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Executives

Jennifer DiBerardino – SVP, IR

Dale Thatcher – CFO

John Marchioni – EVP, Insurance Operations

Greg Murphy – CEO

Analysts

Joe DeMarino – Piper Jaffray

Doug Mewhirter – RBC Capital Markets

Selective Insurance Group, Inc. (SIGI) Q1 2010 Earnings Conference Call April 29, 2010 8:30 AM ET

Operator

Good day, everyone. Welcome to the Selective Insurance Group’s first quarter 2010 earnings conference call. At this time, for opening remarks and introductions, I would like to turn the call over to Senior Vice President, Investor Relations Ms. Jennifer DiBerardino. You may begin.

Jennifer DiBerardino

Thank you, good morning and welcome to Selective Insurance Group’s first quarter 2010 conference call. This call is being simulcast on our website and the replay will be available through May 28, 2010. A supplemental investor package, which includes GAAP reconciliations of non-GAAP financial measures referred to on this call, is available on the Investors page of our website at www.selective.com.

Selective uses operating income, a non-GAAP measure to analyze trends in operations. Operating income is net income excluding the after-tax impact of net realized investment gains or losses as well as the after tax results of discontinued operations. We believe that providing this non-GAAP measure makes it easier for investors to evaluate our insurance business.

As a reminder, some of the statements and projections that will be made during this call are forward-looking statements as defined by the Private Securities Litigation Reform Act of 1995. Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties.

We refer you to Selective’s Annual Report on Form 10-K and any subsequent Form 10-Qs filed with the U.S. Securities and Exchange Commission for a detailed discussion of these risks and uncertainties. Please note that Selective undertakes no obligation to update or revise any forward-looking statements.

Joining me today on the call are the following members of Selective’s executive management team, Greg Murphy, CEO; Dale Thatcher, CFO; John Marchioni, EVP, Insurance Operations; and Ron Zaleski, Chief Actuary. Now, I’ll turn the call over to Dale to review the quarter results.

Dale Thatcher

Thanks, Jen; good morning. As we previously announced, catastrophe losses totalled $24 million in the first quarter and resulted from five February (inaudible) in the northeast and Mid-Atlantic states. Although it was the worst catastrophe quarter for selective in over 20 years, underlying quarterly results were well within expectations. For the first quarter we reported operating income for diluted share of $0.12 as compared to $0.05 a year ago.

Earnings were reduced by catastrophe losses but offsetting these were significant improvement in alternative investment income, favorable prior year reserve development due to ongoing favorable claim trends, and improved non-catastrophe property results as compared to the first quarter of 2009.

The first quarter statutory combined ratio was 102.8%, 2.6 points higher than a year ago. Catastrophe losses accounted for 6.8 points on the combined ratio in the quarter partially offset by favorable reserve development of $9 million pretax or 2.5 points.

Commercial lines growth continues to be a challenge given the economic and competitive conditions. Commercial lines premium declined 4% in the quarter driven by $18 million in return audit, and endorsement premium compared to $17.5 million a year ago.

We still anticipate that the return premium trend will reverse later in 2010 if unemployment rates don’t increase from current levels. New business declined 12% in the quarter while renewal pure price was up 3.4% and policy retention improved to 76.6%.

We’re one of the few carriers who have been successful in getting positive commercial lines peer price since the second quarter of 2009 when pricing increased 0.6%. Our price increases are now exceeding projected loss cost trends. We reported a commercial line statutory combined ratio of 101.9% in the first quarter.

Commercial property ex-catastrophes performed very well in the quarter with an 80.5% statutory combined ratio. Non-cat property losses in the commercial property line improved 19.3 points from the first quarter of 2009.

General liability also had a good quarter reporting a statutory combined ratio of 92.8%. Premium growth in this line was negatively impacted by return premium in the quarter as approximately 50% of this premium is subject to audit.

The first quarter workers’ compensation statutory combined ratio of 116.7% continues to be impacted by return audit and endorsement premium and also includes about 9 points of adverse reserve development related to severity in the 2008 and 2009 accident years.

Frequency has not been an issue. Commercial auto came in at 90.9% combined ratio, which included 9.4 points of favorable reserve development primarily from the 2008 and prior accident years.

Net premium written was down 5% due mainly to competitive conditions in the marketplace. Personal line net premium written grew 12% in the quarter to $56 million. The personal line statutory combined ratio for the quarter was essentially flat with the year ago at 107.1% including 11.1 points of catastrophe losses.

Turning to investments, first quarter net investment income increased 77% and it was primarily driven by after tax alternative investment income, which increased $15.9 million from the first quarter 2009 to a $2.5 million gain.

