Situated on approximately 137 acres in Branchville, NJ, is our 315,000 square foot facility owned by Wantage Avenue Holding Company, Inc. This office complex and the informations systems office below are used by all segments of the business. All regional, field underwriting, information systems, and subsidiary office locations, as indicated below are leased. The regional offices are used by the Insurance Operations segment. The subsidiary offices are used by the Diversified Insurance Services segment.
REGIONAL OFFICES - ---------------- CHESAPEAKE REGION HUNT VALLEY, MARYLAND 6 North Park Drive, Suite 200
INFORMATION SYSTEMS OFFICE - -------------------------- GLASTONBURY, CONNECTICUT 500 Winding Brook Drive
SUBSIDIARY OFFICES - ------------------ ALTA SERVICES LLC IBIS Plaza 3525 Quakerbridge Road Hamilton, New Jersey 08619
SELECTIVE HR SOLUTIONS, INC. 6414 14th Street W Bradenton, Florida 34207
1. Net premiums written in 1997 were increased by approximately $30 million due to a conversion of New Jersey personal automobile policies from six-month to annual terms. This conversion had no effect on net premiums earned. See Financial Review for a more detailed discussion.
3. Refer to the Glossary of Insurance Terms on page 60 of this report on Form 10-K for definitions of specific measures.
5. The 1996, 1995, 1994, 1993, 1992, 1991 and 1990 underwriting losses included taxes and assessments imposed as a result of the Fair Automobile Insurance Reform Act adopted in New Jersey in the amounts of $2 million, $7 million, $7 million, $6 million, $13 million, $12 million and $10 million, respectively.
MANAGEMENT'S DISCUSSION & ANALYSIS OF FINANCIAL CONDITIONS AND RESULTS OF OPERATIONS.
RESULTS OF OPERATIONS 1999 COMPARED WITH 1998 - -------------------------------------------------------------------------------- FINANCIAL HIGHLIGHTS - --------------------------------------------------------------------------------
The personal lines SBU 1999 net premiums written remained flat compared with 1998 and included $41 million of direct new business. Although the overall personal lines net premiums written were flat, there were fluctuations within lines and regions. In March 1999, the New Jersey Automobile Insurance Cost Reduction Act ("AICRA") became effective and required a statewide average personal automobile premium reduction of 15%. The implementation of AICRA resulted in a $19 million reduction in voluntary New Jersey automobile premiums. This reduction in New Jersey voluntary premiums was partially offset by an $8 million increase in Urban Enterprise Zone ("UEZ") business. The UEZ program requires New Jersey automobile insurers to write an amount of urban automobile insurance proportionate to their market share, which approximates 3.1% for Selective. The loss ratio on this business tends to be higher than our other personal automobile business. The net reduction in New Jersey automobile premiums was offset by an $11 million increase in net written premiums in our other states.
The ratio of losses and loss expenses incurred to net premiums earned increased by 3.9 points to 74.1%. The increase was attributable to a 5.3 point increase in the 1999 loss ratio when compared to 1998, primarily due to large property (1.4 points), workers' compensation (1.5 points) as well as weather-related catastrophe claims (1 point), partially offset by a 1 point decrease in the loss expense ratio. During 1999, the Company incurred $20 million of net losses from catastrophe claims. The most notable was Hurricane Floyd, which resulted in net losses and loss expenses of $14 million. Our loss ratio also reflected an increase in our New Jersey automobile loss ratio due to increased UEZ business and the effects of the New Jersey 15% rate rollback.
The Company continues to focus on loss cost containment initiatives. These initiatives include: (i) a comprehensive managed care program which reduced 1999 workers' compensation and automobile losses; (ii) a special investigative unit and claims professionals which uncovered fraudulent claims; (iii) a voluntary automobile repair shop program which reduced repair costs in 1999 while maintaining a 96% customer service satisfaction rating; and (iv) a small estimate automobile and property review program. The Company has also reduced loss expenses by: (i) using inside staff counsel, which has a cost per closed suit of approximately 61% lower than outside staff counsel; (ii) reducing the number of outside panel firms; (iii) active case management; and (iv) more favorable fee arrangements.
Total Federal income tax expense remained flat in 1999 at $10 million, an effective tax rate of 15.3%, compared to an effective tax rate of 15.9% in 1998. The Company's effective tax rate differs from the Federal corporate rate of 35% primarily as a result of tax-exempt investment income.
