2 Data for 2012 through 2014 has been restated to reflect the implementation of ASU 2015-03, Interest-Imputation of Interest (Topic 835-30): Simplifying the Presentation of Debt Issue Costs, which was adopted in the fourth quarter of 2015.
Standard Commercial Lines - comprised of insurance products and services provided in the standard marketplace to our commercial enterprises, which are typically businesses, non-profit organizations, and local government agencies.
Our Standard Commercial and Standard Personal Lines products and services are written through our nine insurance subsidiaries, some of which write flood business through the Write Your Own ("WYO") program of the National Flood Insurance Program ("NFIP"). Our E&S Lines products and services are written through one subsidiary, Mesa Underwriters Specialty Insurance Company ("MUSIC"). This subsidiary provides us with a nationally-authorized non-admitted platform to offer insurance products and services to customers who have not obtained coverage in the standard marketplace.
We have identified the policies and estimates described below as critical to our business operations and the understanding of the results of our operations. Our preparation of the 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 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. Those estimates that were most critical to the preparation of the Financial Statements involved the following: (i) reserves for losses and loss expenses; (ii) pension and post-retirement benefit plan actuarial assumptions; (iii) investment valuation and other-than-temporary-impairments (“OTTI”); and (iv) reinsurance.
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 an estimate of amounts needed to pay reported and unreported net losses and loss expenses. We had accrued $3.7 billion of gross loss and loss expense reserves and $3.1 billion of net loss and loss expense reserves at December 31, 2016. At December 31, 2015, these gross and net reserves were $3.5 billion and $3.0 billion, respectively.
The following tables provide case and incurred but not reported (“IBNR”) reserves for losses and loss expenses, and reinsurance recoverable on unpaid losses and loss expenses as of December 31, 2016 and 2015:
When a claim is reported to us, claims personnel establish a “case reserve” for the estimated amount of the reported loss. The amount of the reserve is primarily based on a case-by-case evaluation of the type of claim involved, the circumstances surrounding each claim, and the policy provisions relating to the type of losses, less any amounts previously paid to the claimant. The estimate reflects the informed judgment of such personnel based on their knowledge, experience, and general insurance reserving practices. Until the claim is resolved, these estimates are revised as deemed appropriate by the responsible claims personnel based on subsequent developments and periodic reviews of the case.
Using generally accepted actuarial reserving techniques, we project our estimate of ultimate losses and loss expenses at each reporting date. Our IBNR reserve is the difference between the projected ultimate losses and loss expenses incurred and the sum of: (i) case losses and loss expense reserves; and (ii) paid losses and loss expenses. The actuarial techniques used in determining ultimate losses are part of a comprehensive reserving process that includes two primary components. The first component is a detailed quarterly reserve analysis performed by our internal actuarial staff. In completing this analysis, the actuaries must gather substantially similar data in sufficient volume to ensure statistical credibility of the data, while maintaining appropriate differentiation. This process defines the reserving segments, to which various actuarial projection methods are applied. When applying these methods, the actuaries are required to make numerous assumptions including, for example, the selection of loss and loss expense development factors and the weight to be applied to each individual projection method. These methods include paid and incurred versions for the following: loss and loss expense development, Bornhuetter-Ferguson, Berquist-Sherman, and frequency/severity modeling (chain-ladder approach). The second component of the analysis is the projection of the expected ultimate loss and loss expense ratio for each line of business for the current accident year. This projection is part of our planning process wherein we review and update expected loss and loss expense ratios each quarter. This review includes actual versus expected pricing changes, loss and loss expense trend assumptions, and updated prior period loss and loss expense ratios from the most recent quarterly reserve analysis.
In addition to the quarterly reserve analysis, a range of possible IBNR reserves is estimated annually and continually considered, among other factors, in establishing IBNR for each reporting period. Loss and loss expense trends are also considered, which include, but are not limited to, large loss activity, asbestos and environmental claim activity, large case reserve additions or reductions for prior accident years, and reinsurance recoverable issues. We also consider factors such as: (i) per claim information; (ii) company and industry historical loss experience; (iii) legislative enactments, judicial decisions,
At December 31, 2016, our general liability line of business had recorded reserves, net of reinsurance, of $1.1 billion, which represented 36% of our total net reserves. In 2016, this line experienced favorable development of $45.0 million, attributable mainly to lower than anticipated claims severities in accident years 2008 through 2013 and 2015.
During 2015, this line experienced favorable development of $51.0 million, attributable mainly to accident years 2013 and prior. This was primarily driven by severities that continued to develop lower than expected, within both the premises and operations and products liability coverages. In addition, the reduction in frequencies that we had seen in the immediately prior accident years continued into accident year 2015.
At December 31, 2016, our commercial automobile line of business had recorded reserves, net of reinsurance, of $413 million, which represented 13% of our total net reserves. In 2016, this line experienced unfavorable development of $25.3 million, which was mainly driven by higher severity in accident year 2014 and higher frequency and severity in 2015.
In 2015, this line experienced unfavorable development of $2.2 million, which was driven by bodily injury liability for accident years 2013 and 2014. This was partially offset by favorable development in accident years 2010 and 2011.
Continuing to leverage our predictive modeling and analytical capabilities to provide more granular and actionable rate per exposure unit guidance on new business opportunities, while also developing and executing targeted rate change and underwriting actions on our renewal portfolio.
At December 31, 2016, our E&S Lines had recorded reserves, net of reinsurance, of $281 million, which represented 9% of our total net reserves. In 2016, these lines experienced unfavorable development of $7.1 million, mostly associated with accident year 2014. In 2015, these lines experienced unfavorable development of $15.5 million, associated with accident years 2012 through 2014. Since we have limited historical loss experience in this segment, our reserve estimates are partially based on development patterns of companies that have similar operations. Therefore, these estimates are subject to somewhat greater uncertainty than the comparable standard operations lines of business. As our own experience matures, we will continue to place greater weight upon it, and less weight upon the surrogate patterns.
