Selective Insurance Group Inc (SIGIP) 2006 Q2 法說會逐字稿

Good day everyone.

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 Vice President, Assistant Treasurer, Ms. Jennifer DiBerardino.

Please go ahead.

Good morning and welcome to Selective Insurance Group second-quarter 2006 conference call.

This call is being simulcast on our website and the replay will be available through August 25, 2006.

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

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

Operating income is net income excluding the after-tax impact of net realized investment gains or losses, discontinued operations and the cumulative affect of change in accounting principle.

We believe that to providing this non-GAAP measure makes it easier for investors to evaluate our insurance business.

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

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

We refer you to Selective's annual report on Form 10-K filed with the U.S.

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

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

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

Greg Murphy, our CEO;

Ron Zaleski, Chief Actuary;

Diederik Olijslager, our Head of Fixed Income;

Jim Ochiltree, our Head of Insurance Operations and members of his senior leadership team consisting of Ed Pulkstenis, Chuck Musilli, and John Marchioni.

At this time I would like to introduce our CFO, Dale Thatcher, to review second-quarter results.

Thank you.

Good morning.

We continued to generate solid results in the second quarter despite a more competitive marketplace.

Net income increased 31% to $42 million or $1.36 per share and operating income increased 6% to $32.6 million or $1.06 per share compared to second quarter 2005.

The quarter results include a $0.04 per share non-recurring expense related to an exchange in May of approximately 50% of the $116 million senior convertible notes then outstanding.

As we continue to actively manage our capital, we chose to induce early conversion to increase our financial flexibility.

Net premiums written were up a strong 7% to $397 million for the quarter overall with Commercial Lines growing 7.5% and Personal Lines 5.3%.

Based on A.M.

Best's 2005 industry net premiums written, Selective moved up to the 47th largest Property and Casualty writer.

The statutory combined ratio for the quarter increased 0.7 points year-over-year to 95.6% including catastrophe losses of 1.3 points versus a minimal 0.2 points last year.

Catastrophe losses were largely a result of tornado activity in our Midwestern states in April, and to a lesser degree, storm activity in the Northeast in June.

Our second-quarter Commercial Line growth of 7.5% is more than three times A.M.

Best's estimated Commercial Lines growth for 2006.

As we continue to experience solid growth we're mindful of the delicate balance between pricing and retention.

Renewal price increases were 2% in the quarter including exposure growth of about 4% indicating a pure price of a negative 2%.

Retention remained steady at 79%.

Commercial Line's results continue to be very strong as we achieved the 10th consecutive quarter of below 100 statutory combined ratio with a 95.4%, versus 92.4% for the same period last year.

This quarter's combined ratio includes 1 point of catastrophe losses versus only 0.2 points last year.

We continue to be profitable in every line of business with the exception of workers' compensation.

Overall Commercial Lines loss costs were up about 2.8%.

Frequency was down 3.6% but severity was up 6.7%.

Net premium earned per policy was up 1.1%.

In the quarter we experienced a 4.7 point improvement in the workers' compensation combined ratio which came in at 111% for the quarter.

We continue to execute on our workers' compensation underwriting strategy aimed at reducing the combined ratio by 7 points over the next two years.

In addition, we have other initiatives in safety management and managed care that will also improve results over time.

One facet of the our workers' compensation strategy is to rank our operating states in tiers and target the states with the best opportunities for profitable growth.

Workers' compensation premium increased 7% in the quarter from the same period last year with new business up 20%.

Our best states, tiers 1 and 2, now represent 76% of our new business, an increase of 13 points from the same period last year.

This new business represents rounding out existing profitable package business as we are not a market for monoline workers' compensation.

While our performance in this line of business reflects substantial progress, we do not expect that our progress towards a 7 point reduction will be as dramatic each quarter.

Effective July 1, we successfully renewed our Property and Casualty excess of loss treaties with little change in terms and conditions.

Both treaties are quoted on a July 1, 2006 to June 30, 2007 fiscal year.

The property excess of loss treaty, $23 million in excess of $2 million retention, was placed with estimated ceded premium of $8.7 million down from $9.1 million from the prior fiscal year.

The favorable terms are a result of the historical profitability of our property book, geographic diversification, excellent underwriting guidelines and a reduction in the second layer occurrence limits.

The structure of the casualty per occurrence excess of loss treaty remained the same this year.

The workers' compensation treaty, $3 million in excess of $2 million retention, renewed with estimated ceded premium of $5 million, up from $4.3 million for the same period one year ago.

Reflecting some signs of softening market conditions, the balance of the casualty excess of loss treaty, $45 million in excess of $5 million retention, renewed with estimated ceded premium of $9 million, flat with the prior fiscal year despite increased exposure.