There is an excess profits law in New Jersey, which sets a maximum profit level on personal automobile insurance. Under New Jersey regulations, an insurer's excess profits earned on direct insurance written in New Jersey on private passenger automobiles, as determined pursuant to an actuarial formula set forth in applicable regulations ("NJ Excess Profits"), are subject to refund or credit to policy holders. A NJ Excess Profits calculation must be made by an insurer for this purpose and submitted to the New Jersey Department of Banking and Insurance each year for the three-year period including the year for which the calculation is done and the two calendar years immediately preceding such year. For the period ended December 31, 1999, the Company did not incur an obligation to make an excess profit premium refund. The premium reductions imposed by the New Jersey Automobile Insurance Cost Reduction Act imposed in 1999, the apparent lack of equivalent cost savings in the law, and the effect of policy assignments the Company was required to take pursuant to the state's UEZ law, will diminish the likelihood of a future excess profits refund.
Operating income (net income excluding net realized gains, net of tax effect) decreased 37% to $35 million, or $1.21 per diluted share, compared to $55 million, or $1.79 per diluted share, in 1998. Realized gains net of tax, for 1999 were $19 million compared with a $1 million realized loss for 1998. The 1999 realized gains reflect $24 million in gains from the sale of equity securities partially offset by $5 million in losses from debt securities. The losses in the debt securities are attributable to a bond swap involving approximately $100 million in par value. The acquired bonds have a higher yield, which will generate additional annual income. Net income for the year was $54 million, which equals the net income for 1998; however, the diluted earnings per share is $1.87 per share in 1999 compared with $1.74 per share in 1998. Operating and net income for 1999 included weather-related losses, net of tax, of $13 million, or $0.44 per diluted share compared with $7 million, or $0.22 per diluted share for 1998.
Net premiums written for 1998 increased by 4% to $749 million. The conversion of New Jersey personal automobile policies from six-month to annual terms (the "Conversion") increased 1997 net premiums written by approximately $30 million for renewal business. Excluding the effects of the Conversion, and a $4 million reinsurance premium buyout adjustment in 1998, net premiums written for 1998 increased about 8%. The increase in net premiums written occurred across all SBUs with the exception of the commercial lines Community Services and Organizations SBU. The growth in net premiums written resulted in a 7% increase in 1998 net premiums earned.
The commercial SBUs' net premiums written increased 11%, or $52 million. This increase included $167 million of net premiums written attributable to new business, after deducting reinsurance costs of approximately $7 million, generated principally by the increase in the number of AMSs, the Company's Midwestern expansion, and the Company's strengthening of agency relationships. The increases in net premiums written were partially offset by: i) a reduction in existing business (renewal retention) attributable to a highly competitive commercial lines marketplace, as well as non-renewals resulting from the Company's regular review of its business (approximately $102 million); ii) workers' compensation rate decreases and premium credits, which lowered net premiums written by approximately $20 million; and iii) lower premium volume of approximately $10 million due to agency terminations.
Net investment income earned for 1998 decreased 1%, or $1 million to $99 million. The level of investment income was negatively impacted by: (i) lower yields on the reinvested proceeds from maturities and redemptions of $270 million during 1998 and 1997; and (ii) use of cash to purchase common shares of the Company (totaling $38 million in 1998 and $8 million in 1997). The Company's after-tax investment yield was 4.4% in 1998, down slightly from 4.6% in 1997.
Policy acquisition costs expressed as a percentage of net premiums earned for 1998 increased 1.1 points to 32.6%. The increase reflects record profit sharing commission and special incentives for agents, which increased the ratio by 0.6 points. The 1998 total dollar amount of labor costs (excluding employee incentive compensation awards) and other operating costs rose moderately (0.2 points) in relation to 1998 net premiums earned.
Total Federal income tax expense in 1998 was $10 million (an effective tax rate of 15.9%), an $11 million decrease compared to $21 million in 1997 (an effective tax rate of 23.5%). The effective tax rate for 1998 was lower than 1997 primarily due to the tax benefits from the higher level of 1998 underwriting losses due, in part, to the weather-related catastrophe claims. The Company's effective tax rate differs from the Federal corporate rate of 35% primarily as a result of tax-exempt investment income.
1998, by a slight margin, was the second strongest year in the history of the Company. Operating income (income excluding net realized gains, net of tax effect) reached $55 million in 1998, or $1.79 per diluted share, compared to $66 million, or $2.15 per diluted share, in 1997. Net income for 1998 was impacted by realized investment losses (net of tax effect) for 1998 of $1 million, or $.05 per diluted share, incurred as part of the Company's tax planning strategy. Net income for 1998 decreased 23% to $54 million, or $1.74 per diluted share, from $70 million, or $2.27 per diluted share, in 1997. Operating and net income for 1998 included weather-related catastrophe losses, net of tax, of $7 million, or $0.22 per diluted share.
