The total carried net losses and loss expense reserves for these claims was $23.0 million as of December 31, 2014 and $25.2 million as of December 31, 2013. The emergence of these claims is slow and highly unpredictable. For example, within our Standard Commercial Lines book, certain landfill sites are included on the National Priorities List (“NPL”) by the United States Environmental Protection Agency (“USEPA”). Once on the NPL, the USEPA determines an appropriate remediation plan for these sites. A landfill can remain on the NPL for many years until final approval for the removal of the site is granted from the USEPA. The USEPA has the authority to re-open previously closed sites and return them to the NPL. We currently have reserves for eight customers related to four sites on the NPL.
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.
If there is a decline in the equity method value of an other investment 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 and record the charge through earnings as a component of realized losses.
In its Review & Preview report issued in February 2015, A.M. Best noted that the U.S. property and casualty industry is expected to record its second consecutive year of underwriting profitability in 2014, although at a lower level than last year. Their expectation is for an industry statutory combined ratio of 97.2% for the year, 0.8 points higher than last year’s 96.4%. This expectation includes catastrophe losses of 4.4 points and overall favorable prior year reserve development of 1.9 points. This compares with our statutory combined ratio for 2014 of 95.7%, which included 3.2 points of catastrophe losses and 2.6 points of favorable prior year casualty reserve development. In addition, A.M. Best projects a decline in investment yields, continuing a trend that has persisted over the past five years, with yields on new investments remaining significantly lower than those on investments that mature or are called. This is consistent with our experience, which has continued into 2014 with bonds that we purchased having a yield of 2.0% and bonds that were called, matured, or otherwise disposed of yielding 2.3%.
A.M. Best expects the industry combined ratio to deteriorate almost 200 basis points in 2015 to 99.1%, reflecting: (i) a reduction in rate increases; (ii) a modest catastrophe loss increase to 4.9 points, a level that is more in line with recent averages; and (iii) reductions in the level of favorable prior year development to one point on the statutory combined ratio. They believe the main challenges facing the industry include: (i) low returns on fixed-income investments; (ii) reserve shortfalls due to current accident year underestimations and prior accident year unfavorable development; (iii) developing, attracting, and maintaining underwriting talent; (iv) continuing the evolution of data analytics; and (v) addressing the uncertainties surrounding emerging risks such as terrorism, cyber risk, and infectious diseases. Considering these, among other factors, A.M. Best has a negative outlook on the commercial lines market and a stable outlook on the personal lines market. Additionally, after declining in each of the past two years, A.M. Best expects investment income to increase modestly in 2015, driven by growth in invested assets from positive cash flow as yields will continue to be challenged.
The fluctuations in the statutory combined ratios reflect: (i) earned renewal pure price increases of 7.9% in 2014 and 2013, exceeding our projected loss inflation trends and improving profitability by approximately 3 points in both years; and (ii) changes in prior year development.
The significant combined ratio improvement in 2013 compared to 2012 was driven by a change in the mix of business, a reduction in acquisition and integration costs, and significant underwriting actions to improve profitability.
We use the results of the Risk Management Solutions (“RMS”) and AIR Worldwide (“AIR”) 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 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 2014:
Our investment philosophy includes certain return and risk objectives for the fixed income, equity, and other investment portfolios. Although yield and income generation remain the key drivers to our investment strategy, our overall philosophy is to invest with a long-term horizon with predominantly a "buy-and-hold" approach. The primary fixed income portfolio return objective is to maximize after-tax investment yield and income while balancing risk. A secondary objective is to meet or exceed a weighted-average benchmark of public fixed income indices. The equity portfolio strategy is designed to generate consistent dividend income and long term capital appreciation benchmarked to the S&P 500 Index. The return objective of the other investment portfolio, which includes alternative investments, is to meet or exceed the S&P 500 Index.
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, 2014 and 2013, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2014, 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 standard commercial, standard personal, and excess and surplus lines (“E&S”) 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.
Certain amounts in our prior years' Financial Statements and related notes have been reclassified to conform to the 2014 presentation. Such reclassifications had no effect on our net income, stockholders' equity, or cash flows.
We recorded depreciation expense of $12.6 million, $10.2 million, and $9.2 million for 2014, 2013, and 2012, 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 a 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.
We have various operating leases for office space and equipment. Rental expense for such leases is recorded on a straight-line basis over the lease term. If a lease has a fixed and determinable escalation clause, or periods of rent holidays, the difference between rental expense and rent paid is included in "Other liabilities" as deferred rent in the Consolidated Balance Sheets.
An NOL carryforward, a similar tax loss, or a tax credit carryfoward is not available as of the reporting date under the governing tax law to settle taxes that would result from the disallowance of the tax position; or
We presently anticipate contributing $11.9 million to the Retirement Income Plan in 2015, none of which represents minimum required contribution amounts.
In determining expense to be recorded for stock options granted under our share-based compensation plans, the fair value of each option award is estimated on the date of grant using the Black Scholes option valuation model ("Black Scholes"). The following are the significant assumptions used in applying Black Scholes: (i) the risk-free interest rate, which is the implied yield currently available on U.S. Treasury zero-coupon issues with an equal remaining term; (ii) the expected term, which is based on historical experience of similar awards; (iii) the dividend yield, which is determined by dividing the expected per share dividend during the coming year by the grant date stock price; and (iv) the expected volatility, which is based on the volatility of the Parent's stock price over a historical period comparable to the expected term. In applying Black Scholes, we use the weighted average assumptions illustrated in the following table: