| SELECTIVE INSURANCE GROUP INC Item 1A Risk Factors 19 Item 1A Risk Factors Certain risk factors exist that can have a significant impact on Selectiveapstas business, results of operations, and financial condition |
| The impact of these risk factors could also impact certain actions that Selective takes as part of its long-term capital strategy including, but not limited to, contributing capital to subsidiaries in its Insurance Operations and Diversified Insurance Services segments, issuing additional debt and/or equity securities, repurchasing shares of the Companyapstas common stock, or increasing stockholders &apos dividends |
| The following list of risk factors is not exhaustive and others may exist |
| Selective operates in a continually changing business environment, and new risk factors emerge from time to time |
| Consequently, Selective can neither predict such new risk factors nor assess the impact, if any, they might have on its business in the future |
| The property and casualty insurance industry is cyclical |
| Historically, the results of the property and casualty insurance industry have experienced significant fluctuations due to high levels of competition, economic conditions, interest rates, and other factors |
| During 2005, Commercial Lines premium pricing, excluding exposure, was flat compared to 2004, while Commercial Lines premium pricing increased from 2001 to 2004; and decreased for several years before 2000 |
| The industryapstas profitability also is affected by unpredictable developments, including: • Natural and man-made disasters; • Fluctuations in interest rates and other changes in the investment environment that affect investment returns; • Inflationary pressures (medical and economic) that affect the size of losses; • Judicial decisions that affect insurers &apos liabilities; • Pricing and availability of reinsurance in the marketplace; and • Weather-related impacts due to the effects of global warming trends |
| Catastrophic events Results of property and casualty insurers are subject to weather and other conditions |
| While one year may be relatively free of major weather or other disasters, another year may have numerous such events causing results to be materially worse than other years |
| Selectiveapstas Insurance Subsidiaries have experienced catastrophe losses and the Company expects them to experience such losses in the future |
| Various natural and man-made events can cause catastrophes, including, but not limited to hurricanes, tornadoes, windstorms, earthquakes, hail, terrorism, explosions, severe winter weather, and fires |
| The frequency and severity of these catastrophes are inherently unpredictable |
| The extent of losses from a catastrophe is determined by the severity of the event and the total amount of insured exposures in the area affected by the event |
| Although catastrophes can cause losses in a variety of property and casualty lines, most of the catastrophe-related claims of Selectiveapstas Insurance Subsidiaries historically have been related to commercial property and homeowners coverages |
| Selectiveapstas property and casualty insurance business is concentrated geographically in the Eastern and Midwestern regions of the United States |
| New Jersey accounts for 34prca of the Companyapstas total net premiums written |
| Selectiveapstas Insurance Subsidiaries seek to reduce its exposure to catastrophe losses through the purchase of catastrophe reinsurance |
| Reinsurance, however, may prove inadequate if: • The modeling software used to analyze the Insurance Subsidiaries &apos risk proves inadequate; or • A major catastrophic loss exceeds the reinsurance limit or the reinsurers &apos financial capacity; or • The frequency of catastrophe losses result in Selective exceeding its one reinstatement |
| On November 26, 2002, the Terrorism Risk Insurance Act of 2002 ( "e TRIA "e ) legislation was signed into law |
| TRIA was amended in December 2005 to be in effect through December 31, 2007 |
| TRIA requires sharing the risk of future losses from terrorism between private insurers and the federal government, and is applicable to almost all commercial lines of insurance |
| Insurance companies with direct commercial insurance exposure in the United States are required to participate in this program |
| TRIA rescinded all previously approved exclusions for terrorism |
| Policyholders for non-workers compensation policies have the option to accept or decline the terrorism coverage Selective offers in its policies, or negotiate other terms |
| In 2005, approximately 90prca of Selectiveapstas commercial non-workers compensation policyholders purchased terrorism coverage |
| The terrorism coverage is mandatory for all workers compensation primary policies |
| In addition, ten of the twenty primary states in which Selective writes commercial property coverage mandate the coverage of fire following an act of terrorism |
| These provisions apply to new policies written after enactment of TRIA A terrorism act must be certified by the Secretary of Treasury in order to be covered by TRIA TRIA limits the certified losses to "e international terrorism "e defined as an act committed on behalf of any foreign person or foreign interest in which the damage from the event is in excess of dlra50 million in 2006 and dlra100 million in 2007, and the event was not committed in the course of a war declared by the United States |
| Each participating insurance company will be responsible for paying out a certain amount in claims (a deductible) before federal assistance becomes available |
| This deductible, which is equal to dlra160 million in 2006, is based on a percentage of commercial lines direct earned premiums for lines subject to TRIA from the prior calendar year |