Selective Insurance Group, Inc. ("Parent") is an insurance holding company, the principal assets of which are investments in insurance and Diversified Insurance Services subsidiaries. The primary means of meeting its liquidity requirements is through dividends from these subsidiaries, the payment of which is governed by state regulatory requirements for the insurance subsidiaries. Dividends are generally payable only from earned surplus as reported on the insurer's annual statement as of the preceding December 31.
limitations on the payment of dividends by the insurance subsidiaries to the Parent and amounts available for the payment of such dividends, see Note 10 to the consolidated financial statements.
Total assets at December 31, 1999, were $2.5 billion, representing an increase of $81 million, or 3%, from December 31, 1998. The growth in total assets was primarily due to an increase in reinsurance recoverable on unpaid losses and loss expenses of $52 million, an increase in premiums receivable of $19 million, a $32 million increase in goodwill, and the establishment of a deferred tax asset of $16 million. These increases were partially offset by a $60 million reduction in invested assets resulting primarily from a decline in market value on debt securities available-for-sale due to rising interest rates. This change in fair value was also the principal reason for the fluctuation in deferred taxes. The increase in reinsurance recoverable on unpaid losses and loss expenses is primarily attributable to a $24 million increase in losses ceded to the National Flood Insurance Program, primarily attributable to Hurricane Floyd and a $34 million increase in personal injury protection claims ceded to the New Jersey Unsatisfied Claim Judgement Fund ("UCJF"). During 1999, the Company completed a comprehensive review of lifetime claim benefits and adjusted outstanding loss projections to the new ultimate loss projections. Since incurred losses on these claims have exceeded the retention level, increases to reserves are 100% ceded. The 8% increase in premiums receivable, from 1998 to 1999 corresponds to the 8% increase in net premiums written. Goodwill increased due to the acquisition of two subsidiaries during 1999.
Total liabilities at December 31, 1999 were $1.9 billion, representing an increase of $119 million, or 7%, from 1998. This increase was primarily due to higher loss reserves for losses and loss expenses of $82 million. Approximately half of this increase is attributable to the increase in the previously mentioned lifetime claim reserves ceded to the UCJF. The balance of the increase in reserves is reflective of increased large property and workers' compensation losses and the overall business growth during 1999. Unearned premiums increased by $13 million, due primarily to increased net premiums written. Short-term borrowings on various lines of credit increased by $23 million during 1999. The increase in short-term borrowing is the result of the Company's common stock repurchase program. During 1999, the Company repurchased 2.5 million shares of stock at a total cost of $46 million. On February 3, 2000, the Company's Board of Directors authorized the Company to repurchase an additional 2 million shares, bringing the overall repurchase authorization to 8 million shares. The determination to make such purchases is based on market conditions, available cost and alternative investment opportunities. The Company believes such repurchases enhance shareholder value and are an efficient use of capital.
unsecured notes in a private placement transaction. The decision to issue such notes will be dependent on the overall attractiveness of market conditions, including general interest rate levels, credit spreads and maturities. Proceeds from such an issuance would be used to reduce outstanding debt on lines of credit and for general corporate purposes. The Company is not under any current requirement to raise capital, believes it has adequate liquidity, and is confident that its credit lines will be renewed on their maturity. The Company entered into an interest rate hedge on February 11, 2000, to protect against interest rate increases in the eventuality that it issues such notes.
The strategic companies of our Diversified Insurance Services segment include Selective HR Solutions, Inc. ("Selective HR"), Alta Services LLC, ("Alta") and Consumer Health Network Plus, LLC ("CHN"), which are subject to certain regulations.
Selective HR is a professional employer organization ("PEO"). In this capacity, it is a co-employer for its clients. As a co-employer, Selective HR is affected by federal, state and local laws relating to labor, tax and employment matters. By contracting with its clients and creating a co-employer relationship with employees assigned to work at client company locations, Selective HR assumes certain contractual obligations and assumes certain legal obligations and responsibilities of an employer under these laws. Many of these laws do not specifically address the obligations and responsibilities of co-employers such as PEOs. If these laws, for example, the Employee Retirement Income Security Act, and federal and state employment laws and tax laws, are ultimately applied to a PEO's co-employer relationship with their work-site employees, they could have a material adverse effect on Selective HR's results of operations or financial condition.
