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SELECTIVE INSURANCE GROUP INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
[April 24, 2014]

SELECTIVE INSURANCE GROUP INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS


(Edgar Glimpses Via Acquire Media NewsEdge) Forward-Looking Statements In this Quarterly Report on Form 10-Q, we discuss and make statements regarding our intentions, beliefs, current expectations, and projections regarding our company's future operations and performance. Such statements are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are often identified by words such as "anticipates," "believes," "expects," "will," "should," and "intends" and their negatives. We caution prospective investors that such forward-looking statements are not guarantees of future performance.



Risks and uncertainties are inherent in our future performance. Factors that could cause actual results to differ materially from those indicated by such forward-looking statements include, but are not limited to, those discussed under Item 1A. "Risk Factors" below in Part II "Other Information." These risk factors may not be exhaustive. We operate in a continually changing business environment and new risk factors emerge from time to time. We can neither predict such new risk factors nor can we assess the impact, if any, of such new risk factors on our businesses or the extent to which any factor or combination of factors may cause actual results to differ materially from those expressed or implied in any forward-looking statements in this report. In light of these risks, uncertainties, and assumptions, the forward-looking events discussed in this report might not occur. We make forward-looking statements based on currently available information and assume no obligation to update these statements due to changes in underlying factors, new information, future developments, or otherwise.

Introduction We classify our business into three operating segments: • Our Standard Insurance Operations segment, which is comprised of both commercial lines ("Commercial Lines") and personal lines ("Personal Lines") business, sells property and casualty insurance products and services in the standard market, including flood insurance through the National Flood Insurance Program's ("NFIPs") write-your-own ("WYO") program; • Our E&S Insurance Operations segment sells Commercial Lines property and casualty insurance products and services to insureds who have not obtained coverage in the standard market; and • Our Investments segment, which invests the premiums collected by our Standard and E&S Insurance Operations and amounts generated through our capital management strategies, which may include the issuance of debt and equity securities.


Our Standard Insurance Operations products and services are sold through nine subsidiaries that write Commercial Lines and Personal Lines business, some of which write flood business through the NFIP's WYO program.

Our E&S Insurance Operations products and services are sold through one subsidiary. This subsidiary, Mesa Underwriters Specialty Insurance Company ("MUSIC"), provides us with a nationally-authorized non-admitted platform to write commercial and personal E&S lines business.

Our ten insurance subsidiaries are collectively referred to as the "Insurance Subsidiaries." The purpose of Management's Discussion and Analysis ("MD&A") is to provide an understanding of the consolidated results of operations and financial condition and known trends and uncertainties that may have a material impact in future periods. Consequently, investors should read the MD&A in conjunction with the consolidated financial statements in our 2013 Annual Report filed with the U.S.

Securities and Exchange Commission ("SEC").

In the MD&A, we will discuss and analyze the following: • Critical Accounting Policies and Estimates; • Financial Highlights of Results for First Quarter 2014 and First Quarter 2013; • Results of Operations and Related Information by Segment; • Federal Income Taxes; • Financial Condition, Liquidity, Short-term Borrowings, and Capital Resources; • Ratings; • Off-Balance Sheet Arrangements; and • Contractual Obligations, Contingent Liabilities, and Commitments.

24-------------------------------------------------------------------------------- Table of Contents Critical Accounting Policies and Estimates These unaudited interim consolidated financial statements include amounts based on our informed estimates and judgments for those transactions that are not yet complete. Such estimates and judgments affect the reported amounts in the consolidated financial statements. Those estimates and judgments most critical to the preparation of the consolidated financial statements involve the following: (i) reserves for loss and loss expenses; (ii) pension and post-retirement benefit plan actuarial assumptions; (iii) other-than-temporary investment impairments; and (iv) reinsurance. These estimates and judgments require the use of assumptions about matters that are highly uncertain and, therefore, are subject to change as facts and circumstances develop. If different estimates and judgments had been applied, materially different amounts might have been reported in the financial statements. For additional information regarding our critical accounting policies, refer to our 2013 Annual Report, pages 44 through 52.

Financial Highlights of Results for First Quarter 2014 and First Quarter 20131 Quarter ended March 31, ($ and shares in thousands, except per share Change amounts) 2014 2013 % or Points Generally Accepted Accounting Principles ("GAAP") measures: Revenues $ 509,071 459,949 11 % Pre-tax net investment income 35,534 32,870 8 Pre-tax net income 25,084 27,333 (8 ) Net income 17,974 21,308 (16 ) Diluted net income per share 0.31 0.38 (18 ) Diluted weighted-average outstanding shares 57,172 56,455 1 GAAP combined ratio 101.1 % 97.1 4.0 pts Statutory combined ratio2 100.8 % 96.8 4.0 Return on average equity 6.1 % 7.7 (1.6 ) Non-GAAP measures: Operating income3 $ 13,283 20,124 (34 ) % Diluted operating income per share3 0.23 0.36 (36 ) Operating return on average equity3 4.5 % 7.2 (2.7 ) pts 1 Refer to the Glossary of Terms attached to our 2013 Annual Report as Exhibit 99.1 for definitions of terms used in this Form 10-Q.

