Selective Insurance Group Inc (SIGIP) 2005 Q2 法說會逐字稿

Good day, everyone, and welcome to the Selective Insurance Group second-quarter earnings release conference call.

At this time for opening remarks and introductions, I would like to turn the call over to the Vice President, Assistant Treasurer, Ms. Jennifer DiBerardino.

Please go ahead.

Thank you.

Good morning and welcome to Selective Insurance Group's second-quarter 2005 conference call.

A supplemental investor packet which includes GAAP reconciliations of non-GAAP financial measures referred to on this call is available on the investors page of our website at www.selective.com.

This call is being simulcast on our website, and the webcast replay will be available through August 26, 2005.

Again, at www.selective.com.

Some of the statements and projections that will be made during this call are "forward-looking statements," as defined by the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties.

We refer you to Selective's periodic filings with the U.S.

Securities and Exchange Commission for a detailed discussion of these risks and uncertainties.

Please note that Selective undertakes no obligation to update or revise any forward-looking statements.

With us today are several members of Selective's senior management team.

At this time, it is my pleasure to introduce Executive Vice President and Chief Financial Officer, Dale Thatcher.

Good morning.

Our strong second quarter was driven by excellent results in our commercial lines operation and a 17% increase in after-tax investment income.

For the second quarter of 2005 compared with the second quarter of 2004, net income was up 11% to $32.1 million or $1.02 per diluted share.

Operating income increased 10% to $31.7 million or $1.01 per diluted share.

Total net premiums written increased 6% to just under $370 million, led by 9% net premium written growth in commercial lines.

Our GAAP combined ratio was relatively flat at 96.0%, and the statutory combined ratio was steady at 94.9%.

Annualized operating return on equity was 13.9%.

Selective uses operating income, a non-GAAP measure, to analyze trends in our operations.

Operating income differs from net income by excluding the realized gains and losses net of taxes and the cumulative effect of accounting changes net of taxes.

GAAP reconciliations are included in the supplemental investor packet on our website.

Weather-related catastrophe losses accounted for only 0.2 points of the GAAP and statutory combined ratios for the second quarter 2005, or $0.5 million after-tax.

That compared favorably to 0.8 points or $1.7 million after-tax for the second quarter of 2004.

The only disappointment in an otherwise strong quarter was the recent New Jersey Supreme Court decision that eliminated the serious life impact standard of the personal auto verbal tort threshold.

In light of the court's action, we analyzed our claim files and loss experience both pre and post-AICRA, which resulted in an increase to our estimate of New Jersey personal auto reserves of $13 million.

This was partially offset by eliminating a reserve of $5.5 million for estimated New Jersey personal auto excess profits, which is no longer necessary given the expected higher claim costs.

The $7.5 million net reserve increase reduced diluted earnings per share for the quarter by $0.15.

For the balance of 2005, we now expect our New Jersey personal auto business to generate a statutory combined ratio of 101.0%.

We continue to review market conditions, and will take additional actions as necessary.

At present, we are considering the potential withdrawal of certain previously filed New Jersey personal auto rate decreases.

Commercial lines, which represents 85% of our business, delivered a solid 92.4% statutory combined ratio for the quarter, a 3.1 point improvement over second-quarter 2004.

For the same period, commercial lines net premiums written grew a strong 9%, driven by a 16% increase in net new business to $71 million.

Commercial renewal price increases were just over 3%, primarily from increased exposure, while policy retention remained stable.

Loss trends for commercial lines were up about 3% for the quarter.

They were down 1%, excluding workers' compensation loss trends, which were up 11%.

Over the last six years, workers' compensation loss trends have increased an average of 4% per year, driven by an average increase of almost 7% per year in medical losses.

The workers' compensation segment remains an important component of our highly profitable commercial account business.

However, at a statutory combined ratio of 115.7% for the quarter, it is not performing to our standards.

To address the challenges associated with this business, we have begun work on a more comprehensive workers' compensation strategy that combines basic underwriting execution tactics with sophisticated automation.

Our efforts include: a profitability plan for each of our primary operating states; defined appetites and enhanced guidelines within selected classes; online tools that enhance risk selection and ease-of-use; multi-disciplinary teams to review loss drivers including: claims performance, loss control risk improvement, automation of premium audit, and loss leakage; and new informational tools such as predictive modeling to price risks in a more granular fashion.