Some states in which Selective HR operates have passed licensing or registration requirements for PEOs. These regulatory laws vary from state to state but generally provide for monitoring the fiscal responsibility of PEOs.
The Company has two subsidiaries, Alta and CHN, which operate as a managed care organization ("MCO") and/or a preferred provider organization ("PPO"). These companies are subject to laws and/or regulations in some states in which they do business, which require them to be licensed to operate as an MCO or a PPO.
Alta and CHN are also affected by both federal and state laws regarding privacy of medical records and patient privacy. This is an evolving area of regulation requiring the Company to continually monitor and review, especially in dealings with their clients.
While Selective HR, Alta and CHN are currently in compliance with all laws affecting their operations, there can be no assurance that, in the future, they will be able to satisfy revised licensing and regulatory requirements.
The Company's Y2K awareness initiative successfully addressed its interaction with its independent agents, suppliers and customers. The Company's Y2K project adequately modified and safeguarded its internal systems and the Company has not experienced any business disruptions as a result of its dealings with its suppliers or service providers.
The costs incurred for the Y2K project were $2.7 million as of December 31, 1999. Costs charged to earnings in 1999, 1998, 1997 and 1996 are approximately $900,000, $500,000, $700,000, and $100,000, respectively. The remaining $500,000 expended has been capitalized.
Debt securities, held-to-maturity are carried at amortized cost because management has the ability and intent to hold such securities until maturity. Securities, available-for-sale are carried at fair value. Net unrealized gains and losses on debt securities, held-to-maturity are not reflected in consolidated net income or stockholders' equity. Net unrealized gains and losses on securities, available-for-sale, net of deferred income tax effect, are not reflected in consolidated net income, but are included in comprehensive income as well as accumulated other comprehensive income, a separate component of stockholders' equity. No material investments of the Company were non-income producing for the years ended December 31, 1999 and 1998.
Realized gains and losses are determined on the basis of the cost of specific investments sold and are credited or charged to income. In the event that a decline in fair value of an investment is considered to be other than temporary, such investments are written down to their net realizable value.
The value of real estate, furniture and equipment is stated at cost less accumulated depreciation. Provisions for depreciation are computed using the straight-line method over the estimated useful lives of the assets, which range from three to forty years for financial statement purposes and the straight-line method and various accelerated methods for Federal income tax purposes. The Company capitalizes the costs of computer software developed or obtained for internal use in accordance with the American Institute of Certified Public Accountants' Statement of Position No. 98-1 "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"). As a result of SOP 98-1, the Company capitalized $5 million and $3 million, of internal computer software development costs in 1999 and 1998, respectively, which will be amortized using the straight-line method over estimated useful lives of five and seven years.
Goodwill resulting from business acquisitions represents the excess of cost over fair value of assets acquired and is being amortized over estimated useful lives, which range between nine and twenty-five years, using the straight-line method. Amortization expense, which is included in other expense, was $2,153,000, $1,346,000 and $617,000 million for 1999, 1998 and 1997, respectively. Periodically, the Company reviews intangible assets for impairments where the fair value is less than the carrying value.
The preparation of the consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported financial statement balances, as well as the disclosure of contingent assets and liabilities. Actual results could differ from those estimates.
By using both individual estimates of reported claims and generally accepted actuarial reserving techniques, the Company estimates the ultimate net liability for losses and loss expenses. While the ultimate actual liability may be higher or lower than reserves established, the Company believes the reserves to be adequate. The Company does not discount to present value that portion of its loss reserves expected to be paid in future periods, however, the loss reserves include anticipated recoveries for salvage and subrogation claims. Such salvage and subrogation amounted to $39,702,000 and $31,344,000 in 1999 and 1998, respectively.
Short-term investments is comprised of highly liquid investments that are readily convertible into known amounts of cash. Such investments have maturities of 90 days or less from the date of purchase.
(1) Investment Securities: Fair values for debt securities, held-to-maturity are based on quoted market prices where available. For debt securities, held-to-maturity not actively traded, fair values are estimated using values obtained from independent pricing services. The fair values for debt securities, available-for-sale and equity securities, available-for-sale, which also represent the carrying amounts, are based on quoted market prices. Fair values for other investments are not material and are carried at either cost or the equity method, which approximates fair value.
(n) RECLASSIFICATIONS Certain amounts in the Company's prior years' consolidated financial statements and related footnotes have been reclassified to conform with the 1999 presentation. Such reclassification had no effect on the Company's net income or stockholders' equity.
