Our main office is located in Branchville, New Jersey on a site owned by a subsidiary with approximately 114 acres and 315,000 square feet of operational space. We lease all of our other facilities. The principal office locations related to our Insurance Operations segment is described in the “Field and Technology Strategies Supporting Independent Agent Distribution” section of Item 1. “Business.” of this Form 10-K We believe our facilities provide adequate space for our present needs and that additional space, if needed, would be available on reasonable terms.
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 Exchange Act for forward-looking statements. These statements relate to our intentions, beliefs, projections, estimations or forecasts of future events or future financial performance and involve known and unknown risks, uncertainties and other factors that may cause us or the 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, forward-looking statements may be identified by use of the 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.
We offer property and casualty insurance products through our various subsidiaries. We classify our businesses into two operating segments: (i) Insurance Operations, which consists of Commercial Lines and Personal Lines, including our flood line of business and (ii) Investments. For further information on our segments see Item 1. “Business.” of this Form 10-K.
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. As of December 31, 2010, we had accrued $2.8 billion of gross loss and loss expense reserves compared to $2.7 billion at December 31, 2009.
In addition to the most recent loss trends, a range of possible IBNR reserves is determined annually and continually considered, among 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. We also consider 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, uncertainty associated with actuarial assumptions 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 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.
At December 31, 2010, our commercial automobile line of business had recorded reserves, net of reinsurance, of $358 million, which represented 14% of our total net reserves. This line of business experienced favorable prior year loss development from 2005 through 2010, which was driven by a downward trend in frequency of large claims. The number of large claims has a high degree of volatility from year to year, and therefore, requires a longer period before true trends are recognized and can be acted upon. While management has not identified any specific trends related to this line, the volatility of large claims creates additional uncertainty in our analysis for the most recent accident years.
Workers Compensation, General Liability and Commercial Automobile (Impact of Claims Initiatives and Inflation)
In addition to the line of business specific issues mentioned above, these lines of business have been impacted by a number of initiatives undertaken by our claims department that have resulted in volatility in the average case reserves. This change in the average level of case reserves increases the uncertainty in the short run, but the longer- term benefit is a more refined management of the claims process. Additionally, inflationary changes are perceived to be more likely in the current economic environment. Uncertainty regarding future inflation or deflation creates the potential for additional volatility in our reserves for both of these lines of business.
At December 31, 2010, our personal automobile line of business had recorded reserves, net of reinsurance, of $132 million, which represented 5% of our total net reserves. The majority of the reserves are from business written in New Jersey. Over the past several years we have been decreasing the amount of business written in New Jersey while increasing the amount of business written in other states. We review the reserves for states other than New Jersey on a combined basis so that there is a sufficient volume of data to ensure statistical credibility. However, the state mix of business changes over time, which may increase the uncertainty surrounding our personal automobile reserves.
In addition to the normal amount of volatility, our commercial automobile line of business has realized significant favorable development in 2005 through 2010. This favorable development was driven in large part by a reduction in our bodily injury loss experience. The actual number of large claims has a high degree of volatility from year to year in terms of timing and ultimate final emergence. Even if large losses are ultimately consistent from year to year, if they are identified at different times than previous years, traditional loss development factors may overstate or understate actuarial indications. If the timing of large losses is significantly variable, it is our judgment that actual loss development factors could be +/- 5% different from those selected in our reserve review, which would increase/decrease our indicated commercial auto reserves by approximately $55 million for accident years 2009 and prior.
For the 2010 accident year, the expected ultimate loss ratio by line of business is a key assumption. This assumption is based upon a large number of inputs that are assessed periodically, such as historical loss ratios, projected future loss trend, and planned pricing amounts. In our judgment, it is possible that the actual ultimate loss ratio for the 2010 accident year could be +/-7% from the one selected in our latest reserve analysis for the combination of our four major long-tailed lines of business. The table below summarizes the possible impact on our reserves of varying our expected loss ratio assumption by +/-7% by line of business for the 2010 accident year.
However, we are not aware of any emerging trends that could result in future reserve adjustments. Moreover, normal historically-based actuarial approaches are difficult to apply because relevant history is not available. While models can be applied, such models can produce significantly different results with small changes in assumptions. As a result, we do not calculate a specific environmental loss range, as we believe it would not be meaningful.
The table below summarizes the number of asbestos and non-asbestos claims outstanding at December 31, 2010, 2009, and 2008. For additional information about our environmental reserves, see Item 1. “Business.” and Item 8. “Financial Statements and Supplementary Data.” Note 9. of this Form 10-K.
1 The number of environmental claims includes all multiple claimants who are associated with the same site or incident.
Our marketing efforts for all of our product lines within our Insurance Operations revolve around independent agencies and their touch points with our shared customers, the policyholders.
We had deferred policy acquisition costs of $209.6 million at December 31, 2010 compared to $218.6 million at December 31, 2009. In October 2010, the Financial Accounting Standards Board issued accounting guidance regarding accounting for costs associated with acquiring or renewing insurance contracts, which we anticipate will result in a significant reduction of our deferred policy acquisition cost balance, resulting in a reduction to GAAP equity. For further discussion regarding the impact of this new accounting guidance see the “Pending Accounting Pronouncements” section below.
As of December 31, 2010, our pension assets were $173.3 million, up from $139.7 million at the end of 2009. In 2010, we made $23.0 million in contributions to our plan assets to further improve the funded status of the plan. Volatility in the marketplace, coupled with changes in the discount rate assumption, could materially impact our pension valuation in the future.
The issuer’s current financial condition and ability to make future scheduled principal and interest payments on a timely basis;
In making our assessment, we perform a DCF to determine the present value of future cash flows to be generated by the underlying collateral of the security. Any shortfall in the expected present value of the future cash flows, based on the DCF, from the amortized cost basis of a security is considered a “credit impairment,” with the remaining decline in fair value of a security considered as a “non-credit impairment.” As mentioned above, credit impairments are charged to earnings as a component of realized losses, while non-credit impairments are recorded to OCI as a component of unrealized losses.
The discount rate we use in the 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.
If applicable, we use a conditional default rate assumption in the DCF to estimate future defaults. The conditional default rate is the proportion of all loans outstanding in a security at the beginning of a time period that is expected to default during that period. Our assumption of this rate takes into consideration the uncertainty of future defaults as well as whether or not these securities have experienced significant cumulative losses or delinquencies to date.
