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SELECTIVE INSURANCE GROUP INC - Quarter Report: 2018 September (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: September 30, 2018
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.
Yes x           No o
 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x           No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer x
 
Accelerated filer o
Non-accelerated filer o 
Smaller reporting company o
 
 
Emerging growth company o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).                                                              Yes o          No x
As of October 15, 2018, there were 58,888,985 shares of common stock, par value $2.00 per share, outstanding. 


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SELECTIVE INSURANCE GROUP, INC.
 
 
Table of Contents
 
 
 
Page No.
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


Table of Contents

PART I. FINANCIAL INFORMATION
 
ITEM 1. FINANCIAL STATEMENTS.
 
SELECTIVE INSURANCE GROUP, INC.
CONSOLIDATED BALANCE SHEETS
 
Unaudited
 
 
($ in thousands, except share amounts)
 
September 30,
2018
 
December 31,
2017
ASSETS
 
 

 
 

Investments:
 
 

 
 

Fixed income securities, held-to-maturity – at carrying value (fair value:  $46,240 – 2018; $44,100 – 2017)
 
$
44,582

 
42,129

Fixed income securities, available-for-sale – at fair value (amortized cost: $5,216,964 – 2018; $5,076,716 – 2017)
 
5,190,156

 
5,162,522

Equity securities – at fair value (cost:  $134,530 – 2018; $143,811 – 2017)
 
157,867

 
182,705

Short-term investments (at cost which approximates fair value)
 
304,572

 
165,555

Other investments
 
163,930

 
132,268

Total investments (Note 4 and 6)
 
5,861,107


5,685,179

Cash
 
446

 
534

Restricted cash
 
12,386

 
44,176

Interest and dividends due or accrued
 
41,016

 
40,897

Premiums receivable, net of allowance for uncollectible accounts of:  $10,100 – 2018; $10,000 – 2017
 
826,923

 
747,029

Reinsurance recoverable, net of allowance for uncollectible accounts of: $4,500 – 2018; $4,600 – 2017
 
603,827

 
594,832

Prepaid reinsurance premiums
 
167,108

 
153,493

Current federal income tax
 

 
3,243

Deferred federal income tax
 
52,347

 
31,990

Property and equipment – at cost, net of accumulated depreciation and amortization of:
$227,639 – 2018; $213,227 – 2017
 
64,225

 
63,959

Deferred policy acquisition costs
 
258,033

 
235,055

Goodwill
 
7,849

 
7,849

Other assets
 
91,485

 
78,195

Total assets
 
$
7,986,752

 
7,686,431

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 

 
 

Liabilities:
 
 

 
 

Reserve for loss and loss expense (Note 8)
 
$
3,925,155

 
3,771,240

Unearned premiums
 
1,483,794

 
1,349,644

Long-term debt
 
439,436

 
439,116

Current federal income tax
 
12,133

 

Accrued salaries and benefits
 
95,352

 
131,850

Other liabilities
 
292,362

 
281,624

Total liabilities
 
$
6,248,232

 
5,973,474

 
 
 
 
 
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: 102,786,738 – 2018; 102,284,564 – 2017
 
205,573

 
204,569

Additional paid-in capital
 
385,451

 
367,717

Retained earnings
 
1,824,607

 
1,698,613

Accumulated other comprehensive (loss) income (Note 11)
 
(92,576
)
 
20,170

Treasury stock – at cost
(shares:  43,897,753 – 2018; 43,789,442 – 2017)
 
(584,535
)
 
(578,112
)
Total stockholders’ equity
 
$
1,738,520

 
1,712,957

Commitments and contingencies
 


 


Total liabilities and stockholders’ equity
 
$
7,986,752

 
7,686,431


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 INCOME
 
Quarter ended September 30,
 
Nine Months ended September 30,
($ in thousands, except per share amounts)
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 

 
 

 
 
 
 
Net premiums earned
 
$
614,277

 
572,055

 
1,810,941

 
1,700,939

Net investment income earned
 
52,443

 
40,446

 
141,227

 
119,295

Net realized and unrealized (losses) gains:
 
 

 
 

 
 
 
 
Net realized investment (losses) gains on disposals
 
(751
)
 
6,871

 
4,034

 
12,252

Other-than-temporary impairments
 
(1,426
)
 
(43
)
 
(5,459
)
 
(4,729
)
Other-than-temporary impairments on fixed income securities recognized in other comprehensive income
 

 
(30
)
 

 
(36
)
Unrealized losses on equity securities
 
(2,610
)
 

 
(15,563
)
 

Total net realized and unrealized (losses) gains
 
(4,787
)
 
6,798

 
(16,988
)
 
7,487

Other income
 
2,538

 
1,994

 
7,896

 
8,526

Total revenues
 
664,471

 
621,293

 
1,943,076

 
1,836,247

 
 
 
 
 
 
 
 
 
Expenses:
 
 

 
 

 
 
 
 
Loss and loss expense incurred
 
379,199

 
344,587

 
1,130,468

 
1,003,618

Amortization of deferred policy acquisition costs
 
124,511

 
118,143

 
368,265

 
350,071

Other insurance expenses
 
80,108

 
78,874

 
244,342

 
243,799

Interest expense
 
6,073

 
6,085

 
18,350

 
18,272

Corporate expenses
 
7,450

 
6,289

 
22,065

 
26,669

Total expenses
 
597,341

 
553,978

 
1,783,490

 
1,642,429

 
 
 
 
 
 
 
 
 
Income before federal income tax
 
67,130

 
67,315

 
159,586

 
193,818

 
 
 
 
 
 
 
 
 
Federal income tax expense:
 
 

 
 

 
 
 
 
Current
 
10,314

 
16,859

 
23,529

 
48,917

Deferred
 
1,381

 
3,738

 
2,878

 
6,317

Total federal income tax expense
 
11,695

 
20,597

 
26,407

 
55,234

 
 
 
 
 
 
 
 
 
Net income
 
$
55,435

 
46,718

 
133,179

 
138,584

 
 
 
 
 
 
 
 
 
Earnings per share:
 
 

 
 

 
 
 
 
Basic net income
 
$
0.94

 
0.80

 
2.26

 
2.37

 
 
 
 
 
 
 
 
 
Diluted net income
 
$
0.93

 
0.79

 
2.23

 
2.34

 
 
 
 
 
 
 
 
 
Dividends to stockholders
 
$
0.18

 
0.16

 
0.54

 
0.48

 
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 September 30,
 
Nine Months ended September 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Net income
 
$
55,435

 
46,718

 
133,179

 
138,584

 
 
 
 
 
 
 
 
 
Other comprehensive (loss) income, net of tax:
 
 

 
 

 
 
 
 
Unrealized (losses) gains on investment securities:
 
 

 
 

 
 
 
 
Unrealized holding (losses) gains arising during period
 
(17,036
)
 
10,874

 
(103,389
)
 
50,961

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

 
19

 

 
23

  Amounts reclassified into net income:
 
 
 
 
 
 
 
 
Held-to-maturity securities
 
(6
)
 
(35
)
 
(22
)
 
(95
)
Non-credit other-than-temporary impairments
 

 
25

 

 
25

Realized losses (gains) on disposals of available-for-sale securities
 
8,563

 
(4,394
)
 
14,424

 
(4,638
)
Total unrealized (losses) gains on investment securities
 
(8,479
)
 
6,489

 
(88,987
)
 
46,276

 
 
 
 
 
 
 
 
 
Defined benefit pension and post-retirement plans:
 
 

 
 

 
 
 
 
Amounts reclassified into net income:
 
 
 
 
 
 
 
 
Net actuarial loss
 
420

 
329

 
1,260

 
989

  Total defined benefit pension and post-retirement plans
 
420

 
329

 
1,260

 
989

Other comprehensive (loss) income
 
(8,059
)
 
6,818

 
(87,727
)
 
47,265

Comprehensive income
 
$
47,376

 
53,536

 
45,452

 
185,849

 
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
 
Nine Months ended September 30,
($ in thousands, except per share amounts)
 
2018
 
2017
Common stock:
 
 

 
 

Beginning of year
 
$
204,569

 
203,241

Dividend reinvestment plan (shares:  17,683 – 2018; 22,278 – 2017)
 
35

 
45

Stock purchase and compensation plans (shares:  484,491 – 2018; 537,588 – 2017)
 
969

 
1,075

End of period
 
205,573

 
204,361

 
 
 
 
 
Additional paid-in capital:
 
 

 
 

Beginning of year
 
367,717

 
347,295

Dividend reinvestment plan
 
1,013

 
1,025

Stock purchase and compensation plans
 
16,721

 
14,417

End of period
 
385,451

 
362,737

 
 
 
 
 
Retained earnings:
 
 

 
 

Beginning of year, as previously reported
 
1,698,613

 
1,568,881

Cumulative effect adjustment due to adoption of equity security guidance, net of tax (Note 2)
 
30,726

 

Cumulative effect adjustment due to adoption of stranded deferred tax guidance (Note 2)
 
(5,707
)
 

Balance at beginning of year, as adjusted
 
1,723,632

 
1,568,881

Net income
 
133,179

 
138,584

Dividends to stockholders ($0.54 per share – 2018; $0.48 per share – 2017)
 
(32,204
)
 
(28,424
)
End of period
 
1,824,607

 
1,679,041

 
 
 
 
 
Accumulated other comprehensive (loss) income:
 
 

 
 

Beginning of year, as previously reported
 
20,170

 
(15,950
)
Cumulative effect adjustment due to adoption of equity security guidance, net of tax (Note 2)
 
(30,726
)
 

Cumulative effect adjustment due to adoption of stranded deferred tax guidance (Note 2)
 
5,707

 

Balance at beginning of year, as adjusted
 
(4,849
)
 
(15,950
)
Other comprehensive (loss) income
 
(87,727
)
 
47,265

End of period
 
(92,576
)
 
31,315

 
 
 
 
 
Treasury stock:
 
 

 
 

Beginning of year
 
(578,112
)
 
(572,097
)
Acquisition of treasury stock (shares: 108,311 – 2018; 136,012 – 2017)
 
(6,423
)
 
(6,005
)
End of period
 
(584,535
)
 
(578,102
)
Total stockholders’ equity
 
$
1,738,520

 
1,699,352

 
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 FLOWS
 
Nine Months ended September 30,
($ in thousands)
 
2018
 
2017
Operating Activities
 
 

 
 

Net income
 
$
133,179

 
138,584

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

 
 

Depreciation and amortization
 
34,961

 
38,163

Stock-based compensation expense
 
12,150

 
10,139

Undistributed gains of equity method investments
 
(4,243
)
 
(4,247
)
Distributions in excess of current year income of equity method investments
 
3,210

 
552

Loss on disposal of fixed assets
 
62

 
998

Net realized and unrealized losses (gains)
 
16,988

 
(7,487
)
 
 
 
 
 
Changes in assets and liabilities:
 
 

 
 

Increase in reserve for loss and loss expense, net of reinsurance recoverable
 
144,920

 
104,429

Increase in unearned premiums, net of prepaid reinsurance
 
120,535

 
115,855

Decrease in net federal income taxes
 
18,339

 
15,674

Increase in premiums receivable
 
(79,894
)
 
(88,175
)
Increase in deferred policy acquisition costs
 
(22,978
)
 
(19,592
)
Decrease (increase) in interest and dividends due or accrued
 
72

 
(1,088
)
Decrease in accrued salaries and benefits
 
(36,498
)
 
(19,804
)
Increase in other assets
 
(13,881
)
 
(6,304
)
(Decrease) increase in other liabilities
 
(34,437
)
 
12,621

Net cash provided by operating activities
 
292,485

 
290,318

 
 
 
 
 
Investing Activities
 
 

 
 

Purchase of fixed income securities, held-to-maturity
 
(7,150
)
 

Purchase of fixed income securities, available-for-sale
 
(1,974,253
)
 
(1,517,474
)
Purchase of equity securities
 
(57,834
)
 
(44,480
)
Purchase of other investments
 
(47,238
)
 
(34,586
)
Purchase of short-term investments
 
(2,711,360
)
 
(3,025,824
)
Sale of fixed income securities, available-for-sale
 
1,382,677

 
811,991

Sale of short-term investments
 
2,572,399

 
3,032,802

Redemption and maturities of fixed income securities, held-to-maturity
 
3,923

 
36,092

Redemption and maturities of fixed income securities, available-for-sale
 
456,037

 
439,616

Sale of equity securities
 
79,676

 
19,007

Sale of other investments
 
3,497

 

Distributions from other investments
 
23,420

 
17,041

Purchase of property and equipment
 
(11,150
)
 
(11,806
)
Net cash used in investing activities
 
(287,356
)
 
(277,621
)
 
 
 
 
 
Financing Activities
 
 

 
 

Dividends to stockholders
 
(30,694
)
 
(26,915
)
Acquisition of treasury stock
 
(6,423
)
 
(6,005
)
Net proceeds from stock purchase and compensation plans
 
5,001

 
4,744

Proceeds from borrowings
 
130,000

 
64,000

Repayments of borrowings
 
(130,000
)
 
(64,000
)
Repayments of capital lease obligations
 
(4,891
)
 
(3,267
)
Net cash used in financing activities
 
(37,007
)
 
(31,443
)
Net decrease in cash and restricted cash
 
(31,878
)
 
(18,746
)
Cash and restricted cash, beginning of year
 
44,710

 
37,405

Cash and restricted cash, end of period
 
$
12,832

 
18,659

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. Basis of Presentation
As used herein, the "Company,” “we,” “us,” or “our” refers to Selective Insurance Group, Inc. (the "Parent"), and its subsidiaries, except as expressly indicated or unless the context otherwise requires. Our interim unaudited consolidated financial statements (“Financial Statements”) have been prepared by us in conformity with U.S. generally accepted accounting principles (“GAAP”) and 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 2018 presentation. Specifically, we reclassified restricted cash balances related to our participation in the National Flood Insurance Program ("NFIP") from other assets in our consolidated balance sheet into a separate line item on the face of that statement. Additionally, refer to Note 2. "Adoption of Accounting Pronouncements" below for a discussion of the retroactive restatements that are included in these financial statements in relation to the adoption of new accounting pronouncements for the treatment of restricted cash and distributions from equity method investments on the consolidated statements of cash flows.

Our 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. Our Financial Statements cover the third quarters ended September 30, 2018 (“Third Quarter 2018”) and September 30, 2017 (“Third Quarter 2017”) and the nine-month periods ended September 30, 2018 ("Nine Months 2018") and September 30, 2017 ("Nine Months 2017"). The Financial Statements do not include all of the information and disclosures required by GAAP and the SEC for audited annual financial statements. Results of operations for any interim period are not necessarily indicative of results for a full year. Consequently, our 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, 2017 (“2017 Annual Report”) filed with the SEC.

NOTE 2. Adoption of Accounting Pronouncements 
In January 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-01, Financial Instruments - Overall: Recognition and Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). ASU 2016-01 provides guidance to improve certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. Specifically the guidance: (i) requires equity securities held in our investment portfolio to be measured at fair value with changes in fair value recognized in earnings; (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment; (iii) eliminates the requirement to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost; (iv) requires the use of the exit price notion when measuring the fair value of financial instruments for disclosure purposes; and (v) clarifies that the need for a valuation allowance on a deferred tax asset related to an available-for-sale ("AFS") security should be evaluated with other deferred tax assets.

We adopted ASU 2016-01 in the first quarter of 2018 and recognized a $30.7 million cumulative-effect adjustment to the opening balances of accumulated other comprehensive income ("AOCI") and retained earnings, which represents the after-tax net unrealized gain on our equity portfolio as of December 31, 2017. Additionally, beginning in the first quarter of 2018, changes in unrealized gains or losses on this portfolio are no longer recorded to AOCI, but are instead recognized in income through "Unrealized losses on equity securities" on our Consolidated Statements of Income. See Note 4 (j) below for information regarding unrealized equity losses recognized in income in Third Quarter and Nine Months 2018.

There were two accounting updates that we adopted with a retrospective transition in the first quarter of 2018 that related to our statements of cash flows. These accounting updates impacted our categorization of distributions from equity method investees (ASU 2016-15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments ("ASU 2016-15")) and the presentation of restricted cash (ASU 2016-18, Statement of Cash Flows: Restricted Cash ("ASU 2016-18")). These ASUs are discussed below and the discussions are followed with a table presenting the impact of the prior period restatements.
 
In August 2016, the FASB issued ASU 2016-15. As mentioned above, this ASU adds guidance on the categorization of distributions from equity method investees within the statement of cash flows. In accordance with this guidance, we made an accounting policy election to classify these distributions using the cumulative earnings approach. This election resulted in a restatement to operating and investing cash flows as outlined in the table below. ASU 2016-15 also added or clarified guidance on the cash flow classification of certain cash receipts and payments, including, but not limited to: (i) debt prepayment or debt

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extinguishment costs; (ii) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; and (iii) separately identifiable cash flows and application of the predominance principle. The updated guidance for these topics did not impact our statement of cash flows.

In November 2016, the FASB issued ASU 2016-18. ASU 2016-18 requires restricted cash and restricted cash equivalents to be included with cash and cash equivalents in the reconciliation of beginning and ending cash on the statements of cash flows. This update also requires a reconciliation of the statement of the cash flows to the balance sheet if the balance sheet includes more than one line item containing cash, cash equivalents, and restricted cash. We have restricted cash related to our participation in the NFIP, which we had previously reported as part of "Other assets" on the Consolidated Balance Sheet. Beginning in the first quarter of 2018, we are reporting restricted cash in its own line item on the Consolidated Balance Sheets to aid in the reconciliation of the amounts presented on the Consolidated Statements of Cash Flows. We have also restated prior year balances on the Consolidated Balance Sheets to conform to the current year presentation.

The adoption of this guidance resulted in a restatement of operating cash flows in Nine Months 2017 to remove the impact of the change in restricted cash from operating activities and include the restricted cash balance in the reconciliation of beginning and ending cash balances on the Statements of Cash Flows. In addition, we have included the required reconciliation in Note 3. "Statements of Cash Flows" below.