The new version of the catastrophe modeling software, RMS Version 6.0, has increased modeled losses industrywide.

Compared to RMS Version 5.0 modeled losses have increased 55% on a short-term high frequency or stochastic view because the revised model anticipates a more active hurricane season.

On a more traditional historic view, modeled losses increased 30%.

In response to the new RMS 6.0 modeling results, we purchased an additional $30 million of property catastrophe coverage effective June 15.

The total catastrophe program now has coverage of $250 million in excess of $20 million retention.

This provides Selective coverage for a 1- in 150-year event under the stochastic RMS 6.0 view and a 1- in 200-year event under the historical RMS 6.0 view.

This level of possible net loss represents approximately 3% of surplus after tax.

The Personal Lines statutory combined ratio was 101.1% for the quarter excluding flood.

Reflecting increased homeowner severity, catastrophe losses of 3.2 points compared to only 0.3 points in the second quarter of 2005 and ongoing competition for New Jersey personal auto business.

Last year's combined ratio of 113.1% for the quarter included a 14 point impact of a net reserve charge following a New Jersey Supreme Court decision on the verbal tort threshold.

The second quarter homeowner statutory combined ratio of 99.3% included 11 points of catastrophe losses versus 1.4 points last year on a combined ratio of 94.8%.

For Personal Lines, claim costs increased 17% driven by unusually low severity in the prior year and the higher claim costs associated with the verbal tort threshold.

Earned premium per policy was down 3%.

We continued to see decline in personal autos we insure in New Jersey which were down to 84,000 from 86,000 last quarter as the competitive environment continues.

Over time the new Personal Line strategy will allow us to profitably compete for over 85% of the typical risks in an agent's office.

This initiative began with the July launch of our knowledge-based rating model, MATRIX, for New Jersey personal auto new business.

MATRIX is designed to enhance Selective's competitive position through an expanded appetite that better matches price to risk and has about 1 million more pricing points than the existing program.

The program is on track to roll out companywide by year end.

However, it will take several quarters before the transition of the renewal book begins to show positive results.

Independent agents control about 35% of the total Personal Lines marketplace and we want to drive the same relative penetration in our agencies for Personal Lines that we have for Commercial Line.

We're leveraging our Commercial Line's technical capabilities for Personal Lines with the rollout of our xSELerate agency integration system in September.

During the quarter our Personal Line service center went live with a group of pilot agencies in New Jersey.

The center is now servicing Personal Lines premium of $17 million which is expected to increase to about $35 million by year end as we roll out the center to the balance of our New Jersey agents.

The center will open to all Personal Lines agents in 2007.

Revenue for Diversified Insurance Services grew 13% to $28 million and return on revenue was 10% for the second quarter.

Driven by June flooding in the mid-Atlantic states, our flood operation processed about 800 claims in the second quarter generating fee-based revenue of $0.4 million.

For the quarter, flood premium grew 24% bringing total flood service premium to $106 million.

At Selective HR Solutions, total worksite employees are up 10% year-over-year driven in part by the launch of the rebranded Employer Protection Program which continues to resonate well with agents.

Prospective accounts in the sales pipeline are up 43% compared to second quarter 2005 and new accounts sold by Selective agents are up 24%.

For the second quarter, our net investment income after-tax increased to$29 million, up 15% from a year ago.

The increase reflects a 7.5% rise in bond income, a nearly tripling of short-term interest income and a 71% rise in alternative investment income to $2.2 million after tax.

The after-tax annualized yield was 3.6%, up from 3.5% last year.

Continued strong operating cash flow of $73 million for the quarter contributed to investment portfolio growth as the portfolio reached $3.2 billion at June 30 an increase of 9% from June 2005.

The general rise in interest rates in the quarter lead to $21.5 million of unrealized bond portfolio losses on an after-tax basis.

This negatively impacted book value by $0.48 per share.

Book value per share was $34.41 at June 30, 4% higher than a year ago.

The fixed-income portfolio duration was 4.1 years at June 30, 2006.

Historically duration has ranged between 3.7 to 4.6 years.

Although we do not try to forecast interest rate moves, we do proactively manage interest rate risk through a well-laddered maturity structure of the bond portfolio.

Our capital management strategy is geared toward maximizing shareholder returns by generating profitable growth, utilizing share repurchases and increasing dividends to manage our overall capital levels.

During the second quarter, we repurchased 422,000 shares at an average share price of $53.66 or 1.5 times price to book value.

For the year, we have repurchased 1.4 million shares at in average price of $54.41 or 1.6 times price to book.