If applicable, conditional default rate assumptions apply at the total collateral pool level held in the securitization trust. Generally, collateral conditional default rates will “ramp-up” over time as the collateral seasons, the performance begins to weaken and losses begin to surface. As time passes, depending on the collateral type and vintage, losses will peak and performance will begin to improve as weaker borrowers are removed from the pool through delinquency resolutions. In the later years of a collateral pool’s life, performance is generally materially better as the resulting favorable selection of the portfolio improves the overall quality and performance.
If applicable, we also use a loan loss severity assumption in our DCF that is applied at the loan level of the collateral pool. The loan loss severity assumptions represent the estimated percentage loss on the loan-to-value exposure for a particular security. For CMBS, the loan loss severities applied are based on property type. Losses generated from the evaluations are then applied to the entire underlying deal structure in accordance with the original service agreements.
Evaluation for OTTI of an equity security, may include, but is not limited to, the evaluation of the following factors:
Reinsurance recoverables on paid and unpaid losses and loss expenses represent estimates of the portion of such liabilities that will be recovered from reinsurers. Each reinsurance contract is analyzed to ensure that the transfer of risk exists to properly record the transactions in the financial statements. Amounts recovered from reinsurers are recognized as assets at the same time and in a manner consistent with the paid and 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. This allowance totaled $3.4 million at December 31, 2010 and $2.5 million at December 31, 2009. We continually monitor developments that may impact recoverability from our reinsurers and have available to us contractually provided remedies if necessary. For further information regarding reinsurance, see the “Reinsurance” section below and Note 8. “Reinsurance” in Item 8. “Financial Statements and Supplementary Data.” of this Form 10-K.
Pre-tax net income increased by $49.9 million in 2010 compared to 2009 and decreased $13.1 million in 2009 compared to 2008. After-tax net income increased by $29.1 million in 2010 and decreased $7.4 million in 2009 compared to the respective prior years. These fluctuations were primarily due to:
Pre-tax net income also includes the results of our discontinued operation, Selective HR Solutions (“Selective HR”). We sold Selective HR at the end of 2009, and the $12.9 million pre-tax loss in 2009 reflects both the results of Selective HR’s operations in 2009 as well as the estimated loss on the sale. The pre-tax loss of $5.8 million in 2010 represents adjustments to the estimated proceeds on the sale due to changes in assumptions regarding worksite live generation and retention, which are inherent in the determination of the contingent sales proceeds related to this transaction.
Operating income in 2010 remained relatively flat compared to 2009 reflecting the aforementioned improvements in investment income and net realized losses, which were offset by a reduction in underwriting income. The decrease in operating income in 2009 was primarily attributable to the decrease in net investment income. Refer to Exhibit 99.1 of this Form 10-K for a definition of operating income.
Audit and endorsement return premium of $47.4 million compared to $62.0 million in 2009.
The decrease in NPW in 2009 compared to 2008 was also largely attributable to the economic factors discussed above as illustrated by:
The increase in the GAAP loss and loss expense ratio of 1.4 points in 2010 compared to 2009 was primarily attributable to an increase in property losses of $50.3 million, which included increased catastrophe losses of $47.9 million, or 3.4 points, to $56.5 million in 2010. Catastrophe losses were unusually high in 2010, more than double the level that we anticipated, as we incurred losses on more than 20 storms and such losses exceeded our historical trend. Partially offsetting this increase for 2010 was: (i) favorable casualty prior year development of approximately $39 million, or 2.8 points, in 2010 compared to approximately $29 million, or 2.0 points, in 2009; and (ii) a reduction of loss costs due to the mix of our casualty lines of business. For more information on the favorable prior year development on our casualty lines of business, please refer to the “Review of Underwriting Results by Lines of Business” below.
The modest increase in the GAAP underwriting expense ratio of 0.4 points in 2010 was primarily due to declines in earned premium coupled with benefits recognized in 2009 related to the elimination of retiree life insurance benefits for current employees amounting to a total benefit of $4.2 million, pre-tax.
The commercial lines industry remains very competitive and market conditions do not support broad-based renewal price increases. In an effort to write profitable business in this environment, we continue to implement a defined plan of improving risk selection and mitigating higher frequency trends to complement our strong agency relationships and unique field-based model. In addition, we modified our pricing strategy to focus our pricing efforts to improve profitability on our worst performing business while focusing on retention of our best performing business. The price increases that we have obtained demonstrate the overall strength of the relationships that we have with our independent agents, even in difficult economic and competitive times. Renewal pure price increased 3.1% in 2010, while point of renewal retention remained stable at 87% compared to the prior year. A recent report from the Commercial Lines Insurance Pricing Survey (“CLIPS”) showed that industry pricing declined by 0.6% during the third quarter of 2010.
The personal lines market has been more receptive to price increases and our Personal Lines operations continue to experience NPW growth driven by: (i) ongoing rate increases that went into effect in 2010, which are expected to generate an additional $14.8 million in annual premium; (ii) an increase in new business premium of $6.8 million, to $62.0 million in 2010; (iii) improvement in policy point of renewal retention of approximately two points, to 92%, in 2010; and (iv) an increase in new policy counts of nearly 10% from a year ago. We were able to obtain increased Personal Lines renewal pure pricing of more than 5% in 2010.
In January 2011, A.M. Best revised its outlook for the commercial lines industry from stable to negative, reflecting: (i) continued competitive market conditions; (ii) gradual price deterioration; and (iii) reduced levels of favorable loss reserve development. Combined with loss cost inflation, they believe the pricing trend will continue to compress margins for the commercial lines industry. However, A.M. Best is maintaining a stable outlook for the personal lines industry as operating performance is expected to remain adequate during 2011 while capitalization will continue to be strong. A.M. Best expects continued strain on operating performance and capital levels because of economic uncertainty, pricing pressure, and low investment returns, however they believe that the industry is sufficiently capitalized to withstand these challenges. A.M. Best is projecting a combined ratio of 103.5% in 2011, which includes 4.5 points of catastrophe losses. Fitch expressed a similar combined ratio projection, stating a 103.6% in its report entitled “2011 Outlook: U.S. Property/Casualty Insurance.” Their outlook for next year, however, remains stable for both commercial and personal lines.