The improvement in the equity and credit markets in the latter half of the year drove the improvement for alternatives. As was the case last quarter, six of the seven alternative strategies had positive investment income in the quarter with commercial real estate still producing a loss. Partially offsetting the positive impact alternative investments had on investment income was a decrease in fixed income due to lower yields.

Our fixed income portfolio after tax yield was 2.9% for the quarter. Additionally, expenses were higher in the quarter due to a one time $1.6 million charge from the outsourcing of the investment department. In the quarter versus a year ago, our unrealized loss improved from $17 million to an unrealized gain of $35 million after tax driven largely by our available for sale fixed maturity securities.

Other than temporary impairments or OTTI in the quarter were recorded at $5.4 million after tax versus $17.6 million in the first quarter of 2009 primarily reflecting the continuing credit crisis in the associated securitized problem loans.

Invested assets were up 5% from a year ago to $3.8 billion. Market to amortized cost on the whole fixed income portfolio remained strong ending the quarter at 102.3%, up from 98.8% a year ago. Our fixed income portfolio overall maintains a very high credit quality of AA+ and a duration of 3.4 years including short term and 3.6 years excluding short term. We believe we are conservatively postured for any additional market volatility as the economic and political environments remain in flux.

We continue to watch for inflationary trends and feel we are well positioned to weather potential increases in inflation.

Our cash position is higher than we have kept historically, believe it is still appropriate. However, given the steep yield curve, we do carefully monitor market opportunities to increase yield. Surplus grew to $994 million and stockholders’ equity increased 1% to $1 billion from year end.

Book value per share increased from $18.83 at year end to $18.97 at the end of the quarter. The improvement in our capital position continues as the premium to surplus ratio was 1.4 to 1 at quarter end, down from 1.8 to 1 a year ago. We remain comfortable at our current levels of operating leverage in capital. We expect to maintain excess capital to be prepared for an anticipated market hardening and to be positioned to fully (inaudible) growth capabilities.

Now I’ll turn the call over to John Marchioni to review the insurance operations.

John Marchioni

Thanks Dale, good morning. We’re in the business of covering losses and occasionally large catastrophic events will impact our industry. This quarter included historically large catastrophe losses for us. The five storms we experienced provided an opportunity to demonstrate the power of our field service model.

Claims management specialist or CMSs were on the scene quickly because they live and work in the territories they service. Our CMS has adjusted about 2600 storm claims through April demonstrating our credo response is everything.

Lot of operations worked alongside our CMSs to bring relief to families in need throughout the northeastern and Mid-Atlantic states. This service model continues to generate significant customer loyalty for us.

The commercial lines marketplace is still very competitive but we continue to achieve pure price increases due to the combined efforts of our superior agency force, field and inside underwriters. Together they work with our sophisticated underwriting tools in a very disciplined and targeted way to minimize the impact of the soft market and retain business with us.

Our inside renewal underwriting teams work hard to balance price increases with retention levels. With the success we have had in driving price on a targeted portion of our book of business, commercial lines policy retention increased from year end to 76.6%. On a point of renewal basis overall policy retention for the quarter was 88%, up slightly from 2009.

Pressure on retention levels remains greatest on the larger accounts. The overall mix of our business continues to improve with policy retention at point of renewal for the lower quality 1 and 2 diamond business at 9 points less than average as we achieved rate increases on this business of 10.3%. Our best performing 4 and 5 diamond business retained at 2 points better than average with rate increases of 1.7%.

We believe this demonstrates that our underwriting discipline and predictive modeling tools are working as intended. These tools combined with strong relationships with an outstanding group of 970 agency partners allow us to outpace the market in terms of price management.

Our field underwriters are writing the majority of new business in the highest quality 4 and 5 diamond range. Submission activity from our agents remain strong but there continues to be pressure on hit ratios.

Also noteworthy is that new business pricing was up a strong 4.9% in the quarter. Together these factors demonstrate the discipline we’ve installed in our operations.

Commercial lines new business was down 12% compared to the first quarter of 2009. By segment One and Done automated small business was up 11% to $20 million.

Middle market or AMS generated business was down 19% to $39 million. Selective risk managers, our large account business, was down 32% to $4 million.

We continue to make progress growing our commercial lines non contractor book. In the quarter non-contractor new business comprised 68% of commercial lines new business, up from 61% a year ago. Personal lines results are improving but that improvement is masked this quarter by extreme catastrophe activity. Excluding cat losses, the combined ratio in the quarter was 96%. The pricing, product, and technology changes we’ve made to grow the book with granular pricing capabilities to our matrix modeling is beginning to show traction.

We continue to grow the book with new business up 33% in the quarter. We anticipate filing aid increases in 2010 that can potentially generate $14 million in additional premium. Eight increases were already filed in the first quarter.

