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SELECTIVE INSURANCE GROUP INC - Quarter Report: 2018 June (Form 10-Q)

Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
 
FORM 10-Q
(Mark One)
 
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended: June 30, 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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
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 (Do not check if a smaller reporting company)
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 July 20, 2018, there were 58,835,249 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)
 
June 30,
2018
 
December 31,
2017
ASSETS
 
 

 
 

Investments:
 
 

 
 

Fixed income securities, held-to-maturity – at carrying value (fair value:  $43,373 – 2018; $44,100 – 2017)
 
$
42,016

 
42,129

Fixed income securities, available-for-sale – at fair value (amortized cost: $5,153,737 – 2018; $5,076,716 – 2017)
 
5,137,653

 
5,162,522

Equity securities – at fair value (cost:  $150,638 – 2018; $143,811 – 2017)
 
176,578

 
182,705

Short-term investments (at cost which approximates fair value)
 
164,118

 
165,555

Other investments
 
145,203

 
132,268

Total investments (Note 4 and 6)
 
5,665,568


5,685,179

Cash
 
4,876

 
534

Restricted cash
 
11,604

 
44,176

Interest and dividends due or accrued
 
40,978

 
40,897

Premiums receivable, net of allowance for uncollectible accounts of:  $10,100 – 2018; $10,000 – 2017
 
821,173

 
747,029

Reinsurance recoverable, net of allowance for uncollectible accounts of: $4,700 – 2018; $4,600 – 2017
 
544,979

 
594,832

Prepaid reinsurance premiums
 
157,561

 
153,493

Current federal income tax
 

 
3,243

Deferred federal income tax
 
51,615

 
31,990

Property and equipment – at cost, net of accumulated depreciation and amortization of:
$220,874 – 2018; $213,227 – 2017
 
62,731

 
63,959

Deferred policy acquisition costs
 
248,467

 
235,055

Goodwill
 
7,849

 
7,849

Other assets
 
88,272

 
78,195

Total assets
 
$
7,705,673

 
7,686,431

 
 
 
 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 

 
 

Liabilities:
 
 

 
 

Reserve for loss and loss expense (Note 8)
 
$
3,804,365

 
3,771,240

Unearned premiums
 
1,436,855

 
1,349,644

Long-term debt
 
439,331

 
439,116

Current federal income tax
 
5,090

 

Accrued salaries and benefits
 
85,372

 
131,850

Other liabilities
 
236,505

 
281,624

Total liabilities
 
$
6,007,518

 
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: 102,729,946 – 2018; 102,284,564 – 2017
 
205,460

 
204,569

Additional paid-in capital
 
381,641

 
367,717

Retained earnings
 
1,779,928

 
1,698,613

Accumulated other comprehensive (loss) income (Note 11)
 
(84,517
)
 
20,170

Treasury stock – at cost
(shares:  43,894,894 – 2018; 43,789,442 – 2017)
 
(584,357
)
 
(578,112
)
Total stockholders’ equity
 
$
1,698,155

 
1,712,957

Commitments and contingencies
 


 


Total liabilities and stockholders’ equity
 
$
7,705,673

 
7,686,431


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

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Table of Contents

SELECTIVE INSURANCE GROUP, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF INCOME
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in thousands, except per share amounts)
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 

 
 

 
 
 
 
Net premiums earned
 
$
604,836

 
568,030

 
1,196,664

 
1,128,884

Net investment income earned
 
45,553

 
41,430

 
88,784

 
78,849

Net realized and unrealized (losses) gains:
 
 

 
 

 
 
 
 
Net realized investment gains on disposals
 
54

 
2,951

 
4,785

 
5,381

Other-than-temporary impairments
 
(2,821
)
 
(1,211
)
 
(4,033
)
 
(4,686
)
Other-than-temporary impairments on fixed income securities recognized in other comprehensive income
 

 
(6
)
 

 
(6
)
Unrealized gains (losses) on equity securities
 
1,115

 

 
(12,953
)
 

Total net realized and unrealized (losses) gains
 
(1,652
)
 
1,734

 
(12,201
)
 
689

Other income
 
3,179

 
3,291

 
5,358

 
6,532

Total revenues
 
651,916

 
614,485

 
1,278,605

 
1,214,954

 
 
 
 
 
 
 
 
 
Expenses:
 
 

 
 

 
 
 
 
Loss and loss expense incurred
 
366,328

 
341,559

 
751,269

 
659,031

Amortization of deferred policy acquisition costs
 
122,661

 
116,578

 
243,754

 
231,928

Other insurance expenses
 
80,994

 
82,874

 
164,234

 
164,925

Interest expense
 
6,125

 
6,081

 
12,277

 
12,187

Corporate expenses
 
3,283

 
8,464

 
14,615

 
20,380

Total expenses
 
579,391

 
555,556

 
1,186,149

 
1,088,451

 
 
 
 
 
 
 
 
 
Income before federal income tax
 
72,525

 
58,929

 
92,456

 
126,503

 
 
 
 
 
 
 
 
 
Federal income tax expense:
 
 

 
 

 
 
 
 
Current
 
12,782

 
17,785

 
13,215

 
32,058

Deferred
 
924

 
(282
)
 
1,497

 
2,579

Total federal income tax expense
 
13,706

 
17,503

 
14,712

 
34,637

 
 
 
 
 
 
 
 
 
Net income
 
$
58,819

 
41,426

 
77,744

 
91,866

 
 
 
 
 
 
 
 
 
Earnings per share:
 
 

 
 

 
 
 
 
Basic net income
 
$
1.00

 
0.71

 
1.32

 
1.57

 
 
 
 
 
 
 
 
 
Diluted net income
 
$
0.99

 
0.70

 
1.30

 
1.55

 
 
 
 
 
 
 
 
 
Dividends to stockholders
 
$
0.18

 
0.16

 
0.36

 
0.32

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


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SELECTIVE INSURANCE GROUP, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Net income
 
$
58,819

 
41,426

 
77,744

 
91,866

 
 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of tax:
 
 

 
 

 
 
 
 
Unrealized (losses) gains on investment securities:
 
 

 
 

 
 
 
 
Unrealized holding (losses) gains arising during period
 
(18,955
)
 
23,326

 
(86,353
)
 
40,087

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

 
4

 

 
4

  Amounts reclassified into net income:
 
 
 
 
 
 
 
 
Held-to-maturity securities
 
(6
)
 
(28
)
 
(16
)
 
(60
)
Realized losses (gains) on disposals of available-for-sale securities
 
2,267

 
(1,225
)
 
5,861

 
(244
)
Total unrealized (losses) gains on investment securities
 
(16,694
)
 
22,077

 
(80,508
)
 
39,787

 
 
 
 
 
 
 
 
 
Defined benefit pension and post-retirement plans:
 
 

 
 

 
 
 
 
Amounts reclassified into net income:
 
 
 
 
 
 
 
 
Net actuarial loss
 
420

 
330

 
840

 
660

  Total defined benefit pension and post-retirement plans
 
420

 
330

 
840

 
660

Other comprehensive (loss) income
 
(16,274
)
 
22,407

 
(79,668
)
 
40,447

Comprehensive income (loss)
 
$
42,545

 
63,833

 
(1,924
)
 
132,313

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


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SELECTIVE INSURANCE GROUP, INC.
UNAUDITED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
 
Six Months ended June 30,
($ in thousands, except per share amounts)
 
2018
 
2017
Common stock:
 
 

 
 

Beginning of year
 
$
204,569

 
203,241

Dividend reinvestment plan (shares:  12,373 – 2018; 15,419 – 2017)
 
25

 
31

Stock purchase and compensation plans (shares:  433,009 – 2018; 515,011 – 2017)
 
866

 
1,030

End of period
 
205,460

 
204,302

 
 
 
 
 
Additional paid-in capital:
 
 

 
 

Beginning of year
 
367,717

 
347,295

Dividend reinvestment plan
 
686

 
693

Stock purchase and compensation plans
 
13,238

 
11,994

End of period
 
381,641

 
359,982

 
 
 
 
 
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
 
77,744

 
91,866

Dividends to stockholders ($0.36 per share – 2018; $0.32 per share – 2017)
 
(21,448
)
 
(18,927
)
End of period
 
1,779,928

 
1,641,820

 
 
 
 
 
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
 
(79,668
)
 
40,447

End of period
 
(84,517
)
 
24,497

 
 
 
 
 
Treasury stock:
 
 

 
 

Beginning of year
 
(578,112
)
 
(572,097
)
Acquisition of treasury stock (shares: 105,452 – 2018; 134,910 – 2017)
 
(6,245
)
 
(5,948
)
End of period
 
(584,357
)
 
(578,045
)
Total stockholders’ equity
 
$
1,698,155

 
1,652,556

 
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
 
Six Months ended June 30,
($ in thousands)
 
2018
 
2017
Operating Activities
 
 

 
 

Net income
 
$
77,744

 
91,866

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

 
 

Depreciation and amortization
 
21,771

 
25,409

Stock-based compensation expense
 
9,636

 
8,372

Undistributed gains of equity method investments
 
(1,628
)
 
(3,584
)
Distributions in excess of current year income of equity method investments
 
1,450

 
552

Loss on disposal of fixed assets
 
29

 
998

Net realized and unrealized losses (gains)
 
12,201

 
(689
)
 
 
 
 
 
Changes in assets and liabilities:
 
 

 
 

Increase in reserve for loss and loss expense, net of reinsurance recoverable
 
82,978

 
59,152

Increase in unearned premiums, net of prepaid reinsurance
 
83,143

 
83,633

Decrease in net federal income taxes
 
9,887

 
7,263

Increase in premiums receivable
 
(74,144
)
 
(82,729
)
Increase in deferred policy acquisition costs
 
(13,412
)
 
(12,339
)
Decrease (increase) in interest and dividends due or accrued
 
2

 
(204
)
Decrease in accrued salaries and benefits
 
(46,478
)
 
(29,703
)
Increase in other assets
 
(6,550
)
 
(3,862
)
Decrease in other liabilities
 
(64,372
)
 
(48,684
)
Net cash provided by operating activities
 
92,257

 
95,451

 
 
 
 
 
Investing Activities
 
 

 
 

Purchase of fixed income securities, held-to-maturity
 
(3,650
)
 

Purchase of fixed income securities, available-for-sale
 
(1,331,607
)
 
(1,194,142
)
Purchase of equity securities
 
(46,402
)
 
(22,115
)
Purchase of other investments
 
(26,032
)
 
(22,121
)
Purchase of short-term investments
 
(1,462,238
)
 
(2,259,305
)
Sale of fixed income securities, available-for-sale
 
938,276

 
717,072

Sale of short-term investments
 
1,463,726

 
2,348,892

Redemption and maturities of fixed income securities, held-to-maturity
 
3,654

 
28,730

Redemption and maturities of fixed income securities, available-for-sale
 
311,590

 
300,430

Sale of equity securities
 
43,590

 
6,289

Sale of other investments
 
3,497

 

Distributions from other investments
 
15,927

 
9,300

Purchase of property and equipment
 
(6,733
)
 
