sigi-20211231
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
(Mark One)
☒ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: December 31, 2021
or
☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from_______________________to_______________________
Commission file number: 001-33067
SELECTIVE INSURANCE GROUP, INC.
(Exact Name of Registrant as Specified in Its Charter)
40 Wantage Avenue
Branchville, New Jersey07890
(Address of Principal Executive Offices) (Zip Code)
(Registrant's Telephone Number, Including Area Code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class Trading Symbol (s) Name of each exchange on which registered
Common Stock, par value $2 per share SIGI The Nasdaq Stock Market LLC
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
☒Yes☐ No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
☐ Yes ☒No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.☒Yes☐ No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).☒Yes☐ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
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Large accelerated filer ☒ Accelerated filer ̈
Non-accelerated filer ̈ Smaller reporting company ☐
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
☐
Indicate by check mark whether the registrant has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☒
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).☐ Yes ☒ No
The aggregate market value of the voting company common stock held by non-affiliates of the registrant, based on the closing price on the Nasdaq Global Select Market, was $4,787,831,538 on June 30, 2021. As of January 31, 2022, the registrant had outstanding 60,186,063 shares of common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement for the 2022 Annual Meeting of Stockholders to be held on May 3, 2022, are incorporated by reference into Part III of this report.
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SELECTIVE INSURANCE GROUP, INC.
Table of Contents
Page No.
PART I
Item 1. Business 4
Item 1A. Risk Factors 20
Item 1B. Unresolved Staff Comments 32
Item 2. Properties 32
Item 3. Legal Proceedings 32
Item 4. Mine Safety Disclosures 32
PART II
Item 6. Reserved 34
Forward-looking Statements 34
Introduction 34
Critical Accounting Policies and Estimates 35
Results of Operations and Related Information by Segment 46
Federal Income Taxes 59
Liquidity and Capital Resources 59
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 63
Item 8. Financial Statements and Supplementary Data 70
Consolidated Balance Sheets as of December 31, 2021 and 2020 72
Consolidated Statements of Income for the Years Ended
Consolidated Statements of Comprehensive Income for the Years Ended
Consolidated Statements of Stockholders’ Equity for the Years Ended
Consolidated Statements of Cash Flows for the Years Ended
Notes to Consolidated Financial Statements 77
Item 9A. Controls and Procedures 127
Item 9B. Other Information 129
Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections 129
PART III
Item 10. Directors, Executive Officers and Corporate Governance 129
Item 11. Executive Compensation 129
Item 14. Principal Accountant Fees and Services 130
PART IV
Item 15. Exhibit and Financial Statement Schedules 130
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PART I
Item 1. Business.
Overview
Selective Insurance Group, Inc. (“Parent”) is a New Jersey insurance holding company incorporated in 1977 that owns ten property and casualty insurance subsidiaries ("Insurance Subsidiaries"). The Insurance Subsidiaries sell products and services only in the United States ("U.S.") exclusively through independent insurance agents and wholesale brokers. Various state departments of insurance (i) license nine of our subsidiaries as admitted carriers to write specific lines of property and casualty insurance in the standard marketplace and (ii) authorize the tenth subsidiary as a non-admitted carrier to write property and casualty insurance in the excess and surplus ("E&S") lines market. We refer throughout this document to the Parent and the Insurance Subsidiaries collectively as "we," “us,” or “our.” We use Parent only to distinguish the holding company from the Insurance Subsidiaries.
Our main office is located in Branchville, New Jersey. Our common and preferred stock are listed and traded on the Nasdaq Global Select Market under the symbols “SIGI” and "SIGIP," respectively. In 2021, AM Best Company (“AM Best”) ranked us as the 39th largest property and casualty group in its annual list of “Top 200 U.S. Property/Casualty Writers,” based on 2020 net premiums written (“NPW”). We have a long and successful history in the property and casualty industry since our founding in 1926. Our AM Best financial strength rating is currently "A+" (Superior).
Strategic Advantages
We have three key sustainable competitive advantages:
•A distribution model that emphasizes franchise value, meaning we focus on appointing high-quality independent distribution partners, with whom we have meaningful and close business relationships;
•A unique field model, in which we (i) locate our Standard Commercial Lines underwriting and safety management personnel in the geographic territories they serve, (ii) organize our claims operation regionally by specialty, with local personnel managing our customer, claimant, and agency relationships, and (iii) provide our teams with sophisticated tools and technologies to inform underwriting, pricing, safety management, and claims decisions; and
•A superior omnichannel customer experience provided by best-in-class employees, enhanced by digital platforms and value-added services to increase customer engagement and retention.
Several nationally recognized statistical rating organizations ("NRSROs") issue opinions on our financial strength, operating performance, strategic position, and ability to meet policyholder obligations:
NRSRO Financial Strength Rating Outlook
AM Best A+ Stable
Standard & Poor’s Global Ratings (“S&P”) A Stable
Moody’s Investors Services (“Moody’s”) A2 Stable
Fitch Ratings (“Fitch”) A+ Stable
In the fourth quarter of 2021, AM Best (i) upgraded our financial strength rating to "A+" (Superior) from "A" (Excellent), the second-highest of their 13 financial strength ratings, and (ii) revised our outlook to "Stable" from "Positive." In taking this action, AM Best cited our strong balance sheet strength, strong operating performance, favorable business profile, and appropriate enterprise risk management.
We believe that our ability to write insurance business is most influenced by our AM Best rating. Our independent distribution partners recommend insurance carriers based, in part, on financial strength ratings, which many of our customers also consider in their purchasing decisions. Distribution partners generally recommend higher-rated carriers to limit their potential liability for error and omission claims by customers. Most of our customers often have minimum insurer rating requirements in loans, mortgages, and other agreements securing real and personal property.
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These NRSROs also rate our long-term debt creditworthiness. Credit ratings indicate the ability of debt issuers to meet obligations in a timely manner and are important factors in our overall funding profile and ability to access certain types of liquidity. Our current senior debt credit ratings are as follows:
NRSRO Credit Rating Long-Term Credit Outlook
AM Best a- Stable
S&P BBB Stable
Moody’s Baa2 Stable
Fitch BBB+ Stable
Our S&P, Moody's, and Fitch financial strength and associated credit ratings affect our ability to access capital markets.
We have provided a glossary of terms defining certain industry-specific and other terms that we use as Exhibit 99.1 to this Form 10-K.
Human Capital
We recognize that developing and protecting our human capital complements and contributes to superior longer-term financial performance. We are committed to maintaining a safe and inclusive workplace that promotes diversity and provides attractive benefits to our approximately 2,440 employees. In 2021, we (i) were designated as a Great Place to Work CertifiedTM organization for the second year in a row, with 88% of employees identifying us as a great place to work, (ii) received the "2021 Best Places to Work" award from Business Intelligence Group, and (iii) were recognized by Forbes as one of "America's Best-in-State Employers."
We discuss our approach to (i) physical, social, and financial well-being of our employees; (ii) talent development and employee retention; and (iii) diversity, equity, and inclusion more fully below.
Physical, Social, and Financial Well-Being of our Employees
We invest significantly in our employees' physical, social, and financial well-being, which is essential to attracting and retaining the best talent. We are committed to fair pay and regularly analyze and adjust compensation to ensure internal equity and external market alignment. To support the financial well-being of our employees and their families, we offer competitive financial benefit programs, including a 401(k) plan with non-elective and employer matching contributions, an employee stock purchase plan that allows our stock to be purchased at a discount, and tuition reimbursement and student loan repayment. Most of our employees are eligible to participate in our annual cash incentive program, the funding and payout of which is based on the achievement of our financial and strategic objectives, and our long-term stock-based incentive compensation program. To promote the health and well-being of our employees, we offer a range of competitive and convenient health and wellness programs. We also support our employees' social well-being, encouraging connections with their colleagues and communities through various programs, such as paid time off for volunteer work and matching charitable donations.
Talent Development and Employee Retention
We invest significant time and resources in training and development to assist our employees in fulfilling their professional potential and having rewarding careers. We are committed to ongoing learning, personal growth, and continuous improvement. Our employees have access to various live instructor-led training courses and over 22,000 online skills training courses and resources. We also have leadership and talent development programs and initiatives at all levels of the organization. Examples include our (i) Next Generation of Leaders program, which identifies early- and mid-career management for focused development opportunities that prepare them for future senior leadership, and (ii) RISE (Retain Include Support Engage) program, which is an accelerated professional development program for diverse individual contributors interested in first-level management positions.
The COVID-19 pandemic has accelerated our capabilities and cultural adaptation to a flexible work environment. As a result, we have instituted changes to increase flexibility and enhance employee engagement and productivity. During 2021, most of our office-based employees remained fully remote. In the future, when we return to the office, we will be adhering to our new hybrid work policy that allows most employees to work remotely 40% of the time. To retain our best talent and foster a positive work-life balance, we invest in talent development, and focus on workplace flexibility. Our employee turnover rate in 2021 was approximately 13%. Employees with over 20 years of service represented approximately 17% of our workforce.
Diversity, Equity, and Inclusion
We recognize that when employees with diverse backgrounds, ideas, and experiences collaborate, it can foster innovation that improves operational performance, products and services, customer experience, market opportunities, and revenue. We have initiatives to increase representation and cultivate greater inclusion of people with different ethnicity, race, age, sexual
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orientation, gender identity and expression, and socio-economic background. Some recent initiatives include (i) increasing gender and racial diversity in our Next Generation of Leaders program, which was 79% in 2021 and 66% in 2020, and through the launch of various employee resource groups for women, Black, and LGBTQ+ employees, (ii) increasing the focus on leadership development programs for under-represented groups through our RISE program, (iii) implementing business objectives tied to supporting and participating in diversity, equity and inclusion initiatives, (iv) enhanced hiring, retention, and promotion practices intended to increase the level of diversity at all levels within the organization, and (v) increasing the size of our Board of Directors ("Board"), adding new directors with diverse backgrounds, skills, experience, and ethnicity and race.
As of December 31, 2021, women represented 58% of our non-officer workforce and 32% of our officer workforce, compared to 57% and 31% at December, 31, 2020, respectively. Increasing the representation of women in first-level, middle, and senior management roles is a prioritized goal. Our ethnic diversity for officers and non-officers is consistent with the national average for financial services, but our objective is to increase this representation over time. Currently, approximately 80% of our workforce is White; and 20% of our workforce is a combination of Black, Latin, Asian, and all other ethnicities combined, compared to 82% and 18% at December, 31, 2020, respectively. In addition, we have five directors who identify as diverse.
Segments
We have four reportable segments:
•Standard Commercial Lines, which represents 73% of consolidated revenues and comprises property and casualty insurance products and services provided in the standard marketplace to commercial enterprises, typically businesses, non-profit organizations, and local government agencies. This business represented 81% of our total insurance operations’ NPW in 2021 and is primarily sold in 27 states and the District of Columbia. The average premium per policyholder in 2021 was approximately $14,000.
•Standard Personal Lines, which represents 9% of consolidated revenues and comprises property and casualty insurance products and services provided primarily to individuals acquiring coverage in the standard marketplace. This business represented 9% of our total insurance operations’ NPW in 2021 and is sold in 15 states. The average premium per policyholder in 2021 was approximately $2,500. Standard Personal Lines also includes flood insurance coverage sold through the Write Your Own ("WYO") program of the National Flood Insurance Program ("NFIP"). Based on 2020 direct premiums written ("DPW") as reported in the S&P Market Intelligence platform, we are the fourth-largest writer of this coverage through the NFIP. We write flood business in all 50 states and the District of Columbia.
•E&S Lines, which represents 8% of consolidated revenues and comprises commercial property and casualty insurance products and services provided to customers unable to obtain coverage in the standard marketplace, generally because of unusual or high-risk exposures. E&S insurers do not have constraints related to form and rate regulations like standard market insurers, and they are exempt from many other standard market requirements. E&S carriers are authorized to write an insurance policy if the party seeking insurance coverage has been rejected by three separate standard line carriers. This business represented 10% of our total insurance operations’ NPW in 2021 and is sold in all 50 states and the District of Columbia. The average premium per policyholder in 2021 was approximately $3,300.
•Investments, which represents 10% (including net realized and unrealized gains and losses) of consolidated revenues and invests the (i) premiums collected by our insurance operations and (ii) amounts generated through our capital management strategies, which include the issuance of debt and equity securities.
We derive nearly all of our income/loss in three ways:
•Underwriting income/loss from our insurance operations. Underwriting income/loss is comprised of revenues, which are the net premiums earned ("NPE") from our insurance products and services less expenses. Gross premiums are DPW plus premiums assumed from other insurers and mandatory pools and associations. NPW is equal to gross premiums less premiums ceded to reinsurers. NPW is recognized as revenue ratably over a policy’s term as NPE.
Expenses related to our insurance operations fall into three categories depicted on our Consolidated Statements of Income: (i) "Loss and loss expense incurred," which includes losses associated with claims and all loss expenses for adjusting claims incurred during a policy's term, net of losses and loss expenses ceded to reinsurers; (ii) "Amortization of deferred policy acquisition costs," which includes expenses related to the successful acquisition of
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insurance policies, such as commissions to our distribution partners and premium taxes, recognized ratably over a policy's term; and (iii) "Other insurance expenses," which includes acquisition and other insurance-related expenses not otherwise classified as "Loss and loss expense incurred" or "Amortization of deferred policy acquisition costs" incurred in maintaining policies and policyholder dividends.
Total underwriting expenses are the total of Amortization of deferred policy acquisition costs and Other insurance expenses, offset by Other income on our Consolidated Statements of Income. Other income primarily includes installment fees, which are fees charged to customers paying their premiums on an installment basis.
•Net investment income earned from our investment segment. We generate income from investing insurance premiums and amounts generated through our capital management strategies. Net investment income consists primarily of (i) interest earned on fixed income investments and commercial mortgage loans, (ii) dividends earned on equity securities, (iii) other income primarily generated from our alternative investments portfolio, partially offset by (iv) investment expenses.