| Although the provisions of TRIA will serve to mitigate Selectiveapstas exposure in the event of a large-scale terrorist attack, the Companyapstas deductible is substantial |
| In addition, it is uncertain whether TRIA will be extended past its current termination date of December 2007 and, therefore, it may not be a permanent solution |
| Selective continues to monitor concentrations of risk and has purchased a separate terrorism treaty to supplement its protection to this highly unknown exposure |
| Selectiveapstas reserves may not be adequate to cover actual losses and expenses |
| Selective is required to maintain loss reserves for its estimated liability for losses and loss expenses associated with reported and unreported insurance claims for each accounting period |
| From time -to time, Selective adjusts reserves and, if the reserves are inadequate, the Company will be required to increase reserves |
| An increase in reserves: (i) reduces net income and stockholders &apos equity for the period in which the deficiency in reserves is identified, and (ii) could have a material adverse effect on Selectiveapstas results of operations, liquidity, financial condition and financial strength, and debt ratings |
| Selectiveapstas estimates of reserve amounts are based on facts and circumstances of which it is aware, including its expectations of the ultimate settlement and claim administration expenses, predictions of future events, trends in claims severity and frequency, and other subjective factors |
| There is no method for precisely estimating the Companyapstas ultimate liability for settlement and claims |
| Selective regularly reviews its reserving techniques and its overall amount of reserves |
| The Company also reviews: * Information regarding each claim for losses; * The Companyapstas loss history and the industryapstas loss history; * Legislative enactments, judicial decisions and legal developments regarding damages; * Changes in political attitudes; and * Trends in general economic conditions, including inflation |
| Selective cannot be certain that the reserves it establishes are adequate or will be adequate in the future |
| Selective is heavily regulated in the states in which it operates |
| Selective is subject to extensive supervision and regulation in the states in which their Insurance Subsidiaries transact insurance business |
| The primary purpose of insurance regulation is to protect individual policyholders and not shareholders or other investors |
| Selectiveapstas business can be adversely affected by regulations affecting property and casualty insurance companies |
| For example, laws and regulations can lead to mandated reductions in rates to levels that Selective does not believe are adequate for the risks it insures |
| Other laws and regulations limit the Companyapstas ability to cancel or refuse to renew policies and require Selective to offer coverage to all consumers |
| Changes in laws and regulations, or their interpretations, pertaining to insurance may also have an impact on Selectiveapstas business |
| Selectiveapstas concentration of business may expose the Company to increased risks of regulatory matters in the states in which it writes insurance that are greater than the risks of having business in a greater number of geographic markets |
| 20 _________________________________________________________________ Although the federal government does not directly regulate the insurance industry, federal initiatives, from time to time, can also impact the insurance industry |
| Proposals intended to control the cost and availability of healthcare services have been debated in the US Congress and state legislatures |
| Although Selective neither writes health insurance nor assumes any healthcare risk, rules affecting healthcare services can affect workers compensation, commercial and personal automobile, liability, and other insurance that it does write |
| The Company cannot determine whether, or in what form, healthcare reform legislation may be adopted by the US Congress or any state legislature |
| Selective also cannot determine the nature and effect, if any, that the adoption of healthcare legislation or regulations, or changing interpretations, at the federal or state level would have on the Company |
| Examples of insurance regulatory risks include: Automobile Insurance Regulation In 1998, New Jersey instituted an Urban Enterprise Zone ( "e UEZ "e ) Program, which requires New Jersey auto insurers to have a market share in certain urban territories that is in proportion to their statewide market share |
| Due to mandated urban rate caps, the premiums on these UEZ policies are typically insufficient to cover losses |
| From time to time, legislative proposals are passed and judicial decisions are rendered related to automobile insurance regulation, which could adversely affect Selectiveapstas results of operation |
| For example, in 2005 the New Jersey Supreme Courtapstas decision eliminated the application of the serious life impact standard to personal automobile bodily injury liability cases under the verbal tort threshold of New Jerseyapstas Automobile Insurance Cost Reduction Act ( "e AICRA "e ) |
| This now allows claimants to file lawsuits for non-economic damages without proving that the injuries sustained had a serious impact on their life |
| Workers Compensation Insurance Regulation Because Selective voluntarily writes workers compensation insurance, it is required by state law to support the involuntary market |
| Insurance companies that underwrite voluntary workers compensation insurance can either directly write involuntary coverage, which is assigned by state regulatory authorities, or participate in a sharing arrangement, where the business is written by a servicing carrier and the profits or losses of that serviced business are shared among the participating insurers |