(7,047
)
Net cash used in investing activities
 
(96,402
)
 
(94,017
)
 
 
 
 
 
Financing Activities
 
 

 
 

Dividends to stockholders
 
(20,437
)
 
(17,922
)
Acquisition of treasury stock
 
(6,245
)
 
(5,948
)
Net proceeds from stock purchase and compensation plans
 
3,930

 
4,045

Proceeds from borrowings
 
130,000

 
64,000

Repayments of borrowings
 
(130,000
)
 
(64,000
)
Repayments of capital lease obligations
 
(1,333
)
 
(2,254
)
Net cash used in financing activities
 
(24,085
)
 
(22,079
)
Net decrease in cash and restricted cash
 
(28,230
)
 
(20,645
)
Cash and restricted cash, beginning of year
 
44,710

 
37,405

Cash and restricted cash, end of period
 
$
16,480

 
16,760

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 second quarters ended June 30, 2018 (“Second Quarter 2018”) and June 30, 2017 (“Second Quarter 2017”) and the six-month periods ended June 30, 2018 ("Six Months 2018") and June 30, 2017 ("Six 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 gains (losses) on equity securities" on our Consolidated Statements of Income. See Note 4 (j) below for information regarding unrealized equity gains (losses) recognized in income in Second Quarter and Six 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 Six 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:
 
 
June 30, 2017
(in thousands)
 
Prior to Adoption
 
After Adoption
Undistributed gains of equity method investments
 
(3,575
)
 
(3,584
)
Distributions in excess of current year income of equity method investments
 

 
552

Decrease (increase) in other assets
 
24,953

 
(3,862
)
Net cash provided by operating activities
 
123,723

 
95,451

 
 
 
 
 
Distributions from other investments
 
9,843

 
9,300

Net cash used in investing activities
 
(93,474
)
 
(94,017
)

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
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 are currently evaluating the impact of this guidance on our financial condition and results of operations.

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

 
 

Interest
 
$
12,064

 
11,963

Federal income tax
 
4,193

 
27,000

 
 
 
 
 
Non-cash items:
 
 
 
 
Exchange of fixed income securities, AFS
 
32,101

 
1,029

Non-cash acquisition of fixed income securities, AFS
 
32

 

Assets acquired under capital lease arrangements
 

 
278

Non-cash purchase of property and equipment
 
18

 


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)
 
June 30, 2018
 
December 31, 2017
Cash
 
$
4,876

 
534

Restricted cash
 
11,604

 
44,176

Total cash and restricted cash shown in the Statements of Cash Flows
 
$
16,480

 
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 June 30, 2018 and December 31, 2017 was as follows:
June 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
 
$
22,490

 
49

 
22,539

 
721

 

 
23,260

Corporate securities
 
19,567

 
(90
)
 
19,477

 
761

 
(125
)
 
20,113

Total HTM fixed income securities
 
$
42,057

 
(41
)
 
42,016

 
1,482

 
(125
)
 
43,373

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.


8

Table of Contents

(b) Information regarding our AFS securities as of June 30, 2018 and December 31, 2017 was as follows:
June 30, 2018
 
 
 
 
 
 
 
 
($ in thousands)
 
Cost/
Amortized
Cost
 
Unrealized
Gains
 
Unrealized
Losses
 
Fair
Value
AFS fixed income securities:
 
 
 
 
 
 
 
 
U.S. government and government agencies
 
$
39,368

 
291

 
(763
)
 
38,896

Foreign government
 
18,024

 
87

 
(129
)
 
17,982

Obligations of states and political subdivisions
 
1,240,487

 
17,622

 
(4,442
)
 
1,253,667

Corporate securities
 
1,630,998

 
6,617

 
(23,131
)
 
1,614,484

Collateralized loan obligations and other asset-backed securities ("CLO and other ABS")
 
768,466

 
4,948

 
(1,817
)
 
771,597

Commercial mortgage-backed securities ("CMBS")
 
457,344

 
258

 
(6,009
)
 
451,593

Residential mortgage-backed securities (“RMBS”)
 
999,050

 
2,726

 
(12,342
)
 
989,434

Total AFS securities
 
$
5,153,737

 
32,549

 
(48,633
)
 
5,137,653

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 1% of amortized cost at both June 30, 2018 and December 31, 2017. Quantitative information regarding unrealized losses on our AFS portfolio is provided below. Our HTM portfolio had $0.3 million of unrealized/unrecognized losses at June 30, 2018, and $0.1 million of unrealized/unrecognized losses at December 31, 2017.
June 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
 
$
28,005

 
(763
)
 

 

 
28,005

 
(763
)
Foreign government
 
7,740

 
(129
)
 

 

 
7,740

 
(129
)
Obligations of states and political subdivisions
 
342,653

 
(4,316
)
 
3,422

 
(126
)
 
346,075

 
(4,442
)
Corporate securities
 
1,147,312

 
(22,989
)
 
2,762

 
(142
)
 
1,150,074

 
(23,131
)
CLO and other ABS
 
427,307

 
(1,813
)
 
774

 
(4
)
 
428,081

 
(1,817
)
CMBS
 
378,523

 
(6,009
)
 

 

 
378,523

 
(6,009
)
RMBS
 
739,217

 
(11,962
)
 
10,895

 
(380
)
 
750,112

 
(12,342
)
Total AFS securities
 
$
3,070,757

 
(47,981
)
 
17,853

 
(652
)
 
3,088,610

 
(48,633
)


9

Table of Contents

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 driven by higher interest rates, with a 65-basis point increase in 2-year U.S. Treasury Note yields and a 45-basis point increase in the 10-year U.S. Treasury Note yields during Six Months 2018. We do not 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. 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 June 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 June 30, 2018:
 
 
AFS
 
HTM
($ in thousands)
 
Fair Value
 
Carrying Value
 
Fair Value
Due in one year or less
 
$
186,138

 
8,309

 
8,383

Due after one year through five years
 
2,034,623

 
27,160

 
28,544

Due after five years through 10 years
 
2,733,420

 
6,547

 
6,446

Due after 10 years
 
183,472

 

 

Total fixed income securities
 
$
5,137,653

 
42,016

 
43,373

  
(e) The following table summarizes our other investment portfolio by strategy:
Other Investments
 
June 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
 
$
59,681

 
110,833

 
170,514

 
52,251

 
99,026

 
151,277

   Private credit
 
40,916

 
89,757

 
130,673

 
37,743

 
94,959

 
132,702

   Real assets
 
23,430

 
36,588

 
60,018

 
25,379

 
27,014

 
52,393

Total alternative investments
 
124,027

 
237,178

 
361,205

 
115,373

 
220,999

 
336,372

Other securities
 
21,176

 

 
21,176

 
16,895

 

 
16,895

Total other investments
 
$
145,203

 
237,178

 
382,381

 
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 six-month periods ended March 31 is included in our Second Quarter and Six Months results. This information is as follows:
Income Statement Information
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in millions)
 
2018
 
2017
 
2018
 
2017
Net investment loss
 
$
(6.4
)

(88.0
)
 
(41.8
)
 
(62.4
)
Realized gains (losses)
 
629.5


(69.2
)
 
1,223.5

 
(304.3
)
Net change in unrealized (depreciation) appreciation
 
(1,200.2
)

1,328.5

 
(738.6
)
 
1,890.0

Net (loss) gain
 
$
(577.1
)

1,171.3

 
443.1

 
1,523.3

Selective’s insurance subsidiaries’ alternative investments gain
 
$
1.9

 
5.2

 
3.5

 
6.8

 
(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 June 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 June 30, 2018:
($ in millions)
 
FHLBI Collateral
 
FHLBNY Collateral
 
State and Regulatory Deposits
 
Total
U.S. government and government agencies
 
$

 

 
22.3

 
22.3

Obligations of states and political subdivisions
 

 

 
3.1

 
3.1

CMBS
 
7.2

 
9.6

 

 
16.8

RMBS
 
58.2

 
79.8

 

 
138.0

Total pledged as collateral
 
$
65.4

 
89.4

 
25.4


180.2

 
(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 June 30, 2018 or December 31, 2017.

(h) The components of pre-tax net investment income earned were as follows:
 
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Fixed income securities
 
$
43,774


37,668

 
$
85,815

 
74,559

Equity securities
 
1,820


1,419

 
3,797

 
2,887

Short-term investments
 
611


377

 
1,134

 
627

Other investments
 
2,094


5,231

 
3,657

 
6,834

Investment expenses
 
(2,746
)

(3,265
)
 
(5,619
)
 
(6,058
)
Net investment income earned
 
$
45,553

 
41,430

 
$
88,784

 
78,849


(i) OTTI charges were $2.8 million and $1.2 million in Second Quarter 2018 and Second Quarter 2017, respectively, and $4.0 million and $4.7 million in Six Months 2018 and Six 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 fair value. 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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Table of Contents

(j) Net realized and unrealized gains and losses (excluding OTTI charges) for Second Quarter and Six Months 2018 and 2017 included the following:
 
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Net realized (losses) gains on the disposals of securities:
 
 
 
 
 
 
 
 
Fixed income securities
 
$
(1,174
)
 
2,606

 
(4,509
)
 
4,570

Equity securities
 
1,226

 
350

 
9,295

 
350

Short-term investments
 
2

 

 
(1
)
 

Other investments
 

 
(5
)
 

 
461

Net realized gains on the disposal of securities
 
54

 
2,951

 
4,785

 
5,381

OTTI charges
 
(2,821
)
 
(1,217
)
 
(4,033
)
 
(4,692
)
Net realized (losses) gains
 
(2,767
)
 
1,734

 
752

 
689

Unrealized gains (losses) recognized in income on equity securities1
 
1,115

 

 
(12,953
)
 

Total net realized and unrealized investment (losses) gains
 
$
(1,652
)
 
1,734

 
$
(12,201
)
 
689

1Includes unrealized holding gains (losses) of: (i) $2.3 million in Second Quarter 2018 and $(2.7) million in Six Months 2018 on equity securities remaining in our portfolio as of June 30, 2018; and (ii) $(1.2) million in Second Quarter 2018 and $(10.3) million in Six Months 2018 on equity securities sold during the period.

