

 
34,006

 
66,873

 
66,634


(h) The following tables summarize OTTI by asset type for the periods indicated:
Second Quarter 2013
 
Gross 
 
Included in Other
Comprehensive
Income (“OCI”)
 
Recognized in
Earnings
($ in thousands) 
 
 
 
HTM fixed maturity securities
 
 

 
 

 
 

ABS
 
$
(44
)
 
(47
)
 
3

Total HTM fixed maturity securities
 
(44
)
 
(47
)
 
3

Equity securities
 
429

 

 
429

Other investments
 
123

 

 
123

OTTI losses
 
$
508

 
(47
)
 
555

 
Second Quarter 2012
 
Gross
 
Included in OCI
 
Recognized in Earnings
($ in thousands)
 
 
 
AFS fixed maturity securities
 
 

 
 

 
 

ABS
 
$
30

 

 
30

RMBS
 
10

 
(54
)
 
64

OTTI losses
 
$
40

 
(54
)
 
94



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Table of Contents

Six Months 2013
 
Gross 
 
Included in OCI
 
Recognized in
Earnings
($ in thousands) 
 
 
 
HTM fixed maturity securities
 
 
 
 
 
 
ABS
 
$
(44
)
 
(47
)
 
3

Total HTM fixed maturity securities
 
(44
)
 
(47
)
 
3

AFS fixed maturity securities
 
 

 
 

 
 

RMBS
 
(22
)
 
(30
)
 
8

Total AFS fixed maturity securities
 
(22
)
 
(30
)
 
8

Equity securities
 
646

 

 
646

Total AFS securities
 
624

 
(30
)
 
654

Other investments
 
1,847

 

 
1,847

OTTI losses
 
$
2,427

 
(77
)
 
2,504


Six Months 2012
 
Gross 
 
Included in OCI
 
Recognized in
Earnings
($ in thousands) 
 
 
 
AFS fixed maturity securities
 
 

 
 

 
 

ABS
 
$
62

 

 
62

CMBS
 
108

 

 
108

RMBS
 
(44
)
 
(218
)
 
174

Total AFS fixed maturity securities
 
126

 
(218
)
 
344

Equity securities
 
171

 

 
171

Total AFS securities
 
297

 
(218
)
 
515

OTTI losses
 
$
297

 
(218
)
 
515


The majority of the OTTI charges in Six Months 2013 relate to an investment in a limited liability company within our other investments portfolio that has sustained significant losses for which we do not anticipate recovery. For a discussion of our evaluation for OTTI of fixed maturity securities, short-term investments, equity securities and other investments, refer to Note 2. "Summary of Significant Accounting Policies" in Item 8. "Financial Statements and Supplementary Data" of our 2012 Annual Report.

The following tables set forth, for the periods indicated, credit loss impairments on fixed maturity securities for which a portion of the OTTI charge was recognized in OCI, and the corresponding changes in such amounts:
 
 
Quarter ended June 30,
($ in thousands)
 
2013
 
2012
Balance, beginning of period
 
$
7,486

 
6,711

Addition for the amount related to credit loss for which an OTTI was not previously recognized
 

 

Reductions for securities sold during the period
 

 

Reductions for securities for which the amount previously recognized in OCI was recognized in earnings because of intention or potential requirement to sell before recovery of amortized cost
 

 

Reductions for securities for which the entire amount previously recognized in OCI was recognized in earnings due to a decrease in cash flows expected
 

 

Additional increases to the amount related to credit loss for which an OTTI was previously recognized
 
2

 
64

Accretion of credit loss impairments previously recognized due to an increase in cash flows expected to be collected
 

 

Balance, end of period
 
$
7,488

 
6,775



13

Table of Contents

 
 
Six Months ended June 30,
($ in thousands)
 
2013
 
2012
Balance, beginning of period
 
$
7,477

 
6,602

Addition for the amount related to credit loss for which an OTTI was not previously recognized
 

 

Reductions for securities sold during the period
 

 

Reductions for securities for which the amount previously recognized in OCI was recognized in earnings because of intention or potential requirement to sell before recovery of amortized cost
 

 

Reductions for securities for which the entire amount previously recognized in OCI was recognized in earnings due to a decrease in cash flows expected
 

 

Additional increases to the amount related to credit loss for which an OTTI was previously recognized
 
11

 
173

Accretion of credit loss impairments previously recognized due to an increase in cash flows expected to be collected
 

 

Balance, end of period
 
$
7,488

 
6,775


(i) The components of net realized gains, excluding OTTI charges, for the periods indicated were as follows:
 
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in thousands)
 
2013
 
2012
 
2013
 
2012
HTM fixed maturity securities
 
 
 
 
 
 
 
 
Gains
 
$
3

 
2

 
3

 
155

Losses
 
(12
)
 
(25
)
 
(49
)
 
(106
)
AFS fixed maturity securities
 
 

 
 

 
 
 
 
Gains
 
967

 
368

 
1,918

 
773

Losses
 
(46
)
 
(74
)
 
(299
)
 
(117
)
AFS equity securities
 
 

 
 

 
 
 
 
Gains
 
4,800

 

 
10,471

 
4,775

Losses
 
(3
)
 

 
(171
)
 
(428
)
Short-term investments
 
 

 
 

 
 
 
 
Losses
 

 

 

 
(2
)
Other Investments
 
 
 
 
 
 
 
 
Gains
 

 
1

 

 
1

     Losses
 



 
(860
)
 

Total other net realized investment gains
 
5,709


272

 
11,013

 
5,051

Total OTTI charges recognized in earnings
 
(555
)

(94
)
 
(2,504
)
 
(515
)
Total net realized gains
 
$
5,154


178

 
8,509

 
4,536

 
Realized gains and losses on the sale of investments are determined on the basis of the cost of the specific investments sold. Of the $5.7 million and $11.0 million in net realized gains in Second Quarter and Six Months 2013, $4.7 million relates to the sale of a private equity security due to the acquisition of this investment by a third party. In addition, $5.6 million in net realized gains in Six Months 2013 and $4.3 million in Six Months 2012 were related to the sale of AFS equity securities due to the rebalancing of our high dividend yield strategy holdings within our equity portfolio.

Proceeds from the sale of AFS securities were $42.2 million in Second Quarter 2013 and $49.1 million in Six Months 2013, and $24.1 million and $95.9 million in in the same periods a year ago.












14

Table of Contents

NOTE 6. Fair Value Measurements
The following table presents the carrying amounts and estimated fair values of our financial instruments as of June 30, 2013 and December 31, 2012:
 
 
June 30, 2013
 
December 31, 2012
($ in thousands)
 
Carrying Amount
 
Fair
Value
 
Carrying Amount
 
Fair
Value
Financial Assets
 
 

 
 

 
 

 
 

Fixed maturity securities:
 
 

 
 

 
 

 
 

HTM
 
$
479,507

 
507,625

 
554,069

 
594,661

AFS
 
3,419,811

 
3,419,811

 
3,296,013

 
3,296,013

Equity securities, AFS
 
172,064

 
172,064

 
151,382

 
151,382

Short-term investments
 
186,499

 
186,499

 
214,479

 
214,479

Receivable for proceeds related to sale of Selective HR Solution (“Selective HR”)
 

 

 
2,705

 
2,705

Financial Liabilities
 
 

 
 

 
 

 
 

Notes payable:
 
 

 
 

 
 

 
 

2.90% borrowings from FHLBI
 
13,000

 
13,451

 
13,000

 
13,595

1.25% borrowings from FHLBI
 
45,000

 
44,927

 
45,000

 
45,590

7.50% Junior Notes
 

 

 
100,000

 
101,480

6.70% Senior Notes
 
99,486

 
109,000

 
99,475

 
107,707

7.25% Senior Notes
 
49,914

 
52,994

 
49,912

 
52,689

5.875% Senior Notes
 
185,000

 
170,644

 

 

Total notes payable
 
$
392,400

 
391,016

 
307,387

 
321,061

 
The fair values of our financial assets and liabilities 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 or liability's classification within the fair value hierarchy is based on the lowest level of significant input to its valuation. Transfers between levels in the fair value hierarchy are recognized at the end of the reporting period.

For a discussion of the techniques used to value the majority of our financial assets and liabilities, refer to Note 2. "Summary of Significant Accounting Policies" in Item 8. "Financial Statements and Supplementary Data." of our 2012 Annual Report. The 5.875% Senior Notes were valued based on a quoted market price (Level 1). The fair value at June 30, 2013 of the 6.70% Senior Notes due November 1, 2035 is based on a matrix pricing model prepared by an external pricing service due to the availability and nature of the pricing at the valuation date (Level 2).


15

Table of Contents

The following tables provide quantitative disclosures of our financial assets that were measured at fair value at June 30, 2013 and December 31, 2012:
 
June 30, 2013
 
 
 
Fair Value Measurements Using
($ in thousands)
 
Assets
 Measured at
 Fair Value
 at 6/30/13
 
Quoted Prices in
Active Markets for
Identical Assets/
Liabilities (Level 1)1
 
Significant Other
 Observable
Inputs
 (Level 2)1
 
Significant Unobservable
 Inputs
 (Level 3)
Description
 
 

 
 

 
 

 
 

Measured on a recurring basis:
 
 

 
 

 
 

 
 

AFS:
 
 
 
 
 
 
 
 
U.S. government and government agencies
 
$
177,994

 
48,236

 
129,758

 

Foreign government
 
29,670

 

 
29,670

 

Obligations of states and political subdivisions
 
894,318

 

 
894,318

 

Corporate securities
 
1,523,971

 

 
1,523,971

 

ABS
 
155,426

 

 
155,426

 

CMBS
 
135,584

 

 
133,953

 
1,631

RMBS
 
502,848

 

 
502,848

 

Total AFS fixed maturity securities
 
3,419,811

 
48,236

 
3,369,944

 
1,631

Equity securities
 
172,064

 
169,164

 

 
2,900

Short-term investments
 
186,499

 
186,499

 

 

 
 
 
 
 
 
 
 
 
Measured on a non-recurring basis:
 
 
 
 
 
 
 
 
ABS, HTM2
 
335

 

 
335

 

Total assets
 
$
3,778,709

 
403,899

 
3,370,279

 
4,531

1
There were no transfers of securities between Level 1 and Level 2.
2 
As of June 30, 2013, as the result of our OTTI analysis, we impaired one ABS HTM security down to fair value, which is typically not carried at fair value.
 
December 31, 2012
 
 
 
Fair Value Measurements Using
($ in thousands)
 
Assets
 Measured at
Fair Value
at 12/31/12
 
Quoted Prices in
 Active Markets for
Identical Assets/Liabilities
(Level 1)1
 
Significant
Other Observable
Inputs
 (Level 2)1
 
Significant Unobservable
Inputs
 (Level 3)
Description
 
 

 
 

 
 

 
 

Measured on a recurring basis:
 
 

 
 

 
 

 
 

AFS:
 
 
 
 
 
 
 
 
U.S. government and government agencies
 
$
259,092

 
115,861

 
123,442

 
19,789

Foreign government
 
30,229

 

 
30,229

 

Obligations of states and political subdivisions
 
818,024

 

 
818,024

 

Corporate securities
 
1,450,247

 

 
1,447,301

 
2,946

ABS
 
128,640

 

 
122,572

 
6,068

CMBS
 
137,119

 

 
129,957

 
7,162

RMBS
 
472,662

 

 
472,662

 

Total AFS fixed maturity securities
 
3,296,013

 
115,861

 
3,144,187

 
35,965

Equity securities
 
151,382

 
147,775

 

 
3,607

Short-term investments
 
214,479

 
214,479

 

 

Receivable for proceeds related to sale of Selective HR
 
2,705

 

 

 
2,705

Total assets
 
$
3,664,579

 
478,115

 
3,144,187

 
42,277

1 
There were no transfers of securities between Level 1 and Level 2.

 

16

Table of Contents

The following tables provide a summary of the changes in the fair value of securities measured using Level 3 inputs and related quantitative information for the periods ended June 30, 2013 and December 31, 2012:

Six Months 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
($ in thousands)
 
Government
 
Corporate
 
ABS
 
CMBS
 
Equity
 
Receivable for
Proceeds
Related to Sale
of Selective HR
 
Total
Fair value, December 31, 2012
 
$
19,789

 
2,946

 
6,068

 
7,162

 
3,607

 
2,705

 
42,277

Total net (losses) gains for the period included in:
 
 

 
 

 
 
 
 

 
 
 
 

 
 
OCI1
 
(537
)
 
(7
)
 
(266
)
 
684

 
3,935

 

 
3,809

Net income2,3
 
(76
)
 

 

 
351

 

 
(1,480
)
 
(1,205
)
Purchases
 

 

 

 

 

 

 

Sales
 

 

 

 

 

 

 

Issuances
 

 

 

 

 

 

 

Settlements
 
(1,847
)
 
(168
)
 

 
(1,581
)
 

 
(225
)
 
(3,821
)
Transfers into Level 3
 

 

 

 

 

 

 

Transfers out of Level 3
 
(17,329
)
 
(2,771
)
 
(5,802
)
 
(4,985
)
 
(4,642
)
 
(1,000
)
 
(36,529
)
Fair value, June 30, 2013
 
$

 

 

 
1,631

 
2,900

 

 
4,531

1 Amounts are reported in “Unrealized holding (losses) gains arising during period” on the Consolidated Statements of Comprehensive Income.
2 Amounts are reported in “Net realized gains” for realized gains and “Net investment income earned” for amortization of securities on the Consolidated Statements of Income.
3 For the receivable related to the sale of Selective HR, amounts in “Loss on disposal of discontinued operations, net of tax” relate to an impairment charge and amounts in “Other income” relate to interest accretion on the Consolidated Statements of Income.

December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 
 
 
($ in thousands)
 
Government
 
Corporate
 
ABS
 
CMBS
 
Equity
 
Receivable for
 Proceeds
Related to Sale
 of Selective HR
 
Total
Fair value, December 31, 2011
 
$
21,741

 
2,603

 

 
354

 

 
3,212

 
27,910

Total net (losses) gains for the period included in:
 
 

 
 

 
 
 
 

 
 
 
 

 
 

OCI1
 
(22
)
 
185

 
68

 
858

 

 

 
1,089

Net income2,3
 
(193
)
 

 

 
(51
)
 

 
244

 

Purchases
 

 

 
7,300

 
5,611

 

 

 
12,911

Sales
 

 

 

 

 

 

 

Issuances
 

 

 

 

 

 

 

Settlements
 
(1,737
)
 
(630
)
 

 
(624
)
 

 
(751
)
 
(3,742
)
Transfers into Level 3
 

 
788

 

 
8,247

 
3,607

 

 
12,642

Transfers out of Level 3
 

 

 
(1,300
)
 
(7,233
)
 

 

 
(8,533
)
Fair value, December 31, 2012
 
$
19,789

 
2,946

 
6,068

 
7,162

 
3,607

 
2,705

 
42,277

1 Amounts are reported in “Unrealized holding gains arising during period” on the Consolidated Statements of Comprehensive Income in our 2012 Annual Report.
2 Amounts are reported in “Net realized gains (losses)” for realized gains and losses and “Net investment income earned” for amortization for the CMBS securities on the Consolidated Statements of Income in our 2012 Annual Report.
3 Amounts are reported in “Other income” for the receivable related to the sale of Selective HR on the Consolidated Statements of Income in our 2012 Annual Report and are related to interest accretion on the receivable.

As discussed in Note 2. "Summary of Significant Accounting Policies," in Item 8. "Financial Statements and Supplementary Data." in our 2012 Annual Report, the fair value of our Level 3 fixed maturity securities is typically obtained through non-binding broker quotes based on unobservable inputs, which we review for reasonableness. At June 30, 2013 and December 31, 2012, fixed maturity securities with aggregate fair values of $1.6 million and $36.0 million, respectively, were measured using Level 3 inputs primarily due to the availability and nature of the pricing used at the valuation dates.

During Six Months 2013, fixed maturity securities with a fair value of $30.9 million were transferred out of Level 3 due to the availability of Level 2 pricing at June 30, 2013 that was not available previously.


17

Table of Contents

In 2012, fixed maturity securities with a fair value of $9.0 million were transferred into Level 3 during the year. These transfers were primarily related to securities that had been previously priced using Level 2 inputs, but due to the availability and nature of the pricing used at the valuation dates, were priced using Level 3 inputs at December 31, 2012. In addition, certain of these transfers related to securities that had previously been classified as HTM, and therefore not measured at fair value, for which available pricing at December 31, 2012 used Level 3 inputs. Securities with a fair value of $8.5 million were transferred out of Level 3 due to the availability of Level 2 pricing at December 31, 2012 that was not available previously.
  
Equity securities with fair values of $2.9 million and $3.6 million were measured using Level 3 inputs at June 30, 2013 and December 31, 2012, respectively. During 2012, two non-publicly traded equity securities were transferred into Level 3 due to the nature of the quotes used at the valuation date. One of these securities was transferred out of Level 3 and into Level 2 at March 31, 2013, as the pricing as of that date was based on a quoted price in an inactive market. This security was subsequently sold in Second Quarter 2013 for an amount that approximated the March 31, 2013 value. At each reporting date, we review the fair values on the remaining Level 3 security for reasonableness.

At December 31, 2012, the receivable related to the sale of Selective HR was contingent on the purchaser's ability to retain business subsequent to the sale. At that time, the fair value of this receivable was measured using unobservable inputs, the most significant of which was our assumption regarding the retention of business. In Six Months 2013, we reached an agreement with the purchaser to settle this receivable for an aggregate of $1.0 million, which was paid in two installments. As a result, the receivable was transferred out of Level 3 and we have subsequently received the $1.0 million. See Note 12. "Discontinued Operations" of this Form 10-Q for a discussion of the impairment charge that was recorded on this receivable in the first quarter of 2013.