2 The statutory combined ratio for First Quarter 2013 included 1.3 points related to the Retirement Income Plan amendments that curtailed the accrual of additional benefits for all eligible employees participating in the plans after March 31, 2016.

3 Operating income is used as an important financial measure by us, analysts, and investors, because the realization of investment gains and losses on sales in any given period is largely discretionary as to timing. In addition, these realized investment gains and losses, as well as other-than-temporary impairments ("OTTI") that are charged to earnings and the results of discontinued operations, could distort the analysis of trends. See below for a reconciliation of operating income to net income in accordance with GAAP.

Operating return on average equity is calculated by dividing annualized operating income by average stockholders' equity.

The following table reconciles operating income and net income for the periods presented above: Quarter ended March 31, ($ in thousands, except per share amounts) 2014 2013 Operating income $ 13,283 20,124 Net realized gains, net of tax 4,691 2,181 Loss on disposal of discontinued operations, net of tax - (997 ) Net income $ 17,974 21,308 Diluted operating income per share $ 0.23 0.36 Diluted net realized gains per share 0.08 0.04 Diluted net loss from disposal of discontinued operations per share - (0.02 ) Diluted net income per share $ 0.31 0.38 25-------------------------------------------------------------------------------- Table of Contents Over the long term, we target a return on average equity that is three points higher than our cost of capital, or 12%, excluding the impact of realized gains and losses, which is referred to as operating return on average equity. Our operating return on average equity was 4.5% in First Quarter 2014 compared to 7.2% in First Quarter 2013. Our operating return on average equity contribution by component is as follows: Operating Return on Average Equity Quarter ended March 31, 2014 2013 Standard Insurance Operations (1.3 )% 2.8 % E&S Insurance Operations 0.2 % - Investments 9.1 % 8.9 % Other (3.5 )% (4.5 )% Total 4.5 % 7.2 % Our operating return on average equity in First Quarter 2014 reflects a higher GAAP combined ratio of 101.1% compared to 97.1% in First Quarter 2013. Extreme winter weather was a significant driver of our First Quarter 2014 results.

Information concerning these property losses, as well as other variances are as follows: • Catastrophe losses for First Quarter 2014 were $34 million, or 7.5 points, compared to $1.6 million, or 0.4 points, in First Quarter 2013. The majority of these catastrophe losses were attributed to weather events defined by Insurance Services Office property claims service ("PCS") as CATs 31 and 32 in January, which brought freezing temperatures and snowstorms to our 22-state standard lines footprint.

• Non-catastrophe property losses in First Quarter 2014 that were at one of the highest levels that we have experienced in recent years. The impact varied by line but, for both standard lines and E&S, non-catastrophe property losses for First Quarter 2014 were approximately $91 million, or 20 points, on our total combined ratio. This was about 5 points higher than First Quarter 2013 and 6 points higher than the non-catastrophe property loss quarterly average over the last three-year period. These non-catastrophe property losses were primarily the result of roof collapses, frozen pipes, and fires which were often related to the extreme weather experienced throughout our footprint states.

Partially offsetting these losses were: • Renewal pure price increases of 7.6% that we achieved in full-year 2013, which are currently earning in at about 7.3%. This earned rate is above the loss cost trend of approximately 3%. After taking into account the incremental expenses associated with the additional premium, the net benefit to the combined ratio is about 2.5 points.

• Favorable prior year casualty development in First Quarter 2014 that was $14 million, or 3.1 points, compared to favorable prior year casualty development of $2 million, or 0.4 points, in First Quarter 2013. We experienced stable workers compensation trends in the quarter with no development either favorable or unfavorable. The level of releases in First Quarter 2014 was driven by improving claim trends within our general liability line of business for the 2009 through 2012 accident years.

• $8 million, or 1.8 points, in other income for the March 2014 sale of the renewal rights to our self-insured group, or "SIG," book of pooled public entity business. Although we did not solicit buyers, we decided to sell this very small and specialized book of business when the opportunity presented itself because it had significant production outside of our standard lines footprint, and proved difficult to grow. We, however, have retained our substantial individual risk public entity book of business and we will continue to look for opportunities to grow it.

The remaining fluctuation in our operating return on average equity was driven by reduced corporate expenses that included the following: (i) the First Quarter 2013 redemption of our previously outstanding 7.50% Junior Subordinated Notes due 2066, that resulted in capitalized debt issue costs of $3.3 million, pre-tax, being charged to expense; and (ii) reduced long-term employee compensation expense associated with changes in our stock price. These items are captured within the "Other" component in the table above.

26-------------------------------------------------------------------------------- Table of Contents The following table provides a quantitative foundation for analyzing our overall Insurance Subsidiaries' underwriting results: All Lines Quarter ended March 31, ($ in thousands) 2014 2013 Change % or Points GAAP Insurance Operations Results: Net premiums written ("NPW") $ 476,750 450,124 6 % Net premiums earned ("NPE") 456,495 420,940 8 Less: Loss and loss expense incurred 320,546 269,849 19 Net underwriting expenses incurred 139,726 137,844 1 Dividends to policyholders 1,238 1,086 14 Underwriting (loss) gain $ (5,015 ) 12,161 (141 ) % GAAP Ratios: Loss and loss expense ratio 70.2 % 64.1 6.1 pts Underwriting expense ratio 30.6 32.7 (2.1 ) Dividends to policyholders ratio 0.3 0.3 - Combined ratio 101.1 97.1 4.0 Statutory Ratios: Loss and loss expense ratio1 70.2 64.1 6.1 Underwriting expense ratio1 30.3 32.4 (2.1 ) Dividends to policyholders ratio 0.3 0.3 - Combined ratio1 100.8 % 96.8 4.0 pts 1 Statutory ratios for First Quarter 2013 included 0.3 points in the loss and loss expense ratio, 1.0 points in the underwriting ratio, and 1.3 points in the combined ratio related to the Retirement Income Plan amendments that curtailed the accrual of additional benefits for all eligible employees participating in the plans after March 31, 2016.