ASU 2016-15 and ASU 2016-18 resulted in the following line item restatements within operating and investing cash flows on the Statements of Cash Flows:
 
 
September 30, 2017
($ in thousands)
 
Prior to Adoption
 
After Adoption
Undistributed gains of equity method investments
 
$
(5,157
)
 
(4,247
)
Distributions in excess of current year income of equity method investments
 

 
552

Decrease (increase) in other assets
 
12,678

 
(6,304
)
Net cash provided by operating activities
 
307,838

 
290,318

 
 
 
 
 
Distributions from other investments
 
18,503

 
17,041

Net cash used in investing activities
 
(276,159
)
 
(277,621
)

In January 2017, the FASB issued ASU 2017-04, Intangibles-Goodwill and Other: Simplifying the Test for Goodwill Impairment (“ASU 2017-04”). ASU 2017-04 eliminates the second step of the two part goodwill impairment test, which required entities to determine the fair value of individual assets and liabilities of a reporting unit to measure the goodwill impairment. Under the new guidance, a goodwill impairment is calculated as the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The amendments in this update should be applied on a prospective basis for annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. We adopted ASU 2017-04 in the first quarter of 2018 and it had no impact on us.

In February 2018, the FASB issued ASU 2018-02, Income Statement - Reporting Comprehensive Income ("ASU 2018-02"). ASU 2018-02 allows a one-time reclassification from AOCI to retained earnings for the stranded tax assets that were created in AOCI from the enactment of the Tax Cuts and Jobs Act of 2017 ("Tax Reform"). We adopted ASU 2018-02 in the first quarter of 2018 and recognized a $5.7 million cumulative-effect adjustment for the deferred tax charge to income in the fourth quarter of 2017 that was associated with net unrealized gains on our investment portfolio and pension plan resulting from the enactment of Tax Reform.

Pronouncements to be effective in the future
The FASB has issued new leasing guidance through ASU 2016-02, Leases, which was issued in February 2016, as well as additional implementation guidance that was issued in 2018 (collectively referred to as "ASU 2016-02"). ASU 2016-02 requires all lessees to recognize assets and liabilities on their balance sheets for the rights and obligations created by leases with terms longer than 12 months. For leases with a term of 12 months or less, an accounting policy election is allowed to recognize lease expense on a straight-line basis over the lease term. Under the new lease guidance, we expect an increase in assets and liabilities as we will recognize operating leases for office space, fleet vehicles, and equipment on our balance sheet for the first time. However, these increases will not have a material impact to our financial condition. ASU 2016-02 allows for certain practical expedients, accounting policy elections, and a transition method election. We currently plan to adopt practical expedients related to reassessing: (i) whether our existing contracts are, or contain, leases; (ii) lease classification for existing leases; and (iii) initial direct costs for existing leases. Additionally, we plan to adopt accounting policy elections to: (i)

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aggregate lease and non-lease components of a contract into a single lease component; and (ii) expense short-term leases on a straight-line basis over the lease term. We will be adopting ASU 2016-02 on January 1, 2019 with a cumulative-effect adjustment to the opening balance of retained earnings as of that date. We do not anticipate the impact of this guidance to be material to our financial condition or results of operations.

In June 2018, the FASB issued ASU 2018-07, Compensation - Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting ("ASU 2018-07"). The amendments in ASU 2018-07 expand the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. ASU 2018-07 is effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Early adoption is permitted. We do not anticipate the adoption of this guidance to have a material impact on our financial condition or results of operations.

In August 2018, the FASB issued ASU 2018-13, Fair Value Measurement: Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”). ASU 2018-13 modifies the disclosure requirements for fair value measurements. The modifications removed the following disclosure requirements: (i) the amount of, and reasons for, transfers between Level 1 and Level 2 of the fair value hierarchy; (ii) the policy for timing of transfers between levels; and (iii) the valuation processes for Level 3 fair value measurements. This ASU added the following disclosure requirements: (i) the changes in unrealized gains and losses for the period included in other comprehensive income ("OCI") for recurring Level 3 fair value measurements held at the end of the reporting period; and (ii) the range and weighted average of significant observable inputs used to develop Level 3 fair value measurements. This update is effective for annual and interim periods beginning after December 15, 2019, with early adoption permitted. As the requirements of this literature are disclosure only, ASU 2018-13 will not impact our financial condition or results of operations.

In August 2018, the FASB issued ASU 2018-14, Compensation - Retirement Benefits - Defined Benefit Plans - General: Disclosure Framework - Changes to the Disclosure Requirements for Defined Benefit Plans (“ASU 2018-14”). ASU 2018-14 modifies the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. These modifications include: (i) removing the requirement to disclose the amount in AOCI expected to be recognized as components of net periodic benefit cost over the next fiscal year; and (ii) adding the requirement to disclose an explanation of the reasons for significant gains or losses related to changes in the benefit obligation for the period. This update is effective for fiscal years ending after December 15, 2020, with early adoption permitted. As the requirements of this literature are disclosure only, ASU 2018-14 will not impact our financial condition or results of operations.

In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software: Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (“ASU 2018-15”). ASU 2018-15 aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. This update is effective for annual and interim periods beginning after December 15, 2019, with early adoption permitted. We are currently evaluating the impact of this guidance on our financial condition or results of operations.

NOTE 3. Statements of Cash Flows
Supplemental cash flow information was as follows:
 
 
Nine Months ended September 30,
($ in thousands)
 
2018
 
2017
Cash paid during the period for:
 
 

 
 

Interest
 
$
15,449

 
15,356

Federal income tax
 
7,193

 
39,000

 
 
 
 
 
Non-cash items:
 
 
 
 
Corporate actions related to fixed income securities, AFS1
 
32,757

 
6,192

Corporate actions related to equity securities1
 
944

 
4,725

Assets acquired under capital lease arrangements
 
4,114

 
278

1Examples of such corporate actions include exchanges, non-cash acquisitions, and stock splits.

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The following table provides a reconciliation of cash and restricted cash reported within the Consolidated Balance Sheets that equate to the amount reported in the Consolidated Statements of Cash Flows:
($ in thousands)
 
September 30, 2018
 
December 31, 2017
Cash
 
$
446

 
534

Restricted cash
 
12,386

 
44,176

Total cash and restricted cash shown in the Statements of Cash Flows
 
$
12,832

 
44,710


Amounts included in restricted cash represent cash received from the NFIP, which is restricted to pay flood claims under the Write Your Own Program.

NOTE 4. Investments
(a) Information regarding our held-to-maturity ("HTM") fixed income securities as of September 30, 2018 and December 31, 2017 was as follows:
September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
($ in thousands)
 
Amortized
Cost
 
Net
 Unrealized Gains
 (Losses)
 
Carrying
Value
 
Unrecognized
 Holding
Gains
 
Unrecognized Holding
 Losses
 
Fair
Value
Obligations of states and political subdivisions
 
$
21,834

 
36

 
21,870

 
526

 

 
22,396

Corporate securities
 
22,798

 
(86
)
 
22,712

 
1,132

 

 
23,844

Total HTM fixed income securities
 
$
44,632

 
(50
)
 
44,582

 
1,658

 

 
46,240

December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
($ in thousands)
 
Amortized
Cost
 
Net
 Unrealized Gains
 (Losses)
 
Carrying
Value
 
Unrecognized
 Holding
Gains
 
Unrecognized Holding
 Losses
 
Fair
Value
Obligations of states and political subdivisions
 
$
25,154

 
84

 
25,238

 
1,023

 

 
26,261

Corporate securities
 
16,996

 
(105
)
 
16,891

 
1,003

 
(55
)
 
17,839

Total HTM fixed income securities
 
$
42,150

 
(21
)
 
42,129

 
2,026

 
(55
)
 
44,100

 
Unrecognized holding gains and losses of HTM securities are not reflected in the Financial Statements, as they represent fair value fluctuations from the date a security is designated as HTM through the date of the balance sheet.

(b) Information regarding our AFS securities as of September 30, 2018 and December 31, 2017 was as follows:
September 30, 2018
 
 
 
 
 
 
 
 
($ in thousands)
 
Cost/
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
AFS fixed income securities:
 
 
 
 
 
 
 
 
U.S. government and government agencies
 
$
97,304

 
306

 
(1,148
)
 
96,462

Foreign government
 
18,015

 
88

 
(120
)
 
17,983

Obligations of states and political subdivisions
 
1,161,322

 
10,848

 
(7,261
)
 
1,164,909

Corporate securities
 
1,662,613

 
6,342

 
(19,302
)
 
1,649,653

Collateralized loan obligations and other asset-backed securities ("CLO and other ABS")
 
772,738

 
4,571

 
(2,540
)
 
774,769

Commercial mortgage-backed securities ("CMBS")
 
495,208

 
328

 
(5,987
)
 
489,549

Residential mortgage-backed securities (“RMBS”)
 
1,009,764

 
2,670

 
(15,603
)
 
996,831

Total AFS securities
 
$
5,216,964

 
25,153

 
(51,961
)
 
5,190,156


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December 31, 2017
 
 
 
 
 
 
 
 
($ in thousands)
 
Cost/
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
AFS fixed income securities:
 
 
 
 
 
 
 
 
U.S. government and government agencies
 
$
49,326

 
647

 
(233
)
 
49,740

Foreign government
 
18,040

 
526

 
(11
)
 
18,555

Obligations of states and political subdivisions
 
1,539,307

 
44,245

 
(582
)
 
1,582,970

Corporate securities
 
1,588,339

 
30,891

 
(1,762
)
 
1,617,468

CLO and other ABS
 
789,152

 
6,508

 
(202
)
 
795,458

CMBS
 
382,727

 
1,563

 
(841
)
 
383,449

RMBS
 
709,825

 
6,487

 
(1,430
)
 
714,882

Total AFS fixed income securities
 
5,076,716

 
90,867

 
(5,061
)
 
5,162,522

AFS equity securities:
 
 
 
 
 
 
 
 
Common stock
 
129,696

 
38,287

 
(226
)
 
167,757

Preferred stock
 
14,115

 
904

 
(71
)
 
14,948

Total AFS equity securities
 
143,811

 
39,191

 
(297
)
 
182,705

Total AFS securities
 
$
5,220,527

 
130,058

 
(5,358
)
 
5,345,227


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 other-than-temporary impairment ("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. As of the first quarter of 2018, equity securities are no longer required to be included in the table above with the adoption of new accounting guidance through which unrealized gains and losses on equity securities are no longer recognized in AOCI, but are instead recognized through income. Refer to Note 2. "Adoption of Accounting Pronouncements" for additional information regarding the adoption of ASU 2016-01.
  
(c) The severity of impairment on securities in an unrealized/unrecognized loss position averaged approximately 2% of amortized cost at September 30, 2018 and approximately 1% at December 31, 2017. Quantitative information regarding unrealized losses on our AFS portfolio is provided below. Our HTM portfolio had $0.2 million of unrealized/unrecognized losses at September 30, 2018, and $0.1 million of unrealized/unrecognized losses at December 31, 2017.
September 30, 2018
 
Less than 12 months
 
12 months or longer
 
Total
($ in thousands)
 
Fair Value
 
Unrealized
Losses1
 
Fair Value
 
Unrealized
Losses1
 
Fair Value
 
Unrealized
Losses
1
AFS fixed income securities:
 
 

 
 

 
 

 
 

 
 
 
 
U.S. government and government agencies
 
$
26,414

 
(843
)
 
8,497

 
(305
)
 
34,911

 
(1,148
)
Foreign government
 
7,281

 
(120
)
 

 

 
7,281

 
(120
)
Obligations of states and political subdivisions
 
411,980

 
(7,008
)
 
6,397

 
(253
)
 
418,377

 
(7,261
)
Corporate securities
 
1,140,349

 
(19,052
)
 
6,373

 
(250
)
 
1,146,722

 
(19,302
)
CLO and other ABS
 
497,809

 
(2,479
)
 
4,335

 
(61
)
 
502,144

 
(2,540
)
CMBS
 
376,359

 
(5,940
)
 
2,340

 
(47
)
 
378,699

 
(5,987
)
RMBS
 
699,336

 
(14,727
)
 
19,183

 
(876
)
 
718,519

 
(15,603
)
Total AFS securities
 
$
3,159,528

 
(50,169
)
 
47,125

 
(1,792
)
 
3,206,653

 
(51,961
)


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December 31, 2017
 
Less than 12 months
 
12 months or longer
 
Total
($ in thousands)
 
Fair
Value
 
Unrealized
Losses1
 
Fair Value
 
Unrealized
Losses1
 
Fair Value
 
Unrealized
Losses
1
AFS fixed income securities:
 
 

 
 

 
 

 
 

 
 
 
 
U.S. government and government agencies
 
$
23,516

 
(233
)
 
250

 

 
23,766

 
(233
)
Foreign government
 
1,481

 
(11
)
 

 

 
1,481

 
(11
)
Obligations of states and political subdivisions
 
107,514

 
(422
)
 
14,139

 
(160
)
 
121,653

 
(582
)
Corporate securities
 
238,326

 
(1,744
)
 
3,228

 
(18
)
 
241,554

 
(1,762
)
CLO and other ABS
 
74,977

 
(196
)
 
1,655

 
(6
)
 
76,632

 
(202
)
CMBS
 
154,267

 
(773
)
 
5,214

 
(68
)
 
159,481

 
(841
)
RMBS
 
269,485

 
(1,285
)
 
11,200

 
(145
)
 
280,685

 
(1,430
)
Total AFS fixed income securities
 
869,566

 
(4,664
)
 
35,686

 
(397
)
 
905,252

 
(5,061
)
AFS equity securities:
 
 
 
 
 
 
 
 
 
 
 
 
Common stock
 
4,727

 
(226
)
 

 

 
4,727

 
(226
)
Preferred stock
 
3,833

 
(71
)
 

 

 
3,833

 
(71
)
Total AFS equity securities
 
8,560

 
(297
)
 

 

 
8,560

 
(297
)
Total AFS
 
$
878,126

 
(4,961
)
 
35,686

 
(397
)
 
913,812

 
(5,358
)
  1 Gross unrealized losses include non-OTTI unrealized amounts and OTTI losses recognized in AOCI. 

The increase in the less than 12 months unrealized loss position was due to higher interest rates, with a 94-basis point increase in 2-year U.S. Treasury Note yields and a 66-basis point increase in 10-year U.S. Treasury Note yields during the nine-month period ending September 30, 2018. We do not currently intend to sell any of the securities in the tables above, nor will we be required to sell any of these securities. Considering these factors, and in accordance with our review of these securities under our OTTI policy, as described in Note 2. “Summary of Significant Accounting Policies” within Item 8. “Financial Statements and Supplementary Data.” of our 2017 Annual Report, we have concluded that they are temporarily impaired as we believe: (i) they will mature at par value; (ii) they have not incurred a credit impairment; and (iii) future values of these securities will fluctuate with changes in interest rates. 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.
 
(d) Fixed income securities at September 30, 2018, by contractual maturity, are shown below. Mortgage-backed securities are included in the maturity tables using the estimated average life of each security. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations, with or without call or prepayment penalties.
 
Listed below are the contractual maturities of fixed income securities at September 30, 2018:
 
 
AFS
 
HTM
($ in thousands)
 
Fair Value
 
Carrying Value
 
Fair Value
Due in one year or less
 
$
176,545

 
14,017

 
14,150

Due after one year through five years
 
2,107,663

 
20,518

 
21,926

Due after five years through 10 years
 
2,759,167

 
10,047

 
10,164

Due after 10 years
 
146,781

 

 

Total fixed income securities
 
$
5,190,156

 
44,582

 
46,240

  
(e) The following table summarizes our other investment portfolio by strategy:
Other Investments
 
September 30, 2018
 
December 31, 2017
($ in thousands)
 
Carrying Value
 
Remaining Commitment
 
Maximum Exposure to Loss1
 
Carrying Value
 
Remaining Commitment
 
Maximum Exposure to Loss1
Alternative Investments
 
 

 
 

 
 
 
 
 
 
 
 
   Private equity
 
$
75,508

 
99,346

 
174,854

 
52,251

 
99,026

 
151,277

   Private credit
 
37,525

 
85,747

 
123,272

 
37,743

 
94,959

 
132,702

   Real assets
 
25,214

 
33,088

 
58,302

 
25,379

 
27,014

 
52,393

Total alternative investments
 
138,247

 
218,181

 
356,428

 
115,373

 
220,999

 
336,372

Other securities
 
25,683

 

 
25,683

 
16,895

 

 
16,895

Total other investments
 
$
163,930

 
218,181

 
382,111

 
132,268

 
220,999

 
353,267

1The maximum exposure to loss includes both the carry value of these investments and the related unfunded commitments. In addition, tax credits that have been previously recognized in Other securities are subject to the risk of recapture, which we do not consider significant. 

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We do not have a future obligation to fund losses or debts on behalf of the investments above; however, we are contractually committed to make additional investments up to the remaining commitment outlined above. We have not provided any non-contractual financial support at any time during 2018 or 2017.

The following table sets forth gross summarized financial information for our other investments portfolio, including the portion not owned by us. The majority of these investments are carried under the equity method of accounting. The last line of the table below reflects our share of the aggregate income or loss, which is the portion included in our Financial Statements. As the majority of these investments report results to us on a one quarter lag, the summarized financial statement information for the three- and nine-month periods ended June 30 is included in our Third Quarter and Nine Months results. This information is as follows:
Income Statement Information
 
Quarter ended September 30,
 
Nine Months ended September 30,
($ in millions)
 
2018
 
2017
 
2018
 
2017
Net investment income (loss)
 
$
11.9


0.6

 
(29.9
)
 
(61.8
)
Realized gains (losses)
 
124.8


43.3

 
1,348.3

 
(261.0
)
Net change in unrealized appreciation
 
1,434.3


1,296.3

 
695.8

 
3,186.3

Net gain
 
$
1,571.0


1,340.2

 
2,014.2

 
2,863.5

Selective’s insurance subsidiaries’ alternative investments gain
 
$
7.1

 
2.7

 
10.6

 
9.5

 
(f) We have pledged certain AFS fixed income securities as collateral related to our relationships with the Federal Home Loan Bank of Indianapolis ("FHLBI") and the Federal Home Loan Bank of New York ("FHLBNY"). In addition, certain securities were on deposit with various state and regulatory agencies at September 30, 2018 to comply with insurance laws. We retain all rights regarding all securities pledged as collateral.