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

 
44

 
2

 
44

Losses
 

 

 

 
(1
)
AFS fixed income securities
 
 

 
 

 
 
 
 
Gains
 
1,971

 
2,715

 
4,594

 
6,267

Losses
 
(3,145
)
 
(153
)
 
(9,105
)
 
(1,740
)
Equity securities
 
 

 
 

 
 
 
 
Gains
 
1,226

 
350

 
9,625

 
350

Losses
 

 

 
(330
)
 

Short-term investments
 
 
 
 
 
 
 
 
Gains
 
2

 

 
3

 
2

Losses
 

 

 
(4
)
 
(2
)
Other investments
 
 
 
 
 
 
 
 
Gains
 

 

 

 
480

      Losses
 


(5
)
 

 
(19
)
Total net realized gains on disposals of securities
 
$
54


2,951

 
4,785

 
5,381


Realized gains and losses on the sale of investments are determined on the basis of the cost of the specific investments sold. Net realized gains in Second Quarter and Six Months 2018 were primarily driven by opportunistic sales in our equity portfolio and higher trading volume in our fixed income securities portfolio. Proceeds from the sales of AFS fixed income securities were $262.9 million and $122.3 million in Second Quarter 2018 and Second Quarter 2017, respectively, and $938.3 million and $717.1 million in Six Months 2018 and Six Months 2017, respectively. Proceeds from the sales of equity securities were $2.9 million and $0.8 million in Second Quarter 2018 and Second Quarter 2017, respectively, and $43.6 million and $6.3 million in Six Months 2018 and Six 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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Table of Contents


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 Six 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 June 30, 2018 and December 31, 2017:
June 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
 
$
38,896

 
22,479

 
16,417

 

Foreign government
 
17,982

 

 
17,982

 

Obligations of states and political subdivisions
 
1,253,667

 

 
1,253,667

 

Corporate securities
 
1,614,484

 

 
1,614,484

 

CLO and other ABS
 
771,597

 

 
768,408

 
3,189

CMBS
 
451,593

 

 
451,593

 

RMBS
 
989,434

 

 
989,434

 

Total AFS fixed income securities
 
5,137,653

 
22,479

 
5,111,985

 
3,189

Equity securities:
 
 
 
 
 
 
 
 
Common stock2
 
172,157

 
145,038

 

 

Preferred stock
 
4,421

 
4,421

 

 

Total equity securities
 
176,578

 
149,459

 

 

Short-term investments
 
164,118

 
163,120

 
998

 

Total assets measured at fair value
 
$
5,478,349

 
335,058

 
5,112,983


3,189

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 $27.1 million at June 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.

13

Table of Contents


There were no material changes in the fair value of securities measured using Level 3 prices in Six Months 2017. The following table provides a summary of Level 3 changes in Six Months 2018:
June 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:
 
 
 
 
 
Other comprehensive income ("OCI")

 

 

Net income

 

 

Purchases

 

 
3,189

Sales

 

 

Issuances

 

 

Settlements

 

 

Transfers into Level 3

 

 

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

Fair value, June 30, 2018
$

 

 
3,189


The following tables provide quantitative information regarding our financial assets and liabilities that were disclosed at fair value at June 30, 2018 and December 31, 2017:
June 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
 
$
23,260

 

 
23,260

 

Corporate securities
 
20,113

 

 
11,628

 
8,485

Total HTM fixed income securities
 
$
43,373

 

 
34,888

 
8,485

 
 
 
 
 
 
 
 
 
Financial Liabilities
 
 

 
 

 
 

 
 

Long-term debt:
 
 
 
 
 
 
 
 
7.25% Senior Notes
 
$
57,231

 

 
57,231

 

6.70% Senior Notes
 
108,453

 

 
108,453

 

5.875% Senior Notes
 
186,924

 
186,924

 

 

1.61% borrowings from FHLBNY
 
23,979

 

 
23,979

 

1.56% borrowings from FHLBNY
 
23,915

 

 
23,915

 

3.03% borrowings from FHLBI
 
58,483

 

 
58,483

 

Total long-term debt
 
$
458,985

 
186,924

 
272,061

 



14

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 June 30,
 
Six Months ended June 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Premiums written:
 
 

 
 

 
 

 
 

Direct
 
$
753,363

 
706,408

 
$
1,467,597

 
1,390,228

Assumed
 
6,536

 
6,488

 
12,807

 
12,179

Ceded
 
(104,651
)
 
(99,082
)
 
(200,596
)
 
(189,889
)
Net
 
$
655,248

 
613,814

 
$
1,279,808

 
1,212,518

Premiums earned:
 
 

 
 

 
 

 
 

Direct
 
$
696,723

 
654,588

 
$
1,380,456

 
1,301,316

Assumed
 
6,612

 
6,063

 
12,736

 
11,842

Ceded
 
(98,499
)
 
(92,621
)
 
(196,528
)
 
(184,274
)
Net
 
$
604,836

 
568,030

 
$
1,196,664

 
1,128,884

Loss and loss expenses incurred:
 
 

 
 

 
 

 
 

Direct
 
$
391,014

 
389,550

 
$
811,930

 
731,672

Assumed
 
2,364

 
7,766

 
10,368

 
12,203

Ceded
 
(27,050
)
 
(55,757
)
 
(71,029
)
 
(84,844
)
Net
 
$
366,328

 
341,559

 
$
751,269

 
659,031


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 June 30,
 
Six Months ended June 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Ceded premiums written
 
$
(66,341
)
 
(63,808
)
 
$
(123,010
)
 
(120,142
)
Ceded premiums earned
 
(60,143
)
 
(57,655
)
 
(119,134
)
 
(114,932
)
Ceded loss and loss expenses incurred
 
(10,261
)
 
(15,140
)
 
(25,980
)
 
(21,681
)

15

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:
 
 
Six Months ended June 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
 
756,855

 
684,877

Prior years
 
(5,586
)
 
(25,846
)
Total incurred loss and loss expense
 
751,269

 
659,031

Paid loss and loss expense for claims occurring in the:
 
 

 
 

Current year
 
214,169

 
171,724

Prior years
 
457,441

 
425,521

Total paid loss and loss expense
 
671,610

 
597,245

Net reserve for loss and loss expense, at end of period
 
3,265,044

 
3,142,305

Add: Reinsurance recoverable on unpaid loss and loss expense, at end of period
 
539,321

 
588,916

Gross reserve for loss and loss expense at end of period
 
$
3,804,365

 
3,731,221


The $72.0 million increase in current year loss and loss expense incurred illustrated in the table above was primarily driven by non-catastrophe property losses, as well as an increase in exposure due to premium growth. Non-catastrophe property losses, which increased $44.0 million, to $188.7 million, in Six Months 2018, were principally related to the early January deep freeze in our footprint states and a relatively large number of severe fire losses.

Prior year development in Six Months 2018 of $5.6 million included $12.0 million of favorable casualty development partially offset by $6.4 million of unfavorable property development. The favorable casualty development included $33.0 million of development in our workers compensation line of business, partially offset by unfavorable development of $15.0 million in our commercial automobile line of business and $6.0 million in our excess and surplus ("E&S") casualty lines.

Prior year development in Six Months 2017 of $25.8 million was primarily driven by favorable prior year casualty reserve development of $37.4 million in our general liability line of business and $15.3 million in our workers compensation line of business. This was partially offset by unfavorable development of $21.0 million in our commercial automobile line of business 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.


16

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 June 30,
 
Six Months ended June 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Standard Commercial Lines:
 
 

 
 

 
 
 
 
Net premiums earned:
 
 

 
 

 
 
 
 
Commercial automobile
 
$
122,104

 
108,316

 
240,335

 
215,445

Workers compensation
 
80,021

 
79,460

 
158,844

 
158,786

General liability
 
153,002

 
141,503

 
302,831

 
281,487

Commercial property
 
82,162

 
78,052

 
162,488

 
154,443

Businessowners’ policies
 
25,829

 
24,989

 
51,420

 
49,834

Bonds
 
8,335

 
6,986

 
16,469

 
13,484

Other
 
4,559

 
4,288

 
8,989

 
8,529

Miscellaneous income
 
2,882

 
3,016

 
4,708

 
5,876

Total Standard Commercial Lines revenue
 
478,894

 
446,610

 
946,084

 
887,884

Standard Personal Lines:
 
 
 
 
 
 
 
 
Net premiums earned:
 
 
 
 
 
 
 
 
Personal automobile
 
41,810

 
37,663

 
82,252

 
74,613

Homeowners
 
32,223

 
32,467

 
64,424

 
65,167

Other
 
1,644

 
1,542

 
3,257

 
3,093

Miscellaneous income
 
297

 
275

 
649

 
656

Total Standard Personal Lines revenue
 
75,974

 
71,947

 
150,582

 
143,529

E&S Lines:
 
 
 
 
 
 
 
 
Net premiums earned:
 
 
 
 
 
 
 
 
Casualty lines
 
39,379

 
39,054

 
77,919

 
76,966

Property lines
 
13,768

 
13,710

 
27,436

 
27,037

Miscellaneous income
 

 

 
1

 

Total E&S Lines revenue
 
53,147

 
52,764

 
105,356

 
104,003

Investments:
 
 

 
 

 
 

 
 

Net investment income
 
45,553

 
41,430

 
88,784

 
78,849

Net realized and unrealized investment (losses) gains
 
(1,652
)
 
1,734

 
(12,201
)
 
689

Total Investments revenue
 
43,901

 
43,164

 
76,583

 
79,538

Total revenues
 
$
651,916

 
614,485

 
1,278,605

 
1,214,954

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

 
 

 
 
 
 
Underwriting gain, before federal income tax
 
$
41,016

 
34,759

 
47,820

 
77,305

Underwriting gain, after federal income tax
 
32,403

 
22,593

 
37,778

 
50,248

Combined ratio
 
91.4
%
 
92.2

 
94.9

 
91.2

 
 
 
 


 


 


Standard Personal Lines:
 
 
 
 
 
 
 
 
Underwriting gain (loss), before federal income tax
 
$
4,805

 
(5,768
)
 
3,299

 
(662
)
Underwriting gain (loss), after federal income tax
 
3,796

 
(3,749
)
 
2,606

 
(430
)
Combined ratio
 
93.7
%
 
108.0

 
97.8

 
100.5

 
 
 
 
 
 
 
 
 
E&S Lines:
 
 
 
 
 
 
 
 
Underwriting (loss) gain, before federal income tax
 
$
(7,789
)
 
1,319

 
(8,354
)
 
2,889

Underwriting (loss) gain, after federal income tax
 
(6,154
)
 
857

 
(6,600
)
 
1,878

Combined ratio
 
114.7
%
 
97.5

 
107.9

 
97.2

 
 
 
 
 
 
 
 
 
Investments:
 
 

 
 

 
 
 
 
Net investment income
 
$
45,553

 
41,430

 
88,784

 
78,849

Net realized and unrealized investment (losses) gains
 
(1,652
)
 
1,734

 
(12,201
)
 
689

Total investment income, before federal income tax
 
43,901

 
43,164

 
76,583

 
79,538

Tax on investment income
 
7,617

 
11,734

 
12,843

 
21,336

      Total investment income, after federal income tax

$
36,284


31,430

 
63,740

 
58,202


17

Table of Contents

Reconciliation of Segment Results to Income Before Federal Income Tax
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Underwriting gain (loss)
 
 
 
 
 
 
 
 
Standard Commercial Lines
 
$
41,016

 
34,759

 
47,820

 
77,305

Standard Personal Lines
 
4,805

 
(5,768
)
 
3,299

 
(662
)
E&S Lines
 
(7,789
)
 
1,319

 
(8,354
)
 
2,889

Investment income
 
43,901

 
43,164

 
76,583

 
79,538

Total all segments
 
81,933

 
73,474

 
119,348

 
159,070

Interest expense
 
(6,125
)
 