We believe that the actions above will not only lead to earlier identification of severe claims, but also earlier claims resolutions with improved outcomes. We have begun to see the benefits of the actions above, through significantly lower loss adjustment expenses.
The strategic realignment of our CMS model to handle property claims under $5,000.
The continued use of our PCSs and our LLU. Our PCSs handle claims between $5,000 and $100,000, while the LLU handles claims above $100,000. Both groups form the core of our catastrophe response team. During 2016, we began increasing the number of property claims specialists to respond to property claims with higher severity and/or complexity. This provides us with more staff to respond to claim volume, including the fluctuations that result from catastrophes, while ensuring we have the highest level of property expertise available to apply to our more complex claims.
Although inflationary volatility is expected to be low in the near term, current United States monetary policy and global economic conditions bring additional uncertainty in the long-term given the length of time required for claim settlement and the impact of medical cost trends relating to longer-tail liability and workers compensation claims. Uncertainty regarding future inflation or deflation creates the potential for additional volatility in our reserves for these lines of business.
The sensitivities of loss and loss expense reserves to these key assumptions are illustrated below for the major casualty lines. The first table shows the estimated impacts from changes in expected reported loss and loss expense development patterns. It shows reserve impacts by line of business if the actual calendar year incurred amounts are greater or less than current expectations by the selected percentages. While the selected percentages by line are judgmentally based, they reflect the relative contribution of the specific line of business to the overall reserve range. The second table shows the estimated impacts from changes to the expected loss and loss expense ratios for the current accident year. It shows reserve impacts by line of business if the expected loss and loss expense ratios for the current accident year are greater or less than current expectations by the selected percentages.
Our pension and post-retirement benefit obligations and related costs are calculated using actuarial methods, within the framework of U.S. GAAP. 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 and mortality.
value of benefit obligations and generally increases pension expense. For additional information regarding our discount rate selection, refer to Note 14. “Retirement Plans” in Item 8. “Financial Statements and Supplementary Data.” of this Form 10-K.
The expected long-term rate of return on the plan assets is determined by considering 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 decreased 13 basis points, to 6.24%, in 2016 as compared to 6.37% in 2015, reflecting the current interest rate environment.
At December 31, 2016, our pension and post-retirement benefit plan obligation was $346.0 million compared to $324.8 million at December 31, 2015. Plan assets were $316.5 million and $249.7 million at December 31, 2016 and December 31, 2015, respectively. Volatility in the marketplace, coupled with changes in the discount rate assumption, could materially impact our pension and post-retirement life valuation in the future. For additional information regarding our pension and post-retirement benefit plan obligations, see Note 14. “Retirement Plans” in Item 8. “Financial Statements and Supplementary Data.” of this Form 10-K.
Reconciliations of net income, net income per share, and ROE to operating income, operating income per share, and operating ROE, respectively, are provided in the tables below:
In addition to the cumulative pure renewal price increases we have achieved over the past several years, we have benefited from underwriting and claims process enhancements, as well as a shift in our business mix towards higher quality accounts. For example, our workers compensation book of business, which represents approximately 20% of our Standard Commercial Lines business, continues to benefit from the steps we have taken in recent years to increase premium rates and to improve the business mix by shifting towards lower hazard and smaller accounts from higher hazard and larger accounts. Additionally, claims initiatives, such as having an increased focus on reducing workers compensation medical costs through more favorable PPO contracts and greater PPO penetration, have helped to improve profitability of this line. The statutory combined ratios for this line of business improved, aided by net favorable loss development, from 110.1% in 2014 to 88.2% in 2015 and 80.7% in 2016. Our E&S segment has also seen an improvement in underwriting results as we have continued to deploy our corporate claims practices in this operation, although we have not yet met our financial targets for this segment. For a full discussion of the claims initiatives that we have deployed, refer to the “Reserves for Loss and Loss Expenses” section within Critical Accounting Policies in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”
The improvements to our underwriting profitability and after tax net investment income discussed above drove our long-term goal of generating an operating ROE that is approximately 300 basis points in excess of our weighted average cost of capital over time. Although our operating income increased in 2016, compared to 2015, our operating ROE was below 2015 levels, due to higher comprehensive income, partially offset by dividends paid to our shareholders, which has increased our shareholders' equity. Our ROE and operating ROE contributions by component are as follows:
The key metric in understanding our insurance segments’ contribution to ROE is the GAAP combined ratio. The following table provides a quantitative foundation for analyzing this ratio:
Growth in our net premiums earned, which was driven by the acquisition of new business as well as renewal pure price increases on our standard lines business of 2.9% in 2016, 3.5% in 2015, and 5.8% in 2014. The renewal pure price increases provided earned rate of approximately 3.1% in 2016 and 4.0% in 2015, both of which were above our rate of expected claim inflation and thus contributed to improved combined ratios in each of the three years presented. However, as described below, our combined ratios are also significantly impacted by prior year casualty reserve development, net catastrophe loss activity, and non-catastrophe property losses.
The improvement in the loss and loss expense ratio of 0.3 points, to 57.4% in 2016 from 57.7% in 2015 was offset by increases in the underwriting expense ratio of 0.8 points in 2016. The higher expense ratio was driven by 0.7 points of higher supplemental commission expense to our distribution partners as a result of improved underwriting profitability, as well as increased compensation paid to our employees, partially offset by reduced pension costs driven in part by the curtailment of our pension plan in the first quarter of 2016.