We recognize workers' compensation is a long-tail line, and improving the results will take time.

We remain committed to making this segment a stronger component of our profitable commercial package business.

Our other commercial lines of business performed well this quarter.

Commercial property delivered a statutory combined ratio of 62.4%, including low catastrophe losses.

Commercial auto, our largest single line of business, had a statutory combined ratio of 83.7%.

Excluding workers' compensation, every commercial line of business delivered an underwriting profit.

As part of our ongoing geographic diversification strategy, we continue to refine our personal lines operation.

For the quarter, the personal lines statutory combined ratio was 109% compared to 92.2% for the same period last year.

The increase is mainly due to the New Jersey personal auto reserve charge, which accounts for 14.4 points, as well as a few large fire losses.

Our flood business had a favorable impact of 4.1 points.

Although the flood operation is fee-based and included within our Diversified Insurance Services business with no underwriting risk it is included here in our personal line statutory combined ratio in accordance with statutory reporting requirements.

Personal lines net premiums written declined about 11% for the quarter, primarily due to increased personal auto competition in New Jersey.

We now insure 90,450 vehicles in New Jersey, down more than 7% from year-end, and we continue to implement a series of rating and underwriting initiatives targeting the best accounts.

The percentage of accounts in our top two underwriting tiers is 69%, up from 67% at year-end.

New Jersey personal auto currently represents only 7% of company-wide premium, down from 22% a decade ago.

For the quarter, the overall homeowners' statutory combined ratio was 94.8% compared to 91.9% for the same period last year, due to a few large fire losses.

Our overall solid performance reflects lower catastrophe losses, higher retention, and premium growth of almost 11%.

Underlying results and trends continue to improve in our personal lines expansion states.

For the quarter, net premiums written increased more than 7% in these states, and the statutory combined ratio was relatively flat at 100.2%, excluding the favorable impact of flood.

We continue to see steady improvement in auto and homeowner accident year frequencies, as rate, tier and underwriting changes are beginning to favorably impact this business.

We recently completed successful renewals of our July excess of loss reinsurance treaties.

As a regional carrier with small and middle market risks, we are able to maintain the same reinsurance costs year-on-year, despite higher subject premium.

We continue to work with highly-rated carriers.

Our Diversified Insurance Services turned in a strong quarter, contributing $0.11 in earnings per diluted share.

Compared to second quarter 2004, revenue was up 13% to $29.7 million, and return on revenue increased 3.5 points to 12%.

Favorable results were led by the fee-based flood operation which generated revenue of $8.5 million for the quarter, including $0.6 million from the processing of 1,200 flood claims.

New flood business increased 17%.

Selective is now the eighth largest flood carrier in the nation, with total flood premium serviced of approximately $85 million.

The managed care business also performed well for the quarter, generating a return on revenue of more than 21%.

Our provider network has grown to almost 100,000 locations and remains the largest network in New Jersey.

After-tax investment income was up 17% for the quarter to $25.2 million.

The increase was fueled by a larger asset base generated by strong cash flow from operations of $117.8 million over the last six months.

In addition, income from alternative investments was $2 million, up 85% compared to second quarter 2004.

The overall annualized after-tax portfolio yield was 3.4%.

We actively manage our capital position and use appropriate levels of financial and operating leverage to minimize our cost of capital, which is currently 9.9%, and maximize shareholder returns.

We currently operate at a 1.6 to 1 premium-to-surplus ratio and a 21% adjusted debt-to-capitalization ratio.

To increase economic value, we use share buybacks, debt issuance and retirement, as well as dividends.

We repurchased almost 70,000 shares of Selective stock during the quarter at an average share price of $47.55.

There are approximately 4.9 million shares remaining available for repurchase under our stock plan.

I will now turn the call over to Greg Murphy.

Thank you, Dale, and good morning.

We delivered another solid performance this quarter, as we continue to build upon the successful strategies that have made Selective one of the premier super-regional property and casualty companies in the industry.

Significant measures of ongoing progress include: a commercial lines statutory combined ratio of 92.4%; and annualized operating return on equity of about 14%.

This is over 400 basis points of economic value above our cost of capital.

Selective is now the 51st largest property and casualty company in the United States according to A.M. Best.

The Professional Independent Agents of New Jersey again named us the top regional carrier.

In June A.M.

Best affirmed our "A+" (Superior) rating for the 44th consecutive year, noting in part our solid capitalization, disciplined underwriting culture, and strong regional market presence.