In June of 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" ("FASB 133"). FASB 133 establishes accounting and reporting standards for derivative instruments, including certain derivative instruments embedded in other contracts (collectively referred to as derivatives) and for hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial position and measure those instruments at fair value. This statement was previously effective for all fiscal quarters of fiscal years beginning after June 15, 1999. Earlier application was encouraged, but was permitted only as of the beginning of any fiscal quarter that begins after issuance of financial statements of prior periods. In June 1999, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 137, which defers the effective date of FASB 133 to all fiscal quarters of fiscal years beginning after June 15, 2000. The Company does not anticipate the adoption of this statement to have a material effect on the Company's results of operations or financial condition.
Changes in deferred policy acquisition costs and policy acquisition costs expensed are summarized as follows:
(e) The cost/amortized cost, estimated fair values and gross unrealized gains (losses) of securities, available-for-sale at December 31, 1999 and 1998, respectively, are as follows:
(i) The Company is not exposed to significant concentrations of credit risk within the investment portfolio.
The Debentures were issued under an Indenture dated December 29, 1982, ("Indenture") in the principal amount of $25,000,000, bearing interest at a rate of 8.75% per annum, which is payable on the unpaid principal semiannually on January 1 and July 1 in each year to holders of record at the close of business on the preceding December 15 and June 15. The Debentures are convertible into common stock at an effective conversion price of $7.08 per share. The principal amount of the Debentures, including any accrued interest, is due on January 1, 2008.
The Indenture requires the Company to retire, through the operation of a mandatory sinking fund, 5% of the original $25,000,000 aggregate principal amount of the debentures on January 1 of each of the years from 1994, to and including, 2007. Voluntary conversions have satisfied this obligation through the year 2007.
(2) On November 24, 1992, the Company entered into a $50,000,000 note purchase agreement with various lenders covering the 7.84% Senior Notes. The Company made its fourth required principal payment of the 7.84% Senior Notes of $7,143,000 on November 15, 1999. The Company will continue to make the required principal payment of $7,143,000 per annum through November 15, 2001, inclusive, together with accrued interest thereon. Any outstanding principal amount of the 7.84% Senior Notes on November 15, 2002, will be payable on that date, including any accrued interest. The unpaid principal amount of the 7.84% Senior Notes accrues interest and is payable semiannually on May 15 and November 15 of each year, until the principal is paid in full.
The Company has revolving lines of credit amounting to $75,000,000 at December 31, 1999 and $50,000,000 at December 31, 1998. At December 31, 1999 and 1998, respectively, $51,302,000 and $28,287,000 was outstanding under these lines. Interest is determined on a LIBOR, prime rate or money market rate basis at the Company's option. At December 31, 1999 and 1998 there was approximately $191,870 and $215,078, in accrued interest relating to the outstanding balance and the weighted average interest rate on these borrowings was 5.7% in both years. The amount available under these agreements at December 31, 1999 and 1998, was $23,698,000 and $21,713,000, respectively.
In the ordinary course of business, the insurance subsidiaries assume and cede premiums with other insurance companies and various pools and associations of which they are members. A large portion of the reinsurance is effected under reinsurance contracts known as treaties and, in some instances, by negotiation on each individual risk. In addition, there are excess of loss and catastrophe reinsurance contracts which protect against losses over stipulated amounts arising from any one occurrence or event. The reinsurance arrangements provide greater diversification of business and can serve to limit the maximum net loss on catastrophes and large and unusually hazardous risks.
Under the Company's reinsurance arrangements, which are all prospective in nature, reinsurance premiums ceded are recorded as prepaid reinsurance and amortized over the remaining contract period in proportion to the insurance protection provided, and recoveries are recognized as losses are recorded.
The following is a table of assumed and ceded amounts by income statement caption:
Losses ceded during 1999 increased substantially over 1998 due to an increase of $47,000,000 in incurred losses ceded to the National Flood Insurance Program primarily as a result of Hurricane Floyd and $40,000,000 New Jersey Personal Injury Protection (PIP) claims, an increase of $36,000,000 over the prior year, ceded to the New Jersey Unsatisfied Claims Judgement Fund for reimbursement to the Company in accordance with state law. The Company performed a comprehensive review of New Jersey PIP claims and determined that 27 claims should be re-classified to "lifetime" benefit status. Adjusting outstanding loss reserves on these 27 claims to new ultimate projections resulted in the additional loss reserves.
The Company offers a voluntary defined contribution retirement savings plan with an added 401(k) feature to employees who meet eligibility requirements. The plan allows employees to make contributions to a number of diversified investment options including the Company's common stock, on a before and/or after-tax basis. During 1999 and 1998, 37,963 and 35,876 shares of the Company's common stock were issued under this plan, respectively.