Improved underwriting profitability that resulted in higher supplemental commission expense to our distribution partners and increased the ratio by 0.3 points;
Pension expense increases due to the accrual of service costs for eligible employees and the negative impact of
The ROE contribution from investment income has decreased from 2014 through 2016 reflecting declining investment leverage as a result of overall stockholders' equity growth outpacing investment income growth. This was, in part, due to strong profitability in our insurance operations coupled with declining portfolio yields.
Net realized gains/losses, which is another component of our investment segments' results, experienced volatility in its contribution to ROE in 2014 through 2016. For qualitative information regarding these fluctuations, which include OTTI charges and investment sales that are largely discretionary as to timing, refer to Note 5. "Investments" in Item 8. "Financial Statements and Supplementary Data." of this Form 10-K.
The ROE contribution from "other" above in the "Return on Average Equity" table, remained consistent from 2014 through 2016. However, we have restructured our long-term incentive program, which is included in other expenses, and expect these expenses to decrease by approximately $10 million over the next twelve months.
In 2017, we expect we will continue to focus on seeking out additional growth opportunities in our insurance operations while working towards our profit targets. We have been able to achieve NPW growth that has significantly exceeded the industry’s growth rate, while at the same time generating solid underwriting margins. In 2016, our Standard Commercial Lines experienced NPW growth of 9%, which was significantly above the A.M. Best expected industry growth rate for commercial lines. In addition, we have about a 1% market share in the 22 states in which we operate and our long-term goal is to increase our market share to approximately 3%. As we continue to leverage our agency franchise model by offering our distribution partners superior technology solutions and customer experience, we are targeting a 12% share of the business within our agencies, from our current 7% share, which we refer to as our "share of wallet." We are also seeking to increase our agency appointments over time to represent a 25% market share of the states in which we are fully operational, from our current 17% share. We believe our relationships with our distribution partners are among the strongest in the industry and underpin our success. During 2016, we appointed 110 new agents and we are planning for an additional 85 agency appointments in 2017.
Turning to investments, we generated after-tax net investment income of $98.4 million, compared to $93.8 million in 2015 and 2% below our February 4, 2016 guidance of $100.0 million. Our challenge in 2017 will be navigating the increased market volatility that may accompany uncertainty regarding fiscal and monetary policy changes. For instance, the potential impact of limiting or eliminating tax-advantaged municipal bond interest may be significant to the returns of our municipal bond portfolio. Likewise, a reduction in the corporate tax rate, a border-adjustment tax, and repealing or replacing the ACA may have significant repercussions in the marketplace. Weighing these risks when seeking new opportunities, and managing the risks for existing positions and sectors in the portfolio, will be a key focus in the upcoming year.
In summary, we are positioning ourselves for a more competitive environment with a focus on generating adequate returns for our shareholders. We are preparing ourselves for changes in a period of heightened uncertainty surrounding interest rates, tax law changes, legislative changes, and inflation. We also have a number of internal strategic initiatives in place to enhance our technological offerings to our agents while improving the overall customer experience.
A statutory combined ratio, excluding catastrophe losses, of approximately 90.5%. This assumes no prior year casualty reserve development;
The statutory underwriting expense ratio remained relatively flat in 2016 compared to 2015. The difference to GAAP is primarily due to higher supplemental commission expenses in the fourth quarter of 2015 that were immediately recognized on a statutory basis but earned in the GAAP underwriting expense ratio during 2016.
The 1.4-point increase in the GAAP underwriting expense ratio in 2015 compared to 2014 was primarily attributable to: (i) higher supplemental commission expense to our distribution partners of 0.4 points; (ii) increases in annual incentive compensation expense to employees of 0.2 points; and (iii) pension expense increases of 0.3 points. Additionally, the 2014 underwriting ratio included $8.0 million, or 0.6 points, of non-recurring benefit related to the sale of the renewal rights to our SIG book of business in March 2014.
2016: favorable prior year development of 8.5 points attributable to accident years 2008 through 2013 and 2015. This was primarily driven by lower than anticipated claims severities.
In 2016, new business was up 9% over last year, while in 2015, new business was up 23% from 2014. In addition, renewal pure price increases and strong retention contributed to NPW growth in both periods. NPE increases in 2016 and 2015 were consistent with the fluctuations in NPW for their respective twelve-month periods ended December 31.
2014: Favorable development of 1.2 points driven by bodily injury liability for accident years 2012 and prior, partially offset by accident year 2013 due to higher frequency of claims.
NPW increases in both periods were due to: (i) renewal pure price increases; and (ii) increased retention. The NPW increases in 2015 compared to 2014 were also driven by increases in direct new business.
The 7.5-point decrease in the statutory combined ratio in 2016 compared to 2015 was due primarily to the following:
Favorable prior year casualty reserve development of $56.0 million, or 18.2 points, compared $37.0 million and 12.8 points in 2015. The favorable development in both periods was attributable to virtually all prior accident years.
Favorable prior year casualty reserve development of $37.0 million, or 12.8 points, attributable to virtually all prior accident years, compared to no development in 2014.
Lower expected loss costs for the current accident year that resulted in an improvement of 9.3-points in 2015, reflecting our ongoing focus on improving this competitive line of business through pricing and claims initiatives, as discussed further above.
Favorable prior year casualty reserve development for both years is primarily driven by continued decreasing severities in accident years 2014 and prior. We believe these claim outcome improvements are due, in part, to lower medical inflation than originally anticipated, as well as the various claims initiatives that we have implemented, including, but not limited to:
The fluctuation in the statutory combined ratios over the three-year period for this line were due to fluctuations in non-catastrophe property losses and catastrophe losses. Quantitative information regarding these items is as follows:
NPW in this segment decreased over the three-year period as shown in the table above. As illustrated in the table below, in both 2016 and 2015 new business has not been sufficient to compensate for the attrition in the retention ratio.