| Selective currently participates through a sharing arrangement in all states, except New Jersey, where it currently writes involuntary coverage directly |
| Historically, workers compensation business has been unprofitable whether written directly or handled through a sharing arrangement |
| Additionally, Selective is required to provide workers compensation benefits for losses arising from acts of terrorism under its workers compensation policies |
| The impact of any terrorist act is unpredictable, and the ultimate impact on Selective will depend upon the nature, extent, location and timing of such an act |
| Any such impact on Selective could be material |
| Homeowners Insurance Regulation Selective is subject to regulatory provisions that are designed to address potential availability and/or affordability problems in the homeowners property insurance marketplace |
| Involuntary market mechanisms, such as the New Jersey Insurance Underwriting Association ( "e New Jersey FAIR Plan "e ), generally result in assessments to the Company |
| The New Jersey FAIR Plan writes fire and extended coverage on homeowners for those individuals unable to secure insurance elsewhere |
| Insurance companies who voluntarily write homeowners insurance in New Jersey are assessed a portion of any deficit from the New Jersey FAIR Plan based on their share of the voluntary market |
| Similar involuntary plans exist in most other states where Selective operates |
| Flood Insurance Regulation The Federal Governmentapstas NFIP program, currently covers flooding caused by storm surge where water is pushed toward the shore by the force of the winds swirling around a storm |
| If this federal program is modified in an unfavorable manner whereby flooding related to storm surge is no longer covered or is required to be covered by homeowners policies, such modification could have a material adverse effect on Selectiveapstas Flood and/or Homeowners results |
| Selective may be adversely impacted by a change in its ratings |
| Insurance companies are subject to financial strength ratings produced by external rating agencies, based upon factors relevant to policyholders |
| Ratings are not recommendations to buy, hold, or sell any of Selectiveapstas securities |
| Higher ratings generally indicate financial stability and a strong ability to pay claims |
| 21 _________________________________________________________________ Selective depends on independent insurance agents and other third party service providers |
| Selective markets and sells its insurance products through independent, non-exclusive insurance agencies and brokers |
| Agencies and brokers are not obligated to promote Selectiveapstas insurance products, and they may also sell the insurance products of the Companyapstas competitors |
| As a result, Selectiveapstas business depends in part on the marketing and sales efforts of these agencies and brokers |
| As the Company diversifies and expands its business geographically, it may need to expand its network of agencies and brokers to successfully market its products |
| If these agencies and brokers fail to market Selectiveapstas products successfully, its business may be adversely impacted |
| Also, independent agents may decide to sell their businesses to banks, other insurance agencies, or other businesses |
| Agents with a Selective appointment may decide to buy other agents |
| Changes in ownership of agencies or expansion of agencies through acquisition could adversely affect an agencyapstas ability to control growth and profitability, thereby adversely affecting Selectiveapstas business |
| In addition to independent insurance agents, Selective also relies on third party service providers to conduct a portion of its premium audits, loss control services and claims adjusting services |
| Selectiveapstas HR Outsourcing business relies on third party service providers for products such as health coverage, flexible spending accounts, and 401(k) savings plans |
| If these third party service providers fail to perform their respective services and/or fail to provide their products successfully and/or accurately, Selectiveapstas business may be adversely impacted |
| Selectiveapstas ability to reduce its exposure to risks depends on the availability and cost of reinsurance |
| Selective transfers its risk exposure to other insurance and reinsurance companies through reinsurance arrangements |
| Through these arrangements, another insurer assumes a specified portion of the Companyapstas losses and loss adjustment expenses in exchange for a specified portion of the insurance policy premiums |
| The availability, amount, and cost of reinsurance depend on market conditions, which may vary significantly |
| Any decrease in the amount of Selectiveapstas reinsurance will increase its risk of loss |
| Selective also faces credit risk with respect to reinsurance |
| The inability of any of the Companyapstas reinsurers to meet their financial obligations could materially and adversely affect Selectiveapstas operations, as the Company remains primarily liable to its customers under the policies that it has reinsured |
| Selective faces significant competition from other regional and national insurance companies, agents and from self-insurance |
| Selective competes with both regional and national property and casualty insurance companies, including those that do not use independent agents and write directly with insureds |
| Many of these competitors are larger than Selective and have greater financial, technical, and operating resources |
| Because Selective sells its coverages through independent insurance agents who also are agents of its competitors, the Company faces competition within each of its appointed independent insurance agencies |
| The property and casualty insurance industry is highly competitive on the basis of both price and service |