Given the rate increases we were able to achieve in 2010 which will be earned in 2011, we are expecting to generate overall full year statutory and GAAP combined ratios of between 101% and 102%, which include an elevated catastrophe loss assumption of two points. Combined ratios do not include any assumptions for reserve development, favorable or unfavorable. Weighted average shares at year-end 2011 are expected to be approximately 55 million.
NPW decreased in 2010 compared to 2009, and in 2009 compared to 2008, due to economic conditions and a very competitive insurance marketplace despite renewal pure price increases of 3.1%. We have experienced reduced levels of exposure consistent with the soft economy coupled with our concentration of business within the contractor class, which accounted for 35% of our business in 2010 and 39% in 2009. These factors are evidenced by the following:
Audit and endorsement return premium of $47.9 million in 2010 compared to $61.9 million in 2009;
Reductions in new business premiums of $55.0 million, to $210.8 million, in 2010; and
NPE decreased in 2010 compared to 2009, and in 2009 compared to 2008 consistent with the fluctuation in NPW over the same periods.
In 2009, the decline in catastrophe losses was offset by non-catastrophe property losses of $4.2 million, or 1.0 points, coupled with a ratio impact attributable to loss cost trends outpacing premium trends.
The prior year casualty development for the respective years was as follows:
Endorsement and audit return premium of $24.6 million in 2010, compared to $27.2 million in 2009.
Endorsement and audit return premium of $27.2 million in 2009, compared to $7.8 million in 2008.
The decrease in the statutory combined ratio for 2010 compared to 2009 was driven by favorable prior year development in accident years 2006 and prior of approximately $27 million, or 7.9 points, in 2010 compared to favorable prior year development of approximately $8 million, or 2.3 points, in 2009. The 2009 increase compared to 2008 was driven by an increase in loss and loss costs, partially offset by the previously mentioned prior year development compared to adverse prior year development of approximately $4 million, or 0.9 points, in 2008. Favorable development in the general liability line of business is often times volatile year-to-year and, therefore, requires a longer period of time before true trends are recognized and can be acted upon.
NPW for this line of business decreased over the three-year period presented above reflecting reduced levels of exposure consistent with the economic factors that existed during this period. The impact of the soft economy is evidenced by the following:
Net renewals down 3%, or $7.7 million, to $219.7 million; and
Endorsement and audit return premium of $20.5 million in 2010, compared to $29.2 million in 2009.
Net renewals down 8%, or $18.9 million, to $227.4 million; and
The increase in the statutory combined ratio over the three-year period was primarily attributable to higher loss costs in each accident year, the impact of prior year development on current year results, and continued pressure on NPE driven by endorsement and audit return premium. Prior year development was as follows:
2010: unfavorable by $21 million, or 8.3 points, driven by increased severity in the 2008 and 2009 accident years;
In some instances, we see rate increases being enacted by certain states, which over time will begin to help address the profitability of this line when coupled with various claims initiatives that we are implementing that we believe will help us better manage our loss costs in this line as well as others.
As with our general liability and workers compensation lines of business, economic factors continue to put pressure on NPW for this line as exposure levels are reduced. The decrease in 2010 included:
A reduction in net renewal premiums of $10.6 million or 4%.
These decreases were partially offset by renewal pure price increases of 2.9% in 2010 compared to increases of 1.1% in 2009.
The decrease in premium for 2009 compared to 2008 was driven by net renewal premiums down $4.8 million, or 2%, from 2008 coupled with a two-point decrease in point of renewal retention to 87%.
In 2009, favorable prior year development of approximately $10 million, or 3.2 points, driven by lower than anticipated severity primarily in accident year 2007.
Physical damage losses that were $4.5 million, or approximately 1.2 points, lower in 2009 compared to 2008.
Renewal pure price increases of 0.3% in 2009 compared to decreases of 4.1% in 2008.
The increase in the statutory combined ratio in 2010 was driven by an increase in catastrophe losses of $27.9 million, or 14.0 points, to $31.8 million. This increased level of catastrophe losses is due largely to a high frequency of weather related catastrophic events in our footprint area, of which the majority occurred in the first half of the year. These catastrophe losses were partially offset by a decrease in non-catastrophe property losses of $6.4 million, or 3.5 points, compared to 2009.
The increase in NPW in 2010 compared to 2009 is primarily due to:
New business direct premium written increases of $6.8 million, or 12%, to $62.0 million in 2010.
The increase in NPW in 2009 compared to 2008 is primarily due to: (i) the impact of rate actions that became effective during 2009 generating $6.7 million in annual premium; and (ii) new business direct premium written increases of $11.8 million to $55.2 million.
The 0.5-point decrease in the GAAP loss and loss expense ratio in 2009 compared to 2008 was driven by: (i) increased rate on the book of business favorably impacting NPE; and (ii) a decrease in catastrophe losses of $2.0 million, or 1.0 point. Partially offsetting these items were increased non-catastrophe property losses of $8.9 million, or 3.4 points.
The increase in the GAAP underwriting expense ratio in 2009 compared to 2008 was primarily attributable to increased commissions resulting from the mix of premium. Partially offsetting this increase were the expense initiatives that we implemented in 2008 and 2009, including a $0.5 million total benefit related to the elimination of retiree life insurance benefits recognized in the first quarter of 2009, combined with a $0.5 million restructuring charge in the first quarter of 2008.
We have reinsurance contracts that cover both property and casualty business. We use traditional forms of reinsurance and do not utilize finite risk reinsurance. Available reinsurance can be segregated into the following key categories:
Property Reinsurance - includes our Property Excess of Loss treaty purchased for protection against large individual property losses and our Property Catastrophe treaty purchased to provide protection for the overall property portfolio against severe catastrophic events. Facultative reinsurance is also used for property risks that are in excess of our treaty capacity.
Other Reinsurance - includes smaller treaties, such as our Surety and Fidelity Excess of Loss, NWCRP and our Equipment Breakdown Coverage treaties, which do not fall within the categories above.
The Property Catastrophe treaty renewed effective January 1, 2011 with an increase in coverage and a 1% decrease in premium. The current treaty structure provides for coverage of $360 million in excess of $40 million compared to the $310 million in excess of $40 million we had in place during 2010. This represents a net increase in coverage of $40.5 million after co-participation. Annual aggregate limit net of our co-participation increased to $670 million for 2011 compared to $589.0 million in 2010.