The growth in NPW for our Insurance Subsidiaries in First Quarter 2014 compared to First Quarter 2013 was primarily driven by renewal pure price increases and strong retention in our Standard Commercial Lines Insurance Operations.

NPE increases in First Quarter 2014 were consistent with the fluctuations in NPW for the twelve-month period ended March 31, 2014 compared to the twelve-month period ended March 31, 2013.

The increase in the combined ratio for First Quarter 2014 was primarily driven by property results that were impacted by extreme winter weather. For a discussion on these property losses as well as other variances, see the discussion above.

Outlook In their 2013 year-end review, dated February 4, 2014, A.M. Best and Company ("A.M. Best") projected an industry combined ratio of 99.4% for 2014. Their report cited: "In looking ahead to 2014, A.M. Best expects premiums to continue growing through price increases, but the pace of these rate changes are expected to slow and temper growth in premium." Underwriting results should improve slightly on the rate level achieved in recent years, although less favorable development of prior years' loss reserves is anticipated. In addition, a more normal level of catastrophe losses could increase combined ratios by almost 200 basis points, and the industry will continue to be challenged by the relatively low investment yields that are expected to persist through 2014, as well as the slow recovery from the recession of 2007 through 2009.

Although A.M. Best is continuing to maintain its negative outlook for the commercial lines market reflecting "the uncertainty around loss-reserve development and continued low profit margins driven by low investment yields," it anticipates a 99.9% statutory combined ratio driven by: (i) a more normal level of catastrophe losses; (ii) less favorable loss-reserve development; and (iii) loss trends that are partially offset by lower pricing. For personal lines, A.M. Best maintains a stable outlook in the coming year reflecting ongoing stability of the auto line and successful carriers continuing to enhance the granularity of their home pricing models. Standard & Poor's ("S&P"), while maintaining a stable outlook on the property and casualty industry, believes that "rate increases will lose steam and fail to outpace loss cost trends" in 2014.

In early 2012, we laid out a three-year plan to achieve overall annual renewal pure price increases of 5% to 8%. Our expectation for full-year 2014 is 6% to 7%, and we achieved 6.4% in First Quarter 2014. In addition, we are revising our previously disclosed expectations for our Standard Personal Lines and our E&S Lines as we are currently expecting this business, as well as our Standard Commercial Lines business, to each achieve renewal pure price increases of 6% to 7% for 27-------------------------------------------------------------------------------- Table of Contents full-year 2014. In our Standard Commercial Lines, we have achieved renewal pure price increases for 20 consecutive quarters, including 6.4% for First Quarter 2014, 7.6% for full-year 2013, and 6.3% for full-year 2012. The 7.6% renewal pure price increase in 2013 translated into earned price increases of 7.3% in First Quarter 2014 which is above loss cost trends of approximately 3%. The 6% to 7% overall renewal pure price increases that we expect to achieve in 2014 are also above loss cost trends, and will continue to add to profitability in 2015.

Furthermore in First Quarter 2014, we achieved renewal pure price increases of 6.8% in our Standard Personal Lines, and 4.1% in our E&S Lines.

Our First Quarter 2014 statutory combined ratio, excluding catastrophes, was 93.3%, which is in line with our stated full-year 2014 goal of 92%. The catastrophe losses in First Quarter 2014 of $34 million added 7.5 points to our statutory combined ratio, compared to our full-year catastrophe loss expectation of four points. This increased level of catastrophe losses was related to extreme winter weather, primarily driven by weather events defined by PCS as CATs 31 and 32 in January.

The yield on the 10-year U.S. Treasury Notes fell by 31 basis points in First Quarter 2014. The continued low interest rate environment has several significant impacts on our business, some of which are beneficial and some of which present a challenge to us. The benefits include lower inflation rates that suppress loss trends, as well as reduce our cost of capital. However, the interest rate environment presents a significant challenge in generating after-tax return on our investment portfolio as fixed income securities mature and money is re-invested at lower rates. Because maturing and called bonds generally carry a higher book yield than is available in the current market, we expect the yield on the overall investment portfolio to continue to decline, albeit at a less significant pace than we have been experiencing.

In 2014, we expect to generate: • A full-year combined ratio of 92% excluding catastrophe losses and assuming no additional prior year casualty reserve development; • Four points of catastrophe losses for the year; • After-tax investment income of approximately $100 million; and • Weighted-average shares of approximately 57.4 million.