The following table summarizes the market value of these securities at September 30, 2018:
($ in millions)
 
FHLBI Collateral
 
FHLBNY Collateral
 
State and Regulatory Deposits
 
Total
U.S. government and government agencies
 
$

 

 
22.2

 
22.2

Obligations of states and political subdivisions
 

 

 
3.8

 
3.8

CMBS
 
7.2

 
9.4

 

 
16.6

RMBS
 
57.8

 
76.3

 

 
134.1

Total pledged as collateral
 
$
65.0

 
85.7

 
26.0


176.7

 
(g) We did not have exposure to any credit concentration risk of a single issuer greater than 10% of our stockholders' equity, other than certain U.S. government-backed investments, as of September 30, 2018 or December 31, 2017.

(h) The components of pre-tax net investment income earned were as follows:
 
 
Quarter ended September 30,
 
Nine Months ended September 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Fixed income securities
 
$
45,088


38,865

 
130,903

 
113,424

Equity securities
 
2,079


1,605

 
5,876

 
4,492

Short-term investments
 
867


396

 
2,001

 
1,023

Other investments
 
7,211


2,659

 
10,868

 
9,493

Investment expenses
 
(2,802
)

(3,079
)
 
(8,421
)
 
(9,137
)
Net investment income earned
 
$
52,443

 
40,446

 
141,227

 
119,295


(i) OTTI charges were $1.4 million and $0.1 million in Third Quarter 2018 and Third Quarter 2017, respectively, and $5.5 million and $4.8 million in Nine Months 2018 and Nine Months 2017, respectively. All of the OTTI charges in 2018 and a majority of the charges in 2017 were related to securities for which we had the intent to sell, with each security type's charge not exceeding 1% of its amortized cost. For a discussion of our evaluation for OTTI, refer to Note 2. "Summary of Significant Accounting Policies" in Item 8. "Financial Statements and Supplementary Data." of our 2017 Annual Report.


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(j) Net realized and unrealized gains and losses (excluding OTTI charges) for Third Quarter and Nine Months 2018 and 2017 included the following:
 
 
Quarter ended September 30,
 
Nine Months ended September 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Net realized (losses) gains on the disposals of securities:
 
 
 
 
 
 
 
 
Fixed income securities
 
$
(9,413
)
 
1,996

 
(13,922
)
 
6,566

Equity securities
 
8,665

 
4,875

 
17,960

 
5,225

Short-term investments
 
2

 

 
1

 

Other investments
 
(5
)
 

 
(5
)
 
461

Net realized gains on the disposal of securities
 
(751
)
 
6,871

 
4,034

 
12,252

OTTI charges
 
(1,426
)
 
(73
)
 
(5,459
)
 
(4,765
)
Net realized (losses) gains
 
(2,177
)
 
6,798

 
(1,425
)
 
7,487

Unrealized (losses) recognized in income on equity securities1
 
(2,610
)
 

 
(15,563
)
 

Total net realized and unrealized investment (losses) gains
 
$
(4,787
)
 
6,798

 
$
(16,988
)
 
7,487

1Includes unrealized holding gains (losses) of: (i) $5.5 million in Third Quarter 2018 and $4.2 million in Nine Months 2018 on equity securities remaining in our portfolio as of September 30, 2018; and (ii) $(8.1) million in Third Quarter 2018 and $(19.8) million in Nine Months 2018 on equity securities sold during the respective periods.

The components of net realized gains on disposals of securities for the periods indicated were as follows:
 
 
Quarter ended September 30,
 
Nine Months ended September 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
HTM fixed income securities
 
 
 
 
 
 
 
 
Gains
 
$

 

 
2

 
44

Losses
 

 

 

 
(1
)
AFS fixed income securities
 
 

 
 

 
 
 
 
Gains
 
462

 
2,070

 
5,056

 
8,337

Losses
 
(9,875
)
 
(74
)
 
(18,980
)
 
(1,814
)
Equity securities
 
 

 
 

 
 
 
 
Gains
 
10,584

 
4,875

 
20,209

 
5,225

Losses
 
(1,919
)
 

 
(2,249
)
 

Short-term investments
 
 
 
 
 
 
 
 
Gains
 
3

 

 
6

 
2

Losses
 
(1
)
 

 
(5
)
 
(2
)
Other investments
 
 
 
 
 
 
 
 
Gains
 

 

 

 
480

      Losses
 
(5
)


 
(5
)
 
(19
)
Total net realized gains (losses) on disposals of securities
 
$
(751
)

6,871

 
4,034

 
12,252


Realized gains and losses on the sale of investments are determined on the basis of the cost of the specific investments sold.
Proceeds from the sales of AFS fixed income securities were $444.4 million and $94.9 million in Third Quarter 2018 and Third Quarter 2017, respectively, and $1,382.7 million and $812.0 million in Nine Months 2018 and Nine Months 2017, respectively. Proceeds from the sales of equity securities were $36.1 million and $12.7 million in Third Quarter 2018 and Third Quarter 2017, respectively, and $79.7 million and $19.0 million in Nine Months 2018 and Nine Months 2017, respectively.

NOTE 5. Indebtedness
Our long-term debt balance has not changed materially since December 31, 2017. However, Selective Insurance Company of America ("SICA") borrowed the following short-term funds in the first quarter of 2018 from the FHLBNY:
On February 27, 2018, SICA borrowed $75 million at an interest rate of 1.75%. This borrowing was repaid on March 20, 2018; and
On March 28, 2018, SICA borrowed $55 million at an interest rate of 1.98%. This borrowing was repaid on April 18, 2018.

For detailed information on our indebtedness, see Note 10. "Indebtedness" in Item 8. "Financial Statements and Supplementary Data." of our 2017 Annual Report.

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NOTE 6. Fair Value Measurements
Our financial assets are measured at fair value as disclosed on the Consolidated Balance Sheets. The fair values of our long-term debt are provided in this footnote and the related carry values have changed by less than 1% during Nine Months 2018. For a discussion of the fair value and hierarchy of the techniques used to value our financial assets and liabilities, refer to Note 2. "Summary of Significant Accounting Policies" in Item 8. "Financial Statements and Supplementary Data." of our 2017 Annual Report.

The following tables provide quantitative disclosures of our financial assets that were measured and recorded at fair value at September 30, 2018 and December 31, 2017:
September 30, 2018
 
 
 
Fair Value Measurements Using
($ in thousands)
 
Assets
Measured at
Fair Value
 
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 fixed income securities:
 
 
 
 
 
 
 
 
U.S. government and government agencies
 
$
96,462

 
76,760

 
19,702

 

Foreign government
 
17,983

 

 
17,983

 

Obligations of states and political subdivisions
 
1,164,909

 

 
1,164,909

 

Corporate securities
 
1,649,653

 

 
1,649,653

 

CLO and other ABS
 
774,769

 

 
770,628

 
4,141

CMBS
 
489,549

 

 
489,549

 

RMBS
 
996,831

 

 
996,831

 

Total AFS fixed income securities
 
5,190,156

 
76,760

 
5,109,255

 
4,141

Equity securities:
 
 
 
 
 
 
 
 
Common stock2
 
154,845

 
124,445

 

 

Preferred stock
 
3,022

 
3,022

 

 

Total equity securities
 
157,867

 
127,467

 

 

Short-term investments
 
304,572

 
303,572

 
1,000

 

Total assets measured at fair value
 
$
5,652,595

 
507,799

 
5,110,255


4,141

December 31, 2017
 
 
 
Fair Value Measurements Using
($ in thousands)
 
Assets
Measured at
Fair Value
 
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 fixed income securities:
 
 
 
 
 
 
 
 
U.S. government and government agencies
 
$
49,740

 
24,652

 
25,088

 

Foreign government
 
18,555

 

 
18,555

 

Obligations of states and political subdivisions
 
1,582,970

 

 
1,582,970

 

Corporate securities
 
1,617,468

 

 
1,617,468

 

CLO and other ABS
 
795,458

 

 
795,458

 

CMBS
 
383,449

 

 
376,895

 
6,554

RMBS
 
714,882

 

 
714,882

 

Total AFS fixed income securities
 
5,162,522

 
24,652

 
5,131,316

 
6,554

AFS equity securities:
 
 
 
 
 
 
 
 
Common stock2
 
167,757

 
138,640

 

 
5,398

Preferred stock
 
14,948

 
14,948

 

 

Total AFS equity securities
 
182,705

 
153,588

 

 
5,398

Total AFS securities
 
5,345,227

 
178,240

 
5,131,316

 
11,952

Short-term investments
 
165,555

 
165,555

 

 

Total assets measured at fair value
 
$
5,510,782

 
343,795

 
5,131,316

 
11,952

1 
There were no transfers of securities between Level 1 and Level 2.
2 
Investments amounting to $30.4 million at September 30, 2018, and $23.7 million at December 31, 2017, were measured at fair value using net asset value per share (or its practical expedient) and have not been classified in the fair value hierarchy. The fair value amounts presented in this table are intended to permit reconciliation of the fair value hierarchy to total assets measured at fair value.

14

Table of Contents


There were no material changes in the fair value of securities measured using Level 3 prices in Nine Months 2017. The following table provides a summary of Level 3 changes in Nine Months 2018:
September 30, 2018
 
 
 
 
 
($ in thousands)
CMBS
 
Common Stock
 
CLO and Other ABS
Fair value, December 31, 2017
$
6,554

 
5,398

 

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

 

 

Net income

 

 

Purchases

 

 
4,141

Sales

 

 

Issuances

 

 

Settlements

 

 

Transfers into Level 3

 

 

Transfers out of Level 3
(6,554
)
 
(5,398
)
 

Fair value, September 30, 2018
$

 

 
4,141


The following tables provide quantitative information regarding our financial assets and liabilities that were disclosed at fair value at September 30, 2018 and December 31, 2017:
September 30, 2018
 
 
 
Fair Value Measurements Using
($ in thousands)
 
Assets/
Liabilities
Disclosed at
Fair Value
 
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:
 
 

 
 

 
 

 
 

Obligations of states and political subdivisions
 
$
22,396

 

 
22,396

 

Corporate securities
 
23,844

 

 
11,583

 
12,261

Total HTM fixed income securities
 
$
46,240

 

 
33,979

 
12,261

 
 
 
 
 
 
 
 
 
Financial Liabilities
 
 

 
 

 
 

 
 

Long-term debt:
 
 
 
 
 
 
 
 
7.25% Senior Notes
 
$
57,733

 

 
57,733

 

6.70% Senior Notes
 
106,760

 

 
106,760

 

5.875% Senior Notes
 
184,778

 
184,778

 

 

1.61% borrowings from FHLBNY
 
23,936

 

 
23,936

 

1.56% borrowings from FHLBNY
 
23,871

 

 
23,871

 

3.03% borrowings from FHLBI
 
57,795

 

 
57,795

 

Total long-term debt
 
$
454,873

 
184,778

 
270,095

 



15

Table of Contents

December 31, 2017
 
 
 
Fair Value Measurements Using
($ in thousands)
 
Assets/
Liabilities
Disclosed at
Fair Value
 
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:
 
 

 
 

 
 

 
 
Obligations of states and political subdivisions
 
$
26,261

 

 
26,261

 

Corporate securities
 
17,839

 

 
12,306

 
5,533

Total HTM fixed income securities
 
$
44,100

 

 
38,567

 
5,533

 
 
 
 
 
 
 
 
 
Financial Liabilities
 
 

 
 
 
 
 
 
Long-term debt:
 
 
 
 
 
 
 
 
7.25% Senior Notes
 
$
61,391

 

 
61,391

 

6.70% Senior Notes
 
116,597

 

 
116,597

 

5.875% Senior Notes
 
186,332

 
186,332

 

 

1.61% borrowings from FHLBNY
 
24,270

 

 
24,270

 

1.56% borrowings from FHLBNY
 
24,210

 

 
24,210

 

3.03% borrowings from FHLBI
 
60,334

 

 
60,334

 

Total long-term debt
 
$
473,134

 
186,332

 
286,802

 


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 2017 Annual Report.
 
 
Quarter ended September 30,
 
Nine Months ended September 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Premiums written:
 
 

 
 

 
 

 
 

Direct
 
$
752,834

 
706,918

 
$
2,220,431

 
2,097,146

Assumed
 
7,084

 
8,506

 
19,891

 
20,685

Ceded
 
(108,250
)
 
(111,147
)
 
(308,846
)
 
(301,036
)
Net
 
$
651,668

 
604,277

 
$
1,931,476

 
1,816,795

Premiums earned:
 
 

 
 

 
 

 
 

Direct
 
$
706,497

 
666,048

 
$
2,086,953

 
1,967,364

Assumed
 
6,484

 
7,623

 
19,220

 
19,465

Ceded
 
(98,704
)
 
(101,616
)
 
(295,232
)
 
(285,890
)
Net
 
$
614,277

 
572,055

 
$
1,810,941

 
1,700,939

Loss and loss expenses incurred:
 
 

 
 

 
 

 
 

Direct
 
$
477,427

 
455,728

 
$
1,289,357

 
1,187,400

Assumed
 
6,529

 
5,420

 
16,897

 
17,623

Ceded
 
(104,757
)
 
(116,561
)
 
(175,786
)
 
(201,405
)
Net
 
$
379,199

 
344,587

 
$
1,130,468

 
1,003,618


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:
Ceded to NFIP
 
Quarter ended September 30,
 
Nine Months ended September 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Ceded premiums written
 
$
(70,100
)
 
(68,132
)
 
$
(193,110
)
 
(188,274
)
Ceded premiums earned
 
(61,448
)
 
(59,847
)
 
(180,582
)
 
(174,779
)
Ceded loss and loss expenses incurred
 
(89,396
)
 
(112,994
)
 
(115,376
)
 
(134,675
)

16

Table of Contents


NOTE 8. Reserve for Loss and Loss Expense
The table below provides a roll forward of reserve for loss and loss expense balances:
 
 
Nine Months ended September 30,
($ in thousands)
 
2018
 
2017
Gross reserve for loss and loss expense, at beginning of year
 
$
3,771,240

 
3,691,719

Less: reinsurance recoverable on unpaid loss and loss expense, at beginning of year
 
585,855

 
611,200

Net reserve for loss and loss expense, at beginning of year
 
3,185,385

 
3,080,519

Incurred loss and loss expense for claims occurring in the:
 
 

 
 

Current year
 
1,148,032

 
1,037,079

Prior years
 
(17,564
)
 
(33,461
)
Total incurred loss and loss expense
 
1,130,468

 
1,003,618

Paid loss and loss expense for claims occurring in the:
 
 

 
 

Current year
 
369,036

 
314,686

Prior years
 
610,734

 
581,186

Total paid loss and loss expense
 
979,770

 
895,872

Net reserve for loss and loss expense, at end of period
 
3,336,083

 
3,188,265

Add: Reinsurance recoverable on unpaid loss and loss expense, at end of period
 
589,072

 
647,535

Gross reserve for loss and loss expense at end of period
 
$
3,925,155

 
3,835,800


The $111.0 million increase in current year loss and loss expense incurred illustrated in the table above was primarily driven by: (i) non-catastrophe property losses; (ii) an increase in current year loss costs on our commercial automobile line of business; and (iii) an increase in exposure due to premium growth. Non-catastrophe property losses, which increased $61.9 million, to $278.5 million, in Nine Months 2018, were partially related to the early January 2018 deep freeze in our footprint states and a relatively large number of fire losses over the course of the year.

Prior year development in Nine Months 2018 of $17.6 million included $24.0 million of favorable casualty development, partially offset by $6.4 million of unfavorable property development. The favorable casualty development included $53.0 million of development in our workers compensation line of business and $8.0 million in our general liability line of business, partially offset by unfavorable development of $25.0 million in our commercial automobile line of business and $12.0 million in our excess and surplus ("E&S") casualty lines.

Prior year development in Nine Months 2017 of $33.5 million was primarily driven by favorable prior year casualty reserve development of $48.3 million in our general liability line of business and $29.3 million in our workers compensation line of business. This was partially offset by unfavorable development of $26.0 million in our commercial automobile line of business, $10.0 million in our E&S segment, and $4.0 million in our personal automobile line of business.

For a discussion of the trends and recent developments impacting these lines, refer to the "Critical Accounting Policies and Estimates" section of Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations." in our 2017 Annual Report.

NOTE 9. Segment Information
The disaggregated results of our four reportable segments are used by senior management to manage our operations. These reportable segments are evaluated as follows:

Our Standard Commercial Lines, Standard Personal Lines, and E&S Lines are evaluated based on before and after-tax underwriting results (net premiums earned, incurred loss and loss expense, policyholder dividends, policy acquisition costs, and other underwriting expenses), and combined ratios.

Our Investments segment is evaluated based on after-tax net investment income and net realized gains and losses.

