Flood business is included in statutory underwriting results in accordance with prescribed statutory accounting practices. On a GAAP basis only, flood servicing revenue and expense has been reclassified from underwriting results to Diversified Insurance Services. 1998 - 2002 have been restated to reflect the exclusion of results from discontinued operations.
Certain statements in this report, including information incorporated by reference, are "forward-looking statements" as that term is defined in the Private Securities Litigation Reform Act of 1995 (PSLRA). The PSLRA provides a safe harbor under the Securities Act of 1933 and the Securities Exchange Act of 1934 for forward-looking statements. These statements relate to our intentions, beliefs, projections, estimations or forecasts of future events or our future financial performance and involve known and unknown risks, uncertainties and other factors that may cause our or our industry's actual results, levels of activity, or performance to be materially different from those expressed or implied by the forward-looking statements. In some cases, you can identify forward-looking statements by use of words such as "may," "will," "could," "would," "should," "expect," "plan," "anticipate," "target," "project," "intend," "believe," "estimate," "predict," "potential," "pro forma," "seek," "likely" or "continue" or other comparable terminology. These statements are only predictions, and we can give no assurance that such expectations will prove to be correct. We undertake no obligation, other than as may be required under the federal securities laws, to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.
Factors, that could cause our actual results to differ materially from those projected, forecasted or estimated by us in forward-looking statements are discussed in further detail later in this Item 7 under "Risk Factors." These risk factors may not be exhaustive. We operate in a continually changing business environment, and new risk factors emerge from time-to-time. We can neither predict such new risk factors nor can we assess the impact, if any, of such new risk factors on our businesses or the extent to which any factor or combination of factors may cause actual results to differ materially from those expressed or implied in any forward-looking statements in this report. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this report might not occur.
Refer to the Glossary of Terms in Exhibit 13 to this Annual Report on Form 10-K for definitions of terms used in this financial review, which exhibit is incorporated by reference herein.
In 2004, each of our three operating segments, which consist of our Insurance Operations segment, Investment segment and Diversified Insurance Services segment contributed to our strong financial performance. The Insurance Operations segment was led by its core commercial lines operations (Commercial Lines), which represents 84% of its business. The Commercial Lines component of our Insurance Operations segment produced growth in net premiums written of more than 14% to $1.1 billion for 2004, compared to $1.0 billion in 2003 and $849.2 million in 2002 due to: (i) $235.9 million of new commercial business in 2004 compared to $231.2 million of new business in 2003 and $197.4 million in 2002; (ii) increased commercial renewal pricing, including exposure, of 9% in 2004 compared to 13% in 2003 and 19% in 2002; and (iii) retention of 82% for the year, which was up from 80% in 2003 and 78% in 2002.
The Investments segment produced net investment income earned for the year of $120.5 million compared to $114.7 million in 2003 and $103.1 million in 2002. Net investment income earned increased as a result of an increased investment base of $2.8 billion in 2004, compared to $2.4 billion in 2003 and $2.1 billion in 2002. This increased investment base was largely due to increased operating cash flows of $367.1 million in 2004 compared with $281.9 million in 2003 and $180.1 million in 2002. Proceeds of $49.9 million from the November 2004 debt issuance contributed to the investment base in 2004 over 2003 and 2002. Lower investment rates available in the marketplace reduced the overall pre-tax investment yields to 4.7% for 2004, compared to 5.1% for 2003 and 5.4% for 2002. The Investments segment also included net realized gains of $24.6 million in 2004 compared to $12.8 million in 2003 and $3.3 million in 2002. Net realized gains in 2004 included a $14.9 million gain on the sale of an equity security within the investment portfolio as compared to prior periods.
The Diversified Insurance Services segment produced $104.4 million of revenue and $9.3 million of net income for 2004, compared to $91.8 million of revenue and $6.2 million of net income for 2003 and $80.8 million of revenue and $4.1 million of net income for 2002. The segment's after tax return on revenue increased to 8.9% for 2004, compared to 6.7% for 2003 and 5.0% for 2002. These improvements were largely attributable to the flood insurance and human resource administration outsourcing operations. Higher margin claim revenue related to an active hurricane season in our flood insurance operation, coupled with pricing improvements and increased worksite lives in our human resource outsourcing operation, resulted in the improved profitability and return on revenue compared to prior years.
The result of these segments' strong performance was an increase in total revenue of 16% to $1.6 billion in 2004 compared to $1.4 billion in 2003 and $1.2 billion in 2002. Net income increased 94% to $128.6 million in 2004 compared to $66.3 million in 2003 and $42.0 million in 2002. Selective's overall financial strength has provided a competitive advantage in the marketplace, and directly impacted where agents place their business. Only 7% of commercial lines companies have "A+" or higher ratings from A.M. Best, and we have been rated "A+" for 43 consecutive years. This is an important factor as the property and casualty insurance market becomes increasingly more competitive. Pricing in the Property and Casualty industry is cyclical. Since 2000 prices have been increasing resulting in improving earnings. In 2004, the rate of increase has slowed. Currently, the low available investment returns and rating agency pressures to generate consistent results encourage pricing discipline. However, as the pricing environment changes, Selective must balance the competitive pressures to reduce prices with preservation of the franchise and the goal of providing consistent returns to stockholders. In managing Selective's operations, management believes that Selective's technology, its ability to analyze and improve its underwriting results, its field model and its relationship with independent insurance agents, maintenance of its ratings with A.M. Best and other rating agencies, and its management of its investment portfolio are important factors to Selective's long-term success.
The following discussion and analysis of Selective Insurance Group, Inc. and subsidiaries' (collectively, the Company or Selective) financial condition and results of operations should be read in conjunction with the consolidated financial statements of the Company and related notes included in Item 8. "Financial Statements and Supplementary Data." in this Form 10-K.
The loss and loss expense ratio decreased 4.8 points to 65.7% in 2004 compared to 70.5% in 2003. In 2003 the loss and loss expense ratio decreased by 1.8 points to 70.5% compared to 72.3% in 2002. The improvements were primarily due to increased premium rates, underwriting improvements in both our commercial and personal lines of business, and loss control efforts, which included 1,700 inspections and value-added safety visits in 2004 for accounts of all sizes in an effort to prevent claims. Earned premium price increases outpaced loss trends by 2.3 points in 2004 compared to 3.1 points 2003. Additionally, weather-related catastrophe losses in 2004 improved 1.3 points compared to 2003, while weather-related catastrophe losses in 2003 were 1.6 points worse compared to 2002.
For 2004, our overall combined ratio was 96.9%, down from 102.2% for 2003 and 103.9% for 2002. The decrease in the combined ratio is attributable to the decreases in the loss and loss expense ratio and the underwriting expense ratio discussed above.
Commercial lines net premiums written were $1.1 billion for 2004, or approximately 84% of total net premiums written, compared to $999.5 million for 2003 and $849.2 million for 2002. Growth in our core Commercial Lines operation was led by new business and renewal premium price increases coupled with increased retention. Included in the net premiums written totals are new business of $235.9 million in 2004, compared to $231.2 million in 2003 and $197.4 million in 2002. Ease of doing business is a key factor in getting business commitments from agents. Each of our 71 field underwriters generates about $3.0 million in new commercial premium each year. It is our hands-on-ability to review and price each risk that differentiates us from other carriers and provides a competitive advantage to earn more of an agent's best business. Renewal premium price increases, including exposure, were 9% for 2004 compared to 13% for 2003 and 19% for 2002. We anticipate these premium price increases will continue to decelerate in 2005 as prices are softening industry-wide. Retention was 82% for 2004, compared with 80% in 2003 and 78% in 2002. One factor in improved retention is our underwriting Service Center. Currently the Service Center manages $61.1 million in commercial premium compared to $42.0 million in 2003 and $24.5 million in 2002. Retention for the Service Center business is about five points better than our traditional commercial business.
The loss and loss expense ratio decreased 5.3 points to 64.0% in 2004, compared to 69.3% in 2003. In 2003 the loss and loss expense ratio decreased by 1.1 points to 69.3% compared to 70.4% in 2002. The improvements were primarily due to increase premium rates, underwriting improvements in our commercial lines business, and loss control efforts, which included 1,700 inspections and value-added safety visits in 2004 for accounts of all sizes in an effort to prevent claims. Earned premium price increases outpaced loss trends by 1.8 points in 2004 compared to 2.9 points 2003. Additionally, weather-related catastrophe losses in 2004 improved 0.9 points compared to 2003, while weather-related catastrophe losses in 2003 were 1.3 points worse compared to 2002.
Our commercial automobile line of business had $315.2 million of statutory net premiums written in 2004, or 28% of total commercial lines net premiums written, compared to $275.0 million in 2003 and $233.6 million in 2002. The statutory combined ratio was 85.8% in 2004, compared to 93.1% in 2003 and 99.2% in 2002. The improved profitability of this line is being driven by price increases, stricter underwriting standards and the removal of certain classes of business determined to be unprofitable. This has also led to positive development in our statutory loss and loss expense reserves of approximately $20 million in 2004 compared to approximately $3 million in 2003, which was driven by reductions in claim frequency and severity.