28-------------------------------------------------------------------------------- Table of Contents Results of Operations and Related Information by Segment Insurance Operations Standard Insurance Operations Our Standard Insurance Operations segment, which represents 93% of our combined insurance operations NPW, sells insurance products and services primarily in 22 states in the Eastern and Midwestern U.S. and the District of Columbia, through approximately 1,100 independent retail insurance agencies. This segment consists of two components: (i) Commercial Lines, which markets primarily to businesses and represents approximately 83% of the segment's NPW; and (ii) Personal Lines, including our flood business, which markets primarily to individuals and represents approximately 17% of the segment's NPW.

Quarter ended March 31, Change % or ($ in thousands) 2014 2013 Points GAAP Insurance Operations Results: NPW $ 446,688 421,744 6 % NPE 424,259 390,881 9 Less: Loss and loss expense incurred 300,666 250,731 20 Net underwriting expenses incurred 128,345 126,989 1 Dividends to policyholders 1,238 1,086 14 Underwriting (loss) gain $ (5,990 ) 12,075 (150 ) % GAAP Ratios: Loss and loss expense ratio 70.9 % 64.1 6.8 pts Underwriting expense ratio 30.2 32.5 (2.3 ) Dividends to policyholders ratio 0.3 0.3 - Combined ratio 101.4 96.9 4.5 Statutory Ratios: Loss and loss expense ratio1 70.9 64.2 6.7 Underwriting expense ratio1 29.9 32.3 (2.4 ) Dividends to policyholders ratio 0.3 0.3 - Combined ratio1 101.1 % 96.8 4.3 pts 1 Statutory ratios for First Quarter 2013 included 0.3 points in the loss and loss expense ratio, 1.1 points in the underwriting ratio, and 1.4 points in the combined ratio related to the Retirement Income Plan amendments that curtailed the accrual of additional benefits for all eligible employees participating in the plans after March 31, 2016.

The improvements in NPW in First Quarter 2014 compared to First Quarter 2013 include the following: Quarter ended March 31, Quarter ended March 31, 2014 2013 Renewal Renewal Pure Price Pure Price ($ in millions) Increase Retention Increase Retention Standard Commercial Lines 6.4 % 84 % 7.5 % 83 % Standard Personal Lines 6.8 82 8.5 87 The decrease in the Standard Personal Lines retention was driven by targeted actions that we have taken to reduce our exposure to certain coverages that have historically been less profitable for us. Excluding the impact of these targeted actions, retention remains strong and comparable to last year.

NPE increases in First Quarter 2014 were consistent with the fluctuations in NPW for the twelve-month period ended March 31, 2014 as compared to the twelve-month period ended March 31, 2013.

29-------------------------------------------------------------------------------- Table of Contents The GAAP loss and loss expense ratio increased 6.8 points in First Quarter 2014 compared to First Quarter 2013. The increase in this ratio was primarily driven by extreme winter weather, including: (i) an increased level of catastrophe losses; and (ii) higher non-catastrophe property losses. These losses were partially offset by: (i) Standard Insurance Operations renewal pure price increases that amounted to 6.5% in First Quarter 2014 and 7.6% in full year 2013, the earning of which exceeds our 3% projected loss trend; and (ii) favorable prior year casualty reserve development. Quantitative information regarding the property losses and the reserve development is as follows: First Quarter 2014 First Quarter 2013 Impact on Impact on Loss and Loss Expense Loss and Loss Loss and Loss Loss and Loss Change in ($ in millions) Incurred Expense Ratio Expense Incurred Expense Ratio Ratio Catastrophe losses $ 34.2 8.1 pts 1.3 0.3 pts 7.8 Non-catastrophe property losses 86.2 20.3 60.7 15.5 4.8 Favorable prior year casualty reserve development (14.0 ) (3.3 ) (2.5 ) (0.6 ) (2.7 ) The breakdown of favorable prior year casualty reserve development in our Standard Insurance Operations by line of business is as follows: Favorable/(Unfavorable) Prior Year Casualty Reserve Development Quarter ended March 31, ($ in millions) 2014 2013 General liability $ 11.0 4.0 Commercial automobile - - Workers compensation - (7.5 ) Businessowners' policies 1.0 3.0 Homeowners - 1.5 Personal automobile 2.0 1.0 Other $ - 0.5 Total favorable prior year casualty reserve development $ 14.0 2.5 Favorable impact on loss ratio 3.3 pts 0.6 pts Favorable prior year casualty reserve development of $14 million in First Quarter 2014 was driven by improving claim trends for the 2009 through 2012 accident years on our general liability line of business. Excluding the impact of the workers compensation line of business prior year development in First Quarter 2013, the remainder of the casualty lines experienced a level of development comparable in First Quarter 2014 to First Quarter 2013.

The improvement in the GAAP underwriting expense ratio of 2.3 points in First Quarter 2014 compared to First Quarter 2013 was primarily driven by income generated from the renewal rights sale of our SIG book of business for $8 million, or 1.9 points. For additional information regarding the sale, see Note 8. "Segment Information" in Item 1. "Financial Statements" of this Form 10-Q.