The following table presents Risk Management Solutions, Inc.’s (“RMS”) v. 9.0 modeled hurricane losses based on the Insurance Subsidiaries’ property book of business as of July 2010:
The Casualty Excess of Loss treaty (“Casualty Treaty”) was renewed on July 1, 2010 and is effective through June 30, 2011, with the same terms as the expiring treaty. The current program provides the following coverage:
The second layer provides coverage for 90% of up to $5.0 million in excess of $4.0 million for contract surety and 90% of up to $2.0 million in excess of $4.0 million for fidelity and commercial surety.
Effective January 1, 2011, we renewed the NWCRP treaty which covers our participation in the involuntary NCCI pool, a residual workers compensation market, and essentially keeps the same coverage as the expiring treaty. The NWCRP treaty provides 100% Quota Share coverage, including terrorism coverage for assumed business from the NCCI and has an aggregate combined ratio limit of approximately 140% for the 2011 underwriting year. The 2011 treaty is placed with three carriers with ratings of “A” by A.M. Best. We believe that the continued protection provided within this treaty for residual market business is especially beneficial given current market conditions and the expected deterioration in the experience of the NCCI pool.
Improved market conditions compared to 2009 and 2008 resulted in an increase in our overall unrealized gain position of $37.7 million, to $82.9 million, as of December 31, 2010. At the same time, after-tax investment income increased significantly driven by improved performance from our alternative investment strategy. For further discussion regarding invested assets and investment income, see the respective sections below.
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, 2010 and 2009, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2010, 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.
Selective Insurance Group, Inc., through its subsidiaries, (collectively referred to as “we,” “us,” or “our”) offers 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.
Prior to 2009, our segments were: Insurance Operations, Investments, and Diversified Insurance Services (which included federal flood insurance administrative services (“Flood”) and human resource administration outsourcing (“HR Outsourcing”)):
Fixed maturity securities may include bonds, redeemable preferred stocks, and mortgage and asset-backed securities. Fixed maturity securities classified as available-for-sale (“AFS”) are reported at fair value. Those fixed maturity securities that we have the ability and positive intent to hold to maturity are classified as held-to-maturity (“HTM”) and are carried at either: (i) amortized cost; or (ii) market value at the date of transfer into the HTM category, adjusted for subsequent amortization. The amortized cost of fixed maturity securities is adjusted for amortization of premiums and accretion of discounts over the expected life of the security using the effective interest method. Premiums and discounts arising from the purchase of mortgage-backed securities are amortized over the expected life of the security based on future principal payments, and considering prepayments. These prepayments are estimated based upon historical and projected cash flows. Prepayment assumptions are reviewed quarterly and adjusted to reflect actual prepayments and changes in expectations. Future amortization of any premium and/or discount is also adjusted to reflect the revised assumptions. Interest income, as well as amortization and accretion, is included in "Net investment income earned" on our Consolidated Statements of Income. The carrying value of fixed maturity 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. Unrealized gains and losses on fixed maturity securities classified as AFS, net of tax, are included in accumulated other comprehensive income (loss) ("AOCI").
Realized gains and losses on the sale of investments are determined on the basis of the cost of the specific investments sold and are credited or charged to income. Also included in realized gains and losses are the other-than-temporary impairment ("OTTI") charges recognized in earnings, which are discussed below.
To determine if an impairment is other than temporary, discounted cash flow analyses (“DCFs”) are performed on all fixed maturity securities meeting certain criteria. In addition, DCFs are performed on all previously-impaired debt securities that continue to be held by us and all structured securities that were not of high-credit quality at the date of purchase. These impairment assessments include, but are not limited to, the following security types: commercial mortgage-backed securities (“CMBS”); residential mortgage-backed securities (“RMBS”); asset-backed securities (“ABS”); collateralized debt obligations (“CDOs”); and corporate fixed maturity securities.
For CMBS, we may also consider the net operating income (“NOI”) generated by the underlying properties. Our assumptions of the properties’ ultimate cash flows take into consideration both an immediate reduction to the reported NOIs and decreases to projected NOIs.
If applicable, we also use a loan loss severity assumption in our DCF that is applied at the loan level of the collateral pool. The loan loss severity assumption represents the estimated percentage loss on the loan-to-value exposure for a particular security. For CMBS, the loan loss severities applied are based on property type. Losses generated from the evaluations are then applied to the entire underlying deal structure in accordance with the original service agreements.
If there is a decline in fair value on an equity security that we do not intend to hold, or if we determine the decline is other-than-temporary, we write down the cost of the investment to its fair value and record the charge through earnings as a component of realized losses.
For approximately 95% of our fixed maturity portfolio, we utilize a market approach, using primarily matrix pricing models prepared by external pricing services. Matrix pricing models use mathematical techniques to value debt securities by relying on the securities relationship to other benchmark quoted securities, and not relying exclusively on quoted prices for specific securities, as the specific securities are not always frequently traded. As a matter of policy, we consistently use one pricing service as our primary source and we use secondary pricing services if prices were not available from the primary pricing service. We validate the prices used for reasonableness in one of two ways: (i) randomly sampling the population and verifying the price to a separate third -party source; or (ii) analytically validating the entire portfolio against a third pricing service. Historically, we have not experienced significant variances in prices and therefore we have consistently used either our primary or secondary pricing service. These prices are typically Level 2 in the fair value hierarchy.
Short-term investments are carried at cost, which approximates fair value. Given the liquid nature of our short-term investments, we generally validate their fair value by way of active trades within approximately a week of the financial statement close. These securities are classified as Level 1 in the fair value hierarchy.
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 consolidated 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.
Goodwill results from business acquisitions where the cost of assets and liabilities acquired exceeds the fair value of those assets and liabilities. Goodwill is tested for impairment annually, or more frequently if events or changes in circumstances indicate that goodwill may be impaired. Goodwill is allocated to the reporting units for the purposes of the impairment test.
Reserves for losses and loss expenses are comprised of both case reserves and reserves for claims incurred but not yet reported ("IBNR"). Case reserves result from claims that have been reported to our seven insurance subsidiaries (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, we also consider a range of possible loss and loss adjustment expense reserves in establishing IBNR.
By using both individual estimates of reported claims and generally accepted actuarial reserving techniques, we estimate the ultimate net liability for losses and loss expenses. While the ultimate actual liability may be higher or lower than reserves established, we believe the reserves make a reasonable provision, in the aggregate, for all unpaid loss and loss adjustment expenses incurred. Any changes in the liability estimate may be material to the results of operations in future periods. We do not discount to present value that portion of our loss reserves expected to be paid in future periods; however, our loss reserves include anticipated recoveries for salvage and subrogation claims.