(6,081
)
 
(12,277
)
 
(12,187
)
Corporate expenses
 
(3,283
)
 
(8,464
)
 
(14,615
)
 
(20,380
)
Income, before federal income tax
 
$
72,525

 
58,929


92,456

 
126,503


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 June 30,
 
Six Months ended June 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Net Periodic Benefit Cost:
 
 
 
 
 
 
 
 
Interest cost
 
$
3,095

 
3,110

 
6,190

 
6,221

Expected return on plan assets
 
(5,681
)
 
(4,855
)
 
(11,363
)
 
(9,709
)
Amortization of unrecognized net actuarial loss
 
493

 
482

 
987

 
963

Total net periodic benefit cost1
 
$
(2,093
)
 
(1,263
)
 
(4,186
)
 
(2,525
)
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
 
 
Six Months ended June 30,
 
 
2018
 
2017
Weighted-Average Expense Assumptions:
 
 
 
 
Discount rate
 
3.78
%
 
4.41
%
Effective interest rate for calculation of interest cost
 
3.46

 
3.84

Expected return on plan assets
 
6.36

 
6.24



18

Table of Contents

NOTE 11. Comprehensive Income
The components of comprehensive income, both gross and net of tax, for Second Quarter and Six Months 2018 and 2017 are as follows:
Second Quarter 2018
 
 
 
 
 
 
($ in thousands)
 
Gross
 
Tax
 
Net
Net income
 
$
72,525

 
13,706

 
58,819

Components of other comprehensive loss:
 
 

 
 

 
 

Unrealized losses on investment securities:
 
 

 
 

 
 

Unrealized holding losses during period
 
(23,993
)
 
(5,038
)
 
(18,955
)
Amounts reclassified into net income:
 
 
 
 
 
 
HTM securities
 
(8
)
 
(2
)
 
(6
)
Realized losses on disposals of AFS securities
 
2,870

 
603

 
2,267

    Total unrealized losses on investment securities
 
(21,131
)
 
(4,437
)
 
(16,694
)
Defined benefit pension and post-retirement plans:
 
 

 
 

 
 

Amounts reclassified into net income:
 
 

 
 

 
 

Net actuarial loss
 
531

 
111

 
420

    Total defined benefit pension and post-retirement plans
 
531

 
111

 
420

Other comprehensive loss
 
(20,600
)
 
(4,326
)
 
(16,274
)
Comprehensive income
 
$
51,925

 
9,380

 
42,545

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Second Quarter 2017
 
 
 
 
 
 
($ in thousands)
 
Gross
 
Tax
 
Net
Net income
 
$
58,929

 
17,503

 
41,426

Components of OCI:
 
 

 
 

 
 

Unrealized gains on investment securities:
 
 

 
 

 
 

Unrealized holding gains during period
 
35,887

 
12,561

 
23,326

Non-credit portion of OTTI recognized in OCI
 
6

 
2

 
4

Amounts reclassified into net income:
 
 
 
 
 
 
HTM securities
 
(43
)
 
(15
)
 
(28
)
Realized gains on disposals of AFS securities
 
(1,885
)
 
(660
)
 
(1,225
)
    Total unrealized gains on investment securities
 
33,965

 
11,888

 
22,077

Defined benefit pension and post-retirement plans:
 
 

 
 

 
 

Amounts reclassified into net income:
 
 

 
 

 
 

Net actuarial loss
 
508

 
178

 
330

    Total defined benefit pension and post-retirement plans
 
508

 
178

 
330

Other comprehensive income
 
34,473

 
12,066

 
22,407

Comprehensive income
 
$
93,402

 
29,569

 
63,833


19

Table of Contents

Six Months 2018
 
 
 
 
 
 
($ in thousands)
 
Gross
 
Tax
 
Net
Net income
 
$
92,456

 
14,712

 
77,744

Components of other comprehensive loss:
 
 

 
 

 
 

Unrealized losses on investment securities:
 
 

 
 

 
 

Unrealized holding losses during period
 
(109,308
)
 
(22,955
)
 
(86,353
)
Amounts reclassified into net income:
 
 
 
 
 
 
HTM securities
 
(20
)
 
(4
)
 
(16
)
Realized losses on disposals of AFS securities
 
7,419

 
1,558

 
5,861

    Total unrealized losses on investment securities
 
(101,909
)
 
(21,401
)
 
(80,508
)
Defined benefit pension and post-retirement plans:
 
 

 
 

 
 

Amounts reclassified into net income:
 
 

 
 
 
 
Net actuarial loss
 
1,063

 
223

 
840

    Total defined benefit pension and post-retirement plans
 
1,063

 
223

 
840

Other comprehensive loss
 
(100,846
)
 
(21,178
)
 
(79,668
)
Comprehensive loss
 
$
(8,390
)
 
(6,466
)
 
(1,924
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months 2017
 
 
 
 
 
 
($ in thousands)
 
Gross
 
Tax
 
Net
Net income
 
$
126,503

 
34,637

 
91,866

Components of OCI:
 
 

 
 
 
 
Unrealized gains on investment securities:
 
 

 
 
 
 
Unrealized holding gains during period
 
61,672

 
21,585

 
40,087

Non-credit portion of OTTI recognized in OCI
 
6

 
2

 
4

Amounts reclassified into net income:
 
 
 
 
 
 
HTM securities
 
(92
)
 
(32
)
 
(60
)
Realized gains on disposals of AFS securities
 
(375
)
 
(131
)
 
(244
)
    Total unrealized gains on investment securities
 
61,211

 
21,424

 
39,787

Defined benefit pension and post-retirement plans:
 
 

 
 

 
 

Amounts reclassified into net income:
 
 

 
 
 
 
Net actuarial loss
 
1,015

 
355

 
660

    Total defined benefit pension and post-retirement plans
 
1,015

 
355

 
660

Other comprehensive income
 
62,226

 
21,779

 
40,447

Comprehensive income
 
$
188,729

 
56,416

 
132,313


The balances of, and changes in, each component of AOCI (net of taxes) as of June 30, 2018 were as follows:
June 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
 

 

 
(86,353
)
 
(86,353
)
 

 
(86,353
)
Amounts reclassified from AOCI
 

 
(16
)
 
5,861

 
5,845

 
840

 
6,685

Net current period OCI
 

 
(16
)
 
(80,492
)
 
(80,508
)
 
840

 
(79,668
)
Balance, June 30, 2018
 
$
(71
)
 
(32
)
 
(12,636
)
 
(12,739
)
 
(71,778
)
 
(84,517
)


20

Table of Contents

The reclassifications out of AOCI were as follows:
 
Quarter ended June 30,
 
Six Months ended June 30,
Affected Line Item in the Unaudited Consolidated Statements of Income
($ in thousands)
2018
 
2017
 
2018
 
2017
HTM related
 
 
 
 
 
 
 
 
Unrealized losses on HTM disposals
$
(7
)
 
17

 
(6
)
 
30

Net realized and unrealized (losses) gains
Amortization of net unrealized gains on HTM securities
(1
)
 
(60
)
 
(14
)
 
(122
)
Net investment income earned
 
(8
)
 
(43
)
 
(20
)
 
(92
)
Income before federal income tax
 
2

 
15

 
4

 
32

Total federal income tax expense
 
(6
)
 
(28
)
 
(16
)
 
(60
)
Net income
Realized losses (gains) on AFS and OTTI
 
 
 
 
 
 
 
 
Realized losses (gains) on AFS disposals and OTTI
2,870

 
(1,885
)
 
7,419

 
(375
)
Net realized and unrealized (losses) gains
 
2,870

 
(1,885
)
 
7,419

 
(375
)
Income before federal income tax
 
(603
)
 
660

 
(1,558
)
 
131

Total federal income tax expense
 
2,267

 
(1,225
)
 
5,861

 
(244
)
Net income
Defined benefit pension and post-retirement life plans
 
 
 
 
 
 
 
 
Net actuarial loss
113

 
111

 
225

 
221

Loss and loss expense incurred
 
418

 
397

 
838

 
794

Other insurance expenses
Total defined benefit pension and post-retirement life
531

 
508

 
1,063

 
1,015

Income before federal income tax
 
(111
)
 
(178
)
 
(223
)
 
(355
)
Total federal income tax expense
 
420

 
330

 
840

 
660

Net income
 
 
 
 
 
 
 
 
 
Total reclassifications for the period
$
2,681

 
(923
)
 
6,685

 
356

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.
  
During 2018, 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 June 30,
 
Six Months ended June 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Statutory tax rate
 
21
%
 
35

 
21

 
35

Tax at statutory rate
 
$
15,231

 
20,625

 
19,416

 
44,276

Tax-advantaged interest
 
(1,393
)
 
(2,757
)
 
(2,904
)
 
(5,564
)
Dividends received deduction
 
(210
)
 
(625
)
 
(336
)
 
(956
)
Stock-based compensation
 
(82
)
 
(374
)
 
(2,548
)
 
(3,323
)
Other
 
160

 
634

 
1,084

 
204

Federal income tax expense
 
$
13,706

 
17,503

 
14,712

 
34,637



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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 June 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 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.

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").


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Table of Contents

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 second quarters ended June 30, 2018 (“Second Quarter 2018”) and June 30, 2017 (“Second Quarter 2017”) and the six-month periods ended June 30, 2018 ("Six Months 2018") and June 30, 2017 ("Six 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.
 
Financial Highlights of Results for Second Quarter and Six Months 2018 and Second Quarter and Six Months 20171 
($ and shares in thousands, except per share amounts)
 
Quarter ended June 30,
 
Change
% or Points
 
 
Six Months ended June 30,
 
Change
% or Points
 
 
2018
 
2017
 
 
 
2018
 
2017
 
 
Revenues
 
$
651,916

 
614,485

 
6

%
 
$
1,278,605

 
1,214,954

 
5

%
After-tax net investment income
 
37,589

 
30,303

 
24

 
 
73,379

 
57,754

 
27

 
After-tax underwriting income
 
30,045

 
19,702

 
52

 
 
33,784

 
51,696

 
(35
)
 
Net income before federal income tax
 
72,525

 
58,929

 
23

 
 
92,456

 
126,503

 
(27
)
 
Net income
 
58,819

 
41,426

 
42

 
 
77,744

 
91,866

 
(15
)
 
Diluted net income per share
 
0.99

 
0.70

 
41

 
 
1.30

 
1.55

 
(16
)
 
Diluted weighted-average outstanding shares
 
59,597

 
59,222

 
1

 
 
59,579

 
59,185

 
1

 
Combined ratio
 
93.7
%
 
94.7

 
(1.0
)
pts 
 
96.4
%
 
93.0

 
3.4

pts 
Invested assets per dollar of stockholders' equity
 
$
3.34

 
3.33

 

%
 
$
3.34

 
3.33

 

%
After-tax yield on investments
 
2.7
%
 
2.2

 
0.5

pts
 
2.6
%
 
2.1

 
0.5

pts
Annualized return on average equity ("ROE")
 
14.0

 
10.2

 
3.8

 
 
9.1

 
11.5

 
(2.4
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-Generally Accepted Accounting Principles ("GAAP") operating income2
 
$
60,124

 
40,299

 
49

%
 
$
87,383

 
91,418

 
(4
)
%
Diluted non-GAAP operating income per share2
 
1.01

 
0.68

 
49

 
 
1.46

 
1.54

 
(5
)
 
Annualized non-GAAP operating ROE2
 
14.3
%
 
9.9

 
4.4

pts 
 
10.2
%
 
11.5

 
(1.3
)
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.