30-------------------------------------------------------------------------------- Table of Contents Review of Underwriting Results by Line of Business Standard Commercial Lines Quarter ended March 31, Change % or ($ in thousands) 2014 2013 Points GAAP Insurance Operations Results: NPW $ 379,350 353,189 7 % NPE 349,441 317,845 10 Less: Loss and loss expense incurred 242,639 203,139 19 Net underwriting expenses incurred 109,194 107,518 2 Dividends to policyholders 1,238 1,086 14 Underwriting (loss) gain $ (3,630 ) 6,102 159 % GAAP Ratios: Loss and loss expense ratio 69.4 % 63.9 5.5 pts Underwriting expense ratio 31.2 33.9 (2.7 ) Dividends to policyholders ratio 0.4 0.3 0.1 Combined ratio 101.0 98.1 2.9 Statutory Ratios: Loss and loss expense ratio1 69.4 63.9 5.5 Underwriting expense ratio1 30.5 33.4 (2.9 ) Dividends to policyholders ratio 0.4 0.3 0.1 Combined ratio1 100.3 % 97.6 2.7 pts 1 Statutory ratios for First Quarter 2013 included 0.4 points in the loss and loss expense ratio, 1.0 points in the underwriting ratio, and 1.4 points in the combined ratio related to the Retirement Income Plan amendments that curtailed the accrual of additional benefits for all employees eligible to participate in the plans after March 31, 2016.

The increase in NPW in First Quarter 2014 compared to First Quarter 2013 is primarily the result of the following: Quarter ended March 31, ($ in millions) 2014 2013 Retention 84 % 83 Renewal pure price increases 6.4 7.5 NPE increases in First Quarter 2014 were consistent with the fluctuations in NPW for the twelve-month period ended March 31, 2014 compared to the twelve-month period ended March 31, 2013.

The GAAP loss and loss expense ratio increased 5.5 points in First Quarter 2014 compared to First Quarter 2013 driven by extreme winter weather, including: (i) an increased level of catastrophe losses; and (ii) higher non-catastrophe property losses. These losses were partially offset by the following: (i) renewal pure price increases that averaged 6.4% in First Quarter 2014 and 7.6% in full-year 2013, the earning of which exceeds our projected loss trend of approximately 3%; and (ii) favorable prior year casualty reserve development.

Quantitative information regarding the property losses and the reserve development is as follows: First Quarter 2014 First Quarter 2013 Impact on Losses Impact on ($ in millions) Losses Incurred Loss Ratio Incurred Loss Ratio Change in Ratio Catastrophe losses $ 25.9 7.4 pts 0.7 0.2 pts 7.2 pts Non-catastrophe property losses 58.8 16.8 37.0 11.6 5.2 Favorable prior year casualty reserve development (12.0 ) (3.5 ) (0.5 ) (0.1 ) (3.4 ) The improvement in the GAAP underwriting expense ratio of 2.7 points in First Quarter 2014 compared to First Quarter 2013 was primarily driven by the income generated from the renewal rights sale of our SIG book of business for $8 million, or 2.3 points. For additional information regarding the sale, see Note 8. "Segment Information" in Item 1. "Financial Statements" of this Form 10-Q.

31-------------------------------------------------------------------------------- Table of Contents The following is a discussion of our most significant standard Commercial Lines of business and their respective statutory results: General Liability Quarter ended March 31, Change % or ($ in thousands) 2014 2013 Points Statutory NPW $ 119,504 109,405 9 % Direct new business 19,835 19,781 - Retention 84 % 83 1 pts Renewal pure price increases 7.6 % 8.5 (0.9 ) Statutory NPE 108,818 97,703 11 % Statutory combined ratio 80.7 % 95.9 (15.2 ) pts % of total statutory standard Commercial Lines NPW 32 % 31 The growth in NPW and NPE for our general liability business in First Quarter 2014 reflects renewal pure price increases and strong retention.

The statutory combined ratio improvement for First Quarter 2014 was driven by renewal pure price increases of 7.6% that continue to outpace loss cost trends on this line as well as the following: First Quarter 2014 First Quarter 2013 Impact on Impact on (Benefit) Combined Change ($ in millions) (Benefit) Expense Combined Ratio Expense Ratio Points Favorable prior year casualty reserve development $ (11.0 ) (10.1 ) pts (4.0 ) (4.1 ) pts (6.0 ) pts Sale of SIG renewal rights (2.1 ) (1.8 ) - - (1.8 ) Retirement Income Plan curtailment charge - - 1.4 1.3 (1.3 ) Commercial Automobile Quarter ended March 31, Change % or ($ in thousands) 2014 2013 Points Statutory NPW $ 89,122 81,872 9 % Direct new business 14,806 14,904 (1 ) Retention 83 % 83 - pts Renewal pure price increases 6.2 % 7.0 (0.8 ) Statutory NPE 82,216 74,347 11 % Statutory combined ratio 94.9 % 98.0 (3.1 ) pts % of total statutory standard Commercial Lines NPW 23 % 23 The growth in NPW and NPE for our commercial automobile business in First Quarter 2014 reflects renewal pure price increases and strong retention.

The statutory combined ratio improvement for First Quarter 2014 is primarily driven by the following: (i) earned price increases that are outpacing loss costs on this line of business; (ii) income of 1.7 points related to the the renewal rights sale of our SIG book of business; and (iii) the Retirement Income Plan curtailment charge that increased the overall combined ratio by 1.3 points for First Quarter 2013.