Selective remains one of only 7% of commercial lines carriers with an "A+" or better A.M.

Best rating.

Agents tell us financial strength is very important and is the primary reason they place their best business with Selective.

Now the question becomes, how do we continue to grow profitably in a more competitive market?

We believe the answer is Selective's powerful combination of financial stability, broad commercial lines appetite, cutting edge technology, a field model that is virtually unmatched in the industry, and a critical eye to the future.

Our 6% premium growth for the quarter is about three times higher than the estimated industry average from A.M.

Best, and was driven by a strong 9% increase in commercial lines.

Commercial lines growth clearly reflects the quality of Selective's field-based underwriting and claims model, as well as our business-driven technology initiatives.

We are still comfortable with the pricing of commercial lines new business, with average credits increasing about 3% for the first six months of 2005, which is a leading indicator of market conditions.

Compared to this time last year, agent-automated small business is up about 35% to more than $182,000 per work day or $12 million for the quarter.

We now have hundreds of business classes directly available to agents in their offices.

For the year we expect to write about $38 million of small-business at an estimated marginal expense ratio of 23%.

We intend to widen the small commercial lines pipeline over time, as our Knowledge Management initiative delivers information that enables us to more precisely underwrite and price each risk.

In a softening market, having experienced decision-makers in the field is a competitive advantage that helps write business quickly and at a fair price.

Our field underwriters generated almost $49 million of new business during the quarter.

Selective's large business segment, which includes accounts over $250,000 in annual premium, generated more than $10 million in new business this quarter.

Essential to our success is the customized loss control service we offer large accounts.

Year-to-date we have conducted almost 8,000 loss control surveys for accounts of all sizes.

Agents increasingly use our technology to manage their commercial business.

They enter about 90% of new business into our systems.

And they process more than 60% of endorsements, while underwriting templates automatically renew about 44% of all policies.

In our insurance operations, total net premiums written per insurance employee were up 7% to $803,000 compared to the second quarter of 2004.

Through the first six months of 2005: commercial lines account retention remains stable and slightly ahead of expectations; commercial renewal price increases were up about 5%; and excluding exposure, pure price increased approximately 1%.

We expect pricing to remain under pressure for the balance of the year.

Selective's market planning initiative provides data that targets potential growth segments at a county level across our 20-state commercial lines footprint.

Agents and field underwriters will use this enhanced information to develop a more precise three-year business plan.

We've reviewed the new program with agents in four of our six regions, and they tell us no other company is equipping them with this kind of actionable market data.

Looking further down the road, we expect our Knowledge Management program to continue to deliver better analytics to aid business leaders and field underwriters in the pricing and underwriting decisions.

During the quarter, new analytical information was used to adjust pricing within our 72 business segments for more than 50% of our commercial lines premiums.

As the predictive modeling phase of our Knowledge Management is implemented, we will be able to more accurately predict underwriting risks, thereby expanding our business appetite and more effectively targeting areas for profitable growth.

You hear us talk a lot about initiatives, processes, and systems we are constantly rolling out and improving.

It bears mentioning that most of our initiatives are not about fixing problems, but making a good company a great company.

For 2005, the assumptions upon which we based earnings guidance include: a GAAP combined ratio below 96%; an overall statutory combined ratio of 95%; catastrophe losses of 1.5 points for the remainder of 2005, an increase in after-tax investment income of 12%, up from our previous estimate of 6%; and Diversified Insurance Services revenue growth of 11% and a return on revenue of 7%.

Given our success in the first half of the year, we are increasing our earnings estimate.

For 2005, we now estimate between $3.80 and $4.05 of operating earnings.

Thank you, and I will now turn the call back to the operator for your questions.

(OPERATOR INSTRUCTIONS).

Greg Peters with Raymond James.

I want to, before I launch some of my questions, apologize upfront.

I missed part of your opening comments.

So if you already talked about this, I apologize.

But I guess two areas that I was hoping to focus on.

First, in relation to the agent count, new appointments, any cancellations, any consolidations within your agency force, can you give us some flavor there?

And then I'll ask a follow-up.

Chuck Musilli will answer that question.

So far this year, we have appointed about 25 new agencies.

Our overall count is up, I think in the neighborhood of 10 to 15 agents; nothing dramatic.

Primary growth is in our midwestern territories where we have a lot of open gaps.

