sigi-20231231
Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
☒ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended: December 31, 2023
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: (973) 948-3000
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.
Large accelerated filer ☒ Accelerated filer ☐ Emerging growth company ☐
Non-accelerated filer ☐ Smaller reporting company ☐
1
Table of Contents
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. ☒
If securities are registered pursuant to Section 12(b) of the Act, indicate by check mark whether the financial statements of the registrant included in the filing reflect the correction of an error to previously issued financial statements. ☐
Indicate by check mark whether any of those error corrections are restatements that required a recovery analysis of incentive-based compensation received by any of the registrant’s executive officers during the relevant recovery period pursuant to §240.10D-1(b). ☐
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 $5,764,421,938 on June 30, 2023. As of January 31, 2024, the registrant had outstanding 60,641,846 shares of common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive Proxy Statement for the 2024 Annual Meeting of Stockholders to be held on May 1, 2024, are incorporated by reference into Part III of this report.
2
Table of Contents
SELECTIVE INSURANCE GROUP, INC.
Table of Contents
PageNo.
PART I
Item 1. Business 4
Item 1A. Risk Factors 23
Item 1B. Unresolved Staff Comments 34
Item 1C. Cybersecurity 34
Item 2. Properties 36
Item 3. Legal Proceedings 36
Item 4. Mine Safety Disclosures 36
PART II
Item 6. Reserved 38
Forward-looking Statements 38
Introduction 38
Critical Accounting Policies and Estimates 39
Results of Operations and Related Information by Segment 50
Federal Income Taxes 64
Liquidity and Capital Resources 64
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 68
Item 8. Financial Statements and Supplementary Data 76
Consolidated Balance Sheets as of December 31, 2023 and 2022 78
Notes to Consolidated Financial Statements 83
Item 9A. Controls and Procedures 136
Item 9B. Other Information 138
Item 9C. Disclosure Regarding Foreign Jurisdictions that Prevent Inspections 138
PART III
Item 10. Directors, Executive Officers and Corporate Governance 138
Item 11. Executive Compensation 138
Item 14. Principal Accountant Fees and Services 138
PART IV
Item 15. Exhibit and Financial Statement Schedules 139
3
Table of Contents
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.") and 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. Throughout this document, we refer to the Parent and the Insurance Subsidiaries collectively as "we," "us," or "our." We use the term "Parent" when appropriate to distinguish it from the Insurance Subsidiaries. We also use specific property and casualty industry-related terms defined in a glossary attached as Exhibit 99.1 to this Form 10-K.
Our main office is in Branchville, New Jersey. We list our common (stock symbol "SIGI") and preferred (stock symbol "SIGIP") stocks on the Nasdaq Global Select Market. In 2023, AM Best Company ("AM Best") ranked us as the 37th largest property and casualty group in its annual "Top 200 U.S. Property/Casualty Writers" list based on 2022 net premiums written ("NPW"). Our current AM Best financial strength rating is "A+" (Superior). We have had a long and successful history in the property and casualty insurance industry since our 1926 founding.
Strategic Advantages
Our market is competitive and crowded, making it critical to clearly demonstrate our value proposition to customers, distribution partners, employees, and investors. We have five key sustainable competitive advantages:
•A unique field model, placing empowered underwriting staff near our distribution partners and customers.
•Our ability to develop sophisticated risk selection, pricing, and claims management tools, and put them in the hands of our front-line employees.
•A franchise value distribution model, defined by meaningful and close business relationships with a group of high-quality independent agents and brokers.
•A commitment to delivering a superior omnichannel customer experience enhanced by digital platforms and value-added services.
•A highly engaged and aligned team of extremely talented employees.
Several nationally recognized statistical rating organizations ("NRSROs") issue opinions on our financial strength, operating performance, strategic position, and ability to meet policyholder obligations, as follows:
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 Positive
Fitch Ratings ("Fitch") A+ Stable
We believe our AM Best rating has the most significant influence on our ability to write insurance business. Our independent distribution partners recommend insurance carriers based partly on financial strength ratings to limit their potential liability for customer error and omission claims. Similarly, many customers consider ratings when purchasing insurance because they have loans, mortgages, and other real and personal property security agreements that require minimum carrier rating requirements.
4
Table of Contents
These NRSROs also rate our long-term debt creditworthiness. Credit ratings indicate our ability to meet our obligations when due. They 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 Positive
Fitch BBB+ Stable
In November 2023, S&P adopted its updated risk-based capital model, and we were named as one of more than sixty companies under "criteria observation." S&P's criteria observation means that new or revised criteria has not yet been applied to the rating and its impact is not yet known. S&P’s criteria observation is not equivalent to a CreditWatch, which highlights the potential direction of a short- or long-term rating and focuses on identifiable events and short-term trends that cause ratings to be placed under special surveillance by S&P’s analytical staff. It does not indicate the likelihood of a credit rating change, the timeline for any potential change, the direction of a potential change, or modify any rating definition. S&P has stated it expects to finish its criteria observation in the first quarter of 2024.
Our S&P, Moody's, and Fitch financial strength and credit ratings influence our access to capital markets more than our AM Best rating.
Segments
We have four reportable segments:
•Standard Commercial Lines, which represented 73% of our 2023 "Total revenues" on our Consolidated Statements of Income and 79% of our 2023 total NPW. We sell our Standard Commercial Lines property and casualty insurance products and services to commercial enterprises, typically businesses, non-profit organizations, and local government agencies, primarily in 30 states and the District of Columbia. Our average 2023 Standard Commercial Lines premium per policyholder was approximately $17,000.
•Standard Personal Lines, which represented 9% of our 2023 "Total revenues" on our Consolidated Statements of Income and 10% of our 2023 total NPW. We sell our Standard Personal Lines property and casualty insurance products and services primarily to individuals in 15 states. Our average 2023 Standard Personal Lines premium per policyholder was approximately $3,000. Standard Personal Lines includes flood insurance coverage sold in all 50 states and the District of Columbia through the Write Your Own ("WYO") program of the National Flood Insurance Program ("NFIP"). Based on 2022 direct premiums written ("DPW") as reported in the S&P Market Intelligence platform, we are the fourth-largest WYO carrier.
•E&S Lines, which represented 9% of our 2023 "Total revenues" on our Consolidated Statements of Income and 11% of our 2023 NPW. We sell our E&S Lines property and casualty insurance products and services in all 50 states and the District of Columbia. We sell our E&S Lines property and casualty insurance products and services to commercial customers unable to obtain coverage in the standard marketplace, generally because of unusual or high-risk exposures. E&S insurers are exempt from many standard market requirements, including form and rate regulation. E&S carriers may write an insurance policy if three separate standard line carriers have declined to write the risk to be insured. Our average 2023 E&S lines premium per policyholder was approximately $4,600.
•Investments, which represents 9% (including net realized and unrealized gains and losses) of Total revenues, invests the (i) premiums our Insurance Subsidiaries collect and (ii) amounts generated through our capital management strategies, including debt and equity securities issuance.
We derive nearly all of our income/loss in three ways:
•Underwriting income/loss from our insurance operations. DPW, gross premiums, NPW, and net premiums earned ("NPE") are components of evaluating underwriting income/loss. DPW are the amounts billed to policyholders for insurance coverage and services. Gross premiums are DPW plus premiums assumed from other insurers and mandatory pools and associations. NPW are calculated by subtracting premiums ceded to reinsurers from gross premiums. NPE is NPW recognized as revenue ratably over a policy’s term. Underwriting income/loss is NPE minus insurance operations-related expenses incurred.
5
Table of Contents
Insurance operations-related expenses fall into three categories on our Consolidated Statements of Income: (i) "Loss and loss expense incurred," which includes losses associated with claims and 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 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. These expenses include, but are not limited to, certain labor expenses, depreciation expense, and policyholder dividends.
Total underwriting expenses are the sum 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 charged to customers paying their premiums in installments.
•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, and (iii) income 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. Net realized and unrealized gains and losses from our investment portfolio result from (i) security disposals through sales, calls, and redemptions, (ii) losses on securities that 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, including long-term employee incentive compensation and other general corporate expenses, (ii) interest on our debt obligations, (iii) federal income taxes, and (iv) dividends to preferred stockholders.
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 this non-GAAP measure because it is an important financial measure used by us, analysts, and investors because the timing of realized and unrealized investment gains and losses on securities in any given period is largely discretionary. In addition, net realized and unrealized investment gains and losses on investments could distort the analysis of trends.
We use the combined ratio as the key performance measure in assessing the underwriting profitability of our insurance operations. The combined ratio is the sum of (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 one over 100% indicates an underwriting loss. The combined ratio does not reflect net investment income earned, net realized and unrealized investment gains or losses, federal income taxes, interest expense, or corporate expenses. The loss and loss expense ratio typically has the most significant impact on our combined ratio. Key inputs in our loss and loss expense ratio include catastrophe and non-catastrophe property loss and loss expenses incurred, current year casualty loss and loss expenses, and prior year casualty reserve development.