•Net realized and unrealized gains and losses on investment securities from our investments segment. Realized gains and losses from our investment portfolio are the result of (i) security disposals through sales, calls, and redemptions,(ii) losses on securities for which we intend to sell, (iii) credit loss expense or benefit, and (iv) net unrealized gains and losses on equity securities.
Net income (or loss) available to common stockholders on our Consolidated Statements of Income also includes (i) corporate expenses, which includes the Parent's long-term incentive compensation to our employees and other general corporate expenses, (ii) interest on our debt obligations, (iii) federal income taxes, and (iv) dividends to preferred shareholders.
We use net income (or loss) available to common stockholders and non-U.S. generally accepted accounting principles ("GAAP") operating income as measures of financial performance. Non-GAAP operating income differs from net income available to common stockholders by excluding after-tax net realized and unrealized gains and losses on investments.
We use combined ratio as the key performance measure in assessing our insurance operations. The combined ratio is calculated by adding (i) the loss and loss expense ratio, which is the ratio of net loss and loss expense incurred to NPE, (ii) the expense ratio, which is the ratio of underwriting expenses to NPE, and (iii) the dividend ratio, which is the ratio of policyholder dividends to NPE. A combined ratio under 100% indicates an underwriting profit, and a combined ratio over 100% indicates an underwriting loss. The combined ratio does not reflect net investment income, net realized and unrealized investment gains or losses, federal income taxes, or Parent income or expense. The loss and loss expense ratio is typically the largest contributor to our combined ratio. Key drivers typically are the amount of catastrophe and non-catastrophe property loss and loss expenses incurred, current year casualty loss estimates, and the impact of prior year casualty reserve development.
We principally use after-tax net investment income as the key measure in assessing the financial performance of our investments segment. We also assess total return, which we calculate by adding pre-tax net realized and unrealized investment gains or losses (including losses on securities we intend to sell and credit loss expense or benefit) to pre-tax net investment income. Our investment philosophy includes setting specific risk and return objectives for the fixed income, equity, and other investment portfolios and comparing each portfolio's returns to a weighted-average benchmark of comparable indices.
We also consider return on common equity ("ROE") and non-GAAP operating return on common equity ("non-GAAP operating ROE") as important measures of our overall financial performance. ROE is a profitability measurement calculated by dividing net income available to common stockholders by average common stockholders' equity during the period. Non-GAAP operating ROE is calculated by dividing non-GAAP operating income available to common stockholders by average common stockholders' equity during the period. We evaluate our segments, in part, based on their contribution to non-GAAP operating ROE. We establish our non-GAAP operating ROE target annually based on the sum of (i) our current estimated weighted average cost of capital and (ii) an appropriate spread over our estimated weighted average cost of capital. We also consider the current interest rate environment and property and casualty insurance industry market conditions when establishing our non-GAAP operating ROE target. For 2022, our non-GAAP operating ROE target is 11%.
For further details about our 2021 results related to these performance measures, refer to "Financial Highlights of Results for Years Ended December 31, 2021, 2020, and 2019" in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations." of this Form 10-K.
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In addition to measuring and monitoring our results by segment using combined ratio and non-GAAP operating ROE metrics, we also monitor key operating leverage metrics, such as NPW to surplus and invested assets per dollar of common stockholders’ equity.
We define operating leverage as the ratio of NPW to statutory surplus, and we target a ratio between 1.35x and 1.55x. Our operating leverage at December 31, 2021 was 1.33x, compared to the U.S. standard commercial and personal lines industry average of approximately 0.7x that Conning, Inc. reported in its Fourth Quarter 2021 Property-Casualty Forecast & Analysis (Source: ©2022 Conning, Inc. Used with permission.). In recent years, our operating leverage has declined, principally driven by our strong profitability, which has increased our statutory capital and statutory surplus.
Our higher operating leverage than the industry average, coupled with our casualty-oriented business profile, has resulted in higher investment leverage than the industry. We define investment leverage as invested assets per dollar of common stockholders’ equity. Our investment leverage at December 31, 2021 was $2.88, compared to the U.S. commercial and personal lines average invested assets to statutory surplus of $2.09 that Conning, Inc. reported in its Fourth Quarter 2021 Property-Casualty Forecast & Analysis (Source: ©2022 Conning, Inc. Used with permission.). Due to our higher investment leverage, we have adopted a slightly more conservative investment management philosophy with fixed income securities and short-term investments, representing 91% of our invested assets. As of December 31, 2021, these fixed income securities and short-term investments had a weighted average credit rating of "A+" and an effective duration of 3.9 years, compared to "AA-" and 3.8 years as of December 31, 2020. The weighted average credit rating decline reflects a planned reduction in our sector allocation to agency residential mortgage-backed securities over the past year. Given this asset class's very low reinvestment rates, we have reallocated these non-sale disposal cash flows into other high-quality fixed income sectors, including corporate securities and other asset-backed security classes that lack a "AAA" rating but currently have a better risk versus reward trade-off. For additional information about the design and credit quality characteristics of our investment segment, refer to "Credit Risk" in Item 7A. "Quantitative and Qualitative Disclosures About Market Risk." and Note 5. "Investments" in Item 8. "Financial Statements and Supplementary Data." of this Form 10-K.
We believe we have a lower financial risk profile than our industry because:
•Our Standard Commercial Lines segment underwriting risk appetite is focused on small-to-medium sized accounts, with risks generally characterized as low- to medium-hazard. Our average premium per policyholder is approximately $14,000, with about 86% of our casualty lines business in this segment having limits of $1 million or less (excluding workers compensation policies, as they do not have limits), and about 92% of our property lines of business in this segment having limits of $3 million or less;
•We maintain sophisticated pricing tools and disciplined financial planning and reserving practices. The latter includes quarterly ground-up reserve reviews for most lines of business, semi-annual independent external reserve reviews, and year-end regulatory actuarial reserve opinions issued by an independent external actuary;
•We purchase significant levels of reinsurance, including (i) a property catastrophe reinsurance program that limits the net after-tax impact of a 1 in 250 year catastrophe to about 4% of our GAAP equity, and (ii) property and casualty excess of loss reinsurance agreements that limit the impact of individual property claims to $3 million per risk and casualty claims to $2 million per occurrence; and
•We maintain a conservative investment portfolio principally invested in high quality and liquid fixed income and short-term investments, with a modest allocation to risk assets.
Our strong financial strength and lower financial and underwriting risk profile has permitted us historically to operate with higher operating leverage than our industry as a whole. This strategy, while requiring us to balance growth and profit, provides us the opportunity to generate higher underwriting and investment portfolio ROEs, assuming profitable operations. We generate 0.9 points of ROE for each point on the combined ratio and 2.3 points of ROE for each point of pre-tax investment yield. In 2021, we generated a 14.8% ROE and a 14.3% non-GAAP operating ROE, exceeding our 2021 11% ROE target, driven by strong underwriting income and investment results, which included higher gains on our alternative investment portfolio, as discussed further in "Financial Highlights of Results for Years Ended December 31, 2021, 2020, and 2019" in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations." of this Form 10-K.
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Insurance Operations
Overview
We derive all our insurance operations revenue from selling insurance policies in return for insurance premiums. The vast majority of our sales are annual insurance policies. Our most significant cost associated with the sale of insurance policies is our loss and loss expense for insured events covered under these policies.
Loss and loss expense reserves are one of our critical estimates and represent the ultimate amounts we will need in the future to pay insured claims and related expenses for insured claims that have not yet been settled or reported. Estimating reserves as of any given date is an inherently uncertain process, requiring the application of estimation techniques and a considerable degree of judgment. We regularly review our overall reserve position through internal and external actuarial reserve analyses. For a full discussion regarding our loss reserving process, see "Critical Accounting Policies and Estimates" in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations." and Note 2. "Summary of Significant Accounting Policies" in Item 8. "Financial Statements and Supplementary Data." of this Form 10-K.
As part of our risk management efforts associated with the sale of our products and services, we use reinsurance to protect our capital resources and insure us against losses on the risks we underwrite. We enter into reinsurance contracts and arrangements with third parties that cover various policies we issue to our customers. Similarly, we maintain an internal reinsurance pooling agreement by which each Insurance Subsidiary shares in premiums and losses based on specified percentages. For information regarding reinsurance treaties and agreements, see "Reinsurance" in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations." of this Form 10-K.
Products and Services
The types of insurance we sell in our insurance operations fall into two broad categories:
•Casualty insurance, which generally covers the financial consequences of (i) employee injuries in the course of employment, (ii) bodily injury and/or property damage to a third party as a result of an insured’s negligent acts, omissions, or legal liabilities, and (iii) the obligation to defend our insured(s) when the claim is covered. Casualty claims have long tails and may take several years and, in some situations, even decades to be reported and settled.
•Property insurance, which generally covers the accidental loss to an insured’s real property, personal property, and/or earnings due to the property's loss. Property claims are generally reported and settled in a relatively short period from the date of loss.
Our insurance premiums relate to the property and casualty insurance policies we underwrite and issue. The following table shows the principal types of policies we write:
Commercial Property (including Inland Marine) Property X X
Commercial Automobile Property/Casualty X X
General Liability (including Excess Liability/Umbrella) Casualty X X
Workers Compensation Casualty X
Businessowners' Policy Property/Casualty X
Bonds (Fidelity and Surety) Casualty X
Homeowners Property/Casualty X
Personal Automobile Property/Casualty X
Personal Umbrella Casualty X
Flood1 Property X X
1The majority of our exposure to flood losses comes from our participation in the NFIP's WYO program where our flood insurance premiums and losses are 100% ceded to the NFIP. The results of our Standard Personal Lines and Standard Commercial Lines flood operations are reported solely within our Standard Personal Lines segment results.
Product Development and Pricing
Our insurance policies are contracts with our policyholders that specify the losses we cover and the amounts we will pay on a covered loss. We develop our coverages by (i) adopting policy forms created or filed by statistical rating agencies or other third parties, notably Insurance Services Office, Inc. (“ISO”), American Association of Insurance Services, Inc. ("AAIS"), and the National Council on Compensation Insurance, Inc. ("NCCI"), (ii) independently creating our own policy forms, or (iii) modifying third-party policy forms. In developing products and services, we consider market demands, profitability, competitive research and feedback from our independent distribution partners, and the potential impact of the product or service in making our customers’ commercial or personal endeavors safer.
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Our policies provide coverage for future events, so the actual individual policy loss costs are unknown at the point of sale. Determining pricing for coverage requires us to consider many variables. Like most property and casualty insurance companies, our loss data alone is not sufficiently credible to independently establish the complex sets of loss costs and rating variables required for our products. Therefore, we often adopt loss costs and rating structures filed by statistical rating agencies, such as ISO and NCCI. We typically modify these loss costs or factors based on actuarial analyses of our own credible historical statistical data, factoring in loss trends and other expected impacts. The resulting loss costs are converted to premium rates by adding provisions for expense and profit. In some cases, we supplement the indicated rates with competitive market information to determine our final filed rates.
We have developed predictive models for many of our Standard Commercial and Standard Personal Lines that we use to refine the statistical rating agencies' rating plans or independently develop our own rating plans. Predictive models analyze historical statistical data related to various risk characteristics that drive loss experience. For our Standard Commercial Lines, we use the output of these models to group existing or potential policies based on their expected loss potential. These groupings are inputs in the underwriting and pricing process for individual risks. We use these models to develop factors in our filed Standard Personal Lines rating plans. In all cases, the predictive capabilities of these models depend on the quantity and quality of available statistical data. Consequently, we may supplement them with other competitive market information or underwriting judgment.
Customers and Customer Markets
We categorize our Standard Commercial Lines customers into the following strategic business units ("SBUs"):
Percentage of Standard Commercial Lines Description
Contractors 43% General contractors and trade contractors
Manufacturing and Wholesale 15% Manufacturers, wholesalers, and distributors
Bonds 1% Fidelity and surety
Total Standard Commercial Lines 100%
We do not categorize our Standard Personal Lines customers or our E&S Lines customers by SBU. No one customer accounts for 10% or more of our insurance operations in the aggregate.
We manage volatility in our underwriting results, in part, by writing accounts with lower-limits profiles. The table below illustrates the percentage of accounts with total insured value and exposure limits at and below $1 million for property and casualty insurance accounts, respectively:
Property Casualty
Standard Commercial Lines 77% 86%1
Standard Personal Lines 81% 97%
1Standard Commercial Lines excludes policies written in our workers compensation line of business, which do not have statutory policy limits, but are covered by our casualty excess of loss reinsurance treaty, which provides coverage for losses above $2 million.
We also purchase significant levels of reinsurance from reinsurers with an average credit rating of "A" or better. Our reinsurance program supports our ability to write accounts with larger policy limits by limiting the impact of individual property and casualty losses to $3 million per risk for property claims and $2 million per occurrence for casualty claims. For information regarding reinsurance treaties and agreements, see "Reinsurance" in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations." of this Form 10-K.
Geographic Markets
We sell our insurance products and services in the following geographic markets:
•Standard Commercial Lines products and services are primarily sold in 27 states located in the Eastern, Midwestern, and Southwestern regions of the U.S. and the District of Columbia.
•Standard Personal Lines products and services are sold in 15 states located in the Eastern, Midwestern, and Southwestern regions of the U.S. In addition, flood insurance, which is reported in this segment, is sold in all 50 states and the District of Columbia.
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•E&S Lines products and services are sold in all 50 states and the District of Columbia.
We plan to expand our current 27-state Standard Commercial Lines segment footprint to 30 states by year-end 2022 by adding, subject to regulatory approvals, Vermont, Alabama, and Idaho. This expansion should allow us to issue policies to customers who have exposures in these states, allowing us to compete more effectively against insurers with national footprints. Our ultimate plan is to expand our Standard Commercial Lines footprint throughout the Continental U.S. We currently do not intend to expand the states in which we write Standard Personal Lines.