Our general liability line of business accounted for $329.9 million or 29% of total Commercial Lines statutory net premiums written in 2004, compared to $281.1 million in 2003 and $235.6 million in 2002. The statutory combined ratio was 98.7% in 2004, compared to 99.1% in 2003 and 101.0% in 2002. Our favorable performance trend in this line reflects our long-term improvement strategy that incorporates higher pricing, heightened loss control efforts and continued underwriting enhancements. Partially offsetting the favorable performance in this line of business were increases in the statutory loss and loss expense reserves for prior year development of approximately $19 million, of which approximately $11 million related to our products/completed operations business in 2004. Also included in the increases to the statutory loss and loss expense reserves was $1.7 million that was the result of rating agency downgrades of certain reinsurers, which caused us to reevaluate our ability to collect under certain reinsurance contracts. During 2003, our general liability business included approximately $22 million in prior year development, of which approximately $18 million related to our products/completed operations business. This deficiency in both years was created mainly by our contractor completed operations business. Prior to 2002, we had more exposure to faulty workmanship and materials for both the general contractors and subcontractors and inadequate limits on subcontractors. After 2002, we took extensive underwriting actions to limit our exposure. We adopted the Insurance Service Office (ISO) general liability insurance form, which excluded subcontractors for faulty workmanship. We also placed mold limitations or exclusions on most policies and required subcontractors to carry equal insurance limits to those carried by the general contractor as well as mandated that our insureds be named on any potential subcontractor's policy as an additional insured on a primary and noncontributory basis. Workers' Compensation
Workers' compensation statutory net premiums written were $272.7 million or 24% of total commercial lines net premium written for 2004, compared to $240.9 million in 2003 and $203.1 million in 2002. The workers' compensation line of business, improved modestly to a 108.2% statutory combined ratio compared to 109.6% in 2003, and 110.9% in 2002. Rating agency downgrades of certain reinsurers during 2004 caused us to reevaluate our ability to collect under certain reinsurance contracts, which resulted in an increase to our statutory loss reserves of $1.8 million to this line of business adding 0.6 points to the statutory loss and loss expense ratio for 2004 compared to prior periods. This line of business also continues to be impacted by unfavorable external factors, including: a regulatory climate that makes it difficult to obtain rate increases in some states; rising medical costs; increasing indemnity benefits; and a decreasing number of workers' compensation-only providers who can provide our agents with alternative markets for this line of business. Although results for this line of business are not at an acceptable level, the Company continues to maintain an underwriting position for the workers' compensation business that focuses on low-to-medium hazard business. In addition, our underwriting measures include requiring job site inspections and increasing the number of our trained loss control representatives. Our workers' compensation pricing, excluding exposure, has increased by 40% since 2000 through a combination of rate increases, credit and dividend reductions, and moving business to higher-priced tiers. However, the rate increases that have been approved have just kept pace with loss trends. Since 2000, overall commercial lines policy counts have risen 11% while workers' compensation policy counts have decreased almost 1%. Given the Company's broad desire for business, it is essential that we write this line of business, where appropriate, to meet the overall account needs of agents and their clients. However, when it is appropriate, we encourage our agents to place this line elsewhere. Currently, less than 5% of our workers compensation business is unsupported by another commercial line. Our action plans to improve this line of business in 2005 include: (i) a rate increase, effective January 1, 2005, of almost 9% in New Jersey, which represents about 26% of our workers' compensation premium; (ii) ongoing loss control initiatives that include work site safety inspections, OSHA certification training for contractors, and the direct involvement of Selective loss control professionals on insured workplace safety committees; and (iii) writing more, non-contracting workers' compensation policies through our small business, One & Done system, which is currently performing about 18 points better than our traditional workers' compensation business.
BOP statutory net premiums written were $48.8 million or 4% of total commercial lines net premium written for 2004, compared to $46.8 million in 2003 and $42.6 million in 2002. The BOP line of business posted a statutory combined ratio of 107.1% compared to 118.0% in 2003, and 108.3% in 2002. We are aggressively pursuing profitability for this line of business by focusing growth efforts on the more profitable "office" segment. In addition, we continue to implement ongoing pricing and underwriting actions to improve results, including the elimination of certain classes of businesses, which have been consistently unprofitable.
The "Statutory Combined Ratio" includes the flood line of business, which is included in the Diversified Insurance Services Segment on a GAAP basis and therefore excluded from the GAAP combined ratio. The total Statutory Combined Ratio excluding flood is 101.8% in 2004, 106.5% in 2003, and 109.2% in 2002.
Personal Lines (Personal Lines) net premiums written were $223.4 million in 2004, or approximately 16% of total net premiums written, compared to $219.7 million in 2003 and $204.3 million in 2002. Growth in our personal lines operation was led by new business and renewal premium price increases. Included in the net premiums written totals is new business of $29.9 million in 2004, compared to $33.7 million in 2003 and $27.4 million in 2002. Price increases were 6% for 2004 compared to 7% for 2003 and 9% for 2002. During third quarter 2004, we implemented a new rate filing that allows us to use credit scoring for New Jersey auto business, as well as tier changes, which reduce rates by an average of approximately 2.5%. Additionally, a 4.3% rate reduction, effective March 15, 2005, should lead to a more competitive product, while maintaining our profitability. These enhancements should lead to greater savings for our best risks, while improving the overall book of business.
The Personal Lines loss and loss expense ratio was 74.0% in 2004, down from 75.8% in 2003 and 80.0% in 2002. The 2004 improvement in the loss and loss expense ratio was primarily the result of lower weather-related catastrophe losses, which were $2.4 million or 1.1 points in 2004 compared to $8.2 million or 3.9 points in 2003 and $2.9 million or 1.4 points in 2002. Also contributing to our improvement in the loss and loss expense ratio was the impact of price increases and lower loss frequency.
For 2004, our personal lines combined ratio was 100.9% down from 105.5% in 2003 and 108.8% in 2002. The decrease in the combined ratio was primarily attributable to the decreases in the loss and loss expense ratio as well as the underwriting expense ratio discussed above.
Our personal automobile line of business accounted for $181.3 million or 81% of total Personal Lines statutory net premiums written in 2004, compared to $180.8 million in 2003 and $169.1 million in 2002. The statutory combined ratio was 98.9% in 2004, compared to 103.4% in 2003 and 110.7% in 2002. This improvement reflects continued progress in our New Jersey personal automobile business resulting from significant actions taken over the last four years, including aggressive pricing initiatives; a redesign of our rating tiers; and an improving political and regulatory climate. The state of New Jersey, which represents 74% of total personal automobile net premiums written, had a statutory combined ratio of 94.0% for 2004 compared to 99.7% in 2003 and 106.9% in 2002. Continued profitability in our New Jersey personal automobile business resulting in combined ratios below 98.0% on a long-term basis could result in an excess profits tax and partially offset our profitability. Additionally, the number of vehicles we insure declined to 97,700 in 2004, compared to 106,700 in 2003 and 111,000 in 2002. This reduction was primarily due to lower new business submissions. As the New Jersey market grows increasingly more competitive, including the entrance of several new insurers into the state, we are taking actions to enhance our competitive position within the market. A rate filing in the third quarter allowed us to use credit scoring for the first time for New Jersey automobile business. Combined with tier changes to attract and retain our best business, this change reduced rates by approximately 2.5%. Additionally, a 4.3% rate reduction, effective March 15, 2005, should lead to a more competitive product, while maintaining our profitability.
Our Property Catastrophe treaty renewed at existing limits of $150.0 million and retention of $15.0 million. The property catastrophe reinsurance program was changed from a five layer program in 2004 to a three layer program for the January 1, 2005 renewal. However, the total coverage under the program remained essentially unchanged at $133.4 million. Effective January 1, 2005, the three layers provide the following coverage: (i) 95% of losses in excess of $15.0 million up to $50.0 million; (ii) 95% of losses in excess of $50.0 million up to $100.0 million; and (iii) 81% of losses in excess of $100.0 million up to $165.0 million. The treaty provides one reinstatement with $266.8 million in annual aggregate limit, net of our co-participation. Terrorism coverage is excluded per the definition of TRIA, as well as NBC losses regardless of whether or not they are certified under TRIA. However, these losses are covered up to an annual aggregate of $45.0 million once our $15.0 million annual aggregate retention is met under a separate Terrorism Excess of Loss treaty, which is discussed earlier in this section. The overall program cost for this treaty in 2004 is $6.9 million, compared to $7.5 million in 2003. The $15.0 million retention could be reduced to a minimum retention of $1.0 million due to a provision under the treaty that affords Selective up to $14.0 million of benefit from other available reinsurance arrangements.
The Casualty Excess of Loss treaty, renewed effective July 1, 2004, provides per occurrence coverage of $46.5 million in excess of the Company's $2.0 million retention and $1.5 million co-participation in the layer covering $3.0 million in excess of the $2.0 million retention. Our co-participation in this layer in the July 1, 2003 treaty was $0.8 million. The casualty treaty distinguishes between certified and non-certified terrorism losses. Non-certified terrorism losses (other than NBC) are subject to the normal limits under the treaty: i) $3 million in excess of $2 million layer provides six reinstatements, $10.5 million annual aggregate limit, net of our co-participation; ii) $7 million in excess of $5 million layer provides three reinstatements, $28 million annual aggregate limit; iii) $9 million in excess of $12 million layer provides two reinstatements, $27 million annual aggregate limit; iv) $9 million in excess of $21 million layer provides one reinstatement, $18 million annual aggregate limit; v) $10 million in excess of $30 million layer provides one reinstatement, $20 million annual aggregate limit; and vi) $10 million in excess of $40 million layer provides one reinstatement, $20 million annual aggregate limit. The annual aggregate limit for certified TRIA losses (other than NBC) is capped at two times each layer's occurrence limit, or $93.0 million, net of our co-participation. Consistent with the July 1, 2003 treaty: all NBC losses are excluded from the Casualty Excess of Loss treaty regardless of whether or not they are certified under TRIA; however, our Terrorism Excess of Loss treaty, which is discussed earlier in this section, does cover these exposures up to an annual aggregate of $45.0 million once our $15.0 million annual aggregate retention is met. There is no exclusion for mold or cyber risks in this contract.