We use after-tax net investment income earned as the main measure of our investments segment's financial performance. We also assess total return, calculated as the ratio of the sum of pre-tax (i) net investment income, (ii) net realized and unrealized investment gains or losses (including losses on securities we intend to sell and credit loss expense or benefit) in income, and (iii) unrealized investment gains or losses included in accumulated other comprehensive income or loss, to average invested assets. Our investment philosophy includes setting specific risk and return objectives for the fixed income, equity, and alternative investment portfolios and comparing each to a weighted-average benchmark of comparable indices.
Other important measures of our overall financial performance that we consider include return on common equity ("ROE") and non-GAAP operating return on common equity ("non-GAAP operating ROE"). Our basis for using this non-GAAP measure is consistent with our use of non-GAAP operating income described above. ROE is calculated by dividing net income available to common stockholders by average common stockholders' equity. Non-GAAP operating ROE is calculated by dividing non-GAAP operating income available to common stockholders by average common stockholders' equity. We evaluate our
6
Table of Contents
segments, in part, based on their contribution to non-GAAP operating ROE. Our non-GAAP operating ROE target is 12% and is set approximately 300 to 400 basis points above our weighted average cost of capital. Our non-GAAP operating ROE was 14.4% in 2023.
For further details about our 2023 results compared to these performance measures, refer to "Financial Highlights of Results for Years Ended December 31, 2023, 2022, and 2021" in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations." of this Form 10-K.
Other key financial metrics we measure include operating leverage and investment leverage.
We define operating leverage as the ratio of NPW to statutory surplus. We target a ratio between 1.35x and 1.55x. Our operating leverage at December 31, 2023, was 1.51, compared to the U.S. standard commercial and personal lines industry average of approximately 0.8 that Conning, Inc. reported in its Fourth Quarter 2023 Property-Casualty Forecast & Analysis (Source: ©2024 Conning, Inc. Used with permission.). We are comfortable managing our business with operating leverage above the industry average, as we believe we have a lower financial risk profile than the industry, as noted below.
Primarily because we write more longer-tail casualty insurance than shorter-tail property insurance, our operating leverage is higher than the industry average. We also operate with higher investment leverage than the industry average. We define investment leverage as invested assets per dollar of common stockholders’ equity. Our investment leverage at December 31, 2023, was 3.16, compared to the average invested assets to statutory surplus of 2.14 that Conning, Inc. reported for the U.S. commercial and personal lines in its Fourth Quarter 2023 Property-Casualty Forecast & Analysis (Source: ©2024 Conning, Inc. Used with permission.). To better manage the risks of our higher investment leverage, we have adopted a conservative investment management philosophy, with fixed income securities and short-term investments representing 92% of our invested assets as of December 31, 2023. As of December 31, 2023, our fixed income securities and short-term investments had a weighted average credit rating of "AA-" and an effective duration of 4.0 years, compared to "AA-" and 4.1 years as of December 31, 2022.
For additional information about our investments segment's design and credit quality characteristics, see "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 our financial risk profile is lower than the industry because:
•Our Standard Commercial Lines segment underwriting risk appetite focuses on small-to-medium-sized accounts with smaller limit profiles and risks weighted more towards low- to medium-hazard than high-hazard. Our average premium per policyholder is approximately $17,000;
•We have sophisticated pricing tools and maintain disciplined financial planning and reserving practices, which help us identify and quantify risk at the policy and portfolio level. We conduct quarterly ground-up reserve reviews for most lines of business, with semi-annual reserve reviews by an independent third-party actuary who issues our year-end regulatory actuarial reserve opinions;
•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 through traditional privately placed reinsurance and a newly-issued catastrophe bond transaction, which provides additional, fully-collateralized coverage at the top end of our reinsurance program and (ii) property and casualty excess of loss reinsurance agreements that limit our retained losses of individual property claims losses to $5 million per risk and casualty claims to $2 million per occurrence; and
•We maintain a conservative investment portfolio, with high quality liquid fixed income and short-term investments, and a 10%-14% allocation to risk assets.
Our financial strength and lower investment and underwriting risk profile have permitted us to operate with higher operating leverage than the industry average. This strategy requires us to balance growth and profit, allowing us to generate higher underwriting and investment portfolio ROEs when profitable. We generate (i) 1.2 points of ROE for each point on the combined ratio and (ii) 2.6 points of ROE for each point of pre-tax investment yield. In 2023, our underwriting and investment income helped generate a 14.3% ROE and a 14.4% non-GAAP operating ROE, with the latter exceeding our 12% non-GAAP operating ROE target. For further details about our 2023 ROE results, please see "Financial Highlights of Results for Years Ended December 31, 2023, 2022, and 2021" in Item 7. "Management's Discussion and Analysis of Financial Condition and
7
Table of Contents
Results of Operations." of this Form 10-K.
Insurance Operations
Overview
We generate our insurance operations' revenue by selling insurance policies and services in return for insurance premiums. One-year term policies constitute the vast majority of our sales. 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 accounting estimates and represent the ultimate amounts we will need in the future to pay covered claims and related expenses that have been incurred under policies we have sold, but have not yet been paid. Estimating reserves as of any given date is inherently uncertain, requiring estimation techniques and a considerable degree of judgment. We regularly analyze our overall reserve position through internal and external actuarial reserve reviews. For a discussion of 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.
To protect our capital resources and manage the risks associated with our insured risks, we purchase reinsurance from and enter into other risk transfer agreements with third parties. Our insurance subsidiaries transfer risks and share premiums and losses based on percentages specified in an internal reinsurance pooling agreement. For information on our 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
Our Insurance Subsidiaries sell insurance that falls into two broad categories:
•Casualty insurance, which generally covers the financial consequences of (i) injuries employees suffer in the course of employment, (ii) third-party bodily injury and/or property damage from an insured's negligent acts, omissions, or legal liabilities, and (iii) our obligation to defend our insured(s) for covered claims. Casualty claims are long-tailed, regularly taking several years to be reported and settled – and even longer in certain situations.
•Property insurance, which generally covers accidental loss to an insured's real property, personal property, and/or property loss-related earnings. Property claims are usually reported and settled in a relatively short period after the date of loss.
The following table shows the principal types of property and casualty insurance policies we underwrite and issue:
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 flood loss exposure relates to our participation in the NFIP's WYO program, to which we cede 100% of our flood insurance premiums and losses. Our Standard Personal Lines segment results include our WYO policies issued to Standard Personal Lines and Standard Commercial Lines customers.
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 claim. 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 policy forms, or (iii) modifying third-party policy forms. In developing products and services, we consider market demands, profitability, competitive research, feedback from our independent distribution partners, and the product or service's potential to make our customers' commercial or personal endeavors safer.
8
Table of Contents
Our policies provide coverage for future events, so we do not know actual individual policy loss costs at the time of sale. We consider many variables in determining pricing for coverage. Like most property and casualty insurers, our loss data is not sufficiently credible to independently establish the complex loss cost and rating variable structures our products require. Consequently, we often adopt loss costs and rating structures that statistical rating agencies, such as ISO and NCCI, file with state insurance regulators. We typically modify these loss costs or factors based on actuarial analyses of our credible historical statistical data, factoring in loss trends and other expected impacts. We combine the resulting loss costs with expense and profit provisions to develop premium rates. We sometimes supplement the indicated rates with market information to determine our final filed rates.
We have developed predictive models for many of our Standard Commercial Lines and Standard Personal Lines. We use these models to refine statistical rating agencies' rating plans or independently develop our own rating plans. Predictive models analyze historical statistical data about 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 our model's view of their expected loss potential. These groupings are inputs in the individual risk underwriting and pricing process. We use these models to develop factors in our filed Standard Personal Lines rating plans. The predictive capabilities of our models depend on the quantity and quality of available statistical data, and we may supplement them with other 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 44% General contractors and trade contractors
Manufacturing and Wholesale 14% Manufacturers, wholesalers, and distributors
Bonds 1% Fidelity and surety
Total Standard Commercial Lines 100%
We do not categorize Standard Personal Lines or E&S Lines customers into SBUs. No one customer accounts for 10% or more of our insurance operations in the aggregate.
We manage our underwriting volatility by focusing on accounts with lower-limits profiles. 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 individual property and casualty retained losses to $5 million per risk for property claims and $2 million per occurrence for casualty claims. For information on our 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 primarily in 30 states in the contiguous U.S. and the District of Columbia.
•Standard Personal Lines products and services primarily in 15 states in the Eastern, Midwestern, and Southwestern regions of the U.S. Flood insurance, reported in this segment, is sold in all 50 states and the District of Columbia.
•E&S Lines products and services in all 50 states and the District of Columbia.