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


17

Table of Contents

The following summaries present revenues (net investment income and net realized and unrealized gains on investments in the case of the Investments segment) and pre-tax income for the individual segments:
Revenue by Segment
 
Quarter ended September 30,
 
Nine Months ended September 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Standard Commercial Lines:
 
 

 
 

 
 
 
 
Net premiums earned:
 
 

 
 

 
 
 
 
Commercial automobile
 
$
124,862

 
111,711

 
365,197

 
327,156

Workers compensation
 
78,784

 
77,580

 
237,628

 
236,366

General liability
 
154,974

 
141,059

 
457,805

 
422,546

Commercial property
 
83,056

 
78,151

 
245,544

 
232,594

Businessowners’ policies
 
25,994

 
25,019

 
77,414

 
74,853

Bonds
 
8,778

 
7,420

 
25,247

 
20,904

Other
 
4,608

 
4,310

 
13,597

 
12,839

Miscellaneous income
 
2,228

 
1,712

 
6,936

 
7,588

Total Standard Commercial Lines revenue
 
483,284

 
446,962

 
1,429,368

 
1,334,846

Standard Personal Lines:
 
 
 
 
 
 
 
 
Net premiums earned:
 
 
 
 
 
 
 
 
Personal automobile
 
42,772

 
38,612

 
125,024

 
113,225

Homeowners
 
32,293

 
32,215

 
96,717

 
97,382

Other
 
2,092

 
1,774

 
5,349

 
4,867

Miscellaneous income
 
310

 
282

 
959

 
938

Total Standard Personal Lines revenue
 
77,467

 
72,883

 
228,049

 
216,412

E&S Lines:
 
 
 
 
 
 
 
 
Net premiums earned:
 
 
 
 
 
 
 
 
Casualty lines
 
42,179

 
40,090

 
120,098

 
117,056

Property lines
 
13,885

 
14,114

 
41,321

 
41,151

Miscellaneous income
 

 

 
1

 

Total E&S Lines revenue
 
56,064

 
54,204

 
161,420

 
158,207

Investments:
 
 

 
 

 
 

 
 

Net investment income
 
52,443

 
40,446

 
141,227

 
119,295

Net realized and unrealized investment (losses) gains
 
(4,787
)
 
6,798

 
(16,988
)
 
7,487

Total Investments revenue
 
47,656

 
47,244

 
124,239

 
126,782

Total revenues
 
$
664,471

 
621,293

 
1,943,076

 
1,836,247

Income Before and After Federal Income Tax
 
Quarter ended September 30,
 
Nine Months ended September 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Standard Commercial Lines:
 
 

 
 

 
 
 
 
Underwriting gain, before federal income tax
 
$
26,333

 
35,329

 
74,153

 
112,634

Underwriting gain, after federal income tax
 
20,803

 
22,964

 
58,581

 
73,212

Combined ratio
 
94.5
%
 
92.1

 
94.8

 
91.5

 
 
 
 


 


 


Standard Personal Lines:
 
 
 
 
 
 
 
 
Underwriting gain, before federal income tax
 
$
3,158

 
8,179

 
6,457

 
7,517

Underwriting gain, after federal income tax
 
2,495

 
5,316

 
5,101

 
4,886

Combined ratio
 
95.9
%
 
88.7

 
97.2

 
96.5

 
 
 
 
 
 
 
 
 
E&S Lines:
 
 
 
 
 
 
 
 
Underwriting gain (loss), before federal income tax
 
$
3,506

 
(11,063
)
 
(4,848
)
 
(8,174
)
Underwriting gain (loss), after federal income tax
 
2,770

 
(7,191
)
 
(3,830
)
 
(5,313
)
Combined ratio
 
93.7
%
 
120.4

 
103.0

 
105.2

 
 
 
 
 
 
 
 
 
Investments:
 
 

 
 

 
 
 
 
Net investment income
 
$
52,443

 
40,446

 
141,227

 
119,295

Net realized and unrealized investment (losses) gains
 
(4,787
)
 
6,798

 
(16,988
)
 
7,487

Total investment income, before federal income tax
 
47,656

 
47,244

 
124,239

 
126,782

Tax on investment income
 
8,562

 
13,236

 
21,405

 
34,572

      Total investment income, after federal income tax

$
39,094


34,008

 
102,834

 
92,210


18

Table of Contents

Reconciliation of Segment Results to Income Before Federal Income Tax
 
Quarter ended September 30,
 
Nine Months ended September 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Underwriting gain (loss)
 
 
 
 
 
 
 
 
Standard Commercial Lines
 
$
26,333

 
35,329

 
74,153

 
112,634

Standard Personal Lines
 
3,158

 
8,179

 
6,457

 
7,517

E&S Lines
 
3,506

 
(11,063
)
 
(4,848
)
 
(8,174
)
Investment income
 
47,656

 
47,244

 
124,239

 
126,782

Total all segments
 
80,653

 
79,689

 
200,001

 
238,759

Interest expense
 
(6,073
)
 
(6,085
)
 
(18,350
)
 
(18,272
)
Corporate expenses
 
(7,450
)
 
(6,289
)
 
(22,065
)
 
(26,669
)
Income, before federal income tax
 
$
67,130

 
67,315


159,586

 
193,818


NOTE 10. Retirement Plans
SICA's primary pension plan is the Retirement Income Plan for Selective Insurance Company of America (the “Pension Plan”). SICA also sponsors the Supplemental Excess Retirement Plan (the “Excess Plan”) and a life insurance benefit plan. All plans are closed to new entrants and benefits ceased accruing under the Pension Plan and the Excess Plan after March 31, 2016. For more information concerning SICA's retirement plans, refer to Note 14. “Retirement Plans” in Item 8. “Financial Statements and Supplementary Data.” of our 2017 Annual Report.

The following tables provide information regarding the Pension Plan:
 
 
Pension Plan
 
Pension Plan
 
 
Quarter ended September 30,
 
Nine Months ended September 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Net Periodic Benefit Cost:
 
 
 
 
 
 
 
 
Interest cost
 
$
3,095

 
3,111

 
9,285

 
9,332

Expected return on plan assets
 
(5,681
)
 
(4,854
)
 
(17,044
)
 
(14,563
)
Amortization of unrecognized net actuarial loss
 
494

 
481

 
1,481

 
1,444

Total net periodic benefit cost1
 
$
(2,092
)
 
(1,262
)
 
(6,278
)
 
(3,787
)
1 The components of net periodic benefit cost are included within "Loss and loss expense incurred" and "Other insurance expenses" on the Consolidated Statements of Income.

 
 
Pension Plan
 
 
Nine Months ended September 30,
 
 
2018
 
2017
Weighted-Average Expense Assumptions:
 
 
 
 
Discount rate
 
3.78
%
 
4.41
%
Effective interest rate for calculation of interest cost
 
3.46

 
3.83

Expected return on plan assets
 
6.36

 
6.24



19

Table of Contents

NOTE 11. Comprehensive Income
The components of comprehensive income, both gross and net of tax, for Third Quarter and Nine Months 2018 and 2017 are as follows:
Third Quarter 2018
 
 
 
 
 
 
($ in thousands)
 
Gross
 
Tax
 
Net
Net income
 
$
67,130

 
11,695

 
55,435

Components of other comprehensive loss:
 
 

 
 

 
 

Unrealized losses on investment securities:
 
 

 
 

 
 

Unrealized holding losses during period
 
(21,565
)
 
(4,529
)
 
(17,036
)
Amounts reclassified into net income:
 
 
 
 
 
 
HTM securities
 
(8
)
 
(2
)
 
(6
)
Realized losses on disposals of AFS securities
 
10,839

 
2,276

 
8,563

    Total unrealized losses on investment securities
 
(10,734
)
 
(2,255
)
 
(8,479
)
Defined benefit pension and post-retirement plans:
 
 

 
 

 
 

Amounts reclassified into net income:
 
 

 
 

 
 

Net actuarial loss
 
532

 
112

 
420

    Total defined benefit pension and post-retirement plans
 
532

 
112

 
420

Other comprehensive loss
 
(10,202
)
 
(2,143
)
 
(8,059
)
Comprehensive income
 
$
56,928

 
9,552

 
47,376

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Third Quarter 2017
 
 
 
 
 
 
($ in thousands)
 
Gross
 
Tax
 
Net
Net income
 
$
67,315

 
20,597

 
46,718

Components of OCI:
 
 

 
 

 
 

Unrealized gains on investment securities:
 
 

 
 

 
 

Unrealized holding gains during period
 
16,729

 
5,855

 
10,874

Non-credit portion of OTTI recognized in OCI
 
30

 
11

 
19

Amounts reclassified into net income:
 
 
 
 
 
 
HTM securities
 
(54
)
 
(19
)
 
(35
)
Non-credit OTTI
 
38

 
13

 
25

Realized gains on disposals of AFS securities
 
(6,760
)
 
(2,366
)
 
(4,394
)
    Total unrealized gains on investment securities
 
9,983

 
3,494

 
6,489

Defined benefit pension and post-retirement plans:
 
 

 
 

 
 

Amounts reclassified into net income:
 
 

 
 

 
 

Net actuarial loss
 
507

 
178

 
329

    Total defined benefit pension and post-retirement plans
 
507

 
178

 
329

Other comprehensive income
 
10,490

 
3,672

 
6,818

Comprehensive income
 
$
77,805

 
24,269

 
53,536


20

Table of Contents

Nine Months 2018
 
 
 
 
 
 
($ in thousands)
 
Gross
 
Tax
 
Net
Net income
 
$
159,586

 
26,407

 
133,179

Components of other comprehensive loss:
 
 

 
 

 
 

Unrealized losses on investment securities:
 
 

 
 

 
 

Unrealized holding losses during period
 
(130,873
)
 
(27,484
)
 
(103,389
)
Amounts reclassified into net income:
 
 
 
 
 
 
HTM securities
 
(28
)
 
(6
)
 
(22
)
Realized losses on disposals of AFS securities
 
18,258

 
3,834

 
14,424

    Total unrealized losses on investment securities
 
(112,643
)
 
(23,656
)
 
(88,987
)
Defined benefit pension and post-retirement plans:
 
 

 
 

 
 

Amounts reclassified into net income:
 
 

 
 
 
 
Net actuarial loss
 
1,595

 
335

 
1,260

    Total defined benefit pension and post-retirement plans
 
1,595

 
335

 
1,260

Other comprehensive loss
 
(111,048
)
 
(23,321
)
 
(87,727
)
Comprehensive income
 
$
48,538

 
3,086

 
45,452

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months 2017
 
 
 
 
 
 
($ in thousands)
 
Gross
 
Tax
 
Net
Net income
 
$
193,818

 
55,234

 
138,584

Components of OCI:
 
 

 
 
 
 
Unrealized gains on investment securities:
 
 

 
 
 
 
Unrealized holding gains during period
 
78,401

 
27,440

 
50,961

Non-credit portion of OTTI recognized in OCI
 
36

 
13

 
23

Amounts reclassified into net income:
 
 
 
 
 
 
HTM securities
 
(146
)
 
(51
)
 
(95
)
Non-credit OTTI
 
38

 
13

 
25

Realized gains on disposals of AFS securities
 
(7,135
)
 
(2,497
)
 
(4,638
)
    Total unrealized gains on investment securities
 
71,194

 
24,918

 
46,276

Defined benefit pension and post-retirement plans:
 
 

 
 

 
 

Amounts reclassified into net income:
 
 

 
 
 
 
Net actuarial loss
 
1,522

 
533

 
989

    Total defined benefit pension and post-retirement plans
 
1,522

 
533

 
989

Other comprehensive income
 
72,716

 
25,451

 
47,265

Comprehensive income
 
$
266,534

 
80,685

 
185,849


The balances of, and changes in, each component of AOCI (net of taxes) as of September 30, 2018 were as follows:
September 30, 2018
 
 
 
Defined Benefit
Pension and Post-Retirement Plans
 
 
 
 
Net Unrealized Gains (Losses) on Investment Securities
 
 
Total AOCI
($ in thousands)
 
OTTI
Related
 
HTM
Related
 
All
Other
 
Investments
Subtotal
 
 
Balance, December 31, 2017
 
$
(59
)
 
(14
)
 
80,648

 
80,575

 
(60,405
)
 
20,170

Cumulative effect adjustments
 
(12
)
 
(2
)
 
(12,792
)
 
(12,806
)
 
(12,213
)
 
(25,019
)
Balance, December 31, 2017 as adjusted
 
(71
)
 
(16
)
 
67,856

 
67,769

 
(72,618
)
 
(4,849
)
OCI before reclassifications
 

 

 
(103,389
)
 
(103,389
)
 

 
(103,389
)
Amounts reclassified from AOCI
 

 
(22
)
 
14,424

 
14,402

 
1,260

 
15,662

Net current period OCI
 

 
(22
)
 
(88,965
)
 
(88,987
)
 
1,260

 
(87,727
)
Balance, September 30, 2018
 
$
(71
)
 
(38
)
 
(21,109
)
 
(21,218
)
 
(71,358
)
 
(92,576
)


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The reclassifications out of AOCI were as follows:
 
Quarter ended September 30,
 
Nine Months ended September 30,
Affected Line Item in the Unaudited Consolidated Statements of Income
($ in thousands)
2018
 
2017
 
2018
 
2017
OTTI related
 
 
 
 
 
 
 
 
Non-credit OTTI on disposed securities
$

 
38

 

 
38

Net realized and unrealized (losses) gains
 

 
38

 

 
38

Income before federal income tax
 

 
(13
)
 

 
(13
)
Total federal income tax expense
 

 
25

 

 
25

Net income
HTM related
 
 
 
 
 
 
 
 
Unrealized losses on HTM disposals
$
11

 
11

 
5

 
41

Net realized and unrealized (losses) gains
Amortization of net unrealized gains on HTM securities
(19
)
 
(65
)
 
(33
)
 
(187
)
Net investment income earned
 
(8
)
 
(54
)
 
(28
)
 
(146
)
Income before federal income tax
 
2

 
19

 
6

 
51

Total federal income tax expense
 
(6
)
 
(35
)
 
(22
)
 
(95
)
Net income
Realized losses (gains) on AFS and OTTI
 
 
 
 
 
 
 
 
Realized losses (gains) on AFS disposals and OTTI
10,839

 
(6,760
)
 
18,258

 
(7,135
)
Net realized and unrealized (losses) gains
 
10,839

 
(6,760
)
 
18,258

 
(7,135
)
Income before federal income tax
 
(2,276
)
 
2,366

 
(3,834
)
 
2,497

Total federal income tax expense
 
8,563

 
(4,394
)
 
14,424

 
(4,638
)
Net income
Defined benefit pension and post-retirement life plans
 
 
 
 
 
 
 
 
Net actuarial loss
112

 
110

 
337

 
331

Loss and loss expense incurred
 
420

 
397

 
1,258

 
1,191

Other insurance expenses
Total defined benefit pension and post-retirement life
532

 
507

 
1,595

 
1,522

Income before federal income tax
 
(112
)
 
(178
)
 
(335
)
 
(533
)
Total federal income tax expense
 
420

 
329

 
1,260

 
989

Net income
 
 
 
 
 
 
 
 
 
Total reclassifications for the period
$
8,977

 
(4,075
)
 
15,662

 
(3,719
)
Net income

NOTE 12. Federal Income Taxes
(a) On December 22, 2017, Tax Reform was signed into law, which among other implications, reduced our statutory corporate tax rate from 35% to 21% beginning with our 2018 tax year.

We continue to provide provisional amounts for loss reserve discounting because the Internal Revenue Service ("IRS") has not yet issued guidance with regard to the discount rates to be used under Tax Reform. For additional information, refer to Note 13. "Federal Income Taxes" in Item 8. "Financial Statements and Supplementary Data." of our 2017 Annual Report.
  
We will continue to monitor IRS guidance to complete the analysis of loss reserve discounting.

(b) A reconciliation of federal income tax on income at the corporate rate to the effective tax rate is as follows:
 
 
Quarter ended September 30,
 
Nine Months ended September 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Statutory tax rate
 
21
%
 
35

 
21

 
35

Tax at statutory rate
 
$
14,097

 
23,560

 
33,513

 
67,836

Tax-advantaged interest
 
(1,338
)
 
(2,915
)
 
(4,242
)
 
(8,479
)
Dividends received deduction
 
(107
)
 
(382
)
 
(443
)
 
(1,338
)
Stock-based compensation
 
(415
)
 
(86
)
 
(2,963
)
 
(3,409
)
Other
 
(542
)
 
420

 
542

 
624

Federal income tax expense
 
$
11,695

 
20,597

 
26,407

 
55,234




22

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 ten insurance subsidiaries ("Insurance Subsidiaries") as either: (i) liability insurers defending or providing indemnity for third-party claims brought against our customers; or (ii) 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 any potential ultimate liability in such ordinary course claims litigation will not be material to our consolidated financial condition, results of operations, or cash flows after consideration of provisions made for potential losses and costs of defense.
 
From time to time, our Insurance Subsidiaries also are named as defendants 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. Similarly, our Insurance Subsidiaries are also named from time-to-time in individual actions seeking extra-contractual damages, punitive damages, or penalties, some of which allege bad faith in the handling of insurance claims. We believe that we have valid defenses to these cases. We expect that any potential ultimate liability in any such lawsuit will not be material to our consolidated financial condition, after consideration of provisions made for estimated losses. Nonetheless, given the inherent unpredictability of litigation and the large or indeterminate amounts sought in certain of these actions, an adverse outcome in certain matters could possibly have a material adverse effect on our consolidated results of operations or cash flows in particular quarterly or annual periods.

As of September 30, 2018, we do not believe the Company was involved in any legal action that could have a material adverse effect on our consolidated financial condition, results of operations, or cash flows.

NOTE 14. Subsequent Events
Hurricane Michael made landfall on October 10, 2018 in the Florida Panhandle as a powerful Category 4 hurricane and continued into Georgia and other southeastern states. While relatively early given the complexity of losses involved, we currently estimate our losses from this event to be approximately $10 million.

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

Forward-Looking Statements
As used herein, the "Company," "we," "us," or "our" refers to Selective Insurance Group, Inc. (the "Parent"), and its subsidiaries, except as expressly indicated or unless the context otherwise requires. 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
The Parent, through its ten insurance subsidiaries, collectively referred to as the "Insurance Subsidiaries," offers property and casualty insurance products in the standard and excess and surplus ("E&S") marketplaces. We classify our business into four reportable segments, which are as follows:

Standard Commercial Lines;
Standard Personal Lines;
E&S Lines; and
Investments.


23

Table of Contents

For further details regarding these segments, refer to Note 9. "Segment Information" in Item 1. "Financial Statements." of this Form 10-Q and Note 11. "Segment Information" in Item 8. "Financial Statements and Supplementary Data." of our Annual Report on Form 10-K for the year ended December 31, 2017 ("2017 Annual Report").

Our Standard Commercial and Standard Personal Lines products and services are written through nine of our Insurance Subsidiaries, some of which write flood business through the Write Your Own ("WYO") program of the National Flood Insurance Program ("NFIP"). Our E&S products and services are written through one subsidiary, Mesa Underwriters Specialty Insurance Company ("MUSIC"). This subsidiary provides us with a nationally-authorized non-admitted platform to offer insurance products and services to customers who have not obtained coverage in the standard marketplace.
The following is Management’s Discussion and Analysis (“MD&A”) of the consolidated results of operations and financial condition, as well as known trends and uncertainties, that may have a material impact in future periods. Consequently, investors should read the MD&A in conjunction with Item 1. "Financial Statements." of this Form 10-Q and the consolidated financial statements in our 2017 Annual Report filed with the U.S. Securities and Exchange Commission.
In the MD&A, we will discuss and analyze the following:
Critical Accounting Policies and Estimates;
Financial Highlights of Results for the third quarters ended September 30, 2018 (“Third Quarter 2018”) and September 30, 2017 (“Third Quarter 2017”) and the nine-month periods ended September 30, 2018 ("Nine Months 2018") and September 30, 2017 ("Nine Months 2017");
Results of Operations and Related Information by Segment;
Federal Income Taxes;
Financial Condition, Liquidity, and Capital Resources;
Ratings;
Off-Balance Sheet Arrangements; and
Contractual Obligations, Contingent Liabilities, and Commitments.