In December 2009, the FASB issued ASU 2009-17, Consolidations (Topic 810) - Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities. This guidance requires the reporting entity to perform a qualitative analysis that results in a variable interest entity (“VIE”) being consolidated if the reporting entity: (i) has the power to direct activities of the VIE that significantly impact the VIE’s financial performance; and (ii) has an obligation to absorb losses or receive benefits that may be significant to the VIE. This guidance also requires enhanced disclosures, including disclosure of significant judgments and assumptions as to whether a VIE must be consolidated, and how involvement with a VIE affects the company’s financial statements. The adoption of this guidance, which was effective for fiscal years beginning after November 15, 2009, did not impact our financial condition or results of operations.
In December 2010, the FASB issued ASU 2010-29 Business Combinations (Topic 805) Disclosure of Supplementary Pro Forma Information for Business Combinations. This guidance relates to disclosure of pro forma information for business combinations that have occurred in the current reporting period. It requires that an entity presenting comparative financial statements include revenue and earnings of the combined entity as though the combination had occurred as of the beginning of the comparable prior annual period only. This guidance is effective prospectively for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010, and therefore, the adoption of this guidance and its corresponding impact will only need to be assessed to the extent that we engage in any future business combinations.
Cash paid or received during the year for interest and federal income taxes, as well as non-cash financing activities, was as follows for the years ended December 31, 2010, 2009, and 2008:
(a) Net unrealized gains (losses) on investments included in OCI by asset class are as follows:
CMBS includes government guaranteed agency securities with a carrying value of $8.9 million at December 31, 2010 and $10.8 million at December 31, 2009.
RMBS includes government guaranteed agency securities with a carrying value of $4.0 million at December 31, 2010 and $3.9 million at December 31, 2009.
U.S. government includes corporate securities fully guaranteed by the Federal Deposit Insurance Corporation (“FDIC”) with a fair value of $121.0 million at December 31, 2010 and $136.2 million at December 31, 2009.
RMBS includes government guaranteed agency securities with a fair value of $91.1 million at December 31, 2010 and $105.2 million at December 31, 2009.
Unrealized gains/losses of AFS securities represent fair value fluctuations from the later of: (i) the date a security is designated as AFS; or (ii) the date that an OTTI charge is recognized on an AFS security, through the date of the balance sheet. These unrealized gains and losses are recorded in AOCI on the Consolidated Balance Sheets.
(d) The following tables summarize, for all securities in a net unrealized/unrecognized loss position at December 31, 2010 and December 31, 2009, the fair value and gross pre-tax net unrealized/unrecognized loss by asset class and by length of time those securities have been in a net loss position:
Gross unrealized losses include non-OTTI unrealized amounts and OTTI losses recognized in AOCI. In addition, this column includes remaining unrealized gain or loss amounts on securities that were transferred to a HTM designation in the first quarter of 2009 for those securities that are in a net unrealized/unrecognized loss position.
Unrecognized holding gains/(losses) represent market value fluctuations from the later of: (i) the date a security is designated as HTM; or (ii) the date that an OTTI charge is recognized on an HTM security.
We have reviewed the securities in the tables above in accordance with our OTTI policy, as described in Note 2. “Summary of Significant Accounting Policies” above. At December 31, 2010, unrealized/unrecognized losses on securities that were in a loss position for more than 12 months amounted to $8.6 million, primarily driven by $5.8 million in our CMBS portfolio. This was comprised of: (i) $3.7 million of unrealized/unrecognized losses primarily driven by non-credit OTTI charges recognized in AOCI that were generated concurrently with credit-related charges; and (ii) $2.1 million on securities with an average decline in fair value of 17% of their amortized cost. All scheduled principal and interest payments have been received to date. The remaining $2.8 million of unrealized/unrecognized losses are comprised of 37 securities, 21 of which are municipal securities and 16 of which are either RMBS or ABS. Declines in the fair value of these municipal, RMBS, and ABS securities averaged 5% of their amortized cost.
In December 2010, we sold our investments in five limited partnerships with an aggregate carrying value of $21.5 million for $16.4 million. The loss realized on theses sales of $5.2 million, pre-tax, is included in “Net realized investment gains” on the Consolidated Statements of Income. These sales, which were in our mezzanine financing, secondary private equity, private equity, and real estate strategies, reduced our remaining commitment by $22.2 million in the aggregate, which is broken down by strategy as follows:
In addition to the sales, the carrying value of our other investments portfolio in 2010 was primarily impacted by an increase in the value of our limited partnerships of $20.3 million, pre-tax, which is included in net investment income. The increase in value was driven primarily by improved equity and credit markets as well as increased stability in the financial markets in 2010. Alternative investments are reported to us on a quarter lag and during periods of rapid growth or declines, the delayed impact on the value of the alternative investments may be more pronounced. During 2010, contributions of $20.7 million under our remaining commitments were more than offset by distributions of $21.9 million from the limited partnerships. Excluding proceeds from the sale of a partnership last year, this is the first time since 2007 that these investments have produced positive cash flow.
$2.5 million of equity OTTI charges during 2010. These charges were driven primarily by a change in our intent to hold these securities to recovery as we lower our exposure to equities and pursue a more index-neutral position for this asset class in the near term, providing greater sector and sponsor diversification.
$11.8 million of CMBS credit OTTI charges during 2009. These charges taken during 2009 related to reductions in the related cash flows of the underlying collateral of these securities. These securities, on average, showed signs of loss at conditional default rates between 2.5 to 3.0 and had declines in fair value of 77% as compared to their amortized cost. As a result, we did not believe it was probable that we would receive all contractual cash flows for these securities.
$2.5 million of ABS credit OTTI charges during 2009. These charges related primarily to two bonds from the same issuer, who was in technical default, that were previously written down.
The following is a discussion surrounding the credit-related OTTI charges taken during 2008 as outlined in the table above:
$16.4 million of ABS charges. These charges related to issuer-specific credit events that revolved around the performance of the underlying collateral, which had materially deteriorated; however, none of which were bankruptcy related. In general, these securities were experiencing increased conditional default rates and expected loss severities, and as a result, our stress test scenarios were indicating less of a margin to absorb losses going forward. Although some of these securities were insured or guaranteed by monoline bond guarantors, downgrades reduced our confidence in their ability to perform in the event of default. In addition, credit support for these securities began to erode, thereby further increasing the potential for eventual loss.