In 2022, we began writing Standard Commercial Lines business in Vermont, Alabama, and Idaho. This expansion permits us to compete more effectively against national insurers and diversify our portfolio risk. We expect to write new business in West Virginia and Maine in early 2024, and Washington, Oregon, and Nevada in late 2024. Over time, we plan to expand our Standard Commercial Lines footprint into most of the contiguous U.S.
We manage and support our business from offices in (i) Branchville, New Jersey, our corporate headquarters, (ii) Farmington, Connecticut, the principal office for investment operations, (iii) Glastonbury, Connecticut, used by several corporate areas, but primarily our information technology ("IT") department, (iv) Richmond, Virginia, the location of our underwriting and claims
9
Table of Contents
service center ("USC"), and (v) six regional branches, with the locations listed in the following table:
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
West Scottsdale, Arizona
Our E&S Lines have offices in Scottsdale, Arizona, and Dresher, Pennsylvania. Our Flood business has offices in Branchville, New Jersey, and Miami, Florida. Our Staff Counsel operation, which defends our policyholders with employee-lawyers, has ten leased offices primarily located in the Eastern region of the U.S.
Distribution Channel
The property and casualty insurance market is highly competitive and regulated, 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 for one insurer.
By segment, we use the following types of independent distribution partners to sell our insurance products and services:
•Standard Commercial Lines: Independent retail agents;
•Standard Personal Lines: Independent retail agents; and
•E&S Lines: Wholesale general agents.
We seek to compensate our distribution partners fairly and consistently with market practices, generally paying them commissions calculated as a percentage of DPW, with supplemental amounts paid based on profitability and considerations for increased premium or policy counts. No one independent distribution partner is responsible for 10% or more of our combined insurance operations' premium. In 2023, our top 20 distribution partners generated approximately 42% of our DPW, excluding E&S Lines and the flood line of business.
Independent Retail Agents and Standard Lines
A 2022 Independent Insurance Agents & Brokers of America study estimated there are 40,000 independent property/casualty insurance agents and brokers in the U.S., up 11% from their 2020 study. We expect that independent retail insurance agents – representing most of our independent distribution partners – will remain a significant force in overall insurance industry premium production. Their business model, representing multiple insurance carriers, gives customers a broader choice of insurance products, more competitive pricing, and individualized risk-based consultation.
Approximately 1,550 distribution partners sell our standard lines products and services through approximately 2,650 office locations. About 850 of these distribution partners sell our Standard Personal Lines products. Approximately 6,400 distribution partners sell our flood insurance products.
Wholesale General Agents and E&S Lines
We have approximately 90 wholesale general agents, with an aggregated 340 office locations, selling our E&S Lines business. We have granted these wholesale general agents limited binding authority for risks meeting our prescribed underwriting and pricing guidelines. Risks that are not eligible for binding authority are referred to our underwriters.
Marketing
Our primary marketing strategy is to:
•Use a locally-based, 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 Operating Model" section below.
•Execute on a distribution model that emphasizes the franchise value of appointment to sell our Insurance Subsidiaries' products and services to the principals and producers of our high-quality independent insurance agency partners. To help our agency partners grow profitability and succeed, we establish meaningful and close business relationships by
10
Table of Contents
(i) soliciting, gathering, and acting on their feedback and that of our mutual customers on various topics, including our products and services and brand awareness, (ii) advising them on our new product offerings, and (iii) providing education and development programs focused on producer recruitment, sales training, agency perpetuation, customer experience enhancement, online marketing, and distribution operations.
•Develop and carefully monitor annual goals with each distribution partner on (i) the types and mix of risks they place with us, (ii) new business and renewal retention expectations and pricing, and (iii) the profitability of the business they place with us.
•Develop brand recognition and meaningful customer engagement through a data-driven multi-channel marketing strategy focused on delivering a superior customer experience. We expect this integrated marketing and customer engagement approach will position us as a marketplace leader and (i) afford us a dynamic view of the changing marketplace and customer expectations, (ii) provide us insight into unique value-added products and services that might have the greatest impact on each customer, and (iii) help drive brand health and perception leading to increased retention and business acquisition.
Technology, Innovation, and Operating Model
We continue to evolve our technology and operating model, focusing on innovation and providing our customers and distribution partners with a superior omnichannel experience and "around-the-clock" digital access to account information and transactional capabilities. While many insurers offer digital customer solutions for personal lines, we strive to be a digital and customer experience leader in all three of our insurance operation segments.
Technology
We leverage technology in our business and invest significantly in IT platforms, integrated systems, and cloud-based solutions. We leverage artificial intelligence ("AI") to increase our efficiency within our underwriting and claims functions where it demonstrates the capability to provide efficiency, increase decision speed, or support an omnichannel experience. Additionally, we are in the early stages of deploying general-purpose and industry-trained generative AI and large language models.
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;
•Our service representatives with a customer account-centric view of our policyholders, reducing customer inquiry response time and complementing customer access to on-demand digital transactional capabilities;
•Our underwriters with advanced underwriting and pricing tools and predictive models that provide guidance and automatic retrieval of relevant public information on existing and potential policyholders, allowing for improved and quicker decisions, contributing to enhanced profitability and premium growth; and
•Our claims adjusters with predictive tools to identify specific claims likely to involve escalating losses, fraud, subrogation opportunities, or litigation.
Our digital strategy provides our Standard Commercial Lines and Standard Personal Lines customers with a mobile application and a self-service portal branded MySelective. Our award-winning mobile application continues to satisfy users, reaching an all-time high rating of 4.7 out of 5 stars on the Apple App Store. As of December 31, 2023, 56% of our customers registered for MySelective, compared to 50% as of December 31, 2022. MySelective gives policyholders on-demand self-service access to account information, electronic bill payment, and claims reporting. We continue to provide customers with additional digital value-added services, such as proactive messaging about vehicle and product recalls, adverse weather, and claim status.
Our primary technology operations are in Branchville, New Jersey, and Glastonbury, Connecticut. We have agreements with multiple consulting, IT, and supplemental staffing service providers to augment our internal resources. These providers supply approximately 54% of our skilled technology capacity, with 78% of their resources located overseas. We retain management oversight of all projects and ongoing IT production operations. We have procedures to manage an efficient transition to new technology vendors without significantly impacting our operations if we terminate any current service provider.
Innovation
We have a dedicated innovation team under our Chief Marketing and Innovation Officer to maintain our culture of innovation and long-term value proposition to our customers and distribution partners. We established this team to (i) apply proven
11
Table of Contents
innovation techniques and methods for identifying, prioritizing, and advancing strategic, innovative ideas and opportunities, (ii) stay apprised of critical industry and insurance technology trends that impact our customers, distribution partners, and employees, and (iii) expand our innovation culture by providing training and skill-building opportunities to our employees and facilitate departmental and cross-functional strategy and innovation sessions.
Operating Model
We believe our unique operating 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) personnel are provided with sophisticated tools and technologies to inform underwriting, pricing, safety management, and claims decisions.
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 SBU and line of business. Through formal letters of authority, our Chief Underwriting Officer ("CUO") delegates underwriting authority after assessing an underwriter's job grade and segment 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 primarily handled in each region with support from our USC. The regions assign AMSs, Production Underwriters, and underwriters to specific distribution partners and the USC assigns underwriters to support specific distribution partners within the USC.
Our operating model also focuses on improving insured 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 93 Safety Management Specialists ("SMSs") in the field supporting our policyholders locally. These specialists regularly interact with current and prospective customers. Their safety enhancement and best practices recommendations reduce our customers' property, liability, and workers compensation risks, including higher-profile risks like sexual abuse. Their account-specific analyses let our underwriters better understand our customers' exposures, enhancing our new business and renewal underwriting decisions.
As part of our safety management initiatives, we proactively provide policyholders with notifications and alerts, identify risks, mitigate potential loss occurrences, and provide tools and technologies that improve safety and reduce losses. Examples include:
•Vehicle recall notifications to our policyholders and distribution partners;
•Weather preparation notices for large storms or hurricanes, including guides on structural improvements, roof and drainage maintenance, and measures to prevent clogged or frozen plumbing and sprinkler systems;
•Food and product recall notifications to policyholders in food manufacturing, distribution, and preparation;
12
Table of Contents
and
•Digital customer self-assessments of workplace hazards, with best practices recommendations tailored to the customer's specific risks.
In 2023, we continued to expand capabilities of our new Standard Commercial Lines agency interface platform designed to streamline new small business policy quoting and issuance. Writing small business, which we define as lower hazard risks in specific industry classes with less than $25,000 in policy premium, is a core part of our strategy. In recent years, the small business market has become more competitive, with more carriers using 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 enhanced our rating platform's user experience by reducing the amount of required information before quote generation and continuing to improve eligibility of agency-issued business that needs no underwriter involvement ("straight-through processing"). In addition, at the end of 2023, we completed our roll-out of comparative rating tools for specific lines of businesses within Standard Commercial Lines.