There hasn't been a whole lot of consolidation this year.

Really pretty quiet on that front.

The 10 new agents, what kind of time period do you generally allow them before you start looking at things like premium level and things of that nature?

Again, it's going to vary on the territory and the state that they're in, but our expectation is that in the three-year period, you get up to a level of profit-sharing eligibility for us.

We expect $1 million generally in the three-year period for an agent to show their commitment to us.

Can you just remind me, I think the statistic or can you remind me of the statistic of what percentage of your agency force are you the one, two or three carrier in?

We are number one, two or three in about 50% of our agents.

If you look at them after five years of appointment, that rises up to about 80% of our agency plan.

So as we appoint new agents, obviously that keeps that statistic down a little bit, but it's something that we monitor very closely.

So right now, it is running at 50% of your total agency force?

Yes.

And can you give us a perspective in the context of your comments, Dale, about rising to 80% over five years?

Can you give us some perspective of how that has changed in the last year or two?

I'd say in the last year or two, it really hasn't changed substantially.

But I would say, Greg, over time that clearly has.

Our focus on agency management has significantly increased over the last five years in terms of how we manage an agency and what the field underwriters' responsibility is for the profitability of that agency, the growth of that agency, and the relationship in terms of the holistic use of that agency.

I don't know how many years ago we went to a color-coded chart that identified every strategy that we had, and then matched that agency up against those strategies in red, yellow, green, so we knew whether they are selling our flood business, not selling our flood business, whether they have a diversified book of business, whether they are profitable, whether they are growing.

So I would say that has definitely heightened over the last three to four-year time period.

Okay, fair enough.

And then I just thought we could circle back on the auto results, specifically the decline there.

And I'm curious, obviously it would appear that you are maintaining some discipline on a pricing perspective and still losing market share.

Can you update us with respect to credit pricing or credit-based pricing?

And from a broader perspective, Greg, maybe shed a viewpoint on -- at some point you lose the scale necessary to keep this viable business, or am I thinking about this too dramatically?

I think you're thinking about it too dramatically.

I think the relationship in our agency plant, the New Jersey, we have been there for the long-term with clearly look to Selective as a primary company.

What we have done in terms of pricing, and we continue to work on our pricing initiatives, as we have mentioned several times before, our problem in New Jersey is we are a legacy company and getting some of the legacy issues fixed is more problematic for a legacy company than it is for some of the new entrants in the market.

The department understands that difference and is trying to remedy some of that.

All we ask for in New Jersey is a level playing field to be able to operate with the full force of pricing that is complete and actuarially sound.

With respect to the unit drop, I mean our unit count did go down in New Jersey auto.

Our cars in force at the end of June is just over 90,000.

We would like to see that count stay, and we have seen some changes in our writing of new business since our personal lines people have made a number of changes in the underwriting pricing over the past several quarters, as well as some other tuning that we have done.

So we have started to see some of that level out.

But I have to say that our ongoing expectation right now for personal automobile is 101 combined ratio, given the law change.

So we are assessing that.

We are assessing our opportunities in the marketplace.

We are assessing what is happening from a competitive standpoint, but you have to understand that that information to us in terms of just coming up with our reserve charge is all within the last few weeks.

So we are still working through that.

And you say that you're -- as a legacy carrier in the market, you are trying to argue with the department for a level playing field.

I get the sense that other large legacy players, auto, in that market are making the same arguments but not making much headway.

How would you characterize where you are in that process?

I think we are making a lot more headway, and I'm pretty pleased with the progress, but until it is done, it is not done.

Okay, fair enough.

Thank you for your answers.

Mike Grasher with Piper Jaffray.

Just to follow-up with another question on that, the potential withdrawal of the lower-tier lines, is that correlated to the legacy issues or is it change in law or the general competitiveness of the market?

I'm sorry.

When you say lower tier, can you just define that question a little bit better?

I think you had mentioned in the opening remarks that you were considering withdrawing some of your lower-tier business.

Well, no, not necessarily withdrawing lower-tiering businesses; that we found that some of the question when you start to lose market share is, okay, how is it changing the configuration of your book of business.

And what we're saying is our best two tiers are actually a larger percent of our overall book, so it is not weakening the quality of our book.

It's not that we want to lose business anywhere, but we just want to make sure that we made the point that we are not losing our best business on a total proportionate basis.

That's the purpose of that comment only.