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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 June 30,
 
Six Months ended June 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Net income
 
$
58,819

 
41,426

 
77,744

 
91,866

Net realized losses (gains) and OTTI
 
2,767

 
(1,734
)
 
(752
)
 
(689
)
Net unrealized (gains) losses recognized in income on equity securities
 
(1,115
)
 

 
12,953

 

Net realized (gains) losses, OTTI, and unrealized (gains) losses
 
1,652

 
(1,734
)
 
12,201

 
(689
)
Tax expense (benefit)
 
(347
)
 
607

 
(2,562
)
 
241

Non-GAAP operating income
 
$
60,124

 
40,299

 
87,383

 
91,418

Reconciliation of net income per share to non-GAAP operating income per share
 
Quarter ended June 30,
 
Six Months ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Diluted net income per share
 
$
0.99

 
0.70

 
1.30

 
1.55

Net realized losses (gains) and OTTI
 
0.05

 
(0.03
)
 
(0.01
)
 
(0.01
)
Net unrealized (gains) losses recognized in income on equity securities
 
(0.02
)
 

 
0.21

 

Net realized (gains) losses, OTTI, and unrealized (gains) losses
 
0.03

 
(0.03
)
 
0.20

 
(0.01
)
Tax expense (benefit)
 
(0.01
)
 
0.01

 
(0.04
)
 

Diluted non-GAAP operating income per share
 
$
1.01

 
0.68

 
1.46

 
1.54

Reconciliation of annualized ROE to annualized non-GAAP operating ROE
 
Quarter ended June 30,
 
Six Months ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Insurance operations
 
7.2
 %
 
4.9

 
4.0

 
6.5

Investment income1
 
9.0

 
7.5

 
8.6

 
7.3

Other
 
(1.9
)
 
(2.5
)
 
(2.4
)
 
(2.3
)
Net realized (losses) gains and OTTI
 
(0.7
)
 
0.4

 
0.1

 
0.1

Net unrealized gains (losses) recognized in income on equity securities
 
0.3

 

 
(1.5
)
 

Total net realized (losses) gains, OTTI, and unrealized gains (losses)1
 
(0.4
)
 
0.4

 
(1.4
)
 
0.1

Tax on net realized losses (gains), OTTI, and unrealized (gains) losses1
 
0.1

 
(0.1
)
 
0.3

 
(0.1
)
Annualized ROE
 
14.0
 %
 
10.2

 
9.1

 
11.5

 
 
 
 
 
 
 
 
 
Annualized ROE
 
14.0

 
10.2

 
9.1

 
11.5

Net realized losses (gains) and OTTI
 
0.7

 
(0.4
)
 
(0.1
)
 
(0.1
)
Net unrealized (gains) losses recognized in income on equity securities
 
(0.3
)
 

 
1.5

 

Net realized (gains) losses, OTTI, and unrealized (gains) losses
 
0.4

 
(0.4
)
 
1.4

 
(0.1
)
Tax expense (benefit)
 
(0.1
)
 
0.1

 
(0.3
)
 
0.1

Annualized non-GAAP operating ROE
 
14.3
 %
 
9.9

 
10.2

 
11.5

1 Investment segment results are the combination of "Net investment income earned," "Net realized and unrealized losses," and "Tax on net realized and unrealized losses."

After the severe winter weather losses incurred in the first quarter of 2018, our strong results in Second Quarter 2018 resulted in a 14.0% annualized ROE for Second Quarter 2018 and a 9.1% annualized ROE for Six Months 2018. The 3.8-point increase in annualized ROE in Second Quarter 2018 compared to Second Quarter 2017 was driven by: (i) an improvement in underwriting results, as the combined ratio was lower by 1.0 points in Second Quarter 2018 compared to Second Quarter 2017; (ii) an increase in investment income due to higher yields on our fixed income securities portfolio; (iii) a decrease in other expenses, as Second Quarter 2018 included a benefit related to stock compensation expense as a result of stock price fluctuations that have impacted the fair value of our liability awards; and (iv) a 1.9-point benefit from the lower corporate tax rate provided for in the Tax Cuts and Jobs Act of 2017 ("Tax Reform"). The 2.4-point decrease in annualized ROE in Six Months 2018 compared to Six Months 2017 reflects: (i) a 3.4-point increase in our combined ratio from 93.0% in Six Months 2017 to 96.4% in Six Months 2018; and (ii) the impact of net unrealized losses on equity securities in our income statement; partially offset by a 0.9-point benefit from the lower corporate tax rate provided for in Tax Reform. The combined ratio increase was primarily driven by non-catastrophe property losses that were 3.0 points higher than Six Months 2017, mostly due to the severe winter weather and a relatively large number of severe fire losses in the first quarter of 2018.

Our Second Quarter and Six Months 2018 results continue to reflect our efforts to: (i) achieve renewal pure price increases at the account level within our Standard Commercial Lines segment and overall rate level increases in our Standard Personal Lines and E&S segments; (ii) generate new business; and (iii) improve the underlying profitability of our business through various underwriting and claims initiatives. Our net premiums written ("NPW") growth of 7% for Second Quarter 2018 and 6% for Six Months 2018 was aided by the net appointment of 109 retail agents in 2017 and 66 retail agents in Six Months 2018, excluding agency consolidations. Included in these net appointments were 26 agents that were appointed in our new states of

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Table of Contents

Arizona and New Hampshire in 2017 and 12 agents that were appointed in Arizona, New Hampshire, and Colorado in Six Months 2018.

In addition to the cumulative renewal pure price increases we have achieved over the past several years, we have driven underwriting and claims process enhancements, and have improved our mix of business based on expected future profitability. For example, our workers compensation book of business, which represents approximately 17% 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; and (ii) better outcomes driven by our workers compensation strategic case unit. In addition, we continue to work towards an improved mix of business in this line, that shifts towards lower hazard and smaller accounts from higher hazard and larger accounts. For a full discussion of the claims initiatives that 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.

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 Second Quarter and Six Months 2018, we recorded unfavorable prior year casualty reserve development of $7.0 million and $15.0 million, respectively, mainly for accident years 2015 through 2017. The industry-wide statutory combined ratio for 2018 is expected to average approximately 112% as the industry has been experiencing higher than expected claim frequencies largely due to increased miles driven as a result of lower unemployment, lower gasoline prices, and an increase in distracted driving. Our combined ratio was 108.8% for Second Quarter 2018 and 110.0% for Six Months 2018. We achieved renewal pure price increases on this line of 7.5% in Second Quarter 2018 and 7.4% in Six 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.

Our E&S Lines segment also remains a focus area, with a combined ratio of 114.7% for Second Quarter 2018 and 107.9% for Six Months 2018. We face a competitive environment in this segment, and our pricing and underwriting initiatives aimed at improving profitability have resulted in a decline in new business volume. To improve our profitability, we have increased new and renewal pricing, implemented business mix changes, and enhanced claims management practices. We expect continued pressure on NPW growth in this segment until we achieve our risk-adjusted return expectations.

Pre-tax net investment income grew 10% in Second Quarter 2018 and 13% in Six Months 2018 compared to the same prior year periods, driven by higher yields on our fixed income securities portfolio. We have continued to diversify our exposure to risk assets and move towards a long-term allocation of approximately 10% of total invested assets. Risk assets, which principally include public equities, high-yield fixed income securities, and private assets, represented 7.6% of our total invested assets at June 30, 2018.

We generated an annualized non-GAAP operating ROE of 14.3% in Second Quarter 2018 and 10.2% in Six Months 2018, compared to 9.9% in Second Quarter 2017 and 11.5% in Six Months 2017. The 4.4-point increase in Second Quarter 2018 compared to Second Quarter 2017 was mainly due to the increase in underwriting income and investment income, as discussed above. The 1.3-point decrease in Six Months 2018 compared to Six Months 2017 was mainly due to lower levels of underwriting income as discussed above, partially offset by an increase in investment income.

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Table of Contents

Insurance Operations
The key metric in understanding our insurance segments’ contribution to annualized non-GAAP operating ROE is the GAAP combined ratio. The following table provides a quantitative foundation for analyzing this ratio:
All Lines
 
Quarter ended June 30,
 
Change % or Points
 
 
Six Months ended June 30,
 
Change % or Points
 
($ in thousands)
 
2018
 
2017
 
 
 
2018
 
2017
 
 
Insurance Operations Results:
 
 
 
 
 
 
 
 
 
 
 
 
NPW
 
$
655,248

 
613,814

 
7

%
 
$
1,279,808

 
1,212,518

 
6

%
Net premiums earned (“NPE”)
 
604,836

 
568,030

 
6

 
 
1,196,664

 
1,128,884

 
6

 
Less:
 
 
 
 

 
 
 
 
 
 
 
 
 
 
Loss and loss expense incurred
 
366,328

 
341,559

 
7

 
 
751,269

 
659,031

 
14

 
Net underwriting expenses incurred
 
198,899

 
194,237

 
2

 
 
398,646

 
388,494

 
3

 
Dividends to policyholders
 
1,577

 
1,924

 
(18
)
 
 
3,984

 
1,827

 
118

 
Underwriting income
 
$
38,032

 
30,310

 
25

%
 
$
42,765

 
79,532

 
(46
)
%
Combined Ratios:
 
 
 
 

 
 
 
 
 
 
 
 
 
 
Loss and loss expense ratio
 
60.5

%
60.2

 
0.3

pts 
 
62.8

%
58.4

 
4.4

pts 
Underwriting expense ratio
 
32.9

 
34.2

 
(1.3
)
 
 
33.3

 
34.4

 
(1.1
)
 
Dividends to policyholders ratio
 
0.3

 
0.3

 

 
 
0.3

 
0.2

 
0.1

 
Combined ratio
 
93.7

 
94.7

 
(1.0
)
 
 
96.4

 
93.0

 
3.4

 

The loss and loss expense ratio increased 0.3 points in Second Quarter 2018 and increased 4.4 points in Six Months 2018 compared to the same prior year periods, driven by the following:
 
Second Quarter 2018
 
Second 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
$
18.7

3.1

pts
 
$
29.3

5.2

pts
(2.1
)
pts
(Favorable) prior year casualty reserve development
(4.0
)
(0.7
)
 
 
(14.3
)
(2.5
)
 
1.8

 
Non-catastrophe property losses
82.9

13.7

 
 
73.3

12.9

 
0.8

 
Total
97.6

16.1

 
 
88.3

15.6

 
0.5

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months 2018
 
Six 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
$
44.8

3.7

pts
 
$
41.5

3.7

pts

pts
(Favorable) prior year casualty reserve development
(12.0
)
(1.0
)
 