$10.2 million associated with corporate bond charges. These charges were due to issuer-specific events, primarily related to two Icelandic bank debt securities, for which the banks were placed in receivership.
$6.6 million from six equity securities, including $1.5 million related to an externally managed trading portfolio. These securities were written down because we no longer had the intent to hold these securities through their anticipated recovery period as we did not control day-to-day trading decisions for this portfolio. These charges related to the sharp selloff in the global equity markets stemming from the mortgage and credit crisis, which led to concerns that both U.S. and global economic growth would slow in the near future.
$4.8 million from two alternative investments. These charges were directly related to a security held in their portfolio that had considerable unrealized losses because of the severe volatility in the current financial markets and the dramatic market selloff, specifically in commodity prices.
Amounts are reported in “Other net unrealized gains (losses) on investment securities, net of deferred income tax” on the Consolidated Statements of Stockholders’ Equity.
The fluctuation in ceded premium (written and earned) and ceded losses were primarily attributable to changes in our Flood book of business, in which all of our Flood premiums, losses, and loss expenses are ceded to the NFIP. The associated amounts are as follows:
In 2010, we experienced favorable loss development of approximately $44 million, which was primarily driven by favorable loss development in accident years 2004 through 2007, partially offset by unfavorable loss development in accident years 2008 to 2009 of approximately $24 million. The main driver of this development was favorable prior year development in our commercial automobile and general liability lines of business, partially offset by unfavorable development in our workers compensation line. Commercial automobile experienced favorable development of approximately $28 million driven by lower than anticipated severity emergence primarily in accident years 2004 to 2009. General liability experienced favorable development of approximately $26 million driven by favorable loss emergence for accident years 2006 and prior, partially offset by adverse development in our products/completed operations business. Workers compensation experienced unfavorable prior year development of approximately $22 million primarily driven by increases in accident years 2008 and 2009, which have experienced increases in average severity. Our remaining lines of business collectively experienced approximately $11 million of favorable development. While there were some offsetting impacts among these lines, homeowners contributed $6 million of favorable development towards the total development. This was due to lower than expected liability losses in accident years 2008 and 2009.
(5) In the first quarter of 2009, Selective Insurance Company of the Southeast and Selective Insurance Company of South Carolina (“Indiana Subsidiaries”) joined and invested in the FHLBI, which provides them with access to additional liquidity. The Indiana Subsidiaries’ aggregate investment is $0.8 million and this investment provides the ability to borrow up to 20 times the total amount of the FHLBI common stock purchased with additional collateral, at comparatively low borrowing rates. All borrowings from FHLBI are required to be secured by certain investments. In 2009, the Indiana Subsidiaries borrowed $13 million in the aggregate from the FHLBI. The unpaid principal amount accrues interest of 2.9% and is paid on the 15th of every month. The principal amount is due on December 15, 2014.
The funds borrowed by the Indiana Subsidiaries have been loaned to the Parent as of December 31, 2010 and are being used for general corporate purposes.
Investments, which is evaluated based on net investment income and net realized gains and losses.
As discussed in Note 1. “Organization,” we revised our segments as follows in 2009:
Net investment income includes income (loss) from our alternative investments, which are accounted for by the equity method, of $20.3 million at December 31, 2010, $(21.7) million at December 31, 2009, and $(12.7) million at December 31, 2008.
In 2009 and 2008, we recorded goodwill impairment charges of $7.9 million and $2.6 million, respectively, after-tax, which were the result of Selective HR’s estimated fair value not being sufficient to support its carrying value. In determining the impairment, we calculated the fair value of that reporting unit utilizing an income approach (i.e. expected present value of future cash flows).
(a) A reconciliation of federal income tax on income from continuing operations before federal income tax at the corporate rate to the effective tax rate is as follows:
Stockholders' equity reflects tax benefits related to compensation expense deductions for share-based compensation awards of $16.7 million at December 31, 2010, $17.4 million at December 31, 2009, and $18.6 million at December 31, 2008.
We have analyzed our deferred tax positions in all open tax years, which as of December 31, 2010 were 2007, 2008 and 2009. Based on this analysis, we do not have unrecognized tax benefits as of December 31, 2010. We believe our tax positions will more likely than not be sustained upon examination, including related appeals or litigation. In the event we had a tax position that did not meet the more likely than not criteria, any tax, interest, and penalties incurred related to such a position would be reflected in "Total federal income tax expense (benefit)" on our Consolidated Statements of Income.
The Internal Revenue Service (“IRS”) is conducting an examination of our 2008 and 2009 capital loss carryback refunds for purposes of Joint Committee of Taxation reporting. We do not expect any significant changes as a result of this examination.
Selective Insurance Company of America ("SICA") offers a voluntary defined contribution 401(k) plan to employees who meet eligibility requirements. Participants, other than highly compensated employees (“HCEs”) as defined by the IRS can contribute up to 50% of their defined compensation to the Retirement Savings Plan. Employees age 50 or older who are contributing the maximum may also make additional contributions not to exceed the additional amount permitted by the IRS. Certain terms of the Retirement Savings Plan were amended effective January 1, 2011. The following table presents information regarding plan terms in effect as of December 31, 2010 and the related January 1, 2011 revisions:
In addition to the deferrals elected by the Participants, SICA 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 Retirement Savings Plan due to limitations under the Internal Revenue Code or the Retirement Savings Plan. The Deferred Compensation Plan was amended effective January 1, 2010 to add a non-elective contribution of 4% of eligible compensation to the extent a participant could not receive the maximum enhanced contribution in the Retirement Savings Plan due to the limitations of the Retirement Savings Plan and the Internal Revenue Code. SICA may also choose at any time to make discretionary contributions to the deferral account of any Participant in our sole discretion. No discretionary contributions were made in 2010, 2009, or 2008. SICA contributed $0.2 million in 2010, $0.1 million in 2009, and $0.2 million in 2008 to the Deferred Compensation Plan.
The Retirement Income Plan is a noncontributory defined benefit plan covering all SICA employees who met eligibility requirements prior to January 1, 2006. As of such date, the plan was amended to eliminate eligibility for plan participation by employees first hired on or after January 1, 2006. If otherwise qualified, these employees will, however, be eligible for enhanced matching and non-elective contributions from SICA under the Retirement Savings Plan as discussed above.