In 2024, we plan to add additional business capabilities within Standard Commercial Lines small business, such as introducing small business eligibility to new lines of businesses, streamlining quoting capabilities through data prefill functionality, and in-platform user experience improvements to optimize new small business growth and straight-through processing with our distribution partners.
•Standard Personal Lines: Our Standard Personal Lines underwriting operations are centralized and highly automated. Most new and renewal business is underwritten and priced through an automated system containing our filed rates and rules. Exceptions to our internal underwriting guidelines 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 better serve the mass affluent market, where we believe our strong coverage and servicing capabilities make us more competitive. We have multiple initiatives in place to improve this segment's overall results, including the prioritization of rate filings on a state-by-state basis and the introduction of new homeowners' policy terms and conditions.
•E&S Lines: Our E&S Relationship and Underwriting Managers focus on marketing our product capabilities to wholesale general agents, training them on underwriting guidelines and automation, and obtaining market insight from them. Our wholesale general agents provide front-line new and renewal underwriting and policy administration services per our prescribed guidelines. Our small commercial E&S underwriters review all requested exceptions or declinations based on individual account risk characteristics. Our middle market E&S commercial underwriters write larger accounts. They receive complete submissions for individual account risk characteristics from wholesale general agents and make underwriting, exposure validation and pricing decisions based on that submitted information supplemented by other third-party data. Wholesale general agents who submit middle-market commercial risks do not have the authority to quote or bind accounts on our behalf.
In 2022, our E&S Lines implemented an automated small business rate, quote, bind, and issue system. This new system allows our underwriting teams and agents to cost-effectively and efficiently grow their business with us by reducing manual touchpoints throughout the policy lifecycle. Underwriting rules embedded in the system qualify the submissions within an agent’s authority and route accounts requiring additional review directly to an underwriter. Further investments in product expansion, risk evaluation, and operational efficiency for middle market E&S accounts are in progress and are expected to be introduced in 2024.
Our independent distribution partners designate Standard Commercial Lines and Standard Personal Lines accounts to be serviced by our USC. All USC employees are licensed agents who respond to policyholder inquiries about insurance coverage, billing transactions, and other matters. For the convenience of us handling USC transactions, our distribution partners agree to receive a slightly lower-than-standard commission on the associated premium. As of December 31, 2023, our USC was servicing NPW of about $110 million, representing 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 an essential service 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 automobile liability, general liability, property, and workers
13
Table of Contents
compensation, with each business line having a specialized claims unit focused on high severity or technically complex losses and litigation;
•Claims customer managers and agency executives ("CAEs") who are responsible for enhancing the relationship among our policyholders, distribution partners, and 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 deliver appropriate claims service, communicate trends, and discuss results and client services;
•Cost-effective delivery of claims services and control of loss and loss expense. Our Claims Service Center manages our high volume, low severity automobile and property claims, leveraging virtual adjusting tools that provide prompt and efficient service to our customers; and
•Timely and adequate claims reserving and resolution.
We have been executing a multi-year claims system modernization and process transformation strategy to (i) provide our adjusters with increased quality, real-time data, enabling quicker decisions, (ii) monitor our adjusting team's workflows, (iii) optimize processes, and (iv) deliver an exceptional customer experience. This strategy also ensures each line of business has an efficient workflow tied to each file's complexity. The system will use business rules to assign claims to an appropriately experienced adjuster. This is expected to (i) reduce cycle times and claims adjudication costs and (ii) improve insured and distribution partner customer service. The modernized system will enable expedited low-touch or no-touch claims processing, depending on the type and severity of the exposure. Our claims adjusters will be able to provide improved visibility and transparency throughout the life cycle of a claim file to our insureds, claimants, and agents.
Throughout 2024, we will be integrating our claims system with key third-party vendors to (i) enable texting capabilities with claimants and (ii) streamline management of replacement rental vehicles and auto physical damage evaluation and repair estimates. Consequently, our adjusters will need to work in fewer systems, increasing their efficiency, and improving the overall customer experience through reduced cycle times and improved communication. In 2024, we will also be (i) introducing a digital payment solution allowing direct fund transfer to insureds, claimants, and vendors and (ii) increasing our payment functionality to allow digital payments to single, multi-party, lien holder, and mortgage payees. These changes should reduce paper check printing and mailing expenses and allow for quicker receipt of claim payments by claimants.
Our Special Investigations Unit ("SIU") supports all insurance operations by investigating potential insurance fraud and abuse. The SIU works consistent with applicable law and direction from regulatory bodies and non-profit organizations dedicated to combating and preventing insurance crime. The SIU adheres to uniform internal procedures to improve detection and act on potentially fraudulent claims. We have developed a proprietary SIU fraud detection model that identifies potential fraud cases early in a claim's life. We report SIU findings to the proper authorities consistent with legal obligations.
Insurance Operations Competition
We face substantial competition in the insurance marketplace from public, private, and mutual insurance companies with varying levels of brand recognition, scale and operational efficiency, capital bases, book of business diversification, and cost of capital. Many competitors rely on independent partners to distribute their products and services like us. Other insurance carriers either employ their agents, who represent only them, or use a combination of distribution partners, captive agents, and direct marketing.
The property and casualty insurance market is highly competitive in 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 on coverage terms, claims service, customer experience, safety management services, ease of technology use, price, value-added services, and financial strength ratings. We also face increased competition from established direct-to-consumer insurers, existing competitors, and new entrants, many with lower cost structures and digital technology.
Investments Segment
Our investment portfolio's objectives are to maximize after-tax net investment income and generate long-term growth in book value per share. We aim to accomplish this by maximizing the portfolio's overall total return by investing (i) the premiums from our insurance operations and (ii) amounts generated through our capital management strategies, including debt and equity security issuances. We balance those objectives against prevailing market conditions, capital preservation considerations, and our enterprise risk-taking appetite. We maintain (i) a well-diversified portfolio across issuers, sectors, and asset classes and (ii) a high credit quality fixed income securities portfolio with a duration and maturity profile at an acceptable risk level that
14
Table of Contents
provides ample liquidity. Our fixed income securities primarily include corporate, asset-backed and mortgage-backed securities, and state and local municipal obligations. We also invest in public equity securities, commercial mortgage loans, short-term investments, alternative investments, and other investments. Alternative investments primarily include limited partnership investments in private equity, private credit, and real estate strategies. Other investments include Federal Home Loan Bank ("FHLB") stock and tax credit investments.
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 investment information, see the "Investments Segment" section 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
Insurance regulation and taxation 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 not to 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. Adopting 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 other 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 thirteen (13) industry financial ratios and specifies "usual values" for each. Departure from the usual values on four or more 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 most IRIS ratio tests.
15
Table of Contents
•Risk-Based Capital ("RBC"). RBC is measured by four major property and casualty insurance risks: (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 2023 statutory financial statements prepared in accordance with SAP, all our Insurance Subsidiaries had total adjusted capital substantially exceeding the regulatory action levels defined by the NAIC.
•Group Capital Calculation ("GCC"). 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 calculation provides state insurance regulators with additional analytical information for assessing group risks and capital adequacy, complementing the existing holding company disclosures and analyses. Based on our 2023 statutory financial statements prepared in accordance with SAP, our GCC ratio exceeds the regulatory action minimum threshold.
•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) corporate governance, and (iii) internal control over financial reporting. As permitted under the Model Audit Rule, the Audit Committee of our Board of Directors ("Board") serves as the audit committee of each of our Insurance Subsidiaries.
•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, adopted by the state domicile insurance regulators of our Insurance Subsidiaries, requires an insurer to annually file an internal assessment of the adequacy of its risk management framework and current and projected future solvency position. For more information on our internal process of assessing our significant risks, refer to the "Corporate Governance, Sustainability, and Social Responsibility" section below.
NRSROs
Rating agencies monitor our capital adequacy but are not formal regulators. Two are (i) AM Best, with its Best Capital Adequacy Ratio ("BCAR") model, and (ii) S&P, with its capital model. Both evaluate the strength of an insurer's balance sheet, comparing 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, the BCAR model, and the S&P capital model show similar direction as scenarios change, they react differently to variations in economic conditions, underwriting and investment portfolio mix, and capital. We regularly evaluate our capital adequacy relative to these capital models to ensure we can effectively pursue our business strategies. Rating agencies also revise their capital adequacy models and requirements more frequently than the NAIC updates its financial monitoring tools.
Federal Regulation
While primarily regulated at the state level, our business is subject to 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 possessing 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”) govern publicly-traded companies. These laws require or permit national stock exchanges or associations, such as the Nasdaq Stock Market LLC, where we list our equity securities, to mandate certain governance practices.
16
Table of Contents
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 authority under the 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 regulation and the potential impact of regulatory changes on our business, refer to the regulation risk factor within Item 1A. "Risk Factors." of this Form 10-K.
Corporate Governance, Sustainability, and Social Responsibility
We strive to maintain high ethics and integrity in our business practices. We are committed to understanding and mitigating risk, serving customers and distribution partners responsibly, enabling our employees’ professional development and work/life balance, and helping the communities where we live, work, and serve while being environmentally responsible.