The GAAP loss and loss expense ratio increased 3.1 points in 2015 compared to 2014, primarily driven by: (i) favorable prior year casualty reserve development that was lower than 2014 by 2.2 points; and (ii) property losses that were higher than 2014 by 0.9 points.
Quantitative information over the three-year period related to these items is as follows:
The increase in the GAAP underwriting expense ratio in 2016 compared to 2015 was primarily driven by increased costs related to: (i) increased costs associated with capital improvements, (ii) underwriting expenses from third-party data vendors; and (iii) higher supplemental commission expense to our distribution partners.
The increase in the underwriting expense ratio in 2015 compared to 2014 was driven by: (i) staffing additions, such as Standard Personal Lines Marketing Specialists, to support our growth initiatives; (ii) increases in annual incentive compensation expense to employees through our corporate-wide incentive plan; (iii) pension expense increases; and (iv) increased costs associated with capital improvements.
We continue to focus on profitability drivers in our E&S operations and have achieved overall price increases of 4.9% and 2.9% in 2016 and 2015, respectively. While the NPW growth rate has declined as a consequence of these actions, our primary focus is on bringing this segment to targeted levels of profitability. Quantitative information is as follows:
NPE increases in 2016 and 2015 were consistent with the increases in NPW for their respective twelve-month periods ended December 31, 2016.
The GAAP loss and loss expense ratio decreased 4.2 points in 2016 compared to 2015, primarily due to lower unfavorable prior year casualty reserve development that decreased by 6.4 points compared to 2015. This decrease was partially offset by a 1.3-point increase in the current year loss costs.
The GAAP underwriting expense ratio decreased 2.2 points in 2016 compared to 2015, primarily due to the following: (i) a 1.6-point reduction from the annual cash incentive plan payment for employees in this segment based on 2015 underwriting results; and (ii) 0.5-point decrease from lower supplemental commission expense to our distribution partners.
Property Reinsurance - includes our property excess of loss treaties purchased for protection against large individual property losses and our property catastrophe treaties purchased to provide protection for the overall property portfolio against severe catastrophic events. Facultative reinsurance is used for property risks that are in excess of our treaty capacity.
In addition to the above categories, we have entered into several reinsurance agreements with Montpelier Re Insurance Ltd. as part of the acquisition of MUSIC. Together, these agreements provide protection for losses on policies written prior to the December 2011 acquisition and any development on reserves established by MUSIC as of the date of acquisition. The reinsurance recoverables under these treaties are collateralized.
2 Net loss does not include reinstatement premiums, taxes, or flood claims handling fees.
We use the results of the Risk Management Solutions and AIR Worldwide models in our review of exposure to hurricane risk. Each of these third party vendors provide two views of the modeled results as follows: (i) a long-term view that closely relates modeled event frequency to historical hurricane activity; and (ii) a medium-term view that adjusts historical frequencies to reflect higher expectations of hurricane activity in the North Atlantic Basin. We believe that modeled estimates provide a range of potential outcomes and we review multiple estimates for purposes of understanding our catastrophic risk. The following
table provides modeled hurricane results based on a blended view of the four models for the Insurance Subsidiaries' combined property book as of July 2016:
Our current catastrophe reinsurance program exhausts at a 1 in 265 year return period, or events with 0.38% probability, based on a multi-model view of hurricane risk. Our actual gross and net losses incurred from U.S. landfalling hurricanes will vary, perhaps materially, from our estimated modeled losses.
The property excess of loss treaty, which covers both our standard market and E&S business, was renewed on July 1, 2016 with an additional layer also renewed on January 1, 2017. The major terms of these treaties are consistent with the prior year. The details of the current year treaty are included in the table below.
All NBCR losses are excluded regardless of whether or not they are certified under TRIPRA. For non-NBCR losses, the treaty distinguishes between acts committed on behalf of foreign persons or foreign interests ("Foreign Terrorism") and those that are not. The treaty provides annual aggregate limits for Foreign Terrorism (other than NBCR) acts of $24 million for the first layer and $60 million for the second layer and for the third layer approximately $36 million in annual aggregate limits. Non-foreign terrorism losses (other than NBCR) are covered to the same extent as non-terrorism losses.
We regularly reevaluate our overall reinsurance program and try to develop effective ways to manage transfer of risk. Our analysis is based on a comprehensive process that includes periodic analysis of modeling results, aggregation of exposures, exposure growth, diversification of risks, limits written, projected reinsurance costs, financial strength of reinsurers, and projected impact on earnings, equity, and statutory surplus. We strive to balance sometimes opposing considerations of reinsurer credit quality, price, terms, and our appetite for retaining a certain level of risk.
During 2016, we determined that a more active management approach to our investment portfolio was appropriate to maximize the risk-adjusted after-tax income and total return of the portfolio, while maintaining a similar level of credit quality and duration risk. We evaluated our previous buy-and-hold low turnover approach in the context of the current market environment, and concluded that a change was appropriate to more effectively diversify, navigate, and manage the portfolio in response to a persistently low and volatile interest rate environment, the potential for rising inflation, and an uncertain political and tax landscape.
We have audited the accompanying consolidated balance sheets of Selective Insurance Group, Inc. and its subsidiaries (the “Company”) as of December 31, 2016 and 2015, and the related consolidated statements of income, comprehensive income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2016. In connection with our audits of the consolidated financial statements, we also have audited financial statement schedules I to V. These consolidated financial statements and financial statement schedules are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedules based on our audits.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Selective Insurance Group, Inc. and its subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedules, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Selective Insurance Group, Inc. and its subsidiaries' internal control over financial reporting as of December 31, 2016, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 21, 2017, expressed an unqualified opinion on the effectiveness of the Company’s internal controls over financial reporting.