   



18

Table of Contents

The following tables provide quantitative information regarding our financial assets and liabilities that were disclosed at fair value at June 30, 2013 and December 31, 2012:
June 30, 2013
 
 
 
Fair Value Measurements Using
($ in thousands)
 
Assets/
Liabilities
Disclosed at
Fair Value at 6/30/2013
 
Quoted Prices in
 Active Markets for
 Identical Assets/
Liabilities
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Financial Assets
 
 

 
 

 
 

 
 

HTM:
 
 

 
 

 
 

 
 

Foreign government
 
$
5,658

 

 
5,658

 

Obligations of states and political subdivisions
 
446,893

 

 
446,893

 

Corporate securities
 
38,881

 

 
38,881

 

ABS
 
6,245

 

 
5,049

 
1,196

CMBS
 
9,613

 

 
9,613

 

Total HTM fixed maturity securities
 
$
507,290

 

 
506,094

 
1,196

Financial Liabilities
 
 

 
 

 
 

 
 

Notes payable:
 
 

 
 

 
 

 
 

2.90% borrowings from FHLBI
 
$
13,451

 

 
13,451

 

1.25% borrowings from FHLBI
 
44,927

 

 
44,927

 

6.70% Senior Notes
 
109,000

 

 
109,000

 

7.25% Senior Notes
 
52,994

 

 
52,994

 

5.875% Senior Notes
 
170,644

 
170,644

 

 

Total notes payable
 
$
391,016

 
170,644

 
220,372

 

December 31, 2012
 
 
 
Fair Value Measurements Using
($ in thousands)
 
Assets/
Liabilities
Disclosed at
Fair Value at 12/31/2012
 
Quoted Prices in
 Active Markets for
 Identical Assets/
Liabilities
(Level 1)
 
Significant Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
Financial Assets
 
 

 
 

 
 

 
 

HTM:
 
 

 
 

 
 

 
 
Foreign government
 
$
5,871

 

 
5,871

 

Obligations of states and political subdivisions
 
526,922

 

 
526,922

 

Corporate securities
 
42,121

 

 
37,289

 
4,832

ABS
 
7,097

 

 
5,698

 
1,399

CMBS
 
12,650

 

 
12,650

 

Total HTM fixed maturity securities
 
$
594,661

 

 
588,430

 
6,231

Financial Liabilities
 
 

 
 
 
 
 
 
Notes payable:
 
 

 
 
 
 
 
 
2.90% borrowings from FHLBI
 
$
13,595

 

 
13,595

 

1.25% borrowings from FHLBI
 
45,590

 

 
45,590

 

7.50% Junior Notes
 
101,480

 
101,480

 

 

6.70% Senior Notes
 
107,707

 
107,707

 

 

7.25% Senior Notes
 
52,689

 

 
52,689

 

Total notes payable
 
$
321,061

 
209,187

 
111,874

 


19

Table of Contents


NOTE 7. Reinsurance
The following table contains a listing of direct, assumed, and ceded reinsurance amounts for premiums written, premiums earned, and loss and loss expenses incurred for the periods indicated. For more information concerning reinsurance, refer to Note 8. “Reinsurance” in Item 8. “Financial Statements and Supplementary Data.” of our 2012 Annual Report.
 
 
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in thousands)
 
2013
 
2012
 
2013
 
2012
Premiums written:
 
 

 
 

 
 
 
 
Direct
 
$
551,190

 
507,520

 
1,080,006

 
983,486

Assumed
 
4,378

 
4,747

 
12,860

 
26,736

Ceded
 
(93,391
)
 
(86,704
)
 
(180,565
)
 
(164,487
)
Net
 
$
462,177

 
425,563

 
912,301

 
845,735

Premiums earned:
 
 

 
 

 
 

 
 

Direct
 
$
504,081

 
463,330

 
998,147

 
915,318

Assumed
 
8,951

 
16,039

 
21,414

 
31,088

Ceded
 
(86,780
)
 
(87,157
)
 
(172,369
)
 
(175,365
)
Net
 
$
426,252

 
392,212

 
847,192

 
771,041

Loss and loss expense incurred:
 
 

 
 

 
 

 
 

Direct
 
$
338,954

 
301,451

 
704,600

 
553,654

Assumed
 
6,420

 
10,470

 
15,494

 
21,069

Ceded
 
(65,780
)
 
(24,018
)
 
(170,651
)
 
(33,914
)
Net
 
$
279,594

 
287,903

 
549,443

 
540,809

 
The growth in direct premium written ("DPW") for our ten insurance subsidiaries ("Insurance Subsidiaries") in both Second Quarter and Six Months 2013 compared to Second Quarter and Six Months 2012 reflects: (i) pure price increases that we have achieved in our Standard Insurance Operations; and (ii) strong retention in our Standard Insurance Operations.
 
Direct premiums earned increases in Second Quarter and Six Months 2013 were consistent with the fluctuation in DPW for the twelve-month period ended June 30, 2013 as compared to the twelve-month period ended June 30, 2012.

Assumed premiums written for Six Months 2013 decreased compared to the same period last year as E&S business, which was previously written through a reinsurance fronting agreement, is now written directly by our Insurance Subsidiaries. Decreases in assumed premiums earned in Second Quarter and Six Months 2013 compared to Second Quarter and Six Months 2012 were driven by the E&S premiums.
Direct loss and loss expense incurred in Six Months 2013 included an increase of approximately $75 million related to flood losses covered under the NFIP for Hurricane Sandy, which occurred in October 2012. Total estimated gross flood losses for this storm were $1,127 million at June 30, 2013 and $1,052 million at December 31, 2012, of which approximately $1,108 million was paid through June 30, 2013.
As all flood losses are fully ceded under the NFIP, the increase in the direct loss and loss expenses drive the corresponding increase in our ceded losses. The ceded premiums and losses related to our participation in the NFIP, under which 100% of our flood premiums, losses, and loss expenses are ceded to the NFIP, are as follows:
NFIP
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in thousands)
 
2013
 
2012
 
2013
 
2012
Ceded premiums written
 
$
(62,461
)
 
(60,525
)
 
(119,168
)
 
(112,249
)
Ceded premiums earned
 
(56,450
)
 
(52,768
)
 
(111,777
)
 
(104,673
)
Ceded loss and loss expense incurred
 
(51,725
)
 
(6,754
)
 
(127,901
)
 
8,168

 
In addition to the direct and ceded losses being higher in Six Months 2013, 2012 reflects the fact that Hurricane Irene and Tropical Storm Lee claims were settled for less than their original estimates.

20

Table of Contents

NOTE 8. Segment Information
The results of our three operating segments are used by senior management to manage our operations. These segments are evaluated based on the following:
Our Standard Insurance Operations segment and our E&S Insurance Operations segment are evaluated based on statutory underwriting results (net premiums earned, incurred loss and loss expenses, policyholders dividends, policy acquisition costs, and other underwriting expenses), and statutory combined ratios; and
Our Investments segment is evaluated based on net investment income and net realized gains and losses.

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

The following summaries present 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 by Segment
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in thousands)
 
2013
 
2012
 
2013
 
2012
Standard Insurance Operations:
 
 

 
 

 
 
 
 
Net premiums earned:
 
 

 
 

 
 
 
 
Commercial automobile
 
$
76,706

 
71,540

 
151,053

 
142,024

Workers compensation
 
64,855

 
66,661

 
130,939

 
132,472

General liability
 
99,766

 
92,632

 
197,469

 
182,775

Commercial property
 
54,937

 
50,377

 
108,352

 
99,748

Businessowners’ policies
 
18,625

 
17,266

 
37,165

 
34,123

Bonds
 
4,775

 
4,700

 
9,539

 
9,363

Other
 
2,993

 
3,113

 
5,985

 
6,281

Total standard Commercial Lines
 
322,657

 
306,289

 
640,502

 
606,786

Personal automobile
 
38,526

 
37,897

 
76,919

 
75,353

Homeowners
 
31,702

 
28,808

 
62,837

 
56,766

Other
 
3,320

 
3,251

 
6,828

 
6,446

Total standard Personal Lines
 
73,548

 
69,956

 
146,584

 
138,565

Total Standard Insurance Operations net premiums earned
 
396,205

 
376,245

 
787,086

 
745,351

Miscellaneous income
 
3,528

 
2,438

 
6,248

 
5,895

Total Standard Insurance Operations revenue
 
399,733

 
378,683

 
793,334

 
751,246

E&S Insurance Operations:
 
 
 
 
 
 
 
 
Net premiums earned
 
30,047

 
15,967

 
60,106

 
25,690

Investments:
 
 

 
 

 
 

 
 

Net investment income
 
34,003

 
34,006

 
66,873

 
66,634

Net realized investment gains
 
5,154

 
178

 
8,509

 
4,536

Total investment revenues
 
39,157

 
34,184

 
75,382

 
71,170

Total all segments
 
468,937

 
428,834

 
928,822

 
848,106

Other income
 
8

 
73

 
72

 
149

Total revenues from continuing operations
 
$
468,945

 
428,907

 
928,894

 
848,255

 

21

Table of Contents

Income from Continuing Operations before Federal Income Tax
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in thousands)
 
2013
 
2012
 
2013
 
2012
Standard Insurance Operations:
 
 

 
 

 
 
 
 
Commercial Lines underwriting gain (loss)
 
$
9,743

 
(14,424
)
 
15,845

 
(14,015
)
Personal Lines underwriting gain (loss)
 
(2,975
)
 
(7,438
)
 
2,998

 
(4,317
)
Total Standard Insurance Operations underwriting gain (loss), before federal income tax
 
6,768

 
(21,862
)
 
18,843

 
(18,332
)
GAAP combined ratio
 
98.3
%
 
105.8

 
97.6

 
102.5

Statutory combined ratio
 
97.0
%
 
105.5

 
96.9

 
101.8

 
 
 
 
 
 
 
 
 
E&S Insurance Operations:
 
 
 
 
 
 
 
 
Underwriting loss
 
(2,285
)
 
(5,100
)
 
(2,199
)
 
(9,993
)
GAAP combined ratio
 
107.6
%
 
131.9

 
103.7

 
138.9

Statutory combined ratio
 
106.8
%
 
116.1

 
102.6

 
118.0

 
 
 
 
 
 
 
 
 
Investments:
 
 

 
 

 
 

 
 

Net investment income
 
34,003

 
34,006

 
66,873

 
66,634

Net realized investment gains
 
5,154

 
178

 
8,509

 
4,536

Total investment income, before federal income tax
 
39,157

 
34,184

 
75,382

 
71,170

 
 
 
 
 
 
 
 
 
Total all segments
 
43,640

 
7,222

 
92,026

 
42,845

Interest expense
 
(5,570
)
 
(4,723
)
 
(11,401
)
 
(9,423
)
General corporate and other expenses
 
(1,869
)
 
(3,191
)
 
(15,556
)
 
(10,923
)
Income (loss) from continuing operations before federal income tax
 
$
36,201

 
(692
)
 
65,069

 
22,499

 
 
 
 
 
 
 
 
 
 
NOTE 9. Indebtedness
In the first quarter of 2013, we issued $185 million of 5.875% Senior Notes due 2043. The Senior Notes will pay interest on February 15, May 15, August 15, and November 15 of each year, beginning on May 15, 2013, and at maturity. The notes are callable by us on or after February 8, 2018, at a price equal to 100% of their principal outstanding amount, plus accrued and unpaid interest to, but excluding, the date of redemption. A portion of the proceeds from this debt issuance was used to fully redeem the $100 million aggregate principal amount of our 7.5% Junior Subordinated Notes due 2066, which had an associated $3.3 million pre-tax write-off for the remaining capitalized debt issuance costs on these notes. Of the remaining net proceeds, $57.1 million was used to make capital contributions to the Insurance Subsidiaries, while the balance was used for general corporate purposes. For additional information related to all our outstanding debt, refer to Note 10. "Indebtedness" in Item 8. "Financial Statements and Supplementary Data" of our 2012 Annual Report.

NOTE 10. Retirement Plans
The Retirement Income Plan for Selective Insurance Company of America and the Supplemental Excess Retirement Plan (jointly referred to as the "Retirement Income Plan") were amended in the first quarter of 2013 to curtail the accrual of additional benefits for all employees eligible to participate in the plans after March 31, 2016. The curtailment of the plans resulted in a net actuarial gain recognized in OCI of $44.0 million on a pre-tax basis.

As a result of the curtailment, the Retirement Income Plan was re-measured as of March 31, 2013. When determining the most appropriate discount rate to be used in the valuation, we consider, among other factors, our expected payout patterns of the Retirement Income Plan's obligations, as well as our investment strategy. We ultimately select the rate that we believe best represents our estimate of the inherent interest rate at which the Retirement Income Plan's liabilities can be effectively settled. The expected rate of return on plan assets at March 31, 2013 remained at 7.40%, consistent with our December 31, 2012 assumption. For re-measurement, we determined that the most appropriate discount rate was 4.66%, up slightly from 4.42% determined as of December 31, 2012.

Eligible employees impacted by the curtailment of the Retirement Income Plan began receiving, on April 5, 2013, an enhanced company contribution to the Selective Insurance Retirement Savings Plan of 4% of base salary, which is the enhanced company contribution currently provided to all employees not eligible to participate in the Retirement Income Plan.


22

Table of Contents

The funded status of the Retirement Income Plan recognized in the Consolidated Balance Sheets as of June 30, 2013, the valuation of which was updated as of March 31, 2013 as a result of the first quarter curtailment discussed above, and December 31, 2012, was as follows:

 
Retirement Income Plan
($ in thousands)
 
June 30, 2013
 
December 31, 2012
Change in Benefit Obligation:
 
 
 
 
Benefit obligation, beginning of year
 
$
302,647

 
254,009

Service cost
 
2,449

 
8,091

Interest cost
 
3,303

 
12,981

Actuarial (gain) losses
 
(11,485
)
 
33,596

Benefits paid
 
(1,598
)
 
(6,030
)
Impact of curtailment
 
(29,603
)
 

Benefit obligation, end of period
 
$
265,713

 
302,647

 
 
 
 
 
Change in Fair Value of Assets:
 
 
 
 
Fair value of assets, beginning of year
 
$
207,150

 
182,614

Actual return on plan assets, net of expenses
 
6,760

 
21,896

Contribution by employer to funded plans
 
2,650

 
8,550

Contribution by employer to unfunded plans
 
30

 
120

Benefits paid
 
(1,598
)
 
(6,030
)
Fair value of assets, end of period
 
$
214,992

 
207,150

 
 
 
 
 
Funded status
 
$
(50,721
)
 
(95,497
)
Amount Recognized in Consolidated Balance Sheet:
 
 
 
 
Liabilities
 
$
(50,721
)
 
(95,497
)
Net pension liability, end of period
 
$
(50,721
)
 
(95,497
)
Amount Recognized in AOCI:
 
 
 
 
Prior service cost
 
$

 
26

Net actuarial loss
 
57,543

 
103,365

Total
 
$
57,543

 
103,391

Other Information:
 
 
 
 
Accumulated benefit obligation
 
$
257,412

 
265,899

Weighted-Average Liability Assumptions:
 
 
 
 
Discount Rate
 
4.66
%
 
4.42
Rate of compensation increase
 
4.00
%
 
4.00


23

Table of Contents

The following table shows the cost of the Retirement Income Plan and the life insurance benefit ("Retirement Life Plan") for the quarterly and six month periods ended June 30, 2013 and June 30, 2012:

 
 
Retirement Income Plan
Quarter ended June 30,
 
Retirement Life Plan
Quarter ended June 30,
($ in thousands)
 
2013
 
2012
 
2013
 
2012
Components of Net Periodic Benefit Cost and Other Amounts Recognized in OCI:
 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
Net Periodic Benefit Cost:
 
 
 
 
 
 
 
 
Service cost
 
$
1,857

 
2,154

 

 

Interest cost
 
3,051

 
3,230

 
69

 
74

Expected return on plan assets
 
(3,985
)
 
(3,547
)
 

 

Amortization of unrecognized prior service cost
 

 
37

 

 

Amortization of unrecognized net actuarial loss
 
772

 
1,383

 
17

 
8

Total net periodic cost
 
$
1,695

 
3,257

 
86

 
82

 
 
 
 
 
 
 
 
 
Other Changes in Plan Assets and Benefit Obligations Recognized in OCI:
 
 
 
 
 
 
 
 
Reversal of amortization of net actuarial loss
 
$
(772
)
 
(1,383
)
 
(17
)
 
(8
)
Reversal of amortization of prior service cost
 

 
(37
)
 

 

Total recognized in OCI
 
$
(772
)
 
(1,420
)
 
(17
)
 
(8
)
 
 
 
 
 
 
 
 
 
Total recognized in net periodic benefit cost and OCI
 
$
923

 
1,837

 
69

 
74


 
 
Retirement Income Plan
Six Months ended June 30,
 
Retirement Life Plan
Six Months ended June 30,
($ in thousands)
 
2013
 
2012
 
2013
 
2012
Components of Net Periodic Benefit Cost and Other Amounts Recognized in OCI:
 
 

 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
Net Periodic Benefit Cost:
 
 
 
 
 
 
 
 
Service cost
 
$
4,306

 
4,308

 

 

Interest cost
 
6,354

 
6,460

 
139

 
148

Expected return on plan assets
 
(7,833
)
 
(7,094
)
 

 

Amortization of unrecognized prior service cost
 
10

 
75

 

 

Amortization of unrecognized net actuarial loss
 
2,594

 
2,766

 
35

 
15

Curtailment expense
 
16

 

 

 

Total net periodic cost
 
$
5,447

 
6,515

 
174

 
163

 
 
 
 
 
 
 
 
 
Other Changes in Plan Assets and Benefit Obligations Recognized in OCI:
 
 
 
 
 
 
 
 
Net actuarial gain due to curtailment
 
$
(44,000
)
 

 

 

Reversal of amortization of net actuarial loss
 
(2,594
)
 
(2,766
)
 
(35
)
 
(15
)
Reversal of amortization of prior service cost
 
(10
)
 
(75
)
 

 

Curtailment expense
 
(16
)
 

 

 

Total recognized in OCI
 
$
(46,620
)
 
(2,841
)
 
(35
)
 
(15
)
 
 
 
 
 
 
 
 
 
Total recognized in net periodic benefit cost and OCI
 
$
(41,173
)
 
3,674

 
139

 
148



The amortization of prior service cost related to the Retirement Income 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 Retirement Income Plan.