Corporate Governance
Strong governance, oversight, and transparency are the foundation of our financial and operating success. Our mature risk culture and governance structure are cornerstones of our risk management framework, designed to enhance the decision making process and strengthen risk-reward evaluations.
Our internal control framework follows the Committee of Sponsoring Organizations of the Treadway Commission (COSO) model, deploying 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, supporting the first line in understanding, monitoring, and managing our risk profile through an Executive Risk Committee ("ERC") and dedicated risk team.
•The third line of defense is our Internal Audit team, which provides separate, 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.
Our risk governance structure consists of the following major components:
RiskOversight Board of Directors
•Executive Committee •Finance and Investments Committee
•Audit Committee •Risk Committee
2 STRATEGY SETTING AND ESTABLISHING RISK TOLERANCE
Risk Management Management and Operating Committees
•Management Investment Committee ("MIC") •Reserve Committee
•Underwriting Committee •Executive Risk Committee
•Emerging Risk Committee •Disclosure Committee
•Large Claims Committee
2 APPETITE AND LIMIT GOVERNANCE
Risk Identification & Reporting Enterprise Risk Management Function
•Supported by individual business units and functional areas.
Board Oversight
Our Board's function is one of oversight and guidance. The Board and its committees ("Board Committees") oversee our
17
Table of Contents
business performance and the management team ("Management"). The Board reviews and discusses Management reports about our performance, strategy, risk and significant issues. Twelve of thirteen Board members are independent.
Our Board oversees our Enterprise Risk Management ("ERM") process, and all Board Committees oversee risks specific to their areas of supervision and report their activities and findings to the entire Board. In addition, effective January 1, 2024, the Board created a Risk Committee to oversee our ERM framework and practices and assist the Board in overseeing our operational activities and identifying and reviewing related risks. Previously, the Board's Audit Committee had responsibility for oversight of our ERM framework and practices.
Management and Operating Committees
Our Chief Executive Officer (“CEO”) directs the implementation of our business strategy. Management regularly reports to the Board on significant events, issues, and risks that may materially affect our business or financial performance. A description of each Management committee and our ERM function follows:
•Management Investment Committee - Responsible for (i) setting and implementing the investment objectives and asset allocation, (ii) approving and overseeing compliance with investment policies, (iii) selecting qualified external investment managers and advisors, and (iv) monitoring performance, transactions, and specific risk metrics. Our investment team and external investment managers execute our investment strategy and objectives. The MIC typically meets two times every quarter and more often as needed and reports quarterly to the Board's Finance and Investment Committee.
•Underwriting Committee - Responsible for (i) establishing and reviewing authority levels of the CUOs and head of E&S Lines and (ii) reviewing and making decisions on any underwriting transaction and/or action that is outside of their authority. The Underwriting Committee oversees the underwriting authority distribution process across our insurance operations. This committee meets as appropriate and evaluates a variety of information related to specific accounts presented, including underwriting, safety management, claims, and market considerations, as well as key projected catastrophe modeling metrics when considering a large property account.
•Emerging Risk Committee - Responsible for identifying and monitoring new and evolving risk issues that could significantly impact our financial strength, reputation, or long-term strategy. This committee meets quarterly and reports the most significant risks to the ERC and the Board and its applicable committees.
•Enterprise Project Management Office ("EPMO") - Responsible for the oversight of large-scale projects. Our EPMO framework uses a consistent methodology to review the return on investment for each major capital expenditure (such as IT system purchases). Projects above a certain dollar threshold require Board approval. 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. The EPMO meets ten times per year and more often as needed.
•Large Claims Committee - Reviews and approves all claim loss or loss reserves or payments above the Chief Claims Officer's authority before the Chief Claims Officer takes any action. Claims that (i) have or are likely to exceed a reinsurance policy coverage limit, (ii) have bad faith exposure of $15 million or more, (iii) are likely to generate significant news interest or negative publicity, or (iv) potentially create a significant legal precedent on an insurance coverage issue are reported to the Board's Risk Committee. The Large Claims Committee meets on an as-needed basis.
•Reserve Committee - Responsible for monitoring loss and loss expense reserve levels and taking management actions regarding financial recording of reserves. The reserve committee meets quarterly and as needed and reports reserve indications and actions to the Board and it's Audit Committee. In addition, key reserve metrics are reported to the ERC and the Board's Risk Committee.
•Executive Risk Committee - Responsible for the holistic evaluation and supervision of our risk profile, and determining future risk management actions supporting our overall risk profile. The ERC provides management oversight of our ERM function. The ERC relies on several management committees to analyze and manage specific major risks, including the Emerging Risk Committee and the Underwriting Committee. The ERC meets quarterly, and as needed, to review and discuss various topics and the interrelation of our significant risks, including, without limitation, capital modeling results, capital adequacy, risk metrics, emerging risks, and sensitivity analysis.
18
Table of Contents
•Disclosure Committee - Responsible for establishing and implementing procedures to ensure compliance with Regulation FD and other applicable securities laws. This committee meets two times every quarter and more often as needed.
•Market Security Committee - Responsible for reinsurance purchase decisions, approving of individual reinsurers on our panel, assessing reinsurer counterparty risk, and monitoring catastrophe risk. The MSC is comprised of executives and senior leaders with diverse financial and underwriting expertise. The MSC meets semiannually, before each major treaty renewal and more often as needed. At least semiannually, the MSC updates the Board's Risk Committee on reinsurance purchases, including market trends and any changes in treaty structure and terms and conditions. For any reinsurance-related catastrophe bond issuance, the Board’s Finance and Investments Committee reviews and approves related security offerings.
ERM Function
The ERM unit identifies, measures, monitors, and reports key and aggregated enterprise-wide risks to the ERC, the Board and its Risk Committee. The ERM unit works with other functional areas to develop appropriate responses to identified risks and supports the successful execution of our business strategy.
We rely on quantitative and qualitative tools to identify, prioritize, and manage our major risks, including proprietary and third-party computer modeling and other analyses. When appropriate, we engage subject matter experts, such as external actuaries, third-party risk modeling firms, and IT and cybersecurity consultants. Our Insurance Subsidiaries annually file an ORSA report with their domiciliary state insurance regulators. ORSA is an internal solvency assessment developed by the Chief Risk Officer ("CRO") in coordination with the ERC and reviewed by our Board.
We categorize our major risks into five broad categories:
•Asset risk, stemming primarily from our investment portfolio and reinsurance recoverables and includes credit and market risk;
•Underwriting risk, which is the risk 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 expenses;
•Other risks, which include a broad range of operational risks, many challenging 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 (i) heightened levels of economic inflation, (ii) the enactment of reviver statutes for abuse victims, (iii) climate change, (iv) the increased threat of cyber incidents, and (v) the increased use of artificial intelligence all to be emerging risks.
The table below maps our management and operating committees to their responsibilities for our five major risks.
Asset Risk X X X
Underwriting Risk X X X X X
Liquidity Risk X X X
Other Risks X X X X
Emerging Risks X X
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
19
Table of Contents
sure that an event or series of unanticipated events will (i) occur or 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.
Sustainability and Social Responsibility
We integrate sustainability principles into our business and partner with key stakeholders to develop solutions that enhance resilience, well-being, and customer service. Our areas of focus include (i) developing our human capital to create a highly engaged and diverse team of employees and leaders who will guide us into the future, (ii) understanding and attempting to mitigate the environmental impact that climate change has on our business and operations, and (iii) providing customers with empathetic claims service and risk mitigation solutions.
Human Capital
We recognize that developing and protecting our human capital and providing a beneficial employee experience complements and contributes to superior longer-term financial performance. We are committed to maintaining a safe and inclusive workplace for our approximately 2,650 employees. In 2023, we were (i) designated as a Great Place to Work CertifiedTM organization for the fourth consecutive year and (ii) recognized by Forbes as one of "America's Best Mid-Size Employers" for the third time.
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 pay competitively and regularly analyze compensation and take appropriate action to ensure internal equity and external market alignment. We offer competitive financial benefit programs to support the fiscal well-being of our employees and their families. Among the offerings are a 401(k) plan with non-elective and employer matching contributions, an employee stock purchase plan offering discounted stock purchases, and tuition reimbursement and student loan repayment programs. Most employees are eligible to participate in our annual cash incentive program, funded and paid based on the achievement of established financial and strategic objectives. Employees above certain levels are eligible to participate in our long-term stock-based incentive compensation programs. We also offer a wide range of competitive and convenient health and wellness programs. To support our employees' social and emotional well-being, we encourage connections with their colleagues and communities through various programs, such as paid time off for volunteer work, matching charitable donations, employee engagement events, employee resource groups, and unique programming to meet employee needs.