All amounts in the reconciliation of funded status were recognized in the balance sheets for 1999 and 1998. There were no amounts to be included in other comprehensive income for the periods shown resulting from a change in the minimum pension liability.
All amounts in the reconciliation of funded status were recognized in the balance sheets for 1999 and 1998. There was no unrecognized prior service costs for 1999 and 1998. There were no amounts to be included in other comprehensive income for the periods shown.
The Company has incentive compensation plans in which all employees are eligible to participate based on corporate and individual performance goals. The total compensation costs charged to expense in connection with the plans were $883,000, $5,217,000 and $8,914,000 in 1999, 1998 and 1997, respectively. The decrease in incentive compensation for 1999 reflects the absence of a payout in the insurance companies due to the difficult market conditions experienced during 1999.
The weighted-average fair value of options and stocks granted per share, during the year for 1999, 1998 and 1997, respectively, is as follows:
Compensation expense, based on the increase or decrease in the fair value of the Company's common stock, is charged or (credited) to other expense in recognition of the SARs attached to the granted options. Such amounts were $(194,750), $(1,481,000) and $485,000 in 1999, 1998 and 1997, respectively.
Under the Company's stock option plan II, the Committee may, at its discretion, make restricted or unrestricted grants of common stock, or grant rights to receive common stock, to employees in addition to or in substitution for options and/or SARs granted. The Company granted a total of 230,328, 157,356 and 198,550 restricted shares for 1999, 1998 and 1997, respectively, and 23,293, 27,295 and 41,400 shares were forfeited in 1999, 1998 and 1997, respectively. Each such grant must be expressly subject to the attainment of one or more performance-related objectives for certain executive officers, and may be subject to the attainment of one or more performance-related objectives for other employees, as determined by the Committee and set forth in an award agreement. Each such grant also is subject to a vesting period or other terms, conditions, restrictions and limitations as determined by the Committee at its discretion and set forth in an award agreement.
Under the terms of the employee stock purchase plan, the number of shares of common stock available to be purchased is 614,740. This plan is available to all employees who meet the eligibility requirements and provides for the issuance of options to purchase shares of common stock. The purchase price is the lower of: (i) 85% of the closing market price at the time the option is granted or (ii) 85% of the closing price at the time the option is exercised. The Company issued 87,026 shares, 74,613 shares and 49,897 shares in 1999, 1998 and 1997, respectively, to employees and charged to expense $235,000, $235,000 and $365,000 in 1999, 1998 and 1997, respectively.
Beginning in 1998, certain officers of the Company were granted phantom stock units in lieu of grants of restricted stock. The total number of phantom stock units awarded in 1999 and 1998 was 6,000 and 23,000, respectively. The value of the phantom stock units is being charged to expense over the estimated remaining employment period. The value of the phantom stock units will be paid in cash upon retirement.
Under the Company's stock option plan for directors, 367,000 shares of the Company's common stock are available for issuance. Each director who is not a full-time employee of the Company participates in the plan and automatically receives a nonqualified option to purchase 3,000 shares of common stock at not less than fair value on March 1 of each year. Each option becomes exercisable one year after the option was granted and expires no more than ten years from the date the option is granted. Under this plan, the Company granted options of 36,000, 33,000 and 36,000 for 1999, 1998 and 1997, respectively.
Under the terms of the agents' stock purchase plan, the number of shares of common stock available to be purchased is 944,589. This plan provides for four quarterly offerings in which independent insurance agents can purchase the Company's common stock at a 5% discount. The Company issued 59,285 shares, 85,672 shares and 84,996 shares in 1999, 1998 and 1997, respectively, to agents and charged to expense $54,000, $98,000 and $100,000 in 1999, 1998 and 1997, respectively.
Shares repurchased in conjunction with restricted stock vestings and option exercises are 9,000, 21,000 and 28,000 for 1999, 1998 and 1997, respectively at a total cost of $169,000, $455,000 and $607,000, respectively.
The National Association of Insurance Commissioners ("NAIC") has risk-based capital ("RBC") requirements that require insurance companies to calculate and report information under a risk-based formula, which measures statutory capital and surplus needs based on a regulatory definition of risk in a company's mix of products and its balance sheet. At December 31, 1999 and 1998, all the Companies have an amount above the authorized control level RBC, as defined by the NAIC.