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Table of Contents

The estimated net actuarial loss for the Retirement Income Plan that will be amortized from AOCI into net periodic benefit cost during the 2013 fiscal year is $4.1 million.
 
 
Retirement Income Plan
Six Months ended June 30,
 
Retirement Life Plan
Six Months ended June 30,
 
 
2013
 
2012
 
2013
 
2012
Weighted-Average Expense Assumptions:
 
 
 
 
 
 
 
 
Discount rate
 
4.66
%
 
5.16
 
4.66
 
5.16
Expected return on plan assets
 
7.40
%
 
7.75
 
 
Rate of compensation increase
 
4.00
%
 
4.00
 
 

The following table presents future benefit payments expected under the Retirement Income Plan:
($ in thousands)
 
Retirement Income Plan
Benefits Expected to be Paid in Future Years
 
 

Fiscal Years:
 
 

2013
 
$
7,586

2014
 
8,384

2015
 
9,148

2016
 
9,942

2017
 
10,810

2018-2022
 
67,447


For additional information regarding our retirement plans, refer to Note 15. "Retirement Plans" included in Item 8. "Financial Statements and Supplementary Data." of our 2012 Annual Report.

NOTE 11. Comprehensive Income
The components of comprehensive income, both gross and net of tax, for Second Quarter and Six Months 2013 and 2012 are as follows:
 
Second Quarter 2013
 
 
 
 
 
 
($ in thousands)
 
Gross
 
Tax
 
Net
Net income
 
$
36,201

 
9,079

 
27,122

Components of OCI:
 
 

 
 

 
 

Unrealized losses on investment securities:
 
 

 
 

 
 

Unrealized holding losses during the period
 
(91,314
)
 
(31,961
)
 
(59,353
)
Non-credit OTTI recognized in OCI
 
47

 
16

 
31

Amounts reclassified into net income:
 
 
 
 
 
 
HTM securities
 
(614
)
 
(215
)
 
(399
)
Non-credit OTTI
 
6

 
3

 
3

Realized gains on AFS securities
 
(5,288
)
 
(1,850
)
 
(3,438
)
Net unrealized losses
 
(97,163
)
 
(34,007
)
 
(63,156
)
Amounts reclassified into net income:
 
 

 
 

 
 

Net actuarial loss
 
789

 
276

 
513

Defined benefit pension and post-retirement plans
 
789

 
276

 
513

Other comprehensive loss
 
(96,374
)
 
(33,731
)
 
(62,643
)
Comprehensive loss
 
$
(60,173
)
 
(24,652
)
 
(35,521
)
 

25

Table of Contents

Second Quarter 2012
 
 
 
 
 
 
($ in thousands)
 
Gross
 
Tax
 
Net
Net income
 
$
(692
)
 
(980
)
 
288

Components of OCI:
 
 

 
 

 
 

Unrealized gains on investment securities:
 
 

 
 

 
 

Unrealized holding gains during the period
 
7,849

 
2,748

 
5,101

Non-credit OTTI recognized in OCI
 
54

 
19

 
35

Amounts reclassified into net income:
 
 
 
 
 
 
HTM securities
 
(701
)
 
(245
)
 
(456
)
Non-credit OTTI
 
60

 
21

 
39

Realized gains on AFS securities
 
(199
)
 
(71
)
 
(128
)
Net unrealized gains
 
7,063

 
2,472

 
4,591

Defined benefit pension and post-retirement plans:
 
 

 
 

 
 

Amounts reclassified into net income:
 
 

 
 

 
 

Net actuarial loss
 
1,391

 
486

 
905

Prior service cost
 
37

 
13

 
24

Defined benefit pension and post-retirement plans
 
1,428

 
499

 
929

Other comprehensive income
 
8,491

 
2,971

 
5,520

Comprehensive income
 
$
7,799

 
1,991

 
5,808

 
Six Months 2013
 
 
 
 
 
 
($ in thousands)
 
Gross
 
Tax
 
Net
Net income
 
$
63,534

 
15,104

 
48,430

Components of OCI:
 
 

 
 

 
 

Unrealized losses on investment securities:
 
 

 
 

 
 

Unrealized holding losses during the period
 
(87,630
)
 
(30,671
)
 
(56,959
)
Non-credit OTTI recognized in OCI
 
77

 
27

 
50

Amounts reclassified into net income:
 
 
 
 
 
 
HTM securities
 
(1,331
)
 
(466
)
 
(865
)
Non-credit OTTI
 
13

 
5

 
8

Realized gains on AFS securities
 
(11,264
)
 
(3,942
)
 
(7,322
)
Net unrealized losses
 
(100,135
)
 
(35,047
)
 
(65,088
)
Defined benefit pension and post-retirement plans:
 
 

 
 

 
 

Net actuarial gain
 
44,000

 
15,400

 
28,600

Amounts reclassified into net income:
 
 

 
 

 
 

Net actuarial loss
 
2,629

 
920

 
1,709

Prior service cost
 
10

 
4

 
6

Curtailment expense
 
16

 
5

 
11

Defined benefit pension and post-retirement plans
 
46,655

 
16,329

 
30,326

Other comprehensive loss
 
(53,480
)
 
(18,718
)
 
(34,762
)
Comprehensive income
 
$
10,054

 
(3,614
)
 
13,668



26

Table of Contents

Six Months 2012
 
 
 
 
 
 
($ in thousands)
 
Gross
 
Tax
 
Net
Net income
 
$
22,499

 
4,118

 
18,381

Components of OCI:
 
 

 
 

 
 

Unrealized gains on investment securities:
 
 

 
 

 
 

Unrealized holding gains during the period
 
27,653

 
9,679

 
17,974

Non-credit OTTI recognized in OCI
 
218

 
76

 
142

Amounts reclassified into net income:
 
 
 
 
 
 
HTM securities
 
(1,565
)
 
(548
)
 
(1,017
)
Non-credit OTTI
 
263

 
92

 
171

Realized gains on AFS securities
 
(4,488
)
 
(1,571
)
 
(2,917
)
Net unrealized gains
 
22,081

 
7,728

 
14,353

Defined benefit pension and post-retirement plans:
 
 

 
 

 
 

Amounts reclassified into net income:
 
 

 
 

 
 

Net actuarial loss
 
2,781

 
973

 
1,808

Prior service cost
 
75

 
26

 
49

Defined benefit pension and post-retirement plans
 
2,856

 
999

 
1,857

Other comprehensive income
 
24,937

 
8,727

 
16,210

Comprehensive income
 
$
47,436

 
12,845

 
34,591


The balances of, and changes in, each component of AOCI (net of taxes) as of June 30, 2013 are as follows:

June 30, 2013
 
Net Unrealized (Loss) Gain on Investment Securities
 
 
 
 
($ in thousands)
 
OTTI
Related
 
HTM
Related
 
All
Other
 
Investments
Subtotal
 
Defined Benefit
Pension and Post-Retirement Plans
 
Total AOCI
Balance, December 31, 2012
 
$
(1,658
)
 
2,594

 
121,391

 
122,327

 
(68,287
)
 
54,040

OCI before reclassifications
 
50

 
(27
)
 
(56,932
)
 
(56,909
)
 
28,600

 
(28,309
)
Amounts reclassified from AOCI
 
8

 
(865
)
 
(7,322
)
 
(8,179
)
 
1,726

 
(6,453
)
Net current period OCI
 
58

 
(892
)
 
(64,254
)
 
(65,088
)
 
30,326

 
(34,762
)
Balance, June 30, 2013
 
$
(1,600
)
 
1,702

 
57,137

 
57,239

 
(37,961
)
 
19,278



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Table of Contents

The reclassifications out of AOCI for Second Quarter and Six Months 2013 are as follows:
 
Amount Reclassified from AOCI
 
Affected Line Item in the Unaudited Consolidated Statement of Income
($ in thousands)
Quarter ended June 30, 2013
 
Six Months ended June 30, 2013
 
OTTI related
 
 
 
 
 
Amortization of non-credit OTTI losses on HTM securities
 
 
 
 
 
 
$
6

 
13

 
Net investment income earned
 
6

 
13

 
Income (loss) from continuing operations, before federal income tax
 
(3
)
 
(5
)
 
Total federal income tax expense (benefit)
 
3

 
8

 
Net income
HTM related
 
 
 
 
 
Unrealized gains and losses on HTM disposals
(70
)
 
(151
)
 
Net realized investment gains
Amortization of net unrealized gains on HTM securities
(544
)
 
(1,180
)
 
Net investment income earned
 
(614
)
 
(1,331
)
 
Income (loss) from continuing operations, before federal income tax
 
215

 
466

 
Total federal income tax expense (benefit)
 
(399
)
 
(865
)
 
Net income
Realized gains and losses on AFS
 
 
 
 
 
Realized gains and losses on AFS disposals
(5,288
)
 
(11,264
)
 
Net realized investments gains
 
(5,288
)
 
(11,264
)
 
Income (loss) from continuing operations, before federal income tax
 
1,850

 
3,942

 
Total federal income tax expense (benefit)
 
(3,438
)
 
(7,322
)
 
Net income
Defined benefit pension and post-retirement life plans
 
 
 
 
 
Net actuarial loss
158

 
558

 
Loss and loss expense incurred
 
631

 
2,071

 
Policy acquisition costs
 
789

 
2,629

 
Income (loss) from continuing operations, before federal income tax
 
 
 
 
 
 
Prior service cost

 
7

 
Loss and loss expense incurred
 

 
3

 
Policy acquisition costs
 

 
10

 
Income (loss) from continuing operations, before federal income tax
 
 
 
 
 
 
Curtailment expense

 
16

 
Policy acquisition costs
 

 
16

 
Income (loss) from continuing operations, before federal income tax
 
 
 
 
 
 
Total defined benefit pension and post-retirement life
789

 
2,655

 
Income (loss) from continuing operations, before federal income tax
 
(276
)
 
(929
)
 
Total federal income tax expense (benefit)
 
513

 
1,726

 
Net income
 
 
 
 
 
 
Total reclassifications for the period
$
(3,321
)
 
$
(6,453
)
 
Net income

Note 12. Discontinued Operations
In the fourth quarter of 2009, we sold 100% of our interest in Selective HR for proceeds to be received over a 10-year period. These proceeds were based on the ability of the purchaser to retain and generate new worksite lives though the independent agents who distribute the products. In Six Months 2013, we settled the remaining receivable for an aggregate of $1.0 million, which was received in two installments during Second Quarter 2013, in full and final settlement of the contingent purchase price. An impairment which amounted to $1.5 million was recorded in the first quarter of 2013 and is included in "Loss on disposal of discontinued operations, net of tax" in the unaudited Consolidated Statements of Income.
    


28

Table of Contents

Note 13. Litigation
In the ordinary course of conducting business, we are named as defendants in various legal proceedings. Most of these proceedings are claims litigation involving our Insurance Subsidiaries as either: (a) liability insurers defending or providing indemnity for third-party claims brought against insureds; or (b) insurers defending first-party coverage claims brought against them. We account for such activity through the establishment of unpaid loss and loss expense reserves. We expect that the ultimate liability, if any, with respect to such ordinary course claims litigation, after consideration of provisions made for potential losses and costs of defense, will not be material to our consolidated financial condition, results of operations, or cash flows.
 
Our Insurance Subsidiaries are also from time-to-time involved in other legal actions, some of which assert claims for substantial amounts. These actions include, among others, putative class actions seeking certification of a state or national class. Such putative class actions have alleged, for example, improper reimbursement of medical providers paid under workers compensation and personal and commercial automobile insurance policies. Our Insurance Subsidiaries also are involved from time to time in individual actions in which extra-contractual damages, punitive damages, or penalties are sought, such as claims alleging bad faith in the handling of insurance claims. We believe that we have valid defenses to these cases. We expect that the ultimate liability, if any, with respect to such lawsuits, after consideration of provisions made for estimated losses, will not be material to our consolidated financial condition. Nonetheless, given the large or indeterminate amounts sought in certain of these actions, and the inherent unpredictability of litigation, an adverse outcome in certain matters could, from time to time, have a material adverse effect on our consolidated results of operations or cash flows in particular quarterly or annual periods.

Note 14. Commitments and Contingencies
At June 30, 2013, we had contractual obligations that expire at various dates through 2026 to invest up to an additional $61.5 million in alternative and other investments. There is no certainty that all of such additional investments will be required.

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Table of Contents


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-Looking Statements
In this Quarterly Report on Form 10-Q, we discuss and make statements regarding our intentions, beliefs, current expectations, and projections regarding our company’s future operations and performance. Such statements are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are often identified by words such as “anticipates,” “believes,” “expects,” “will,” “should,” and “intends” and their negatives. We caution prospective investors that such forward-looking statements are not guarantees of future performance. Risks and uncertainties are inherent in our future performance. Factors that could cause actual results to differ materially from those indicated by such forward-looking statements include, but are not limited to, those discussed under Item 1A. “Risk Factors” below in Part II “Other Information”. These risk factors may not be exhaustive. We operate in a continually changing business environment and new risk factors emerge from time to time. We can neither predict such new risk factors nor can we assess the impact, if any, of such new risk factors on our businesses or the extent to which any factor or combination of factors may cause actual results to differ materially from those expressed or implied in any forward-looking statements in this report. In light of these risks, uncertainties, and assumptions, the forward-looking events discussed in this report might not occur. We make forward-looking statements based on currently available information and assume no obligation to update these statements due to changes in underlying factors, new information, future developments, or otherwise.
  
Introduction
We classify our business into three operating segments:
Standard Insurance Operations - comprised of both commercial lines ("Commercial Lines") and personal lines ("Personal Lines") insurance products and services that are sold in the standard marketplace;
Excess and Surplus ("E&S") Insurance Operations - comprised of Commercial Lines insurance products and services that are unavailable in the standard market due to market conditions or characteristics of the insured that are caused by the insured's claim history or the characteristics of their business; and
Investments - invests the premiums collected by our Standard and E&S Insurance Operations, as well as amounts generated through our capital management strategies, which may include the issuance of debt and equity securities.
Our Standard Insurance Operations products and services are sold through nine subsidiaries that write Commercial Lines and Personal Lines business, some of which write flood business through the National Flood Insurance Program's ("NFIP") write-your-own ("WYO") program. Two of these subsidiaries, Selective Casualty Insurance Company ("SCIC") and Selective Fire and Casualty Insurance Company ("SFCIC"), were created in 2012. These subsidiaries began writing direct premium in 2013 and have been included in our reinsurance pooling agreement as of July 1, 2012.
Our E&S Insurance Operations products and services are sold through a subsidiary that was acquired in December 2011. This subsidiary, Mesa Underwriters Specialty Insurance Company ("MUSIC"), provides us with a nationally-authorized non-admitted platform to write commercial and personal E&S lines business. For additional information regarding our E&S acquisitions, refer to Note 12. “Business Combinations” in Item 8. “Financial Statements and Supplementary Data.” contained in our Annual Report on Form 10-K for the year ended December 31, 2012 ("2012 Annual Report").
Our ten insurance subsidiaries are collectively referred to as the "Insurance Subsidiaries".
The purpose of Management’s Discussion and Analysis (“MD&A”) is to provide an understanding of the consolidated results of operations and financial condition and known trends and uncertainties that may have a material impact in future periods. Consequently, investors should read the MD&A in conjunction with the consolidated financial statements in our 2012 Annual Report.
In the MD&A, we will discuss and analyze the following:
Critical Accounting Policies and Estimates;
Financial Highlights of Results for second quarters ended June 30, 2013 (“Second Quarter 2013”) and June 30, 2012 (“Second Quarter 2012”) and the six-month periods ended June 30, 2013 ("Six Months 2013") and June 30, 2012 ("Six Months 2012");
Results of Operations and Related Information by Segment;
Federal Income Taxes;
Financial Condition, Liquidity, Short-term Borrowings, and Capital Resources;
Ratings;
Off-Balance Sheet Arrangements; and
Contractual Obligations, Contingent Liabilities, and Commitments.

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Table of Contents


Critical Accounting Policies and Estimates
These unaudited interim consolidated financial statements include amounts based on our informed estimates and judgments for those transactions that are not yet complete. Such estimates and judgments affect the reported amounts in the consolidated financial statements. Those estimates and judgments most critical to the preparation of the consolidated financial statements involve the following: (i) reserves for loss and loss expenses; (ii) deferred policy acquisition costs; (iii) pension and post-retirement benefit plan actuarial assumptions; (iv) other-than-temporary investment impairments; and (v) reinsurance. These estimates and judgments require the use of assumptions about matters that are highly uncertain and, therefore, are subject to change as facts and circumstances develop. If different estimates and judgments had been applied, materially different amounts might have been reported in the financial statements. For additional information regarding our critical accounting policies, refer to our 2012 Annual Report, pages 44 through 53. However, for changes related to actuarial assumptions used in the measurement of the Retirement Income Plan for Selective Insurance Company of America and The Selective Insurance Supplemental Pension Plan (jointly referred to as the "Retirement Income Plan"), see Note 10. "Retirement Plans" of this Form 10-Q.
 