Okay, that's helpful.

We're not trying to just drive away -- if all of your business is priced appropriately through tier one to tier five and you're making money consistently in all tiers, it is not a problem.

But we do have a tendency, our more profitable tiers are one, two, and three; to a lesser extent four and five.

With regard to the Supreme Court decision in the reserves that were put up, is that in your review one and done, or is it sort of wait and see, or how did you go about establishing that level?

Yes, our actuary, Ron Zaleski, will talk to that.

Yes, we looked at our current case reserves and we split that out into what was litigated and what was not litigated.

We also looked at our reopened claims.

We put up estimates for claims that we have never seen and some legal expense.

We have done a lot of work in the claims area in evaluating the position of those claims, and we think that $7.5 million is a very reasonable number at this point in time.

But understand that that's fit inside a range.

We have made our best estimate based on the work that all of our claim people have done reviewing thousands of files, and the benefits of a company that has been in the marketplace knowing what our costs were running pre-AICRA versus post-AICRA.

So when you say one and done, you are talking about a -- I guess I would just like some -- onetime charge, right.

Sure.

And then if I may -- and then obviously this has an ongoing effect on future claim costs until something happens with this from a legislative standpoint.

Which is why we provided a new estimate that New Jersey auto will run at a 101 for the remainder of the year.

Understood.

Okay, thanks.

And then with regard to -- if you could comment a little bit more about the workers' comp in terms of policy count.

Did you say it was flat, or maybe you didn't?

I was going back over my notes.

And then just in terms of the rate environment within the workers' comp that you are seeing.

Yes, our rate in the comp, that's our lead price line increase.

Although our prices increased around 3% for the quarter, our comp is up 9% for the year-to-date, and our year-to-date pricing is up about 5%.

So comp continues to run at almost two times the average, which is just a reflection of the ongoing pressure on medical costs in that line.

So we haven't been actively growing that segment as much in the past, although I have to say that given our total reassessment of our strategy in comp and I think some better disciplines, we might find that we need to retune that book and go after certain segments to better balance that overall mix.

We are going to be using our loss control efforts, our much more aggressive claim handling practices.

As Dale mentioned in his prepared comments, a deeper review of all of our networks in terms of the handled medical claims as well as the benefits of having in-field nursing to try and drive all those costs down.

So that continues to be the line that increases the most from a price standpoint, but it is also the line that has the biggest pressure on the cost of goods sold.

Congratulations on the quarter.

Jeff Thompson with KBW.

First on the earnings, were there any unusual reserve releases that balanced the charge in personal auto?

In total, our reserve development for the quarter would be about 6 million -- approximately $6 million, and that really represents that portion of the $7.5 million charge that applies to prior accident years.

With respect -- so that is pretty much it for the quarter.

So the answer to the question is no, there isn't.

There is some pushing around within the lines in workers' comp.

About five points in that line is development in prior years, but that was offset in other areas, other commercial lines areas for the most part in the Company.

So the answer to your question is a little bit pushing around line to line, but in total it is pretty much -- it would be around 6 million for the quarter.

Can you quantify -- we have raised the earnings guidance here.

Can you quantify the impact from New Jersey auto going forward in dollar terms?

Is it $0.05 for --?

I'll give you the numbers.

You guys can just punch it out on your calculator.

Our expectation on New Jersey auto went up about four points on, let's say, $120 million book of business.

So take that times tax affected and divide it by 32.5 million shares, and you've got your number.

Lastly, would you think with all these national carriers, what kind of pressure do you think the legislature and the regulators are going to feel from this change in the law, and what do you think can happen to help the situation?

Well, you know, it's hard to really comment on that since there are so many moving pieces.

You have got a gubernatorial election forthcoming.

You have got some changes around the perimeter that it's going to be somewhat difficult to assess what will happen.

So I have a little trouble making a prediction on that.

But I have to say that some of the newer entrants into the market that have garnered tremendous market shares are going to seriously -- have to seriously look at their cost of goods sold to make sure that their pricing is appropriate.

And you can tell from my prepared comments before if you read through the thing, we have been losing some of our market share in the tiers four and five.

That should tell you something as well.

So you guys do the homework, and then you can see that some of the pressure is going to come through the cost of goods sold, and it is going to go back to the driving populace of New Jersey.

There is about 5 million cars in New Jersey and they're all going to feel some ramification to this long-term.

