Selective Insurance Group, Inc., ("Selective," the "Company," "we," or "our") offers property and casualty insurance products and diversified insurance services through its various subsidiaries. Selective classifies its businesses into three operating segments: (i) Insurance Operations; (ii) Investments; and (iii) Diversified Insurance Services.
• The relationship of market prices per share to book value per share at the date of acquisition and date of evaluation;
Increased competition in the New Jersey personal automobile market partially offset the items above, and resulted in a cumulative decrease in rates of 5.2% along with a 10% reduction in the number of cars we insured during 2005 compared to 2004. In 2004, there was an increase in rates of 6.3% along with an 8% reduction in the number of cars we insured compared to 2003.
• Knowledge Management. We are accumulating and organizing existing underwriting data to enhance underwriting and pricing decisions; and
The increase in our reserves was to address the New Jersey Supreme Court decision to eliminate the application of the serious life impact standard to personal automobile bodily injury liability cases under the verbal tort threshold of New Jersey's Automobile Insurance Cost Reduction Act ("AICRA"). The reserving action was based on an analysis of our claim files and loss experience pre- and post-AICRA, which resulted in an increase to our New Jersey personal automobile loss projections, of which $6.0 million was attributable to prior year development. The implementation of AICRA, combined with our past rating and tiering actions, had enabled us to achieve profitability in the New Jersey personal automobile line of business over the last two years, thus driving the profitability in the Personal Automobile statutory combined ratio in 2004 compared to 2003. However, as a result of this judicial ruling, we had to factor in higher than expected claim costs into our New Jersey personal automobile excess profits calculation, which resulted in the elimination of an excess profits reserve of $5.5 million in 2005. During 2005, losses have not yet developed to the extent expected.
We continue to maintain a conservative, diversified investment portfolio, with fixed maturity investments representing 82% of invested assets. 68% of our fixed maturities portfolio is rated "AAA" while the portfolio has an average rating of "AA," Standard & Poor's ("S&P") second highest credit quality rating. High credit quality continues to be a cornerstone of our investment strategy, as evidenced by the fact that almost 100% of the fixed maturities are investment grade.
Additionally, our cash requirements include principal and interest payments on senior convertible notes, various notes payable and convertible subordinated debentures, dividends to stockholders, and payment of claims and other operating expenses, income taxes, the purchase of investments, and other expenses. Our operating obligations and cash outflows include the following: claim settlements; agents' commissions; labor costs; premium taxes; general and administrative expenses; investment purchases; and capital expenditures. We have additional commitments for alternative investments of up to $65 million; but there is no certainty that any additional investment will be required. For further details regarding our cash requirements see the section below titled "Contractual Obligations and Contingent Liabilities and Commitments."
Effective January 1, 2005, Selective early-adopted the Financial Accounting Standards Board ("FASB") Statement of Financial Accounting Standards No. 123 (Revised 2004), "Share-Based Payments" ("FAS 123R"), which replaces FASB Statement No. 123 "Accounting for Stock Based Compensation" ("FAS 123") and supercedes Accounting Principles Board Opinion No. 25 "Accounting for Stock Issued to Employees" ("APB 25"). FAS 123R applies to all share-based payment transactions in which an entity acquires goods or services by issuing (or offering to issue) its shares, share options, or other equity instruments. FAS 123R requires that the cost resulting from all share-based payment transactions be recognized in the financial statements, based on the fair value of such instruments at the grant date 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. Prior to the adoption of FAS 123R, the Company accounted for its share-based compensation in accordance with the intrinsic value method prescribed by APB 25 as was permitted by FAS 123, wherein Selective recognized compensation cost over the explicit service period. The explicit service period is typically the lesser of the vesting period or the period of time from the grant date to the date of actual retirement, which was the practice for awards granted prior to the adoption of FAS 123R. Share based compensation granted prior to the adoption of FAS 123R continues to be recognized over the remaining explicit service period. The impact on Selective's results of operations or financial condition for the change in the period over which expense is recognized is not material.
(l) The components of comprehensive income, both gross and net of tax, for 2005, 2004, and 2003 are as follows:
For the 8.87% Senior Notes, Selective is required to pay $12.3 million principal amount in each year commencing on May 4, 2006 and ending on May 4, 2010, inclusive, in addition to accrued interest thereon. The unpaid principal amount of these Senior Notes accrues interest and is payable semiannually on May 4 and November 4 of each year, until the principal is paid in full.
• Investments, which are evaluated based on net investment income and net realized gains and losses; and
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 from continuing operations for the individual segments:
Based on our federal tax loss carryback availability, expected levels of pre-tax financial statement income and federal taxable income, we believe that it is more likely than not that the existing deductible temporary differences will reverse during periods in which we generate net federal taxable income or have adequate federal carryback availability. As a result, Selective has no valuation allowance recognized for federal deferred tax assets.
Under the Stock Plan, the Board of Directors' Salary and Employee Benefits Committee ("SEBC") may grant stock options, stock appreciation rights, restricted stock, phantom stock, stock bonuses, and other awards in such amounts and with such terms and conditions as it shall determine, subject to the provisions of the Stock Plan. The Corporate Governance and Nominating Committee makes such determinations for any grants, other than automatic Director grants, made to nonemployee Directors. Each award granted under the Stock Plan (except unconditional stock bonuses and the cash component of Director compensation) shall be evidenced by an agreement containing such restrictions as the SEBC or the Corporate Governance and Nominating Committee, as applicable, may in its sole discretion deem necessary or desirable and which are not in conflict with the terms of the Stock Plan. During 2005, Selective granted 8,750 restricted shares and granted options to purchase 2,500 shares. As of December 31, 2005, 1,749,291 shares of Selective's common stock remain available for issuance pursuant to outstanding stock options and restricted stock awards granted under the Stock Plan.
During the vesting period, dividends are earned on the restricted shares and held in escrow subject to the same vesting period and conditions set forth in the award agreement. Effective September 3, 1996, dividends earned on the restricted shares were reinvested in Selective's common stock at fair value. Selective issued, net of forfeitures, 2,946 restricted shares from the dividend reinvestment plan reserves during 2005, 6,914 restricted shares during 2004, and 12,004 restricted shares during 2003.
Selective paid reinsurance commissions of $0.2 million in 2005 and 2004, as well as $0.1 million in 2003 to PL, LLC. PL, LLC is an insurance fund administrator of which the Rue Agency owns 20% and which places reinsurance through a Selective insurance subsidiary.