| If Selectiveapstas competitors price their products more aggressively, the Companyapstas ability to grow or renew its business as well as its profitability may be adversely impacted |
| There are many companies competing for the same insurance customers in the geographic areas in which Selective operates |
| The Internet has also emerged as a significant source of new competition, both from existing competitors and from new competitors |
| Selective also faces competition, primarily in the commercial insurance market, from entities that self-insure their own risks |
| Many of Selectiveapstas customers and potential customers are examining the benefits and risks of self-insuring as an alternative to traditional insurance |
| A number of new, proposed, or potential legislative or industry developments could further increase competition in the property and casualty insurance industry |
| These developments include: • The Gramm-Leach-Bliley Act, which could result in increased competition from new entrants to the insurance market, including banks and other financial service companies; • Programs in which state-sponsored entities provide property insurance in catastrophe-prone areas or other alternative market types of coverage; and • Changing practices caused by the Internet, which has led to greater competition in the insurance business and, in some cases, greater expectations for customer service |
| New competition from these developments could cause the supply or demand for insurance to change, which could adversely affect Selectiveapstas results of operations and financial condition |
| 22 _________________________________________________________________ Selective is a holding company, and its subsidiaries may have a limited ability to declare dividends, and thus may not have access to the cash that is needed to meet its cash needs |
| Substantially all of Selectiveapstas operations are conducted through its subsidiaries |
| Restrictions on the ability of the Companyapstas subsidiaries, particularly the Insurance Subsidiaries, to pay dividends or make other cash payments to the Parent may materially affect its ability to pay principal and interest on its indebtedness and dividends on its common stock |
| Under the terms of Selectiveapstas debt agreements and financial solvency laws affecting insurers, the Companyapstas subsidiaries are permitted to incur indebtedness up to certain levels that may restrict or prohibit the making of distributions, the payment of dividends, or the making of loans by the subsidiaries to the Parent |
| The Company cannot assure that the agreements governing the current and future indebtedness of its subsidiaries will permit such subsidiaries to provide the Parent with sufficient dividends, distributions, or loans to fund its cash needs |
| Sources of funds for the Insurance Subsidiaries primarily consist of premiums, investment income, and proceeds from sales and redemption of investments |
| Such funds are applied primarily to payment of claims, insurance operating expenses, income taxes and the purchase of investments, as well as dividends and other payments |
| The Insurance Subsidiaries may declare and pay dividends to the Parent only if they are permitted to do so under the insurance regulations of their respective state of domicile |
| All of the states in which Selectiveapstas Insurance Subsidiaries are domiciled regulate the payment of dividends |
| Some states, including New Jersey, North Carolina, and South Carolina, require that Selective give notice to the relevant state insurance commissioner prior to its Insurance Subsidiaries declaring any dividends and distributions payable to the Parent |
| During the notice period, the state insurance commissioner may disallow all or part of the proposed dividend upon determination that: (i) the insurerapstas surplus is not reasonable in relation to its liabilities and adequate to its financial needs and those of the policyholders, or (ii) in the case of New Jersey, the insurer is otherwise in a hazardous financial condition |
| In addition, insurance regulators may block dividends or other payments to affiliates that would otherwise be permitted without prior approval upon determination that, because of the financial condition of the insurance subsidiary or otherwise, payment of a dividend or any other payment to an affiliate would be detrimental to an insurance subsidiaryapstas policyholders or creditors |
| Selectiveapstas SHRS subsidiary may also declare and pay dividends |
| Potential dividends are restricted only by the operating needs of SHRS Class action litigation could affect Selectiveapstas business practices and financial results |
| Selectiveapstas industries have been the target of class action litigation in areas including the following: • After-market crash parts; • Urban homeowner underwriting practices; • Health maintenance organization practices; and • Discounting and payment of personal injury protection claims |
| A change in Selectiveapstas market share in New Jersey could adversely impact the results in its private passenger automobile business |
| New Jersey insurance regulations require New Jersey auto insurers to involuntarily write private passenger automobile insurance for individuals who are unable to obtain insurance in the voluntary market |
| These policies are priced according to a separate rating scheme that is established by the assigned risk plan and subject to approval by DOBI The amount of involuntary insurance an insurer must write in New Jersey depends on the insurerapstas statewide market share - the greater the market share the more involuntary coverage the insurer is required to write |
| The underwriting of involuntary personal automobile insurance in New Jersey has been historically unprofitable |
| Selective depends on key personnel |