Note 12 Reconciliation of Statutory To Generally Accepted Accounting Principles Financial Statements
(b) The insurance subsidiaries prepare their statutory financial statements in accordance with accounting practices prescribed or permitted by the various states of domicile. Prescribed statutory accounting practices include state laws, regulations and general administrative rules, as well as a variety of publications of the NAIC. Permitted statutory accounting practices encompass all accounting practices that are not prescribed; such practices differ from state to state, may differ from company to company within a state and may change in the future. The insurance subsidiaries do not utilize any permitted statutory accounting practices that materially affect the determination of statutory surplus or risk-based capital. Furthermore, the NAIC had a project to codify statutory accounting practices, which becomes effective for reporting periods beginning after January 1, 2001, and is expected to constitute the principal source of "prescribed" statutory accounting practices.
The following table provides a reconciliation of the numerators and denominators of the basic and diluted EPS computations of net income for the year ended:
The Company is primarily engaged in writing property and casualty insurance. The Company has classified its business into three segments which are Insurance Operations (commercial lines underwriting, personal lines underwriting), Investments, and Diversified Insurance Services (formerly called Fee-For-Service Operations). The insurance segments are evaluated based on their GAAP underwriting results, and the diversified insurance operations are evaluated based on results of operations in accordance with Generally Accepted Accounting Principals ("GAAP").
The following summaries present revenues (net investment income and net realized gains (losses) in the case of the investments segment) and pre-tax income for the individual segments:
In August 1998, certain officers of Selective purchased stock on the open market with proceeds advanced by the Company. These officers gave Selective promissory notes ($1,773,000). The notes bear interest at 2.5% and are secured by the purchased shares of Selective's common stock. The promissory notes are full recourse and subject to certain employment requirements. At December 31, 1999, the principal amount outstanding was $1,590,000.
(a) Reserves established for liability insurance continue to reflect exposure to environmental claims, both asbestos and non-asbestos. These claims have arisen primarily under older policies containing exclusions for environmental liability which certain courts, in interpreting such exclusions, have determined do not bar such claims. The emergence of these claims is slow and highly unpredictable. Since 1986, policies issued by the insurance subsidiaries have contained a more expansive exclusion for losses related to environmental claims. There are significant uncertainties in estimating the Company's exposure to environmental claims (for both cases and IBNR reserves) resulting from lack of historical data, long reporting delays, uncertainty as to the number and identity of claimants and complex legal and coverage issues. Legal issues which arise in environmental cases include the determination of whether a case is one for a federal or state forum, choice of law, causation, admissibility of evidence, allocation of damages and contribution among joint defendants, successor and predecessor liability and whether direct action against insurers can be maintained. Coverage issues which arise in environmental cases include the interpretation and application of policy exclusions, the determination and calculation of policy limits, the determination of the ultimate amount of a loss, the extent to which a loss is covered by a policy, if at all, the obligation of an insurer to defend a claim and the extent to which a party can prove the existence of coverage. Courts have reached different and sometimes inconsistent conclusions on these legal and coverage issues. The Company does not discount to present value that portion of its loss reserves expected to be paid in future periods.
Based on the Company's aggregate reserve for net losses and loss expenses at December 31, 1999, the Company does not expect that liabilities associated with environmental and non-environmental claims will have a materially adverse impact on its future liquidity, financial position and results of operations. However, given the complexity of coverage and other legal issues, and the significant assumptions used in estimating such exposures, actual results could significantly differ from the Company's current estimates.
The table on page 50 provides a roll-forward of the Company's gross and net environmental incurred losses and loss expenses and related reserves thereon. The total environmental claims net incurred losses and loss expenses for 1999 increased slightly when compared to 1998. The total environmental claims net incurred losses and loss expenses for 1998 increased by $1 million when compared to 1997. The increase was due to the greater number of new asbestos and non-asbestos related claims received during 1998.
The following table provides a roll-forward of the Company's gross and net environmental incurred losses and loss expenses and related reserves thereon:
(c) The Company has not experienced any significant year 2000 problems to date and management does not expect any significant problems that would impair operations. However, due to the magnitude and complexity of the year 2000 issue, even the most conscientious efforts cannot guarantee that every problem was found and corrected.