We continue to be optimistic about achieving our goal of being profitable in the third or fourth quarter of 2010.

Now I’ll turn the call over to Greg.

Greg Murphy

Thank you, John and good morning. For the quarter, the underlying commercial and personal lines results were solid and our investment performance improved with alternative investments generating positive returns. As we previously announced we made a strategic decision to outsource our investment operations, but we don’t anticipate any broad changes in investment strategy, we expect our performance to improve with less overall risk.

We have access to broad sector specific knowledge and expect to utilize advance risk management tools. An additional benefit will be greater flexibility in trade execution through the outside managers more significant buying power. We’ve hired Susan Sweeney as the Chief Investment Officer to oversee the outsourcing arrangement. Susan has over 20 years of experience managing an outsourced portfolio most recently as Chief Investment Officer with the State of Connecticut Pension Fund.

The economy continues to take its toll on commercial lines results. Return audit and endorsement premiums reduced the topline again this quarter, outpacing our expectations. Had there not been $18 million of return audit and endorsement premium in the quarter, commercial lines premium (inaudible) instead of declining 4%. The contracting book representing 37% of the commercial lines continues to be disproportionately impacted by those return premiums.

Our commercial lines claim trends continue to be positive, which led the favorable reserve development this quarter. We also continue to drive rate increases through disciplined underwriters and dedicated agents supported by sophisticated underwriting tools. As John mentioned, we’ve achieved pure price increases on difficult accounts while retaining our best business. This doesn’t mean it’s easy being the first in the marketplace to raise pricing.

By maintaining our underwriting discipline, we’re sacrificing some top line growth. We’re willing to accept a lighter top line in exchange for the ability to write profitable business.

In January, I laid out four commercial lines industry fundamentals that should foster a hard market. Now you can add a significant first quarter catastrophe activity to the list. You’ve seen some big cat numbers being posted for the quarter. We strongly believe that commercial lines rate levels need to move higher and recent catastrophe losses only magnified that situation. While catastrophe losses are part of our business and you can never truly be excluded I want to highlight our solid results this quarter excluding catastrophe.

A 96 combined ratio for both commercial lines and personal ones. Therefore with only one quarter behind us, we’re maintaining our 2010 statutory and GAAP combined ratio guidance of 101.5. The weighted average shares assumption of $54 million at year end remains the same. Now I’ll turn the call back to the operator for your questions.

Operator

Thank you. We will now begin the question-and-answer session.

Question-and-Answer Session

(Operator Instructions)

Our first question comes from Joe DeMarino. You may ask your question. Please state your company name.

Joe DeMarino – Piper Jaffray

Thank you, I’m with Piper Jaffray, good morning. I just have a couple of questions. Did you talk about pricing on new business within commercial?

Greg Murphy

We’ll take them one at a time. Go ahead, John, why don’t you address this?

John Marchioni

The pricing number that we cited in the prepared comments of positive 4.9% was a commercial lines new business pure price number.

Joe DeMarino – Piper Jaffray

Okay, how are you able –

Greg Murphy

And Joe, I would add that on the personal line side, as you know we’ve gotten a series of rate increases and I think, what we told basically the street was that we’re expecting about additional $14 million in rate level on the personal lines book generated by rate increases over the course of the year as well.

Joe DeMarino – Piper Jaffray

Okay, but it seems like – so pricing on new businesses is off just as it is on renewal business within commercial, is that correct?

John Marchioni

It is, it’s up that 4.9%. And as we said the downside to that obviously is the pressure that puts on hit ratios and that’s from our perspective a big measure of discipline. So you combine the improving distribution from a quality perspective with the improving price and while we think our folks are making the right decision, it’s clearly putting pressure on new business premium.

Joe DeMarino – Piper Jaffray

Okay. So on business that you’re walking away from or not retaining how bad is pricing on some of that still?

John Marchioni

It’s all over the board. If you’re talking about lost renewals, you will still see renewals on occasion loss for 10% to 20% and on new business opportunities again, in many cases you’re going to lose it for double digits. Based on our relationships with our agents and where we stand in terms of the business they quote with us, we’re generally not going to lose for a couple of points because of the service, the claims service and the coverages that we offer. So generally speaking you’re in that double digit range, it varies on who it is we’re talking about. You see different companies and different marketplaces being that outlier but it’s still happening.

Greg Murphy

And, Joe, I would kind of add to that. I’m disappointed, I expected commercial lines pricing to build through the quarter and that hasn’t happened.

Joe DeMarino – Piper Jaffray

Okay, all right. Moving on, it looks like workers’ comp, correct me if I’m wrong, I think premiums were pretty much flat there year-over-year but you also mentioned you had some return premium there.