As mentioned earlier we negotiated a private exchange resulting in the conversion of approximately half of our senior convertible notes and about 2 million additional shares being issued.

For the quarter we generated a 13.3% annualized average return on equity which exceeded our cost of capital by 360 basis points.

Now I'd like to turn the call over to our CEO, Greg Murphy.

Thanks, Dale, and good morning.

Yesterday we received additional validation of our successful business model and strategy execution for the financial strength rating upgrade from Standard & Poor's to A+ with a stable outlook.

S&P cited the major rating factors for the upgrade as: strong business position, strong operating performance, very strong capital adequacy and good financial flexibility.

As the second quarter results indicated we are successfully navigating through the current competitive pricing cycle.

The most intense competition is for accounts greater than $250,000, significantly above our average account size of 11,000.

We are carefully picking our spots to write business without jeopardizing underwriting discipline.

All our strategies and initiative are focused on outperforming the industry through the cycle including: Market Planning, Knowledge Management and Predictive Modeling.

Market planning gives our agents and agency management specialists or AMS's, the ability to target pockets of business that Selective wants to write; and the results are evident. 85% of our 80 Commercial Lines customer groups were profitable for the six months of 2006.

We've also been very successful this year growing new business by 22% for the top half of our most profitable customer groups and only 2% for the bottom half.

The detailed analytics provided under our Knowledge Management initiative enable us to better understand the aggregate underwriting results for both new and renewal business.

Enhanced reporting includes data on state, agency, hazard group, frequency and severity as well as factors not typically reviewed in underwriting accounts such as payment history and account size.

Statistically, these have an impact on loss experience.

This information allows for a level of pricing granularity that when coupled with our field presence gives us a competitive edge in the marketplace.

The first predictive model for workers' compensation rolled out in the second quarter and we're beginning to see the positive impact despite this being a long tail line.

The model allows us to focus on growing profitable new business and re-underwrite our existing business in a more efficient manner.

For example, we've identified that policy size is one of the predictors of profitability for workers' compensation; and we are growing the accounts indicated to be the most profitable.

Premium level adequacy is also reviewed to ensure proper classification and payroll amounts for our workers' compensation business.

The results to date are encouraging as we continue to target a 7 point combined ratio improvement in the workers' compensation over the next two years.

The predictive model for our Businessowner Program was completed during the quarter and will be deployed next quarter.

Selective, a super-regional carrier operating in 20 states, has ample opportunity to grow.

These 20 states represent almost half the Commercial Lines premium volume and 47% for the Personal Lines premium in the United States.

Our agents are committed to growing with Selective as we have a generalist appetite and numerous competitive advantages based on our “High-Tech, High-Touch” business model.

We continue to expand our agency partnerships as we anticipate adding 150 agents by year-end 2007.

Today 29 agents have been added.

In addition, 10 of our agents were consolidated by other existing Selective agents leaving those storefronts basically intact.

Overall agency count stands at 757.

In spite of the many requests for appointments, our growth in agencies is measured since it takes time to craft the type of long-term commitment we expect.

The key indicator of the success of our agency franchise is the Commercial Lines new business which grew 3% to $71 million for the quarter.

Pricing on new business mirrors renewal book, reflecting continued discipline.

New Commercial Lines business is generated by the following sources, One & Done automated small-business, $12 million up 4%;

AMS or middle-market $48 million up 8%; and large account business Selective Risk Managers $8 million and that is down 25%.

For the quarter we averaged $190,000 of premiums per workday through our automated small-business system.

Today nearly 95% of our agents are using the system and we're experiencing broad-based growth in many segments.

To give you a sense of the potential growth of this system, if you annualized $190,000 per workday this equates to $49 million in premium written at a 23% marginal expense ratio.

Currently there are 335 eligible classes of business in One & Done and that will be increased to 375 by year end.

Selective's strong field force particularly the AMS's continues to drive growth in the middle market.

For us middle market accounts range from about $10,000 in premium up to $250,000.

Seven AMS's were added in 2006 bringing the total to 82.

Based on annualized six-month numbers for 2006, each AMS will generate about $2.5 million in middle market commercial new business.

We believe the AMS is critical to the progress Selective makes in the agency ranking, top three and 70% of our agents who have been with us for five years or longer.

Hyatt Brown, of Brown & Brown Insurance, says the AMS role gives Selective "a competitive advantage over other companies who do not do that and gives Selective a better risk selection".

Our Market Planning and Knowledge Management initiatives have also had a positive impact on our business our field force is writing.

As previously mentioned the most competition is in accounts over $250,000 in premium.

This business tends to be middle market for many larger carriers and is more susceptible to competition.