Talent Development and Employee Retention
We invest significant time and resources in (i) training and development to assist our employees in fulfilling their professional potential and having rewarding careers and (ii) efforts to retain our best talent and foster a positive work-life balance. We are committed to ongoing employee learning, personal growth, and continuous improvement. Our employees have access to a wide range of resources, including live instructor-led training courses and online skills training courses. 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, (ii) RISE (Retain Include Support Engage) program, which is an accelerated professional development program for individual contributors interested in first-level management positions, (iii) Accelerate program, which provides training for new managers to enhance leadership capabilities, (iv) Elevate program, which prepares high school students for an insurance-industry career, and (v) our Ignite Internship and Momentum Trainee programs, which are early career programs that help develop our future talent pipeline. Our early career initiatives earned the 2023 Campus Forward Award from RippleMatch and the Elite 50 Internships Award from Rising Insurance Start Executives.
Of our 2,650 employees at December 31, 2023, 1,170 are normally home-based; 790 are in our regional offices; and the remainder are in our corporate office. Our Flexible Work Location Policy permits most office-based employees to work remotely 60% of the time. Our 2023 employee turnover rate was approximately 11%, compared to 15% in 2022. Employees with over 20 years of service represented approximately 15% of our workforce.
Diversity, Equity, and Inclusion
We fully support the premise that collaboration by employees with diverse backgrounds, ideas, and experiences can foster innovation, improving operational performance, product and service development, customer experience, market opportunities, and profitability. We have initiatives to increase representation and cultivate greater inclusion of individuals with different ethnicities, races, ages, veteran statuses, sexual orientations, gender identities and expressions, disabilities and socio-economic backgrounds. Initiatives include (i) sponsoring employee resource groups open to all employees that focus on interests and
20
Table of Contents
concerns of females, Black, LGBTQ+, veterans and those serving in the military, employees early in their career, and employees impacted by physical, mental, or emotional challenges, (ii) a professional development program focused on individual contributors, (iii) implementing business objectives tied to creating an inclusive and engaging work environment, (iv) enhanced hiring, retention, and promotion practices including diverse candidate pools and interviewing panels and training on implicit bias, (v) recruiting at diverse colleges and universities, (vi) partnering with the National African American Insurance Association and the Latin American Association of Insurance Agencies for services and programming for our employees' use, and (vii) adding new Board directors with diverse backgrounds, skills, and experiences through a robust process managed by our Board's CGNC.
As of December 31, 2023, women represented (i) 58% of our non-officer workforce, consistent with December 31, 2022, and (ii) 35% of our officer workforce, up two points from December 31, 2022. Our ethnic diversity for officers and non-officers is consistent with the national average for financial services. Approximately 77% of our workforce was White at year-end 2023, compared to 78% at year-end 2022, and 23% were a combination of Black, Latin, Asian, and all other ethnicities combined at year-end 2023, compared to 22% at year-end 2022. We have a diverse Board, with five directors on our Board identifying as part of one or more underrepresented groups.
Environmental
As a property and casualty insurance company, we cover thousands of individuals and businesses against the financial impact of insured losses, including catastrophic events. Climate change increases the unpredictability of weather-related loss frequency and severity, posing a long-term risk to our customers’ lives and livelihoods – and our business. We aim to mitigate the impacts of climate change by (i) prudently overseeing and managing catastrophe risk exposure, (ii) helping our customers through responsive claims handling, safety management services, and proactive weather alerts, (iii) preparing for the continuing transition to clean energy, and (iv) reducing our carbon footprint. Understanding and helping mitigate climate change perils for our business and customers is core to our operations and strategy. We believe these efforts (i) contribute to our corporate responsibility to help mitigate the impact of climate change and (ii) will reward our shareholders with sustained superior financial and operating performance over time.
The Emerging Risk Committee identified climate change as a "high" level emerging risk, reviewing it at least quarterly with the ERC and Board. The ERM unit, the ERC, and Management stay informed on key climate change risk developments through industry publications, webinars, conferences, and regular engagement with outside sources, such as our reinsurance brokers, investment managers, and trade associations.
Our ERM function is responsible for measuring, assessing, and monitoring the mitigation of the physical and transition risks due to climate change. Physical risks arise from the changing frequency, severity, and characteristics of acute events, such as hurricanes, floods, and wildfires. These risks can directly affect our underwriting results, the long-term viability of certain business lines we write, and our investment portfolio. 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.
Due to our business risk profile and geographic concentration in the Northeast and Mid-Atlantic states, hurricane peril is our most significant natural catastrophe exposure, driving the “tail” of our modeled catastrophe loss distribution. This risk has influenced our decision to diversify our underwriting portfolio geographically and set rigorous coastal property exposure guidelines. In addition to managing our peak hurricane exposure risk, we seek to manage our exposures to other perils, such as severe convective storms, winter storms, flooding, and wildfires. We do not write crop insurance, have minimal exposure to private flood, and have a small geographic footprint in the Western U.S., so our exposures to specific weather-related perils, such as droughts, wildfires, and flooding, tend to be relatively modest. We monitor our investment exposure to carbon-intensive industries to measure our vulnerability to climate-related risks involved with the transition to a low-carbon economy.
The ERM unit evaluates our catastrophe risk exposure relative to our established tolerances. This evaluation incorporates the results of third-party vendor models and proprietary analysis in its review of exposure to hurricane and other perils on both a gross and net basis. For quantitative information on the modeled results of our underwriting property portfolio by peril, refer to the "Reinsurance" section in "Results of Operations and Related Information by Segment" of Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations."
Managing Climate-related Risks
For information regarding our risks associated with climate change, refer to risks identified with the symbol "" in Item 1A. "Risk Factors." of this Form 10-K.
21
Table of Contents
Insurance Operations
In managing our insurance operations' physical climate-related risks, we model our property portfolio for hurricanes and other wind events semiannually in July and January. Wildfire risk, which presents significantly lower exposure for our portfolio compared to hurricanes and other wind events, is modeled annually in July. For some time, we have not underwritten specific environmentally-hazardous risks related to production from coal mines, thermal coal plants, or oil sands extraction because they are outside our underwriting appetite.
Our underwriting controls employ authority levels in writing large individual property risks and large property accounts that could create or exacerbate a property aggregation issue. If any individual location exceeds the CUO's property limit authority, it must be approved by the Underwriting Committee, comprised of the Standard Lines Chief Operating Officer, CFO, Standard Commercial Lines CUO, Executive Vice President of E&S Lines, and CRO. When considering large property accounts, the Underwriting Committee typically reviews an evaluation of property aggregations in the particular county and state and projections of marginal impact on our aggregate modeled losses, assuming we wrote the risk. The discussion covers our catastrophe risk aggregation appetite and the appropriate pricing for taking the increased risk aggregation.
We believe that we have created an effective control environment for managing natural catastrophe risk on a gross exposure basis by (i) setting overall portfolio growth expectations, (ii) monitoring actual results and property aggregations, (iii) having appropriate underwriting authority controls around our largest accounts, and (iv) consistently focusing on appropriate pricing of catastrophe risk.
Our established catastrophic risk tolerance requires that no more than 10% of stockholders’ equity is exposed to a loss from a hurricane event at a 99.6% confidence level (1-in-250 year event or 0.4% probability) on a net of reinsurance and after-tax basis. For additional quantitative and qualitative information about our modeled results by scenario on stockholders' equity, refer to the "Reinsurance" section in "Results of Operations and Related Information by Segment" of Item 7. "Management’s Discussion and Analysis of Financial Condition and Results of Operations."
Property insurance is the primary climate-related insurance operations risk. However, we have potential climate-related claims under liability policies, such as directors’ and officers’ ("D&O") liability insurance policies. We monitor these liability risks, but our liability-related climate exposure is partially mitigated through our (i) D&O appetite selection, which includes no public companies or financial institutions, and (ii) focus on writing business with small regional footprints and avoiding environmentally-hazardous risks.
Investments
We incorporate sustainability considerations into our robust investment due diligence processes. To establish appropriate sustainability investment governance, we maintain (i) a well-diversified portfolio across issuers, sectors, and asset classes, and (ii) a high credit quality fixed income securities portfolio with a duration and maturity profile at an acceptable risk level that provides ample liquidity. In addition, we work with our third-party investment managers to ensure they incorporate sustainability guidelines and protocols into their investment process while managing our mandates. 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. We believe that as society transitions to a low-carbon economy, the value of these assets could be at greater risk.
Other
In addition to mitigating insurance operations and investment risk, we:
•Have robust plans to ensure operational continuity if we suffer unforeseen or catastrophic events. We have business continuity plans for our key data processing facility (Disaster Recovery Plan), the leadership team (Executive Crisis Management Plan), and significant operational areas. We review, update, and test these plans at least annually. Our tests include, but are not limited to, “tabletop” exercises and planned hands-on tests.
•Track our Scope 1 and Scope 2 greenhouse gas ("GHG") emissions; however, as an insurance holding company, we are a low GHG emitter relative to entities in many other industries. Our Scope 1 emissions include consumption of natural gas, diesel, refrigerant, and the fuel employees use for work travel in company cars, and our Scope 2 emissions comprise our electricity usage.