We manage and support our business from our (i) corporate headquarters in Branchville, New Jersey, (ii) six regional branches (referred to as our “Regions”), and (iii) underwriting and claims service center in Richmond, Virginia. The table below lists our Regions and their main office locations:
Region Office Location
Heartland Indianapolis, Indiana
New Jersey Hamilton, New Jersey
Northeast Branchville, New Jersey
Mid-Atlantic Allentown, Pennsylvania, and Hunt Valley, Maryland
Southern Charlotte, North Carolina
Southwest Scottsdale, Arizona
In addition, our E&S Lines has offices in Dresher, Pennsylvania, and Scottsdale, Arizona.
Distribution Channel
The property and casualty insurance market is highly regulated and competitive with fragmented market share, particularly in standard commercial lines. The market has three main distribution methods: (i) sales through appointed independent insurance agents and wholesale brokers; (ii) direct sales to personal and commercial customers, including Internet-based digital platforms; and (iii) sales through captive insurance agents employed by or contracted to sell exclusively with one insurance company.
We sell our insurance products and services through the following types of independent distribution partners:
•Standard Commercial Lines: Independent retail agents;
•Standard Personal Lines: Independent retail agents; and
•E&S Lines: Wholesale general agents.
We generally pay our distribution partners commissions calculated as a percentage of DPW, often supplemented by amounts based on profitability or other considerations for business placed with us. We seek to compensate them fairly and consistently with market practices. No one independent distribution partner is responsible for 10% or more of our combined insurance operations' premium. Our top 20 distribution partners generated approximately 38% of our DPW, excluding the flood line of business, in 2021.
Independent Retail Agents
A 2020 Independent Insurance Agents & Brokers of America study reported that independent retail insurance agents and brokers write approximately 85% of standard commercial lines insurance and 36% of standard personal lines insurance in the U.S. We expect that independent retail insurance agents, the bulk of our independent distribution partners, will remain a significant force in overall insurance industry premium production because they generally represent multiple insurance carriers. This business model provides customers with a wider choice of insurance products, more competitive pricing, and individualized risk-based consultation.
We have approximately 1,430 distribution partners selling our standard lines business. These 1,430 distribution partners sell our products and services through approximately 2,500 office locations. We also have approximately 6,200 distribution partners selling our flood insurance products.
Wholesale General Agents
We have approximately 80 wholesale general agents, with an aggregated 320 office locations, selling our E&S Lines business. We have granted these wholesale general agents limited binding authority for risks that meet our prescribed underwriting and pricing guidelines.
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Marketing
Our primary marketing strategy is to:
•Use an empowered field underwriting model for Standard Commercial Lines to provide our distribution partners with resources near their businesses and our mutual customers. For further discussion on this model, see the “Technology, Innovation, and Field Model” section below.
•Develop a distribution model that emphasizes franchise value, meaning we focus our independent insurance agency appointments to high-quality partners with whom we have meaningful and close business relationships, particularly with their principals and producers, by (i) soliciting, gathering, and acting on feedback from them and our mutual customers on various topics, including our products and services and brand awareness, (ii) advising them on our product development efforts, and (iii) providing education and development programs focused on producer recruitment, sales training, enhancing customer experience, online marketing, and distribution operations, all designed to help them profitably grow and succeed.
•Develop and carefully monitor annual goals with each distribution partner on (i) types and mix of risks placed with us, (ii) new business and renewal retention expectations, (iii) customer service and engagement rates, (iv) pricing of their in-force book and renewal price changes, and (v) profitability of business placed with us.
•Develop brand recognition and meaningful customer engagement through a data-driven marketing strategy and a focus on superior customer experience. This integrated marketing and customer engagement approach (i) affords us a dynamic view of the changing marketplace and customer expectations, (ii) provides us insight into the unique value-added products and services that will have the greatest impact on each customer, and (iii) will help drive business acquisition and retention, and brand health, which we expect will position us as a marketplace leader.
Technology, Innovation, and Field Model
We continue to evolve our technology and field model by maintaining a strong focus on innovation, providing our customers and distribution partners with "around the clock" digital access to account information and transactional capabilities. While many insurers offer such digital customer solutions in personal lines, we strive to be a digital and customer experience leader in all three segments of our insurance operations.
Technology
We leverage technology in our business and make significant investments in information technology ("IT") platforms, integrated systems, and cloud-based solutions.
We make these technology investments to provide:
•Our distribution partners with accurate business information and seamless integration with our systems, permitting easy policy transaction processing. In 2021, Insurance Business America (IBA) recognized us as a "Five-Star Carrier" for superior performance in five of eleven key categories, one of which was online platforms and services.
•Our service representatives with a customer account-centric view of our policyholders, not a traditional policy-centric view, which reduces customer inquiry response time, complementing customer access to on-demand digital transactional capabilities.
•Our underwriters with advanced underwriting and pricing tools with pricing guidance and automated retrieval of relevant public information on existing and potential policyholders, which enhances profitability and enables premium growth. We have used predictive models in our Standard Commercial Lines underwriting for over 15 years.
•Our claims adjusters with predictive tools that identify specific claims likely to experience escalating losses, fraud or subrogation recovery, or litigation.
As part of our digital strategy, we provide our Standard Commercial Lines and Standard Personal Lines customers with a mobile application and a self-service portal. Our mobile application received Best Mobile App Awards' Platinum Award for "Best Mobile Design," in the summer of 2020. As of December 31, 2021, 47% of our customers registered for these digital self-service capabilities. Both the application and portal encourage policyholders to use on-demand self-service access for account information, electronic bill payment, and claims reporting. We provide customers with other digital value-added services, such as proactive messaging about vehicle and product recalls, adverse weather, and claim status.
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We manage our IT projects through an Enterprise Project Management Office (“EPMO”). The EPMO is supported by certified project managers who apply methodologies to (i) communicate project management standards, (ii) provide project management training and tools, (iii) manage projects, (iv) review project status, including external and internal costs and any projected net present value of project benefits, and (v) provide non-technology project management consulting services to the rest of the organization. The EPMO, which includes senior management representatives from all primary business and corporate areas, meets regularly to review all significant initiatives and receives status reports on other projects. The EPMO is an important factor in the success of our business strategy and technology implementations. Our primary technology operations are located in Branchville, New Jersey and Glastonbury, Connecticut. We have agreements with multiple consulting, IT, and supplemental staffing service providers to augment our internal resources. Collectively, these providers supply approximately 54% of our skilled technology capacity, with 74% of their resources overseas. We retain management oversight of all projects and ongoing IT production operations. We have existing procedures to manage an efficient transition to new technology vendors without significant impact on our operations if we terminated any current service provider.
Our business relies heavily on IT and application systems that may be accessed from, or are connected to, the Internet. Consequently, a malicious cyber-attack could affect us. Our systems also contain proprietary and confidential information, including personally identifiable information, about our operations, employees, agents, and customers and their employees and property. We have a dedicated unit responsible for implementing and reporting on cybersecurity risks and controls led by our Senior Vice President, Enterprise Strategy and Execution. We work with carefully selected industry-leading security consulting and technology partners and follow security-minded design principles. The cybersecurity team receives oversight and executive support through engagement with our Executive Risk Committee ("ERC"). Similarly, the team works with our Enterprise Risk Management ("ERM") function on business alignment and procuring cybersecurity insurance. Our cybersecurity program balances responsiveness to rapidly-changing threats with ensuring long-term results. It focuses on six key areas:
•Proactive cybersecurity, including cyber threat hunting, ethical hacking campaigns, and periodic cybersecurity program assessments;
•Reactive cybersecurity processes that we regularly test using incident response and disaster recovery exercises, based on realistic scenarios;
•Endpoint controls that provide data encryption, threat detection, malicious software defense, and data backups;
•Identity and access management controls that include multi factor authentication and additional safeguards for employees with elevated privileges;
•Employee cyber risk awareness programs that leverage general education, role-based training, and simulated phishing attacks; and
•Third-party risk management and security standards that include due diligence, continuous monitoring, and cyber risk scoring.
For further information regarding our risks associated with cyber-attacks, see Item 1A. “Risk Factors.” of this Form 10-K. For additional information regarding our ERM function and ERC, see the section entitled, “Enterprise Risk Management” in Item 1. “Business.” of this Form 10-K.
Innovation
To continue advancing (i) an organizational culture of innovation, (ii) agility, (iii) digital and customer experience initiatives, and (iv) our long-term value proposition to our customers and distribution partners, we have undertaken several important strategic actions, which include the following:
•Created a team dedicated to innovation under a Chief Innovation Officer. We established this team to (i) apply proven innovation techniques and methods for identifying, prioritizing, and advancing strategic innovative ideas and opportunities, (ii) stay apprised on critical industry and insurance technology trends that impact our customers, distribution partners, and employees, and (iii) further expand our innovation culture by providing training and skill-building opportunities, facilitating departmental and cross-functional strategy and innovation sessions, and leading relevant communities of interest that intersect with the lifecycle of innovation;
•Established an innovation lab at our corporate headquarters in late-2019 to spur innovation and further our efforts to identify and deploy product, agency and customer experience, and operational efficiency improvements. In response to the COVID-19 pandemic, we accelerated our ability to drive innovation virtually. We now can conduct innovation design work (i) in-person, using our innovation lab at our corporate headquarters, (ii) fully virtual, combining live facilitation with collaboration software and digital whiteboard and polling capabilities, and (iii) hybrid capabilities, mixing live attendance and digital capabilities at our innovation lab with attendees at remote locations; and
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•Expanded the scope of our Strategic Investment Committee to review and act on potential investment opportunities, including technology and Insurtech platforms that may positively impact our business or the industry.
These efforts position us to offer customers an improved service experience and demonstrate our long-term value proposition to our customers and distribution partners.
Field Model
We believe our unique field model is a competitive advantage. To support and build better and stronger relationships with our independent distribution partners, our (i) Standard Commercial Lines underwriting and safety management personnel are located in the geographic territories they serve, (ii) claims operation is organized regionally by specialty, with local personnel managing our customer, claimant, and distribution partner relationships, and (iii) teams are provided with sophisticated tools and technologies to inform underwriting, pricing, safety management, and claims decisions. At December 31, 2021, we had approximately 2,440 employees, 730 of whom are normally home-based, 935 are based in our regional offices, with the remainder in our corporate office. Due to the COVID-19 pandemic, most of our office-based employees remained fully remote throughout 2021.
Underwriting Process
Our underwriting process by segment is as follows:
•Standard Commercial Lines: Our Standard Commercial Lines corporate underwriting department oversees our underwriting guidelines and philosophy for each industry segment and line of business. Through formal letters of authority, our Chief Underwriting Officer ("CUO") delegates underwriting authority after assessing an individual underwriter's job grade and industry and line of business expertise. Our corporate underwriting department coordinates with our actuarial department to determine adequate pricing levels for all Standard Commercial Lines products.
Under the CUO's delegated authorities, our regional underwriting operations make most individual policyholder underwriting and pricing decisions. New business is underwritten by Agency Management Specialists ("AMSs"), with contributions from Production Underwriters, Small Business Teams, and Large Account Underwriters. Renewal business is handled primarily in each Region, but some renewals are handled through our Underwriting Service Center ("USC"), where underwriters are assigned to specific distribution partners.
Our field model also focuses on improving safety and risk management programs, loss experience, and retention, including:
•Risk evaluation, and virtual and on-site improvement surveys that evaluate potential exposures and provide solutions for mitigation;
•Internet-based safety management educational resources, including an extensive library of coverage-specific safety materials, videos, and online courses, such as defensive driving and employee educational safety courses;
•Thermographic infrared surveys that identify potential electrical hazards; and
•Occupational Safety and Health Administration construction and general industry certification training.
We brand these services as “Safety Management: Solutions for a safer workplace.”SMWe have 87 Safety Management Specialists ("SMS") supporting our policyholders locally in the field. These specialists regularly interact with customers and prospective accounts. They provide advice on risk mitigation for perils such as property damage, liability, and workers compensation risks, including best practices for preventing abuse claims. Their efforts permit our underwriters to understand our customers' exposures, and their safety enhancement recommendations reduce our customers' risk exposure, enhancing our new business and renewal underwriting decisions.
Over the past two years, we have embarked on safety management initiatives to proactively service policyholders with notifications and alerts, risk identification and mitigation of potential loss occurrence, and tools and technologies to reduce losses and improve safety. Examples include:
•Vehicle recall notifications to our policyholders and distribution partners;
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•Weather preparation notices for large storms or hurricanes, including guides on structural improvements, roof and drainage maintenance, and measures to prevent plumbing from freezing or clogging; and
•Food and product recall notifications to policyholders in food manufacturing, distribution, and preparation.
In 2021, we continued rolling out a new Standard Commercial Lines platform designed to streamline new small business policy quoting and issuance for our distribution partners. We generally consider small business to be lower hazard risks in specific industry classifications with policy premiums less than $25,000. Writing small business has always been a core part of our strategy. The small business market has become more competitive in recent years, with more carriers entering the market with technology dedicated to new business generation. We continue to execute a multi-year strategy to (i) improve small business writing ease and speed for our distribution partners, and (ii) offer a best-in-class small business customer experience. We are enhancing our rating platform's user experience by reducing the amount of information required to be input before generating a quote. We have deployed this new small business platform for most of our lines of business, including businessowners, commercial automobile, workers compensation, commercial property, and general liability. Our plans include adding capabilities in 2022 to help us maximize new business growth and share of small business with our distribution partners.
•Standard Personal Lines: Our Standard Personal Lines underwriting operations are centralized and highly automated. Most of our new and renewal business is underwritten and priced through an automated system reflecting our filed rates and rules. Exceptions are approved under the direction of our Standard Personal Lines CUO. For long-term growth, we are actively repositioning our Standard Personal Lines business to provide our insurance products to a customer base that is less price-sensitive and more focused on insurance product coverage and service.