Financial Highlights of Results for Second Quarter 2013 and Six Months 20131 
 
 
Quarter ended June 30,
 
 
 
Six Months ended June 30,
 
 
($ and shares in thousands, except per share amounts)
 
2013
 
2012
 
Change
% or Points
 
 
 
2013
 
2012
 
Change
% or Points
 
 
Generally Accepted Accounting Principles ("GAAP") measures:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues
 
$
468,945

 
428,907

 
9

 
%
 
928,894

 
848,255

 
10

 
%
Pre-tax net investment income
 
34,003

 
34,006

 

 
 
 
66,873

 
66,634

 

 
 
   Pre-tax net income (loss)
 
36,201

 
(692
)
 
5,331

 
 
 
63,534

 
22,499

 
182

 
 
Net income
 
27,122

 
288

 
9,317

 
 
 
48,430

 
18,381

 
163

 
 
Diluted net income per share
 
0.48

 
0.01

 
4,700

 
 
 
0.86

 
0.33

 
161

 
 
Diluted weighted-average outstanding shares
 
56,616

 
55,681

 
2

 
 
 
56,530

 
55,642

 
2

 
 
GAAP combined ratio
 
98.9
%
 
106.9

 
(8.0
)
 
pts 
 
98.0

 
103.7

 
(5.7
)
 
pts 
   Statutory combined ratio2
 
97.7
%
 
106.2

 
(8.5
)
 
 
 
97.3

 
102.7

 
(5.4
)
 
 
Return on average equity
 
9.7
%
 
0.1

 
9.6

 
 
 
8.8

 
3.4

 
5.4

 
 
Non-GAAP measures:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating income3
 
$
23,773

 
172

 
13,722

 
%
 
$
43,897

 
15,432

 
184

 
%
Diluted operating income per share3
 
0.42

 
0.01

 
4,100

 
 
 
0.78

 
0.28

 
179

 
 
Operating return on average equity3
 
8.5
%
 
0.1

 
8.4

 
pts 
 
8.0

 
2.9

 
5.1

 
pts 
1 
Refer to the Glossary of Terms attached to our 2012 Annual Report as Exhibit 99.1 for definitions of terms used in this Form 10-Q.
2 
Six Months 2013 includes 0.7 points related to the Retirement Income Plan amendments that curtail the accrual of additional benefits for all eligible employees participating in the plans after March 31, 2016.
3 
Operating income is used as an important financial measure by us, analysts, and investors, because the realization of investment gains and losses on sales in any given period is largely discretionary as to timing. In addition, these realized investment gains and losses, as well as other-than-temporary impairments (“OTTI”) that are charged to earnings 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 GAAP. Operating return on average equity is calculated by dividing annualized operating income by average stockholders’ equity.

 The following table reconciles operating income and net income for the periods presented above:
 
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in thousands, except per share amounts)
 
2013
 
2012
 
2013
 
2012
Operating income
 
$
23,773

 
172

 
43,897

 
15,432

Net realized gains, net of tax
 
3,349

 
116

 
5,530

 
2,949

Loss on disposal of discontinued operations, net of tax
 

 

 
(997
)
 

Net income
 
$
27,122

 
288

 
48,430

 
18,381

 
 
 
 
 
 
 
 
 
Diluted operating income per share
 
$
0.42

 
0.01

 
0.78

 
0.28

Diluted net realized gains per share
 
0.06

 

 
0.10

 
0.05

Diluted net loss from disposal of discontinued operations per share
 

 

 
(0.02
)
 

Diluted net income per share
 
$
0.48

 
0.01

 
0.86

 
0.33



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Over the long term, we target a return on average equity that is three points higher than our historic cost of capital of approximately 9%, excluding the impact of realized gains and losses, which is referred to as operating return on equity. Our operating return on average equity was 8.5% in Second Quarter 2013 compared to 0.1% in Second Quarter 2012. For Six Months 2013 and Six Months 2012, our operating return on average equity was 8.0% and 2.9%, respectively. Our operating return on average equity contribution by component is as follows:

Operating Return on Average Equity
 
Quarter ended June 30,
 
Six Months ended June 30,

 
2013
 
2012
 
2013
 
2012
Insurance Operations
 
1.0
 %
 
(6.5
)
 
2.0

 
(3.4
)
Investments
 
9.2

 
9.5

 
9.2

 
9.4

Other
 
(1.7
)
 
(2.9
)
 
(3.2
)
 
(3.1
)
Total
 
8.5

 
0.1

 
8.0

 
2.9


Improvements in the operating return on average equity generated from our Insurance Subsidiaries reflect increases in underwriting profitability of $31.4 million in the quarter and $45.0 million in the year-to-date periods. These fluctuations were driven primarily by: (i) higher underwriting profitability in our Standard Insurance Operations of $28.6 million and $37.2 million, respectively, reflecting the impact of earning renewal pure price increases that have been exceeding loss costs trends over the past year along with decreases in catastrophe and non-catastrophe property losses quarter over quarter and significantly lower catastrophe losses year over year; and (ii) improvements in our E&S Insurance Operations of $2.8 million and $7.8 million, respectively. E&S operations were primarily affected by: (i) earned premiums that now reflect the full operations of this business; (ii) renewal pure price increases; and (iii) a decrease in initial start-up expenditures.

Our investment segment's contribution to operating return on equity was relatively consistent both in Second Quarter 2013 compared to Second Quarter 2012 and Six Months 2013 compared to Six Months 2012. Net investment income continues to be negatively impacted by the interest rate environment, which has lowered reinvestment yields within our fixed maturity securities portfolio when comparing periods. However, higher returns in our other investments portfolio, which were driven by higher returns from the alternative investments within that portfolio along with increased dividend income from our equity portfolio, have partially offset the impact of lower returns from our fixed maturity securities portfolio.

The Second Quarter 2013 improvement in our operating return on average equity attributable to our "Other" results of 1.2 points was driven by the impact of a lower effective tax rate adjustment in Second Quarter 2013 as compared to Second Quarter 2012. We are required, through accounting rules, to record each quarter's taxes at the expected annual marginal tax rate regardless of the relative magnitude of the individual components within any one quarter. As net income in Second Quarter 2012 was disproportionate compared to expected full year net income, a more significant effective tax rate adjustment was required compared to Second Quarter 2013 in which net income is more in line with full year expected results. While the year-to-date period was also impacted by a lower effective tax rate adjustment, for the six-month period, this improvement was offset by the write-off of debt costs associated with the redemption of our 7.50% Junior Notes due 2066 in the first quarter of 2013, coupled with higher stock compensation expense due to the increase in our stock price.
                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 

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Table of Contents

The following table provides a quantitative foundation for analyzing our overall Insurance Subsidiaries underwriting results:
All Lines
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in thousands)
 
2013
 
2012
 
Change % or Points
 
 
 
2013
 
2012
 
Change % or Points
 
 
GAAP Insurance Operations Results:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Net premiums written ("NPW")
 
$
462,177

 
425,563

 
9

 
%
 
912,301

 
845,735

 
8

 
%
Net premiums earned (“NPE”)
 
426,252

 
392,212

 
9

 
 
 
847,192

 
771,041

 
10

 
 
Less:
 
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
Loss and loss expense incurred
 
279,594

 
287,903

 
(3
)
 
 
 
549,443

 
540,809

 
2

 
 
Net underwriting expenses incurred
 
141,194

 
130,041

 
9

 
 
 
279,038

 
256,413

 
9

 
 
Dividends to policyholders
 
981

 
1,230

 
(20
)
 
 
 
2,067

 
2,144

 
(4
)
 
 
Underwriting gain (loss)
 
$
4,483

 
(26,962
)
 
117

 
%
 
16,644

 
(28,325
)
 
159

 
%
GAAP Ratios:
 
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
Loss and loss expense ratio
 
65.6

%
73.4

 
(7.8
)
 
pts 
 
64.9

 
70.1

 
(5.2
)
 
pts 
Underwriting expense ratio
 
33.1

 
33.2

 
(0.1
)
 
 
 
32.9

 
33.3

 
(0.4
)
 
 
Dividends to policyholders ratio
 
0.2

 
0.3

 
(0.1
)
 
 
 
0.2

 
0.3

 
(0.1
)
 
 
Combined ratio
 
98.9

 
106.9

 
(8.0
)
 
 
 
98.0

 
103.7

 
(5.7
)
 
 
Statutory Ratios:
 
 
 
 

 
 
 
 
 
 
 
 
 
 
 
 
Loss and loss expense ratio
 
65.6

 
73.4

 
(7.8
)
 
 
 
64.9

 
70.1

 
(5.2
)
 
 
Underwriting expense ratio
 
31.9

 
32.5

 
(0.6
)
 
 
 
32.2

 
32.3

 
(0.1
)
 
 
Dividends to policyholders ratio
 
0.2

 
0.3

 
(0.1
)
 
 
 
0.2

 
0.3

 
(0.1
)
 
 
Combined ratio
 
97.7

%
106.2

 
(8.5
)
 
pts 
 
97.3

 
102.7

 
(5.4
)
 
pts 

The growth in NPW for our Insurance Subsidiaries in Second Quarter 2013 and Six Months 2013 compared to prior year periods reflects the following in our Standard Insurance Operations: (i) renewal pure price increases that we have achieved; (ii) strong retention; and (iii) new business.

NPE increases in Second Quarter 2013 and Six Months 2013 were consistent with the fluctuations in NPW for the twelve-month period ended June 30, 2013 compared to the twelve-month period ended June 30, 2012.

The combined ratio improved for both the quarterly and year-to-date periods. This improvement reflects overall improvements in pricing, as well as significantly lower catastrophe losses and non-catastrophe property losses quarter over quarter and significantly lower catastrophe losses year over year. Renewal pure price increases averaged 7.4% for the quarterly period and 7.5% for the year-to-date period in our Standard Insurance Operations in 2013. These price increases exceeded loss trends by approximately 4 points.

Outlook
In their 2012 year-end review, A.M. Best and Company ("A.M. Best") projected an industry combined ratio of 101.2% for 2013. This projection reflects a more normal level of catastrophe losses as well as the impact of pricing improvements that were achieved in 2012 and are expected to continue in 2013. However, A.M. Best expects that the industry's performance will remain challenged by the continuing sluggish macroeconomic environment, which includes persisting low investment yields, the lingering effects of the soft market conditions that have prevailed in recent years, and a reduced level of loss reserve redundancies. These challenges are expected to lead to more negative rating actions than positive rating actions in 2013.

For 2013, we expect to achieve a statutory combined ratio of 96% excluding catastrophes and any favorable or unfavorable prior year casualty reserve development. Our estimate for catastrophe losses in 2013 is three points. In addition, we expect our E&S Insurance Operations to produce a combined ratio between 100% and 102% for 2013, and be at profitability levels similar to our Standard Insurance Operations in 2014. We also expect to achieve an overall statutory combined ratio of 92% by year-end 2014 excluding three points of expected catastrophe losses. Our Insurance Subsidiaries reported a statutory combined ratio of 93.1%, excluding catastrophe losses, for Second Quarter 2013 and 94.8% for Six Months 2013, which included favorable prior year casualty reserve development of $2 million in Second Quarter 2013 and $3 million in Six Months 2013 compared to $5 million in Second Quarter 2012 and $8 million in Six Months 2012.

A key component of meeting our combined ratio targets is our ability to generate Commercial Lines renewal pure price increases in excess of our predicted loss trends. Although A.M. Best is maintaining its negative outlook for the commercial lines market, it does anticipate that sustained pricing momentum will continue in 2013. We achieved renewal pure price

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Table of Contents

increases of 7.3% for standard Commercial Lines and 8.4% for standard Personal Lines in Six Months 2013. While these increases demonstrate our ability to generate price at a granular level, we anticipate that 2014 standard renewal rates will be modestly below the current year 7.5% rate that we achieved.

Although interest rates rose during the quarter, they are still low by historical standards. The continued low interest rate environment has several significant impacts on our business, some of which are beneficial and some of which present a challenge to us. The benefits include lower inflation rates that suppress loss trends, as well as reduce our cost of capital. However, the low interest rate environment presents a significant challenge in generating after-tax returns on our investment portfolio as fixed income securities mature and money is re-invested at lower rates. Even if current interest rate levels were to increase by 50 basis points per year for the next few years, book yields on our overall portfolio would continue to underperform 2012 book yield levels until we reach 2018. As a result, for 2013, we anticipate after-tax investment income of approximately $95 million, lower than the $100 million we earned on an after-tax basis in 2012.

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Table of Contents


Results of Operations and Related Information by Segment
 
Insurance Operations
 
Standard Insurance Operations
Our Standard Insurance Operations segment, which represents 93% of our combined insurance operations NPW, sells insurance products and services primarily in 22 states in the Eastern and Midwestern U.S. and the District of Columbia, through approximately 1,100 independent retail insurance agencies. This segment consists of two components: (i) Commercial Lines, which markets primarily to businesses and represents approximately 82% of the segment's NPW; and (ii) Personal Lines, including our flood business, which markets primarily to individuals and represents approximately 18% of the segment's NPW.
 
 
Quarter ended June 30,
 
 
 
 
 
Six Months ended June 30,
 
 
 
 
($ in thousands)
 
2013
 
2012
 
Change % or Points
 
 
 
2013
 
2012
 
Change % or Points
 
 
GAAP Insurance Operations Results:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
NPW
 
$
429,511

 
397,224

 
8

 
%
 
851,255

 
791,601

 
8

 
%
NPE
 
396,205

 
376,245

 
5

 
 
 
787,086

 
745,351

 
6

 
 
Less:
 
 
 
 

 
 
 
 
 
 
 
 

 
 
 
 
Loss and loss expense incurred
 
258,520

 
275,297

 
(6
)
 
 
 
509,251

 
520,736

 
(2
)
 
 
Net underwriting expenses incurred
 
129,936

 
121,580

 
7

 
 
 
256,925

 
240,803

 
7

 
 
Dividends to policyholders
 
981

 
1,230

 
(20
)
 
 
 
2,067

 
2,144

 
(4
)
 
 
Underwriting gain (loss)
 
$
6,768

 
(21,862
)
 
131

 
%
 
18,843

 
(18,332
)
 
203

 
%
GAAP Ratios:
 
 
 
 

 
 
 
 
 
 
 
 

 
 
 
 
Loss and loss expense ratio
 
65.2

%
73.2

 
(8.0
)
 
pts 
 
64.7

 
69.9

 
(5.2
)
 
pts 
Underwriting expense ratio
 
32.9

 
32.3

 
0.6

 
 
 
32.6

 
32.3

 
0.3

 
 
Dividends to policyholders ratio
 
0.2

 
0.3

 
(0.1
)
 
 
 
0.3

 
0.3

 

 
 
Combined ratio
 
98.3

 
105.8

 
(7.5
)
 
 
 
97.6

 
102.5

 
(4.9
)
 
 
Statutory Ratios:
 
 
 
 

 
 
 
 
 
 
 
 

 
 
 
 
Loss and loss expense ratio1
 
65.3

 
73.3

 
(8.0
)
 
 
 
64.7

 
69.9

 
(5.2
)
 
 
Underwriting expense ratio1
 
31.5

 
31.9

 
(0.4
)
 
 
 
31.9

 
31.6

 
0.3

 
 
Dividends to policyholders ratio
 
0.2

 
0.3

 
(0.1
)
 
 
 
0.3

 
0.3

 

 
 
Combined ratio1
 
97.0

%
105.5

 
(8.5
)
 
pts 
 
96.9

 
101.8

 
(4.9
)
 
pts 
1
Six Months 2013 includes 0.2 points in the loss and loss expense ratio, 0.5 points in the underwriting ratio, and 0.7 points in the combined ratio related to the Retirement Income Plan amendments recorded in the first quarter of 2013 that curtail the accrual of additional benefits for all eligible employees participating in the plans after March 31, 2016.

The improvements in NPW in Second Quarter and Six Months 2013 compared to Second Quarter and Six Months 2012 are primarily the result of the following:
 
 
Quarter ended June 30, 2013
 
 
Quarter ended June 30, 2012
 
($ in millions)
 
Renewal Pure Price Increase
 
Retention
 
 
Renewal Pure Price Increase
 
Retention
 
Standard Commercial Lines
 
7.2
%
83
%
 
6.4
 
82
 
Standard Personal Lines
 
8.3
 
87
 
 
5.6
 
87
 

 
 
Six Months ended June 30, 2013
 
 
Six Months ended June 30, 2012
 
($ in millions)
 
Renewal Pure Price Increase
 
Retention
 
 
Renewal Pure Price Increase
 
Retention
 
Standard Commercial Lines
 
7.3
%
82
%
 
5.8
 
82
 
Standard Personal Lines
 
8.4
 
86
 
 
5.7
 
86
 

NPE increases in Second Quarter and Six Months 2013 were consistent with the fluctuations in NPW for the twelve-month period ended June 30, 2013 as compared to the twelve-month period ended June 30, 2012.