Selective Insurance Group, Inc., through its subsidiaries, (collectively referred to as “we,” “us,” or “our”) offers standard commercial, standard personal, and excess and surplus ("E&S") lines property and casualty insurance products. Selective Insurance Group, Inc. (referred to as the “Parent”) was incorporated in New Jersey in 1977 and its main offices are located in Branchville, New Jersey. The Parent’s common stock is publicly traded on the NASDAQ Global Select Market under the symbol “SIGI.” We have provided a glossary of terms as Exhibit 99.1 to this Form 10-K, which defines certain industry-specific and other terms that are used in this Form 10-K.
Standard Commercial Lines - comprised of insurance products and services provided in the standard marketplace to commercial enterprises, which are typically businesses, non-profit organizations, and local government agencies.
Certain amounts in our prior years' Financial Statements and related notes have been reclassified to conform to the 2016 presentation. Such reclassifications had no effect on our net income, stockholders' equity, or cash flows.
Equity securities, which are classified as AFS, may include common and non-redeemable preferred stocks. These securities are carried at fair value and the related dividend income is included in "Net investment income earned" on our Consolidated Statements of Income. The cost of equity securities is written down to fair value when a decline in value is considered to be other than temporary. See the discussion below on realized investment gains and losses for a description of the accounting for impairments. After-tax unrealized gains and losses are included in AOCI.
Short-term investments may include certain money market instruments, savings accounts, commercial paper, and debt issues purchased with a maturity of less than one year. We also enter into reverse repurchase agreements that are included in short-term investments. These loans are fully collateralized with high quality, readily marketable instruments at a minimum of 102% of the loan principal. At maturity, we receive principal and interest income on these agreements. All short-term investments are carried at cost, which approximates fair value. The associated income is included in "Net investment income earned" on our Consolidated Statement of Income.
a security considered a “non-credit impairment.” Credit impairments are charged to earnings as a component of realized losses, while non-credit impairments are recorded to Other Comprehensive Income ("OCI") as a component of unrealized losses.
The discount rate we use in a DCF is the effective interest rate implicit in the security at the date of acquisition for those structured securities that were not of high-credit quality at acquisition. For all other securities, we use a discount rate that equals the current yield, excluding the impact of previous OTTI charges, used to accrete the beneficial interest. Discounted cash flow models may include, but are not necessarily limited to: (i) generating cash flows for each tranche considering tranche-specific data, market data, and other pertinent information such as the historical performance of the underlying collateral, including net operating income generated by underlying properties, conditional default rate assumptions, loan loss severity assumptions, consensus projections, prepayment projections, and actual pool and collateral information; (ii) identifying applicable benchmark yields; and (iii) applying market-based tranche specific spreads to determine an appropriate yield by incorporating collateral performance, tranche-level attributes, trades, bids, and offers.
The relationship of market prices per share to book value per share at the date of acquisition and date of evaluation;
The length of time and the extent to which the fair value has been, or is expected to be, less than its cost in the near term; and
Share-based compensation consists of all share-based payment transactions in which an entity acquires goods or services by issuing (or offering to issue) its shares, share units, share options, or other equity instruments. The cost resulting from all share-based payment transactions are recognized in the Financial Statements based on the fair value of both equity and liability awards. The fair value is measured at grant date for equity awards, whereas the fair value for liability awards are remeasured at each reporting period. Both the fair value of equity and liability awards is recognized over the requisite service period. The requisite service period is typically the lesser of the vesting period or the period of time from the grant date to the date of retirement eligibility. The expense recognized for share-based awards, which, in some cases, contain performance criteria, is based on the number of shares or units expected to be issued at the end of the performance period. We repurchase the Parent’s stock from our employees in connection with, and as permitted under, our stock-based compensation plans. This activity is disclosed in our Consolidated Statements of Stockholders' Equity.
We recorded depreciation expense of $17.4 million, $16.4 million, and $12.6 million for 2016, 2015, and 2014, respectively.
Goodwill results from business acquisitions where the cost of assets and liabilities acquired exceeds the fair value of those assets and liabilities. A quantitative goodwill impairment analysis is performed if our quarterly qualitative analysis indicates that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Goodwill is allocated to the reporting units for purposes of these analyses. Based on our analysis at December 31, 2016, goodwill was not impaired.
Claims are counted at the occurrence, line of business, and policy level. For example, if a single occurrence (e.g. an auto accident) leads to a claim under an auto and an associated umbrella policy, they are each counted separately. Conversely, multiple claimants under the same occurrence/line/policy would contribute only a single count. The claim counts provided are on a reported basis. A claim is considered reported when a reserve is established or payment is made. Therefore, claims closed without payment are included in the count as long as there was an associated case reserve at some point in its life cycle.
We also write a small amount of assumed reinsurance. Currently, this business is limited to our share of certain involuntary pools. Since the associated claims are not processed by us, they are not captured within our claims system. Therefore, the claim counts reported exclude this business.
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 unless facts indicate that a more frequent review is required. The discount rate enables us to state expected future cash flows at their present value on the measurement date. The purpose of the discount rate is to determine the interest rates inherent in the price at which pension benefits could be effectively
settled. Our discount rate selection is based on high-quality, long-term corporate bonds. 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. Other assumptions involve demographic factors such as retirement age and mortality.
In January 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-01, Accounting for Investments in Qualified Affordable Housing Projects ("ASU 2014-01"). ASU 2014-01 applies to all reporting entities that invest in flow-through limited liability entities that manage or invest in affordable housing projects that qualify for a low-income housing tax credit. ASU 2014-01 permits reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using a newly defined "proportional amortization method" if certain conditions are met. This policy election is required to be applied consistently to all qualifying investments, rather than a decision to be applied to individual investments. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received, and recognizes the net investment performance in the Consolidated Statements of Income as components of "Federal income tax expense". We adopted this guidance in the third quarter of 2014 and have made a policy election to use the proportional amortization method. The adoption of this guidance did not materially impact our financial condition or results of operations.