 
(28.7
)
(2.5
)
 
1.5

 
Non-catastrophe property losses
188.7

15.8

 
 
144.7

12.8

 
3.0

 
Total
221.5

18.5

 
 
157.5

14.0

 
4.5

 

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Details of the prior year casualty reserve development were as follows:
(Favorable)/Unfavorable Prior Year Casualty Reserve Development
Quarter ended June 30,
 
Six Months ended June 30,
($ in millions)
2018
 
2017
 
2018
 
2017
General liability
$

 
(15.0
)
 

 
(37.4
)
Commercial automobile
7.0

 
15.0

 
15.0

 
21.0

Workers compensation
(17.0
)
 
(15.3
)
 
(33.0
)
 
(15.3
)
Bonds

 
(2.0
)
 

 
(2.0
)
   Total Standard Commercial Lines
(10.0
)
 
(17.3
)
 
(18.0
)
 
(33.7
)
 
 
 
 
 
 
 
 
Homeowners

 
1.0

 

 
1.0

Personal automobile

 
2.0

 

 
4.0

   Total Standard Personal Lines

 
3.0

 

 
5.0

 
 
 
 
 
 
 
 
E&S
6.0

 

 
6.0

 

 
 
 
 
 
 
 
 
Total (favorable) prior year casualty reserve development
$
(4.0
)
 
(14.3
)
 
(12.0
)
 
(28.7
)
 
 
 
 
 
 
 
 
(Favorable) impact on loss ratio
(0.7
)
pts
(2.5
)
 
(1.0
)
 
(2.5
)

The underwriting expense ratio decreased 1.3 points and 1.1 points in Second Quarter and Six Months 2018 compared to the same prior year periods due to the following:

A 0.8-point and 0.6-point decrease in employee-related expenses in Second Quarter 2018 and Six Months 2018, respectively. These decreases included a reduction in profit-based compensation to our employees of 0.3 points in the quarter and 0.2 points in the year-to-date period.

A 0.3-point decrease in supplemental commissions to our distribution partners in both periods compared to Second Quarter 2017 and Six Months 2017.

For a qualitative discussion of this reserve development, please refer to the respective insurance segment section below in
"Results of Operations and Related Information by Segment."

Other
Our interest and other corporate expenses, which are primarily comprised of stock compensation expense at the holding company level, contributed an annualized ROE of (1.9) points in Second Quarter 2018, and (2.4) points in Six Months 2018 compared to (2.5) points in Second Quarter 2017 and (2.3) points in Six Months 2017. The quarter-to-date variance was driven primarily by a 1.6-point decrease in stock compensation expense as a result of stock price fluctuations that have impacted the fair value of our liability awards.

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%. A.M. Best also estimates 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 increase 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 the claim payments that are made during the current year, as well as estimates of the loss and loss expense reserves for claims to be settled 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

27

Table of Contents

Commercial Lines business in 25 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.

In 2017, we opened Arizona and New Hampshire for Standard Commercial Lines business, and effective January 1, 2018, we started writing Standard Commercial Lines business in Colorado. We have appointed an aggregate of 38 agents in these states, with appointments controlling approximately 10%-20% of that state's available Standard Commercial Lines premium. We expect to open New Mexico and Utah for Standard Commercial Lines business and Arizona and Utah for Standard Personal Lines business by the end 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 continue to expand the use of 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 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 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 $88.8 million in Six Months 2018, which was a 13% 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 active investment management and security selection, principally in our core fixed income portfolio. Risk assets, which principally include high-yield fixed income securities, equities, and our alternative investment portfolio, were 7.6% of our overall portfolio as of June 30, 2018, which is consistent with year-end 2017. We have been gradually diversifying our portfolio, and will likely continue to modestly increase our risk asset allocation over time, up to approximately 10% of our invested assets, depending on market conditions.

After Second Quarter 2018 results, we are confirming our full-year 2018 guidance, which is the following:
A GAAP combined ratio, excluding catastrophe losses, of 92.0%. This assumes no additional prior year casualty reserve development;
Catastrophe losses of 3.5 points;
After-tax net investment income of $150 million, which includes $8 million of after-tax net investment income from our alternative investments;
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.


28

Table of Contents

Results of Operations and Related Information by Segment

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

 
 

 
 

 
 
 
 
 
 
 
 
NPW
 
$
514,930

 
478,917

 
8

%
 
$
1,024,006

 
962,465

 
6

%
NPE
 
476,012

 
443,594

 
7

 
 
941,376

 
882,008

 
7

 
Less:
 
 
 
  

 
 

 
 
 
 
  
 
 
 
Loss and loss expense incurred
 
273,934

 
252,876

 
8

 
 
567,440

 
494,440

 
15

 
Net underwriting expenses incurred
 
159,485

 
154,035

 
4

 
 
322,132

 
308,436

 
4

 
Dividends to policyholders
 
1,577

 
1,924

 
(18
)
 
 
3,984

 
1,827

 
118

 
Underwriting income
 
$
41,016

 
34,759

 
18

%
 
$
47,820

 
77,305

 
(38
)
%
Combined Ratios:
 
 

 
 

 
 

 
 
 
 
 
 
 
 
Loss and loss expense ratio
 
57.6

%
57.1

 
0.5

pts
 
60.3

%
56.0

 
4.3

pts
Underwriting expense ratio
 
33.5

 
34.7

 
(1.2
)
 
 
34.2

 
35.0

 
(0.8
)
 
Dividends to policyholders ratio
 
0.3

 
0.4

 
(0.1
)
 
 
0.4

 
0.2

 
0.2

 
Combined ratio
 
91.4

 
92.2

 
(0.8
)
 
 
94.9

 
91.2

 
3.7

 

The increases in NPW in the quarter and year-to-date periods reflected in the table above were driven by: (i) direct new business; (ii) renewal pure price increases; and (iii) strong retention.
 
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in millions)
 
2018
 
2017
 
2018
 
2017
Retention
 
84

%
83

 
84
%
 
83

Renewal pure price increases
 
3.5

 
3.1

 
3.4

 
3.1

Direct new business
 
$
101.1

 
98.0

 
$
199.0

 
187.5


The loss and loss expense ratio increased 0.5 points in Second Quarter 2018 compared to Second Quarter 2017 and 4.3 points in Six Months 2018 compared to Six Months 2017. These increases were driven by the following:
 
Second Quarter 2018
 
Second 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
$
10.1

2.1

pts
 
$
17.0

3.8

pts
(1.7
)
pts
Non-catastrophe property losses
57.0

12.0

 
 
48.2

10.9

 
1.1

 
(Favorable) prior year casualty reserve development
(10.0
)
(2.1
)
 
 
(17.3
)
(3.9
)
 
1.8

 
Total
57.1

12.0

 
 
47.9

10.8

 
1.2

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months 2018
 
Six 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
$
29.9

3.2

pts
 
$
23.9

2.7

pts
0.5

pts
Non-catastrophe property losses
127.8

13.6

 
 
98.0

11.1

 
2.5

 
(Favorable) prior year casualty reserve development
(18.0
)
(1.9
)
 
 
(33.7
)
(3.8
)
 
1.9

 
Total
139.7

14.9

 
 
88.2

10.0

 
4.9

 


29

Table of Contents

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

There was a 1.2-point decrease in the underwriting expense ratio in Second Quarter 2018 compared to Second Quarter 2017, and a 0.8-point decrease in the underwriting expense ratio in Six Months 2018 compared to Six Months 2017. The significant drivers of these variances were as follows:

A reduction in employee-related expenses of 0.7 points in the quarter and 0.5 points year to date. These decreases included: (i) lower profit-based compensation to our employees of 0.3 points in the quarter and 0.2 points year to date; and (ii) lower medical costs of 0.3 points in the quarter and 0.2 points 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.


The following is a discussion of our most significant Standard Commercial Lines of business:
General Liability
 
 
 
 
 
 
 
 
 
Quarter ended June 30,
 
Change
% or
Points
 
 
Six Months ended June 30,
 
Change
% or
Points
 
($ in thousands)
 
2018
 
2017
 
 
 
2018
 
2017
 
 
NPW
 
$
170,370

 
158,721

 
7

%
 
$
334,879

 
313,858

 
7

%
  Direct new business
 
29,725

 
30,012

 
(1
)
 
 
59,442

 
56,919

 
4

 
  Retention
 
84

%
84

 

pts
 
84

%
84

 

pts
  Renewal pure price increases
 
2.4

 
2.9

 
(0.5
)
 
 
2.5

 
2.6

 
(0.1
)
 
NPE
 
$
153,002

 
141,503

 
8

%
 
$
302,831

 
281,487

 
8

%
Underwriting income
 
15,758

 
26,769

 
(41
)
 
 
29,700

 
61,323

 
(52
)
 
Combined ratio
 
89.7

%
81.1

 
8.6

pts
 
90.2

%
78.2
%
 
12.0

pts
% of total Standard Commercial Lines NPW
 
33

 
33

 
 

 
 
33

 
33

 


 
The combined ratio increase in Second Quarter 2018 compared to Second Quarter 2017 was driven primarily by a decline in favorable prior year casualty reserve development, as illustrated in the table below.

Second Quarter 2018
Second 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
$

pts
$
(15.0
)
(10.6
)
pts
10.6
pts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months 2018
Six 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
$

pts
$
(37.4
)
(13.3
)
pts
13.3
pts

The Second Quarter and Six 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.

Partially offsetting the prior year casualty development is the underwriting expense ratio, which decreased by 1.9 points in Second Quarter 2018 compared to Second Quarter 2017 and by 1.5 points in Six Months 2018 compared to Six Months 2017, primarily attributable to the aforementioned items discussed in the overall Commercial Lines Segment above.