•E&S Lines: Our E&S relationship and underwriting managers focus on marketing our product capabilities, training our wholesale general agents on underwriting guidelines and automation, and collecting market intelligence from our wholesale general agents. In return, our wholesale general agents provide front-line underwriting and policy administration services for new and renewal business per our prescribed guidelines. Our small commercial E&S underwriters review all exceptions our wholesale general agents submit for approval, revision, or declination based on individual account risk characteristics. Our middle market E&S commercial underwriters write larger accounts and receive complete submissions for individual underwriting and pricing based on the account’s exposures. Wholesale general agents who submit middle market commercial risks do not have authority to quote or bind accounts on our behalf.
Our USC services certain Standard Commercial Lines and Standard Personal Lines accounts that our independent distribution partners designate. All USC employees are licensed agents who respond to policyholder inquiries about insurance coverage, billing transactions, and other matters. For the convenience of having us handle USC transactions, our distribution partners agree to receive a slightly lower than standard commission on the associated premium. As of December 31, 2021, our USC was servicing NPW of $93.2 million, which represents 3% of our total NPW.
Claims Management
Timely and appropriate investigation of a claim's facts and circumstances in light of our policy's terms, conditions, and exclusions is one of the essential services we provide to our policyholders, their claimants, and our distribution partners. To address the increasing complexity of coverage evaluation, construction methods, and litigation, we have structured our claims organization to emphasize:
•Claims handling by technical areas of expertise, such as auto liability, general liability, property, and workers compensation, including deployment of specialized claim units within each of these lines of business that focus on high severity or technically complex losses and litigation;
•Claims customer managers and agency executives ("CAEs") who have responsibility for enhancing the relationship among our policyholders, agents, and our claims operation. The CAEs provide a single point-of-contact for our large account customers and distribution partners. They work with our regional underwriters to ensure appropriate claims service delivery, communicate trends, and discuss results and client services;
•Cost-effective delivery of claims services and control of loss and loss expense, including our Claims Service Center that manages our high volume, low severity automobile and property claims with a focus on adjusting tools that provide prompt and efficient service to our customers; and
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•Timely and adequate claims reserving and resolution. As an example, despite the magnitude of the catastrophic weather events during 2021 (including Hurricane Ida), 76% of reported claims had their initial payments made within the first 30 days.
We have been executing a multi-year claims modernization strategy to improve our claims organization’s ability to process claims more efficiently through improved workflows and enhanced capabilities for our employees, customers, and distribution partners. In 2021, we introduced enhanced capabilities, such as electronic payments to injured workers or customers, and bi-directional text enabling same-day payment to insureds. We are actively testing a new digital intake method to allow insureds to file automobile claims to improve the information gathered on first notices of loss. In 2022, we expect to introduce workers compensation to our new claims platform, which will improve claims adjuster efficiency through automated processes, workflows, and business rules. The remaining lines will be put on the platform subsequently.
The Special Investigative Unit ("SIU") supports all insurance operations and investigates potential insurance fraud and abuse, consistent with law and direction from regulatory bodies and trade associations. The SIU adheres to uniform internal procedures to improve detection and take action on potentially fraudulent claims. We have developed a proprietary SIU fraud detection model that identifies potential fraud cases early in a claim's life. The SIU supervises anti-fraud training for all claims adjusters and AMSs. Its operation sends a clear message that we will not tolerate fraud against our policyholders or us. Our practice (and usually our legal requirement) is to notify the proper authorities of SIU findings.
Insurance Operations Competition
We face substantial competition in the insurance marketplace, including public, private, and mutual insurance companies, with varied levels of brand recognition, scale and operational efficiency, capital bases, book of business diversification and cost of capital. Like us, many of our competitors rely on independent partners to distribute their products and services. Other insurance carriers either employ their own agents, who only represent them, or use a combination of distribution partners, captive agents, and direct marketing.
The property and casualty insurance market is highly competitive in each of our insurance segments, with market share fragmented among many companies, particularly in Standard Commercial Lines and E&S Lines. We compete primarily with regional and national insurers, mostly based on coverage terms, claims service, customer experience, safety management services, ease of technology usage, price, and financial ratings. We also face increased competition from established direct-to-consumer insurers, existing competitors, and new entrants that may have a lower cost structure and leverage digital technology that may offer enhanced servicing capabilities or enhanced customer experience.
Investments Segment
Our Investments segment seeks to generate net investment income by investing the premiums we receive from our insurance operations and the amounts generated through our capital management strategies, which may include debt and equity security issuances. Our investment portfolio mainly consists of fixed income securities, which primarily includes corporate securities, asset-backed securities, mortgage-backed securities, and state and local municipal obligations. As of December 31, 2021, 15% of this portfolio was invested in floating rate securities that reset principally on the 90-day U.S. dollar-denominated London Interbank Offered Rate ("LIBOR"). We also invest in both public and private equity securities, commercial mortgage loans, short-term investments, and other investments. Other investments primarily includes alternative investments, which are limited partnership investments in private equity, private credit, and real estate strategies.
The primary objective of our investment portfolio is to maximize after-tax net investment income subject to our risk appetite, market conditions, and our desire for long-term growth in book value per common share. Our investment strategy and objectives are managed by our Management Investment Committee ("MIC") and executed by our internal investment team and its external investment manager relationships. The MIC, comprised of senior management appointed by our Board's Finance Committee, is responsible for (i) setting and implementing the investment objectives and asset allocation, (ii) administering investment policies, (iii) selecting qualified external investment managers and advisors, and (iv) monitoring performance, transactions, and certain risk metrics, in the execution of our investment strategy. The Board's Finance Committee reviews and makes recommendations on our policies and other financial matters, including, without limitation, investments and investment policies and guidelines, financial planning, capital structure and management, dividend policy and dividends, share repurchases, and strategic plans and transactions.
Our investment strategy considers climate change risk by prohibiting any new direct equity or debt investments in thermal coal enterprises, including those generating 30% or more of their (i) revenue from the ownership, exploration, mining, or refining of thermal coal, or (ii) electricity generation from thermal coal.
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For further information regarding our risks associated with the overall investment portfolio, see Item 7A. “Quantitative and Qualitative Disclosures About Market Risk.” and Item 1A. “Risk Factors.” of this Form 10-K. For additional information about investments, see the section entitled, “Investments Segment,” in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” and Note 5. "Investments" included in Item 8. “Financial Statements and Supplementary Data.” of this Form 10-K.
Regulation
Primary Oversight by the States in Which We Operate
The regulation and taxation of insurance is primarily overseen at the state level because of the U.S. Congress's delegation in the McCarran-Ferguson Act. The primary public policy behind insurance regulation is protecting policyholders and claimants over all other constituencies, including shareholders. Property and casualty insurance activities regulated by the states include the following:
•Protection of claimants: Oversight of financial matters to ensure claims-paying ability, including: minimum capital; statutory surplus; solvency standards; accounting methods; form and content of statutory financial statements and other reports; loss and loss expense reserves; investments; reinsurance; dividend payments and other distributions to shareholders; security deposits; and periodic financial examinations.
•Protection of policyholders: Oversight of matters including: certificates of authority and other insurance company licenses; licensing and compensation of distribution partners; underwriting criteria; premium rates (required to not be excessive, inadequate, or unfairly discriminatory); policy forms; policy terminations; claims handling and related practices; cybersecurity; data protection and customer privacy; reporting of premium and loss statistical information; periodic market conduct examinations; unfair trade practices; mandatory participation in shared market mechanisms, such as assigned risk pools and reinsurance pools; mandatory participation in state guaranty funds; and mandated continuing workers compensation coverage post-termination of employment.
•Protection of policyholders, claimants, and shareholders: Related to our ownership of the Insurance Subsidiaries, oversight of matters including: registration of insurance holding company systems in states where we have domiciled insurance subsidiaries, reporting about intra-holding company system developments, self-assessment of current and future risks, including cybersecurity and climate change, and required pre-approval of certain transactions that may materially affect the operations, management, or financial condition of the insurers, including dividends and change in control.
NAIC Financial Monitoring Tools
Our various state insurance regulators are members of the National Association of Insurance Commissioners ("NAIC"), which has established statutory accounting principles ("SAP") and other accounting reporting formats and model insurance laws and regulations governing insurance companies. An NAIC model statute, however, only becomes law after state legislative enactments, and an NAIC model rule only becomes a regulation after state insurance department promulgation. Adoption of specific NAIC model laws and regulations is a condition of the NAIC Financial Regulations Standards and Accreditation Program. This program permits state insurance departments to recognize and rely on the financial examinations and reviews their counterparts conduct, creating efficiencies and limiting overlapping examinations of the same insurance companies.
The following are among the NAIC's various financial monitoring tools, most predicated on NAIC model laws and regulations that are material to the regulators in states in which our Insurance Subsidiaries are organized:
•The Insurance Regulatory Information System ("IRIS"). IRIS identifies 13 industry financial ratios and specifies “usual values” for each ratio. Departure from the usual values on four or more of the financial ratios can lead to inquiries from individual state insurance departments about certain aspects of an insurer's business. Our Insurance Subsidiaries have consistently met the majority of the IRIS ratio tests.
•Risk-Based Capital ("RBC"). RBC is measured by four major areas of risk to which property and casualty insurers are exposed: (i) asset risk; (ii) credit risk; (iii) underwriting risk; and (iv) off-balance sheet risk. Regulators increase their scrutiny, up to and including intervention, as an insurer's total adjusted capital declines below the NAIC required capital level. Based on our 2021 statutory financial statements prepared in accordance with SAP, the total adjusted capital for each of our Insurance Subsidiaries substantially exceeded the required capital as defined by the NAIC.
•Annual Financial Reporting Regulation (referred to as the "Model Audit Rule"). The Model Audit Rule, based closely on the Sarbanes-Oxley Act of 2002, as amended ("Sarbanes-Oxley Act"), regulates (i) auditor independence, (ii)
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corporate governance, and (iii) internal control over financial reporting. As permitted under the Model Audit Rule, the Audit Committee of the Board of the Parent serves as the audit committee of each of our Insurance Subsidiaries, even though the Parent is not an insurance entity.
•Own Risk and Solvency Assessment ("ORSA"). ORSA requires an insurer to maintain a framework for identifying, assessing, monitoring, managing, and reporting “material and relevant risks” associated with the insurers' (or insurance groups') current and future business plans. ORSA, which the state insurance regulators of our Insurance Subsidiaries have adopted, requires an insurer to annually file an internal assessment of the adequacy of its risk management framework, and current and estimated projected future solvency position. For more information on our internal process of assessing our major risks, refer to the "Enterprise Risk Management" section below.
•Group Capital Calculation ("GCC"). In the fourth quarter of 2020, the NAIC adopted the basic structure of the GCC, along with a model law to enable the GCC after state legislative enactment. The calculation provides state insurance regulators with additional analytical information for assessing group risks and capital adequacy, complementing the existing holding company disclosures and analyses. The GCC expands the existing RBC calculation, to include (i) capital requirements for other regulated entities in the group, and (ii) defined capital calculations for other group entities that are unregulated. The GCC model law is expected to be enacted in some states by year-end 2022, and we subsequently will be required to make GCC filings. After reviewing the NAIC's GCC model law and considering our 2021 statutory financial statements prepared in accordance with SAP, we expect our GCC ratio would be well over any regulatory action minimum threshold.
NRSROs
Rating agencies are not formal regulators, but they also monitor our capital adequacy. Two are (i) AM Best, with its Capital Adequacy Ratio ("BCAR"), and (ii) S&P, with its capital model. Both evaluate the strength of an insurer's balance sheet and compare available capital to estimated required capital at various probability or rating levels. BCAR and the S&P model differ from the NAIC financial monitoring tools, particularly RBC. While RBC, BCAR, and the S&P capital model show similar direction as simulation scenarios change, they react differently to changes in economic conditions, underwriting and investment portfolio mix, and capital. Consequently, we analyze capital adequacy model divergence while managing our capital, risk profile, and growth objectives. Rating agencies also revise and update their capital adequacy models and requirements more frequently than the NAIC updates its financial monitoring tools. In December 2021, S&P issued its initial draft of a material update to its Risk-Based Capital Adequacy methodology; its first in more than 10 years. The draft is comprehensive, covering all the original criteria. S&P expects the updated methodology will change up to 10% of its ratings. We expect the final Risk-Based Capital Adequacy methodology update to be released and implemented in 2022.
Federal Regulation
While primarily regulated at the state level, our business is subject to certain federal laws and regulations, including:
•The McCarran-Ferguson Act;
•The Terrorism Risk Insurance Program Reauthorization Act ("TRIPRA");
•The NFIP, overseen by the Mitigation Division of the Federal Emergency Management Agency ("FEMA");
•The Medicare, Medicaid, and SCHIP Extension Act of 2007, which subjects our workers compensation business to Mandatory Medicare Secondary Payer Reporting;
•The economic and trade sanctions of the Office of Foreign Assets Control (“OFAC”);
•Various privacy laws related to possession of personal non-public information, including the following:
◦Gramm-Leach-Bliley Act;
◦Fair Credit Reporting Act;
◦Drivers Privacy Protection Act; and
◦Health Insurance Portability and Accountability Act.
•The Sarbanes-Oxley Act and the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), which govern publicly-traded companies and require or permit national stock exchanges or associations, such as the Nasdaq Stock Market LLC, where our equity securities are listed, to mandate certain governance practices for listed companies.
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The Dodd-Frank Act, enacted in 2010 in response to the 2008 and 2009 financial markets crises, provided for some public company corporate governance reforms and some oversight of the business of insurance, including:
•Establishing the Federal Insurance Office (“FIO”) under the U.S. Department of the Treasury; and
•Granting the Federal Reserve oversight of financial services firms designated as systemically important.