•Built ground-mount and garage-canopy solar photovoltaic facilities at our corporate headquarters. The facilities can generate approximately five million kWh of electricity annually, and we sell the related solar renewable energy credits to others. We sell these solar renewable energy credits, so our renewable energy production does not reduce our GHG
22
Table of Contents
emissions. However, it does contribute to cleaner energy production.
Ongoing Initiatives
Our objective is to continue to reduce our carbon emissions over the long term. We have many initiatives that we expect will reduce GHG emissions over time. Some include:
•Upgrades to our corporate headquarters building management system, which should reduce heating and cooling natural gas consumption;
•Making efforts to transition our company cars from gasoline to hybrid vehicles;
•Conversion of all corporate headquarters light bulbs to LED;
•Hybrid work schedule; and
•Migration of our information technology systems from our corporate headquarters' data center to the cloud.
We have also implemented several initiatives at our corporate headquarters to lower our environmental impact, including:
•Enhanced waste management and recycling;
•Repurposing commingled recyclables;
•Installed electric vehicle charging stations for employee use;
•Elimination of Styrofoam products in our cafeteria;
•Recycling and more efficient energy use of electronic equipment; and
•Reducing our water usage through automatic plumbing features.
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 are accessible on the SEC's website, www.SEC.gov. These filings are also available at www.Selective.com shortly after filing such material with the SEC. Our website and the information contained or linked in it are not part of this Annual Report.
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 in executing our long-term capital strategy. Examples include, without limitation, contributing capital to any or all of our ten property and casualty insurance subsidiaries ("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 from time to time. Consequently, we can neither predict such new risk factors nor assess their potential future impact on our business, if any.
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 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. In many cases, the increase in catastrophe losses relate to small- to- medium-sized events that primary insurers retain and do not cede to reinsurers. Although we use sophisticated catastrophe modeling techniques to manage our catastrophe exposure, catastrophe models provide estimates that may materially differ from actual exposure and loss experience. For example, catastrophe models did not fully estimate the potential for some recent catastrophe loss activity (such as Winter Storm Elliott freeze losses in December 2022) and the concurrent recent economic inflation on construction costs.
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, (iv) earthquakes, and (v) 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
23
Table of Contents
information we obtain from Insurance Services Office, Inc.'s ("ISO") Property Claim Services unit, an internationally recognized authority on insured property losses from catastrophes in the U.S., 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 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
Temperature changes can impact weather patterns and the frequency and/or severity of catastrophes, including hurricanes, severe convective storms, wildfires, and flooding — all of which could cause our catastrophe losses to increase relative to historical levels.
A significant component of climate change risk is that the frequency and severity of extreme weather events may evolve differently relative to historical levels – leading to greater model uncertainty.Climate change models project significant differences in global regional warming above pre-industrial levels, depending on future levels of climate mitigation and geographic location. 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.
Human-made catastrophes
Cyber Attacks and Incidents
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 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 other types of policies, such as commercial property or businessowners policies; and (iii) "silent cyber" exposures, otherwise known as non-affirmative cyber exposures, which describes cyber risk that is neither expressly covered nor excluded in insurance policies. This exposure 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 solutions allow us to meet our customers' needs for cyber insurance while mitigating our underwriting risk as we develop our expertise in the cyber insurance market.
Beyond our cyber-specific policies, 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 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. 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 sub-limits of $25,000 or lower. For policies effective October 1, 2022 and later, we implemented cyber incident exclusions that exclude malicious cyber except for the sub-limited coverage provided in the base ISO coverage forms and our property and businessowners' property “virus and harmful code” extension endorsements. These exclusions clarify coverage and have no premium impact.
24
Table of Contents
•Most of our general liability and businessowners' policies exclude cyber-related liability losses, except for "bodily injury." Our specific cyber-exclusion and liability forms' lack of affirmative sub-limited cyber coverage, effectively limit most "silent cyber" exposure.
•By statute, workers compensation policies do not have cyber exclusions, and a cyber-attack-related workplace injury could trigger coverage.
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 must pay a significant deductible of specified losses before federal assistance is available. Our $543 million deductible is based on a percentage of our prior year’s applicable Standard Commercial Lines and E&S Lines premiums. In 2024, 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, 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 can accept or decline our terrorism coverage or negotiate with us for other terms. In 2023, 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, chemical, or conventional terrorism losses. Our current reinsurance programs cover some losses from conventional foreign and domestic terrorism acts but not NBCR events.
An increase in natural or man-made catastrophe losses, including a systemic cyber-attack that produces 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. 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, increasing the uncertainty of our estimates. More comprehensive claims information available after a reporting period may result in reserve changes in subsequent periods.
Our loss and loss expense reserves may not adequately 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 in-depth reserve review, which uses our loss experience, claims payment and reporting patterns, and our view of underlying claims frequency and severity trends. We supplement the estimates with other subjective considerations, including projected impacts from economic, political, social, and legal developments or trends, such as inflation, continually evolving trends driven by the post-COVID-19 pandemic environment, judicial trends and tort decisions, and various state legislative initiatives. We cannot predict the timing or impact of these developments or trends 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 future loss cost trend estimates prove to be understated, our pricing of future new and renewal business could be inadequate to cover actual loss costs, and our future loss and loss expense reserves could be understated.
Three examples of how loss and loss expense reserves might be affected by economic, political, social, or legal developments or trends are:
•If economic inflation, including medical inflation, is higher than our assumptions, our loss and loss expense reserves
25
Table of Contents
for our longer tail lines of business could be insufficient. For example, 2022 inflation rates reflected in the overall consumer price index ("CPI"), the Core CPI, and the Producer Price Index, were higher than 2021. While inflation moderated in 2023, it remains elevated relative to the Federal Reserve’s long-term 2% target. The workers compensation line of business is particularly susceptible to inflation because of its extended payment pattern and exposure to medical care services and commodities. While medical inflation has been benign for several years, these medical care costs could have a more material impact on our overall loss and loss expense reserves if they were to rise significantly or persist at a higher level for an extended period. Our short-tail property lines of business are also susceptible to inflation because of their exposure to increased labor and material costs.
•Social inflation refers to the phenomenon where societal factors, such as attitudes, perceptions, and cultural changes, contribute to increased insurance claims costs and litigation. It often leads to higher payouts in legal settlements and impacts insurance premiums for businesses and individuals. This inflation is driven by various factors, including changing jury attitudes, increased litigation funding, and larger awards in court cases. Social inflation can affect all lines of business, but the automobile liability, general liability, and corresponding umbrella lines of business that involve third-party claimants tend to be more susceptible to social inflationary impacts. Our reserve for loss and loss expense could be insufficient if the social inflation impacts exceed our assumptions.
•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-evaluating previously-established reserves or creating 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 (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 of our or a predecessor's insurance policies. For those we determine implicate one of our or a predecessor's policy, 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. Our coverage positions may be challenged through litigation or otherwise, so we face litigation risks. These are discussed further below in the Risk Factor entitled, "We are engaged in ordinary routine legal proceedings incidental to our insurance operations that are inherently unpredictable and 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 to third parties through reinsurance contracts. These contracts provide reimbursement of losses exceeding specified amounts or percentages of premiums. Typically, our reinsurance coverages align with the coverages offered under our primary insurance policies.
The availability, quality, amount, and cost of reinsurance depend on market conditions, including traditional privately placed reinsurance, retrocessional reinsurance, and catastrophe bond market capacity. Most of our reinsurance contracts have annual terms. Consequently, reinsurance costs may fluctuate significantly, not necessarily correlating 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 conditions and timing of regulatory approval may not align with the actual expense of 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 cannot negotiate desired reinsurance amounts or terms, we may experience increased reinsurance expense and increased risk retention on individual or aggregate claim losses that could limit 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
26
Table of Contents
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 combination of multiple catastrophe events in a single year is such that our Insurance Subsidiaries' insured losses exceed the aggregate limits of the catastrophe reinsurance treaty or our Insurance Subsidiaries experience an unusually large number of catastrophe losses that fall below our per occurrence reinsurance retention;
•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; or
•The catastrophe losses insured in our primary policies are excluded from coverage in our reinsurance contracts.
Recent economic, geopolitical, and insured loss events have increased global reinsurance market uncertainty. Reinsurance prices have increased, and the availability of reinsurance has reduced due to the impacts of (i) social inflation on liability claim outcomes, including exceptionally high jury awards, (ii) reduced capacity due to reinsurer investment portfolio losses, (iii) weakened Euro-United States dollar currency exchange rates, (iv) challenged reinsurer profitability in recent years, and (v) investor and reinsurer concerns about the potential impacts of climate change. While reinsurance market conditions stabilized somewhat in 2023, purchasers of reinsurance continue to face higher pricing, less reinsurance availability and more market uncertainty than they did pre-2022. We face increased underwriting risk for exposure to specific primary policy losses from risks, like cyber and communicable diseases, now principally excluded from coverage under our reinsurance treaties. Our reinsurance contracts also contain coverage terms restricting our ability to cede certain types of potential losses related to terrorism. Increased underwriting risk could increase our net loss and loss expense, increasing our underwriting results volatility. Decreased reinsurance capacity would also increase our underwriting risk if we cannot fully place our target reinsurance treaty coverage on renewal. If our reinsurers have difficulty collecting their retrocession programs or reinstating retrocession coverage after a large loss, our reinsurance claims may not be timely or fully paid.