In August 2014, the FASB issued ASU 2014-15, Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (“ASU 2014-15”). ASU 2014-15 is intended to define management’s responsibility to evaluate whether there is substantial doubt about an entity’s ability to continue as a going concern and provide related footnote disclosures. Our adoption of this amendment in the fourth quarter of 2016 did not affect us, as the additional disclosure requirements are applicable only to entities that have been subject to events or conditions that cast substantial doubt as to whether the entity has the ability to continue as a going concern.
or a service provider as a variable interest; (iii) the effect of fee arrangements on the primary beneficiary determination; (iv) the
effect of related parties on the primary beneficiary determination; and (v) certain investment funds. We adopted this guidance
In April 2015, the FASB issued ASU 2015-05, Customer's Accounting for Fees Paid in a Cloud Computing Arrangement
(“ASU 2015-05”). ASU 2015-05 provides guidance to customers with cloud computing arrangements that include a software
license. If a cloud computing arrangement includes a software license, the customer's accounting for the software license
does not include a software license, the customer accounts for the arrangement as a service contract. We adopted this guidance
in the first quarter of 2016, with prospective application. The impact of this adoption did not have a material effect on our
per Share (or Its Equivalent) (“ASU 2015-07”). ASU 2015-07 provides that investments for which the practical expedient is
used to measure fair value at net asset value per share ("NAV") must be removed from the fair value hierarchy. Instead, those
In May 2015, the FASB issued ASU 2015-09, Disclosures about Short-Duration Contracts (“ASU 2015-09”). ASU 2015-09 requires companies that issue short duration contracts to disclose additional information, including: (i) incurred and paid claims development tables; (ii) frequency and severity of claims; and (iii) information about material changes in judgments made in calculating the liability for unpaid claim adjustment expenses, including reasons for the change and the effects on the financial statements. We adopted this guidance in the fourth quarter of 2016 and have included the related disclosures in Note 9. "Reserves for Losses and Loss Expenses" below.
In January 2016, the FASB issued ASU 2016-01, Financial Instruments - Overall (Sub-topic 825-10): Recognition and
Measurement of Financial Assets and Financial Liabilities (“ASU 2016-01”). ASU 2016-01 provides guidance to improve
(i) requires equity investments to be measured at fair value with changes in fair value recognized in earnings; (ii) simplifies the
impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to
identify impairment; (iii) eliminates the requirement to disclose the methods and significant assumptions used to estimate the
valuation allowance on a deferred tax asset related to an available-for-sale ("AFS") security should be evaluated with other
ASU 2016-01 is effective for annual periods beginning after December 15, 2017, including interim periods within those annual
the beginning of the year of adoption, otherwise early adoption of ASU 2016-01 is not permitted. We are currently evaluating
retrospective approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in
the financial statements. While we are currently evaluating ASU 2016-02, we do not expect a material impact on our financial
condition or results of operations from the adoption of this guidance.
forfeitures assumptions; and (iv) cash flow classification. ASU 2016-09 is effective for annual periods beginning after
December 15, 2016, and interim periods within those annual periods. Early adoption is permitted. We do not expect this ASU to have a material impact on our financial condition or results of operations.
change the way entities recognize impairment of financial assets by requiring immediate recognition of estimated credit losses
beginning after December 15, 2018. We are currently evaluating the impact of this guidance on our financial condition and
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (“ASU 2016-15”). ASU 2016-15 adds or clarifies
Supplemental cash flow information for the years ended December 31, 2016, 2015, and 2014 is as follows:
The severity of impairment on the securities in the table above averaged 1% of amortized cost at December 31, 2016 and December 31, 2015. The decrease in the unrealized/unrecognized loss balance during 2016 was primarily from our AFS corporate fixed income securities portfolio, which was positively impacted by tightening credit spreads.
Listed below are HTM fixed income securities at December 31, 2016:
Listed below are AFS fixed income securities at December 31, 2016:
(f) We evaluate the alternative investments and tax credit investments included in our other investments portfolio to determine whether those investments are VIEs and if so, whether consolidation is required. A VIE is an entity that either has equity investors that lack certain essential characteristics of a controlling financial interest or lack sufficient funds to finance its own activities without financial support provided by other entities. We consider several significant factors in determining if our investments are VIEs and if we are the primary beneficiary, including whether we have: (i) the power to direct activities of the VIE; (ii) the ability to remove the decision maker of the VIE; (iii) the ability to participate in making decisions that are significant to the VIE; and (iv) the obligation to absorb losses and the right to receive benefits that could potentially be
significant to the VIE. We have determined that the investments in our other investment portfolio are VIEs, but that we are not the primary beneficiary and therefore, consolidation is not required.
Real Estate: This strategy invests opportunistically in real estate in North America, Europe, and Asia via direct property ownership, joint ventures, mortgages, and investments in equity and debt instruments.
(h) We have pledged certain AFS fixed income securities as collateral related to our relationships with the Federal Home Loan Bank of Indianapolis ("FHLBI") and the Federal Home Loan Bank of New York ("FHLBNY"). In addition, certain securities were on deposit with various state and regulatory agencies at December 31, 2016 to comply with insurance laws. We retain all rights regarding securities pledged as collateral.
The following table summarizes the market value of these securities at December 31, 2016:
(j) The following tables summarize OTTI by asset type for the periods indicated:
The majority of the OTTI charges in 2016 were on securities for which we had the intent to sell to facilitate our fixed income strategy change to more actively manage the portfolio to maximize after-tax income and total return, while maintaining a similar level of credit quality and duration risk. Charges in 2015 and 2014 related to equity securities for which we had the intent to sell in relation to a change in our high-dividend yield strategy, with the remaining charges relating to securities that we did not believe would recover in the near term.