The FIO, consistent with its Dodd-Frank Act (i) negotiated a covered agreement with the European Union that, among other things, impacted reinsurance collateral requirements for foreign reinsurers, and (ii) has been gathering insurance market data.
For additional information on the potential impact of regulation and changes in regulation on our business, refer to the regulation risk factor within Item 1A. “Risk Factors.” of this Form 10-K.
Enterprise Risk Management
High-quality, effective ERM is best achieved as a shared organizational cultural value that is the responsibility of every employee. We have developed processes and tools that we believe support a risk management culture and create a robust organizational ERM framework. We have also designed our compensation policies and practices and our governance framework and Board leadership structure to support our overall risk appetite and strategy. Our ERM processes and practices help us identify potential events that may affect us and quantify, evaluate, and manage our significant risks.
As a property and casualty holding company, our Insurance Subsidiaries are in the business of taking risk. We categorize our major risks into six broad categories:
•Asset risk, which stems primarily from our investment portfolio and reinsurance recoverables and includes credit and market risk;
•Underwriting risk, which is the risk that our insured losses exceed our expectations, including:
◦Losses from inadequate loss reserves;
◦Larger than expected non-catastrophe current accident year losses; and
◦Catastrophe losses that exceed our expectations or our reinsurance treaty limits.
•Liquidity risk, which is the risk we will be unable to meet our contractual obligations as they become due because we cannot liquidate assets or obtain adequate funding without incurring unacceptable investment losses or borrowing expense;
•Pension risk, which is the risk that our obligations under the Retirement Income Plan for Selective Insurance Company of America exceed our expectations because its invested assets supporting those obligations underperform or there are adverse changes in the assumptions we used to calculate the pension liabilities;
•Other risks, which include a broad range of operational risks, many difficult to quantify, such as talent/human capital, market conditions, economic, legal, regulatory, reputational, and strategic risks – as well as the risks of fraud, human failure, modeling risks, inadequate business continuity plans, or failure of controls or systems, including cybersecurity risk; and
•Emerging risks, which include risks in the other categories that are new, rapidly evolving, or increasing substantially compared to historical levels. For example, we consider the risks associated with increased frequency and intensity of catastrophes, heightened levels of economic inflation, the enactment of reviver statutes for abuse victims, climate change, increased threat of cyber incidents, and the COVID-19 pandemic's significant economic and societal impacts, including disrupted supply chains and products, services, and labor shortages, all to be emerging risks.
Our internal control framework deploys three lines of defense:
•The first line of defense is the individual business functions that deliberately assume, own, and manage the risk on a daily operational basis.
•The second line of defense is responsible for risk oversight and supports the first line to understand, monitor, and manage our risk profile through an ERC and a dedicated risk team led by our Chief Risk Officer, who reports to the Chief Financial Officer.
•The third line of defense is our Internal Audit team, which provides independent, objective assurance in assessing the adequacy and effectiveness of our internal control environment with oversight from our Board's audit committee. Internal Audit also coordinates risk-based audits, compliance reviews, and other specific initiatives to evaluate and address risk within targeted areas of our business.
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We use ERM as part of our governance and control process to take an entity-wide view of our major risks and their potential impact. We designed our ERM framework to identify, measure, report, and monitor our major risks and develop appropriate responses to support the successful execution of our business strategies.
Our Board oversees our ERM process, and the various Board committees oversee risks specific to their areas of supervision and report their activities and findings to the Board. The ERC is responsible for the holistic monitoring and management of our risk profile. The ERC consists of the Chief Executive Officer, his direct reports, and key operational and financial leaders, including the Chief Risk Officer. The ERC relies on several management committees to analyze and manage specific major risks, including the Emerging Risk Committee and the Underwriting Committee. The Chief Risk Officer reports to the Board or the appropriate Board committee on the ERC's activities, analyses, and findings, providing quarterly updates on specific risk metrics.
We rely on quantitative and qualitative tools to identify, prioritize, and manage our major risks, including proprietary and third-party computer modeling and various other analyses. The ERC meets at least quarterly to review and discuss various topics and the interrelation of our major risks, including, without limitation, capital modeling results, capital adequacy, risk metrics, emerging risks, and sensitivity analysis. When appropriate, we engage subject matter experts, such as external actuaries, third-party risk modeling firms, and IT and cybersecurity consultants. Annually, our Insurance Subsidiaries file their ORSA report, an internal solvency assessment developed by the Chief Risk Officer in coordination with the ERC and reviewed by our Board, with their domiciliary regulators.
COVID-19 remained a risk and an area of focus in 2021. The ERC actively reviews and addresses all significant COVID-19-related operational, compliance, claims management, underwriting, and financial risk matters. This oversight includes such matters as employee health and safety, facilities, operational business continuity, IT and third-party vendors, regulatory developments, and economic impacts, such as heightened inflation, supply chain disruption and labor shortages, premium collections, past due accounts, investments, liquidity, capital, cash flow, claims activity, and other key financial and operational metrics. Our MIC oversees our investment portfolio, reviewing detailed portfolio metrics and market projections. Our Board meets quarterly with senior executives to ensure appropriate corporate governance and oversight.
We have not significantly modified our existing internal controls or processes in response to the COVID-19 pandemic. We also have not experienced any material impact to our internal control environment over financial reporting, despite having most of our employees working remotely in 2021 due to the pandemic. We are continually monitoring and assessing COVID-19-related current events to minimize their potential impact on our internal controls and their design and operating effectiveness. In addition, our cybersecurity program was well-positioned to support increased remote working arrangements and respond to an increase in attempted attacks to exploit the COVID-19 outbreak.
Our risk governance structure facilitates effective risk conversations across all levels and disciplines of the organization and promotes strong risk management practices. All our strategies and controls, however, have inherent limitations. We cannot be certain that an event or series of unanticipated events will (i) not occur and generate losses greater than we expect and (ii) have a material adverse effect on our results of operations, liquidity, financial condition, financial strength, and debt ratings. An investor should carefully consider the risks and all other information included in Item 1A. “Risk Factors.”, Item 7A. “Quantitative and Qualitative Disclosures About Market Risk.", and Item 8. “Financial Statements and Supplementary Data." of this Form 10-K.
Reports to Security Holders
We file with the U.S. Securities and Exchange Commission ("SEC") all required disclosures, including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, Proxy Statements, and any amendments to these reports that we file or furnish pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, which can be accessed on the SEC's website, www.SEC.gov. We also provide access to these filed materials on our Internet website, www.Selective.com, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
Item 1A. Risk Factors.
Certain risk factors can significantly impact our business, liquidity, capital resources, results of operations, financial condition, and debt ratings. These risk factors might affect, alter, or change actions we might take executing our long-term capital strategy. Examples include, without limitation, contributing capital to any or all of the Insurance Subsidiaries, issuing additional debt and/or equity securities, repurchasing our existing debt and/or equity securities, or increasing or decreasing common stockholders’ dividends. We operate in a continually changing business environment, and new risk factors emerge
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from time to time. Consequently, we can neither predict such new risk factors nor assess the potential future impact, if any, they might have on our business.
Risks Related to our Insurance Operations
We are subject to losses from catastrophic events.
Losses from natural and human-made catastrophes can negatively impact our financial results. Examples include, without limitation, hurricanes, tornadoes, windstorms, earthquakes, hail, severe convective storms, severe winter weather, derechos, floods, and fires, some related to climate change, and criminal and terrorist acts, including cyber-attacks, civil unrest, and explosions. The frequency and severity of these catastrophes are inherently unpredictable, and the frequency and severity of catastrophe losses have increased globally in recent years. Although we use sophisticated catastrophe modeling techniques to manage our catastrophe exposure, catastrophe models provide estimates, and actual exposure and loss experience may materially differ. For example, catastrophe models did not fully estimate the potential for some recent catastrophe loss activity (such as the Texas freeze in March of 2021 and Hurricane Ida-related severe flooding in the Mid-Atlantic and Northeast) and the concurrent recent economic inflation on construction costs. Unmodeled or under-modeled catastrophe risks could result in understated catastrophe exposure and our actual catastrophe losses could be higher.
Our insurance operations primarily write risks in the Eastern, Midwestern, and Southwestern regions of the U.S. Our most significant natural and/or human made catastrophe exposures are (i) hurricanes impacting the Eastern U.S., (ii) severe convective storms, including hailstorms and tornadoes, (iii) winter storms, and (iv) terrorism events. Single storms could adversely impact our financial results, but it is also possible that we could experience more than one severe catastrophic event in any given calendar year. We track our severe weather and catastrophe losses using definitions and information we obtain from ISO’s Property Claim Services unit, an internationally recognized authority on insured property losses from catastrophes in the United States, Puerto Rico, and the U.S. Virgin Islands.
Certain factors can impact our estimates of ultimate costs for natural and/or human-made catastrophes, including:
•Inability to access portions of the affected areas after a catastrophic event;
•Scarcity of necessary labor and materials that delay repairs and increase our loss costs;
•Regulatory uncertainties, including new or expanded interpretations of coverage;
•Residual market assessment-related increases in our catastrophe losses;
•Potential fraud and inflated repair costs, partly driven by (a) demand surge post-event, and (b) opportunistic service providers;
•Higher loss adjustment expenses due to shortages of claims adjusters available to appraise damage;
•Late claims reporting;
•Escalation of business interruption costs due to infrastructure disruption; and
•Whether the U.S. Secretary of the Treasury certifies an event as a terrorist act under TRIPRA.
Natural catastrophes
The United Nation’s Intergovernmental Panel on Climate Change (“IPCC”) is an international body responsible for assessing climate change science. In 2018, the IPCC estimated in its "Special Report on Global Warming of 1.5°C" that human activities (i) have caused approximately 1.8°F of global warming above pre-industrial levels and (ii) could cause an additional 0.9°F increase above pre-industrial levels between 2030 and 2052. Climate change models project robust differences in global regional climate characteristics between 1.8°F and 3.6°F. The IPCC's 2019 "Special Report on Climate Change and Land" reinforced these findings, as did the IPCC’s “2021: Summary for Policymakers. In: Climate Change 2021: The Physical Science Basis. Contribution of Working Group I to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change.”
These global regional differences, whether attributable to nature or human activities, include increases in (i) mean temperature in most land and ocean regions, (ii) hot extremes in most inhabited regions, (iii) heavy precipitation in several regions, and (iv) the probability of drought and precipitation deficits in some regions. These temperature changes can impact weather patterns and the frequency and severity of catastrophes, including hurricanes, severe convective storms, and wildfires — all of which could cause our catastrophe losses to increase.
Human-made catastrophes
The risk of a wide-scale criminal or terrorist cyber-attack has become more significant and has drawn increased attention from IT and national security experts, U.S. policymakers, the U.S. military, and the insurance industry. There is increased general recognition that a wide-scale cyber-attack that simultaneously impacts multiple victims is more likely and insurance industry systemic risk has increased. We have identified three primary sources of potential insured exposure to cyber losses: (i) cyber specific policies designed to cover both first-party and third-party losses; (ii) affirmative cyber coverage grants included in
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other types of policies, such as commercial property or businessowners policies; and (iii) “silent cyber” exposures that may exist if courts, regardless of intent, interpret policy forms without specific related coverage exclusions to provide coverage for a cyber-related incident.
We provide cyber-specific policies to our commercial lines and personal lines customers through 100% reinsured solutions with highly-rated specialty cyber markets. These markets allow us to mitigate our underwriting risk, meet our customers’ needs for cyber insurance, and develop our expertise in the cyber insurance market. Our other insurance policies provide some first- and third-party cyber coverages:
•We offer limited first-party affirmative cyber coverage in our commercial property and businessowners policy forms. We believe we have limited our “silent cyber” exposure through an affirmative coverage grant subject to a sub-limit.
•Our base property forms typically include a coverage grant of $2,000 or $10,000 and most of our property policies also contain an affirmative endorsement providing “virus and harmful code” coverage subject to a sub-limit. Over 90% of our policies with virus/harmful code coverage on commercial property, businessowners, commercial output policy, or inland marine forms have sublimits of $25,000 or lower.
•Most of our general liability policies and businessowners policies specifically exclude cyber-related liability losses, except for "bodily injury." Our specific cyber-exclusion and our liability forms' lack of affirmative sub-limited cyber coverage, effectively limit most “silent cyber” exposure. Any related potential exposures, however, are subject to our Casualty Reinsurance Program, which has no cyber-related loss exclusion.
•By statute, workers compensation policies do not have cyber exclusions, and a cyber-attack-related workplace injury could trigger coverage.
An increase in natural or man-made catastrophe losses, including a systemic cyber-attack resulting in an aggregation of property and/or casualty cyber losses, will reduce our net income and stockholders’ equity and could have a material adverse effect on our liquidity, financial strength, and debt ratings. In addition, the closer a catastrophe occurs to the end of a reporting period, the more likely we have limited information to estimate loss and loss expense reserves, adding greater uncertainty to our estimates. More detailed claims information available after a reporting period may result in reserve changes in subsequent periods.
Our loss and loss expense reserves may not be adequate to cover actual losses and expenses.
We maintain reserves for our estimated liability for loss and loss expense associated with reported and unreported insurance claims. Estimating loss and loss expense reserves is inherently uncertain, and there is no method for precisely estimating the ultimate liability for the settlement of claims. We base our loss and loss expense reserve estimates on our internal comprehensive reserve review, which utilizes our own loss experience, including claims payment and reporting patterns, as well as our view of underlying trends in claims frequency and severity. The results are supplemented with other subjective considerations, such as projected impacts from various broad economic, political, social, and legal developments or trends, such as inflation, ongoing impacts of the COVID-19-related governmental actions, judicial tort decisions, and various state legislative initiatives. The timing or impact of these developments or trends cannot be predicted with certainty, and we cannot be sure the reserves we establish are adequate or will be so in the future.