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Table of Contents

The GAAP loss and loss expense ratio improved 8.0 points in Second Quarter 2013 and 5.2 points in Six Months 2013 compared to the same periods a year ago. The improvement in the ratios reflect the earning of renewal pure price increases that averaged 6.3% in our Standard Insurance Operations in 2012 and exceeded loss trends by approximately 3 points. The following variances are included in the GAAP loss and loss expense ratio:

 
Quarter ended June 30, 2013
 
Quarter ended June 30, 2012
 
($ in millions)
Loss and Loss Expense Incurred
Impact on
Loss and Loss Expense Ratio
 
 
Loss and Loss Expense Incurred
Impact on
Loss and Loss Expense Ratio
 
Change in Ratio
Catastrophe losses
$
17.1

4.3
pts
 
30.0

8.0
pts
(3.7
)
Non-catastrophe property losses
50.2

12.7
 
 
57.9

15.4
 
(2.7
)
Favorable prior year casualty reserve development
4

1.0
 
 
5

1.3
 
0.3


 
Six Months ended June 30, 2013
 
 
Six Months ended June 30, 2012
 
 
($ in millions)
Loss and Loss Expense Incurred
Impact on
Loss and Loss Expense Ratio
 
 
Loss and Loss Expense Incurred
Impact on
Loss and Loss Expense Ratio
 
Change in Ratio
Catastrophe losses
$
18.3

2.3
pts
 
36.9

4.9
pts
(2.6
)
Non-catastrophe property losses
110.9

14.1
 
 
108.5

14.6
 
(0.5
)
Favorable prior year casualty reserve development
6

0.8
 
 
8

1.1
 
0.3


The breakdown of favorable prior year casualty reserve development by line of business for the periods indicated is as follows:
Favorable/(Unfavorable) Prior Year Casualty Reserve Development
 
Quarter ended June 30,
 
Six Months ended June 30,
 
($ in millions)
 
2013
 
2012
 
2013
 
2012
 
General liability
 
$
5

 

 
9

 

 
Commercial automobile
 

 
1

 

 
2

 
Workers compensation
 
(3
)
 

 
(11
)
 

 
Businessowners' policies
 
3

 
3

 
6

 
4

 
Homeowners
 

 
2

 
2

 
3

 
Personal automobile
 
(1
)
 
(1
)
 

 
(1
)
 
Total favorable prior year casualty reserve development
 
$
4

 
5

 
6

 
8

 
 
 
 
 
 
 
 
 
 
 
Favorable impact on loss ratio
 
1.0

pts
1.3

pts.
0.8

pts.
1.1

pts.



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Table of Contents

Review of Underwriting Results by Line of Business
 
Standard Commercial Lines
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quarter ended June 30,
 
Change % or
 
 
Six Months ended June 30,
 
Change % or
 
($ in thousands)
 
2013
 
2012
 
Points
 
 
2013
 
2012
 
Points
 
GAAP Insurance Operations Results:
 
 

 
 

 
 

 
 
 
 
 
 
 
 
NPW
 
$
350,651

 
320,419

 
9

%
 
703,840

 
649,250

 
8

%
NPE
 
322,657

 
306,289

 
5

 
 
640,502

 
606,786

 
6

 
Less:
 
 
 
  

 
 

 
 
 
 
  
 
 
 
Loss and loss expense incurred
 
201,316

 
217,322

 
(7
)
 
 
404,455

 
415,128

 
(3
)
 
Net underwriting expenses incurred
 
110,617

 
102,161

 
8

 
 
218,135

 
203,529

 
7

 
Dividends to policyholders
 
981

 
1,230

 
(20
)
 
 
2,067

 
2,144

 
(4
)
 
Underwriting gain (loss)
 
$
9,743

 
(14,424
)
 
168

%
 
15,845

 
(14,015
)
 
213

%
GAAP Ratios:
 
 

 
 

 
 

 
 
 
 
 
 
 
 
Loss and loss expense ratio
 
62.4

%
71.0

 
(8.6
)
pts
 
63.1

 
68.4

 
(5.3
)
pts
Underwriting expense ratio
 
34.3

 
33.3

 
1.0

 
 
34.1

 
33.5

 
0.6

 
Dividends to policyholders ratio
 
0.3

 
0.4

 
(0.1
)
 
 
0.3

 
0.4

 
(0.1
)
 
Combined ratio
 
97.0

 
104.7

 
(7.7
)
 
 
97.5

 
102.3

 
(4.8
)
 
Statutory Ratios:
 
 

 
 

 
 

 
 
 
 
 
 
 
 
Loss and loss expense ratio1
 
62.4

 
71.2

 
(8.8
)
 
 
63.1

 
68.5

 
(5.4
)
 
Underwriting expense ratio1
 
32.9

 
33.1

 
(0.2
)
 
 
33.2

 
32.5

 
0.7

 
Dividends to policyholders ratio1
 
0.3

 
0.4

 
(0.1
)
 
 
0.3

 
0.4

 
(0.1
)
 
Combined ratio
 
95.6

%
104.7

 
(9.1
)
pts
 
96.6

 
101.4

 
(4.8
)
pts
1
Six Months 2013 includes 0.2 points in the loss and loss expense ratio, 0.5 points in the underwriting ratio, and 0.7 points in the combined ratio related to the Retirement Income Plan amendments recorded in the first quarter of 2013 that curtail the accrual of additional benefits for all eligible employees participating in the plans after March 31, 2016.

The increase in NPW in Second Quarter and Six Months 2013 compared to Second Quarter and Six Months 2012 is primarily the result of the following:
 
 
Quarter ended June 30,
 
Six Months ended June 30,

 
2013
 
2012
 
2013
 
2012
Retention
 
83
%
82
 
82
%
82
Renewal pure price increases
 
7.2
 
6.4
 
7.3
 
5.8

NPE increases in Second Quarter and Six Months 2013 were consistent with the fluctuations in NPW for the twelve-month period ended June 30, 2013 compared to the twelve-month period ended June 30, 2012.

The GAAP loss and loss expense ratio improved by 8.6 points in Second Quarter 2013 and 5.3 points in Six Months 2013 compared to the same periods a year ago. The improvement in the ratio reflects the earning of renewal pure price increases that averaged 6.2% in our standard Commercial Lines in 2012 and exceeded loss trends by approximately 3 points. The following variances also impacted the GAAP loss and loss expense ratio as follows:
 
Second Quarter 2013
 
 
Second Quarter 2012
 
 
 
($ in millions)
Losses Incurred
Impact on
Loss Ratio
 
 
Losses
Incurred
Impact on
 Loss Ratio
 
Change in Ratio
 
Catastrophe losses
$
9.2

2.8
pts
 
18.4

6.0
pts
(3.2
)
pts
Non-catastrophe property losses
27.9

8.6
 
 
36.1

11.8
 
(3.2
)
 
Favorable prior year casualty reserve development
5

1.5
 
 
4

1.3
 
(0.2
)
 


37

Table of Contents

 
Six Months 2013
 
 
Six Months 2012
 
 
 
($ in millions)
Losses Incurred
Impact on
Loss Ratio
 
 
Losses
Incurred
Impact on
 Loss Ratio
 
Change in Ratio
 
Catastrophe losses
$
9.9

1.6
pts
 
22.3

3.7
pts
(2.1
)
pts
Non-catastrophe property losses
64.8

10.1
 
 
68.4

11.3
 
(1.2
)
 
Favorable prior year casualty reserve development
4

0.7
 
 
6

1.0
 
0.3

 

The following is a discussion of our most significant standard Commercial Lines of business:
General Liability
 
 
 
 
 
 
 
 
 
Quarter ended June 30,
 
 
 
 
Six Months ended June 30,
 
 
 
($ in thousands)
 
2013
 
2012
 
Change
% or
Points
 
 
2013
 
2012
 
Change
% or
Points
 
Statutory NPW
 
$
110,232

 
99,222

 
11

%
 
219,637

 
199,850

 
10

%
  Direct new business
 
20,859

 
17,226

 
21

 
 
40,640

 
36,313

 
12

 
  Retention
 
82

%
81

 
1

pts
 
82

 
81.0

 
1

pts
  Renewal pure price increases
 
8.7

%
7.2

 
1.5

 
 
8.7

 
6.6

 
2.1

 
Statutory NPE
 
99,766

 
92,632

 
8

%
 
197,469

 
182,775

 
8

%
Statutory combined ratio
 
94.9

%
102.3

 
(7.4
)
pts
 
95.4

 
101.3

 
(5.9
)
pts
% of total statutory standard Commercial Lines NPW
 
31

%
31

 
 

 
 
31

 
31

 
 

 
The growth in NPW and NPE for our general liability business in both Second Quarter and Six Months 2013 reflect: (i) renewal pure price increases; (ii) strong retention; and (iii) higher new business.

The statutory combined ratio improvement for both Second Quarter and Six Months 2013 was due to: (i) the impact of favorable prior year casualty reserve development of 5.0 points and 4.6 points in Second Quarter and Six Months 2013, respectively, compared to no prior year casualty reserve development in Second Quarter and Six Months 2012; and (ii) the impact of earned renewal pure price increases that have exceeded loss cost trends. Partially offsetting these items was the impact of the Retirement Income Plan curtailment charge of $1.4 million, which increased the overall combined ratio by 0.7 points for Six Months 2013.

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Table of Contents


Commercial Automobile
 
 
 
 
 
 
 
 
 
Quarter ended June 30,
 
 
 
 
Six Months ended June 30,
 
 
 
($ in thousands)
 
2013
 
2012
 
Change
% or
Points
 
 
2013
 
2012
 
Change
% or
Points
 
Statutory NPW
 
$
84,254

 
74,912

 
12

%
 
166,126

 
150,750

 
10
%
  Direct new business
 
16,166

 
12,736

 
27

 
 
31,070

 
27,427

 
13
 
  Retention
 
82

%
82

 

pts
 
82

 
82

 
pts
  Renewal pure price increases
 
7.0

%
5.1

 
1.9

 
 
7.0

 
4.6

 
2.4
 
Statutory NPE
 
76,706

 
71,540

 
7

%
 
151,053

 
142,024

 
6
%
Statutory combined ratio
 
95.3

%
96.0

 
(0.7
)
pts
 
96.6

 
96.3

 
0.3
pts
% of total statutory standard Commercial Lines NPW
 
24

%
23

 
 

 
 
24

 
23

 
 
 

Renewal pure price increases coupled with strong retention drove the improvement in NPW and NPE in Second Quarter and Six Months 2013 compared to the same periods in 2012.

The fluctuations in the statutory combined ratios for Second Quarter and Six Months 2013 were impacted by premium increases that outpaced fixed costs coupled with the following:
 
Quarter ended June 30, 2013
 
Quarter ended June 30, 2012
 
($ in millions)
Loss and Loss Expense Incurred
Impact on
Loss and Loss Expense Ratio
 
 
Loss and Loss Expense Incurred
Impact on
Loss and Loss Expense Ratio
 
Change in Ratio
Catastrophe losses
$
(0.3
)
(0.4
)
pts
 
1.0

1.4
pts
(1.8
)
Favorable prior year casualty reserve development


 
 
2

2.1
 
2.1


 
Six Months ended June 30, 2013
 
 
Six Months ended June 30, 2012
 
 
($ in millions)
Loss and Loss Expense Incurred
Impact on
Loss and Loss Expense Ratio
 
 
Loss and Loss Expense Incurred
Impact on
Loss and Loss Expense Ratio
 
Change in Ratio
Catastrophe losses
$
(1.0
)
(0.6
)
pts
 
1.5

1.1
pts
(1.7
)
Favorable prior year casualty reserve development


 
 
3

1.8
 
1.8


In addition, Six Months 2013 included 0.6 points related to the Retirement Income Plan curtailment charge.

Workers Compensation
 
 
 
 
 
 
 
 
 
Quarter ended June 30,
 
 
 
 
Six Months ended June 30,
 
 
 
($ in thousands)
 
2013
 
2012
 
Change
% or
Points
 
 
2013
 
2012
 
 
 
Statutory NPW
 
$
68,589

 
66,764

 
3

%
 
143,994

 
139,952

 
3

%
  Direct new business
 
14,813

 
9,969

 
49

 
 
28,692

 
25,371

 
13

 
  Retention
 
81

%
81

 

pts
 
82

 
80

 
2

pts
  Renewal pure price increases
 
7.6

%
8.7

 
(1.1
)
 
 
7.8

 
7.8

 

 
Statutory NPE
 
64,855

 
66,661

 
(3
)
%
 
130,939

 
132,472

 
(1
)
%
Statutory combined ratio
 
118.3

%
112.7

 
5.6

pts
 
118.6

 
111.8

 
6.8

pts
% of total statutory standard Commercial Lines NPW
 
20

%
21

 
 

 
 
20

 
22

 
 
 

NPW increased by 3% in both Second Quarter and Six Months 2013, respectively, compared to Second Quarter and Six Months 2012, driven by: (i) renewal pure price increases; (ii) strong retention; and (iii) increased new business.
 

39

Table of Contents

The increase in the statutory combined ratios for both periods was primarily attributable to the impact of prior year casualty reserve development as follows:
Second Quarter 2013 was unfavorable by 5.0 points driven primarily by development on the 2012 accident year; and 8.1 points unfavorable development in Six Months 2013 driven primarily by development on the 2012 accident year and a single large claim prior to 2003.
Second Quarter and Six Months 2012 reflect no prior year casualty reserve development.

In addition, the Retirement Income Plan curtailment increased the workers compensation statutory combined ratio by 0.9 points in Six Months 2013.

Commercial Property
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quarter ended June 30,
 
 
 
 
Six Months ended June 30,
 
 
 
($ in thousands)
 
2013
 
2012
 
Change
% or
Points
 
 
2013
 
2012
 
Change
% or
Points
 
Statutory NPW
 
$
59,193

 
53,195

 
11

%
 
116,953

 
106,222

 
10

%
  Direct new business
 
14,396

 
11,865

 
21

 
 
28,781

 
26,048

 
10

 
  Retention
 
82

%
81

 
1

pts
 
81

 
81

 

pts
  Renewal pure price increases
 
5.0

%
4.5

 
0.5

 
 
5.3

 
3.9

 
1.4

 
Statutory NPE
 
54,937

 
50,377

 
9

%
 
108,352

 
99,748

 
9

%
Statutory combined ratio
 
80.9

%
116.3

 
(35.4
)
pts
 
83.7

 
100.3

 
(16.6
)
pts
% of total statutory standard Commercial Lines NPW
 
17

%
17

 
 

 
 
17

 
16

 
 
 

NPW and NPE increased in both Second Quarter and Six Months 2013 compared to the same prior year periods primarily due to: (i) improvement in new business; (ii) renewal pure price increases; and (iii) strong retention.

The improvement in the statutory combined ratio in Second Quarter and Six Months 2013 compared to the same prior year periods was due to: (i) a decrease in non-catastrophe property losses of $9.0 million, or 20.0 points, and $6.9 million, or 9.7 points, for Second Quarter and Six Months 2013, respectively; and (ii) a decrease in catastrophe losses of $6.7 million, or 14.6 points, in Second Quarter 2013 and $6.2 million, or 7.0 points, in Six Months 2013.

Additionally, the statutory combined ratio was increased by 0.7 points due to the Retirement Income Plan curtailment charge during Six Months 2013.



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Table of Contents

Standard Personal Lines
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quarter ended June 30,
 
 
 
 
 
Six Months ended June 30,
 
 
 
($ in thousands)
 
2013
 
2012
 
Change % or Points
 
 
 
2013
 
2012
 
Change % or Points
 
GAAP Insurance Operations Results:
 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
NPW
 
$
78,860

 
76,805

 
3

 
%
 
147,415

 
142,351

 
4

%
NPE
 
73,548

 
69,956

 
5

 
 
 
146,584

 
138,565

 
6

 
Less:
 
 
 
 

 
 
 
 
 
 
 
 

 
 
 
Loss and loss expense incurred
 
57,204

 
57,975

 
(1
)
 
 
 
104,796

 
105,608

 
(1
)
 
Net underwriting expenses incurred
 
19,319

 
19,419

 
(1
)
 
 
 
38,790

 
37,274

 
4

 
Underwriting (loss) gain
 
$
(2,975
)
 
(7,438
)
 
60

 
%
 
2,998

 
(4,317
)
 
169

%
GAAP Ratios:
 
 
 
 

 
 
 
 
 
 
 
 

 
 
 
Loss and loss expense ratio
 
77.8

%
82.9

 
(5.1
)
 
pts
 
71.5

 
76.2

 
(4.7
)
pts
Underwriting expense ratio
 
26.2

 
27.7

 
(1.5
)
 
 
 
26.5

 
26.9

 
(0.4
)
 
Combined ratio
 
104.0

 
110.6

 
(6.6
)
 
 
 
98.0

 
103.1

 
(5.1
)
 
Statutory Ratios:
 
 
 
 

 
 
 
 
 
 
 
 

 
 
 
Loss and loss expense ratio1
 
77.9

 
82.9

 
(5.0
)
 
 
 
71.6

 
76.2

 
(4.6
)
 
Underwriting expense ratio1
 
25.0

 
26.3

 
(1.3
)
 
 
 
26.0

 
27.2

 
(1.2
)
 
Combined ratio1
 
102.9

%
109.2

 
(6.3
)
 
pts
 
97.6
%
 
103.4

 
(5.8
)
pts
1
Six Months 2013 includes 0.1 points in the loss and loss expense ratio, 0.5 points in the underwriting ratio, and 0.6 points in the combined ratio related to the Retirement Income Plan amendments recorded in the first quarter of 2013 that curtail the accrual of additional benefits for all eligible employees participating in the plans after March 31, 2016.