Critical Accounting Policies and Estimates
Our 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 that were most critical to the preparation of the consolidated financial statements involved the following: (i) reserves for loss and loss expense; (ii) pension and post-retirement benefit plan actuarial assumptions; (iii) investment valuation and other-than-temporary-impairments ("OTTI"); and (iv) 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 pages 36 through 44 of our 2017 Annual Report.
 

24

Table of Contents

Financial Highlights of Results for Third Quarter and Nine Months 2018 and Third Quarter and Nine Months 20171 
($ and shares in thousands, except per share amounts)
 
Quarter ended September 30,
 
Change
% or Points
 
 
Nine Months ended September 30,
 
Change
% or Points
 
 
2018
 
2017
 
 
 
2018
 
2017
 
 
Revenues
 
$
664,471

 
621,293

 
7

%
 
$
1,943,076

 
1,836,247

 
6

%
After-tax net investment income
 
42,875

 
29,590

 
45

 
 
116,254

 
87,344

 
33

 
After-tax underwriting income
 
26,068

 
21,089

 
24

 
 
59,852

 
72,785

 
(18
)
 
Net income before federal income tax
 
67,130

 
67,315

 

 
 
159,586

 
193,818

 
(18
)
 
Net income
 
55,435

 
46,718

 
19

 
 
133,179

 
138,584

 
(4
)
 
Diluted net income per share
 
0.93

 
0.79

 
18

 
 
2.23

 
2.34

 
(5
)
 
Diluted weighted-average outstanding shares
 
59,711

 
59,323

 
1

 
 
59,626

 
59,232

 
1

 
Combined ratio
 
94.6
%
 
94.3

 
0.3

pts 
 
95.8
%
 
93.4

 
2.4

pts 
Invested assets per dollar of stockholders' equity
 
$
3.37

 
3.36

 

%
 
$
3.37

 
3.36

 

%
After-tax yield on investments
 
3.0
%
 
2.1

 
0.9

pts
 
2.7
%
 
2.1

 
0.6

pts
Annualized return on average equity ("ROE")
 
12.9

 
11.2

 
1.7

 
 
10.3

 
11.4

 
(1.1
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-Generally Accepted Accounting Principles ("GAAP") operating income2
 
$
59,216

 
42,300

 
40

%
 
$
146,599

 
133,718

 
10

%
Diluted non-GAAP operating income per share2
 
0.99

 
0.72

 
38

 
 
2.46

 
2.26

 
9

 
Annualized non-GAAP operating ROE2
 
13.8
%
 
10.1

 
3.7

pts 
 
11.3
%
 
11.0

 
0.3

pts 
1 
Refer to the Glossary of Terms attached to our 2017 Annual Report as Exhibit 99.1 for definitions of terms used in this Form 10-Q.
2 
Non-GAAP operating income is used as an important financial measure by us, analysts, and investors, because the realization of investment gains and losses on sales of securities in any given period is largely discretionary as to timing. In addition, these net realized investment gains and losses, as well as OTTI that are charged to earnings, and unrealized gains and losses on equity securities, could distort the analysis of trends.

Reconciliations of net income, net income per share, and annualized ROE to non-GAAP operating income, non-GAAP operating income per share, and annualized non-GAAP operating ROE, respectively, are provided in the tables below:
Reconciliation of net income to non-GAAP operating income
 
Quarter ended September 30,
 
Nine Months ended September 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Net income
 
$
55,435

 
46,718

 
133,179

 
138,584

 
 
 
 
 
 
 
 
 
Net realized and unrealized losses (gains), before tax
 
4,787

 
(6,798
)
 
16,988

 
(7,487
)
Tax on net realized and unrealized losses (gains)
 
(1,006
)
 
2,380

 
(3,568
)
 
2,621

Net realized and unrealized losses (gains)
 
3,781

 
(4,418
)
 
13,420

 
(4,866
)
 
 
 
 
 
 
 
 
 
Non-GAAP operating income
 
$
59,216

 
42,300

 
146,599

 
133,718

Reconciliation of net income per share to non-GAAP operating income per share
 
Quarter ended September 30,
 
Nine Months ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Diluted net income per share
 
$
0.93

 
0.79

 
2.23

 
2.34

 
 
 
 
 
 
 
 
 
Net realized and unrealized losses (gains), before tax
 
0.08

 
(0.11
)
 
0.28

 
(0.13
)
Tax on net realized and unrealized losses (gains)
 
(0.02
)
 
0.04

 
(0.05
)
 
0.05

Net realized and unrealized losses (gains)
 
0.06

 
(0.07
)
 
0.23

 
(0.08
)
 
 
 
 
 
 
 
 
 
Diluted non-GAAP operating income per share
 
$
0.99

 
0.72

 
2.46

 
2.26

Reconciliation of annualized ROE to annualized non-GAAP operating ROE
 
Quarter ended September 30,
 
Nine Months ended September 30,
 
2018
 
2017
 
2018
 
2017
Annualized ROE
 
12.9
 %
 
11.2

 
10.3

 
11.4

 
 
 
 
 
 
 
 
 
Net realized and unrealized losses (gains), before tax
 
1.1

 
(1.6
)
 
1.3

 
(0.6
)
Tax on net realized and unrealized losses (gains)
 
(0.2
)
 
0.5

 
(0.3
)
 
0.2

Net realized and unrealized losses (gains)
 
0.9

 
(1.1
)
 
1.0

 
(0.4
)
 
 
 
 
 
 
 
 
 
Annualized non-GAAP operating ROE
 
13.8
 %
 
10.1

 
11.3

 
11.0



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Table of Contents

The components of our annualized ROE are as follows:
Annualized ROE Components
 
Quarter ended September 30,
 
Change Points
 
Nine Months ended September 30,
 
Change Points
 
 
2018
 
2017
 
 
2018
 
2017
 
Standard Commercial Lines Segment
 
4.9
 %
 
5.4

 
(0.5
)
 
4.5

 
6.0

 
(1.5
)
Standard Personal Lines Segment
 
0.6

 
1.3

 
(0.7
)
 
0.4

 
0.4

 

E&S Lines Segment
 
0.6

 
(1.7
)
 
2.3

 
(0.3
)
 
(0.4
)
 
0.1

Total Insurance operations
 
6.1

 
5.0

 
1.1

 
4.6

 
6.0

 
(1.4
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Investment income
 
10.0

 
7.1

 
2.9

 
9.0

 
7.2

 
1.8

Net realized and unrealized (losses) gains
 
(0.9
)
 
1.1

 
(2.0
)
 
(1.0
)
 
0.4

 
(1.4
)
Total Investments segment
 
9.1

 
8.2

 
0.9

 
8.0

 
7.6

 
0.4

 
 
 
 
 
 
 
 
 
 
 
 
 
Other
 
(2.3
)
 
(2.0
)
 
(0.3
)
 
(2.3
)
 
(2.2
)
 
(0.1
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Annualized ROE
 
12.9
 %
 
11.2

 
1.7

 
10.3

 
11.4

 
(1.1
)
                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
Insurance Operations
Our insurance operations' ROE improved by 1.1 points for the quarter, primarily reflecting the lower corporate tax rate provided under the Tax Cuts and Jobs Act of 2017 (“Tax Reform”). Our pre-tax profitability in our overall insurance operations remained consistent with last year, with a combined ratio of 94.6% in Third Quarter 2018 compared to 94.3% in Third Quarter 2017. Despite the benefits from Tax Reform, the insurance operations' non-GAAP operating ROE declined 1.4 points for Nine Months 2018 compared to Nine Months 2017, reflecting an increase in our combined ratio to 95.8% in Nine Months 2018, compared to 93.4% in Nine Months 2017, principally driven by a higher level of non-catastrophe property losses and a lower level of favorable prior year casualty reserve development.

The following table provides quantitative information for analyzing the combined ratio:
All Lines
 
Quarter ended September 30,
 
Change % or Points
 
 
Nine Months ended September 30,
 
Change % or Points
 
($ in thousands)
 
2018
 
2017
 
 
 
2018
 
2017
 
 
Insurance Operations Results:
 
 
 
 
 
 
 
 
 
 
 
 
Net premiums written ("NPW")
 
$
651,668

 
604,277

 
8

%
 
$
1,931,476

 
1,816,795

 
6

%
Net premiums earned (“NPE”)
 
614,277

 
572,055

 
7

 
 
1,810,941

 
1,700,939

 
6

 
Less:
 
 
 
 

 
 
 
 
 
 
 
 
 
 
Loss and loss expense incurred
 
379,199

 
344,587

 
10

 
 
1,130,468

 
1,003,618

 
13

 
Net underwriting expenses incurred
 
199,791

 
193,975

 
3

 
 
598,437

 
582,469

 
3

 
Dividends to policyholders
 
2,290

 
1,048

 
119

 
 
6,274

 
2,875

 
118

 
Underwriting income
 
$
32,997

 
32,445

 
2

%
 
$
75,762

 
111,977

 
(32
)
%
Combined Ratios:
 
 
 
 

 
 
 
 
 
 
 
 
 
 
Loss and loss expense ratio
 
61.7

%
60.2

 
1.5

pts 
 
62.5

%
59.0

 
3.5

pts 
Underwriting expense ratio
 
32.5

 
33.9

 
(1.4
)
 
 
33.0

 
34.2

 
(1.2
)
 
Dividends to policyholders ratio
 
0.4

 
0.2

 
0.2

 
 
0.3

 
0.2

 
0.1

 
Combined ratio
 
94.6

 
94.3

 
0.3

 
 
95.8

 
93.4

 
2.4

 

Our Third Quarter and Nine Months 2018 results continue to reflect our efforts to: (i) achieve meaningful overall renewal rate level increases at levels that we believe exceed expected loss cost inflation; (ii) generate new business; and (iii) improve the underlying profitability of our business through various underwriting and claims initiatives. Our NPW growth of 8% for Third Quarter 2018 and 6% for Nine Months 2018, compared to the prior year periods, was aided by the net appointment of 76 retail agents in Nine Months 2018 and 109 retail agents in 2017, excluding agency consolidations. Included in these net appointments were 38 agents appointed in our new states of Arizona, New Hampshire, and Colorado.


26

Table of Contents

Loss and Loss Expenses
The loss and loss expense ratio increased 1.5 points in Third Quarter 2018 and 3.5 points in Nine Months 2018 compared to the same prior year periods, driven by the following:
 
Third Quarter 2018
 
Third Quarter 2017
 
 
($ 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 losses1
$
28.1

4.6

pts
 
$
23.7

4.1

pts
0.5

pts
(Favorable) prior year casualty reserve development
(12.0
)
(2.0
)
 
 
(9.9
)
(1.7
)
 
(0.3
)
 
Non-catastrophe property losses
89.8

14.6

 
 
71.8

12.6

 
2.0

 
Total
105.9

17.2

 
 
85.6

15.0

 
2.2

 
1Included in these catastrophe losses were $15.0 million, or 2.4 combined ratio points, in Third Quarter 2018 related to Hurricane Florence and $14.4 million, or 2.5 combined ratio points, in Third Quarter 2017 related to Hurricanes Harvey and Irma.
 
 
 
 
 
 
 
 
 
 
 
Nine Months 2018
 
Nine Months 2017
 
 
($ 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
$
72.9

4.0

pts
 
$
65.3

3.8

pts
0.2

pts
(Favorable) prior year casualty reserve development
(24.0
)
(1.3
)
 
 
(38.6
)
(2.3
)
 
1.0

 
Non-catastrophe property losses
278.5

15.4

 
 
216.5

12.7

 
2.7

 
Total
327.4

18.1

 
 
243.2

14.2

 
3.9

 

Details of the prior year casualty reserve development were as follows:
(Favorable)/Unfavorable Prior Year Casualty Reserve Development
Quarter ended September 30,
 
Nine Months ended September 30,
($ in millions)
2018
 
2017
 
2018
 
2017
General liability
$
(8.0
)
 
(10.9
)
 
(8.0
)
 
(48.3
)
Commercial automobile
10.0

 
5.0

 
25.0

 
26.0

Workers compensation
(20.0
)
 
(14.0
)
 
(53.0
)
 
(29.3
)
Bonds

 

 

 
(2.0
)
   Total Standard Commercial Lines
(18.0
)
 
(19.9
)
 
(36.0
)
 
(53.6
)
 
 
 
 
 
 
 
 
Homeowners

 

 

 
1.0

Personal automobile

 

 

 
4.0

   Total Standard Personal Lines

 

 

 
5.0

 
 
 
 
 
 
 
 
E&S
6.0

 
10.0

 
12.0

 
10.0

 
 
 
 
 
 
 
 
Total (favorable) prior year casualty reserve development
$
(12.0
)
 
(9.9
)
 
(24.0
)
 
(38.6
)
 
 
 
 
 
 
 
 
(Favorable) impact on loss ratio
(2.0
)
pts
(1.7
)
 
(1.3
)
 
(2.3
)

As illustrated in the table above, we have seen the most significant favorable prior year casualty reserve development in our workers compensation and general liability lines of business and the most significant unfavorable prior year casualty reserve development in our commercial automobile and E&S lines of business. The following provides some qualitative discussion around the actions we have taken regarding these lines of business:

Workers Compensation
We continue to execute on various claims process enhancements and underwriting initiatives to improve our mix of business based on expected profitability. Our workers compensation book of business, which represents approximately 16% of our Standard Commercial Lines business, continues to benefit from: (i) claims initiatives, such as reducing workers compensation medical costs through more favorable Preferred Provider Organization ("PPO") contracts and greater PPO penetration; (ii) better outcomes driven by our workers compensation strategic case unit; and (iii) an improved mix of business in this line that shifts towards lower hazard and smaller accounts from higher hazard and larger accounts. In addition, this line has benefited in recent years from lower than anticipated medical inflation. For a full discussion of the claims initiatives we have deployed, refer to the “Reserves for Loss and Loss Expense” section within Critical Accounting Policies and Estimates in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” of our 2017 Annual Report.

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Table of Contents


Commercial Automobile
Our commercial automobile line of business has been unprofitable in recent years and remains a significant area of focus for both the industry and us, as we continue to drive various initiatives to improve profitability in this line of business. For Third Quarter and Nine Months 2018, we recorded unfavorable prior year casualty reserve development of $10 million and $25 million, respectively, on this line, mainly for accident years 2016 and 2017. The industry-wide statutory combined ratio for 2018 is expected to average approximately 114%, and our combined ratio was 118.2% for Third Quarter 2018 and 112.8% for Nine Months 2018. We achieved renewal pure price increases on this line of 7.5% in Third Quarter 2018 and 7.4% in Nine Months 2018. We expect on-going industry-wide profitability issues to drive new and renewal pricing higher for this line of business. We have also been managing our commercial automobile in-force book of business in targeted industry segments, and reducing our relative exposure in higher hazard classes to improve the underlying profitability of this business.

General Liability
Our general liability line continues to be a profitable book of business for us. This business includes a diverse set of exposures, and therefore can be influenced by a variety of factors. In recent years, we have been favorably impacted by decreasing frequencies and relatively benign severity trends within this line, although this favorable development has moderated in Nine Months 2018, with the $8 million of development being reflective of favorable development on loss adjustment expenses.

E&S
Our E&S segment continues to perform below our target level and remains an area of focus for us as we continue to experience unfavorable development on prior accident years. We have been taking steps to address profitability in this segment through targeted price increases, shifts in business mix, and improved underwriting standards. We believe our current in-force book of business is priced adequately and is positioned well for future profitability.

For additional qualitative discussions regarding reserve development, please refer to the insurance segment sections below in "Results of Operations and Related Information by Segment."

Underwriting Expenses
The underwriting expense ratio decreased 1.4 points in Third Quarter 2018 and 1.2 points in Nine Months 2018 compared to the respective prior year periods due to the following:

A 0.5-point and 0.6-point decrease in employee-related expenses in Third Quarter 2018 and Nine Months 2018, respectively, reflecting reductions in both periods of 0.2 points for profit-based compensation to employees, driven by the higher combined ratio resulting in a reduced level of underwriting income for both periods, and 0.2-points for pension and medical benefit costs.

A 0.4-point and 0.3-point decrease in supplemental commissions to our distribution partners in Third Quarter 2018 and Nine Months 2018, respectively, compared to Third Quarter 2017 and Nine Months 2017, driven by the higher combined ratio resulting in a reduced level of underwriting income for both periods.

Investments Segment
In total, our Investments segment contributed 9.1 points to our overall annualized ROE in Third Quarter 2018, compared to 8.2 points in Third Quarter 2017, and 8.0 points in Nine Months 2018, compared to 7.6 points in Nine Months 2017. Excluding the impact of net realized and unrealized losses, the Investment segment's contribution to non-GAAP operating ROE improved by 2.9 points in the quarter and 1.8 points in the year-to-date period compared to the respective prior year periods.

The investment income improvement included 1.4 points of benefit from Tax Reform in Third Quarter 2018 and 1.2 points in Nine Months 2018. The remaining improvement in both periods reflected pre-tax net investment income growth of 30% in Third Quarter 2018 and 18% in Nine Months 2018 compared to the same prior year periods, driven by higher yields on our fixed income securities portfolio during the year and improved returns on our alternative investment portfolio in the quarter. Yields on our fixed income portfolio improved due to active investment management and security selection, coupled with the year-to-date increase in the 90-day LIBOR of approximately 70 points, as 17% of our fixed income portfolio is invested in floating rate securities that reset based principally on this rate.