Greg Murphy

Yes.

Joe DeMarino – Piper Jaffray

So I’m wondering do you know what it would have been if you didn’t have the return premium, what growth –

Greg Murphy

Sure, we could tell you that the audit premium and comp was $7 million return for the first quarter on the audit side; on the endorsement side, it was another $1.6 million return. So you can just kind of layer those numbers in to get an essence of it. Just to get a clarification, Joe, on my earlier comment when I was talking about pricing building, I was referring to industry-wide pricing and not our efforts.

Joe DeMarino – Piper Jaffray

Sure.

Greg Murphy

Our efforts are clearly an outlier.

Joe DeMarino – Piper Jaffray

And then on your contractor exposure, are you seeing any type of improvement at all in terms of hiring recently going into the second quarter? Is there any positive signs within any of your contractors business in terms of the impact the economy has there?

John Marchioni

This is John Marchioni. Unfortunately we’re not seeing that and we continue – a lot of the worse than expected return premiums are still coming through our contractors’ books. So we’re just not seeing that turn.

Joe DeMarino – Piper Jaffray

Okay, and then one last question on the alternatives portfolio. Is the commercial real estate, can you remind me, is it on a lag at all, a one quarter ladies and gentlemen?

Dale Thatcher

Yes, the commercial real estate is on a one quarter lag.

Joe DeMarino – Piper Jaffray

Okay. And do you expect that to – what is your outlook for when that one last portion of your portfolio might start to normalize or contribute to noninvestment income and what kind of leverage can that bring to the portfolio?

Dale Thatcher

Well, to be honest with you, I don’t have any prognostication on the real estate marketplace, that’s a difficult one to predict. Obviously that particular piece of the alternative portfolio has a current market value of $15 million. So it represents approximately 10% of our alternative portfolio. It just remains to be seen how that generates over time.

Joe DeMarino – Piper Jaffray

Okay, thank you. That’s very helpful.

Greg Murphy

Joe, one thing I would add. All the other strategies in there were all profitable with the exception of the one you pointed out.

Operator

Thank you. (Operator Instructions) Our next question comes from Doug Mewhirter. You may ask your question, and please state your company name.

Doug Mewhirter – RBC Capital Markets

Hi, good morning. Doug Mewhirter from RBC Capital Markets.

Just two quick questions. First, just a quick cleanup, Dale in your remarks I missed one little factor, you were describing one of the commercial business lines, you mentioned that had 9 points of adverse development. Which line was that, I just missed it? It was right before you talked about commercial auto.

Dale Thatcher

Let me get back to my prepared comments and take a quick look. So the workers’ comp was the only one that had the adverse development and that was the 9 points.

Doug Mewhirter – RBC Capital Markets

Okay, that’s probably the one that I missed that. And actually further to that, the workers’ comp and general liability, we heard some commentary from insurance brokers that ironically maybe an encouraging sign and that buried in some bad news in that. They seem to be getting feedback from their customers, the end buyers that they’re still buying sort of the minimum amount of insurance or buying a low amount of insurance. Even though they may be expressing some private optimism in their business but they’re saying we’re just going to buy 100 units of insurance even though we may need a 120, but we’re going to let audit pick that up later in the year. Have you been getting any kind of feedback or any kind of – is that consistent with what you’re seeing as well?

Greg Murphy

Not from what we’re explicitly seeing. Obviously we saw a pretty heavy return premium going out the door on the endorsement side. So that’s based on some pretty good information. So I mean but that’s a tough one to call.

John Marchioni

The only thing I’ll add in, when you’re getting commentary from the broker market, it probably tends to be your larger accounts and there’s no question over the last couple of years, they’ve become a lot more sophisticated in understanding their exposure base and how that drives premiums. So I’m not surprised to hear that they may be pushing for that to start with a lower point and figure they will get caught up on audit, but we don’t see as much of that in our book because of the size that we generally play in.

Greg Murphy

But the one thing I will add to that though is – I mean traditionally over the course of time, there is just a natural lag both on the return premium side of the audit equation and also on the additional premium side of the equation. So when things do turn around, that’s what you’ll end up seeing ultimately.

Operator

Thank you. At this time I am showing no further questions I’ll turn the call back over to the speakers.

Greg Murphy

All right, great thank you. All right, so we have the capacity for profitable growth. We have the people, tools, and strategies in place to persevere through the soft market, emerge in a very competitive position on the other side.

So with that, thank you. If you have any follow-up questions, please contact Jennifer and Dale. All right, thank you, bye.

Operator

Thank you and this does conclude today’s conference. We thank you for your participation. At this time you may disconnect your line.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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Source: Selective Insurance Group, Inc. Q1 2010 Earnings Call Transcript
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