(k) The components of net realized gains, excluding OTTI charges, were as follows:
Realized gains and losses on the sale of investments are determined on the basis of the cost of the specific investments sold. Proceeds from the sale of AFS securities were $1,046.1 million in 2016, $234.1 million in 2015, and $259.0 million in 2014.
2014: A quantitative rebalancing of our dividend yield strategy holdings within our equity portfolio.
(a) The components of comprehensive income, both gross and net of tax, for 2016, 2015, and 2014 were as follows:
(b) The balances of, and changes in, each component of AOCI (net of taxes) as of December 31, 2016 and 2015 were as follows:
1 There were no transfers of securities between Level 1 and Level 2.
The following table provides a summary of the changes in the fair value of securities measured using Level 3 inputs and related quantitative information during 2016:
The following tables provide quantitative information regarding our financial assets and liabilities that were disclosed at fair value at December 31, 2016 and 2015:
The Insurance Subsidiaries remain liable to policyholders to the extent that any reinsurer becomes unable to meet their contractual obligations. We evaluate and monitor the financial condition of our reinsurers under voluntary reinsurance arrangements to minimize our exposure to significant losses from reinsurer insolvencies. On an ongoing basis, we review amounts outstanding, length of collection period, changes in reinsurer credit ratings, and other relevant factors to determine collectability of reinsurance recoverables. The allowance for uncollectible reinsurance recoverables was $5.5 million at December 31, 2016 and $5.7 million at December 31, 2015.
2 Includes letters of credit, trust funds, and funds held against reinsurance recoverables.
The ceded premiums and losses related to our participation in the NFIP, under which 100% of our flood premiums, and losses and loss expenses are ceded to the NFIP, are as follows:
The prior accident year development during 2016 was favorable by $65.8 million, which included $69.0 million of net favorable casualty development and $3.2 million of unfavorable property development. The net favorable casualty reserve development was largely driven by the general liability line of business, including products liability and excess liability, and by the workers compensation line. Partially offsetting this net favorable development was the commercial auto line of business, which experienced $25.0 million of unfavorable casualty development in 2016. In addition, our E&S Lines experienced unfavorable casualty development of $6.0 million in 2016.
The majority of the 2016 net favorable development was attributable to accident years 2013 and prior, driven by the general liability and workers compensation lines of business. This net favorable development was partially offset by unfavorable development in accident years 2014 and 2015, which was attributable to our commercial auto and E&S Lines of business. The unfavorable development in our commercial auto line of business was driven primarily by bodily injury liability for accident years 2014 and 2015. The unfavorable development in accident year 2014 was driven by higher than expected severity, whereas accident year 2015 was driven by higher than expected frequency and severity.
The majority of the 2014 net favorable development was attributable to accident years 2010 through 2012, although earlier accident years also developed favorably. The general liability, commercial automobile, and personal automobile lines of business all contributed to this development, partially offset by businessowners’ liability. The overall favorable development for accident years 2012 and prior was partially offset by unfavorable development in accident year 2013, which was largely attributable to commercial automobile liability, and partially E&S Lines casualty.
Estimating IBNR reserves for asbestos and environmental claims is difficult because of the delayed and inconsistent reporting patterns associated with these claims. In addition, there are significant uncertainties associated with estimating critical assumptions, such as average clean-up costs, third-party costs, potentially responsible party shares, allocation of damages, litigation and coverage costs, and potential state and federal legislative changes. Normal historically based actuarial approaches cannot be applied to asbestos and environmental claims because past loss history is not indicative of future potential asbestos and
(e) The table below reflects the historical average annual percentage payout of incurred claims by age. For example, the general liability line of business averages payout of 6.5% of its ultimate losses in the first year, 12.4% in the second year, and so forth. The following is supplementary information about average historical claims duration as of December 31, 2016:
(1) In January 2015, Selective Insurance Company of South Carolina ("SICSC") and Selective Insurance Company of the Southeast ("SICSE"), collectively referred to as the "Indiana Subsidiaries," borrowed $15 million in the aggregate from the FHLBI with an interest rate of 0.63%. The funds were used for general corporate purposes. We repaid this borrowing on July 22, 2016.
Refer to "Financial Condition, Liquidity, and Capital Resources" in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations." for further discussion regarding limitations on aggregate borrowings by the FHLBI and FHLBNY permitted by our Line of Credit.
(3) In the first quarter of 2009, the Indiana Subsidiaries joined, and invested in, the FHLBI, which provides them with access to additional liquidity. The Indiana Subsidiaries’ aggregate investment in the FHLBI was $2.8 million at December 31, 2016 and $2.8 million at December 31, 2015. Our investment provides us the ability to borrow approximately 20 times the total amount of the FHLBI common stock purchased with additional collateral, at comparatively low borrowing rates.
In December 2016, the Indiana Subsidiaries borrowed $60 million from the FHLBI at an interest rate of 3.03%. The principal amount of this borrowing is due on December 16, 2026. $45 million of the proceeds were used to repay the then outstanding $45 million borrowing from the FHLBI and the remaining $15 million was used for general corporate purposes.
(7) In November 2005, we issued $100 million of 6.70% Senior Notes due 2035. These notes were issued at a discount of $0.7 million resulting in an effective yield of 6.754%. Net proceeds of approximately $50 million were used to fund an irrevocable trust to provide for certain payment obligations in respect of our outstanding debt. The remainder of the proceeds was used for general corporate purposes. The agreements covering these notes contain a standard default cross-acceleration provision that provides the 6.70% Senior Notes will enter a state of default upon the failure to pay principal when due or upon any event or condition that results in an acceleration of principal of any other debt instrument in excess of $10 million that we have outstanding concurrently with the 6.70% Senior Notes. There are no financial debt covenants to which we are required to comply in regards to these notes.