We continue to maintain a conservative, diversified investment portfolio, with fixed maturity investments representing 83% of invested assets. 64% of our fixed maturities portfolio is rated "AAA" while the portfolio has an average rating of "AA," Standard & Poor's second highest credit quality rating. High credit quality continues to be a cornerstone of our investment strategy, as evidenced by the fact that almost 100% of the fixed maturities are investment grade.
Our investment philosophy is to maximize after-tax returns over extended periods of time. Our overall fixed maturity investment strategy is to make security purchases that are attractively priced in relation to perceived credit risks. We manage the interest rate risk associated with holding fixed maturity investments by monitoring and maintaining the average duration of the portfolio with a view toward achieving an adequate after-tax return without subjecting the portfolio to an unreasonable level of interest rate risk. We invest our fixed maturities portfolio primarily in intermediate-term securities to limit overall interest rate risk of fixed maturity investments. The average duration of the fixed maturity portfolio, excluding short-term investments at December 31, 2004 was 4.3 years compared with 4.5 years at December 31, 2003. To provide liquidity while maintaining consistent performance, fixed maturity investments are "laddered" so that some issues are always approaching maturity, thereby providing a source of predictable cash flow. Managing investment risk by adhering to these strategies is intended to protect the interests of our stockholders as well as those of our policyholders and, at the same time, enhance our financial strength and underwriting capacity.
The Company regularly reviews its entire investment portfolio for declines in value. If we believe a decline in the value of a particular investment is temporary, we record the decline as an unrealized loss in accumulated other comprehensive income. If we believe the decline is "other than temporary," we write down the carrying value of the investment and record a realized loss in our consolidated statements of income. Our assessment of a decline in value includes our current judgment as to the financial position and future prospects of the entity that issued the investment security. Broad changes in the overall market or interest rate environment generally will not lead to a write-down. This is a current topic of review for the SEC and Financial Accounting Standards Board (FASB). We are uncertain what, if any, changes may be made. If our judgment about an individual security changes in the future we may ultimately record a realized loss after having originally concluded that the decline in value was temporary, which could have a material adverse impact on our net income and financial position in future periods.
Relevant rating history, analysis and guidance provided by rating agencies and analysts.
The financial condition and near-term prospects of the issuer, including any specific events that may influence the issuer's operations;
The following table summarizes, for all available-for-sale securities in an unrealized loss position at December 31, 2004 and 2003, the aggregate fair value and gross pre-tax unrealized loss recorded in our accumulated other comprehensive income, by asset class and by length of time those securities have continuously been in an unrealized loss position:
The following table presents information regarding our available-for-sale fixed maturities that were in an unrealized loss position at December 31, 2004 by contractual maturity:
The Diversified Insurance Services operations include three core functions: human resource administration outsourcing (HR outsourcing), flood insurance, and managed care. We measure the performance of these operations based on several measures, including, but not limited to, results of operations in accordance with GAAP.
The continuing operations of the Diversified Insurance Services segment generated $104.4 million of revenue and $9.3 million of net income for 2004, $91.8 million of revenue and $6.2 million of net income for 2003 and $80.8 million of revenue and $4.1 million of net income for 2002. The segment's after-tax return on revenue increased to 8.9% for 2004, compared to 6.7% for 2003 and 5.0% for 2002. Operating cash flows from the segment were $14.2 million in 2004, $14.4 million in 2003 and $18.6 million in 2002.
Revenue for Selective HR Solutions Inc., provider of our human resource administration outsourcing product, was up 22% to $53.7 million for 2004, compared to $44.1 million for 2003 and $38.1 million for 2002. Pre-tax profit was $2.2 million for 2004, compared to a pre-tax loss of $0.4 million for 2003 and a pre-tax loss of $1.4 million for 2002. The improved results reflect price increases and operating expense reductions that have been implemented over the past two years, which have led to an increase in our HR Outsourcing's average administration fee per worksite employee to $549 for 2004, compared to $518 for 2003 and $440 for 2002. In 2004, we added 6,087 new worksite lives, which increased our total worksite lives to 22,846 compared to 20,254 in 2003. As the commercial insurance market becomes more competitive, this product offers an additional agency revenue stream and another value-added touch-point with agency clients.
Revenues for Managed Care (CHN Solutions) were down 14% to $18.9 million for 2004 compared to $22.1 million for 2003 and $22.5 million for 2002. The decrease in revenue during 2004 was attributable to aggressive competition in New Jersey, and overall client turnover, which is generally affecting the industry. Decreased revenues, partially offset by expense reductions that included a 10% reduction in the managed care workforce, resulted in a corresponding decrease in pre-tax profit by 21% to $2.5 million for 2004, compared to $3.2 million for 2003 and $3.0 million for 2002. CHN remains the #1 preferred provider organization in New Jersey, and we continue to closely manage expenses during this highly competitive period. During 2004, our medical provider network expanded to approximately 95,000 locations from 88,000 locations in 2003 and 83,000 locations in 2002. Discontinued Operations
Our total federal income tax expense increased $24.7 million in 2004 to $46.3 million, compared to $21.6 million in 2003 and $10.8 million in 2002. These amounts reflect an effective tax rate of 26.5% for 2004, compared to 24.6% for 2003, and 20.4% in 2002. Our effective rate differs from the federal corporate tax rate of 35% primarily as a result of tax-exempt investment income and the dividends received deduction. The increase in the effective tax rate in 2004, as compared to 2003 and 2002, is mainly attributable to significant improvements in underwriting results and increased capital gains on investment sales. These amounts have been offset slightly by lower levels of taxable investment income, and a favorable resolution of an IRS appeals issue, which resulted in a benefit of $2.3 million. The benefit was in the form of a reduction to the Company's current federal income taxes payable that included a reserve specific to this issue in accordance with FASB Statement No. 5, "Accounting for Contingencies." The IRS had attempted to disallow, on a consolidated basis, a deduction for interest expense incurred by the Parent while its Insurance Subsidiaries held municipal bonds. The Company established reserves over the course of the examination as follows: $0.9 million in 2003; $1.2 million in 2002; and $0.2 million in prior years. A notice that the issue was resolved in the Company's favor was received on September 30, 2004, at which time the entire accrual was reversed.
The Company has a net deferred tax liability of $29.8 million at December 31, 2004, compared with $12.7 million at December 31, 2003. This change is mainly the result of the application of Alternative Minimum Tax credits against regular tax in the current year, increased unrealized gains on the available-for-sale investment portfolio, increased deferred policy acquisition costs, and a significant pension contribution, offset by the increase in the discount on loss and loss expense reserves and increased unearned premium reserves. The following table presents the Company's taxable income, pre-tax financial statement income, and net deferred tax (liability) asset:
Selective Insurance Group, Inc., (Parent) is a holding company whose principal assets are its investments in its subsidiaries. The Parent's primary means of meeting its liquidity requirements is through dividends from these subsidiaries. The payment of dividends from the Insurance Subsidiaries is governed by state regulatory requirements, and these dividends are generally payable only from earned surplus as reported in our statutory Annual Statements as of the preceding December 31. Based upon the 2003 unaudited statutory financial statements, the Insurance Subsidiaries were permitted to pay the Parent in 2004 ordinary dividends in the aggregate amount of approximately $64.0 million. During 2004, the Insurance Subsidiaries provided $20.0 million in ordinary dividends. Based upon the 2004 unaudited statutory financial statements, the Insurance Subsidiaries are permitted to pay the Parent in 2005 ordinary dividends in the aggregate amount of approximately $103 million. There can be no assurance that the Insurance Subsidiaries will be able to pay dividends to the Parent in the future in an amount sufficient to enable the Parent to meet its liquidity requirements. For additional information regarding regulatory limitations on the payment of dividends by the Insurance Subsidiaries to the Parent and amounts available for the payment of such dividends, see Item 8. "Financial Statements and Supplementary Data," Note 9 to the consolidated financial statements.
On November 4, 2003, the Board of Directors authorized a 2.5 million-share stock repurchase program scheduled to expire on November 30, 2005. The Company acquired approximately 141,000 shares for $4.9 million under that program during 2004, leaving a remaining authorization of approximately 2.4 million shares.
Net cash provided by operating activities amounted to $367.1 million in 2004, $281.9 million in 2003, and $180.1 million in 2002. Included in net cash provided by operating activities were paid loss and loss expenses of $653.1 million in 2004, $638.5 in 2003, and $603.4 million in 2002. The increase in net cash provided by operating activities in 2004 is a result of: (i) premium growth, lower loss and loss expense ratios; and (ii) increased investment income from a larger investment portfolio.
We have identified the policies described below are critical to our business operations and the understanding of the results of our operations. For additional discussion on the application of these and other accounting policies, see Item 8. "Financial Statements and Supplementary Data," Note 2 to the consolidated financial statements. Our preparation of the consolidated financial statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our consolidated financial statements, and the reported amounts of revenue and expenses during the reporting period. There can be no assurance that actual results will not differ from those estimates.