Even with the benefits of reinsurance, our catastrophe risk exposure could have a material adverse effect on our results of operations, liquidity, financial condition, financial strength, and debt ratings.
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 us payments 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 significant loss exposure through their own reinsurance programs, or retrocessions, and we do not always have the full details about them. If our reinsurers experience 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 contractual 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 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. 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 independent distribution partners who have access to products from multiple carriers and markets.
27
Table of Contents
•Brand recognition challenges because we closely coordinate marketing with our distribution partners and some customers do not differentiate their insurance agent from their insurer.
•Our market share growth is tied to our distribution partners' market share. 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 emphasizing 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 our independent distribution partners' overall market share, 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. 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 Aggregators acquire them, 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 43% of our DPW at December 31, 2023, up from 33% three years ago. 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.
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, 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 could significantly impact our claims severity across multiple lines of business and could result in adverse reserve development. An economic downturn could also 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 2023, 26% 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 have declining revenue or employee count could adversely affect our total written premium, including audit and endorsement premium.
We write business domestically in the United States, and our insurance operations do not have direct exposure to businesses or individuals in Russia, Ukraine, Israel, or the West Bank. We do not have material exposure to investments subject to embargoes or Russian reinsurance counterparties. However, ongoing wars and conflicts are impacting global economic, banking, commodity, and financial markets by exacerbating ongoing economic challenges, including inflation and supply chain disruption, which influence insurance loss costs, premiums, and investment valuation. The Israeli-Hamas war is creating global political tension that could result in some countries taking political or economic actions, such as Iran's support for the Houthi rebels in Yemen, that could impact the U.S. and global economies.
A downgrade or a potential downgrade in our financial strength or credit ratings could result in a loss of business and have a material adverse effect on our financial condition and results of operations.
A significant financial strength rating downgrade, particularly from AM Best Company ("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 rating from AM Best or Standard & Poor's Global Ratings. Credit rating downgrades could also make it more expensive to access capital markets. We cannot predict rating actions issued by nationally recognized statistical rating organizations that might adversely affect our business or our potential responses. Any significant downgrade in our financial strength and credit ratings below an "A-" 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 (i) consumer and business price sensitivity, (ii) aggressive price competition, and (iii) improvements based on performance characteristics and large data sets. These factors can compact underwriting margins, new products and services, evolving industry standards, and rapid adoption of
28
Table of Contents
technological advancements. Our ability to compete depends heavily on our timely and consistent introduction of innovative new products and services.
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 capital costs, or greater capacity 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 are beginning to explore broader digital Internet offerings and implement artificial intelligence ("AI"). New competitors with variations on traditional business models have emerged. Because the Internet makes it easier and less expensive to bundle products and services, it is also possible that non-insurance companies conducting business on the Internet could enter the insurance business or form strategic alliances with insurers. 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, AI, and digital strategies in our industry also demands that we attract and retain employees in difficult-to-fill data science, advanced analytics, and information technology ("IT") roles. If we cannot attract and retain such employees, our results of operations and financial condition could be materially and adversely affected.
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 importance of data science and analytics to increase, becoming more complex and accurate 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 supplement our data with industry loss experience from Verisk, American Association of Insurance Services, Inc., the National Council on Compensation Insurance, Inc., and other publicly available sources. While relevant, industry data may not correlate specifically to the performance of our underwritten risks or 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 or limitations in financial and statistical models and their embedded assumptions could increase losses. For example, a significant component of climate change risk is that the frequency and severity of extreme weather events may evolve differently relative to historical levels – leading to greater model uncertainty. In addition, increasing insurance regulatory interest in data and model use, combined with any potential restrictions on traditional rating factors or model use, could have a material adverse impact on our financial condition and operating results. Our statistical models are extremely useful in monitoring and controlling risk, but are no 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, (vi) political risk, (vii) sovereign risk, (viii) interest rate fluctuations, or (ix) other factors, including climate change risk and civil unrest.
29
Table of Contents
Our investment portfolio's value is subject to credit risk from our held securities' issuers, guarantors, and financial guarantee insurers, and other counterparties in certain transactions. Defaults on any of our investments by any issuer, guarantor, financial guarantee insurer, or other counterparty could reduce our net investment income and increase net realized investment losses. We are subject to the risk that the issuers or guarantors of our fixed income securities 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 amount of our cash and cash equivalents and the value and liquidity of our 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 that have a material adverse impact on our financial condition and operating results.
Our investment portfolio is exposed to climate change-related transition and physical investment risks.
•Transition risks arise from society’s transition to a low-carbon economy, driven by policy and regulations, low-carbon technology advances, and shifting public sentiment and societal preferences. This transition to renewable energy sources may lead to (i) stranded assets in sectors with high carbon footprints or those closely tied to carbon-based economic activity, such as the fossil fuel and automotive industries, (ii) increased costs for infrastructure reinvestment and replacement, and litigation defense of carbon-intensive sectors, (iii) lower corporate profitability, (iv) lower property values, and (v) lower household wealth. The Paris Agreement Capital Transition Assessment defines the carbon-intensive sectors as the most exposed to transition risks: oil and gas, coal, power, automotive, cement, aviation, and steel. As of December 31, 2023 and December 31, 2022, carbon-intensive sectors within our fixed income securities portfolio represented about 4% of our total invested assets.
•Physical investment risks include the risk of investment losses on our commercial and residential mortgage-backed securities exposed to climate-related catastrophic losses that can cause business disruption, destroy capital, increase costs to recover from disasters, reduce revenue, and cause population displacement and migration. These, in turn, can lower residential and commercial property values, household wealth, and corporate profitability, potentially creating financial and credit market losses impacting insurer asset values. As of December 31, 2023, about 70% of our residential mortgage-backed securities were backed by government agencies. We generally invest in the top tranches of commercial mortgage-backed securities, which limit potential losses from property value declines. As of December 31, 2023, about 75% of our commercial mortgage-backed securities had "AAA" credit ratings.
Significant future investment value declines could require further losses recorded on securities we 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 are subject to the risks inherent in investing in private limited partnerships.
Our alternative investments include private limited partnerships that invest in various strategies, such as private equity, private credit, and real assets. The primary assets and liabilities underlying these limited partnership investments generally do not have quoted prices in active markets for the same or similar assets. Consequently, their valuation is subject to a higher level of subjectivity and unobservable inputs than most of our other investments. We record these limited partnership investments under the equity method of accounting, so valuation decreases could negatively impact our results of operations.
Determining 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. Our allowance for credit losses is subject to significant judgments and assumptions regarding changes in economic conditions, estimated future cash flows, and the accuracy of third-party information used in internal assessments. We revise our evaluations and assessments as conditions change and new information becomes available. 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.
30
Table of Contents
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 expense reserves;
•Exiting geographic markets and/or canceling or non-renewing policies;
•Sustainability-related issues, including sustainability investment mandates;
•Climate change, including potential liability for related public disclosures;
•Assessments for guaranty funds and second-injury funds, and other mandatory assigned risks and reinsurance;
•The types, quality, and concentration of investments we make;
•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.
While we underwrite risks only in the U.S., international regulatory developments, primarily capital adequacy and risk management requirements in the European Union ("EU"), may influence U.S. regulators as they develop or revise domestic regulatory standards.
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. Consequently, we have the risk that one regulator's position or interpretation may conflict with another regulator on the same point. For example, if Congress passed legislation regulating insurer solvency oversight and state regulators remained responsible for rate approval, we could be subject to a conflicting regulatory framework that could impact our profitability and capital adequacy. The cost of complying with various laws and regulations, 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 regulatory, political, and media scrutiny. We are subject to government market conduct reviews 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 various state, federal, and other laws, rules, policies, and other obligations regarding data use and protection.
We are subject to federal and state laws relating to collecting, using, retaining, securing, and transferring personally identifiable
31
Table of Contents
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, but it was not effective until 2018. GDPR regulates data protection and privacy in the EU and transfers of personal data outside the EU. GDPR’s main tenet is to give individuals primary control over their personal data. Because we do not write coverages in the EU, GDPR does not directly impact 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 in our privacy policy on our website, and in other public venues. We could be subject to litigation or governmental actions if we fail to comply with these public statements or federal and state privacy-related and data protection laws and regulations. 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 are inherently unpredictable and 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 competitors or us 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 various 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 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.