The improvements in NPW in Second Quarter 2013 compared to Second Quarter 2012 are primarily the result of the following:
 
 
Quarter ended June 30,
 
 
Six Months ended June 30,
 
($ in millions)
 
2013
 
2012
 
 
2013
 
2012
 
Retention
 
87
%
87

 
86
%
86

Renewal pure price increase
 
8.3
 
5.6
 
 
8.4
 
5.7
 

NPE increases in Second Quarter and Six Months 2013, compared to the same periods last year, are consistent with the fluctuations in NPW for the twelve-month period ended June 30, 2013 as compared to the twelve-month period ended June 30, 2012.

The variance in the loss and loss expense ratios was driven by premiums outpacing loss costs in Second Quarter and Six Months 2013 compared to Second Quarter and Six Months 2012, as well as the following:
 
Second Quarter 2013
 
 
Second Quarter 2012
 
 
 
($ in millions)
Loss and Loss Expense Incurred
Impact on
Loss and Loss Expense Ratio
 
 
Loss and Loss Expense Incurred
Impact on
Loss and Loss Expense Ratio
 
Change in Ratio
 
Catastrophe losses
$
7.9

10.7

pts
 
$
11.6

16.5

pts
(5.8
)
pts
Non-catastrophe property losses
22.3

30.3

 
 
21.8

31.1

 
(0.8
)
 
Flood claims handling fees
(1.3
)
(1.7
)
 
 
(0.7
)
(1.0
)
 
(0.7
)
 
(Unfavorable)/favorable prior year casualty reserve development
(1
)
(1.2
)
 
 
1

1.4

 
(2.6
)
 


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Table of Contents

 
Six Months 2013
 
 
Six Months 2012
 
 
 
($ in millions)
Loss and Loss Expense Incurred
Impact on
Loss and Loss Expense Ratio
 
 
Loss and Loss Expense Incurred
Impact on
Loss and Loss Expense Ratio
 
Change in Ratio
 
Catastrophe losses
$
8.4

5.7

pts
 
$
14.6

10.5

pts
(4.8
)
pts
Non-catastrophe property losses
46.1

31.4

 
 
40.1

29.0

 
2.4

 
Flood claims handling fees
(2.8
)
(1.9
)
 
 
(1.0
)
(0.7
)
 
(1.2
)
 
Favorable prior year casualty reserve development
2

1.2

 
 
2

1.4

 
(0.2
)
 

The improvements in the underwriting expense ratios were driven by higher direct premiums written in our flood business that, coupled with an increase in the flood expense allowance for issuing and servicing these policies, increased our expense allowance earned from our participation in the NFIP. In addition, our statutory underwriting expense ratio included a one-time benefit due to a favorable premium tax ruling on our flood business in Second Quarter 2013. This item was partially offset on a year-to-date basis by the Retirement Income Plan curtailment expense, which added 0.5 points to the Six Months 2013 statutory underwriting expense ratio.

E&S Insurance Operations
Our E&S Insurance Operations segment, which represents 7% of our combined insurance operations NPW, sells Commercial Lines insurance products and services in all 50 states and the District of Columbia through approximately 100 wholesale general agents. Insurance policies in this segment typically cover business risks with unique characteristics, such as the nature of the business or its claim history, that are difficult to profitably insure in the standard commercial lines market. E&S insurers have more flexibility in coverage terms and rates compared to standard market insurers, generally resulting in policies with higher rates, and terms and conditions that are customized for specific risks.

 
 
Quarter ended June 30,
 
 
 
 
Six Months ended June 30,
 
 
 
($ in thousands)
 
2013
 
2012
 
Change
% or
Points
 
 
2013
 
2012
 
Change
% or
Points
 
GAAP Insurance Operations Results:
 
 

 
 

 
 

 
 
 
 
 
 
 
 
NPW
 
$
32,666

 
28,339

 
15

%
 
61,046

 
54,134

 
13

%
NPE
 
30,047

 
15,967

 
88

 
 
60,106

 
25,690

 
134

 
Less:
 
 

 
 

 
 

 
 
 

 
 

 
 

 
Loss and loss expense incurred
 
21,074

 
12,606

 
67

 
 
40,192

 
20,073

 
100

 
Net underwriting expenses incurred
 
11,258

 
8,461

 
33

 
 
22,113

 
15,610

 
42

 
Underwriting loss
 
$
(2,285
)
 
(5,100
)
 
55

%
 
(2,199
)
 
(9,993
)
 
78

%
GAAP Ratios:
 
 

 
 

 
 

 
 
 

 
 

 
 

 
Loss and loss expense ratio
 
70.1

%
79.0

 
(8.9
)
pts
 
66.9

 
78.1

 
(11.2
)
pts
Underwriting expense ratio
 
37.5

 
52.9

 
(15.4
)
 
 
36.8

 
60.8

 
(24.0
)
 
Combined ratio
 
107.6

 
131.9

 
(24.3
)
 
 
103.7

 
138.9

 
(35.2
)
 
Statutory Ratios:
 
 

 
 

 
 

 
 
 

 
 

 
 

 
Loss and loss expense ratio
 
70.3

 
75.1

 
(4.8
)
 
 
66.9

 
75.7

 
(8.8
)
 
Underwriting expense ratio
 
36.5

 
41.0

 
(4.5
)
 
 
35.7

 
42.3

 
(6.6
)
 
Combined ratio
 
106.8

%
116.1

 
(9.3
)
pts
 
102.6

 
118.0

 
(15.4
)
pts

Our E&S business is a small operation whose combined ratios are significantly impacted by premium growth as well as volatility in loss and loss expenses and underwriting expenses. The improvement in the combined ratios in Second Quarter 2013 and Six Months 2013 was driven by: (i) earned premiums that now reflect the full operations of this business, which was not the case in similar prior year periods; (ii) underwriting improvements, including renewal pure price increases of 6.7% and 7.6% in Second Quarter and Six Months 2013, respectively; and (iii) a decrease in initial start-up expenditures. The initial start-up expenses amounted to $0.1 million, or 0.4 points, in Second Quarter 2013 compared to $1.1 million, or 6.7 points, in Second Quarter 2012 and $0.2 million, or 0.4 points, in Six Months 2013 compared to $2.2 million, or 8.4 points, in Six Months 2012.

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Table of Contents


Although year-over-year and quarter-to-quarter comparisons of this business are difficult considering the volatility caused by the items discussed above, results are tracking in line with our expectations to achieve between a 100% and 102% combined ratio for 2013. Excluding unfavorable prior year casualty reserve development of approximately $3 million in Six Months 2013, the E&S Insurance Operations statutory combined ratio would have been 98.4%.



43

Table of Contents

Reinsurance: Standard and E&S Insurance Operations Segments

Reinsurance Treaties and Arrangement

We have successfully completed negotiations of our July 1, 2013 Standard Insurance Operations excess of loss treaties with highlights as follows:
 
Property Excess of Loss
The property excess of loss treaty ("Property Treaty") was renewed with substantially the same terms as the expiring treaty providing for the following per risk coverage of $38.0 million in excess of a $2.0 million retention:
The per occurrence cap on the total program is $84.0 million.
The first layer continues to have unlimited reinstatements. The annual aggregate limit for the second layer, which is $30.0 million in excess of $10.0 million, is consistent with the prior year treaty at $120.0 million.
Consistent with the prior year treaty, the Property Treaty excludes nuclear, biological, chemical, and radiological terrorism losses.

Casualty Excess of Loss
The casualty excess of loss treaty (“Casualty Treaty”) was renewed with substantially the same terms as the expiring treaty providing the following per occurrence coverage:
The first through sixth layers provide coverage for 100% of up to $88.0 million in excess of a $2.0 million retention.
The Casualty Treaty excludes nuclear, biological, chemical, and radiological terrorism losses.
Annual aggregate terrorism limits remain the same as the prior year treaty at $201.0 million.

Investments
Our investment philosophy includes certain return and risk objectives for the fixed maturity, equity, and other investment portfolios. 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 predominantly a “buy-and-hold” approach. The primary fixed maturity portfolio return objective is to maximize after-tax investment yield and income while balancing risk. A secondary objective is to meet or exceed a weighted-average benchmark of public fixed income indices. Within the equity portfolio, the high dividend yield strategy is designed to generate consistent dividend income while maintaining an expected tracking error to the Standard & Poor's Rating Services ("S&P") 500 Index. Additional equity strategies are focused on meeting or exceeding strategy specific benchmarks of public equity indices. The return objective of the other investment portfolio, which includes alternative investments, is to meet or exceed the S&P 500 Index.

Total Invested Assets
 
 
 
 
 
 
($ in thousands)
 
June 30, 2013
 
December 31, 2012
 
Change %
Total invested assets
 
$
4,366,958

 
4,330,019

 
1
 %
Unrealized gain – before tax
 
88,061

 
188,197

 
(53
)
Unrealized gain – after tax
 
57,239

 
122,328

 
(53
)
 
The increase in our investment portfolio compared to year-end 2012 was driven primarily by: (i) operating cash flows; and (ii) net proceeds from our debt issuance in February 2013. These increases were partially offset by a $100.1 million pre-tax decrease in unrealized gains, primarily from our fixed maturity securities portfolio, driven by the rise in interest rates during Second Quarter 2013. During Second Quarter 2013, interest rates on the 10 year U.S. Treasury Note rose by 64 basis points. The cash generated from our insurance operations segments, as well as net amounts generated from our capital management strategies executed in the first quarter of 2013, were used to invest in structured securities, as well as corporate and municipal bonds within our fixed maturity securities portfolio.


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Table of Contents

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

 
 
June 30, 2013
 
December 31, 2012
 
U.S. government obligations
 
4
%
6
 
Foreign government obligations
 
1
 
1
 
State and municipal obligations
 
30
 
31
 
Corporate securities
 
36
 
34
 
Mortgage-backed securities (“MBS”)
 
15
 
14
 
Asset-backed securities (“ABS”)
 
4
 
3
 
Total fixed maturity securities
 
90
 
89
 
Equity securities
 
4
 
3
 
Short-term investments
 
4
 
5
 
Other investments
 
2
 
3
 
Total
 
100
%
100
 

Fixed Maturity Securities 
The average duration of the fixed maturity securities portfolio as of June 30, 2013 was 3.5 years, including short-term investments, compared to the Insurance Subsidiaries’ liability duration of approximately 3.9 years. The fixed maturity securities portfolio duration was slightly longer at June 30, 2013 than at December 31, 2012.  In particular, the MBS portfolio duration has lengthened, in part, through changes in assumptions of pre-payment speeds as higher interest rates dampen some potential refinancing activity.

The current duration of the fixed maturity securities portfolio is within our historical range, and is monitored and managed to maximize yield while managing interest rate risk at an acceptable level. We are experiencing continued pressure on the yields within our fixed maturity securities portfolio, as higher yielding bonds that are either maturing or have been sold are being replaced with lower yielding bonds that are currently available in the marketplace. We manage liquidity with a laddered maturity structure and an appropriate level of short-term investments to avoid liquidation of available-for-sale ("AFS") fixed maturity securities in the ordinary course of business. We typically have a long investment time horizon, and every purchase or sale is made with the intent of maximizing risk adjusted investment returns in the current market environment while balancing capital preservation.

Our fixed maturity securities portfolio had a weighted average credit rating of “AA-” as of June 30, 2013. The following table presents the credit ratings of our fixed maturity securities portfolio:
 
Fixed Maturity Security Rating
 
June 30, 2013
 
December 31, 2012
 
Aaa/AAA
 
15
%
16
 
Aa/AA
 
46
 
47
 
A/A
 
26
 
25
 
Baa/BBB
 
11
 
10
 
Ba/BB or below
 
2
 
2
 
Total
 
100
%
100
 


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Table of Contents

The following table summarizes the fair value, unrealized gain (loss) balances, and the weighted average credit qualities of our AFS fixed maturity securities at June 30, 2013 and December 31, 2012:
 
 
June 30, 2013
 
December 31, 2012
($ in millions)
 
Fair
Value
 
Unrealized
Gain (Loss)
 
Weighted
Average Credit
Quality
 
Fair
Value
 
Unrealized
Gain (Loss)
 
Weighted Average Credit Quality
AFS Fixed Maturity Portfolio:
 
 

 
 

 
 
 
 

 
 

 
 
U.S. government obligations
 
$
178.0

 
12.1

 
AA+
 
259.1

 
17.2

 
AA+
Foreign government obligations
 
29.7

 
0.9

 
AA-
 
30.2

 
1.4

 
AA-
State and municipal obligations
 
894.3

 
9.7

 
AA
 
818.0

 
44.1

 
AA
Corporate securities
 
1,524.0

 
32.1

 
A
 
1,450.3

 
81.3

 
A
MBS
 
638.4

 
0.9

 
AA
 
609.8

 
19.0

 
AA
ABS
 
155.4

 
0.1

 
AAA
 
128.6

 
2.3

 
AAA
Total AFS fixed maturity portfolio
 
$
3,419.8

 
55.8

 
AA-
 
3,296.0

 
165.3

 
AA-
State and Municipal Obligations:
 
 

 
 

 
 
 
 

 
 

 
 
General obligations
 
$
416.2

 
4.9

 
AA+
 
352.3

 
20.5

 
AA+
Special revenue obligations
 
478.1

 
4.8

 
AA
 
465.7

 
23.6

 
AA
Total state and municipal obligations
 
$
894.3

 
9.7

 
AA
 
818.0

 
44.1

 
AA
Corporate Securities:
 
 

 
 

 
 
 
 

 
 

 
 
Financial
 
$
440.7

 
11.2

 
A
 
438.0

 
23.2

 
A
Industrials
 
121.1

 
4.5

 
A-
 
104.2

 
7.4

 
A-
Utilities
 
135.5

 
1.4

 
A-
 
124.2

 
6.6

 
BBB+
Consumer discretionary
 
163.4

 
3.4

 
A-
 
134.7

 
8.3

 
BBB+
Consumer staples
 
158.7

 
3.8

 
A
 
163.6

 
8.6

 
A
Healthcare
 
176.7

 
4.4

 
A+
 
178.2

 
11.0

 
A+
Materials
 
86.6

 
1.0

 
BBB+
 
71.9

 
4.6

 
A-
Energy
 
79.2

 
1.3

 
A-
 
77.4

 
4.3

 
A-
Information technology
 
99.8

 

 
A+
 
100.1

 
3.2

 
A
Telecommunications services
 
54.7

 
0.5

 
BBB+
 
46.7

 
2.8

 
BBB+
Other
 
7.6

 
0.6

 
AA+
 
11.3

 
1.3

 
AA+
Total corporate securities
 
$
1,524.0

 
32.1

 
A
 
1,450.3

 
81.3

 
A
MBS:
 
 

 
 

 
 
 
 

 
 

 
 
Government guaranteed agency commercial mortgage-backed securities ("CMBS")
 
$
39.9

 
1.0

 
AA+
 
48.9

 
2.3

 
AA+
Other agency CMBS
 
9.2

 
(0.3
)
 
AA+
 
1.2

 

 
AA+
Non-agency CMBS
 
86.5

 
(2.2
)
 
AA
 
87.1

 
1.1

 
AA-
Government guaranteed agency residential MBS ("RMBS")
 
72.2

 
1.9

 
AA+
 
91.0

 
3.3

 
AA+
Non-agency RMBS
 
43.3

 
0.5

 
A-
 
44.3

 
0.9

 
A-
Other agency RMBS
 
381.7

 
(0.1
)
 
AA+
 
331.3

 
11.3

 
AA+
Alternative-A (“Alt-A”) RMBS
 
5.6

 
0.1

 
A+
 
6.0

 
0.1

 
AA-
Total MBS
 
$
638.4

 
0.9

 
AA
 
609.8

 
19.0

 
AA
ABS:
 
 

 
 

 
 
 
 

 
 

 
 
ABS
 
$
154.9

 

 
AAA
 
127.2

 
2.0

 
AAA
Alt-A ABS2
 

 

 
 
0.8

 
0.2

 
D
Sub-prime ABS1, 2
 
0.5

 
0.1

 
D
 
0.6

 
0.1

 
D
Total ABS
 
$
155.4

 
0.1

 
AAA
 
128.6

 
2.3

 
AAA
1We define sub-prime exposure as exposure to direct and indirect investments in non-agency residential mortgages with average FICO® scores below 650. 
2Alt-A ABS and subprime ABS each consist of one security whose issuer is currently expected by rating agencies to default on its obligations.