Significant periods of time can elapse between the occurrence of an insured loss, the reporting of the loss to the insurer and the insurer's payment of that loss. To recognize liabilities for unpaid losses and loss expenses, insurers establish reserves as balance sheet liabilities representing estimates of amounts needed to pay reported and unreported net losses and loss expenses. As of December 31, 2004, the Company had accrued $1.8 billion of loss and loss expense reserves compared to $1.6 billion at December 31, 2003.
In accordance with industry practice, we maintain, in addition to case reserves, estimates of reserves for losses and loss expenses incurred but not yet reported (IBNR). Using generally accepted actuarial reserving techniques we project our estimate of ultimate losses and loss expenses at each reporting date. The difference between: (i) projected ultimate loss and loss expense reserves and (ii) case loss reserves and loss expense reserves thereon are carried as the IBNR reserve. A range of possible IBNR reserves is determined annually and considered in addition to the most recent loss trends and other factors in establishing IBNR for each reporting period. Loss trends include, but are not limited to large loss activity, environmental claim activity, large case reserve additions or reductions for prior accident years, and reinsurance recoverable issues. The Company also considers factors such as: (i) per claim information; (ii) Company and industry historical loss experience; (iii) legislative enactments, judicial decisions, legal developments in the imposition of damages, and changes in political attitudes; and (iv) trends in general economic conditions, including the effects of inflation. Based on the consideration of the range of possible IBNR reserves, recent loss trends and other factors, IBNR is established and the ultimate net liability for losses and loss expenses is determined. Such an assessment requires considerable judgment given that it is frequently not possible to determine whether a change in the data is an anomaly until some time after the event. Even if a change is determined to be permanent, it is not always possible to reliably determine the extent of the change until some time later. There is no precise method for subsequently evaluating the impact of any specific factor on the adequacy of reserves because the eventual deficiency or redundancy is affected by many factors. The Company also began using independent actuaries in 2003 to opine on the adequacy of our reserves. The changes in these estimates, resulting from the continuous review process and the differences between estimates and ultimate payments, are reflected in the consolidated statements of income for the period in which such estimates are changed. Any changes in the liability estimate may be material to the results of operations in future periods.
The following tables provide case and IBNR reserves for losses, reserves for loss expenses, and reinsurance recoverable on unpaid losses and loss expenses as of December 31, 2004 and 2003:
*Negative IBNR reserves are due to the inclusion of reserves for recoveries from salvage and subrogation.
Included in our loss and loss expense reserves are amounts for environmental claims, both asbestos and non-asbestos. Carried net loss and loss expense reserves for environmental claims was $38.5 million as of December 31, 2004 and $36.5 million as of December 31, 2003. 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 our Insurance Subsidiaries have contained a more expansive exclusion for losses related to environmental claims. In addition, a portion of our environmental losses relate to homeowners claims covering the leakage of certain underground storage tanks. Our asbestos and non-asbestos environmental claims have arisen primarily from insured exposures in municipal government, small commercial risks and homeowners policies. During 2004, Selective also experienced adverse development in its homeowners line of business as a result of unfavorable trends in claims for groundwater contamination caused by leakage of certain underground heating oil storage tanks in New Jersey. Increased frequency was triggered, in part, by the state's robust real estate market, leading to an increase in home tank inspections. To address this issue, Selective began restricting writings of policies with coverage for underground heating oil storage tanks, company wide, just about two years ago, and are reviewing possible coverage changes for existing business.
The table below summarizes the number of asbestos and non-asbestos claims outstanding at December 31, 2004, 2003 and 2002. For additional information about our environmental reserves, see Item 1. "Business," page 14 and Item 8. "Financial Statements and Supplementary Data," Note 7 to the consolidated financial statements.
Net premiums written equal direct premiums written, plus assumed premiums less ceded premiums. All three components of net premiums written are recognized in revenue over the period that coverage is provided. The Company had net premiums written of $1.4 billion for 2004 compared to $1.2 billion for 2003 and $1.1 billion for 2002. The vast majority of our net premiums written have a coverage period of twelve months. This means we record 1/12 of the net premiums written as earned premium each month, until the full amount is recognized. When premium rates increase, the effect of those increases do not immediately affect earned premium. Rather, those increases are recognized ratably over the period of coverage. The Company earned net premiums of $1.3 billion for 2004 compared with $1.1 billion for 2003 and just under $1.0 billion for 2002. Unearned premiums and prepaid reinsurance premiums, which are recorded on the consolidated balance sheets, represent that portion of premiums written that are applicable to the unexpired terms of policies in force. As of December 31, 2004, the Company had unearned premiums of $702.1 million and prepaid reinsurance premiums of $58.3 million compared to unearned premiums of $649.9 million and prepaid reinsurance premiums of $52.8 million as of December 31, 2003.
The Company's pension benefit and postretirement life benefit obligations and related costs are calculated using actuarial concepts, within the framework of Statement of Financial Accounting Standards No. 87 Employers' Accounting for Pensions (SFAS 87) and Statement of Financial Accounting Standards No. 106, Employers' Accounting for Postretirement Benefits Other than Pension (SFAS 106), respectively. Two key assumptions, the discount rate and the expected return on plan assets, are important elements of expense and/or liability measurement. We evaluate these key assumptions annually. Other assumptions involve demographic factors such as retirement age, mortality, turnover and rate of compensation increases.
The discount rate enables us to state expected future cash flow as a present value on the measurement date. The guideline for setting this rate is a high-quality long-term corporate bond rate. A lower discount rate increases the present value of benefit obligations and increases pension expense. We reduced our discount rate to 6.25% for 2004, from 6.75% in 2003, to reflect market interest rate conditions. To determine the expected long-term rate of return on the plan assets, we consider the current and expected asset allocation, as well as historical and expected returns on each plan asset class. A lower expected rate of return on pension plan assets would increase pension expense. Our long-term expected return on plan assets was 8.25% in 2004 and 2003. Changes in the related pension and postretirement benefit expense may occur in the future due to changes in these assumptions.
Additionally, in December 2004 the Company made a voluntary contribution to its Retirement Income Plan of $20.0 million. This additional contribution in 2004: (i) will reduce pension expense by approximately $1.6 million annually and (ii) reduced the unfunded status of the Company's Retirement Income Plan from $39.6 million as of December 31, 2003 to $20.3 million as of December 31, 2004.
For additional information regarding the Company Pension and Postretirement Benefit Plan, see Item 8 "Financial Statements and Supplementary Data." Note 15(d) to the consolidated financial statements.
Our future cash payments associated with contractual obligations pursuant to operating leases for office space and equipment, senior convertible notes, convertible subordinated debentures and notes payable as of December 31, 2004 are summarized below:
1The Parent has $24.1 million remaining in an irrevocable trust to provide for the repayment of notes due in less than 1 year.
On October 26, 2004, in accordance with the provisions of the Indenture, the Company's Board of Directors voted to permanently waive the stock price contingency provision, which was satisfied for the quarters ended March 31, 2004 and June 30, 2004, when the price of the Company's common stock maintained a 20% premium to the conversion price of $29.29, or $35.15, for 20 of 30 consecutive trading days ending on the last day of each of these respective quarters. If all the Convertible Notes were converted, the Company would be required to issue 3.9 million shares of common stock. We expect to have the capacity to repay and/or refinance all of these obligations as they come due.
Given that the loss and loss expense reserves are estimates as described above and in more detail under "Critical Accounting Policies and Estimates" on pages 45-48 of this Form 10-K, the payment of these estimates are generally not fixed as to amount or timing. Due to this uncertainty, financial accounting standards prohibit us from discounting these reserves to their present value. Additionally, estimated losses as of the financial statement date do not consider the impact of estimated losses from future business. Therefore, the projected settlement of the reserves for net loss and loss expenses will differ, perhaps significantly, from actual future payments.
The information in the "Loss and Loss Expense Reserves" table above is presented in accordance with reporting requirements of the Securities and Exchange Commission. These projected paid amounts by year are estimates based on past experience, adjusted for the effects of current developments and anticipated trends, and include considerable judgment. There is no precise method for evaluating the impact of any specific factor on the projected timing of when loss and loss expense reserves will be paid and as a result the timing and amounts of the actual payments will be affected by many factors. Care must be taken to avoid misinterpretation by those unfamiliar with this information or familiar with other data commonly reported by the insurance industry. As was noted above, for further information regarding the uncertainty associated with loss and loss expense reserves see "Critical Accounting Policies and Estimates" on pages 45-48 of this document.
Information required in accordance with Section 10A(i)(2) of the Securities Exchange Act of 1934, as amended, as added by Section 202 of the Sarbanes-Oxley Act of 2002, regarding non-audit services is included in the Company's Proxy Statement for the 2004 Annual Meeting of Stockholders, which is incorporated herein by reference.
Certain risk factors exist that can affect our business, results of operations, and financial condition. The following list of risk factors is not exhaustive and others may exist. We operate in a continually changing business environment, and new risk factors emerge from time to time. Consequently, we can neither predict such new risk factors nor assess the impact, if any, they might have on our business in the future.
Historically, the results of the property and casualty insurance industry have experienced significant fluctuations due to competition, economic conditions, interest rates, and other factors. For example, commercial lines premium pricing increased from 2001 to 2004; but it decreased for several years before 2000. The industry's profitability also is affected by unpredictable developments, including:
The demand for property and casualty insurance, particularly Commercial Lines, can also vary with the overall level of economic activity.