We review our reserve position quarterly and adjust the reserve position accordingly. An increase in reserves (i) reduces net income and stockholders’ equity, and (ii) could have a material adverse effect on our liquidity, financial strength, and debt ratings. As we underwrite new business and renew existing business, we estimate future loss cost trends in pricing our products to generate an adequate risk-adjusted return. If our estimate of future loss cost trends proves to be understated, our pricing of future new and renewal business may be inadequate to cover actual loss costs, understating our future loss and loss expense reserves.
Three examples of how loss and loss expense reserves might be affected by economic, political, social, or legal developments or trends are:
•If inflation, including medical and social inflation, is higher than our assumptions, our loss and loss expense reserves associated with our longer tail lines of business may prove to be insufficient. For example, inflation rates in 2021 increased from 2020, as reflected in the overall consumer price index ("CPI"), the Core CPI, and the Producer Price Index. We, however, do not know how long elevated inflation will persist. Our workers compensation line of business is susceptible to inflation because of its extended payment pattern and the medical inflationary environment.
•Our loss and loss expense reserves may be impacted by the following COVID-19-related items:
◦All of our commercial property and businessowners' policies require direct physical loss of, or damage to, property by a covered cause of loss in order to trigger a business interruption claim. Whether COVID-19-
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related contamination, the existence of a pandemic, and/or the continuing government actions cause physical loss of or damage to property continues to be the subject of much debate and litigation. While the insurance industry has won most of the cases at the trial level, many cases are now on appeal and we cannot predict the outcome of that litigation. Our practice is to include in, or attach to, all standard lines commercial property and businessowners' policies an exclusion that states that all loss or property damage caused by, or resulting from, any virus, bacterium, or other microorganism that induces or is capable of inducing physical distress, illness, or disease is not a covered cause of loss. We offer some limited coverages that could apply in COVID-19-related claims and circumstances, primarily tied to clean-up and food-contamination that are subject to sub-limits. Principally all of our commercial property and businessowners' policies now include the very specific and regulatory-approved virus exclusion.
◦Limited medical resources availability could result in medical inflation and complicate, delay and/or extend medical treatment that could impact exposure on workers compensation, general liability, and personal and commercial automobile claims.
◦We may have increased workers compensation loss and loss expenses if policyholders' employees in high-risk roles of essential businesses contracted COVID-19 in the workplace. We may experience higher frequency of workers compensation claims, particularly as state legislative or executive order proposals are enacted that create presumptions that the contraction of COVID-19 by an essential business employee who interacted with the public is work-related. We also may see an extension of workers compensation benefits if employees do not have jobs to which they can return.
◦We may experience an increase in liability claims against our policyholders related to business practices as remote-office work-from-home employees return to their pre-COVID-19 pandemic office and business locations. This may be exacerbated by an active plaintiffs’ attorney seeking to generate COVID-19-related claim activity.
◦Loss frequency and severity could increase related to our auto and property coverages due to, among other things, disruptions in supply chains and changes in business practices and individual behaviors resulting from the shelter-in-place and social distancing measures, such as arson and fraud.
◦We may experience delayed reporting of losses, settlement negotiations, and trial of disputed claims that may disrupt our normal claims resolution processes and trends.
•Various states have expanded or could expand the statute of limitations for civil actions alleging sexual abuse. By retroactively permitting previously time-barred claims, these “reviver” laws may result in insurance claims that could significantly increase loss costs and require re-evaluation of previously-established reserves or the creation of new reserves. Since reviver statutes have been enacted, we have received some notices of claims or potential claims for acts alleged to have occurred, some dating as far back as the 1950s. Without prior experience, we cannot estimate how many "reviver" claims notices we may receive. Most notices we have received (i) are blanket notices sent by attorneys representing claimants unsure of the alleged assailant or supervising entity's insurer or policy (if any) and (ii) may not implicate any insurance policies we or a predecessor issued. For those we determine implicate a policy we or a predecessor issued, we (i) have investigated or are investigating facts, (ii) have evaluated policy terms, (iii) believe we have appropriate coverage defenses to most of these claims and/or sufficient reinsurance protections, and (iv) have considered these factors in establishing our reserves, which we believe provide a reasonable estimate of the aggregate ultimate net exposure for these claims. As coverage positions may be challenged through litigation or otherwise, we face litigation risks further discussed below in the Risk Factor entitled, “We are engaged in ordinary routine legal proceedings incidental to our insurance operations that, because litigation outcomes are inherently unpredictable, could impact our reputation and/or have a material adverse effect on our consolidated results of operations or cash flows in particular quarterly or annual periods.”
For further discussion on our loss and loss expense reserves, please see the “Critical Accounting Policies and Estimates” section of Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” and Note 2. "Summary of Significant Accounting Policies" in Item 8. "Financial Statements and Supplementary Data." of this Form 10-K.
Our ability to reduce our risk exposure depends on the availability and cost of reinsurance.
We transfer a significant portion of our underwriting risk exposure – specifically a portion of our loss and loss expense – to reinsurance companies in exchange for a specified portion of premiums. Typically, our reinsurance coverages align with the coverages offered under our primary insurance policies.
The availability, amount, and cost of reinsurance depend on market conditions, including retrocessional reinsurance market capacity. Most of our reinsurance contracts have annual terms, so reinsurance costs may fluctuate significantly and not necessarily correlate to the loss experience of our specific book of business. State insurance regulators generally permit us to consider catastrophe reinsurance expense in our filed rates and rating plans. However, the degree and timing of regulatory
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approval may not align with the actual expense impact from new reinsurance terms. Disproportionate increases in our reinsurance expense that we cannot include in our filed rates and rating plans will reduce our earnings. If we are unable to negotiate desired reinsurance amounts or terms, we may experience (i) increased reinsurance expense, (ii) increased risk assumption on individual or aggregate claim losses, and (iii) limitations on our ability to write future business.
Commercial property and homeowners coverages have historically accounted for most of our catastrophe-related claims. To limit our exposure to catastrophe losses, we purchase catastrophe reinsurance. Our reinsurance coverage may prove to be inadequate, particularly if:
•We do not purchase sufficient amounts of reinsurance because of defects or inaccuracies in the various modeling software programs we use to analyze our Insurance Subsidiaries' risk;
•A major catastrophe loss exceeds (i) the purchased reinsurance limit or (ii) the financial capacity of one or more of our reinsurers even if the loss is within the purchased limit;
•The frequency of catastrophe losses increases and our Insurance Subsidiaries' insured losses exceed the aggregate limits of the catastrophe reinsurance treaty or our Insurance Subsidiaries experience an aggregation of losses that fall below our per occurrence reinsurance retention; or
•Our reinsurance counterparties (i) are unable to access their reinsurance markets, or retrocessions, (ii) suffer significant financial losses, (iii) are sold, (iv) cease writing reinsurance business, or (v) are unable or unwilling to satisfy their contractual obligations to us.
In response to the COVID-19 pandemic and recent increased catastrophic loss activity, the reinsurance industry has sought to tighten contractual terms and conditions, reduce reinsurance capacity, and increase pricing. Tightened terms and conditions include introducing new coverage exclusions, such as excluding losses related to cyber risk and communicable diseases, particularly for business interruption losses in property treaties and, to a lesser extent, in casualty treaties. To the extent we are exposed to losses on our primary policies from risks, such as cyber and communicable disease, that are now principally excluded from coverage under our reinsurance treaties, we face increased underwriting risk. The increased underwriting risk could increase our net loss and loss expenses and increase the volatility in our underwriting results. Decreased reinsurance capacity also would increase our underwriting risk if we cannot fully place our existing reinsurance treaties upon renewal.
Even with the benefits of reinsurance, our exposure to catastrophe risks could have a material adverse effect on our results of operations, liquidity, financial condition, financial strength, and debt ratings.
We may be subject to potentially significant losses from acts of terrorism.
We are required to participate in TRIPRA, now extended to December 31, 2027, for our Standard Commercial Lines and E&S Lines business. TRIPRA rescinded all previously-approved coverage exclusions for terrorism and requires private insurers and the U.S. government to share the risk of loss on future acts of terrorism certified by the U.S. Secretary of the Treasury. Under TRIPRA, each participating insurer is responsible for paying a significant deductible of specified losses before federal assistance is available. Our deductible of $419 million is based on a percentage of our prior year’s applicable Standard Commercial Lines and E&S Lines premiums. In 2022, the federal government will pay 80% of losses above the deductible, with the insurer retaining 20%. Although TRIPRA will mitigate some of our loss exposure to a large-scale terrorist attack, our deductible could have a material adverse effect on our results of operations, liquidity, financial condition, financial strength, and debt ratings. If the U.S. Secretary of the Treasury does not certify specific terrorist events (as occurred with the 2013 Boston Marathon bombing and the 2015 San Bernardino shootings), we could be required to pay terrorism-related covered losses without TRIPRA's risk-sharing benefits. We also could be required to pay terrorism-related losses for customers who declined terrorism coverage.
Our primary workers compensation policies are required to cover terrorism risk, so TRIPRA applies to those policies.Insureds with non-workers compensation commercial policies have the option to accept or decline our terrorism coverage or negotiate with us for other terms. In 2021, 85% of our Standard Commercial Lines non-workers compensation policyholders purchased terrorism coverage that included nuclear, biological, chemical, and radioactive ("NBCR") events. TRIPRA also applies to cyber liability insurance policies reported under a Terrorism Risk Insurance Program-eligible line of insurance.
Many states mandate that commercial property policies cover fire following an act of terrorism - regardless of whether the insured purchased terrorism coverage. We also sometimes elect to provide terrorism coverage for lines of business not included in TRIPRA, such as Commercial Automobile. TRIPRA has never covered personal lines of business. Our Standard Personal Lines homeowner policies exclude nuclear losses but not biological or chemical losses. Our current reinsurance programs generally cover losses from conventional foreign and domestic terrorism acts, but not NBCR events.
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We are exposed to credit risk.
We face credit risk in several areas of our insurance operations, including from:
•Our reinsurers, which are obligated to make payments to us under our reinsurance agreements. Reinsurance credit risk can fluctuate over time, increasing during periods of high industry catastrophe and liability losses. Reinsurers generally manage their large loss exposure through their own reinsurance programs, or retrocessions, about which we do not always have the full details. If our reinsurers have difficulty collecting on their retrocession programs or reinstating retrocession coverage after a large loss, we may not receive timely or full payment of our reinsurance claims. This means that we have direct and indirect counterparty credit risk to our reinsurers and the reinsurance industry, which is a global but concentrated market.
•Certain life insurance companies, if they fail to fulfill their annuity contract obligations to our policyholders or claimants under annuities we purchased as part of structured claims settlements.
•Some of our independent distribution partners, who collect premiums from our policyholders for us.
•Some policyholders, who are directly obligated to us for premium and/or deductible payments, the timing of which may be impacted by mandated payment moratoriums.
Our exposure to credit risk could have a material adverse effect on our results of operations, liquidity, financial condition, financial strength, and debt ratings.
We depend on distribution partners.
We market and sell our insurance products through independent, non-employee distribution partners. Insurance law and regulation makes us responsible for the business practices and customer interactions of our distribution partners. Independent distribution partners have – and we expect will continue to have – a significant role in overall insurance industry premium production. While our customers find advantages in using independent distribution partners, our reliance on independent distribution partners presents risks and challenges, including:
•Competition in our distribution channel, as we must market our products and services to our independent distribution partners who have access to products from multiple carriers and markets.
•Challenges in developing brand recognition because we closely coordinate with our distribution partners and some customers cannot differentiate their insurance agent from their insurance carrier.
•Our market share growth is tied to our distribution partners' market share. Independent retail insurance agencies control 85% of standard commercial lines business and 36% of standard personal lines business in the U.S. Consequently, growth in our Standard Personal Lines could be more limited than in our Standard Commercial Lines. Competitors have focused on lower-cost "direct-to-customer" distribution models that emphasize digital ease and efficiencies to address the discrepancy in agency control of standard personal lines business. Continued advancements in "direct-to-customer" distribution models may impact the overall market share our independent distribution partners control, make it more difficult for us to grow, or require us to establish relationships with more distribution partners.
•Aggregation and consolidation of our independent distribution partners and their market share, as some publicly-traded and private equity-backed independent distribution partners have deployed consolidation strategies to acquire other independent distribution partners and increase their market share ("Aggregators") over the last decade. If more of our independent distribution partners become Aggregators or are acquired by Aggregators, Aggregator demands and influence on our business could increase. For example, Aggregators could develop and implement strategies to consolidate their business with fewer insurers and demand higher base and supplemental commissions. Aggregators accounted for approximately 36% of our DPW at December 31, 2021, up from 28% three years ago. Currently, no one distribution partner is responsible for 10% or more of our combined insurance operations' premium.
Our financial condition and results of operations are impacted by our independent distribution partners' success in marketing and selling our products and services.
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National and global economic conditions could adversely and materially affect our business, results of operations, financial condition, and growth.
Unfavorable economic developments, such as increased inflation levels and the effect, lifting, or lapsing of COVID-19-related governmental directives experienced in 2021, could adversely affect our earnings if our policyholders need less insurance coverage, cancel existing insurance policies, modify coverage, or choose not to renew with us. Inflation and unemployment increases could significantly impact our claims severity across multiple lines of business and could result in adverse reserve development. Heightened levels of economic inflation also could cause higher interest rates, which would likely result in unrealized losses within our portfolio of fixed income securities and lower total returns from our other invested assets. The effect, lifting, or lapsing of COVID-19-related governmental directives in 2021 disrupted supply chains and caused shortages of products, services, and labor. These economic condition-induced shortages may impact our ability to attract and retain labor, including increasing attrition rates, wages, and the cost and difficulty of obtaining third-party resources. An economic downturn also could lead to increased credit and premium receivable risk, failure of reinsurance counterparties and other financial institutions, limitations on our ability to issue new debt, reduced liquidity, and declines in our investments' fair value and financial strength ratings. These potential events and other economic factors could adversely and materially affect our business, results of operations, financial condition, and growth. During 2021, 28% of DPW in our Standard Commercial Lines business was based on payroll or sales of our underlying policyholders. An economic downturn in which our policyholders experience declines in revenue or employee count could adversely affect our total written premium, including audit and endorsement premium.