30

Table of Contents

Commercial Automobile
 
 
 
 
 
 
 
 
 
Quarter ended June 30,
 
Change
% or
Points
 
 
Six Months ended June 30,
 
Change
% or
Points
 
($ in thousands)
 
2018
 
2017
 
 
 
2018
 
2017
 
 
NPW
 
$
134,082

 
119,063

 
13

%
 
$
263,927

 
236,449

 
12

%
  Direct new business
 
25,016

 
20,990

 
19

 
 
47,305

 
39,550

 
20

 
  Retention
 
84

%
84

 

pts
 
84

%
84

 

pts
  Renewal pure price increases
 
7.5

 
6.9

 
0.6

 
 
7.4

 
6.7

 
0.7

 
NPE
 
$
122,104

 
108,316

 
13

%
 
$
240,335

 
215,445

 
12

%
Underwriting loss
 
(10,773
)
 
(17,355
)
 
(38
)
 
 
(24,137
)
 
(25,523
)
 
(5
)
 
Combined ratio
 
108.8

%
116.0

 
(7.2
)
pts
 
110.0

%
111.8

 
(1.8
)
pts
% of total Standard Commercial Lines NPW
 
26

 
25

 
 

 
 
26

 
25

 
 

 

The decreases in the combined ratio of 7.2 points in Second Quarter 2018 compared to Second Quarter 2017 and 1.8 points in Six Months 2018 compared to Six Months 2017 were driven by a decrease in unfavorable prior year casualty reserve development, partially offset by higher non-catastrophe property losses. Quantitative information on the prior year development and property losses is as follows:
 
Second Quarter 2018
 
Second 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
$
19.7

16.1

pts
 
$
14.6

13.5

pts
2.6

pts
Unfavorable prior year casualty reserve development
7.0

5.7

 
 
15.0

13.8

 
(8.1
)
 
Catastrophe losses
0.7

0.5

 
 
0.9

0.8

 
(0.3
)
 
Total
27.4

22.3

 
 
30.5

28.1

 
(5.8
)
 

 
Six Months 2018
 
Six 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
$
40.9

17.0

pts
 
$
30.4

14.1

pts
2.9

pts
Unfavorable prior year casualty reserve development
15.0

6.2

 
 
21.0

9.7

 
(3.5
)
 
Catastrophe losses
1.5

0.6

 
 
1.1

0.5

 
0.1

 
Total
57.4

23.8

 
 
52.5

24.3

 
(0.5
)
 

The significant drivers of the development were as follows:

Second Quarter and Six Months 2018: Development was primarily due to higher claims frequencies, and to some extent severities, in accident years 2015 through 2017.

Second Quarter and Six 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 on this line benefited from the underwriting ratio, which was 1.1 points lower in Second Quarter 2018 compared to Second Quarter 2017 and 0.9 points lower in Six Months 2018 compared to Six Months 2017. These reductions were primarily attributable to the same items discussed in the overall Commercial Lines Segment above.


31

Table of Contents

Workers Compensation
 
 
 
 
 
 
 
 
 
Quarter ended June 30,
 
Change
% or
Points
 
 
Six Months ended June 30,
 
Change
% or
Points
 
($ in thousands)
 
2018
 
2017
 
 
 
2018
 
2017
 
 
NPW
 
$
81,995

 
81,354

 
1

%
 
$
170,901

 
173,194

 
(1
)
%
Direct new business
 
16,070

 
17,269

 
(7
)
 
 
33,418

 
34,306

 
(3
)
 
Retention
 
84

%
83

 
1

pts
 
84

%
83

 
1

pts
Renewal pure price (decreases) increases
 
0.3

 
0.5

 
(0.2
)
 
 
0.1

 
0.6

 
(0.5
)
 
NPE
 
$
80,021

 
79,460

 
1

%
 
$
158,844

 
158,786

 

%
Underwriting income
 
21,795

 
16,738

 
30

 
 
38,221

 
17,892

 
114

 
Combined ratio
 
72.8

%
78.9

 
(6.1
)
pts
 
75.9

%
88.7

 
(12.8
)
pts
% of total Standard Commercial Lines NPW
 
16

 
17

 
 

 
 
17

 
18

 
 
 

The decreases in the combined ratio in Second Quarter and Six 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 the combined ratio due to lower current year loss costs in both the quarter and year-to-date periods. Favorable prior year development, which in all cases was primarily due to lower severities in accident years 2016 and prior, was as follows:
 
Second Quarter 2018
Second 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
$
(17.0
)
(21.2
)
pts
$
(15.3
)
(19.3
)
pts
(1.9
)
pts
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months 2018
Six 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
$
(33.0
)
(20.8
)
pts
$
(15.3
)
(9.6
)
pts
(11.2
)
pts

Additionally, there was a 1.2-point decrease in the underwriting expense ratio in Second Quarter of 2018 compared to Second Quarter 2017, which was primarily attributable to the same items discussed in the overall Commercial Lines Segment above.

Commercial Property
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Quarter ended June 30,
 
Change
% or
Points
 
 
Six Months ended June 30,
 
Change
% or
Points
 
($ in thousands)
 
2018
 
2017
 
 
 
2018
 
2017
 
 
NPW
 
$
88,376

 
81,971

 
8

%
 
$
173,581

 
162,474

 
7

%
  Direct new business
 
19,928

 
19,850

 

 
 
39,412

 
37,163

 
6

 
  Retention
 
82

%
82

 

pts
 
82

%
82

 

pts
Renewal pure price increases
 
3.2

 
1.6

 
1.6

 
 
2.8

 
2.0

 
0.8

 
NPE
 
$
82,162

 
78,052

 
5

%
 
$
162,488

 
154,443

 
5

%
Underwriting income (loss)
 
9,944

 
(1,631
)
 
(710
)
 
 
(2,497
)
 
9,093

 
(127
)
 
Combined ratio
 
87.9

%
102.1

 
(14.2
)
pts
 
101.5

%
94.1

 
7.4

pts
% of total Standard Commercial Lines NPW
 
17

 
17

 
 

 
 
17

 
17

 
 
 


32

Table of Contents

The decrease in the combined ratio in Second Quarter 2018 compared Second Quarter 2017, and the increase in the combined ratio in Six Months 2018 compared to Six Months 2017, were driven by the following:

Second Quarter 2018

Second 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
$
7.8

9.4
pts

$
14.4

18.5
pts
(9.1
)
pts
Non-catastrophe property losses
29.3

35.6


31.0

39.7

(4.1
)

Total
37.1

45.0
 
 
45.4

58.2
 
(13.2
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months 2018
 
Six 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
$
22.5

13.9
pts
 
$
20.5

13.3
pts
0.6

pts
Non-catastrophe property losses
72.4

44.5
 
 
58.1

37.6
 
6.9

 
Total
94.9

58.4
 
 
78.6

50.9
 
7.5

 

Lower catastrophe and non-catastrophe property losses in Second Quarter 2018 compared to Second Quarter 2017 partially offset the severe winter weather losses that we experienced in the first quarter of 2018. On a year -date-basis, the increase in our combined ratio continues to reflect these higher property losses from the first quarter of 2018, which were principally related to the January deep freeze in our footprint states and a relatively large number of severe fire losses.

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

 
 

 
 

 
 
 
 
 
 
 
 
 
NPW
 
$
83,934

 
78,107

 
7

 
%
 
$
151,795

 
142,803

 
6

%
NPE
 
75,677

 
71,672

 
6

 
 
 
149,933

 
142,873

 
5

 
Less:
 
 
 
 

 
 
 
 
 
 
 
 

 
 
 
Loss and loss expense incurred
 
49,260

 
54,725

 
(10
)
 
 
 
104,699

 
99,015

 
6

 
Net underwriting expenses incurred
 
21,612

 
22,715

 
(5
)
 
 
 
41,935

 
44,520

 
(6
)
 
Underwriting income (loss)
 
$
4,805

 
(5,768
)
 
183

 
%
 
$
3,299

 
(662
)
 
598

%
Combined Ratios:
 
 
 
 

 
 
 
 
 
 
 
 

 
 
 
Loss and loss expense ratio
 
65.1

%
76.3

 
(11.2
)
 
pts
 
69.8

%
69.3

 
0.5

pts
Underwriting expense ratio
 
28.6

 
31.7

 
(3.1
)
 
 
 
28.0

 
31.2

 
(3.2
)
 
Combined ratio
 
93.7

 
108.0

 
(14.3
)
 
 
 
97.8

 
100.5

 
(2.7
)
 

The increases in NPW in Second Quarter and Six Months 2018 compared to Second Quarter and Six Months 2017 were due primarily to: (i) new business; (ii) renewal pure price increases; and (iii) improving retention.
 
 
Quarter ended June 30,
 
 
Six Months ended June 30,
 
($ in millions)
 
2018
 
2017
 
 
2018
 
2017
 
New business
 
$
15.9

 
13.2

 
 
$
27.7

 
24.6

 
Retention
 
85

%
84

 
 
85

%
84

 
Renewal pure price increases
 
3.4

 
2.6

 
 
3.6

 
2.7

 


33

Table of Contents

The loss and loss expense ratio decreased 11.2 points in Second Quarter 2018 compared to Second Quarter 2017 and increased 0.5 points in Six Months 2018 compared to Six Months 2017 . Quantitative information on the drivers of these fluctuations is as follows:
 
Second Quarter 2018
 
Second 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
$
19.8

26.2

pts
 
$
20.0

27.9

pts
(1.7
)
pts
Catastrophe losses
5.8

7.7

 
 
9.4

13.0

 
(5.3
)
 
Unfavorable prior year development


 
 
3.0

4.2

 
(4.2
)
 
Total
25.6

33.9

 
 
32.4

45.1

 
(11.2
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months 2018
 
Six 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
$
12.7

8.4

pts
 
$
13.3

9.3

pts
(0.9
)
pts
Unfavorable prior year casualty reserve development


 
 
5.0

3.5

 
(3.5
)
 
Non-catastrophe property losses
45.5

30.3

 
 
36.4

25.4

 
4.9

 
Total
58.2

38.7

 
 
54.7

38.2

 
0.5

 

Lower catastrophe and non-catastrophe property losses in Second Quarter 2018 compared to Second Quarter 2017 provided some offset to the property losses we experienced in the first quarter of 2018. On a year-to-date basis, non-catastrophe property losses remain higher than last year principally related to the January 2018 deep freeze in our footprint states and a relatively large number of severe fire losses.

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

The underwriting expense ratio decreased 3.1 points in Second Quarter 2018 compared to Second Quarter 2017 and 3.2 points in Six Months 2018 compared to Six Months 2017. The significant drivers of these variances were as follows:

A reduction in costs of 1.3 points in the quarter and 1.0 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 1.0 points in the quarter and 0.8 points year to date . These decreases included: (i) lower profit-based compensation to our employees of 0.3 points in the quarter and 0.2 points year to date; and (ii) lower medical costs of 0.2 points in the quarter and 0.1 points year to date.

A 0.6-point reduction in commissions to our distribution partners in both the quarter and year-to-date periods, including 0.4-points related to profit-based commissions.


34

Table of Contents

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

 
 

 
 

 
 
 
 
 
 
 
 
NPW
 
$
56,384

 
56,790

 
(1
)
%
 
$
104,007

 
107,250

 
(3
)
%
NPE
 
53,147

 
52,764

 
1

 
 
105,355

 
104,003

 
1

 
Less:
 
 

 
 

 
 

 
 
 

 
 

 
 

 
Loss and loss expense incurred
 
43,134

 
33,958

 
27

 
 
79,130

 
65,576

 
21

 
Net underwriting expenses incurred
 
17,802

 
17,487

 
2

 
 
34,579

 
35,538

 
(3
)
 
Underwriting (loss) income
 
$
(7,789
)
 
1,319

 
(691
)
%
 
$
(8,354
)
 
2,889

 
(389
)
%
Combined Ratios:
 
 

 
 

 
 

 
 
 

 
 

 
 

 
Loss and loss expense ratio
 
81.2

%
64.4

 
16.8

pts
 
75.1

%
63.0

 
12.1

pts
Underwriting expense ratio
 
33.5

 
33.1

 
0.4

 
 
32.8

 
34.2

 
(1.4
)
 
Combined ratio
 
114.7

 
97.5

 
17.2

 
 
107.9

 
97.2

 
10.7

 

We continue to focus on profitability drivers in our E&S operations and have been actively managing price increases. While NPW has declined as a consequence of these actions, our primary focus is to bring this segment to targeted levels of profitability. Quantitative information regarding new business and price increases is as follows:
 
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in millions)
 
2018
 
2017
 
2018
 
2017
Direct new business
 
$
20.3

 
24.9

 
$
38.5

 
48.7

Casualty new/renewal price increases
 
5.9

%
5.8

 
6.5

%
8.1

 
The NPE increases in Second Quarter and Six Months 2018 compared to Second Quarter and 2017 Six Months 2017 were consistent with the fluctuation in NPW for the twelve-month period ended June 30, 2018 compared with the twelve-month period ended June 30, 2017.