Growth is off in that segment from we expected but retention remains strong at 92%.

Good results continue in our renewal book due to our agency and client relationships which are supported by excellent claims and safety management services these accounts receive.

Ultimately growth in this segment depends on the competitiveness of the marketplace as we are not willing to compromise underwriting discipline to write new business.

In the current market, we've seen other carriers pricing this business below our technical premium levels.

It's not only our “High-Touch” field force building agency relationships.

The senior management team hosts numerous face-to-face agency events and we just recently returned from Selective's annual President's Club Trip with our top 137 agencies.

Annually we host producer council meetings, agency roadshows, and this year Jim Ochiltree and I have been traveling throughout our territories having one-on-one meetings.

We don't believe any other carrier invests the time or provides the unique field model that Selective has to develop such strong agency relationships.

This represents a true competitive advantage over other companies and is hard to replicate.

In the Goldman Sachs semiannual nationwide agency survey, we've been often named the best regional carrier for the “quality of service.” This year for the first time we were named the number one carrier overall for the “quality of service.”

Before we take questions, I'd like to walk through our 2006 guidance.

As we head into the wind season, we are maintaining our full year 2006 combined ratio target of 96.5 on a GAAP basis and 96 on a statutory basis which generates diluted operating earnings per share in the range of $4.30 to $4.50.

Other key assumptions for the next six months include: a normal level of catastrophe losses, $6.5 million after-tax or $0.21 cents per share; diluted weighted average shares of 31.1 million; after-tax investment income growth of 13%; and a Diversified Insurance Services revenue growth of 12%; and return on revenue of 8%.

Now I'd like to turn the call back to the operator for your questions.

(OPERATOR INSTRUCTIONS) Michael Grasher from Piper Jaffray.

Good morning.

Congratulations on the nice quarter.

I wonder if you might walk us through a couple of lines here on the commercial side, the fire and then the commercial auto.

Just looking over the numbers it looks like there was -- I don't know if deterioration is the right word -- but profitability (indiscernible) with the combined ratios that are evident here?

Anything in particular?

Sure.

I would say that.

Let's talk about property which you mentioned first and I guess like you said that is up against a very tough compare from a year ago, extremely low severe losses over that time period.

And I would say that what you are seeing in the property now is a little bit more compression in pricing universally on the property results.

And the fact that that is probably somewhat more of a normalized level for us.

On the commercial level, I would kind of and I will let the insurance ops people add to this, but I would say that kind of reflects I think some of the position where we've come from.

We've had a very profitable book of commercial automobile business.

We're continuing to grow that.

We are seeing some competition there.

But at those levels we have to sacrifice a little bit of combined ratio for growth overall.

Jim or Chuck, anything you'd add to that?

I think the only thing I would add on the commercial auto side might be the weather in the quarter.

We had a little bit more in terms of I think in the physical damage area.

And property just to echo what Greg said was incredibly good in terms of severity, your large losses in the first quarter or second quarter '05 compared to this one which was maybe even a little worse than expected normally.

Okay.

And then to follow-up on the workers' comp.

Obviously improving 470 bps there.

How much of that is due you think to the predictive modeling, the knowledge management systems in place versus just good results?

Ed, do you want to comment on that?

Ed Pulkstenis, who heads up -- is the director of our underwriting.

Go ahead, Ed.

Yes, sure.

I think the break in modeling really started to roll out during the second quarter so I think the results are early and predictive modeling is really only one element of our improvement plan.

So I think what you saw there was the beginning of the entire strategy to improve that line of business.

Part of that was the early stages of predictive modeling but we expect that to continue to kick in as time goes on.

And Mike, what I would add to that too in particular is when we look at our entire workers' compensation inventory, we just view it through a wholly different lens than we ever did before.

There are elements of that business that have been extremely profitable for long periods of time and then there is a very small element of the business that hasn't been profitable for long periods of time.

And I would say what you have to really kind of glean through is the folks in the underwriting side writing the new business as well as our people managing our strategic business units have now the ability to laser in on both sides of that.

We feel confident that we are definitely growing the profitable segments and then doing the right things that need to happen on the segments that aren't as profitable.

And that includes a lot of safety management work; it includes more pricing; and in some cases, it includes some tough discussions with agents about accounts that we feel that we need to make a decision on.

So it is a total different view of how we look at our business.

And to follow up on that, the element on the insurance in force, the weaker element I guess are the insurance in force that you need to sort of turn over or reprice?

This is Ed Pulkstenis, can you just repeat that question?

Yes.

Just a question about the weaker element of the portfolio or the policies in force.

What percent of the total in force does that account for?