Our Insurance Subsidiaries have experienced catastrophe losses and we expect them to experience such losses in the future. A catastrophic event or a series of catastrophic events could have a material adverse effect on the operating results and financial condition of the Insurance Subsidiaries, thereby limiting the ability of the Insurance Subsidiaries to pay dividends to Selective.
A major catastrophic loss exceeds the reinsurance limit or the reinsurers' financial capacity,
An Insurance Subsidiary pays a number of smaller catastrophic loss claims, which individually fall below the subsidiary's retention level, or
The modeling software used to analyze the Insurance Subsidiaries' risk proves inadequate.
Acts of terrorism could have a significant impact on our financial and operational condition.
We are heavily regulated in the states in which we operate.
We are subject to extensive supervision and regulation in the states in which our Insurance Subsidiaries transact insurance business. The primary purpose of insurance regulation is to protect individual policyholders and not shareholders or other investors. Our business can be adversely affected by regulations affecting property and casualty insurance companies. For example, laws and regulations can lead to mandated reductions in rates to levels that we do not believe are adequate for the risks we insure. Other laws and regulations limit our ability to cancel or refuse to renew policies and require us to offer coverage to all consumers. Changes in laws and regulations, or their interpretations, pertaining to insurance, including workers' compensation, healthcare or managed care, preferred provider organizations, and human resource administration outsourcing organizations may also have an adverse effect on our business. Although the federal government does not directly regulate the insurance industry, federal initiatives, from time to time, can also impact the insurance industry.
From time to time, legislative proposals are introduced that, if passed, could adversely affect our results of operation. A bill was introduced in the New Jersey legislature in 2003 to allow claimants to file lawsuits for non-economic damages without proving that the injuries sustained had a serious impact on their life. Although this legislation ultimately was not passed, we anticipate similar legislative proposals will be introduced should the New Jersey Supreme Court uphold the current interpretation of the state's no-fault law.
In addition, ten of the twenty primary states Selective writes commercial property coverage in mandate the coverage of fire following an act of terrorism.
New Jersey insurance regulations require New Jersey auto insurers to involuntarily write private passenger automobile insurance for individuals who are unable to obtain insurance in the voluntary market. These policies are priced according to a separate rating scheme that is established by the assigned risk plan and subject to approval by DOBI. The amount of involuntary insurance, which an insurer must write in New Jersey, depends on the insurer's statewide market share - the greater the market share the more involuntary coverage the insurer is required to write. The underwriting of involuntary personal automobile insurance in New Jersey has been historically unprofitable.
During 2002, DOBI issued an order exempting State Farm Indemnity Company, which had approximately 17% of the market share for New Jersey private passenger automobile insurance, from the state's "take-all-comers" law, assigned risk program, and UEZ program. As a result of State Farm's exemption, in 2003 every other participating insurer's share of the program, including Selective's, was increased to offset the unapplied State Farm share. In 2004, the DOBI issued an order which will transition State Farm back into the assigned risk and UEZ programs, however, they will not be required to meet their full share of these programs during 2005.
We face significant competition from other regional and national insurance companies, agents and from self-insurance.
Changing practices caused by the Internet, which have led to greater competition in the insurance business and, in some cases, greater expectations for customer service.
We are required to maintain loss reserves for our estimated liability for losses and loss expenses associated with reported and unreported insurance claims for each accounting period. From time-to-time, we adjust reserves and, if our reserves are inadequate, we will be required to increase reserves. An increase in reserves: (i) produces an increase in losses, (ii) reduces net income and stockholders' equity for the period in which the deficiency in reserves is identified, and (iii) could have a material adverse effect on our results of operations, liquidity, financial condition and financial strength ratings. Our estimates of reserve amounts are based on facts and circumstances of which we are aware, including our expectations of the ultimate settlement and claim administration expenses, predictions of future events, trends in claims severity and frequency, and other subjective factors. There is no method for precisely estimating our ultimate liability for settlement and claims.
We regularly review our reserving techniques and our overall amount of reserves. We also review:
Our ability to reduce our exposure to risks depends on the availability and cost of reinsurance.
We transfer our risk exposure to other insurance and reinsurance companies through reinsurance arrangements. In these arrangements, another insurer assumes a specified portion of our losses and loss adjustment expenses in exchange for a specified portion of the insurance policy premiums. The availability, amount, and cost of reinsurance depend on market conditions, which may vary significantly. Any decrease in the amount of our reinsurance will increase our risk of loss.
We also face credit risk with respect to reinsurance. The inability of any of our reinsurers to meet their financial obligations could materially and adversely affect our operations, as we remain primarily liable to our customers under the policies that we have reinsured.
We may be adversely impacted by a change in our ratings.
The principal agencies that cover the property and casualty industry are: A.M. Best Company; Standard & Poor's Rating Services (S&P); Moody's Investor Service (Moody's); and Fitch Rating Service (Fitch). We believe our ability to write insurance business is most influenced by our rating from A.M. Best, which currently rates us "A+" (Superior), the second highest of fifteen ratings. A significant downgrade from A.M. Best could materially adversely affect the business we write. We believe that ratings from S&P, Moody's or Fitch, although important, have less impact on our business. We are currently rated "A" by S&P, "A2" by Moody's and "A+" by Fitch. We cannot be sure that we will maintain our current A.M. Best, S&P, Moody's or Fitch ratings. An unfavorable change in any of these ratings could (i) affect our ability to write new business with customers, some of which are required (under various 3rd party agreements) to maintain insurance with a carrier that maintains a specified minimum rating; (ii) be an event of default under our current lines of credit, under which we had no outstanding borrowings at December 31, 2004, 2003, or 2002; (iii) result in an increase in the interest rate charged under those lines of credit; or (iv) make it more expensive for us to access capital markets.
Like many other property and casualty insurance companies, we depend on income from our investment portfolio for a significant portion of our revenues and earnings. Any significant decline in our investment income as a result of falling interest rates, decreased dividend payment rates, or general market conditions would have an adverse effect on our results. Fluctuations in interest rates cause inverse fluctuations in the market value of our debt portfolio. Any significant decline in the market value of our investments would reduce our stockholders' equity and our policyholders' surplus which could impact our ability to write additional premiums. In addition, our notes payable are subject to certain debt-to-capitalization restrictions which could also be impacted by a significant decline in investment values.
The operations of Selective HR Solutions, Inc., (SHRS) are affected by numerous federal and state laws and regulations relating to employment matters, benefits plans and taxes. In performing services for its clients, SHRS assumes some obligations of an employer under these laws and regulations. If these federal or state laws are ultimately applied in a manner unfavorable to SHRS, it could have a material adverse effect on our operations and financial condition. Regulation in the human resource administration outsourcing business is constantly evolving. We are unable to predict what additional government initiatives, if any, affecting SHRS's business may be promulgated in the future. Consequently, we are also unable to predict whether SHRS will be able to adapt to new or modified regulatory requirements or obtain necessary licenses and government approvals.
Regulation in the healthcare, automobile personal injury protection and workers' compensation fields is constantly evolving. We are unable to predict what additional government initiatives, if any, affecting CHN Solutions' business may be promulgated in the future. Consequently, we are also unable to predict whether CHN Solutions will be able to adapt to new or modified regulatory requirements or obtain necessary licenses and government approvals.
Under the terms of our debt agreements and financial solvency laws affecting insurers, our subsidiaries are permitted to incur indebtedness up to certain levels that may restrict or prohibit the making of distributions, the payment of dividends, or the making of loans by our subsidiaries to us. We cannot assure that the agreements governing the current and future indebtedness of our subsidiaries will permit our subsidiaries to provide us with sufficient dividends, distributions or loans to fund our cash needs.
Sources of funds for the Insurance Subsidiaries primarily consist of premiums, investment income, and proceeds from sales and redemption of investments. Such funds are applied primarily to payment of claims, insurance operating expenses, income taxes and the purchase of investments, as well as dividends and other payments.
The Insurance Subsidiaries may declare and pay dividends to us only if they are permitted to do so under the insurance regulations of their respective state of domicile. All of the states in which our Insurance Subsidiaries are domiciled regulate the payment of dividends. Some states, including New Jersey, North Carolina and South Carolina, require that we give notice to the relevant state insurance commissioner prior to our Insurance Subsidiaries declaring any dividends and distributions payable to us. During the notice period, the state insurance commissioner may disallow all or part of the proposed dividend upon determination that (i) the insurer's surplus is not reasonable in relation to its liabilities and adequate to its financial needs and those of the policyholders, or (ii) in the case of New Jersey, the insurer is otherwise in a hazardous financial condition. In addition, insurance regulators may block dividends or other payments to affiliates that would otherwise be permitted without prior approval upon determination that, because of the financial condition of the insurance subsidiary or otherwise, payment of a dividend or any other payment to an affiliate would be detrimental to an insurance subsidiary's policyholders or creditors.
We employ anti-takeover measures that may discourage potential acquirors and could adversely affect the value of our common stock.