46

Table of Contents

The following tables provide information regarding our held-to-maturity (“HTM”) fixed maturity securities and their credit qualities at June 30, 2013 and December 31, 2012:
June 30, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
($ in millions)
 
Fair
Value
 
Carry
Value
 
Unrecognized Holding Gain (Loss)
 
Unrealized Gain (Loss) in Accumulated Other Comprehensive Income ("AOCI")
 
Total Unrealized/ Unrecognized Gain (Loss)
 
Weighted Average Credit Quality
HTM Portfolio:
 
 

 
 

 
 

 
 

 
 

 
 
Foreign government obligations
 
$
5.6

 
5.5

 
0.1

 
0.2

 
0.3

 
AA+
State and municipal obligations
 
446.9

 
426.4

 
20.5

 
4.9

 
25.4

 
AA
Corporate securities
 
38.9

 
35.3

 
3.6

 
(0.7
)
 
2.9

 
A
MBS
 
9.6

 
6.6

 
3.0

 
(1.0
)
 
2.0

 
AA
ABS
 
6.6

 
5.7

 
0.9

 
(0.8
)
 
0.1

 
A+
Total HTM portfolio
 
$
507.6

 
479.5

 
28.1

 
2.6

 
30.7

 
AA
State and Municipal Obligations:
 
 

 
 

 
 

 
 

 
 

 
 
General obligations
 
$
144.3

 
138.2

 
6.1

 
2.7

 
8.8

 
AA
Special revenue obligations
 
302.6

 
288.2

 
14.4

 
2.2

 
16.6

 
AA
Total state and municipal obligations
 
$
446.9

 
426.4

 
20.5

 
4.9

 
25.4

 
AA
Corporate Securities:
 
 

 
 

 
 

 
 

 
 

 
 
Financial
 
$
9.4

 
8.6

 
0.8

 
(0.4
)
 
0.4

 
BBB+
Industrials
 
11.6

 
10.3

 
1.3

 
(0.2
)
 
1.1

 
A+
Utilities
 
14.8

 
13.4

 
1.4

 
(0.1
)
 
1.3

 
A+
Consumer discretionary
 
3.1

 
3.0

 
0.1

 

 
0.1

 
AA
Total corporate securities
 
$
38.9

 
35.3

 
3.6

 
(0.7
)
 
2.9

 
A
MBS:
 
 

 
 

 
 

 
 

 
 

 
 
Non-agency CMBS
 
$
9.6

 
6.6

 
3.0

 
(1.0
)
 
2.0

 
AA
Total MBS
 
$
9.6

 
6.6

 
3.0

 
(1.0
)
 
2.0

 
AA
ABS:
 
 

 
 

 
 

 
 

 
 

 
 
ABS
 
$
4.1

 
3.9

 
0.2

 
(0.1
)
 
0.1

 
BBB+
Alt-A ABS
 
2.5

 
1.8

 
0.7

 
(0.7
)
 

 
AAA
Total ABS
 
$
6.6

 
5.7

 
0.9

 
(0.8
)
 
0.1

 
A+
 



47

Table of Contents

December 31, 2012
 
 
 
 
 
 
 
 
 
 
 
 

 
($ in millions)
 
Fair
Value
 
Carry
Value
 
Unrecognized Holding Gain (Loss)
 
Unrealized Gain (Loss) in AOCI
 
Total Unrealized/ Unrecognized Gain (Loss)
 
Weighted Average Credit Quality
HTM Portfolio:
 
 

 
 

 
 

 
 

 
 

 
 
Foreign government obligations
 
$
5.9

 
5.5

 
0.4

 
0.2

 
0.6

 
AA+
State and municipal obligations
 
526.9

 
498.0

 
28.9

 
6.8

 
35.7

 
AA
Corporate securities
 
42.1

 
37.5

 
4.6

 
(0.8
)
 
3.8

 
A
MBS
 
12.7

 
7.2

 
5.5

 
(1.2
)
 
4.3

 
AA-
ABS
 
7.1

 
5.9

 
1.2

 
(1.1
)
 
0.1

 
A
Total HTM portfolio
 
$
594.7

 
554.1

 
40.6

 
3.9

 
44.5

 
AA
State and Municipal Obligations:
 
 

 
 

 
 

 
 

 
 

 
 
General obligations
 
$
174.4

 
166.0

 
8.4

 
3.8

 
12.2

 
AA
Special revenue obligations
 
352.5

 
332.0

 
20.5

 
3.0

 
23.5

 
AA
Total state and municipal obligations
 
$
526.9

 
498.0

 
28.9

 
6.8

 
35.7

 
AA
Corporate Securities:
 
 

 
 

 
 

 
 

 
 

 
 
Financial
 
$
9.6

 
8.3

 
1.3

 
(0.7
)
 
0.6

 
BBB+
Industrials
 
11.9

 
10.4

 
1.5

 
(0.2
)
 
1.3

 
A+
Utilities
 
15.1

 
13.4

 
1.7

 

 
1.7

 
A+
Consumer discretionary
 
3.5

 
3.4

 
0.1

 
0.1

 
0.2

 
AA
Materials
 
2.0

 
2.0

 

 

 

 
BBB
Total corporate securities
 
$
42.1

 
37.5

 
4.6

 
(0.8
)
 
3.8

 
A
MBS:
 
 

 
 

 
 

 
 

 
 

 
 
Non-agency CMBS
 
$
12.7

 
7.2

 
5.5

 
(1.2
)
 
4.3

 
AA-
Total MBS
 
$
12.7

 
7.2

 
5.5

 
(1.2
)
 
4.3

 
AA-
ABS:
 
 

 
 

 
 

 
 

 
 

 
 
ABS
 
$
4.7

 
4.2

 
0.5

 
(0.3
)
 
0.2

 
BBB+
Alt-A ABS
 
2.4

 
1.7

 
0.7

 
(0.8
)
 
(0.1
)
 
AAA
Total ABS
 
$
7.1

 
5.9

 
1.2

 
(1.1
)
 
0.1

 
A
 
A portion of our AFS and HTM municipal bonds contain insurance enhancements. The following table provides information regarding these insurance-enhanced securities as of June 30, 2013:

Insurers of Municipal Bond Securities
 
 
 
 
 
 
($ in thousands)
 
Fair Value
 
Ratings
 with
Insurance
 
Ratings
without
Insurance
National Public Finance Guarantee Corporation, a subsidiary of MBIA, Inc.
 
$
267,368

 
AA-
 
AA-
Assured Guaranty
 
164,419

 
AA
 
AA-
Ambac Financial Group, Inc.
 
73,995

 
AA
 
AA
Other
 
8,702

 
AA
 
A+
Total
 
$
514,484

 
AA-
 
AA-
 
To manage and mitigate exposure, we perform analysis on MBS 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, as well as other information that aids in determining the health of the underlying assets. We also consider the 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.



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The following table details the top 10 state exposures of the municipal bond portion of our fixed maturity securities portfolio at June 30, 2013:
State Exposures of Municipal Bonds 
 
 
 
 
 
 
 
 
 
 
General Obligation
 
Special
Revenue
 
Fair
Value
 
Weighted Average Credit Quality
($ in thousands)
 
Local
 
State
 
 
 
Texas
 
$
68,315

 
1,082

 
42,024

 
111,421

 
AA+
Washington
 
35,146

 
6,722

 
51,786

 
93,654

 
AA
New York
 
9,773

 

 
68,739

 
78,512

 
AA+
Florida
 

 
15,177

 
51,464

 
66,641

 
AA-
Arizona
 
7,944

 

 
55,042

 
62,986

 
AA
Colorado
 
31,978

 

 
21,084

 
53,062

 
AA-
California
 
3,313

 

 
44,511

 
47,824

 
AA-
North Carolina
 
13,121

 
5,904

 
23,351

 
42,376

 
AA
Missouri
 
16,413

 
6,542

 
19,212

 
42,167

 
AA+
Alaska
 
12,484

 

 
22,108

 
34,592

 
AA+
Other
 
136,219

 
140,073

 
314,956

 
591,248

 
AA
 
 
334,706

 
175,500

 
714,277

 
1,224,483

 
AA
Pre-refunded/escrowed to maturity bonds
 
51,478

 
7,718

 
57,532

 
116,728

 
AA+
Total
 
$
386,184

 
183,218

 
771,809

 
1,341,211

 
AA
 
There has been concern regarding the stress on state and local governments emanating from declining revenues, large unfunded liabilities, and entrenched cost structures. We are comfortable with the quality, composition, and diversification of our $1.3 billion municipal bond portfolio.  Our municipal bond portfolio is very high quality with an average AA rating and is well laddered with 42% maturing within three years, and another 21% maturing between three and five years. The weightings of the municipal bond portfolio are: (i) 57% of high-quality revenue bonds that have dedicated revenue streams; (ii) 29% of local general obligation bonds; and (iii) 14% of state general obligation bonds. In addition, approximately 9% of the municipal bond portfolio has been pre-refunded, meaning assets have been placed in trust to fund the debt service and maturity of the bonds. Our largest state exposure is to Texas, at 8% excluding the impact of pre-refunded bonds.  Of the $68 million in local Texas general obligation bonds, $23 million represents investments in Texas Permanent School Fund bonds, which are considered to have lower risk.

In addition, in July 2013, Moody's Investor Service ("Moody's") downgraded the City of Chicago's debt over concerns about its unfunded pension liabilities. We hold seven securities, six of which have been downgraded, with an aggregate fair value of $17.2 million, of which $16.8 million is included in the "Other" category and $0.4 million is included in the "Pre-refunded/escrowed to maturity bonds" in the table above. These bonds were in an unrealized/unrecognized gain position of approximately $0.7 million as of June 30, 2013. Also, in July 2013, the City of Detroit declared bankruptcy; however, we do not own any of the impacted securities.

The sector composition and credit quality of our special revenue bonds did not significantly change from December 31, 2012. For details regarding our special revenue bond sectors and additional information regarding credit risk associated with our portfolio, see Item 7A. “Quantitative and Qualitative Disclosures About Market Risk.” of our 2012 Annual Report.


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Our top Eurozone exposures as of June 30, 2013 were as follows:
 
June 30, 2013
 
 
 
 
 
 
 
 
($ in millions)
 
Corporate Securities
 
Foreign Government Securities
 
Equity Securities
 
Total Exposure
Country:
 
 

 
 

 
 

 
 

Netherlands
 
$
9.1

 

 
1.4

 
10.5

Luxembourg
 
8.3

 

 

 
8.3

Germany
 

 
5.6

 

 
5.6

Ireland
 

 

 
5.2

 
5.2

France
 
2.7

 

 

 
2.7

Total
 
$
20.1

 
5.6

 
6.6

 
32.3


Uncertainty about the ability of certain sovereign issuers to fully repay their debt triggered significant turbulence in global financial markets in 2012 but has abated somewhat in 2013.  The sovereign debt crisis has been particularly concentrated in the Eurozone, and a number of member countries have been repeatedly downgraded by the major ratings agencies.  The crisis has placed strains on the stability of the Euro currency, but the European Central Bank has supplied liquidity to member nations and their banks.  As of June 30, 2013, we had no direct exposure to issuers domiciled in Italy, Greece, Portugal, or Spain, four of the more economically troubled nations in the Eurozone. We do not own any derivative exposures such as credit default swaps.  Outside of the effect foreign economies have on the underlying investments, we have minimal exposure to Euro depreciation or appreciation.

Equity Securities
Our equity securities portfolio was 4% of invested assets as of June 30, 2013, up slightly from year-end 2012. During Six Months 2013, we rebalanced our high dividend yield strategy holdings within this portfolio, generating purchases of $42.5 million and sales of $37.4 million, with resulting net realized gains of $5.6 million. Also contributing to the increase in this portfolio's value were unrealized gains, which increased by $10.7 million in Six Months 2013.

Other Investments
As of June 30, 2013, other investments represented 2% of our total invested assets.  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
 
Remaining Commitment
($ in thousands)
 
June 30,
2013
 
December 31,
2012
 
June 30, 2013
Alternative Investments:
 
 

 
 

 
 

  Secondary private equity
 
$
26,489

 
28,032

 
7,527

  Energy/power generation
 
18,417

 
18,640

 
7,825

  Private equity
 
17,809

 
18,344

 
11,542

  Mezzanine financing
 
12,868

 
12,692

 
19,712

  Real estate
 
12,149

 
11,751

 
10,290

  Distressed debt
 
12,106

 
12,728

 
2,929

  Venture capital
 
7,378

 
7,477

 
400

Total alternative investments
 
107,216

 
109,664

 
60,225

Other securities
 
1,861

 
4,412

 
1,289

Total other investments
 
$
109,077

 
114,076

 
61,514


In addition to the capital that we have already invested to date, we are contractually obligated to invest up to an additional $61.5 million in our other investments portfolio through commitments that currently expire at various dates through 2026. During Second Quarter 2013, we contracted for one new alternative investment within the private equity strategy. This investment, which has characteristics consistent with our other private equity strategy investments, has a commitment of $7.0 million, none of which has been paid as of June 30, 2013. For a description of our seven alternative investment strategies outlined above, as well as redemption, restrictions, and fund liquidations, refer to Note 5. “Investments” in Item 8. “Financial Statements and Supplementary Data.” of our 2012 Annual Report. In addition, for information on current year activity, refer to Note 5. "Investments" in Item 1. "Financial Statements" of this Form 10-Q.

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Net Investment Income
The components of net investment income earned for the indicated periods were as follows:
 
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in thousands)
 
2013
 
2012
 
2013
 
2012
Fixed maturity securities
 
$
30,298

 
31,759

 
60,387

 
63,109

Equity securities
 
1,874

 
1,280

 
3,081

 
2,517

Short-term investments
 
29

 
29

 
81

 
67

Other investments
 
3,869

 
2,963

 
7,471

 
4,963

Miscellaneous income
 

 
25

 

 
64

Investment expenses
 
(2,067
)
 
(2,050
)
 
(4,147
)
 
(4,086
)
Net investment income earned – before tax
 
34,003

 
34,006

 
66,873

 
66,634

Net investment income tax expense
 
(8,303
)
 
(8,296
)
 
(16,334
)
 
(16,149
)
Net investment income earned – after tax
 
$
25,700

 
25,710

 
50,539

 
50,485

Effective tax rate
 
24.4

%
24.4

 
24.4

 
24.2

Annual after-tax yield on fixed maturity securities
 


 


 
2.4

 
2.6

Annual after-tax yield on investment portfolio
 


 


 
2.3

 
2.4


Net investment income earned was consistent in Second Quarter and Six Months 2013 compared to the same periods last year. Higher income from our alternative investments within our other investment portfolio were offset by the impact of lower investment yields on our fixed maturity securities.

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 gains were as follows:

 
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in thousands)
 
2013
 
2012
 
2013
 
2012
HTM fixed maturity securities
 
 
 
 
 
 
 
 
Gains
 
$
3

 
2

 
3

 
155

Losses
 
(12
)
 
(25
)
 
(49
)
 
(106
)
AFS fixed maturity securities
 
 
 
 

 
 
 
 
Gains
 
967

 
368

 
1,918

 
773

Losses
 
(46
)
 
(74
)
 
(299
)
 
(117
)
AFS equity securities
 
 
 
 

 
 
 
 
Gains
 
4,800

 

 
10,471

 
4,775

Losses
 
(3
)
 

 
(171
)
 
(428
)
Short-term investments
 
 
 
 

 
 
 
 
Gains
 

 

 

 

Losses
 

 

 

 
(2
)
Other Investments
 
 
 
 
 
 
 
 
     Gains
 

 
1

 

 
1

     Losses
 

 

 
(860
)
 

Total other net realized investment gains
 
5,709

 
272

 
11,013

 
5,051

Total OTTI charges recognized in earnings
 
(555
)
 
(94
)
 
(2,504
)
 
(515
)
Total net realized gains
 
$
5,154

 
178

 
8,509

 
4,536


Our general philosophy for sales of securities is to reduce our exposure to securities and sectors based on economic evaluations and when the fundamentals for that security or sector have deteriorated, or to opportunistically trade out of securities to other securities with better economic return characteristics. We typically have a long investment time horizon, and every purchase or sale is made with the intent of maximizing risk adjusted investment returns in the current market environment while balancing capital preservation.
 

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For additional discussion regarding realized gains and losses, see Note 5. “Investments” in Item 1. “Financial Statements” of this Form 10-Q.
 
Other-than-Temporary Impairments
The following table provides information regarding our OTTI charges recognized in earnings:
 
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in thousands)
 
2013
 
2012
 
2013
 
2012
HTM fixed maturity securities:
 
 
 
 
 
 
 
 
ABS
 
$
3

 

 
3

 

Total HTM fixed maturity securities
 
3

 

 
3

 

AFS fixed maturity securities:
 
 
 
 

 
 
 
 
ABS
 

 
30

 

 
62

CMBS
 

 

 

 
108

RMBS
 

 
64

 
8

 
174

Total AFS fixed maturity securities
 

 
94

 
8

 
344

Equity securities
 
429

 

 
646

 
171

Total AFS securities
 
429

 
94

 
654

 
515

Other investments
 
123

 

 
1,847

 

Total OTTI charges recognized in earnings
 
$
555


94

 
2,504

 
515


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 OTTI, through realized losses in earnings for the credit-related portion and through unrealized losses in other comprehensive income ("OCI") for the non-credit related portion. If there is a decline in fair value of an equity security that we do not intend to hold, or if we determine that the decline is other than temporary, we write down the cost of the investment to fair value and record the charge through earnings as a component of realized losses.
 
For discussion of our OTTI methodology, see Note 2. “Summary of Significant Accounting Policies” in Item 8. “Financial Statements and Supplementary Data.” of our 2012 Annual Report.

Unrealized/Unrecognized Losses
As reflected in the table below, our unrealized/unrecognized loss positions increased by $43.3 million as of June 30, 2013 compared to December 31, 2012 as follows:
($ in thousands)
 
 
June 30, 2013
 
December 31, 2012
Number of Issues
% of Market/Book
Unrealized/ Unrecognized Loss
 
Number of
Issues
% of Market/Book
Unrealized/ Unrecognized Loss
504
80% - 99%
$
46,022

 
100
80% - 99%
2,701

1
60% - 79%
238

 
1
60% - 79%
233

40% - 59%

 
40% - 59%

20% - 39%

 
20% - 39%

0% - 19%

 
0% - 19%

 
 
$
46,260

 
 
 
2,934


We have reviewed the securities in the table above in accordance with our OTTI policy, which is discussed in Note 2. “Summary of Significant Accounting Policies” in Item 8. “Financial Statements and Supplementary Data.” of our 2012 Annual Report. We have concluded that these securities are temporarily impaired as of June 30, 2013. For additional information regarding the unrealized/unrecognized losses in our AFS and HTM portfolios, see Note 5. “Investments.” in Item 1. “Financial Statements” of this Form 10-Q.