You know what we do is we look at the business in 10% segments.

So really the business that we are turning over or that we are looking at much more closely is the outer 10% to 15% of business and then of that percentage, we are probably looking at somewhere in the range of making a move on maybe 25% to one-third of that business that we find really needs to be addressed.

As Greg said, there are pockets of profitable business throughout our portfolio.

And we are very careful about segmenting out the accounts that really do need action either pricing action or accounts that we need to make other decisions on.

And then also keeping those accounts that may need to continue to be here because they are continuing to be profitable.

And, Mike, to kind of just to add a little more color to that too, you've got to remember our Commercial Lines business is running at a93.6 through six months and we're pushing at all the various elements and obviously to some extent we know commercial auto and the very profitable property results that you just mentioned are part of a holistic account.

And as we bring the workers' compensation results more in line we also have to look at that totality of the account performance which our people are very closely managing in addition to the relationships that we have with our agents for the business and our growth goal.

So we are trying to push all those different levels and navigate our way in a marketplace.

But I would tell you clearly that we have a very solid handle on those levers as we push and pull every one of them.

Okay, thank you.

Greg Peters from Raymond James.

Good morning everyone.

I understand and appreciate the granular approach that you are taking with workers' compensation.

However, I was struck by the comments in the prepared comments that you made in the use of the phrase "profitable growth" and workers' compensation in the same sentence. (multiple speakers) I'd settle for just profits at this point.

Right.

Can you give us a sense on the reported results with the difference between what you think the current accident year is at versus the reported?

Yes.

I think our current accident year is running -- and I'll let the guys pull that out -- somewhere around 110 is close.

But here is another way to think about it, Greg.

When we disaggregate our results in workers' compensation into the deciles that Edward just mentioned before, the last 20% of our policy count, that's count right, not premium?

Premium count.

The last 20% of our premium count increases our average overall workers' compensation combined ratios/loss ratio by almost 12 points.

To give you an idea if you disaggregate that business and looked at it in different deciles, 20% of your business -- so let's say last year we wrote about $330 million of comp business round numbers -- 20% of that premium volume is pushing your overall comp ratio up by almost 12 points.

Fair enough.

So when you sit there and look at that business and then you try to say how are you going to grow an element of it, there is a huge segmentation of that business now that we're being able to identify that is very profitable.

Part of our strategy is to grow that business and not continue to shrink it because we've been faced from our agents in a sense that almost with an adverse selection scenario because we denied the business for so long that the accounts that ultimately end up getting pushed to write sometimes aren't the best account.

Now we are looking at it more holistically and say there's a segment of the market that we want to grow, that's very profitable that will bring by itself the combined ratio down but then in addition to that, there is these very targeted things that Ed just mentioned to you that we are doing to improve the profitability at the other end of the spectrum.

So I think that's probably -- I kind of put it in those terms to kind of give you a better sense otherwise we're going to keep spinning this one around the table.

Yes, it certainly seems to be a topic that comes up fairly frequently.

Yes.

Switching gears.

And I apologize, I got interrupted in the middle of your prepared remarks.

I'm sure you talked about the agency appointments etc., but you know it is a favorite question of mine.

Where are we with new appointments on a year-to-date basis, etc.?

We added 29, that was in the call, we stand now at 575 and -- 757 excuse me, sorry about that, 757.

And we had 10 agencies that we are consolidating.

What we are working on for you now is more of a storefront number because a lot of our agents every year get consolidated by other Selective agents.

And I think as you continue just to focus in on the actual number of agency contracts that we have you are missing the whole point about how many storefronts we have actually out there selling our product.

And we'd hope to ultimately almost get an idea of how many producers are inside the agency force as well.

So we're going to try to provide better information around that.

But we added 29 and then 10 of our agents this year were consolidated by other Selective agents.

So although that doesn't that show -- that shows as 10 lower in the count instead of 757, we would be at 767 and we still have that same number of horsepower out on the street selling our product.

That's good.

That will be appreciated.

Jim and Chuck want to add maybe something to that.

The only thing I wanted to add to that is we did add seven AMS's -- or our field managers and underwriters out there.

Now we're up to 82 of those.

They typically handle somewhere on an average around 10 agencies.

So part of the reason we do that is to emphasize the appointment of new agencies.

In the comments, did you say something about each AMS handling like $2 million worth of premium or am I --?

$2.5 million of Middle market business. (multiple speakers)

And that's new business.

They write -- so to think about it this way, if you want to do the math, take 82, multiply it by $2.5 million and that's how much theoretically of the average AMS we will write in middle market new business.

On top of that then you have our One & Done pipeline which we are continuing to expand.