The one thing I might add to that is there have been four separate bills introduced in the state legislature to try and correct some of this issue, and they've been introduced on both sides of the aisle.

So there is definitely seemingly support there, but as Greg indicated, in a gubernatorial election year it is difficult to assess the likelihood of success there.

And the type or the nature of the bills, are they just to raise the cost to offset it, or are they to actually try to rectify the ruling?

More in line with including the serious life impact back into the equation.

Serious life impact went back to 1992 when that was put in, and then what happened is it wasn't in the revised AICRA bill.

So, therefore, that is what this Supreme Court battle was over.

Okay, thanks a lot.

Very good quarter.

Beth Malone with Advest Investments.

Good morning and congratulations on the quarter.

Just a clarification on the life impact bill, could you explain exactly what that did, and is that one of those legacy issues and that the new carriers didn't incorporate it or is it industrywide practice?

And does this change indicate a change in the overall expectation that New Jersey markets were starting to improve from a regulatory legislative standpoint, and is that now kind of coming into question?

Let me try to piece the comments back.

Let me start with this is not a legacy issue.

This is an interpretation of AICRA, which now AICRA had a two-tier criterion housed within it that someone had to meet before they could file a suit, and that was it had to have a serious -- the injury needed to have permanency associated with it, and it also had to have a serious life impact.

If it met those two tiers, then a suit could be engaged.

Now what they have done is they have removed the serious life impact, so it only has to have permanency associated with it.

So it is opening up the opportunity for more suits to be filed as a challenge to the verbal tort threshold, because they no longer have to meet both thresholds.

They only have to meet the permanency issue.

So as a result of that, we see higher claim activity that will emerge from this bill.

It affects us and it affects everyone else in the marketplace equally.

It doesn't -- there's no imbalance between new and old carriers, so this is everybody going forward.

So that was -- I know that was the first part of your question.

I was just wondering, does this -- well, secondarily, as a follow-on to that, your change in the reserves indicates there were products that were sold with a certain price in mind that assumed that you would have this legislation in place, and now that has been struck down.

So is the concern here that historically you have priced products with expectation that you're not going to have that exposure?

Now it is likely that you are, so are you going to be adjusting all your pricing in all of your markets going forward?

Yes, part of our response was that given this higher cost of goods sold, our expectation for New Jersey auto would be run at about 101.

So that is up about four points over where it historically was running.

We now are currently assessing the competitive forces in the market, our ability to increase price, which we do have the ability to withdraw certain previously filed rate deviations, and we are currently assessing all of that.

We just haven't seen any real significant change within the marketplace to date, but yet this is all pretty fresh and we're all kind of going through this at this particular point in time.

Do you see this as a setback, like do you -- (multiple speakers) the outlook for New Jersey auto?

I don't see it as a setback.

This is a Supreme Court decision, so this is over the facts of the law and what the AICRA said and didn't say.

So I think from a legislative -- from what we see from the regulators and legislators, the market has been moving in the right direction from our standpoint.

I think this is just a Supreme Court interpretation of a case that was filed a number of years ago, which we all have to figure out how we're going to deal with.

And either the answer could be that's the way the law's going to be; we're going to have to increase price accordingly.

Or there may be another challenge to that or another legislative change that may change that moving forward.

But whatever it is, we're all playing with the same -- just as long as we're all playing from the same rule book, we're fine.

Thank you.

And another question on the workers' comp business, you say you're assessing it.

Are we to assume that -- you have done a tremendous job about implementing technology into many aspects of your business pretty effectively, probably better than most carriers.

Are you taking that same expertise and applying it now to workers' comp to try and manage that business more effectively, or these new strategies that are technology-based that you're going to try and apply to workers' comp to make that business better for you?

Ed Pulkstenis will take that question.

With regard to workers' comp, really the focus there is to strengthen all aspects of both the underwriting and the claims handling of that business.

So it's really -- it applies on the managed care side, it applies on the loss control side, strengthening and automating our premium audit operations, some benchmarking with some industry information that we can have available as well.

In terms of automation, there certainly will be an automation component to that, for example, in some of our loss control and premium audit areas.

However, I would say in terms of the automation areas where we have been most successful with straight-through processing, with agency integration and with other initiatives like that, I would say the workers' comp right now is consistent with the other commercial lines.

I would just say from a technological standpoint, obviously what we're doing in predictive modeling and knowledge management, though, are two areas that will continue to fortify that area significantly.