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Table of Contents

Contractual Maturities
The following table presents amortized cost and fair value information for our AFS fixed maturity securities that were in an unrealized loss position at June 30, 2013 by contractual maturity:
($ in thousands)
 
Amortized
Cost
 
Fair
Value
One year or less
 
$
19,197

 
18,973

Due after one year through five years
 
403,564

 
396,006

Due after five years through ten years
 
809,116

 
774,487

Due after ten years
 
51,736

 
48,722

Total
 
$
1,283,613

 
1,238,188

 
The following table presents amortized cost and fair value information for our HTM fixed maturity securities that were in an unrealized/unrecognized loss position at June 30, 2013 by contractual maturity:
 
($ in thousands)
 
Amortized
Cost
 
Fair
Value
One year or less
 
$
1,231

 
1,217

Due after one year through five years
 
2,524

 
2,468

Total
 
$
3,755

 
3,685


Federal Income Taxes
The following table provides information regarding federal income taxes from continuing operations:

 
Quarter ended June 30,
 
Six Months ended June 30,
($ in million)
2013
 
2012
 
2013
 
2012
Federal income tax expense (benefit) from continuing operations
$
9.1

 
(1.0
)
 
15.6

 
4.1

Effective tax rate
25
%
 
(142
)
 
24

 
18


The increase in federal income tax expense in Second Quarter and Six Months 2013 compared to the same prior year periods was primarily due to an improvement in underwriting results as compared to last year. For a discussion of our underwriting results, see the "Results of Operations and Related Information by Segment" section above.

Financial Condition, Liquidity, Short-term Borrowings, 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 at June 30, 2013 was comprised of $40 million at Selective Insurance Group, Inc. (the “Parent”) and $147 million at the Insurance Subsidiaries. This amount was lower than our $215 million cash and short-term investment position at December 31, 2012, as we were previously maintaining higher liquid assets to fund claim payments related to Hurricane Sandy. As those claims continue to be paid, cash and short-term assets have declined. Short-term investments are generally maintained in AAA-rated money market funds approved by the National Association of Insurance Commissioners. During Six Months 2013, the Parent continued to build a fixed maturity security investment portfolio containing high-quality, highly-liquid government and corporate fixed maturity investments to generate additional yield. This portfolio amounted to $45 million at June 30, 2013 compared to $41 million at December 31, 2012.
 
Sources of cash for the Parent have historically consisted of dividends from the Insurance Subsidiaries, borrowings under lines of credit and loan agreements with certain Insurance 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.


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We currently anticipate the Insurance Subsidiaries will pay approximately $32 million in total dividends to the Parent in 2013, of which $19 million was paid through Six Months 2013, including approximately $11 million of cash dividends that are deemed extraordinary under New Jersey insurance regulations. The determination of whether a dividend is considered ordinary or extraordinary is calculated over the most recent fiscal twelve-month period and is based on a regulatory threshold. One of our Insurance Subsidiaries, Selective Insurance Company of America ("SICA"), in the third quarter of 2012, paid an extraordinary dividend of $134 million that was used by the Parent to provide capitalization for other Insurance Subsidiaries, including two newly-formed New Jersey domiciled companies. Accordingly, SICA paid dividends above the ordinary dividend threshold over the past twelve months, and its dividends during Six Months 2013 are considered extraordinary. As of December 31, 2012, our allowable ordinary maximum dividend was approximately $106 million for 2013.
Any dividends to the Parent are subject to the approval and/or review of the insurance regulators in the respective domiciliary states 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. For additional information regarding dividend restrictions, refer to Note 20. “Statutory Financial Information, Capital Requirements, and Restrictions on Dividends and Transfers of Funds” in Item 8. “Financial Statements and Supplementary Data.” of our 2012 Annual Report.
In the first quarter of 2013, we issued $185 million of 5.875% Senior Notes due 2043. The Senior Notes pay interest on February 15, May 15, August 15, and November 15 of each year beginning on May 15, 2013, and on the date of maturity. The notes are callable by us on or after February 8, 2018, at a price equal to 100% of their principal amount, plus accrued and unpaid interest. A portion of the proceeds from this debt issuance was used to fully redeem the $100 million aggregate principal amount of our 7.5% Junior Subordinated Notes due 2066. Of the remaining net proceeds, $57.1 million was used to make capital contributions to the Insurance Subsidiaries while the balance was used for general corporate purposes. For additional information related to our outstanding debt, refer to Note 10. "Indebtedness" in Item 8. "Financial Statements and Supplementary Data." of our 2012 Annual Report.

The Parent had no private or public issuances of stock during Six Months 2013 or borrowings under its $30.0 million line of credit (“Line of Credit”). We have two Insurance Subsidiaries domiciled in Indiana ("Indiana Subsidiaries") that are members of the Federal Home Loan Bank of Indianapolis ("FHLBI"), Selective Insurance Company of South Carolina ("SICSC") and Selective Insurance Company of the Southeast ("SICSE"). Membership in the FHLBI provides these subsidiaries with access to additional liquidity. The Indiana Subsidiaries' aggregate investment of $2.9 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. All borrowings from the FHLBI are required to be secured by certain investments. For additional information regarding the required collateral, refer to Note 5. "Investments." in Item 1. "Financial Statements" of this Form 10-Q.
  
The Parent's Line of Credit agreement 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. Admitted assets amounted to $496.7 million for SICSC and $380.5 million for SICSE as of December 31, 2012, for a borrowing capacity of approximately $88 million. As our outstanding borrowing with the FHLBI is currently $58 million, the Indiana Subsidiaries have the ability to borrow approximately $30 million more until the Line of Credit borrowing limit is met, of which $22 million could be loaned to the Parent under lending agreements approved by the Indiana Department of Insurance. Similar to the Line of Credit agreement, these lending agreements limit borrowings by the Parent from the Indiana Subsidiaries to 10% of the admitted assets of the respective Indiana Subsidiary. For additional information regarding the Parent's Line of Credit, refer to the section below entitled “Short-term Borrowings.”

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. Our investment portfolio consists of maturity dates that are laddered to continually provide a source of cash flows for claims payments in the ordinary course of business. The duration of the fixed maturity portfolio including short-term investments was 3.5 years as of June 30, 2013, while the liabilities of the Insurance Subsidiaries have a duration of 3.9 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 based on our operating results, financial condition, capital requirements, contractual restrictions, and other relevant factors.
 
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

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pay dividends, if necessary, and/or the availability of other sources of liquidity to the Parent. Upcoming principal payments include $13 million in 2014 and $45 million in 2016. Subsequent to 2016, our next principal repayment is due 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 debt and pay dividends on common stock.

Short-term Borrowings
Our Line of Credit with Wells Fargo Bank, National Association, as administrative agent, and Branch Banking and Trust Company (BB&T), has a borrowing capacity of $30 million, which can be increased to $50 million with the approval of both lending partners. The Line of Credit provides the Parent with an additional source of short-term liquidity. The interest rate on our Line of Credit varies and is based on, among other factors, the Parent’s debt ratings. The Line of Credit expires on June 13, 2014. There were no balances outstanding under this credit facility at June 30, 2013 or at any time during Six Months 2013.
 
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, as well as covenants limiting our ability to: (i) merge or liquidate; (ii) incur debt or liens; (iii) dispose of assets; (iv) make investments and acquisitions; and (v) 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:

 
Required as of
June 30, 2013
Actual as of
June 30, 2013
Consolidated net worth
$854 million
$1.1 billion
Statutory surplus
Not less than $750 million
$1.2 billion
Debt-to-capitalization ratio1
Not to exceed 35%
26.5%
A.M. Best financial strength rating
Minimum of A-
A
1 
Calculated in accordance with the Line of Credit agreement.
 
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 June 30, 2013, we had statutory surplus of $1.2 billion, GAAP stockholders’ equity of $1.1 billion, and total debt of $392.4 million, which equates to a debt-to-capital ratio of approximately 26%.
 
Our cash requirements include, but are not limited to, principal and interest payments on various notes payable, 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, Contingent Liabilities, and Commitments.”
 
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 capital metrics, relative to the macroeconomic environment, that support our targeted financial strength. Based on our analysis and market conditions, we may take a variety of actions, including, but not limited to, contributing capital to the Insurance Subsidiaries in our insurance operations, issuing additional debt and/or equity securities, repurchasing shares of the Parent’s common stock, and increasing stockholders’ dividends.
 

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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 remained relatively flat at $19.72 as of June 30, 2013, from $19.77 as of December 31, 2012, primarily driven by: (i) a decrease in unrealized gains on our investment portfolio driven by the rising interest rate environment, which led to a decrease in book value per share of $1.17; and (ii) the impact of dividends paid to our shareholders, which led to a decrease in book value per share of $0.26. These decreases were offset by the impact of net income and the benefit related to the first quarter pension revaluation and curtailment, which resulted in an increase in book value per share of $0.87 and $0.54, respectively.

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Ratings
We are rated by major rating agencies that 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. In Second Quarter 2013, A.M. Best re-affirmed our rating of “A (Excellent),” their third highest of 13 financial strength ratings, with a “stable” outlook. The rating reflects our solid risk-adjusted capitalization, disciplined underwriting focus, increasing use of predictive modeling technology, strong independent retail agency relationships, and consistently stable loss reserves. We have been rated “A” or higher by A.M. Best for the past 83 years. A downgrade from A.M. Best to a rating below “A-” 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.
Ratings by other major rating agencies are as follows:
Fitch Ratings ("Fitch") - Our “A+” rating was reaffirmed in Second Quarter 2013, citing our improved underwriting results, strong independent agency relationships, solid loss reserve position, and enhanced diversification through continued efforts to reduce our concentration in New Jersey.  Our outlook was revised to negative reflecting increased levels of statutory and financial leverage, a moderate decline in the National Association of Insurance Commissioners ("NAIC") risk-based capital levels, and diminished operating earnings-based interest coverage relative to historical performance.
S&P - On July 11, 2013, S&P lowered our financial strength rating to “A-” from “A” under their recently revised rating criteria. The rating reflects our strong business risk profile and moderately strong financial risk profile, built on a strong competitive position in the regional small to midsize commercial insurance markets in Mid-Atlantic states and strong capital and earnings. The rating revision reflects S&P's view of our capital and earnings volatility relative to our peers. The outlook for the rating is stable citing the expectation that we will sustain our strong competitive position and business risk profile while maintaining a strong capital and earnings profile.
Moody's - Our "A2" financial strength rating was reaffirmed in the first quarter of 2013 by Moody's, which cited our strong regional franchise with established independent agency support, along with solid risk adjusted capitalization and strong invested asset quality. Our outlook was revised to negative, citing that our underwriting results have lagged similarly rated peers. 
Our S&P, Moody's, and Fitch financial strength and associated credit ratings affect our ability to access capital markets.  The interest rate on our Line of Credit varies and is based on, among other factors, the Parent's debt ratings. 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.

Off-Balance Sheet Arrangements
At June 30, 2013 and December 31, 2012, we did not have any material relationships with unconsolidated entities or financial partnerships, such 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 material financing, liquidity, market, or credit risk that could arise if we had engaged in such relationships.
 

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Contractual Obligations, Contingent Liabilities, and Commitments
Our future cash payments associated with loss and loss expense reserves, as well as contractual obligations pursuant to operating leases for office space and equipment, have not materially changed since December 31, 2012. Our future cash payments associated with contractual obligations pursuant to our notes payable as of June 30, 2013 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
Notes payable
$
393.0

 

 
13.0

 
45.0

 
335.0

Interest on debt obligations
554.5

 
22.1

 
43.8

 
42.7

 
445.9

Total
$
947.5

 
22.1

 
56.8

 
87.7

 
780.9


We expect to have the capacity to repay and/or refinance all of our contractual obligations as they come due.

At June 30, 2013, we had contractual obligations that expire at various dates through 2026 that may require us to invest up to an additional $61.5 million in alternative and other 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 17. "Related Party Transactions" included in Item 8. "Financial Statements and Supplementary Data." of our 2012 Annual Report.

ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
There have been no material changes in the information about market risk set forth in our 2012 Annual Report.

ITEM 4.   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 (“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. 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 Second Quarter 2013 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

In May 2013 the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) released its updated Internal Control - Integrated Framework (“Framework”).  The COSO framework is widely used by public companies to comply with the Sarbanes-Oxley Act of 2002.  The effective date for companies to transition to the new Framework is December 15, 2014 when the original framework will no longer be available.  The Company is currently utilizing the original Framework.


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PART II - OTHER INFORMATION

ITEM 1. 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 our Insurance Subsidiaries as either: (a) liability insurers defending or providing indemnity for third-party claims brought against insureds; or (b) insurers defending first-party coverage claims brought against them. We account for such activity through the establishment of unpaid loss and loss expense reserves. We expect that the ultimate liability, if any, with respect to such ordinary course claims litigation, after consideration of provisions made for potential losses and costs of defense, will not be material to our consolidated financial condition, results of operations, or cash flows.
 
Our Insurance Subsidiaries are also from time-to-time involved in other legal actions, some of which assert claims for substantial amounts. These actions include, among others, putative class actions seeking certification of a state or national class. Such putative class actions have alleged, for example, improper reimbursement of medical providers paid under workers compensation and personal and commercial automobile insurance policies. Our Insurance Subsidiaries are also involved from time-to-time in individual actions in which extra-contractual damages, punitive damages, or penalties are sought, such as claims alleging bad faith in the handling of insurance claims. We believe that we have valid defenses to these cases. We expect that the ultimate liability, if any, with respect to such lawsuits, after consideration of provisions made for estimated losses, will not be material to our consolidated financial condition. Nonetheless, given the large or indeterminate amounts sought in certain of these actions, and the inherent unpredictability of litigation, an adverse outcome in certain matters could, from time-to-time, have a material adverse effect on our consolidated results of operations or cash flows in particular quarterly or annual periods.

ITEM 1A. RISK FACTORS
Certain risk factors exist that can have a significant impact on our business, liquidity, capital resources, results of operations, financial condition, and debt ratings. The impact of these risk factors could also impact certain actions that we take as part of 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 equity securities, redeeming our fixed income securities, or increasing or decreasing, stockholders dividends. We operate in a continually changing business environment and new risk factors emerge from time-to-time. Consequently, we can neither predict such new risk factors nor assess the impact, if any, they might have on our business in the future. There have been no material changes from the risk factors disclosed in Item 1A. “Risk Factors.” in our 2012 Annual Report other than as discussed below.

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”). Following the acquisition of MUSIC, the newly-acquired company was included in our Insurance Subsidiaries' intercompany pooling agreement. As a result, the financial strength ratings from A.M. Best and Fitch include MUSIC, while S&P and Moody's Investor Service have not yet taken any rating action on MUSIC. The financial strength ratings are as follows:
 
NRSRO
Financial Strength Rating
Outlook
A.M. Best and Company
“A”
Stable
S&P
“A-”
Stable
Moody's Investor Service
“A2”
Negative
Fitch
“A+”
Negative

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. The Line of Credit requires our Insurance Subsidiaries to maintain an A.M. Best rating of at least “A-” (one level 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 our financial strength ratings could have a material adverse effect on our results of operations, liquidity, financial condition, financial strength, and debt ratings.
 

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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
“bbb+”
Stable
S&P
“BBB-”
Stable
Moody's Investor Services
“Baa2”
Negative
Fitch
“BBB+”
Negative

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 to access capital markets.

Because of the difficulties experienced by many financial institutions during the recent credit crisis, 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 their ratings that could adversely affect our business or the possible actions we may take in response to any such action.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
The following table provides information regarding our purchases of our common stock in Second Quarter 2013:

Period
 
Total Number of
Shares Purchased1
 
Average Price
Paid per Share
 
Total Number of
Shares Purchased
as Part of Publicly
Announced Programs
 
Maximum Number of
Shares that May Yet
Be Purchased Under the Announced Programs
Apri1 1 – 30, 2013
 
4,029

 
$
23.32

 

 

May 1 – 31, 2013
 
648

 
23.17

 

 

June 1 – 30, 2013
 

 

 

 

Total
 
4,677

 
$
23.30

 

 

1During Second Quarter 2013, 648 shares were purchased from employees in connection with the vesting of restricted stock units and 4,029 were purchased from employees in connection with stock option exercises. These repurchases were made to satisfy tax withholding obligations and/or option costs with respect to those employees. These shares were not purchased as part of any publicly announced program. The shares that were purchased in connection with the vesting of restricted stock units were purchased at fair market value as defined in the Selective Insurance Group, Inc. 2005 Omnibus Stock Plan As Amended and Restated Effective as of May 1, 2010. The shares purchased in connection with the option exercises were purchased at the current market prices of our common stock on the date the options were exercised.

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Item 6. EXHIBITS

(a) Exhibits:

Exhibit No.  
 
 
* 10.1+
 
Employment Agreement between Selective Insurance Company of America and Gordon J. Gaudet, dated as of May 6, 2013.
* 10.2
 
Third Amendment to Stock and Asset Purchase Agreement, dated as of June 3, 2013.
* 11
 
Statement Re: Computation of Per Share Earnings.
* 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.
** 101.INS
 
XBRL Instance Document.
** 101.SCH
 
XBRL Taxonomy Extension Schema Document.
** 101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document.
** 101.LAB
 
XBRL Taxonomy Extension Label Linkbase Document.
** 101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document.
** 101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document.
 
* Filed herewith.
** Furnished and not filed herewith.
+ Management compensation plan or arrangement

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SIGNATURES
 
Pursuant to the requirements 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.
Registrant 
 
By: /s/ Gregory E. Murphy
August 1, 2013
Gregory E. Murphy
 
Chairman of the Board, President and Chief Executive Officer
 
 
 
By: /s/ Dale A. Thatcher
August 1, 2013
Dale A. Thatcher
 
Executive Vice President and Chief Financial Officer
 
(principal accounting officer and principal financial officer)
 
 



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