Our Standard Commercial Lines, Standard Personal Lines, and E&S Lines are evaluated based on statutory underwriting results (net premiums earned, incurred losses and loss expenses, policyholders dividends, policy acquisition costs, and other underwriting expenses), and statutory combined ratios.
The goodwill balance of $7.8 million at both December 31, 2016 and 2015 relates to our Standard Commercial Lines reporting unit.
The following summaries present revenues from continuing operations (net investment income and net realized gains on investments in the case of the Investments segment) and pre-tax income for the individual segments:
(a) A reconciliation of federal income tax on income at the corporate rate to the effective tax rate is as follows:
federal carryback availability. As a result, we have no valuation allowance recognized for federal deferred tax assets at December 31, 2016 or 2015.
We have analyzed our tax positions in all open tax years, which as of December 31, 2016 were 2013 through 2015. The 2013 tax year is currently under audit. We do not expect any material adjustments to arise out of the 2013 audit. We do not have unrecognized tax expense or benefit as of December 31, 2016.
SICA offers a voluntary defined contribution 401(k) plan, which is available to most of our employees and is a tax-qualified retirement plan subject to the Employee Retirement Income Security Act of 1974 ("ERISA"). Expense recorded for this plan was $15.0 million in 2016, $14.1 million in 2015, and $13.4 million in 2014.
In addition to the Pension Plan, SICA also sponsors the Supplemental Excess Retirement Plan (the "Excess Plan") and a life insurance benefit plan (the "Retirement Life Plan"). Both of these plans are closed to new entrants and participants in the Excess Plan ceased accruing benefits after March 31, 2016. The Retirement Life Plan does not accrue benefits and this plan applies only to retirees who terminated employment with SICA on or before March 31, 2009. These are both unfunded plans with benefit obligations as of December 31, 2016 and December 31, 2015 of $9.1 million and $8.5 million, respectively, for the Excess Plan and $6.3 million and $6.0 million, respectively, for the Retiree Life Plan. Expense recorded for the Excess Plan was $0.5 million in 2016, $0.8 million in 2015, and $0.6 million in 2014. Expense recorded for the Retiree Life Plan was $0.3 million in 2016 and 2015, and $0.4 million in 2014.
The following tables provide details on the Pension Plan for 2016 and 2015:
1This assumption was 4.00% through March 31, 2016, the date after which benefits ceased accruing for all participants of the Pension Plan.
When determining the most appropriate discount rate to be used in the valuation, we consider, among other factors, our expected payout patterns of the Pension Plan's obligations as well as our investment strategy and we ultimately select the rate that we believe best represents our estimate of the inherent interest rate at which our pension and post-retirement life benefits can be effectively settled. Effective January 1, 2016, the approach used to calculate the service and interest components of net periodic benefit cost for benefit plans was changed to provide a more precise measurement of service and interest costs. Prior to 2016, we calculated these service and interest components utilizing a single weighted-average discount rate derived from the yield curve used to measure the benefit obligation at the beginning of the period. Beginning in 2016, we elected to utilize an approach that discounts the individual expected cash flows using the applicable spot rates derived from the yield curve over the projected cash flow period. We have accounted for this change prospectively as a change in accounting estimate. The weighted average discount rate used to determine 2017 interest cost is 3.83%.
Assets of the Pension Plan are invested to ensure that principal is preserved and enhanced over time. Our return objective is to exceed the returns of the plan's policy benchmark, which is the return the plan would have earned if the assets were invested according to the target asset class weightings and earned index returns shown below. In 2017, we will continue to phase in adjustments to the asset allocation to steadily close the gap between the duration of the assets and the duration of the liabilities, provided certain improved funding targets are achieved.
The investments in global equity collective investment funds and in private equity limited partnerships are valued utilizing net asset value as a practical expedient for fair value. These investments are not classified in the fair value hierarchy.
For discussion regarding the levels within the fair value hierarchy, see Note 2. "Summary of Significant Accounting Policies."
In addition, refer to Note 5. "Investments" for discussion regarding the limited partnership investment strategies, excluding the middle market lending strategy, as these investments are not part of the Pension Plan.
We presently do not anticipate contributing to the Pension Plan in 2017, as we have no minimum required contribution amounts.
The Amended and Restated Stock Purchase Plan for Independent Insurance Agencies (the "Agent Plan").
Shares authorized and available for issuance as of December 31, 2016 are as follows:
1 Awards outstanding under the 2005 Stock Plan consisted of 371,003 RSUs and 355,391 stock options.
The liability recorded in connection with our Cash Plan was $32.0 million at December 31, 2016 and $26.5 million at December 31, 2015. The remaining cost associated with the CIUs is expected to be recognized over a weighted average period of 1.2 years. The CIU payments made were $14.3 million in 2016, $10.2 million in 2015, and $9.0 million in 2014.
In 2005, we established a private foundation, now named The Selective Insurance Group Foundation (the "Foundation"), under Section 501(c)(3) of the Internal Revenue Code. The Board of Directors of the Foundation is comprised of some of the Parent's officers. We made no contributions to the Foundation in 2016. We made contributions to the Foundation in the amount of $1.0 million in 2015 and $0.8 million in 2014.
The addition of all quarters may not agree to annual amounts on the Financial Statements due to rounding.
2 These ranges of high and low prices of the Parent’s common stock, as reported by the NASDAQ Global Select Market, represent actual transactions. 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 3, 2017 and ending February 14, 2017 was $38.50 to $44.35.