Finally, you mentioned that your outlook for pricing, you are seeing some competition.

Do you really think that -- how do you see this coming out over a longer period of time?

Is this now an indication, are we in a soft cycle for small commercial?

If it coming down from the larger case business, or is the experience you're getting pretty much that you are still satisfied with it, because it would appear that the results would argue that the market is pretty healthy?

Right now, we don't see any wholesale changes in the market.

We hear spottiness.

There's areas of some choppiness in particular locations, but holistically we view the market pretty favorably.

Jim, do you want to --?

I would just add, Beth, that we still are in the small end of the market largely, and there's just less pressure down there than there is on -- you're starting to see and hear more of the larger accounts and larger brokers are talking about the types of price pressure they are seeing.

We are seeing that on occasion, but where we are in the market it is not as prevalent or not as big a deal.

(OPERATOR INSTRUCTIONS).

At this time, we will go to Mike Dion with Sandler O'Neill.

Just a follow-up to Beth's last question on pricing.

Maybe if you could just break it down a little bit further in terms of by line of business within the commercial lines.

You mentioned comp, you're still able to get two times the average rate.

But as you indicated in the opening comments that you expect continued pricing pressure for the second half of the year, maybe you could just relate that out to the various lines within commercial lines.

Sure, and I can do that.

For instance, to give you an idea, commercial auto is only up about 2% for the first six months of the year, but look at the profitability in that line of business has been in the mid-80s for a while now.

So that line is seeing some definitely downtick.

To give you an idea of the spread, our GL excluding umbrella is running about 4%; our commercial property is up about 3.

Comp was up 9.

BOP, our BOP business was up 3, and umbrella was up 4.

So that just gives you an idea of the spread.

The average is about 4.6%, but the lead line in there is -- the line that has the most pressure on it is the comp.

The only thing I would add to that is we really write package business.

We write all these lines as an aggregate.

So really I think when an agent or a customer is looking at the price, they're looking at the price for the whole program, and that is really how we sell it.

That's helpful.

Just another question in terms of maybe a little bit more tempered growth expectations for the second half of the year, and with some of the pressure in New Jersey auto with that volatile market.

As you look out and notice that you did repurchase 70,000 shares during the quarter, if growth expectations are lowered would you look to be more active in the market via buyback and/or increase in dividend?

Let me just start out with -- you mentioned things about the Jersey auto business rolling off.

Let me just say that in the next quarter, we will hit our first cycle through some of these new competitors in the marketplace.

So we expect some of that to slightly slow down at that point.

But with respects to overall capital management, I think we are probably one of the more aggressive companies trying to tune its cost of capital in terms of balancing debt and equity, trying to best balance the returns to shareholders in terms of dividend increases, share purchase, and then obviously trying to maintain our sustainable growth rate through internally-generated surplus which, you know, if you look at our longer-term sustainable growth rate, it is probably somewhere in the area of 12 to 14%.

So we have got the ability to generate internally the surplus to grow at those levels.

We have made no -- we are not making any more growth forecasts.

We have backed off that given the market conditions, but we look at all of those factors every quarter.

So we are looking at each and every one of those trim points every quarter.

Doug Mewhirter with Ferris, Baker & Watts.

I just have two quick questions.

One is, do you have an operating cash flow figure for this quarter and the same quarter last year?

Yes, it's about 117 million this quarter.

Dale is pulling out the number of last year.

It was $126 million -- excuse me, that was year-to-date.

For the quarter, second quarter was $70.8 million last year and $71.5 million this year.

Thanks.

And getting really into the capital management question, do you have a range where you try to keep your premium to surplus or a minimum premium to surplus you try to maintain as a target range?

We don't have a specific range per se.

I would say those numbers get pushed around based on where the rating agencies are for the most part.

What we try to do is to deliver a consistent A+ rating to A.M.

Best which we feel is the most critical rating.

From a brand standpoint to our franchise is 750 agents that represent us.

That's what they sell first is the A.M.

Best rating.

I mean, from a capital standpoint if you were to look at the pure academics of the business, you would say you want to run this business at 2.6, 2.7 to 1 because that's where you maximize the returns to shareholders.

But we are always looking at the best balance of that, but yet still maintaining a comfortable margin from a ratings standpoint.

So we have been running at 1.8 to 1 for the last couple of years, 1.8, 1.9.