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Table of Contents


Outlook
Despite our strong financial performance in 2017 and expectations for 2018, the U.S. property and casualty insurance industry continues to be characterized by an abundance of capital, intense competition, and low overall premium growth. According to A.M. Best Company's ("A.M. Best") "US Property/Casualty: 2018 Review & Preview," for 2018, rate increases are expected to remain in the low single digits for most lines of business. A.M. Best is estimating an overall statutory combined ratio for the industry for 2018 of 100.0%, and an estimated after-tax return on surplus of 5.8%. Industry results through six-months 2018, as reported by A.M. Best in an August 2018 report, reflected an industry combined ratio of 96.4%, including 4.2-points of catastrophe losses. In their Review & Preview, A.M. Best also estimated that property and casualty insurance industry loss and loss expense reserve adequacy peaked several years ago, and has been declining since that time. In addition, changes in economic conditions, including changes in U.S. trade policies and the imposition of tariffs on imports, may lead to higher inflation and increased loss costs above expected trends, which would negatively impact our profitability and the property and casualty insurance industry profitability as a whole. Unanticipated inflation would impact both claim payments made during the current year, as well as estimates of loss and loss expense reserves for claims to be paid in the future. For a further discussion, please refer to Item 1A. "Risk Factors" in our 2017 Annual Report, under the subsection entitled, "Risks Related to Our Insurance Operations."

Our long-term growth plans include: (i) building our "ivy league" distribution partnerships to be representative of at least 25% of the available market share in each of our Standard Commercial Lines states; (ii) increasing our share of the business within these distribution partners, which we refer to as our "share of wallet," to 12%, which translates into a 3% market share in each state in which we write Standard Commercial Lines business; and (iii) geographic expansion. To date, we write Standard Commercial Lines business in 27 states and the District of Columbia, which, at a 3% market share, would create a corporate Standard Commercial Lines profile of approximately $5 billion of NPW.

Effective July 1, 2017, we opened Arizona and New Hampshire for Standard Commercial Lines business. Effective January 1, 2018, we started writing Standard Commercial Lines business in Colorado, and on October 1, 2018, we began writing Standard Commercial Lines business in New Mexico and Utah. We have appointed an aggregate of 52 agents in these states, with appointments controlling approximately 10-20% of these states' available Standard Commercial Lines premium. We expect to open Arizona and Utah for Standard Personal Lines business in the fourth quarter of 2018.

Investing in the development and implementation of leading technologies to enhance our underwriting is integral to our overall strategy. The ability to segment our business and present specific account-level pricing guidance to our underwriters based on expected future profitability has positioned us to achieve strong renewal pure price without negatively impacting retention. We deployed our newest underwriting tool that provides real-time insights into how each prospective new business account compares with similar accounts already in our portfolio. We believe this tool positions us better to profitably grow the business regardless of overall market dynamics.

As an organization, we are making significant investments focused on enhancing the overall customer experience in an omni-channel environment, including efforts to obtain: (i) stronger customer engagement through multiple communication touch points, such as mobile notifications and billing alerts; (ii) a 360-degree view of our customers to provide a more integrated service experience; (iii) increased capabilities to allow customers to interact with us in a 24x7 environment in a manner of their choosing; and (iv) deeper insight into metrics regarding customer satisfaction. To that end, we have recently deployed a new customer experience desktop to our contact center employees, and are working closely with our distribution partners and their primary agency management system vendors to ensure we present our customers with a seamless experience. We recognize that our customers' expectations on how they engage with us and our agents are rapidly evolving, and we continue to strive towards providing "best-in-class" customer service in a 24-hour, 365-day environment. Our goals in this area are centered around leveraging technology to improve customer retention rates, which should, over time, enhance the quality of our business.

Our investment portfolio generated pre-tax net investment income of $141.2 million in Nine Months 2018, which was an 18% increase over the same period in 2017. We have generated strong investment returns, while maintaining a similar level of credit quality and duration risk on the portfolio, as a result of: (i) active investment management and security selection, principally in our core fixed income portfolio; and (ii) the 70-point increase in 90-day LIBOR in 2018, as 17% of our fixed income portfolio is invested in floating rate securities that reset based principally on this rate. Additionally, risk assets, which principally include high-yield fixed income securities, equities, and our alternative investments portfolio, were 7.3% of our overall portfolio as of September 30, 2018, which was slightly down from year-end 2017. During 2018, we have been actively managing our risk asset portfolio and trimmed our exposure to public equities and high-yield fixed income securities as a result of market conditions during the year. Overall, we have been gradually diversifying our portfolio, and will work towards modestly increasing our risk asset allocation over time, up to approximately 10% of our invested assets, depending on market conditions.

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Table of Contents


After three quarters of results, we are increasing our full-year 2018 after-tax net investment income guidance by $6 million, to $156 million, as well as increasing catastrophe losses by 0.5 points, to 4.0 points. All other assumptions remain the same. Our full-year expectations are as follows:
A GAAP combined ratio, excluding catastrophe losses, of 92.0%, which is unchanged from prior guidance. This assumes no fourth quarter 2018 prior year casualty reserve development;
Catastrophe losses of 4.0 points reflecting two hurricanes;
After-tax net investment income of $156 million;
An overall effective tax rate of approximately 18%, which includes an effective tax rate of 17% for net investment income, reflecting a tax rate of 5.25% for tax-advantaged municipal bonds and a tax rate of 21% for all other investments; and
Weighted average shares of 59.6 million.

Results of Operations and Related Information by Segment

Standard Commercial Lines Segment
 
 
Quarter ended September 30,
 
Change
% or
Points
 
 
Nine Months ended September 30,
 
Change
% or
Points
 
($ in thousands)
 
2018
 
2017
 
 
 
2018
 
2017
 
 
Insurance Segments Results:
 
 

 
 

 
 

 
 
 
 
 
 
 
 
NPW
 
$
502,312

 
472,051

 
6

%
 
$
1,526,318

 
1,434,516

 
6

%
NPE
 
481,056

 
445,250

 
8

 
 
1,422,432

 
1,327,258

 
7

 
Less:
 
 
 
  

 
 

 
 
 
 
  
 
 
 
Loss and loss expense incurred
 
291,110

 
254,870

 
14

 
 
858,550

 
749,310

 
15

 
Net underwriting expenses incurred
 
161,323

 
154,003

 
5

 
 
483,455

 
462,439

 
5

 
Dividends to policyholders
 
2,290

 
1,048

 
119

 
 
6,274

 
2,875

 
118

 
Underwriting income
 
$
26,333

 
35,329

 
(25
)
%
 
$
74,153

 
112,634

 
(34
)
%
Combined Ratios:
 
 

 
 

 
 

 
 
 
 
 
 
 
 
Loss and loss expense ratio
 
60.5

%
57.3

 
3.2

pts
 
60.4

%
56.5

 
3.9

pts
Underwriting expense ratio
 
33.5

 
34.6

 
(1.1
)
 
 
34.0

 
34.8

 
(0.8
)
 
Dividends to policyholders ratio
 
0.5

 
0.2

 
0.3

 
 
0.4

 
0.2

 
0.2

 
Combined ratio
 
94.5

 
92.1

 
2.4

 
 
94.8

 
91.5

 
3.3

 

NPW in this segment of our business increased 6% in both the current quarter and year-to-date periods driven by renewal pure price increases and strong retention. However, we are experiencing heightened competition in this segment, particularly related to new business, which decreased 7% in Third Quarter 2018 compared to Third Quarter 2017, as illustrated in the table below.
 
 
Quarter ended September 30,
 
Change
% or
Points
 
 
Nine Months ended September 30,
Change
% or
Points
 
($ in millions)
 
2018
 
2017
 
 
 
2018
 
2017
Retention
 
84

%
85

 
(1
)
pts
 
83
%
 
84

(1
)
pts
Renewal pure price increases
 
3.7

 
2.7

 
1.0

 
 
3.5

 
2.9

0.6

 
Direct new business
 
$
90.4

 
96.9

 
(7
)
%
 
$
289.5

 
284.4

2

%

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Table of Contents


The loss and loss expense ratio increased 3.2 points in Third Quarter 2018 compared to Third Quarter 2017, and 3.9 points in Nine Months 2018 compared to Nine Months 2017. These increases were driven by the following:
 
Third Quarter 2018
 
Third Quarter 2017
 
 
($ 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
$
22.1

4.6

pts
 
$
14.3

3.2

pts
1.4
pts
Non-catastrophe property losses
60.1

12.5

 
 
49.1

11.0

 
1.5
 
(Favorable) prior year casualty reserve development
(18.0
)
(3.7
)
 
 
(19.9
)
(4.5
)
 
0.8
 
Total
64.2

13.4

 
 
43.5

9.7

 
3.7
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months 2018
 
Nine Months 2017
 
 
($ 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
$
52.0

3.7

pts
 
$
38.1

2.9

pts
0.8
pts
Non-catastrophe property losses
187.9

13.2

 
 
147.0

11.1

 
2.1
 
(Favorable) prior year casualty reserve development
(36.0
)
(2.5
)
 
 
(53.6
)
(4.0
)
 
1.5
 
Total
203.9

14.4

 
 
131.5

10.0

 
4.4
 

For additional information regarding the favorable prior year casualty reserve development by line of business, see the "Financial Highlights of Results for Third Quarter and Nine Months 2018 and Third Quarter and Nine Months 2017" section above and the line of business discussions below.

There was a 1.1-point decrease in the underwriting expense ratio in Third Quarter 2018 compared to Third Quarter 2017, and a 0.8-point decrease in the underwriting expense ratio in Nine Months 2018 compared to Nine Months 2017. The significant drivers of these variances were as follows:

A reduction in employee-related expenses of 0.4 points in the quarter and 0.5 points year to date. These decreases included: (i) lower profit-based compensation to our employees of 0.2 points in the quarter and year to date, driven by the higher combined ratio resulting in a reduced level of underwriting income for both periods; and (ii) lower pension and medical benefit costs of 0.2 points in the quarter and year to date.

A reduction in profit-based compensation to our distribution partners of 0.3 points in the quarter and 0.2 points year to date, driven by the higher combined ratio resulting in a reduced level of underwriting income for both periods.


The following is a discussion of our most significant Standard Commercial Lines of business:
General Liability
 
 
 
 
 
 
 
 
 
Quarter ended September 30,
 
Change
% or
Points
 
 
Nine Months ended September 30,
 
Change
% or
Points
 
($ in thousands)
 
2018
 
2017
 
 
 
2018
 
2017
 
 
NPW
 
$
160,105

 
147,858

 
8

%
 
$
494,984

 
461,716

 
7

%
  Direct new business
 
26,768

 
28,067

 
(100
)
 
 
86,210

 
84,986

 
1

 
  Retention
 
85

%
85

 

pts
 
84

%
83

 
1

pts
  Renewal pure price increases
 
2.9

 
2.4

 
0.5

 
 
2.7

 
2.5

 
0.2

 
NPE
 
$
154,974

 
141,059

 
10

%
 
$
457,805

 
422,546

 
8

%
Underwriting income
 
24,374

 
24,003

 
2

 
 
54,074

 
85,326

 
(37
)
 
Combined ratio
 
84.3

%
83.0

 
1.3

pts
 
88.2

%
79.8
%
 
8.4

pts
% of total Standard Commercial Lines NPW
 
32

 
31

 
 

 
 
32

 
32

 


 

31

Table of Contents

The combined ratio increases in Third Quarter 2018 compared to Third Quarter 2017, and Nine Months 2018 compared to Nine Months 2017, were driven primarily by lower favorable prior year casualty reserve development, as illustrated in the table below.

Third Quarter 2018
Third Quarter 2017


($ in millions)
Loss and Loss Expense Incurred
Impact on
Combined Ratio

Loss and Loss Expense Incurred
Impact on
Combined Ratio

Change
Points

(Favorable) prior year casualty reserve development
$
(8.0
)
(5.2
)
pts
$
(10.9
)
(7.7
)
pts
2.5
pts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months 2018
Nine Months 2017
 
 
($ in millions)
Loss and Loss Expense Incurred
Impact on
Combined Ratio
 
Loss and Loss Expense Incurred
Impact on
Combined Ratio
 
Change
Points
 
(Favorable) prior year casualty reserve development
$
(8.0
)
(1.7
)
pts
$
(48.3
)
(11.4
)
pts
9.7
pts

The Third Quarter and Nine Months 2018 development was primarily attributable to favorable development on loss adjustment expenses in accident years 2014 through 2017.

The Third Quarter and Nine Months 2017 development was primarily attributable to lower claims frequencies and severities primarily in accident years 2015 and prior, particularly in the products liability and excess liability segments.

In addition, the lower combined ratio benefited from a lower underwriting expense ratio, which decreased by 0.3 points in Third Quarter 2018 compared to Third Quarter 2017, and by 1.1 points in Nine Months 2018 compared to Nine Months 2017, primarily attributable to the aforementioned items discussed in the overall Commercial Lines Segment above.

Commercial Automobile
 
 
 
 
 
 
 
 
 
Quarter ended September 30,
 
Change
% or
Points
 
 
Nine Months ended September 30,
 
Change
% or
Points
 
($ in thousands)
 
2018
 
2017
 
 
 
2018
 
2017
 
 
NPW
 
$
135,579

 
121,749

 
11

%
 
$
399,506

 
358,198

 
12

%
  Direct new business
 
23,363

 
21,906

 
7

 
 
70,668

 
61,456

 
15

 
  Retention
 
82

%
86

 
(4
)
pts
 
83

%
84

 
(1
)
pts
  Renewal pure price increases
 
7.5

 
6.5

 
1.0

 
 
7.4

 
6.7

 
0.7

 
NPE
 
$
124,862

 
111,711

 
12

%
 
$
365,197

 
327,156

 
12

%
Underwriting loss
 
(22,785
)
 
(16,098
)
 
42

 
 
(46,922
)
 
(41,621
)
 
13

 
Combined ratio
 
118.2

%
114.4

 
3.8

pts
 
112.8

%
112.7

 
0.1

pts
% of total Standard Commercial Lines NPW
 
27

 
26

 
 

 
 
26

 
25

 
 

 

The increase in the combined ratio of 3.8 points in Third Quarter 2018 compared to Third Quarter 2017, and 0.1 points in Nine Months 2018 compared to Nine Months 2017, was driven by the following:
 
Third Quarter 2018
 
Third Quarter 2017
 
 
($ in millions)
Loss and Loss Expense Incurred
Impact on
Combined Ratio
 
 
Loss and Loss Expense Incurred
Impact on
Combined Ratio
 
Change in Ratio
 
Non-catastrophe property losses
$
20.5

16.4

pts
 
$
18.5

16.6

pts
(0.2
)
pts
Unfavorable prior year casualty reserve development
10.0

8.0

 
 
5.0

4.5

 
3.5

 
Catastrophe losses
0.4

0.3

 
 
0.5

0.5

 
(0.2
)
 
Total
30.9

24.7

 
 
24.0

21.6

 
3.1

 


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Table of Contents

 
Nine Months 2018
 
Nine Months 2017
 
 
($ in millions)
Loss and Loss Expense Incurred
Impact on
Combined Ratio
 
 
Loss and Loss Expense Incurred
Impact on
Combined Ratio
 
Change in Ratio
 
Non-catastrophe property losses
$
61.4

16.8

pts
 
$
48.9

14.9

pts
1.9

pts
Unfavorable prior year casualty reserve development
25.0

6.8

 
 
26.0

7.9

 
(1.1
)
 
Catastrophe losses
1.9

0.5

 
 
1.6

0.5

 

 
Total
88.3

24.1

 
 
76.5

23.3

 
0.8

 

The significant drivers of the development were as follows:

Third Quarter and Nine Months 2018: Development was primarily due to higher casualty claims frequencies, as well as increases in claim severities, primarily in accident years 2016 and 2017.

Third Quarter and Nine Months 2017: Development was mainly due to higher casualty claim frequencies, and some increases in claim severities, in accident years 2015 and 2016.

In addition to the items described above, the combined ratio in this line of business was adversely impacted by higher current year loss costs of 4.4 points for the quarter, and 2.2 points for the year-to-date period, driven by continued elevated frequencies and to some extent severities.

Workers Compensation
 
 
 
 
 
 
 
 
 
Quarter ended September 30,
 
Change
% or
Points
 
 
Nine Months ended September 30,
 
Change
% or
Points
 
($ in thousands)
 
2018
 
2017
 
 
 
2018
 
2017
 
 
NPW
 
$
77,827

 
80,252

 
(3
)
%
 
$
248,728

 
253,446

 
(2
)
%
Direct new business
 
12,582

 
18,617

 
(32
)
 
 
46,000

 
52,923

 
(13
)
 
Retention
 
84

%
85

 
(1
)
pts
 
84

%
84

 

pts
Renewal pure price (decreases) increases
 

 
(0.4
)
 
0.4

 
 
0.1

 
0.3

 
(0.2
)
 
NPE
 
$
78,784

 
77,580

 
2

%
 
$
237,628

 
236,366

 
1

%
Underwriting income
 
23,380

 
14,661

 
59

 
 
61,601

 
32,553

 
89

 
Combined ratio
 
70.3

%
81.1

 
(10.8
)
pts
 
74.1

%
86.2

 
(12.1
)
pts
% of total Standard Commercial Lines NPW
 
16

 
17

 
 

 
 
16

 
18

 
 
 

The decreases in the combined ratio in Third Quarter and Nine Months 2018 compared to the same prior year periods were driven by favorable prior year casualty reserve development, as well as a 1.5-point reduction in current year loss costs in both the quarter and year-to-date periods. Favorable prior year development, which was primarily due to lower severities in accident years 2016 and prior, was as follows:
 
Third Quarter 2018
Third Quarter 2017
 
 
($ in millions)
Loss and Loss Expense Incurred
Impact on
Combined Ratio
 
Loss and Loss Expense Incurred
Impact on
Combined Ratio
 
Change
Points
 
(Favorable) prior year casualty reserve development
$
(20.0
)
(25.4
)
pts
$
(14.0
)
(18.0
)
pts
(7.4
)
pts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months 2018
Nine Months 2017
 
 
($ in millions)
Loss and Loss Expense Incurred
Impact on
Combined Ratio
 
Loss and Loss Expense Incurred
Impact on
Combined Ratio
 
Change
Points
 
(Favorable) prior year casualty reserve development
$
(53.0
)
(22.3
)
pts
$
(29.3
)
(12.4
)
pts
(9.9
)
pts




33

Table of Contents

Commercial Property
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quarter ended September 30,
 
Change
% or
Points
 
 
Nine Months ended September 30,
 
Change
% or
Points
 
($ in thousands)
 
2018
 
2017
 
 
 
2018
 
2017
 
 
NPW
 
$
89,737

 
84,664

 
6

%
 
$
263,318

 
247,138

 
7

%
  Direct new business
 
18,073

 
18,451

 
(2
)
 
 
57,485

 
55,614

 
3

 
  Retention
 
83

%
83

 

pts
 
82

%
82

 

pts
Renewal pure price increases
 
3.3

 
1.4

 
1.9

 
 
3.1

 
1.7

 
1.4

 
NPE
 
$
83,056

 
78,151

 
6

%
 
$
245,544

 
232,594

 
6

%
Underwriting (loss) income
 
(6,768
)
 
7,824

 
(187
)
 
 
(9,266
)
 
16,917

 
(155
)
 
Combined ratio
 
108.1

%
90.0

 
18.1

pts
 
103.8

%
92.7

 
11.1

pts
% of total Standard Commercial Lines NPW
 
18

 
18

 
 

 
 
17

 
17

 
 
 

The increase in the combined ratio in Third Quarter 2018 compared to Third Quarter 2017, and the increase in the combined ratio in Nine Months 2018 compared to Nine Months 2017, were driven by the following:

Third Quarter 2018

Third Quarter 2017


($ in millions)
Loss and Loss Expense Incurred
Impact on
Combined Ratio


Loss and Loss Expense Incurred
Impact on
Combined Ratio

Change
% or
Points

Catastrophe losses
$
20.1

24.2
pts

$
12.6

16.1
pts
8.1
pts
Non-catastrophe property losses
33.9

40.8


24.1

30.9

9.9

Total
54.0

65.0
 
 
36.7

47.0
 
18.0
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months 2018
 
Nine Months 2017
 
 
($ in millions)
Loss and Loss Expense Incurred
Impact on
Combined Ratio
 
 
Loss and Loss Expense Incurred
Impact on
Combined Ratio
 
Change
% or
Points
 
Catastrophe losses
$
42.6

17.4
pts
 
$
33.1

14.2
pts
3.2
pts
Non-catastrophe property losses
106.3

43.3
 
 
82.2

35.3
 
8.0
 
Total
148.9

60.7
 
 
115.3

49.5
 
11.2
 

Higher catastrophe losses in Third Quarter 2018 compared to Third Quarter 2017 included the impact of Hurricane Florence in the current quarter, while the increase in non-catastrophe property losses reflected a higher number of fire losses compared to last year. On a year-to-date-basis, the increase in non-catastrophe property losses continued to reflect the higher property losses from the first quarter of 2018, which were principally related to the January deep freeze in our footprint states coupled with the relatively large number of fire losses during the year.