32-------------------------------------------------------------------------------- Table of Contents Workers Compensation Quarter ended March 31, Change % or ($ in thousands) 2014 2013 Points Statutory NPW $ 75,971 75,405 1 % Direct new business 13,658 13,879 (2 ) Retention 82 % 82 - pts Renewal pure price increases 4.9 % 8.1 (3.2 ) Statutory NPE 69,413 66,084 5 % Statutory combined ratio 105.9 % 118.9 (13.0 ) pts % of total statutory standard Commercial Lines NPW 20 % 21 First Quarter 2014 NPW remained consistent with First Quarter 2013. NPE increases in First Quarter 2014 were consistent with the fluctuations in NPW for the twelve-month period ended March 31, 2014 compared to the twelve-month period ended March 31, 2013.

While we continue to view workers compensation in the context of an overall account, we remain very focused on improving this competitive line of business through underwriting, where we achieved renewal pure price increases of 4.9% for First Quarter 2014. We are applying all the underwriting tools we have to move pricing higher and write the best risks. We also have a number of claims initiatives aimed at proactively managing return-to-work programs and higher severity claims.

The improvement in the statutory combined ratio was primarily attributable to the following: First Quarter 2014 First Quarter 2013 Impact on Impact on (Benefit) Combined Change ($ in millions) (Benefit) Expense Combined Ratio Expense Ratio Points Unfavorable prior year casualty reserve development $ - - pts $ 7.4 11.1 pts (11.1 ) pts Sale of SIG renewal rights (1.5 ) (2.0 ) - - (2.0 ) Retirement Income Plan curtailment charge - - 1.2 1.7 (1.7 ) The First Quarter 2013 unfavorable prior year casualty reserve development was primarily driven by development on the 2012 accident year and a single large claim prior to 2003.

Commercial Property Quarter ended March 31, Change % or ($ in thousands) 2014 2013 Points Statutory NPW $ 64,096 57,760 11 % Direct new business 14,495 14,385 1 Retention 83 % 82 1 pts Renewal pure price increases 5.5 % 5.6 (0.1 ) Statutory NPE 60,186 53,415 13 % Statutory combined ratio 131.4 % 86.6 44.8 pts % of total statutory standard Commercial Lines NPW 17 % 16 NPW and NPE increased in First Quarter 2014 compared to First Quarter 2013 primarily due to renewal pure price increases and strong retention.

33-------------------------------------------------------------------------------- Table of Contents The increase in the statutory combined ratio in First Quarter 2014 compared to the same prior year period was due to: First Quarter 2014 First Quarter 2013 Change Impact on (Benefit) Impact on % or ($ in millions) (Benefit) Expense Combined Ratio Expense Combined Ratio Points Catastrophe losses $ 18.9 31.5 pts 1.8 3.4 pts 28.1 pts Non-catastrophe property losses 36.4 60.5 20.6 38.6 21.9 Sale of SIG renewal rights (1.4 ) (2.2 ) - - (2.2 ) Retirement Income Plan curtailment charge - - 0.8 1.5 (1.5 ) Standard Personal Lines Quarter ended March 31, Change % or ($ in thousands) 2014 2013 Points GAAP Insurance Operations Results: NPW $ 67,338 68,555 (2 ) % NPE 74,818 73,036 2 Less: Loss and loss expense incurred 58,027 47,592 22 Net underwriting expenses incurred 19,151 19,471 (2 ) Underwriting (loss) gain $ (2,360 ) 5,973 (140 ) % GAAP Ratios: Loss and loss expense ratio 77.6 % 65.2 12.4 pts Underwriting expense ratio 25.6 26.6 (1.0 ) Combined ratio 103.2 91.8 11.4 Statutory Ratios: Loss and loss expense ratio1 77.6 65.3 12.3 Underwriting expense ratio1 26.9 27.1 (0.2 ) Combined ratio1 104.5 % 92.4 12.1 pts 1 Statutory ratios for First Quarter 2013 included 0.1 points in the loss and loss expense ratio, 1.2 points in the underwriting ratio, and 1.3 points in the combined ratio related to the Retirement Income Plan amendments that curtailed the accrual of additional benefits for all employees eligible to participate in the plans after March 31, 2016.

The decrease in NPW is primarily driven by a decrease in new business of $1.9 million. Partially offsetting this decrease are the following: Quarter ended March 31, ($ in millions) 2014 2013 Retention 82 % 87 Renewal pure price increase 6.8 8.5 The decrease in retention was driven by targeted actions that we have taken to reduce our exposure to certain coverages that have historically been less profitable for us. Excluding the impact of these targeted actions, retention remains strong and comparable to last year.

NPE increases in First Quarter 2014 compared to First Quarter 2013, are consistent with the fluctuations in NPW for the twelve-month period ended March 31, 2014 as compared to the twelve-month period ended March 31, 2013.