The loss and loss expense ratio increased 16.8 points in Second Quarter 2018 and 12.1 points in Six Months 2018 compared to the same prior year periods, driven by the items outlined in the table below as well as higher current year loss costs that increased the combined ratio by 4.7 points in both the quarter and year-to-date periods. The unfavorable prior year casualty reserve development outlined in the table below was primarily driven by increased frequencies and severities in accident years 2015 and 2016.
 
Second Quarter 2018
 
 
Second 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

11.3
pts
 
$

pts
11.3

pts
Non-catastrophe property losses
6.1

11.5
 
 
5.1

9.7
 
1.8

 
Catastrophe losses
2.8

5.3
 
 
3.0

5.7
 
(0.4
)
 
Total
14.9

28.1
 
 
8.1

15.4
 
12.7

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Six Months 2018
 
 
Six 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
$
6.0

5.7
pts
 
$

pts
5.7

pts
Non-catastrophe property losses
15.4

14.6
 
 
10.4

10.0
 
4.6

 
Catastrophe losses
2.2

2.1
 
 
4.4

4.2
 
(2.1
)
 
Total
23.6

22.4
 
 
14.8

14.2
 
8.2

 

There was a 1.4-point decrease in the underwriting expense ratio in Six Months 2018 compared to Six Months 2017, which was primarily driven by 0.8-point reductions in profit-based compensation to both our distribution partners and employees.


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Table of Contents

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. The renewal of these treaties included some enhancements in terms and conditions, with the same structure as the expiring treaties as follows:

Property Excess of Loss
The property excess of loss treaty ("Property Treaty") provides $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
The casualty excess of loss treaty (“Casualty Treaty”) provides $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. 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)
 
June 30, 2018
 
December 31, 2017
 
Change % or Points
 
Total invested assets
 
$
5,665,568

 
5,685,179

 

%
Invested assets per dollar of stockholders' equity
 
3.34

 
3.32

 
1


Unrealized gain – before tax1
 
9,816

 
124,679

 
(92
)
 
Unrealized gain – after tax1
 
7,755

 
80,575

 
(90
)
 
1Includes unrealized gains on fixed income securities and equity securities.

Invested assets remained relatively unchanged at June 30, 2018 compared to December 31, 2017. The decrease in unrealized gains during Six Months 2018 was driven by our fixed income securities portfolio, which was unfavorably impacted by rising interest rates.

Fixed Income Securities
At June 30, 2018, our fixed income securities portfolio represented 92% of our total invested assets, largely unchanged compared to December 31, 2017. The effective duration of the fixed income securities portfolio as of June 30, 2018 was 4.0 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. Approximately 17% of our fixed income security portfolio at June 30, 2018 was invested in floating securities that are primarily indexed to the three-month London Interbank Offered Rate ("LIBOR"). 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.


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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 June 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 June 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 June 30,
 
Change
% or Points
 
 
Six Months ended June 30,
Change
% or Points
 
($ in thousands)
 
2018
 
2017
 
 
2018
 
2017
Fixed income securities
 
$
43,774

 
37,668

 
16
 %
 
 
85,815

 
74,559

15
 %
 
Equity securities
 
1,820

 
1,419

 
28

 
 
3,797

 
2,887

32

 
Short-term investments
 
611

 
377

 
62

 
 
1,134

 
627

81

 
Other investments
 
2,094

 
5,231

 
(60
)
 
 
3,657

 
6,834

(46
)
 
Investment expenses
 
(2,746
)
 
(3,265
)
 
(16
)
 
 
(5,619
)
 
(6,058
)
(7
)
 
Net investment income earned – before tax
 
45,553

 
41,430

 
10

 
 
88,784

 
78,849

13

 
Net investment income tax expense
 
(7,964
)
 
(11,127
)
 
(28
)
 
 
(15,405
)
 
(21,095
)
(27
)
 
Net investment income earned – after tax
 
$
37,589

 
30,303

 
24

 
 
73,379

 
57,754

27

 
Effective tax rate
 
17.5
%
 
26.9

 
(9.4
)
pts
 
17.4

 
26.8

(9.4
)
pts
Annualized after-tax yield on fixed income securities
 
2.8

 
2.2

 
0.6

 
 
2.7

 
2.2

0.5

 
Annualized after-tax yield on investment portfolio
 
2.7

 
2.2

 
0.5

 
 
2.6

 
2.1

0.5

 

The increase in pre-tax net investment income in Second Quarter and Six Months 2018 compared to Second Quarter and Six Months 2017 was driven primarily by our fixed income securities portfolio, which benefited from improved new money reinvestment yields and repositioning of the 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 primarily reset based on the 90-day LIBOR, we have benefited from the 64-point rise in LIBOR in Six Months 2018. These improvements were partially offset by lower returns on our alternative investments within our other investment portfolio, primarily related to our energy-sector related investments. 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 June 30,
 
Six Months ended June 30,
($ in thousands)
 
2018
 
2017
 
2018
 
2017
Net realized gains on disposals, excluding OTTI
 
$
54

 
2,951

 
4,785

 
5,381

OTTI charges
 
(2,821
)
 
(1,217
)
 
(4,033
)
 
(4,692
)
Unrealized gains (losses) recognized in income on equity securities
 
1,115

 

 
(12,953
)
 

Total net realized and unrealized (losses) gains
 
$
(1,652
)
 
1,734

 
(12,201
)
 
689

 
The increase in net realized and unrealized losses in Second Quarter 2018 compared to Second Quarter 2017 was driven by OTTI charges recognized in earnings. The increase in net realized and unrealized losses in Six Months 2018 compared to Six Months 2017 was driven by market value fluctuations on our equity portfolio, which are recorded through income due to an 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. For further discussion of our OTTI methodology, see Note 2. "Summary of Significant Accounting Policies" in Item 8. "Financial Statements and Supplementary Data." of our 2017 Annual Report.

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Table of Contents



Federal Income Taxes
The following table provides information regarding federal income taxes:
 
Quarter ended June 30,
 
Six Months ended June 30,
($ in millions)
2018
 
2017
 
2018
 
2017
Federal income tax expense
$
13.7

 
17.5

 
14.7

 
34.6

Effective tax rate
18.9
%
 
29.7

 
15.9

 
27.4


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 Second Quarter and Six Months 2018 compared to Second Quarter and Six Months 2017 reflects: (i) the lower statutory rate; (ii) the contribution of tax-advantaged interest and dividend income in relation to overall pre-tax income this year compared to last; and (iii) an increase in the tax benefit of our share-based payment awards that are recognized through income, which was driven by growth in our stock price.

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 Six 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 the first half of the year.

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 $169 million at June 30, 2018 was comprised of $36 million at the Parent and $133 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 $90 million at June 30, 2018 and December 31, 2017, for a total of $126 million of cash and liquid investments at the Parent at June 30, 2018, compared to $114 million at December 31, 2017. We expect to continue to increase the level of cash and invested assets at the Parent over time, although there will be fluctuations in these balances 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 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 compared to $80 million paid in 2017, of which $50 million was paid during Six 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 4.0 years as of June 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 which varies and is based on, among other factors, the Parent's debt ratings. There were no balances outstanding under the Line of Credit at June 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 June 30, 2018
Actual as of June 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%
20.6%
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
445.8

 
22.3

 

 
22.3

 
1.0

Total
 
 
$
381.4

 
110.0

 
271.4

 
12.1


Short-term Borrowings
In Six 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 Six 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.

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 $4.4 million at June 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.

Capital Resources
Capital resources provide protection for policyholders, furnish the financial strength to support the business of underwriting insurance risks, and facilitate continued business growth. At June 30, 2018, we had GAAP stockholders' equity and statutory surplus of $1.7 billion. With total debt of $439.3 million, our debt-to-capital ratio was approximately 20.6% at June 30, 2018.
 

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Table of Contents

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 decreased to $28.86 as of June 30, 2018, from $29.28 as of December 31, 2017, due to $1.37 in unrealized losses on our investment portfolio and $0.36 in dividends to our shareholders, partially offset by $1.30 in net income per share.

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 Second Quarter 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.

Our S&P, Moody's, and Fitch financial strength and associated credit ratings affect our ability to access capital markets.  The interest rate on our Line of Credit varies and is based on, among other factors, the Parent's debt ratings. There can be no assurance that our ratings will continue for any given period of time or that they will not be changed.  It is possible that positive or negative ratings actions by one or more of the rating agencies may occur in the future.

Off-Balance Sheet Arrangements
At June 30, 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.


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Table of Contents

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 June 30, 2018, we had contractual obligations that expire at various dates through 2036 that may require us to invest up to $237.2 million in alternative investments. There is no certainty that any such additional investment will be required. Additionally, as of June 30, 2018, we had the following contractual obligations: (i) $27.9 million in non-publicly traded common stock within our equity portfolio that expire through 2023, and (ii) $16.8 million in a non-publicly traded collateralized loan obligation in our fixed income securities portfolio that expires in 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 Six 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.
 
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 June 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.

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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.  The current expense allowance is 30.9% of direct premium written.  The servicing fee is 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 July 31, 2018. On July 25, 2018, the U.S. House of Representatives passed a four-month extension authorizing the NFIP until November 30, 2018. On July 31, 2018, the U.S. Senate passed the four-month extension and President Trump signed the extension bill. There continues to be significant public policy and political debate in Congress about 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 by three points, from its current 30.9% 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 one percentage point, from 30.9% to 29.9% 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.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
The following table provides information regarding our purchases of our common stock in Second Quarter 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
April 1 – 30, 2018
 
461

 
$
60.50

 

 

May 1 - 31, 2018
 
1,821

 
55.78

 

 

June 1 - 30, 2018
 

 

 

 

Total
 
2,282

 
$
56.74

 

 


1During Second Quarter 2018, 488 shares were purchased from employees and non-employee directors in connection with the vesting of restricted stock units and 1,794 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.


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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:
August 2, 2018
 
By: /s/ Gregory E. Murphy
 
 
 
Gregory E. Murphy
 
 
 
Chairman of the Board and Chief Executive Officer
 
 
 
 
Date:
August 2, 2018
 
By: /s/ Mark A. Wilcox
 
 
 
Mark A. Wilcox
 
 
 
Executive Vice President and Chief Financial Officer
 
 
 
(principal financial officer)
 

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