We wrote $190,000 per workday in the second quarter.

And then you've got the third element which is the larger end of the market, our SRM, which obviously hasn't been growing as fast so far year-to-date because of the highly competitive nature of that marketplace.

Yes.

I wanted to follow up on that point as well, because I thought I heard the reference to large account business in a couple different spots.

So I thought I'd just step back from a big picture perspective.

You did talk about pressure on pricing for accounts greater than 250.

What are we thinking when we look at Selective, and I understand and appreciate you have a small average premium account size, but what should I be thinking in terms of total premium right now at Selective that is reflective of accounts with 250 premium or greater?

I will tell you that is a measurement that we've now started to track internally.

We have it in bands.

And I will tell you we have it less than 10, 10 to 25, 25 to 50, 50 to 100, over 100.

And we're actually tracking every one of those bands and we're looking at pricing in terms of more than 5% discount, zero to 5, zero, plus 5 -- from zero to 5 positive, and then over 5 positive.

And we are not prepared yet to roll that information out because we still have to go through a little more analysis on what we've got.

And we will be trying to introduce those types of measurements to you, so we will be able to tell you our inventory.

I can tell you the inventory that we have in SRM for last year, Chuck, is about $150 million, I think?

It's about $150 million of premium volume, so you can know that's accounts generally over 250 in nature.

So that I'll throw out there.

I'm sorry to interrupt, but when you're talking about the way that you are tracking this information that you've started to track, you are actually tracking the pricing in each of these bandwidths going all the way down?

Yes.

Without getting into specifics, on the small end of the spectrum are you seeing, you know, the One & Done -- really the small premium business, are you seeing any pressure there whatsoever?

Well, there is a pricing pressure universally, I would say, in the marketplace, particularly in certain pockets.

If we want to talk about our Mid America states in the United States in the Midwestern territory, they're under a certain amount of pressure.

But I would tell you holistically that one of the trends that we see is that the smaller the policy, the less the pressure.

Okay, that makes sense.

One other just follow-up.

I'm sorry I've taken so much time with my questions, but -- actually, I'm not.

Are you getting any pressure from either the competition or from your producers on commissions or contingents or anything like that?

Are you seeing any sort of pressure like that in the system at this point?

I would say that our supplemental commission, we'd rather refer to it as supplemental commission on a side, is clearly in the higher end.

I would say our overall commission rates are in the upper middle tier to even maybe slightly higher than that on just pure base commissions.

And then our supplemental commission program works a lot different than some other companies.

Other people sometimes put caps in their programs so they socialize the commission, or that they pay the most profitable agents to subsidize their weaker performing agents.

We don't do that.

Our supplemental commission right now is targeted at just around 2.7 points of our overall premium.

So if you looked at our expense ratio, 2.7 points of that is our current estimation for what we are going to pay out at the end of the year.

When we disaggregate our supplemental commission numbers and we look at where it goes, the lion's share of that goes to our most profitable agents.

So we truly are rewarding our partners.

So we feel that from an overall compensation standpoint, in addition to everything that we do for our agents in terms of field model, safety management services, field base claim handling, great relationship overall, our commissions are extremely positive.

Okay.

I have other questions, but I will defer to my peers.

Thank you for your answers.

(OPERATOR INSTRUCTIONS) Lara Devieux with Wachovia Securities.

Good morning.

Just a couple of questions.

On the expense ratio, it has kicked up the last couple of quarters.

Can you just talk about what is driving this, and would you consider this to be a run rate going forward?

We haven't broadcasted any kind of a run rate on that.

It is just some of the normal vagaries that you see in the overall process.

And as Greg indicated, we have seen -- the bulk of the movement in our expense ratio over the last few years has really been the fact that we are paying out more in supplemental commissions because of the profitability of our agents.

If you dig into it and get to the underlying overhead component, that has actually been going down over time.

And as Greg indicated, we expect to be 2.7 points or even a shade more on the payout to our agents this year for supplemental commissions.

So would you consider the 30% still your long-term target or the 28%?

Is that what you had commented in the past as your expense ratio target?

In the past what we were looking to do was to get to a 29% expense ratio, and I would say that is still something that ultimately we would like to get to.

But based on the growth that we've seen and the profitability that we're at for payout to our agencies, it has made that a little bit more difficult to get to that level.

But we continue to work on that and continue to have efforts to concentrate on expenses, but we are not committing to a specific time frame on that.

Just to let you know, Lara, our variable expense ratio is a little -- it's like 20.4.

So to give you an idea, what that means is that is commission, premium taxes, bureau dues.

You just take what it costs to write $1 of premium.