The Retirement Income Plan was amended as of July 1, 2002 to provide for different calculations based on service with the company as of that date. Monthly benefits payable under the Retirement Income Plan and Supplemental Excess Retirement Plan at normal retirement age are computed under the terms of those agreements. The earliest retirement age is age 55 with 10 years of service or the attainment of 70 points (age plus years of service). If a participant chooses to begin receiving benefits before their 65th birthday, the amount of their monthly benefit would be reduced in accordance with the provisions of the plan. At retirement, participants receive monthly pension payments and may choose among five payment options, including joint and survivor options.
The funded status of the Retirement Income Plan and Retirement Life Plan was recognized on the Consolidated Balance Sheets for 2010 and 2009, the details of which are as follows:
The estimated net actuarial loss and prior service cost for the Retirement Income Plan that will be amortized from AOCI into net periodic benefit cost during the 2011 fiscal year are $4.4 million and $0.2 million, respectively.
Our measurement date was December 31, 2010 and our expected return on plan assets was 8%, which was based primarily on the Retirement Income Plan's long-term historical returns. Our expected return, which was unchanged in 2010 after examining recent market conditions and trends, approximates our actual 8% annualized return achieved since plan inception for all plan assets. In addition to the plan's historical returns, we consider long-term historical rates of return on the respective asset classes.
Our 2010 discount rate used to value the liability was 5.55% for both the Retirement Income Plan and the Retirement Life Plan. When deciding the most appropriate discount rate to be used in the valuation, we consider, among other factors, our expected pay out patterns of the plans' obligations.
Assets of the Retirement Income Plan are invested to ensure that principal is preserved and enhanced over time. In addition, the Retirement Income Plan is expected to perform above average relative to comparable funds without assuming undue risk, and to add value through active management. Our return objective is to meet or exceed the returns of the plan's policy index, 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. The Retirement Income Plan's exposure to a concentration of credit risk is limited by the diversification of investments across varied financial instruments, including common stocks, mutual funds, non-publicly traded stocks, investments in limited partnerships, fixed income securities, and short-term investments.
The Retirement Income Plan’s assets may not contain investments in any one security or issuer greater than 5% of the portfolio value, regardless of the number of differing issues, except for U.S. Treasury and agency obligations, as well as sovereign debt issues rated A through AAA. The use of leverage is prohibited and the fund managers are prohibited from investing in certain types of securities.
The Retirement Income Plan had no investments in the Parent’s common stock as of December 31, 2010 and 2009.
For valuations of the mutual funds, we utilize a market approach wherein the quoted prices in the active market for identical assets are used. All of the mutual funds are traded in active markets at their net asset value per share. There are no restrictions as to the redemption of these investments nor do we have any contractual obligations to further invest in any of the individual mutual funds. These investments are classified as Level 1 in the fair value hierarchy;
For valuations of the investments in limited partnerships, fair value is based on the Retirement Income Plan’s ownership interest in the reported net asset values as a practical expedient. The majority of the net asset values are reported to us on a one quarter lag. We assess whether these reported net asset values are indicative of market activity that has occurred since the date of their valuation by the investees: (i) by reviewing the overall market fluctuation and whether a material impact to our investments' valuation could have occurred; and (ii) through routine conversations with the underlying funds' general partners/managers discussing, among other things, conditions or events having significant impacts to their portfolio assets that have occurred subsequent to the reported date, if any. The majority of the limited partnership investments cannot be redeemed with the investees as our partnership agreements require our commitment for the duration of the underlying funds’ lives. In the fourth quarter of 2010, we sold three of our limited partnership interest in the secondary market. As of December 31, 2010, there is no active plan to sell any of our remaining interest in the limited partnership investments, however given the volatility in these investments over the recent past, we may continue to entertain potential opportunities to limit our exposure to these investments through the use of the secondary market. These limited partnerships have been fair valued using Level 3 inputs. The Retirement Income Plan has one limited partnership investment in a hedge fund that can be redeemed semi-annually subject to a 30 day notification of intent to redeem. Therefore, we are unable to redeem this investment at the net asset value reported to the plan at December 31, 2010 and 2009. However, we have determined that we have the ability to redeem this investment in the near term and the time between the redemption date and the valuation date is not significant enough to allow for a significant change in fair value. As a result of this determination, this fund has been fair valued using Level 2 inputs as of December 31, 2010 and 2009 using the net asset value of our ownership interest in partners' capital.
The following tables provide a summary of the changes in fair value of securities using significant unobservable inputs (Level 3):
During the vesting period, dividend equivalent units ("DEUs") are earned on RSUs. The DEUs are reinvested in the Parent's common stock at fair value on each dividend payment date. We accrued 38,392 DEUs during 2010; 32,088 DEUs during 2009; and 8,667 DEUs in 2008. The DEUs are subject to the same vesting period and conditions set forth in the award agreements for the RSUs.
During the vesting period, dividends are earned on the restricted stock and held in escrow subject to the same vesting period and conditions set forth in the award agreements. Effective September 3, 1996, dividends earned on the restricted shares were reinvested in the Parent's common stock at fair value. In connection with unvested restricted stock awards granted under Stock Option Plan II, we issued, net of forfeitures, 97 restricted shares from the Dividend Reinvestment Plan (“DRP”) reserves during 2010 and 255 restricted shares during 2008. We experienced net forfeitures of 679 restricted shares from DRP reserves during 2009.
As of December 31, 2010, there were 404,464 shares of the Parent's common stock available for issuance pursuant to outstanding stock options granted under Stock Option Plan III, under which future grants ceased being available with the approval of the Stock Plan. Under Stock Option Plan III, employees were granted qualified and nonqualified stock options, with or without SARs, and restricted or unrestricted stock: (i) at not less than fair value on the date of grant, and (ii) subject to certain vesting restrictions determined by the SEBC. Restricted stock awards also could be subject to achievement of performance objectives as determined by the SEBC. The maximum exercise period for an option grant under this plan was ten years from the date of the grant.
In connection with unvested restricted stock awards granted under Stock Option Plan III, we experienced restricted stock forfeitures of 1,924 shares during 2009, and 21,532 shares during 2008. During the vesting period, dividends earned on restricted shares were reinvested in the Parent's common stock at fair value. We experienced net forfeitures of 23,285 restricted shares from the DRP reserve during 2009 and we issued, net of forfeitures, 1,017 restricted shares during 2008 from the DRP reserve.