| To a large extent, the success of Selectiveapstas businesses is dependent on its ability to attract and retain key employees, in particular its senior officers, key management, sales, information systems, underwriting, claims, HR Outsourcing, and corporate personnel |
| Competition to attract and retain key personnel is intense |
| While Selective has employment agreements with a number of key managers, the Company generally does not have employment contracts with its employees and cannot ensure that it will be able to attract and retain key personnel |
| 23 _________________________________________________________________ Selectiveapstas investments support its operations and provide a significant portion of its revenues and earnings |
| Like many other property and casualty insurance companies, Selective depends on income from its investment portfolio for a significant portion of its revenues and earnings |
| Any significant decline in the Companyapstas investment income as a result of falling interest rates, decreased dividend payment rates, or general market conditions would have an adverse effect on its results |
| Fluctuations in interest rates cause inverse fluctuations in the market value of the Companyapstas debt portfolio |
| Any significant decline in the market value of its investments, excluding its held-to-maturity investments, would reduce the Companyapstas stockholders &apos equity and its policyholders &apos surplus, which could impact the Companyapstas ability to write additional premiums |
| In addition, Selectiveapstas notes payable are subject to certain debt-to-capitalization restrictions, which could also be impacted by a significant decline in investment values |
| Selective faces risks as a servicing carrier in the "e Write-Your-Own "e ( "e WYO "e ) program of the United States governmentapstas National Flood Insurance Program ( "e NFIP "e ) |
| Flood insurance is offered through the NFIP, which is covered by FEMA under the US Department of Homeland Security |
| During 2005, the destruction caused by Hurricanes Katrina and Rita stressed the NFIP with flood losses in excess of dlra20 billion |
| Selective anticipates that given such losses, the present and future of the NFIP will be critically evaluated with a focus on easing the costs of the program |
| If this federal program is modified in a manner unfavorable to the Company, it could have a material adverse effect on its Flood business |
| Selective employs anti-takeover measures that may discourage potential acquirors and could adversely affect the value of its common stock |
| Selective owns all of the shares of stock of its Insurance Subsidiaries domiciled in the states of New Jersey, New York, North Carolina, South Carolina, and Maine |
| State insurance laws require prior approval by state insurance departments of any acquisition or control of a domestic insurance company or of any company that controls a domestic insurance company |
| Any purchase of 10prca or more of Selectiveapstas outstanding common stock would require prior action by all or some of the insurance commissioners of these states |
| Other factors also may discourage, delay or prevent a change of control of Selective, including among others provisions, in the Companyapstas certificate of incorporation, as amended, relating to: • Supermajority voting and fair price to the Companyapstas business combinations; • Staggered terms for the Companyapstas directors; • Supermajority voting requirements to amend the foregoing provisions; • The Companyapstas stockholder rights plan; • Guaranteed payments that must be made to the Companyapstas officers upon a change of control; and • The ability of the Companyapstas board of directors to issue "e blank check "e preferred stock |
| The New Jersey Shareholders Protection Act provides that Selective, as a New Jersey corporation, may not engage in business combinations specified in the statute with a shareholder having indirect or direct beneficial ownership of 10prca or more of the voting power of the Companyapstas outstanding stock (an interested shareholder) for a period of five years following the date on which the shareholder became an interested shareholder, unless the business combination is approved by the board of directors of the corporation before the date the shareholder became an interested shareholder |
| These provisions also could have the effect of depriving Selective stockholders of an opportunity to receive a premium over the prevailing market price if a hostile takeover were attempted and may adversely affect the value of the Companyapstas common stock |
| Selective faces risks from technology-related failures |
| Selectiveapstas businesses are increasingly dependent on computer and Internet-enabled technology |
| The Companyapstas inability to anticipate or manage problems with technology associated with scalability, security, functionality or reliability could adversely affect its ability to write business and service accounts, and could adversely impact its results of operations and financial conditions |
| Selective faces risks in the HR Outsourcing business |
| The operations of SHRS are affected by numerous federal and state laws and regulations relating to employment matters, benefits plans and taxes |
| In performing services for its clients, SHRS assumes some obligations of an employer under these laws and regulations |
| Regulation in the HR Outsourcing business is constantly evolving, which could result in the modification of laws and regulations from time to time |
| Selective is unable to predict what additional government initiatives, if any, affecting SHRSapstas business may be promulgated in the future |
| Consequently, the Company is also unable to predict whether SHRS will be able to adapt to new or modified regulatory requirements or obtain necessary licenses and government approvals |