Generally, our variable cost, and this kind of ties into Greg's question, so part of that is the commission that we pay to our agents and the supplemental commission as well in there.

So our variable cost are running around 20.4.

That will settle in right around the 20.2 to 20.3 range longer-term.

And then it's like you mentioned, it is the nonvariable piece that we continue to try to -- there is a certain amount of scale.

We've made some very heavy lifts in terms of technology.

Our predictive modeling, I mean that is a very significant effort right now.

Not all of that finding is going into the expense ratio because some of that is capitalized;

I don't want to mislead you.

But there are just so many different initiatives that we have going on that are absolutely critical to our long-term success.

We're not managing down the expense ratio at the sacrifice of doing some of these great initiatives that will really, I think, generate a much longer-term benefit for the Company.

For instance, our AMS apprentice program, we've got a whole host of AMS's in the apprentice program.

That costs money, but yet we need to have an inventory of people so we won't lose a beat in the marketplace.

That is a new initiative started not long ago.

Our producer recruitment program that we offer to agents is something new that we've done.

But we're out there helping our agents hire producers to bring more people into the ranks so they can grow their business and write more business with Selective.

That is another new initiative.

Then we go into our decision support, knowledge management, predictive modeling, all the different activities around the table.

And unfortunately, all come with a cost associated with them.

They all have paybacks that are very high.

But yet there always seems to be a bit of drag upfront.

And I think part of it is we need to break out of this 1.5 billion, 1.6 billion premium level that we are in.

Some of it is a scale situation.

We are very comfortable in the 20 states that we are in.

We feel like, as I mentioned before in my prepared comments, 50% of the Commercial Lines business in the United States is in the 20 states that we operate in.

So how much opportunity is there for us to grow?

A huge amount of opportunity.

And we are doing it now, like Jim mentioned, more AMS's, more agencies that we're adding to the pipeline, deeper penetration in the agencies that we are in, and I think all those things are kind of coming together for us as an organization.

The last thing I'll point out, Lara, is more of a mathematical thing if you're looking at a statutory expense ratio, is that the way our premium comes in, we tend to have 53% to 55% of our premium occurs in the first half of the year.

So if you are looking at sequential quarters, you see movement in the expense ratio because of the overall premium volume, first quarter being a heavier premium quarter and, therefore, the expense ratio is much lower that quarter.

Okay, thanks.

That was helpful.

Then just one more question.

Can you just talk about the implications of the ratings upgrade that you received yesterday?

On the positive, are there any benefits to having -- from having an A+ versus an A?

And then on the negative, would this possibly impede your ability to return capital through buybacks?

Well, I will tell you that overall -- I mean, obviously, agents are very dialed into the A.M.

Best rating.

A lot of agents, some agents also focused on the S&P rating.

I think from a business standpoint out there, it's just another signal about the financial strength of the organization.

Another reason that they should sit there and say we should consolidate more and more of our business with Selective, a very strong company, in the marketplace.

So I think that is just again a positive affirmation on that.

In terms of obviously going out to the street in any kind of offering, having now both -- or having all three rating agencies, Fitch, A.M.

Best and S&P at A+ could be a positive in terms of any kind of deal that we did may help get some compression in terms of interest rates that we would go.

Then we also have a line of credit internally that is targeted off of ratings.

So there is some benefit on that side.

So I would say access to Capital Markets may be now slightly increased for some other products that we may now have access to.

I'm not saying we're going out and doing anything today.

But you are asking the question and I'm trying to answer it holistically, so it may give us some flexibility in that area for some things that we may have the capability to do now, or do even cheaper.

And then as far as any kind of buyback activity or anything like that, our capital management activities, what we've said in the past still holds in terms of our desire to manage our capital for maximizing shareholder returns, whether that be share buybacks or increasing dividends or debt issuance or any other type of thing like that.

So we just view this as a positive in helping us to manage our overall capital levels.

Okay, great.

Thank you.

(OPERATOR INSTRUCTIONS) Dan Baransky from Fox-Pitt, Kelton.

I had a few questions.

If we look at your price, the 2.2% rate plus exposures that you put out there, where could we think of that versus where loss trends are overall?

I'm sorry, could you just say that again?

I'm sorry, I didn't hear you, 2.2 --.

In your press release you have, you said that rates plus exposure were up 2.2%.

And I'm just curious, where does that sort of fall, and when you think about loss trends specifically is it kind of still sort of breakeven or keeping ahead of loss trends, or how should we think about that?

And Ron Zaleski, our Chief Actuary, will discuss that with you.

This is Ron.

Our loss costs for total Commercial Lines is up about 2.8%.

Okay, all right.