34-------------------------------------------------------------------------------- Table of Contents The variance in the loss and loss expense ratios was driven by extreme winter weather, including: (i) an increased level of catastrophe losses; and (ii) higher non-catastrophe property losses. Partially offsetting these losses were renewal pure price increases of 6.8% for First Quarter 2014 and 7.8% for full-year 2013, the earning of which exceeds our projected loss cost trend for the casualty component of our Personal Lines. Quantitative information regarding the property losses are as follows: First Quarter 2014 First Quarter 2013 Impact on Impact on Loss and Loss and Loss and Loss Loss Loss and Loss Loss Expense Expense Expense Expense ($ in millions) Incurred Ratio Incurred Ratio Change in Ratio Catastrophe losses $ 8.3 11.1 pts 0.5 0.7 pts 10.4 pts Non-catastrophe property losses 27.4 36.6 23.8 32.5 4.1 The improvement in the GAAP underwriting expense ratio was driven by higher direct premiums written in our flood business coupled with an increase in the flood expense allowance for issuing and servicing policies, which results in a larger commission being received from the NFIP year over year.

E&S Insurance Operations Our E&S Insurance Operations segment, which represents 7% of our combined insurance operations NPW, sells Commercial Lines insurance products and services in all 50 states and the District of Columbia through approximately 85 wholesale general agents. Insurance policies in this segment typically cover business risks with unique characteristics, such as the nature of the business or its claim history, that have not obtained coverage in the standard commercial marketplace. E&S insurers have more flexibility in coverage terms and rates compared to standard market insurers, generally resulting in policies with higher rates, and terms and conditions that are customized for specific risks.

Quarter ended March 31, Change % or ($ in thousands) 2014 2013 Points GAAP Insurance Operations Results: NPW $ 30,062 28,380 6 % NPE 32,236 30,059 7 Less: Loss and loss expense incurred 19,880 19,118 4 Net underwriting expenses incurred 11,381 10,855 5 Underwriting gain $ 975 86 1,034 % GAAP Ratios: Loss and loss expense ratio 61.7 % 63.6 (1.9 ) pts Underwriting expense ratio 35.3 36.1 (0.8 ) Combined ratio 97.0 99.7 (2.7 ) Statutory Ratios: Loss and loss expense ratio 61.7 63.6 (1.9 ) Underwriting expense ratio 36.2 34.6 1.6 Combined ratio 97.9 % 98.2 (0.3 ) pts The improvement in the combined ratio in First Quarter 2014 was driven by significant underwriting actions that we have implemented to improve profitability, including achieving new business pricing of 6.4% and renewal pure price increases of 4.1% in First Quarter 2014, partially offset by non-catastrophe property losses that were 6.8 points higher than last year. In addition, on a GAAP basis, the underwriting expense ratio benefited by the impact of a lower than anticipated supplemental commissions payment to wholesale general agents of $1.1 million from First Quarter 2013. While the recognition of this benefit was immediate on a statutory basis, as evident in the lower statutory underwriting expense ratio in First Quarter 2013, the commission adjustment was deferred and amortized as part of policy acquisition costs on a GAAP basis.

35-------------------------------------------------------------------------------- Table of Contents Investments Our investment philosophy includes certain return and risk objectives for the fixed income, equity, and other investment portfolios. Although yield and income generation remain the key drivers to our investment strategy, our overall philosophy is to invest with a long-term horizon along with predominantly a "buy-and-hold" approach. The primary fixed income portfolio return objective is to maximize after-tax investment yield and income while balancing risk. A secondary objective is to meet or exceed a weighted-average benchmark of public fixed income indices. Within the equity portfolio, the high dividend yield strategy is designed to generate consistent dividend income while maintaining an expected tracking error to the S&P 500 Index. Additional equity strategies are focused on meeting or exceeding strategy specific benchmarks of public equity indices. The return objective of the other investment portfolio, which includes alternative investments, is to meet or exceed the S&P 500 Index.

Total Invested Assets ($ in thousands) March 31, 2014 December 31, 2013 Change % Total invested assets $ 4,640,049 4,583,312 1 % Unrealized gain - before tax 104,515 79,236 32 Unrealized gain - after tax 67,935 51,504 32 The increase in our investment portfolio compared to year-end 2013 was primarily due to: (i) cash flows provided by operating activities of $35.8 million; and (ii) an increase in pre-tax unrealized gains of $25.3 million. These gains were driven by increases in the market value of our fixed income securities portfolio as interest rates decreased during First Quarter 2014. During First Quarter 2014, interest rates on the 10-year U.S. Treasury Note fell by 31 basis points.

While the decrease in interest rates benefited the unrealized gains on our portfolio, our after-tax purchase yield was only 1.9% during First Quarter 2014, thereby putting pressure on existing investment income yields within the portfolio.

We structure our portfolio conservatively with a focus on: (i) asset diversification; (ii) investment quality; (iii) liquidity, particularly to meet the cash obligations of our insurance operations segments; (iv) consideration of taxes; and (v) preservation of capital. We believe that we have a high quality and liquid investment portfolio. The breakdown of our investment portfolio is as follows: March 31, 2014 December 31, 2013 U.S. government obligations 4 % 4 Foreign government obligations 1 1 State and municipal obligations 29 28 Corporate securities 39 39 Mortgage-backed securities ("MBS") 15 15 Asset-backed securities ("ABS") 3 3 Total fixed income securities 91 90 Equity securities 4 4 Short-term investments 3 4 Other investments 2 2 Total 100 % 100 Fixed Income Securities The average duration of the fixed income securities portfolio as of March 31, 2014 was 3.5 years, including short-term investments, compared to the Insurance Subsidiaries' liability duration of approximately 3.8 years. The current duration of the fixed income securities portfolio is within our historical range, and is monitored and managed to maximize yield while managing interest rate risk at an acceptable level. We are experiencing continued pressure on the yields within our fixed income securities portfolio, as higher yielding bonds that are either maturing or have been sold are being replaced with lower yielding bonds that are currently available in the marketplace. We manage liquidity with a laddered maturity structure and an appropriate level of short-term investments to avoid liquidation of available-for-sale ("AFS") fixed income securities in the ordinary course of business. We typically have a long investment time horizon, and every purchase or sale is made with the intent of maximizing risk adjusted investment returns in the current market environment while balancing capital preservation.