As of December 31, 2010, 288,000 shares of the Parent's common stock were available for issuance related to deferred non-employee director awards under the Stock Option Plan for Directors, under which future grants ceased being available with the approval of the Stock Plan. Non-employee directors participated in this plan and automatically received an annual nonqualified option to purchase 6,000 shares of the Parent's common stock at not less than fair value on the date of grant, which was on March 1. Options under this plan vested on the first anniversary of the grant and must be exercised by the tenth anniversary of the grant.
On April 29, 2009, our stockholders approved the Parent’s Employee Stock Purchase Plan (2009) (“ESPP”). This plan replaced the previous employee stock purchase savings plan under which no further purchases could be made as of July 1, 2009. Under the ESPP, there were 1,254,667 shares of the Parent's common stock available for purchase as of December 31, 2010. The ESPP is available to all employees who meet the plan's eligibility requirements. The ESPP 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. Shares are generally issued on June 30 and December 31 of each year. Collectively, under the current and/or prior plans, we issued 149,258 shares to employees during 2010, 190,845 shares during 2009, and 134,561 shares during 2008.
At December 31, 2010, the liability recorded in connection with our Cash Incentive Plan was $8.5 million. The fair value of the liability is re-measured at each reporting period through the settlement date of the awards, which is three years from the date of grant based on an amount expected to be paid. A Monte Carlo simulation is performed to determine the fair value of the cash incentive units that, in accordance with the Cash Incentive Plan, are adjusted to reflect our performance on specified indicators as compared to targeted peer companies. The remaining cost associated with the cash incentive units is expected to be recognized over a weighted average period of 1.1 years. The cash incentive unit payments made were $1.8 million in 2010 and $7.0 million in 2009. No cash incentive unit payments were made in 2008.
The decrease in the six month option value of our ESPP shares from 2009 is driven primarily by a reduction in the volatility of the Parent’s common stock price. During 2009, as a result of the economic crisis and its impact on the global markets, particularly in the financial sector, the Parent’s common stock prices experienced unprecedented volatility, whereas the volatility in 2010 returned to more normalized levels.
William M. Rue, a Director of the Parent, is President of, and owns more than 10% of the equity of, Chas. E. Rue & Sons, Inc., t/a Rue Insurance, a general independent insurance agency ("Rue Insurance"). Rue Insurance is an appointed independent agent of the Insurance Subsidiaries and of the recently discontinued operations of Selective HR, on terms and conditions similar to those of our other agents. Rue Insurance also places insurance for our business operations. Our relationship with Rue Insurance has existed since 1928.
Rue Insurance placed insurance coverage for us with other insurance companies for which Rue Insurance was paid commission pursuant to its agreements with those carriers. We paid premiums for such insurance coverage of $0.3 million in 2010 and $0.5 million in both 2009 and 2008.
Rue Insurance placed human resource outsourcing contracts with Selective HR resulting in revenues to Selective HR of approximately $77,000 in 2009 and $79,000 in 2008. In return, Selective HR paid commissions to Rue Insurance of approximately $10,000 in 2009 and $12,000 in 2008. These revenues are reflected in “Loss from discontinued operations, net of tax” in the Consolidated Statements of Income.
In 2005, we established a private foundation, The Selective 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 contributions to the Foundation in the amount of $0.4 million in 2010 and 2009, and $0.5 million in 2008.
(b) We have various operating leases for office space and equipment. Such lease agreements, which expire at various times, are generally renewed or replaced by similar leases. Rental expense under these leases amounted to $11.4 million in 2010, $11.5 million in 2009, and $11.9 million in 2008. See Note 2(q) for information on our accounting policy regarding leases.
In addition, certain leases for rented premises and equipment are non-cancelable, and liability for payment will continue even though the space or equipment may no longer be in use. At December 31, 2010, the total future minimum rental commitments under non-cancelable leases were $24.6 million and such yearly amounts are as follows:
(c) At December 31, 2010, we have contractual obligations that expire at various dates through 2022 to invest up to an additional $63.6 million in alternative investments. There is no certainty that any such additional investment will be required. For additional information regarding these investments, see item (f) of Note 5. "Investments."
Our Insurance Subsidiaries are also from time-to-time involved in other legal actions, some of which assert claims for substantial amounts. These actions include, among others, putative class actions seeking certification of a state or national class. Such putative class actions have alleged, for example, improper reimbursement of medical providers paid under workers compensation and personal and commercial automobile insurance policies. Our Insurance Subsidiaries also are involved from time-to-time in individual actions in which extra-contractual damages, punitive damages, or penalties are sought, such as claims alleging bad faith in the handling of insurance claims. We believe that we have valid defenses to these cases. We expect that the ultimate liability, if any, with respect to such lawsuits, after consideration of provisions made for estimated losses, will not be material to our consolidated financial condition. Nonetheless, given the large or indeterminate amounts sought in certain of these actions, and the inherent unpredictability of litigation, an adverse outcome in certain matters could, from time-to-time, have a material adverse effect on our consolidated results of operations or cash flows in particular quarterly or annual periods.
The Insurance Subsidiaries prepare their statutory financial statements in accordance with accounting principles prescribed or permitted by the various state insurance departments of domicile. Prescribed statutory accounting principles include state laws, regulations, and general administrative rules, as well as a variety of publications of the National Association of Insurance Commissioners (“NAIC"). Permitted statutory accounting principles encompass all accounting principles that are not prescribed; such principles differ from state to state, may differ from company to company within a state and may change in the future. The Insurance Subsidiaries do not utilize any permitted statutory accounting principles that materially affect the determination of statutory surplus, statutory net income, or risk-based capital (“RBC”). As of December 31, 2010, the various state insurance departments of domicile have adopted the March 2010 version of the NAIC Accounting Practices and Procedures manual in its entirety, as a component of prescribed or permitted practices.
The Insurance Subsidiaries are required to maintain certain minimum amounts of statutory surplus to satisfy their various state insurance departments of domicile. RBC requirements for property and casualty insurance companies are designed to assess capital adequacy and to raise the level of protection that statutory surplus provides for policyholders. Based upon the Insurance Subsidiaries' 2010 unaudited statutory financial statements, their combined total adjusted capital exceeded the authorized control level RBC by 5.1:1, as defined by the NAIC.