It's dropped down to 1.7 -- in the 1.7, 1.6 range today.

But that is not because we're trying to drive that down.

I think it's a confluence of the amount of surplus that we are generating versus the not growing the top line at the same sustainable growth rate that our surplus can support.

(OPERATOR INSTRUCTIONS).

Mike Grasher with Piper Jaffray.

Greg, I think you were throwing out some guidance there towards the end of your comments.

I missed the Diversified Insurance Services.

What was your comment around that?

Diversified Insurance Services revenue growth of 11% and a return on revenue of 7%.

Lara Devieux with Wachovia Securities.

Congratulations on the quarter.

I just had a question on the expense ratio.

I think it has remained in the area of about 31% the last two quarters.

So when do you think the benefits of the expense initiatives that you've been taking over the last year or so, when will these be realized and when should we see the expense ratio move towards, I think, your 29% long-term goal?

We have begun to see a little bit of the expense improvement, but that ends up getting camouflaged by the additional payments of our incentive compensation, because the profitability of our agents and the supplemental commissions that we pay them as well as in the incentive programs that we have for employees here.

So although we have improved the underlying nonvariable piece of the expense ratio, the overall expense ratio hasn't moved.

We continue to look at that and work on that and strive to improve expenses to the best that we can, but also obviously with some of the shrinkage that we have had on the top line as on the personal lines side that mutes our overall growth has also hampered a little bit our ability to move ahead with our expense ratio improvements.

So, obviously, there are two components to that improvement.

So we continue to work on that and we will continue to try and drive that lower.

And there is a lot of what we call speed bump investments, a lot of infrastructure investments being made today around the organization for really the long-term future, whether it be in knowledge management, market planning, what we are doing with agents.

So as we continue to grow and garner scale in the marketplace, we will also see the nonvariable piece of the ratio come down.

As Dale mentioned, our variable costs are running around 19.2, 19.3% of premium.

They are up now more in the higher 19 -- 19.7, 19.8, somewhere in there.

But that reflects the commission, the premium taxes, and the cost to put the business on the books.

So the nonvariable piece has been pretty disciplined over time.

What we need to do is we need to start to garner that organic growth in our 20 states that can better support our infrastructure, which we continue to build out for the future.

We will go to a follow-up with Beth Malone with Advest Investments.

Just not to beat a dead horse, but I just wanted to talk a little bit more about the pricing environment.

Could you articulate a little bit how it is that we are hearing pricing competition, and I know you are in the smaller case business, but what is it that Selective has done that has allowed you to maybe have superior experience in terms of getting the proper pricing and maintaining your persistency, even as competition is increasing in the general marketplace?

I know the niche helps, but what is it that the way you have positioned your company that allows you to continue to maintain the high persistency, even as you're getting adequate pricing, even with greater pressure in the overall market?

I think that comes down to the services that we provide agents and really to the end customers, whether they be loss control services or types of services that we provide.

Claim handling, which in this business doesn't usually get very high marks from customers, but yet our claims services is clearly at the upper end of the market.

The fact that we have field claim people in the market, but the fact that we have field claim underwriters out there, field underwriters and field claim people.

I mean when you aggregate all of the services that we provide to customers, I think that is why we are able to hold the retention line the way it is and also get a little bit more price in the marketplace.

Jim --.

I would echo what Greg says.

I would say relationship is very important, and we have over the past several years continued to finish very high in various agency surveys, both outside and internal.

And I think agents asked themselves a little bit, where would you rather have the business?

Agents do have some say in where the business goes, and they are going to put it with companies that they feel are going to take better care of their customers, and I think that's where we are.

I'll just add one other thing to that.

I think this is also an area where our technology has assisted.

Our agents now have the ability to go into accounts that they write with us with 90 days before the policy expires and look at where the base renewal cost for that is.

And to the extent that they can relieve any of the uncertainty a customer has about whether their policy is going to renew, they can put that renewal to bed earlier.

So there is a lot less upheaval in that book of business as you get closer to the actual expiration date.

So I think the technology improvements that we have implemented over the last couple of years have improved that persistency as well.

It appears there are no further questions at this time.

I would like to turn the call back over to the speakers for any additional or closing remarks.

Thank you all very much.

If you have any follow-up, please get back to Dale and Jennifer.

Thank you very much.

This does conclude today's conference.

At this time, you may disconnect.