The COVID-19 pandemic continues to have widespread, rapidly evolving, and unpredictable impacts on ordinary business commerce and financial markets. Federal and state governments have acted to contain the virus, including establishing social distancing requirements, travel restrictions, and vaccination initiatives. While pandemic containment efforts have resulted in the relaxation of some restrictions, new virus variants are leading to new outbreaks and restrictions. The COVID-19 pandemic has and will likely continue to impact our results of operations, financial position, and liquidity. There is substantial uncertainty about the nature and degree of its continued effects over time. The impact of the COVID-19 pandemic on our business going forward will depend on numerous evolving factors we cannot reliably predict, including the duration and scope of the pandemic, its impact on economic activity, including the possibility of financial market instability or recession, and the response of government, businesses, and individuals.
A downgrade or a potential downgrade in our financial strength or credit ratings could result in a loss of business and could have a material adverse effect on our financial condition and results of operations.
A significant financial strength rating downgrade, particularly from AM Best, would affect our ability to write new or renewal business. Most policyholders are required by various third-party agreements, primarily with lenders, to maintain insurance policies from a carrier with a minimum AM Best or S&P rating. Credit rating downgrades could also make it more expensive for us to access capital markets. We cannot predict the possible rating actions NRSROs might take that could adversely affect our business or our potential actions in response. Any significant downgrade in our financial strength and credit ratings could have a material adverse effect on our results of operations, liquidity, financial condition, financial strength, and debt ratings. For additional information on our current financial strength and credit ratings, refer to "Overview" in Item 1. "Business." of this Form 10-K.
Markets for insurance products and services are highly competitive and subject to rapid technological change, and we may be unable to compete effectively.
We offer our insurance products and services in a highly competitive market characterized by aggressive price competition and downward pressure on underwriting margins, introduction of new products and services, evolving industry standards, continual improvement in product pricing based on performance characteristics and larger data sets, rapid competitor adoption of technological advancements, and consumer and business price sensitivity. Our ability to compete successfully depends heavily on our timely and consistent introduction of innovative new products and services through digital platforms.
We face substantial competition from a wide range of property and casualty insurance companies for customers, distribution partners, and employees. Competitors include public, private, and mutual insurance companies. Many competitors are larger and may have lower relative operating costs, lower cost of capital, or greater ability to absorb or diversify more risk while maintaining their financial strength ratings. Other competitors, such as mutual or reciprocal companies, are owned by or operated cooperatively for insureds and, unlike us, do not have shareholders who evaluate ROE performance. Consequently, some competitors may be able to price their products more competitively.
The Internet has emerged as a significant competitive digital marketplace for existing and new competitors. Established insurance competitors, such as The Progressive Corporation, are beginning to explore broader digital Internet offerings, while new competitors with variations on traditional business models have emerged, such as Lemonade, Root, and Next. Because the Internet makes it easier and less expensive to bundle products and services, it also is possible that non-insurance companies
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conducting business on the Internet could enter the insurance business or form strategic alliances with insurers in the future. Changes in competitors and competition, particularly on the Internet, could cause changes in the supply or demand for insurance and adversely affect our business.
The increasing importance of the Internet, technology, and digital strategy in our industry also highlights our need to attract and retain employees in difficult-to-fill data science, advanced analytics, and IT roles – and the potential negative impact if we fail in so doing.
We have less loss experience data than our larger competitors.
Insurers depend on access to reliable data about their policyholders and loss experience to build complex analytics and predictive models that assess risk profitability, reserve adequacy, adverse claim development potential, recovery opportunities, fraudulent activities, and customer buying habits. Because we use and depend on the aggregated industry loss data assembled by rating bureaus under the antitrust exemptions of the McCarran-Ferguson Act, we likely would be at a competitive disadvantage to larger insurers if Congress repealed the McCarran-Ferguson Act.
We expect the use of data science and analytics to increase and become more complex and accurate, particularly with larger sets of relevant data. Some larger competitors have significantly more data about the performance of their underwritten risks. In comparison, we may not have sufficient volumes of loss experience data to analyze and project our future costs as accurately or granularly. We use industry loss experience from ISO, AAIS, NCCI, and other publicly available sources to supplement our data. While relevant, industry data may not correlate specifically to the performance of our underwritten risks and be as predictive as data on a larger book of our own business.
We are subject to various modeling risks that could have a material adverse impact on our business results.
We rely on complex financial and other statistical models, developed internally and by third parties, to predict (i) underwriting results on individual risks and our overall portfolio, (ii) claims fraud and other claims impacts, such as escalation, (iii) impacts from catastrophes, (iv) enterprise risk management capital scenarios, and (v) investment portfolio changes. We rely on these financial and other statistical models to analyze historical loss costs and pricing, claims severity and frequency trends, catastrophe losses, reinsurance attachment and exhaustion points, investment performance, portfolio risk, and our economic capital position. Flaws in these financial and other statistical models, or in their embedded assumptions, could lead to increased losses. Our statistical models are extremely useful in monitoring and controlling risk, but they are not a substitute for senior management's experience or judgment.
Risks Related to Our Investments Segment
Our investments are exposed to credit risk, interest rate fluctuation, and changes in value.
We depend on income from our investment portfolio for a significant portion of our revenue and earnings. Our investments can be negatively affected by (i) liquidity, (ii) credit deterioration, (iii) financial results, (iv) public equity and/or debt market changes, (v) economic conditions, including heightened levels of economic inflation and any ongoing COVID-19-related governmental orders, (vi) political risk, (vii) sovereign risk, (viii) interest rate fluctuations, or (ix) other factors, including climate change risk and civil unrest. Our investment portfolio's value is subject to credit risk from the issuers, and/or guarantors and insurers, of the securities we hold and other counterparties in certain transactions. Defaults on any of our investments by any issuer, guarantor, insurer, or other counterparty could reduce our net investment income and net realized investment gains - or result in investment losses. We are subject to the risk that the issuers or guarantors of fixed income securities we own may default on principal and interest payment obligations.
Additionally, we are exposed to interest rate risk, primarily related to the market price and cash flow variability associated with changes in interest rates. Consequently, the value and liquidity of our cash, cash equivalents, and marketable and non-marketable securities may fluctuate substantially. Future fluctuations in the value of our cash, cash equivalents, and marketable and non-marketable securities could result in significant losses and have a material adverse impact on our financial condition and operating results.
Our investment portfolio also has climate change-related transition risks. Transition risks arise from society’s transition towards a low-carbon economy, driven by policy and regulations, low-carbon technology advancement, and shifting sentiment and societal preferences. This transition can lead to stranded assets in areas such as the fossil-fuel and automotive industries. It can also result in increased costs to reinvest in and replace infrastructure and litigation against fossil-fuel companies. Transition risks can lead to corporate asset devaluation, lower corporate profitability, lower property values, and lower household wealth. Transition risks may reduce the market value of some energy, transportation, and other investments with high carbon footprints
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or those closely tied to carbon-based economic activity. As of December 31, 2021, sectors identified as carbon intensive within our fixed income securities portfolio represented less than 5% of our total invested assets.
Significant future investment value declines could require further losses recorded on securities we intend to sell and credit losses. For more information regarding market interest rate, credit, and equity price risk, see Item 7A. “Quantitative and Qualitative Disclosures About Market Risk.” of this Form 10-K.
We have securities tied to LIBOR, which will be eliminated on June 30, 2023.
As of December 31, 2021, approximately 15% of our fixed income securities portfolio had floating rate securities primarily tied to the 1- and 3-month U.S. dollar-denominated London Interbank Offered Rate ("LIBOR"). The global banking industry has used LIBOR as a primary metric to calculate interest rates for numerous types of debt obligations, including personal and commercial loans, interest rate swaps, and other derivative products. In anticipation of LIBOR's elimination, the U.S. Federal Reserve established the Alternative Reference Rates Committee ("ARRC") to select a replacement index for U.S. Dollar LIBOR. The ARRC, comprised of a broad group of private-market participants, including banks, asset managers, insurers, and industry regulators, identified the Secured Overnight Financing Rate ("SOFR") as the recommended benchmark rate to replace LIBOR. SOFR is based on overnight repurchase agreement transactions backed by U.S. Treasury securities. The ARRC announced a paced transition plan for this new rate, including specific steps and timelines designed to encourage the adoption of SOFR. Effective December 31, 2021, LIBOR can no longer be used as a benchmark reference rate in new issue loans, securitized products, and other floating rate instruments. Effective June 30, 2023, LIBOR will cease to exist and require remaining floating rate securities to transition to SOFR. Consequently, our fixed income securities portfolio may be subject to (i) interest rate and prepayment risk associated with the resetting of our floating rate coupons from LIBOR to SOFR, (ii) potential rating agency downgrades, (iii) reduced trading liquidity on securities with insufficient fallback transition language, and (iv) lower returns associated with basis risk from a reference rate mismatch between liabilities and assets in certain securitized assets. We continue to monitor the potential impact, if any, the elimination of LIBOR and the transition to SOFR will have on our floating rate investments' performance. We have and continue to evaluate and monitor other LIBOR risks across the organization.
We are subject to the risks inherent in investing in private limited partnerships.
Our other investments include investments in private limited partnerships that invest in various strategies, such as private equity, private credit, and real assets. The primary assets and liabilities underlying the investments in these limited partnerships generally do not have quoted prices in active markets for the same or similar assets, so their valuation is subject to a higher level of subjectivity and unobservable inputs than substantially all of our other investments. Because these limited partnership investments are recorded under the equity method of accounting, any valuation decreases could negatively impact our results of operations. Because of their return relative to risk, we currently expect to slightly increase our allocation to these investments, which may produce additional variability in our net investment income.
The determination of the amount of credit losses taken on our investments is highly subjective and could materially impact our results of operations or our financial position.
The determination of the amount of credit losses taken on our investments is based on our quarterly evaluation and assessment of our investments and known and inherent risks associated with the various asset classes. Such evaluations and assessments are revised as conditions change and new information becomes available. Management updates its evaluations regularly and reflects changes in credit losses at the time of evaluation. There can be no assurance that management has accurately assessed the level of credit losses recorded in our Financial Statements. For further information about our evaluation and considerations for determining whether a security has a credit loss, please refer to “Critical Accounting Policies and Estimates” in Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” of this Form 10-K.
Risks Related to Evolving Laws, Regulations, and Public Policy Debates
We are subject to complex and changing laws, regulations, and public policy debates that expose us to regulatory scrutiny, potential liabilities, increased costs, reputational harm, and other adverse effects on our business.
Our operations are subject to complex and changing state and federal laws, regulations, and public policy debates on subjects, including, without limitation, the following:
•Pricing and underwriting practices;
•Claims practices;
•Loss and loss adjustment expense reserves;
•Exiting geographic markets and/or canceling or non-renewing policies;
•Environmental, social, and governance ("ESG") related issues, including ESG investment mandates;
•Assessments for guaranty funds and second-injury funds, and other mandatory assigned risks and reinsurance;
•The types, quality, and concentration of investments we make;
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•Minimum capital requirements for the Insurance Subsidiaries;
•Dividends from our Insurance Subsidiaries to the Parent;
•Privacy and data security;
•Tax;
•Antitrust;
•Consumer protection;
•Advertising;
•Sales;
•Billing and e-commerce;
•Intellectual property ownership and infringement;
•Digital platforms;
•Internet, telecommunications, and mobile communications;
•Media and digital content;
•Availability of third-party software applications and services;
•Labor and employment;
•Anti-money laundering; and
•Workplace environmental, health, and safety issues.
Changes to laws and regulations can adversely affect our business by increasing our costs, limiting our ability to offer a product or service to customers, requiring changes to our business practices, or otherwise making our products and services less attractive to customers.
If Congress enacted a law directly regulating insurance, particularly insurer solvency oversight, and state regulators remained responsible for rate approval, we could be subject to a conflicting and inconsistent regulatory framework that could impact our profitability and capital adequacy.
While we underwrite risks only in the U.S., international regulatory developments, particularly related to capital adequacy and risk management requirements in the European Union (“EU”), may influence U.S. regulators as they develop or revise domestic regulatory standards. In the fourth quarter of 2020, the NAIC's Group Capital Calculation Working Group adopted the basic structure of its new Group Capital Calculation and drafted model law changes that provide for its adoption as a state law requirement for U.S. insurance groups. It is expected that state legislatures will begin to adopt the group capital calculation model law by year-end 2022. The changes could increase the amount of capital our insurance subsidiaries are required to hold.
We have implemented policies and procedures designed to ensure compliance with applicable laws and regulations. However, we can provide no assurance that our employees, contractors, or independent distribution partners will not violate such laws and regulations or our policies and procedures. To some degree, we have multiple regulators whose authority may overlap and may have different interpretations and/or regulations related to the same legal issues. This creates the risk that one regulator's position or interpretation may conflict with another regulator on the same issue. The cost of complying with various, potentially conflicting laws and regulations, and changes in those laws and regulations, could have a material adverse effect on our results of operations, liquidity, financial condition, financial strength, and debt ratings.
Insurers are subject to intense regulatory, political, and media scrutiny. We are subject to government market conduct review and investigations, legal actions, and penalties. There can be no assurance that our business will not be materially adversely affected by the outcomes of such examinations, investigations, or media scrutiny in the future. If we are found to have violated laws and regulations, it could materially adversely affect our reputation, financial condition, and operating results.
Our business is subject to a variety of state, federal, and other laws, rules, policies, and other obligations regarding data protection.