Other factors also may discourage, delay or prevent a change of control of Selective, including among others provisions in our certificate of incorporation, as amended, relating to:
Guaranteed payments which must be made to our officers upon a change of control; and
The New Jersey Shareholders Protection Act provides that Selective, as a New Jersey corporation, may not engage in business combinations specified in the statute with a shareholder having indirect or direct beneficial ownership of 10% or more of the voting power of our outstanding stock (an interested shareholder) for a period of five years following the date on which the shareholder became an interested shareholder, unless the business combination is approved by the board of directors of the corporation before the date the shareholder became an interested shareholder. These provisions also could have the effect of depriving Selective stockholders of an opportunity to receive a premium over the prevailing market price if a hostile takeover were attempted and may adversely affect the value of our common stock.
Class action litigation could affect our business practices and financial results.
Increase in reserves for losses and loss expenses, net of reinsurance recoverable
The accompanying consolidated financial statements, which include the accounts of Selective and its subsidiaries, have been prepared in conformity with (i) accounting principles generally accepted in the United States of America (GAAP); and (ii) the rules and regulations of the U.S. Securities and Exchange Commission (SEC). All significant intercompany accounts and transactions between Selective and its subsidiaries are eliminated in consolidation.
Fixed maturity securities, which include bonds and redeemable preferred stocks, are purchased to support the investment strategies of Selective. These strategies are developed based on many factors including rate of return, maturity, credit risk, tax considerations and regulatory requirements. Fixed maturity securities that are not classified as either held-to-maturity securities or trading securities are classified as available-for-sale securities and reported at fair value, with unrealized gains and losses excluded from earnings and reported in a separate component of stockholder's equity. Those fixed maturity securities that Selective has the ability and positive intent to hold to maturity are classified as held-to-maturity and carried at amortized cost, which is calculated using the scientific method.
Equity securities include common stocks, while other investments consist primarily of limited partnerships. Common stocks are carried at fair value as of the balance sheet date, and limited partnerships are carried at Selective's percentage of ownership in the equity of the limited partnerships. The investments held by the partnerships are carried at fair value as of the balance sheet date. Equity securities are classified as available-for-sale.
Unrealized gains or losses of investments carried at fair value are excluded from net income and credited or charged, net of applicable deferred income tax, directly to stockholder's equity as a separate component of accumulated other comprehensive income.
(1) Investments: Fair values for fixed maturity and equity securities are based on quoted market prices where available, or from independent pricing services. Other investments are carried at either cost or using the equity method, which approximates fair value.
Selective estimates an allowance for doubtful accounts on its premiums and other trade receivables. The allowance for premiums and other trade receivables is based on historical write-off percentages adjusted for the effects of current and anticipated trends. The allowance for premium receivables was $3.2 million at December 31, 2004 and $3.1 million at December 31, 2003. The allowance for other trade receivables was $0.7 million at December 31, 2004 and $1.1 million at December 31, 2003.
Selective's concentration of credit risk includes accounts receivable due by clients to its human resource administration outsourcing subsidiary, Selective HR Solutions (SHRS). By law and/or by contract, SHRS assumes substantial employer rights, responsibilities, and risks related to certain employees of its clients and becomes a co-employer of the client's employees. Earned but unpaid wages related to SHRS's co-employees are recognized as an accrued payroll liability, as well as an account receivable, during the period in which such wages are earned. Subsequent to the end of each period, such wages are paid and the related co-employer service fees are billed. Accrued co-employer payroll and related service fees were $11.0 million as of December 31, 2004 and $15.5 million as of December 31, 2003. Certain states limit a co-employer's liability for earned payroll to minimum wage and, accordingly, SHRS's potential liability for accrued co-employer payroll could be reduced.
For a discussion regarding reinsurance recoverables and related concentration of credit risk see Note 6, "Reinsurance."
Reinsurance recoverable on unpaid losses and loss expenses represent estimates of the portion of such liabilities that will be recovered from reinsurers. Amounts recoverable from reinsurers are recognized as assets at the same time and in a manner consistent with the unpaid losses associated with the reinsured policies. An allowance for estimated uncollectible reinsurance is recorded based on an evaluation of balances due from reinsurers and other available information. The allowance for reinsurance recoverables was $4.3 million at December 31, 2004 and $2.3 million at December 31, 2003.
Deferred policy acquisition costs amortized to expense were $372.2 million for 2004; $324.6 million for 2003; and $280.6 million for 2002. The investment yields assumed for each reporting period, which are based upon the Company's actual average investment yield before-tax were 4.6% for 2004; 5.0% for 2003; and 5.2% for 2002.
Goodwill results from business acquisitions where the cost of assets acquired exceeds the fair value of those assets. As of January 1, 2002, Selective adopted the FASB Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets" (FAS 142). FAS 142 addresses the initial recognition and measurement of goodwill and other intangible assets. FAS 142 changed the accounting for goodwill and intangible assets that have indefinite useful lives from an amortization approach to an impairment-only approach that requires those assets to be tested at least annually for impairment. FAS 142 is applied to all goodwill and other intangible assets recognized in an entity's financial statements. Selective did not record any FAS 142 impairments during 2004, 2003, or 2002. Selective's goodwill balance by operating segment is as follows:
In accordance with industry practice, Selective maintains reserves for losses and loss expenses. These reserves are made up of both case reserves and reserves for claims incurred but not yet reported (IBNR). Case reserves result from claims that have been reported to the Insurance Subsidiaries and are estimated at the amount of ultimate payment. IBNR reserves are established based on generally accepted actuarial techniques. Such techniques assume that past experience, adjusted for the effects of current developments and anticipated trends, are an appropriate basis for predicting future events. In applying generally accepted actuarial techniques, Selective also considers a range of possible loss and loss adjustment expense reserves in establishing IBNR.
The internal assumptions considered by Selective in the estimation of the IBNR amounts for both environmental and non-environmental reserves at Selective's reporting dates are based on: (i) an analysis of both paid and incurred loss and loss expense development trends; (ii) an analysis of both paid and incurred claim count development trends; (iii) the exposure estimates for reported claims; (iv) recent development on exposure estimates with respect to individual large claims and the aggregate of all claims; (v) the rate at which new environmental claims are being reported; and (vi) patterns of events observed by claims personnel or reported to them by defense counsel. External factors identified by Selective in the estimation of IBNR for both environmental and non-environmental IBNR reserves include: legislative enactments, judicial decisions, legal developments in the determination of liability and the imposition of damages, and trends in general economic conditions, including the effects of inflation. Adjustments to IBNR are made periodically to take into account changes in the volume of business written, claims frequency and severity, the mix of business, claims processing and other items as described that are expected by management to affect Selective's reserves for losses and loss expenses over time.
Selective accounts for stock awards issued to employees in accordance with Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" (APB 25). Under APB 25, Selective recognizes expense based on the intrinsic value of the stock awards. Had Selective adopted Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation" (FAS 123), which was amended by Statement of Financial Accounting Standards No. 148 "Accounting for Stock-based Compensation - Transition and Disclosure" (FAS 148), Selective's net income and earnings per share would have been the following pro forma amounts indicated below:
under fair value-based method for all awards, net of related tax effects
See Note 3, "Adoption of New Accounting Pronouncements" for further details regarding the Company's adoption of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment" (FAS 123R).
During 2004, Selective purchased a property and casualty insurance company, domiciled in Maine, with approximately $5.0 million in surplus that was not currently writing any business, for $5.3 million. The acquisition has been accounted for using the purchase method of accounting as prescribed by FASB Statement of Financial Accounting Standards No. 141, "Business Combinations." The acquisition included assets of approximately $4.9 million in cash and short-term investments, $0.1 million in bonds and $0.3 million of goodwill, which is being accounted for in accordance with FASB Statement of Financial Accounting Standards No. 142, "Goodwill and Other Intangible Assets." There were no liabilities acquired in connection with this acquisition.
In 2003, the FASB issued revised FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" (FIN 46R), which is a revised interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements." FIN 46R is required to be applied starting with fiscal years beginning after December 15, 2003. FIN 46R requires the consolidation of a variable interest entity (VIE) by an enterprise if that enterprise either absorbs a majority of the VIE's expected losses or receives a majority of the VIE's expected residual returns as a result of ownership, contractual or other financial interests in the VIE. Prior to FIN 46R, entities were generally consolidated by an enterprise that had a controlling financial interest through ownership of a majority voting interest in the entity. FIN 46R defines a VIE as an entity in which equity investors do not have the characteristics of a controlling financial interest nor do they have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. Selective has no interests in VIEs or potential VIEs commonly referred to as special-purpose entities and as such, the adoption of this revised interpretation on January 1, 2004 has had no effect on Selective's results of operations or financial condition.
In 2004, the FASB issued Statement No. 123 (revised 2004), "Share-Based Payment" (FAS 123R), which requires all companies to measure compensation expense on the income statement for all share-based payments (including employee stock options) at grant date fair value of the equity instruments. The effective date of this statement for public companies is as of the beginning of the first interim or annual reporting period that begins after June 15, 2005, however early adoption is encouraged. Selective expects to adopt the modified prospective application provisions of FAS 123R as of January 1, 2005. The pro forma results presented in Note 2(n) are in accordance with the required disclosures under Financial Accounting Standards No. 148, "Accounting for Stock-Based Compensation - Transition and Disclosure" (FAS 148), and should provide for a reasonable approximation of the impact the implementation of this statement will have on Selective.