Standard Personal Lines Segment
 
 
Quarter ended September 30,
 
Change
% or
Points
 
 
 
Nine Months ended September 30,
 
Change
% or
Points
 
($ in thousands)
 
2018
 
2017
 
 
 
 
2018
 
2017
 
 
Insurance Segments Results:
 
 

 
 

 
 

 
 
 
 
 
 
 
 
 
NPW
 
$
84,735

 
81,195

 
4

 
%
 
$
236,530

 
223,998

 
6

%
NPE
 
77,157

 
72,601

 
6

 
 
 
227,090

 
215,474

 
5

 
Less:
 
 
 
 

 
 
 
 
 
 
 
 

 
 
 
Loss and loss expense incurred
 
52,631

 
42,120

 
25

 
 
 
157,330

 
141,135

 
11

 
Net underwriting expenses incurred
 
21,368

 
22,302

 
(4
)
 
 
 
63,303

 
66,822

 
(5
)
 
Underwriting income
 
$
3,158

 
8,179

 
(61
)
 
%
 
$
6,457

 
7,517

 
(14
)
%
Combined Ratios:
 
 
 
 

 
 
 
 
 
 
 
 

 
 
 
Loss and loss expense ratio
 
68.2

%
58.0

 
10.2

 
pts
 
69.3

%
65.5

 
3.8

pts
Underwriting expense ratio
 
27.7

 
30.7

 
(3.0
)
 
 
 
27.9

 
31.0

 
(3.1
)
 
Combined ratio
 
95.9

 
88.7

 
7.2

 
 
 
97.2

 
96.5

 
0.7

 


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The increases in NPW reflected in the table above were driven by the following:
 
 
Quarter ended September 30,
Change
% or
Points
 
 
Nine Months ended September 30,
Change
% or
Points
 
($ in millions)
 
2018
 
2017
 
 
2018
 
2017
 
New business
 
$
13.1

 
13.6

(4
)
%
 
$
40.8

 
38.2

7
%
Retention
 
85

%
84

1

pts
 
85

%
84

1
pts
Renewal pure price increases
 
3.8

 
3.1

0.7

 
 
3.6

 
2.8

0.8


The loss and loss expense ratio increased 10.2 points in Third Quarter 2018 compared to Third Quarter 2017, and 3.8 points in Nine Months 2018 compared to Nine Months 2017. Quantitative information on the drivers of these fluctuations is as follows:
 
Third Quarter 2018
 
Third Quarter 2017
 
 
($ 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
 
Non-catastrophe property losses
$
24.7

32.1

pts
 
$
19.1

26.3

pts
5.8

pts
Catastrophe losses
5.4

7.1

 
 
2.2

3.0

 
4.1

 
Total
30.1

39.2

 
 
21.3

29.3

 
9.9

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months 2018
 
Nine Months 2017
 
 
($ 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
$
18.1

8.0

pts
 
$
15.4

7.2

pts
0.8

pts
Unfavorable prior year casualty reserve development


 
 
5.0

2.3

 
(2.3
)
 
Non-catastrophe property losses
70.2

30.9

 
 
55.4

25.7

 
5.2

 
Total
88.3

38.9

 
 
75.8

35.2

 
3.7

 

Non-catastrophe property losses increased in Third Quarter 2018 compared to Third Quarter 2017 driven primarily by an increase in the number of fire and weather-related losses. Additionally, on a year-to-date basis, the increase in non-catastrophe property losses was partially related to the January 2018 deep freeze in our footprint states.

Unfavorable prior year casualty reserve development in Nine Months 2017 was primarily driven by increased frequency and severity in the personal automobile liability line for accident 2016.

The underwriting expense ratio decreased 3.0 points in Third Quarter 2018 compared to Third Quarter 2017, and 3.1
points in Nine Months 2018 compared to Nine Months 2017. The significant drivers of these variances were as follows:

A reduction in costs of 1.3 points in the quarter and 1.1 points year to date associated with the internally-developed software platform used in this segment of our business, which was fully amortized in the fourth quarter of 2017.

A reduction in employee-related expenses of 0.7 points in the quarter and 0.8 points year to date. Similar to our Standard Commercial Lines Segment these decreases included: (i) lower profit-based compensation to our employees; and (ii) lower pension and medical benefit costs.

A reduction in profit-based commissions of 0.3 points in both the quarter and year-to-date periods this year compared to the prior year periods.

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Table of Contents


E&S Lines Segment
 
 
Quarter ended September 30,
 
Change
% or
Points
 
 
Nine Months ended September 30,
 
Change
% or
Points
 
($ in thousands)
 
2018
 
2017
 
 
 
2018
 
2017
 
 
Insurance Segments Results:
 
 

 
 

 
 

 
 
 
 
 
 
 
 
NPW
 
$
64,621

 
51,031

 
27

%
 
$
168,628

 
158,281

 
7

%
NPE
 
56,064

 
54,204

 
3

 
 
161,419

 
158,207

 
2

 
Less:
 
 

 
 

 
 

 
 
 

 
 

 
 

 
Loss and loss expense incurred
 
35,458

 
47,597

 
(26
)
 
 
114,588

 
113,173

 
1

 
Net underwriting expenses incurred
 
17,100

 
17,670

 
(3
)
 
 
51,679

 
53,208

 
(3
)
 
Underwriting (loss) income
 
$
3,506

 
(11,063
)
 
132

%
 
$
(4,848
)
 
(8,174
)
 
41

%
Combined Ratios:
 
 

 
 

 
 

 
 
 

 
 

 
 

 
Loss and loss expense ratio
 
63.2

%
87.8

 
(24.6
)
pts
 
71.0

%
71.6

 
(0.6
)
pts
Underwriting expense ratio
 
30.5

 
32.6

 
(2.1
)
 
 
32.0

 
33.6

 
(1.6
)
 
Combined ratio
 
93.7

 
120.4

 
(26.7
)
 
 
103.0

 
105.2

 
(2.2
)
 

While this segment experienced an improved third quarter, partially driven by better than expected property losses, we continue to address profitability through targeted price increases, business mix shifts, and improved underwriting standards. Pricing on our in-force book of business is essentially at our targeted levels and our strategy in this segment is to pursue growth opportunistically if market conditions allow. Over the past year, we have taken steps to exit some underperforming classes of E&S business, while entering into new distribution relationships. The NPW growth in Third Quarter 2018 reflects the impact of one particularly large relationship that we established in the second quarter of 2018. Quantitative information regarding new business and price increases is as follows:
 
 
Quarter ended September 30,
Change
% or
Points
 
 
Nine Months ended September 30,
Change
% or
Points
 
($ in millions)
 
2018
 
2017
 
 
2018
 
2017
 
Direct new business
 
$
32.2

 
20.6

56
%
 
$
70.8

 
69.3

2

%
Overall new/renewal price increases1
 
3.9

%
3.2

0.7
pts
 
5.2

%
5.5

(0.3
)
pts
1The E&S casualty new/renewal price increases were 2.9% and 5.4% in Third Quarter 2018 and Third Quarter 2017, respectively, and 5.4% and 8.0% in Nine Months 2018 and Nine Months 2017, respectively.
 
The NPE increases in Third Quarter and Nine Months 2018 compared to Third Quarter and Nine Months 2017 were consistent with the fluctuation in NPW for the twelve-month period ended September 30, 2018 compared with the twelve-month period ended September 30, 2017.

The loss and loss expense ratio decreased 24.6 points in Third Quarter 2018 and 0.6 points in Nine Months 2018 compared to the same prior year periods, driven primarily by the following:
 
Third Quarter 2018
 
 
Third Quarter 2017
 
 
 
($ 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
 
Unfavorable prior year casualty reserve development
$
6.0

10.7
pts
 
$
10.0

18.4
pts
(7.7
)
pts
Non-catastrophe property losses
5.0

8.9
 
 
3.7

6.8
 
2.1

 
Catastrophe losses
0.6

1.0
 
 
7.3

13.5
 
(12.5
)
 
Total
11.6

20.6
 
 
21.0

38.7
 
(18.1
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Nine Months 2018
 
 
Nine Months 2017
 
 
 
($ 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
 
Unfavorable prior year casualty reserve development
$
12.0

7.4
pts
 
$
10.0

6.3
pts
1.1

pts
Non-catastrophe property losses
20.4

12.6
 
 
14.1

8.9
 
3.7

 
Catastrophe losses
2.7

1.7
 
 
11.7

7.4
 
(5.7
)
 
Total
35.1

21.7
 
 
35.8

22.6
 
(0.9
)
 


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Table of Contents

The unfavorable prior year casualty reserve development outlined above in Third Quarter 2018 was primarily driven by increased severities in accident year 2015. The Nine Months 2018 development was primarily driven by increased frequencies and severities in accident years 2015 and 2016.

There was a 2.1-point decrease in the underwriting expense ratio in Third Quarter 2018 and 1.6-point decrease in Nine Months 2018 compared to the same prior year periods, which was driven by the following: (i) profit-based compensation to our distribution partners of 0.9 points in the quarter and 0.8 points in the year-to-date period; and (ii) labor related expenses of 1.0 points in the quarter and 1.6 points in the year-to-date period.

Reinsurance
We have successfully completed negotiations of our July 1, 2018 excess of loss treaties, which provide coverage for our Standard Commercial Lines, Standard Personal Lines, and E&S Lines. These treaties were renewed with the same structure as the expiring treaties as follows:

Property Excess of Loss
Our property excess of loss treaty ("Property Treaty") provides protection against large individual property losses with $58.0 million of coverage in excess of a $2.0 million retention:
The per occurrence cap on the first and second layers is $84.0 million.
The first layer has unlimited reinstatements and a limit of $8.0 million in excess of $2.0 million.
The annual aggregate limit, for the $30.0 million in excess of $10.0 million second layer, is $120.0 million.
A third layer has a limit of $20.0 million in excess of $40.0 million, with an annual aggregate limit of approximately $75.0 million.
The Property Treaty excludes nuclear, biological, chemical, and radiological ("NBCR") terrorism losses.

Casualty Excess of Loss
Our casualty excess of loss treaty (“Casualty Treaty”) provides protection against large individual casualty losses with $88.0 million of coverage in excess of a $2.0 million retention:
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 includes a $25.0 million limit, per life, on our workers compensation business, which remains unchanged from the prior treaty.
The Casualty Treaty excludes NBCR terrorism losses and has annual aggregate non-NBCR terrorism limits of $208.0 million.

Investments
The primary objective of the investment portfolio is to maximize after-tax net investment income and the overall total return of the portfolio, while maintaining a high credit quality core fixed income portfolio and managing our duration risk profile. The effective duration of the fixed income securities portfolio as of September 30, 2018 was 3.9 years, compared to the Insurance Subsidiaries’ liability duration as of December 31, 2017 of approximately 3.8 years. The effective duration of the fixed income securities portfolio is monitored and managed to maximize yield while managing interest rate risk and credit risk at an acceptable level. We maintain a well-diversified portfolio across sectors, credit quality, and maturities that affords us ample liquidity. Purchases and sales are made with the intent of maximizing investment returns in the current market environment while balancing capital preservation. Over time, we may seek to increase or decrease the duration and overall credit quality of the portfolio based on market conditions.

Our investment philosophy includes certain return and risk objectives for the fixed income, equity, and other investment portfolios. After-tax yield and net investment income generation are key drivers to our investment strategy, which we believe will be obtained through active management of the portfolio.
Total Invested Assets
 
 
 
 
 
 
 
($ in thousands)
 
September 30, 2018
 
December 31, 2017
 
Change % or Points
 
Total invested assets
 
$
5,861,107

 
5,685,179

 
3

%
Invested assets per dollar of stockholders' equity
 
3.37

 
3.32

 
2


Unrealized (loss) gain – before tax1
 
(3,528
)
 
124,679

 
(103
)
 
Unrealized (loss) gain – after tax1
 
(2,787
)
 
80,575

 
(103
)
 
1Includes unrealized gains on fixed income securities and equity securities.

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Table of Contents


The increase in invested assets at September 30, 2018 compared to December 31, 2017 was driven by operating cash flow generated in Nine Months 2018 of $292 million, partially offset by pre-tax unrealized losses on our fixed income securities portfolio of $113 million. These unrealized losses reflect the unfavorable impact of rising interest rates in 2018.

At September 30, 2018, our fixed income securities portfolio represented 89% of our total invested assets, largely unchanged compared to December 31, 2017. Our fixed income securities portfolio had a weighted average credit rating of “ AA- ,” with 97% of the securities in the portfolio being investment grade quality, at both September 30, 2018 and December 31, 2017. Within our fixed income securities portfolio, we maintained an allocation of non-investment grade high-yield securities, which represented 3% of our fixed income securities portfolio as of both September 30, 2018 and December 31, 2017. The sector composition and credit quality of our major asset categories within our fixed income securities portfolio did not significantly change from December 31, 2017.

For details regarding the credit quality of our portfolio, see Item 7A. “Quantitative and Qualitative Disclosures About Market Risk.” of our 2017 Annual Report.

Net Investment Income
The components of net investment income earned for the indicated periods were as follows:
 
 
Quarter ended September 30,
 
Change
% or Points
 
 
Nine Months ended September 30,
Change
% or Points
 
($ in thousands)
 
2018
 
2017
 
 
2018
 
2017
Fixed income securities
 
$
45,088

 
38,865

 
16
 %
 
 
130,903

 
113,424

15
 %
 
Equity securities
 
2,079

 
1,605

 
30

 
 
5,876

 
4,492

31

 
Short-term investments
 
867

 
396

 
119

 
 
2,001

 
1,023

96

 
Other investments
 
7,211

 
2,659

 
171

 
 
10,868

 
9,493

14

 
Investment expenses
 
(2,802
)
 
(3,079
)
 
(9
)
 
 
(8,421
)
 
(9,137
)
(8
)
 
Net investment income earned – before tax
 
52,443

 
40,446

 
30

 
 
141,227

 
119,295

18

 
Net investment income tax expense
 
(9,568
)
 
(10,856
)
 
(12
)
 
 
(24,973
)
 
(31,951
)
(22
)
 
Net investment income earned – after tax
 
$
42,875

 
29,590

 
45

 
 
116,254

 
87,344

33

 
Effective tax rate
 
18.2
%
 
26.8

 
(8.6
)
pts
 
17.7

 
26.8

(9.1
)
pts
Annualized after-tax yield on fixed income securities
 
2.8

 
2.2

 
0.6

 
 
2.8

 
2.2

0.6

 
Annualized after-tax yield on investment portfolio
 
3.0

 
2.1

 
0.9

 
 
2.7

 
2.1

0.6

 

The increase in pre-tax net investment income in Third Quarter and Nine Months 2018 compared to Third Quarter and Nine Months 2017 was driven primarily by our fixed income securities portfolio, which benefited from improved new money reinvestment yields and repositioning of investment grade securities as a result of active investment management and security selection, principally in our core fixed income portfolio. In addition, with approximately 17% of our fixed income portfolio invested in floating rate securities that reset based principally on the 90-day LIBOR, we have benefited from the 70-point rise in LIBOR in Nine Months 2018. Strong returns on our alternative investments within our other investments portfolio also contributed to the higher pre-tax net investment income in Third Quarter 2018. On an after-tax basis, we benefited from a decrease in the effective tax rate as a result of Tax Reform. See the "Federal Income Taxes" discussion below for additional information regarding the impact of this legislation.

Realized and Unrealized Gains and Losses
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. Net realized and unrealized gains and losses for the indicated periods were as follows:
 
 
Quarter ended September 30,
 
Nine Months ended September 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Net realized (losses) gains on disposals, excluding OTTI
 
$
(751
)
 
6,871

 
4,034

 
12,252

OTTI charges
 
(1,426
)
 
(73
)
 
(5,459
)
 
(4,765
)
Unrealized losses recognized in income on equity securities
 
(2,610
)
 

 
(15,563
)
 

Total net realized and unrealized (losses) gains
 
$
(4,787
)
 
6,798

 
(16,988
)
 
7,487

 
The decrease in net realized and unrealized losses in Third Quarter and Nine Months 2018 compared to the same periods last year were primarily driven by market value fluctuations on our equity portfolio, which are recorded through income due to an

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Table of Contents

accounting change in the first quarter of 2018. For information on this accounting change, see Note 2. "Adoption of Accounting Pronouncements" in Item 1. "Financial Statements." of this Form 10-Q.