We are subject to federal and state laws relating to the collection, use, retention, security, and transfer of personally identifiable information (“PII”). Federal laws include the Gramm-Leach-Bliley Act, the Fair Credit Reporting Act, the Drivers Privacy Protection Act, the Health Insurance Portability and Accountability Act, and Unfair and Deceptive Acts and Practices laws. Several states, like New York, Nevada, Colorado, Virginia, and California, have passed laws in this area, and other jurisdictions are considering imposing additional restrictions or creating new rights concerning PII. These laws continue to develop and may be inconsistent from jurisdiction to jurisdiction. Complying with emerging and changing requirements may cause us to incur substantial costs or require us to change our business practices. Noncompliance could result in significant reputational harm, penalties, and legal liability.
The EU adopted the General Data Protection Regulation ("GDPR") in 2016. Effective since 2018 after a two-year implementation period, GDPR regulates data protection and privacy in the EU and transfers of personal data outside the EU.
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GDPR’s main tenet is to give individuals primary control over their personal data. Because we do not write coverages in the EU, GDPR has no direct impact on us. Some U.S. states have subsequently incorporated individual-control mechanisms into state privacy laws. Future EU data privacy actions likely will influence U.S. regulators over time.
We make statements about our use and disclosure of PII through our privacy policy, information provided on our website, and other public statements. If we fail to comply with these public statements or federal and state privacy-related and data protection laws and regulations, we could be subject to litigation or governmental actions. Such proceedings could impact our reputation and result in penalties, including ongoing audit requirements and significant legal liability.
We are engaged in ordinary routine legal proceedings incidental to our insurance operations that, because litigation outcomes are inherently unpredictable, could impact our reputation and/or have a material adverse effect on our consolidated results of operations or cash flows in particular quarterly or annual periods.
We are engaged in ordinary routine legal proceedings incidental to our insurance operations that include:
•Defense of or indemnity for third-party suits brought against our insureds;
•Defense of actions brought against us by our insureds who disagree with our coverage decisions, some of which allege bad faith claims handling and seek extra-contractual damages, punitive damages, or other penalties;
•Actions we file, primarily for declaratory judgment, seeking confirmation that we have made appropriate coverage decisions under our insurance contracts;
•Actions brought against us or competitors alleging improper business practices and sometimes seeking class status. Such actions historically have included issues and allegations, without limitation, related to (i) unfairly discriminatory underwriting practices, including the impact of credit score usage, (ii) managed care practices, such as provider reimbursement, and (iii) automobile claims practices; and
•Actions we file against third parties and other insurers for subrogation and recovery of other amounts we paid on behalf of our insureds.
From time-to-time, legal proceedings in which we are involved may receive media attention based on their perceived newsworthiness and/or relationship to a variety of broad economic, political, social, and legal developments or trends. Such media stories could negatively impact our reputation.
We expect any potential ultimate liability for ordinary routine legal proceedings incidental to our insurance business will not be material to our consolidated financial condition after considering estimated loss provisions. Litigation outcomes, however, are inherently unpredictable even with meritorious defenses. The time a case is in litigation also is unpredictable, as state court dockets are increasingly overcrowded. Generally, the longer a case is in litigation, the more expensive it can become. Because the amounts sought in certain of these actions are large or indeterminate, any adverse outcomes could have a material adverse effect on our consolidated results of operations or cash flows in particular quarterly or annual periods.
Additionally, we do not have any material litigation risks related to climate change.
Risks Related to Our Corporate Structure and Governance
We are a holding company, and our ability to declare dividends to our shareholders, pay indebtedness, and enter into affiliate transactions may be limited because our Insurance Subsidiaries are regulated.
Restrictions on our Insurance Subsidiaries' ability to pay dividends, make loans or advances to the Parent, or enter into transactions with affiliates may materially affect our ability to pay dividends on our preferred stock and common stock, or repay our indebtedness.
Based on these restrictions, the maximum in ordinary annual dividends the Insurance Subsidiaries can provide the Parent in 2022 is $322 million. Their ability to pay dividends or make loans or advances, however, is subject to domiciliary state insurance regulators' approval or review. For additional details regarding dividend restrictions, see Note 22. “Statutory Financial Information, Capital Requirements, and Restrictions on Dividends and Transfers of Funds” in Item 8. "Financial Statements and Supplementary Data." of this Form 10-K.
The Parent’s ability to pay dividends to its stockholders is also impacted by covenants in its credit agreement (the “Line of Credit”) among the Parent, the lenders named therein (the “Lenders”), and the Bank of Montreal, Chicago Branch, as Administrative Agent. These covenants obligate the Parent to, among other things, maintain a minimum consolidated net worth and a maximum ratio of debt to capitalization. Under the terms of our Preferred Stock, the Parent's ability to declare or pay dividends on, or purchase, redeem or otherwise acquire, shares of its common stock or any shares of the Parent that rank junior to, or on parity with, the Preferred Stock will be subject to certain restrictions if the Parent does not declare and pay (or set aside) dividends on the Preferred Stock for the last preceding dividend period. For additional details about the Line of Credit’s
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financial covenants, see Note 11. “Indebtedness” in Item 8. "Financial Statements and Supplementary Data" of this Form 10-K. For additional details about conditions related to our Preferred Stock, see Note 17. "Preferred Stock" in Item 8. "Financial Statements and Supplementary Data" of this Form 10-K.
Because we are a New Jersey corporation and an insurance holding company, we may be less attractive to potential acquirers and the value of our common stock could be adversely affected.
We are a New Jersey company, and provisions of the New Jersey Shareholders’ Protection Act and our Amended and Restated Certificate of Incorporation may discourage, delay, or prevent us from being acquired. A supermajority of our shareholders must approve (i) certain business combinations with interested shareholders, or (ii) any amendment to the related provisions of our Amended and Restated Certificate of Incorporation unless certain conditions are met. These conditions may relate to, among other things, the interested stockholder’s acquisition of stock, the approval of the business combination by disinterested members of our Board and disinterested stockholders, and the price and payment of the consideration proposed in the business combination. In addition to considering the effects of any action on our shareholders (including any offer or proposal to acquire the Parent), our Board may consider: (i) the long-term, as well as the short-term, interests of the Parent and our shareholders, including the possibility that these interests may best be served by the continued independence of the Parent; (ii) the effects of the action on the Parent's employees, suppliers, creditors, and customers; and (iii) the effects of the action on the community in which the Parent operates.
These provisions of our Amended and Restated Certificate of Incorporation and New Jersey law could deprive our common shareholders of an opportunity to receive a premium over the prevailing market price in the event of a hostile takeover and may adversely affect the value of our common stock.
Because we own insurance subsidiaries, any party seeking to acquire 10% or more of our common stock must seek prior approval from the subsidiaries' domiciliary insurance regulators and file extensive information about their business operations and finances. The New Jersey Department of Banking and Insurance Commissioner, who regulates seven of our Insurance Subsidiaries, also considers whether (i) the acquisition of control of an insurer would be adverse to the public interest or the protection of existing and future policyholders or (ii) persons seeking control would use control adversely to the public interest or the protection of policyholders.
Risks Related to Our General Operations
We, our distribution partners, and our vendors are subject to attempted cyber-attacks, other cybersecurity risks, and system availability risk.
Our business heavily relies on IT and application systems that may be accessed from, or are connected to, the Internet. Consequently, a malicious cyber-attack could affect us. Our systems also contain proprietary and confidential information, including PII, about our operations, employees, agents, and customers and their employees and property. A malicious cyber-attack on (i) our systems, (ii) our distribution partners or their key operating systems, and (iii) any other of our third-party partners or vendors and their key operating systems may interrupt our ability to operate, damage our reputation and result in monetary damages that are difficult to quantify, and have a material adverse effect on our results of operations, liquidity, financial condition, financial strength, and debt ratings.
We have implemented systems and processes, through encryption and authentication technologies, intended to mitigate or secure our IT systems and prevent unauthorized access to, or loss of, sensitive data. As cyber-attacks continue to evolve daily, our security measures may not be sufficient for all eventualities. We may be vulnerable to hacking, employee error, malfeasance, system error, faulty password management, or other irregularities. Any disruption or breach of our systems or data security could damage our reputation, result in monetary damages that are difficult to quantify, and have a material adverse effect on our results of operations, liquidity, financial condition, financial strength, and debt ratings. To mitigate this risk, we have and expect to continue to (i) conduct employee education programs and tabletop exercises and (ii) develop and invest in a variety of controls to prevent, detect, and appropriately react to cyber-attacks, including frequently testing our systems' security and access controls. We have insurance coverage for certain cybersecurity risks, including privacy breach incidents, which coverage may be insufficient to indemnify all losses or types of claims that may arise.
In addition to cyber-attack risk, we face system availability risk. Our business relies heavily on various IT and application systems. We have robust business continuity plans, which are designed to minimize the duration and impact of an unexpected loss of availability of any of these systems. Nevertheless, we could experience an event that impacts one or more of these systems, including those based in facilities where we or our vendors operate, which may interrupt our ability to operate and negatively impact our results of operations, despite our business continuity plans.
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Our long-term strategy to deploy operational leverage is dependent on the success of our risk management strategies, and their failure could have a material adverse effect on our financial condition or results of operations.
As an insurer, we assume risk from our policyholders. Our long-term strategy includes the use of above-average operational leverage, which can be measured as the ratio of NPW to our equity or statutory surplus. We balance and mitigate our operational leverage risk with several risk management strategies within our insurance operations to achieve a balance of growth and profit, including using significant amounts of reinsurance, a disciplined approach to reserving, and a conservative investment philosophy. These strategies have inherent limitations. We cannot be certain that an event or series of unanticipated events will not occur and result in losses greater than we expect. Given our higher operating leverage than that of our industry, an event or series of unanticipated events could have a more material adverse effect on our results of operations, liquidity, financial condition, financial strength, and debt ratings compared to our industry.
Item 1B. Unresolved Staff Comments.
None.
Item 2. Properties.
Our headquarters occupy a 315,000 square foot building located on an owned 56-acre site zoned for office and professional use in Branchville, New Jersey. We lease all our other facilities from unrelated parties. The principal office locations of our insurance operations are listed in the “Geographic Markets” section of Item 1. “Business.” of this Form 10-K. Our Investments operations are principally located in leased space in Farmington, Connecticut. Our facilities provide adequate space for our present needs and, if additional space is needed, should be available on reasonable terms. Our headquarters site also contains our ground-mount solar facility that annually generates approximately three million kilowatt hours ("kWh") of electricity that we sell to others.
Item 3. Legal Proceedings.
Incidental to our insurance operations, we are routinely engaged in legal proceedings with inherently unpredictable outcomes that could have a material adverse effect on our consolidated results of operations or cash flows in particular quarterly or annual periods. For additional information regarding our legal risks, refer to Item 1A. “Risk Factors.” and Note 21. "Litigation" included in Item 8. "Financial Statements and Supplementary Data." of this Form 10-K. As of December 31, 2021, we have no material pending legal proceedings that could have a material adverse effect on our consolidated financial condition, results of operations, or cash flows.
Item 4. Mine Safety Disclosures.
Not applicable.
PART II
Item 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
(a) Market Information
Our common stock is traded on the Nasdaq Global Select Market under the symbol “SIGI.”
(b) Holders
We had 2,949 common stockholders of record as of January 31, 2022, according to the records maintained by our transfer agent.
(c) Dividends
Dividends on shares of our common stock are declared and paid at the discretion of the Board of Directors (the "Board") based on our results of operations, financial condition, capital requirements, contractual restrictions, and other relevant factors. We currently expect to continue to pay quarterly cash dividends on shares of our common stock in the future.
On October 27, 2021, the Board approved a 12% increase in our common stock dividend to $0.28 per share. In addition, on February 3, 2022, the Board declared a $0.28 per share quarterly cash dividend on common stock that is payable March 1, 2022, to stockholders of record as of February 15, 2022.
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(d) Securities Authorized for Issuance under Equity Compensation Plans
The following table provides information about our common stock authorized for issuance under equity compensation plans as of December 31, 2021:
(a) (b) (c)
Equity compensation plans approved by security holders — $ — 5,506,750
1Includes 1,184,849 shares available for issuance under our Employee Stock Purchase Plan (2021); 1,608,234 shares available for issuance under the Stock Purchase Plan for Independent Insurance Agencies; and 2,713,667 shares for issuance under the Selective Insurance Group, Inc. 2014 Omnibus Stock Plan ("Stock Plan"). Future grants under the Stock Plan can be made, among other things, as stock options, restricted stock units, or restricted stock.
(e) Performance Graph
The following chart, produced by Research Data Group, Inc., depicts our performance for the period beginning December 31, 2016, and ending December 31, 2021, comparing total stockholder return on our common stock to the total return of (i) the NASDAQ Composite Index and (ii) a select group of peer companies comprised of NASDAQ-listed companies in SIC Code 6330-6339, Fire, Marine, and Casualty Insurance.
This performance graph is not incorporated into any other filing we have made with the U.S. Securities and Exchange Commission ("SEC") and will not be incorporated by reference into any future SEC filing unless we so specifically state. This performance graph shall not be deemed to be “soliciting material” or to be “filed” with the SEC unless we specifically request so or specifically incorporate it by reference in any filing we make with the SEC.
(f) Purchases of Equity Securities by the Issuer and Affiliated Purchasers
The following table provides information regarding our purchases of our common stock in the fourth quarter of 2021:
1We purchased these shares from employees to satisfy tax withholding obligations associated with the vesting of their restricted stock units.
2On December 2, 2020, we announced our Board authorized a $100 million share repurchase program with no set expiration or termination date. Our repurchase program does not obligate us to acquire any particular amount of our common stock. Management will determine the timing and amount of any share repurchases under the authorization at its discretion based on market conditions and other considerations.
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Item 6. Reserved.
Not applicable.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Forward-looking Statements