(l) The components of comprehensive income, both gross and net of tax, for 2004, 2003 and 2002 are as follows:
The insurance subsidiaries are contingently liable to the extent that any reinsurer becomes unable to meet its contractual obligations. Selective evaluates and monitors the financial condition of its reinsurers under voluntary reinsurance arrangements to minimize its exposure to significant losses from reinsurer insolvencies. On an ongoing basis, Selective reviews amounts outstanding, length of collection period, changes in reinsurance credit standing and other relevant factors to determine collectibility of reinsurance recoverables. During 2004, there were rating downgrades and substantial reserve developments within the reinsurance industry that could affect our ability to collect under certain reinsurance contracts. As a result, Selective increased its loss reserves by $3.5 million and exercised the special termination provision, which was effective in October 2004, on two of its reinsurance contracts. Selective eliminated one carrier and added two highly rated carriers to our Property Catastrophe Excess of Loss and Terrorism Aggregate Excess of Loss treaties.
Assumed written and earned premiums increased primarily due to an increase in mandatory pool assumptions and an increase in writings of voluntary municipal pool business. Offsetting the increases in Selective's flood business, ceded written and earned premiums decreased primarily as a result of the termination of the New Jersey Unsatisfied Claims and Judgment Fund (UCJF). The UCJF was a mandatory reinsurance program that provided for personal injury protection (PIP) coverage for New Jersey auto policies. The UCJF assumed unlimited New Jersey PIP losses in excess of $75,000 up to $250,000 per person/per occurrence from January 1, 1991 through December 31, 2003. Effective January 1, 2004 the program was terminated for all new policies and carriers became responsible for 100% of PIP coverage, which remains capped at $250,000. A final adjustment to the prior treaty year UCJF premium resulted in a return of premium previously ceded of $2.4 million recorded by Selective in this year.
Increases in assumed losses were influenced primarily by increases in losses assumed from mandatory pools. The increases in these assumptions are related to the Company's increased participation in the mandatory pools and general growth of the National Council on Compensation Insurance (NCCI) pool. Increases in ceded incurred losses were primarily attributable to the following: i) increase in losses ceded to the National Flood Insurance program of $35.1 million; ii) increase in losses ceded to casualty excess of loss treaties of $5.7 million; and iii) decrease of $7.2 million in losses ceded to UCJF due to its termination.
Add: Reinsurance recoverable on unpaid loss and loss expenses, at end of year
Incurred loss and loss expense development related to prior years was $4.9 million in 2004, $15.0 million in 2003 and $19.8 million in 2002, while net loss and loss expense reserves increased by $213.2 million in 2004, $160.1 million in 2003 and $111.2 million in 2002. These changes were the result of normal reserve development inherent in the uncertainty in establishing reserves for losses and loss expenses, anticipated loss trends, growth in exposures, as well as increased reinsurance retentions. During 2004, Selective experienced adverse development in its loss and loss expense reserves totaling $4.9 million. This development was driven by an increase to Selective's loss reserves in the general liability and workers compensation lines of business of $3.5 million, which was the result of rating agency downgrades of certain reinsurers during 2004, and reductions in expected bond subrogation recoveries in our bond line of business of $2.0 million. In addition, Selective had net favorable emergence of $0.6 million from our other lines of business, which was primarily the result of increases to its loss reserves for its general liability line of business of approximately $19 million, offset by decreases to its loss reserves for its commercial automobile line of business of approximately $20 million and minor development in other lines. The adverse development in the general liability line of business was mainly due to Selective's contractor completed operations business. The positive development in the commercial automobile line of business was driven by a reduction in claim frequency and severity. The most significant adverse development came from accident years 1999 and 2000, which was offset by favorable development from accident years 2002 and 2003. For the full year 2003, Selective experienced adverse development in its loss and loss expense reserves totaling $15.0 million. Similar to 2004, this development was driven by Selective's general liability line of business, specifically its contractor completed operations business, which increased prior year loss estimates by approximately $18 million. As additional information is collected in the loss settlement process, reserves are adjusted accordingly. These adjustments are reflected in the consolidated statements of income in the period in which such adjustments are recognized. These changes could have a material impact on the results of operations of future periods when the adjustment are made.
Reserves established for liability insurance, written primarily in the general liability line of business, 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 Selective's exposure to environmental claims (for both case and IBNR reserves) resulting from lack of historical data, long reporting delays, uncertainty as to the number and identity of claimants and complex legal and coverage issues. Legal issues which arise in environmental cases include the following: federal or state venue, choice of law, causation, admissibility of evidence, allocation of damages and contribution among joint defendants, successor and predecessor liability and whether direct action against insurers can be maintained. Coverage issues 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. Selective does not discount to present value that portion of its loss reserves expected to be paid in future periods.
Based on its aggregate reserve for net losses and loss expenses at December 31, 2004, Selective 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 its current estimates. The increase in paid losses for non-asbestos environmental claims includes final payment for two large outstanding claims which were included in its 2003 case reserves.
Interest on the Convertible Notes is payable semi-annually at a rate of 1.6155% beginning March 24, 2003 until September 24, 2009, to holders of record at the close of business on the preceding March 9 or September 9, respectively. After that date, cash interest will not be paid on the Convertible Notes prior to maturity unless contingent cash interest becomes payable. Contingent cash interest becomes payable if the average market price of a Convertible Note for the applicable five trading day period equals 120% or more of the sum of the Convertible Note's issue price, accrued original issue discount and accrued cash interest, if any, for a Convertible Note to the day immediately preceding the relevant six-month period. The contingent cash interest payable per the Convertible Note in respect of any quarterly period within any six-month period will equal the greater of (a) any regular cash dividends per share paid by Selective on its common stock during that quarterly period multiplied by the then applicable conversion rate or (b) $0.15 multiplied by 12.9783.
On October 26, 2004, in accordance with the provisions of the Indenture, Selective's Board of Directors voted to permanently waive the stock price contingency provision, which was satisfied for the quarters ended March 31, 2004 and June 30, 2004, when the price of Selective's common stock maintained a 20% premium to the conversion price of $29.29, or $35.15, for 20 of 30 consecutive trading days ending on the last day of each of these respective quarters. If all the Convertible Notes were converted, Selective would be required to issue 3.9 million shares of common stock. No such conversions occurred during 2004.
Selective has various covenants under the Indenture dated September 24, 2002, which include, but are not limited to, timely payment of securities, timely filing of Securities and Exchange Commission and other reports, and compliance with securities laws upon purchase of securities.
Selective maintains a dividend reinvestment plan (DRP). On November 18, 2003, Selective registered with the Securities and Exchange Commission 1,012,873 shares of common shares with the SEC for the DRP, of which 12,873 were previously registered unissued shares. At December 31, 2004, 945,609 shares of common stock were available for issuance. Shares purchased under this plan are issued at fair value. As of December 31, 2004, Selective had an additional 4.8 million shares reserved for various stock compensation plans, retirement plans and debt offerings.
Selective's ability to declare and pay dividends on common stock is affected by the ability of its subsidiaries to declare and pay dividends to the holding company. The dividends from Diversified Insurance Services subsidiaries are restricted only by the operating cash flows of those subsidiaries. The dividends from Insurance Subsidiaries are under the regulatory limitations of the states in which the Insurance Subsidiaries are domiciled: New Jersey, New York, North Carolina, South Carolina and Maine.
Diversified Insurance Services (flood insurance, human resource administration outsourcing and managed care), which, because they are not dependent on insurance underwriting cycles, are evaluated based on several measures including, but not limited to, results of operations in accordance with GAAP.
The Insurance Operations and Diversified Insurance Services segments share either complementary (common marketing or distribution system) or vertical (one business uses another's products or services in its own product or supply output) services. Selective's commercial and personal lines property and casualty insurance products, flood insurance, and HR administration outsourcing products are sold through appointed independent insurance agents. Selective's managed care business provides services to its property and casualty insurance claims operations and to other insurance carriers.
In computing the results of each segment, no adjustment is made for interest expense, net general corporate expenses or federal income taxes. Selective does not maintain separate investment portfolios for the segments and, therefore, does not allocate assets to the segments.
In December 2004, EITF 04-8 became effective. This pronouncement requires that the impact on shares outstanding and diluted earnings per share of a debt issuance with contingent conversion features be reported as if converted from the date of issuance. As noted in Note 3, "Adoption of New Accounting Pronouncements," Selective adopted EITF 04-8 in December 2004 and, as a result, has restated 2003 and 2002 diluted earnings per share to reflect the conversion feature of Selective's September 2002 Senior Convertible Notes, which are further described in Note 8, "Indebtedness."
The following table provides a reconciliation of the numerators and denominators of the basic and diluted earning per share (EPS) computations of net income for the year ended:
(a) A reconciliation of federal income tax on pre-tax earnings at the corporate rate to the effective tax rate is as follows:
The "other" benefit in 2004 was in the form of a reduction to the company's current federal income taxes payable in accordance with FASB Statement No. 5, "Accounting for Contingencies" that related to a favorable resolution of an IRS appeals issue. The IRS had attempted to disallow, on a consolidated basis, a deduction for interest expense incurred by the Parent while its Insurance Subsidiaries held municipal bonds. The company established reserves over the course of the examination as follows: $0.9 million in 2003; $1.2 million in 2002; and $0.2 million in prior years. A notice that the issue was resolved in the Company's favor was received on September 30, 2004, at which time the entire accrual was reversed.
Based on our tax loss carryback availability, expected levels of pre-tax financial statement income and taxable income, we believe that it is more likely than not that the existing deductible temporary differences will reverse during periods in which we generate net taxable income or have adequate carryback availability. As a result, Selective has no valuation allowance recognized for deferred tax assets.