In addition, certain leases for rented premises and equipment are noncancelable, and liability for payment will continue even though the space or equipment may no longer be in use. At December 31, 1999, the total future minimum rental commitments under noncancelable leases was $15,603,000 and such yearly amounts are as follows:
On July 21, 1999, the Company acquired all of the outstanding shares of Selective HR Solutions, Inc. (formerly Modern Employers, Inc.), a professional employer organization, for cash of $29,266,000 of which $5,816,000 was payable at December 31, 1999. The related acquisition costs associated with the acquisition totaled $692,000. The purchase agreement provides for future consideration up to $734,000 if certain financial criteria are met over the next year. As this consideration is incurred, it will be recorded as an increase in goodwill and amortized over the remaining life of the asset. The acquisition has been accounted for using the purchase method of accounting, and included approximately $28,693,000 of goodwill which is being amortized on a straight-line basis over 20 years. The amount of goodwill amortization for 1999 was $476,605.
On December 8, 1998, the Company acquired all of the outstanding shares of PDA Software Services, Inc. (formerly, PDA, Inc.), a software developer which specializes in the insurance industry, for 311,673 shares of the Company's common stock valued at $6,644,000 including related acquisition costs. The acquisition has been accounted for using the purchase method of accounting and included approximately $4,805,000 of goodwill, which is being amortized on a straight-line basis over 24 years. The amount of goodwill amortization for 1999 was $200,000.
(a) A reconciliation of Federal income tax on pretax earnings at the corporate rate to the effective tax rate is as follows:
The following table presents the carrying amounts which are included in the consolidated balance sheets and estimated fair values of the Company's financial instruments as of December 31, 1999 and 1998:
(1.) Refer to the Glossary of Insurance Terms on page 60 of this report on Form 10-K for definitions of specific terms.
(3.) Operating and net income for the third quarter of 1999 were reduced by $9.0 million, after reinsurance and taxes, due to higher losses incurred from weather related storms.
(4.) See note 5(b)(2) and note 10 to the consolidated financial statements and Financial Review for a discussion of dividend restrictions.
(5.) These ranges of high and low prices of the Company's common stock, as reported by The Nasdaq National Market, represent actual transactions. All price quotations do not include retail markups, markdowns and commissions. The range of high and low prices for common stock for the period beginning January 1, 1999, and ending February 29, 2000, was $14 5/8 to $22 1/2 and the last sale price on February 29, 2000, was $15 7/16.
AGENT (INDEPENDENT INSURANCE AGENT) -- an insurance consultant who recommends and markets insurance to individuals and businesses; usually represents several insurance companies. Insurance companies pay agents commission.
ALTERNATIVE MARKET -- any risk transfer mechanism where the customer assumes some or all financial responsibility for an insurable exposure.
GENERALLY ACCEPTED ACCOUNTING PRINCIPLES ("GAAP") -- accounting practices set by the Financial Accounting Standards Board. Public companies follow these practices when preparing financial statements.
INVOLUNTARY COSTS -- insurance company costs incurred as a result of participating in state insurance pools (for example, workers' compensation). Insurance companies must participate in these pools as a condition of doing business in the state.
LOSS EXPENSES -- expenses incurred in the process of evaluating, defending and paying claims.
LOSS AND LOSS EXPENSE RATIO -- the ratio of net loss and loss expenses to net premiums earned.
LOSS AND LOSS EXPENSE RESERVES -- the amount of money an insurance company expects to pay for claim obligations and related expenses resulting from losses which have occurred that are covered by insurance policies it has sold.
OPERATING INCOME -- this measure of income differs from net income by the exclusion of net realized gains or losses. This measure is used by management and analysts to evaluate the profitability of recurring operations and is not intended to replace GAAP net income.
PREMIUMS EARNED -- earned premiums refer to premiums an insurance company has recorded as revenues during a specific accounting period. For example, a one-year policy sold January 1 would produce just three months' worth of "earned premium" in the first quarter of the year.
STATUTORY PREMIUMS TO SURPLUS RATIO -- a statutory measure of solvency risk that is calculated by dividing the net statutory premiums written for the year by the ending statutory surplus. For example, a ratio of 1.5:1 means that for every dollar of surplus, the Company wrote $1.50 in premiums.
STATUTORY UNDERWRITING EXPENSE RATIO -- measures the ratio of statutory underwriting expenses (salaries, commissions, premium taxes, etc.) to net premiums written.
UNDERWRITING RESULT -- may be underwriting profit or underwriting loss and represents premiums earned less insurance losses and loss adjustment expenses and underwriting expenses (determined on a GAAP or statutory basis). Also referred to as GAAP underwriting result or statutory underwriting result. This measure of performance is used by management and analysts to evaluate the profitability of underwriting operations and is not intended to replace GAAP net income.
UNEARNED PREMIUMS -- the portion of a premium representing the unexpired amount of the contract term as of a certain date. For example, a one-year policy sold January 1 would record nine months of unearned premium after the first quarter of the year.