In New Jersey, your 102 -- I guess you had a 102 loss ratio, combined ratio in the quarter.

Yes.

Is that actual real losses flowing through or is that just some conservatism baked in based on the New Jersey ruling?

Well, I will let John Marchioni kind of just go through the whole philosophy of New Jersey personal lines.

But the numbers are the numbers, so that is what we are seeing.

We have -- obviously, there is a lot more competition in New Jersey pricing-wise out on the street.

We have seen -- we were one of the few companies that recognized the New Jersey Supreme Court decision on the verbal threshold.

If you recall, we did put money up for that last year, and we are seeing an increase in severity in our liability book as a result of that.

So we have definitely seen an uptick and we have been always responding to that.

We put the reserve increase up last year and we increased at that time our run rate for costs in that program.

John, what do you want to add to that if anything?

It was a kind of specific question there.

I mean, I can go into a little bit more detail relative to New Jersey.

Clearly, that is built into our costs going forward.

But what we are doing with New Jersey personal auto is not unlike what our comp strategy is.

Our posture the last two years as the market has changed has really started to hit us on the results side.

Our ability to go out and write business at more profitable levels based on a predictive model base pricing methodology is going to benefit us in the long run.

So we will see that number over time on a car count and a combined ratio basis start to float back in the right direction based on that.

Okay, great.

Thanks.

On the growth in the Commercial Lines in the quarter and your commentary on the increased competitiveness for larger account business, is the growth -- are you still growing in the large account business in the quarter?

Was there any growth in the quarter, or is that sort of being pulled back and the smaller comp business is sort of the driver of the growth?

Well, we wrote $8 million of new business in that segment, and that is how basically we are reporting to you how much new business that we wrote.

We wrote $8 million of new business.

That was down year-on-year 25%, just to give you an idea as to -- are we writing that business?

Yes, but we are clearly picking our spots and there are clear indications of some accounts that we have put pricing out and we didn't write it, but other people have written it at 30% or 40% off in some cases what our premium on the street, our pricing was.

So are we writing it?

Yes, but we are being very careful.

And just to let you know, when we say being very careful, we have two actuaries that sit in that unit that are part of that pricing process.

So when we put a number out on the street in terms of our technical premium pricing, it is supported by some pretty substantial efforts behind it.

A lot of other companies are out there.

They are being a lot more aggressive for that style of business.

They're larger accounts, they can better meet their premium goals by doing that.

But the interesting thing is tough as that market has been, we've been able to retain 92% of our existing inventory.

And you may sit there and say, well, why were you able to do that if pricing is so tight in that space?

And I will tell you there it's because of the real high touch -- when a larger account comes in like that, there's one thing you know; they're going to have a certain amount of claim activity.

They have significant safety management initiatives and needs and desires.

I will tell you that is an area where we have field people out there providing those services.

Most other companies, particularly the larger ones, are not -- they are doing these things over the phone.

They don't offer sometimes safety management.

If you want to do safety management, the customer has got to pay for that.

So we are offering a lot of services in that area that once we get into an account and develop that kind of relationship, those are the kind of customer services that when a client looks at another price from someone else, they are going to stay with us.

And our retention clearly indicate that.

Our retention on that business at 92; our profitability in that segment of the market through the five months of May is less than a -- combined ratio on a statutory basis is less than 90.

So that business is profitable, it's sticking.

We're getting renewal price increases on it where we need to get, but we are also providing very, very heavy customer service in that space.

Great, thanks.

That is great information.

Last question I had is did you give any sense -- I'm sorry, I logged in a little late for the call.

On the reinsurance purchases you did, were they kind of up, flat, sideways with the year-ago costs of that reinsurance program?

Yes.

Dale will take that.

Yes, we did, though.

We did give that information, and basically if you look at the property excess of loss treaty, the estimated ceded premium for that is $8.7 million, and that is down from $9.1 million in the prior fiscal year.

And if you look at the casualty treaty, that is basically flat at $9 million for each year, although the workers' comp treaty is up from $4.3 million to $5 million in estimated ceded premium.

So some modest increases there across those two major programs.

And the other thing just to add to that, Dan, we did -- as Dale mentioned, we added a $30 million stretch to our property CAT program, and that $30 million stretch went for a five online.

So that is $1.5 million -- approximately $1.5 million additional expense in 2006 for that program.

Great, thanks.

I have no further questions.

Thanks a lot.

(OPERATOR INSTRUCTIONS) There are no further questions at this time.

All right, thank you, operator.

If you have any follow-ups, Jennifer and Dale are available for any additional comments.

Thank you all very much.

That does conclude today's conference.

Thank you for attending and have a great day.