Federal Income Taxes
The following table provides information regarding federal income taxes:
 
Quarter ended September 30,
 
Nine Months ended September 30,
($ in millions)
2018
 
2017
 
2018
 
2017
Federal income tax expense
$
11.7

 
20.6

 
26.4

 
55.2

Effective tax rate
17.4
%
 
30.6

 
16.5

 
28.5


On December 22, 2017, Tax Reform was signed into law, which among other provisions, reduced our statutory corporate tax rate from 35% to 21% beginning on January 1, 2018. The reduction in the effective tax rate in the table above for Third Quarter and Nine Months 2018 compared to Third Quarter and Nine Months 2017 reflects: (i) the lower statutory rate; and (ii) the contribution of tax-advantaged interest and dividend income in relation to overall pre-tax income this year compared to last.

In general, our effective tax rate differs from the statutory rate principally due to the benefit of tax-advantaged interest and dividend income, which are taxed at lower rates. For a reconciliation of tax expense at the statutory rate to tax expense on our Consolidated Statements of Income, refer to Note 12. "Federal Income Taxes" in Item 1. "Financial Statements." of this Form 10-Q.

Our future effective tax rate will continue to be impacted by similar items, assuming no significant changes to tax laws. However, for full-year 2018, we expect an overall effective tax rate of approximately 18%, which is higher than our effective tax rate for Nine Months 2018, as we expect a greater income contribution from our insurance operations for the remainder of the year compared to the relative contribution during Nine Months 2018.

Financial Condition, Liquidity, and Capital Resources
Capital resources and liquidity reflect our ability to generate cash flows from business operations, borrow funds at competitive rates, and raise new capital to meet operating and growth needs.
 
Liquidity
We manage liquidity with a focus on generating sufficient cash flows to meet the short-term and long-term cash requirements of our business operations. Our cash, excluding restricted cash, and short-term investment position of $305 million at September 30, 2018 was comprised of $28 million at the Parent and $277 million at the Insurance Subsidiaries. Short-term investments are generally maintained in "AAA" rated money market funds approved by the National Association of Insurance Commissioners. The Parent maintains a fixed income security investment portfolio containing high-quality, highly-liquid government and corporate fixed income securities. This portfolio amounted to $113 million at September 30, 2018 and $90 million at December 31, 2017. The Parent had a total of $141 million of cash and liquid investments at September 30, 2018, compared to $114 million at December 31, 2017. We expect fluctuations in these balances over time based on various factors, including the amount and availability of dividends from our Insurance Subsidiaries, investment income, expenses, and other liquidity needs of the Parent. Our target is to hold cash and other liquid assets at the Parent sufficient to meet or exceed two years of its expected annual needs.
 
Sources of Liquidity
Sources of cash for the Parent have historically consisted of dividends from the Insurance Subsidiaries, the investment portfolio discussed above, 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.

Insurance Subsidiary Dividends
We currently anticipate that the Insurance Subsidiaries will pay $100 million in total dividends to the Parent in 2018, a $20 million increase from $80 million paid in 2017, of which $75 million was paid during Nine Months 2018. As of December 31, 2017, our allowable ordinary maximum dividend was $211 million for 2018.


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Table of Contents

Any dividends to the Parent are subject to the approval and/or review of the insurance regulators in the respective Insurance Subsidiaries' 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 19. “Statutory Financial Information, Capital Requirements, and Restrictions on Dividends and Transfers of Funds” in Item 8. “Financial Statements and Supplementary Data.” of our 2017 Annual Report.
The Insurance Subsidiaries 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 continually provide a source of cash flows for claims payments in the ordinary course of business. The effective duration of the fixed income securities portfolio was 3.9 years as of September 30, 2018, while the liabilities of the Insurance Subsidiaries had a duration as of December 31, 2017 of 3.8 years. As protection for the capital resources of the Insurance Subsidiaries, we purchase reinsurance coverage for significantly large claims or catastrophes that may occur during the year.

Line of Credit
The Parent's line of credit with Wells Fargo Bank, National Association, as administrative agent, and Branch Banking and Trust Company (BB&T) (referred to as our "Line of Credit"), was renewed effective December 1, 2015 with a borrowing capacity of $30 million, which can be increased to $50 million with the approval of both lending partners. This Line of Credit expires on December 1, 2020 and has an interest rate that varies and is based on, among other factors, the Parent's debt ratings. There were no balances outstanding under the Line of Credit at September 30, 2018 or at any time during 2018.

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, a minimum combined statutory surplus, and a 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 certain investments and acquisitions; and (v) engage in transactions with affiliates.

The table below outlines information regarding certain of the covenants in the Line of Credit:
 
Required as of September 30, 2018
Actual as of September 30, 2018
Consolidated net worth
Not less than $1.2 billion
$1.7 billion
Statutory surplus
Not less than $750 million
$1.7 billion
Debt-to-capitalization ratio1
Not to exceed 35%
20.2%
A.M. Best financial strength rating
Minimum of A-
A
1 
Calculated in accordance with the Line of Credit agreement.

Several of our Insurance Subsidiaries are members of certain branches of the Federal Home Loan Bank, which provides those subsidiaries with additional access to liquidity. Membership is as follows:
Branch
Insurance Subsidiary Member
Federal Home Loan Bank of Indianapolis ("FHLBI")
Selective Insurance Company of South Carolina ("SICSC")1
Selective Insurance Company of the Southeast ("SICSE")1
Federal Home Loan Bank of New York ("FHLBNY")
Selective Insurance Company of America ("SICA")
Selective Insurance Company of New York ("SICNY")
1These subsidiaries are jointly referred to as the "Indiana Subsidiaries" as they are domiciled in Indiana.

The Line of Credit permits aggregate borrowings from the FHLBI and the FHLBNY up to 10% of the respective member company’s admitted assets for the previous year end. Additionally, as SICNY is domiciled in New York, this company's borrowings from the FHLBNY are limited to the lower of 5% of admitted assets for the most recently completed fiscal quarter or 10% of admitted assets for the previous year end.


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Table of Contents

All borrowings from both the FHLBI and the FHLBNY are required to be secured by investments pledged as collateral. For additional information regarding collateral outstanding, refer to Note 4. "Investments" in Item 1. "Financial Statements." of this Form 10-Q. The following table provides information on the remaining capacity for Federal Home Loan Bank borrowings based on these restrictions, as well as the amount of additional stock that would need to be purchased to allow these member companies to borrow their remaining capacity:
($ in millions)
Admitted Assets
 
Borrowing Limitation
 
Amount Borrowed
 
Remaining Capacity
 
Additional Stock Requirements
 
 
 
 
 
SICSC
$
648.0

 
$
64.8

 
32.0

 
32.8

 
1.4

SICSE
507.5

 
50.8

 
28.0

 
22.8

 
1.0

SICA
2,434.9

 
243.5

 
50.0

 
193.5

 
8.7

SICNY
454.5

 
22.7

 

 
22.7

 
1.0

Total
 
 
$
381.8

 
110.0

 
271.8

 
12.1


Short-term Borrowings
In Nine Months 2018, SICA borrowed: (i) $75 million from the FHLBNY, which was repaid on March 20, 2018; and (ii) $55 million from the FHLBNY, which was repaid on April 18, 2018. For further information regarding this borrowing, see Note 5. "Indebtedness" in Item 1. "Financial Statements." of this Form 10-Q.

Intercompany Loan Agreements
The Parent has lending agreements with the Indiana Subsidiaries that have been approved by the Indiana Department of Insurance, which provide additional liquidity to the Parent. 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. The following table provides information on the Parent’s borrowings and remaining borrowing capacity from the Indiana Subsidiaries:
($ in millions)
Admitted Assets
as of December 31, 2017
 
Borrowing Limitation
 
Amount Borrowed
 
Remaining Capacity
As of June 30, 2018
 
 
 
SICSC
$
648.0

 
$
64.8

 
27.0

 
37.8

SICSE
507.5

 
50.8

 
18.0

 
32.8

Total
 
 
$
115.6

 
45.0

 
70.6


Capital Market Activities
The Parent had no private or public issuances of stock or debt instruments during Nine Months 2018.

Uses of Liquidity
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.

On October 25, 2018, our Board of Directors declared, for stockholders of record as of November 15, 2018, a $0.20 per share dividend to be paid on December 3, 2018. This is an 11% increase compared to the dividend declared on August 1, 2018.

Our ability to meet our interest and principal repayment obligations on our debt, as well as our ability to continue to pay dividends to our stockholders, is dependent on liquidity at the Parent coupled with the ability of the Insurance Subsidiaries to pay dividends, if necessary, and/or the availability of other sources of liquidity to the Parent. Our next two principal
repayments, each in the amount of $25 million, are due in 2021, with the next following principal payment due in 2026. We
have $185 million of Senior Notes due February 9, 2043 that became callable on February 8, 2018, which we may elect to call, in whole or in part, at any time. If we were to call and redeem these Senior Notes, we would expense the associated unamortized debt issuance costs. The balance of the unamortized debt issuance costs associated with our $185 million of Senior Notes was $4.3 million at September 30, 2018.
 
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.


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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 September 30, 2018, we had GAAP stockholders' equity and statutory surplus of $1.7 billion. With total debt of $439.4 million, our debt-to-capital ratio was approximately 20.2% at September 30, 2018.
 
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 commissions to our distribution partners, 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, calling existing debt, repurchasing shares of the Parent’s common stock, and increasing stockholders’ dividends.
 
Our capital management strategy is intended to protect the interests of the policyholders of the Insurance Subsidiaries and our stockholders, while enhancing our financial strength and underwriting capacity.
 
Book value per share increased to $29.52 as of September 30, 2018, from $29.28 as of December 31, 2017, due to $2.23 in net income per share, partially offset by $1.51 in unrealized losses on our investment portfolio and $0.54 in dividends to our shareholders.

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. We have been rated “A” or higher by A.M. Best for the past 88 years. A downgrade from A.M. Best to a rating below “A-” is an event of default under our Line of Credit and could affect our ability to write new business with customers and/or distribution partners, 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.

Our ratings have not changed from those reported in our "Ratings" section of Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations." in our 2017 Annual Report and continue to be as follows:
NRSRO
 
Financial Strength Rating
 
Outlook
A.M. Best
 
A
 
Stable
Moody's Investor Services ("Moody's")
 
A2
 
Stable
Fitch Ratings ("Fitch")
 
A+
 
Stable
Standard & Poor's Global Ratings ("S&P")
 
A
 
Stable

In the first quarter of 2018, Moody’s reaffirmed our "A2" rating with a "stable" outlook. In taking this action, Moody’s cited our solid risk-adjusted capitalization, strong asset quality, and underwriting profitability, as well as our good regional presence and established independent agency support.

In the second quarter of 2018, Fitch reaffirmed our "A+" rating with a "stable" outlook. In taking this action, Fitch cited our strong underwriting results, solid capitalization with growth in stockholders' equity, strong business profile, and stable interest coverage metrics.

On October 1, 2018, S&P reaffirmed our "A" rating with a "stable" outlook. In taking this action, S&P cited our improved operating performance in standard lines supported by sophisticated underwriting tools, a strong network of independent agents, and strong capital adequacy.

On October 3, 2018, A.M. Best reaffirmed our "A" rating with a "stable" outlook. In taking this action, A.M. Best cited our strong balance sheet, sustained profitability, favorable business profile, and appropriate enterprise risk management.


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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 September 30, 2018 and December 31, 2017, 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.

Contractual Obligations, Contingent Liabilities, and Commitments
Our future cash payments associated with: (i) loss and loss expense reserves; (ii) contractual obligations pursuant to operating leases for office space and equipment; and (iii) debt have not materially changed since December 31, 2017. As of September 30, 2018, we had contractual obligations that expire at various dates through 2036 that may require us to invest up to $218.2 million in alternative investments. There is no certainty that any such additional investment will be required. Additionally, as of September 30, 2018, we had the following contractual obligations: (i) $25.8 million to further invest in non-publicly traded common stock within our equity portfolio that expire through 2023; and (ii) $45.9 million to further invest in non-publicly traded collateralized loan obligations in our fixed income securities portfolio that expire through 2030. We expect to have the capacity to repay and/or refinance these obligations as they come due.
 
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. For additional details on transactions with related parties, see Note 16. "Related Party Transactions" in Item 8. "Financial Statements and Supplementary Data." in our 2017 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 2017 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 (the “Exchange Act”)), as of the end of the period covered by this report. In performing this evaluation, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control Integrated Framework ("COSO Framework") in 2013. Based on this 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.

Except for internal controls over financial reporting related to the implementation of a new investment accounting platform, 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 Nine Months 2018 that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Management reviewed and tested the effectiveness of internal controls over financial reporting related to the new investment accounting platform and concluded they were effective.

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: (i) liability insurers defending or providing indemnity for third-party claims brought against our customers; or (ii) insurers defending first-party coverage claims brought against them. We account for such activity through the establishment of unpaid losses and loss expense reserves. We expect that any potential ultimate liability in such ordinary course claims litigation will not be material to our consolidated financial condition, results of operations, or cash flows after consideration of provisions made for potential losses and costs of defense.
 

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From time to time, our insurance subsidiaries also are named as defendants 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. Similarly, our Insurance Subsidiaries are also named from time-to-time in individual actions seeking extra-contractual damages, punitive damages, or penalties, some of which allege bad faith in the handling of insurance claims. We believe that we have valid defenses to these cases. We expect that any potential ultimate liability in any such lawsuit will not be material to our consolidated financial condition, after consideration of provisions made for estimated losses. Nonetheless, given the inherent unpredictability of litigation and the large or indeterminate amounts sought in certain of these actions, an adverse outcome in certain matters could possibly have a material adverse effect on our consolidated results of operations or cash flows in particular quarterly or annual periods.

As of September 30, 2018, we do not believe the Company was involved in any legal action that could have a material adverse effect on our consolidated financial condition, results of operations, or cash flows.

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. These risk factors might affect, alter, or change actions that we might take in executing our long-term capital strategy, including but not limited to, contributing capital to any or all of the Insurance Subsidiaries, issuing additional debt and/or equity securities, repurchasing our 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 potential future impact, if any, they might have on our business. There have been no material changes from the risk factors disclosed in Item 1A. “Risk Factors.” in our 2017 Annual Report other than as discussed below.

We face risks regarding our flood business because of uncertainties regarding the NFIP.
We are the fifth largest insurance group participating in the WYO arrangement of the NFIP, which is managed by the Mitigation Division of the Federal Emergency Management Agency (“FEMA”) in the U.S. Department of Homeland Security.  Under the arrangement, we receive an expense allowance for policies written and a servicing fee for claims administered, and all losses are 100% reinsured by the Federal Government.  Effective October 1, 2018, the expense allowance was reduced to 30.0%, from 30.9%, of direct premium written.  The servicing fee remains the combination of 0.9% of direct premium written and 1.5% of incurred losses.

As a WYO carrier, we are required to follow certain NFIP procedures in the administration of flood policies and claims.  Some of these requirements may differ from our normal business practices and may present a reputational risk to our brand.  While insurance companies are regulated by the states and the NFIP requires WYO carriers to be licensed in the states in which they operate, the NFIP is a federal program and WYO carriers are fiscal agents of the U.S. Government and must follow the NFIP's directives.  Consequently, we have the risk that directives from the NFIP and a state regulator on the same issue may conflict.

The NFIP was authorized until November 30, 2018 as a short-term solution while Congress continues to debate a more comprehensive proposal. There continues to be significant public policy and political debate in Congress about an extension of the NFIP and solutions for flood risk throughout the country. In November 2017, the U.S. House of Representatives passed the 21st Century Flood Reform Act, which would extend the NFIP for five years but reduce the WYO expense allowance over a three-year period to 27.9%. The bill also proposes changes in certain operational processes and provides incentives for the private flood insurance market. The U.S. Senate has yet to consider this bill. FEMA, on its own initiative however, revised the arrangement by: (i) reducing the WYO’s expense allowance by 0.9 points, from 30.9% to 30.0% effective October 2018; and (ii) eliminating the provision allowing FEMA to increase a WYO’s expense allowance by one percentage point to cover additional incurred expenses.

Our flood business could be impacted by:  (i) a lapse in program authorization; (ii) any mandate for primary insurance carriers to provide flood insurance; or (iii) private writers becoming more prevalent in the marketplace.  The uncertainty created by the public policy debate and politics of flood insurance reform make it difficult for us to predict the future of the NFIP and our continued participation in the program.

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ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
The following table provides information regarding our purchases of our common stock in Third Quarter 2018:
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
July 1 – 31, 2018
 
129

 
$
56.50

 

 

August 1 - 31, 2018
 
2,717

 
62.38

 

 

September 1 - 30, 2018
 
13

 
65.60

 

 

Total
 
2,859

 
$
62.13

 

 


1During Third Quarter 2018, 142 shares were purchased from employees in connection with the vesting of restricted stock units and 2,717 shares were purchased from employees in connection with option exercises. These repurchases were made to satisfy tax withholding obligations and/or option costs with respect to those individuals. 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. 2014 Omnibus Stock Plan. The shares purchased in connection with the option exercises were purchased at the current market prices of our common stock on the dates the options were exercised.

ITEM 6. EXHIBITS.
Exhibit No.  
 
 
 
Statement Re: Computation of Per Share Earnings.
 
Certification of Chief Executive Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002.
 
Certification of Chief Financial Officer in accordance with Section 302 of the Sarbanes-Oxley Act of 2002.
 
Certification of Chief Executive Officer in accordance with Section 906 of the Sarbanes-Oxley Act of 2002.
 
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.




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 
 
Date:
October 26, 2018
 
By: /s/ Gregory E. Murphy
 
 
 
Gregory E. Murphy
 
 
 
Chairman of the Board and Chief Executive Officer
 
 
 
 
Date:
October 26, 2018
 
By: /s/ Mark A. Wilcox
 
 
 
Mark A. Wilcox
 
 
 
Executive Vice President and Chief Financial Officer
 
 
 
(principal financial officer)
 

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