Selective offers a voluntary defined contribution 401(k) retirement savings plan to employees who meet eligibility requirements. The plan allows employees to make voluntary contributions to a number of diversified investment options including Selective's common stock, on a before and/or after-tax basis. Shares of Selective's common stock issued under this plan were 11,730 during 2004, 14,251 during 2003 and 23,496 during 2002.
The number of shares of Selective's common stock available to be purchased under the plan was 798,606 at December 31, 2004. During the first six months of 2002, employees could contribute up to a maximum of 12% of their defined compensation and these contributions were matched 50% by Selective up to a maximum of 6%. Effective July 1, 2002 employees can contribute 50% of their defined compensation and these contributions are matched 65% by the Company up to a maximum of 7% of defined compensation.
An additional defined contribution plan is maintained by Selective HR Solutions, a subsidiary of the Diversified Insurance Services segment, which does not participate in Selective's defined contribution plan. Effective January 1, 2002, the plan allows employees to contribute a maximum of 25% of defined compensation and up to 3% of contributions are matched 200% by the employer. Effective January 1, 2004, the maximum allowable employee contribution to the plan was increased from 25% to 75% of defined compensation.
Employer contributions for all the plans amounted to $3.4 million in 2004, $3.7 million in 2003 and $3.1 million in 2002.
In addition to the deferrals elected by the Participants, Selective may choose at any time to make discretionary contributions on a consistent basis to the deferral accounts of all Participants in its sole discretion. No discretionary contributions were made in 2004, 2003, or 2002. Selective may also choose to make matching contributions to the deferral accounts of some or all Participants to the extent a Participant did not receive the maximum matching contribution permissible under the Selective Insurance Retirement Savings Plan due to limitations under the Internal Revenue Code or such plan.
Selective also provides life insurance benefits ("postretirement benefits") for retired employees. Substantially all of Selective's employees may become eligible for these benefits if they reach retirement age while working for Selective and meet a minimum of ten years of eligibility service. Those who retired prior to January 1, 1991 receive life insurance coverage which decreases over ten years to a current ultimate value of $5,000 per retiree. Those retiring on or after January 1, 1991 receive life insurance coverage in an amount equal to 50% of their annual salary amount in effect at the end of their active career to a maximum benefit of $100,000. Those retiring on or after January 1, 2002 receive life insurance coverage in an amount equal to 50% of their annual salary amount in effect at the end of their active career to a maximum benefit of $35,000.
The retirement income plan had no investments in the common stock of the Company at December 31, 2004. The retirement income plan held investments in the common stock of the Company of $1.3 million at December 31, 2003.
Selective has incentive compensation plans in which 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 $16.7 million in 2004, $13.0 million in 2003 and $6.9 million in 2002.
There were no stock appreciation rights (SARs) granted, exercised, or forfeited in 2004, 2003, or 2002. Options exercisable and their weighted average exercise price at year end are 897,276 and $22.42 for 2004, 1,122,491 and $20.41 for 2003, and 1,287,204 and $19.22 for 2002.
The following table summarizes information about stock options outstanding and exercisable under the stock option plans at December 31, 2004:
During the vesting period, dividends are earned and held in escrow on the restricted shares subject to the same vesting period and conditions as set forth in the award agreement. Effective September 3, 1996, dividends earned on the restricted shares are reinvested in Selective's common stock at fair value. Selective issued through the dividend reinvestment feature (net of forfeitures), restricted shares of 6,914 in 2004, 12,004 in 2003 and 16,817 in 2002, from the dividend reinvestment plan reserves.
In May 2002, the stockholders approved Selective's Stock Option Plan III, which has 1,374,245 shares of Selective's common stock available for issuance at December 31, 2004. The plan permits the granting of qualified and nonqualified stock options to employees, which may or may not have stock appreciation rights (SARs) attached. Options and related SARs may be granted at not less than fair value on the date of the grant and may be subject to certain vesting periods as determined by the SEBC. Each grant must be exercised within ten years from the date of the grant. Under this plan, Selective granted options for 104,600 shares in 2004, 146,250 shares in 2003, and 5,000 shares in 2002.
Under Selective's Stock Option Plan III, the SEBC, in its sole discretion, may grant restricted or unrestricted shares of Selective's common stock, or grant rights to receive common stock, to employees in addition to or in substitution for options and/or SARs granted. Selective granted total restricted shares of 328,684 for 2004, 264,069 for 2003 and 11,000 for 2002 and forfeited shares of 27,434 for 2004 and 10,667 in 2003, with no shares being forfeited in 2002. 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 SEBC 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 SEBC at its discretion as set forth in an award agreement. Dividends earned on the restricted shares are reinvested in Selective's common stock at fair value. Selective issued through the dividend reinvestment feature (net of forfeitures), 10,005 restricted shares in 2004, 5,882 restricted shares in 2003, and 75 restricted shares in 2002, from the dividend reinvestment plan reserves.
Unearned stock compensation is recognized for the fair value of the restricted shares when granted and is accounted for as a reduction of stockholders' equity. This balance is amortized into compensation expense over the four year length of the restriction along with the adjustment for the increases or decreases in the fair value of Selective's common stock for share awards subject to the performance related objectives. Unearned stock compensation of $13.2 million in 2004, $5.3 million in 2003, and $0.2 million in 2002 was recorded as a reduction of stockholders' equity and the amounts amortized to compensation expense were $4.6 million in 2004, $1.5 million in 2003, and $14,000 in 2002.
Under the terms of the employee stock purchase plan, the number of shares of common stock available to be purchased is 268,282. 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. Selective issued shares to employees in the amount of 49,780 in 2004, 66,463 in 2003 and 64,869 in 2002.
Three Selective subsidiaries, Consumer Health Network Plus, LLC (CHN), Alta Services, LLC (Alta) and Selective Insurance Company of America (SICA), were named as defendants, together with ten other unrelated parties, in Berlin Medical Associates PA, et al. v. CMI New Jersey Operating Corp., et al., a purported class action that was filed on May 21, 2003, in the Superior Court of New Jersey, Law Division - Camden County. The plaintiffs are several non-hospital health care providers that have preferred provider contracts with CHN. The complaint alleges that CHN breached the preferred provider contracts by improperly reviewing and reducing the amount of its payments for services provided to insureds of insurance carriers, including SICA, which had contracted to lease CHN's network. The complaint, which does not quantify the amount of damages sought, further alleges that insurance carriers were unjustly enriched by CHN's actions. The Selective subsidiaries have vigorously defended this lawsuit and, together with the other defendants, filed a motion to dismiss. After a hearing on that motion, the court ordered the plaintiffs to amend their complaint. The plaintiffs did so in March 2004, and did not name Alta as a defendant. In May 2004, all remaining defendants, including CHN and SICA, moved to dismiss the amended complaint, and in July 2004, they filed a motion to dismiss the class action allegations. Both motions to dismiss were granted by the court on January 14, 2005. On February 28, 2005, the plaintiffs filed an appeal of the decision to grant both motions to dismiss. If the appeal is successful, CHN and SICA will continue to vigorously defend the case. Given the procedural history of the litigation, it is extremely difficult to provide a meaningful estimate or range of any potential loss. At this time, however, Selective believes that an unfavorable outcome in the case would not have a material adverse effect on its financial condition, results of operations, or liquidity.
SICA was named as a defendant in two alleged class action lawsuits filed in the Third Judicial Circuit, Madison County, Illinois, on October 11, 2003 (Eavenson I) and October 27, 2003 (Eavenson II). Both cases are captioned Mark J. Eavenson, D.C., d/b/a/ Multi-Care Specialists, P.C. v. Selective Insurance Company of America. The first complaint (Eavenson I) was amended on June 18, 2004. The second complaint (Eavenson II) was amended on December 3, 2004. Neither of the amended nor original complaints quantify the money damages being sought. In Eavenson I, the plaintiff alleges that SICA's use of non-parties' preferred provider payment schedules, which reduces the medical provider's bill and/or denies payment of part or all of it, violates the Illinois Consumer Fraud Act and results in SICA's unjust enrichment. The plaintiff also alleges that SICA inappropriately uses these schedules when making payments for medical services, on behalf of its insureds, pursuant to its automobile, homeowners, commercial liability and workers' compensation policies. Discovery is on-going and SICA's motion to dismiss the amended complaint is pending, but not yet scheduled for argument. The court has not yet certified whether a class exists. The Eavenson II amended complaint contains similar allegations to those in Eavenson I regarding SICA's use of PPO networks. The Eavenson II complaint also alleges that SICA's use of the PPO networks represents a civil conspiracy, violates the Illinois Consumer Fraud Act, and results in SICA's unjust enrichment. SICA has not yet responded to the amended complaint and the court has not yet certified whether a class exists. Discovery is on-going and SICA anticipates that it will file a motion to dismiss the amended complaint shortly. SICA is vigorously defending both Eavenson I and Eavenson II. Given the early stages of the litigation, it is extremely difficult to provide a meaningful estimate or range of any potential loss. At this time, Selective believes that, should the case ultimately be decided unfavorably, it would not have a material adverse effect on its financial condition, results of operations, or liquidity.
1. Refer to the Glossary of Terms on Exhibit 13 on Form 10-K.
2. See Note 3 to the consolidated financial statements for a discussion regarding 2003 diluted net income per share restatements.
4. These ranges of high and low prices of Selective'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, 2005 and ending February 28, 2005 was $41.75 to $49.00 and the last sale price on February 28, 2005 was $46.01.