36-------------------------------------------------------------------------------- Table of Contents Our fixed income securities portfolio had a weighted average credit rating of "AA-" as of March 31, 2014. The following table presents the credit ratings of our fixed income securities portfolio: Fixed Income Security Rating March 31, 2014 December 31, 2013 Aaa/AAA 16 % 15 Aa/AA 45 45 A/A 25 26 Baa/BBB 13 13 Ba/BB or below 1 1 Total 100 % 100 37-------------------------------------------------------------------------------- Table of Contents The following table summarizes the fair value, unrealized gain (loss) balances, and the weighted average credit qualities of our AFS fixed income securities at March 31, 2014 and December 31, 2013: March 31, 2014 December 31, 2013 Weighted Weighted Average Fair Unrealized Average Credit Fair Unrealized Credit ($ in millions) Value Gain (Loss) Quality Value Gain (Loss) Quality AFS Fixed Income Portfolio: U.S. government obligations $ 171.1 9.6 AA+ 173.4 10.1 AA+ Foreign government obligations 32.4 0.9 AA- 30.6 0.8 AA- State and municipal obligations 979.2 15.9 AA+ 951.6 5.2 AA Corporate securities 1,815.7 38.5 A 1,734.9 27.0 A ABS 131.9 0.5 AAA 140.9 0.5 AAA MBS 685.6 1.9 AA+ 684.1 (4.0 ) AA+ Total AFS fixed income portfolio $ 3,815.9 67.3 AA- 3,715.5 39.6 AA- State and Municipal Obligations: General obligations $ 478.6 7.2 AA+ 472.0 2.6 AA+ Special revenue obligations 500.6 8.7 AA 479.6 2.6 AA Total state and municipal obligations $ 979.2 15.9 AA+ 951.6 5.2 AA Corporate Securities: Financial $ 568.5 13.2 A 534.1 11.7 A Industrials 135.9 4.4 A- 135.1 3.7 A- Utilities 155.1 1.7 A- 146.5 (0.3 ) A- Consumer discretionary 213.9 5.1 A- 190.6 2.7 A- Consumer staples 176.4 3.7 A 171.9 3.0 A Healthcare 174.7 4.2 A 168.5 3.1 A Materials 104.1 2.3 A- 101.2 1.4 A- Energy 104.2 1.7 A- 93.7 0.9 A- Information technology 125.5 0.7 A+ 121.2 (0.6 ) A+ Telecommunications services 50.0 1.1 BBB+ 64.7 1.0 BBB+ Other 7.4 0.4 AA+ 7.4 0.4 AA+ Total corporate securities $ 1,815.7 38.5 A 1,734.9 27.0 A ABS: ABS $ 131.5 0.5 AAA 140.4 0.4 AAA Sub-prime ABS1 0.4 - D 0.5 0.1 D Total ABS 131.9 0.5 AAA 140.9 0.5 AAA MBS: Government guaranteed agency commercial mortgage-backed securities ("CMBS") $ 24.5 0.5 AA+ 30.0 0.9 AA+ Other agency CMBS 10.6 (0.2 ) AA+ 9.1 (0.3 ) AA+ Non-agency CMBS 139.7 2.1 AA+ 132.2 (1.5 ) AA+ Government guaranteed agency residential MBS ("RMBS") 48.3 1.3 AA+ 55.2 1.4 AA+ Other agency RMBS 417.6 (2.3 ) AA+ 411.5 (5.1 ) AA+ Non-agency RMBS 40.5 0.4 A- 41.4 0.6 A- Alternative-A ("Alt-A") RMBS 4.4 0.1 A 4.7 - A Total MBS $ 685.6 1.9 AA+ 684.1 (4.0 ) AA+ 1Subprime ABS consists of one security whose issuer is currently expected by rating agencies to default on its obligations.We define sub-prime exposure as exposure to direct and indirect investments in non-agency residential mortgages with average FICO® scores below 650.

38-------------------------------------------------------------------------------- Table of Contents The following tables provide information regarding our held-to-maturity ("HTM") fixed income securities and their credit qualities at March 31, 2014 and December 31, 2013: March 31, 2014 Unrealized Gain (Loss) in Accumulated Total Weighted Unrecognized Other Unrealized/ Average Fair Carry Holding Gain Comprehensive Unrecognized Credit ($ in millions) Value Value (Loss) Income ("AOCI") Gain (Loss) Quality HTM Fixed Income Portfolio: Foreign government obligations $ 5.6 5.4 0.2 0.1 0.3 AA+ State and municipal obligations 364.3 347.9 16.4 3.4 19.8 AA Corporate securities 24.5 21.6 2.9 (0.3 ) 2.6 A+ ABS 3.3 2.7 0.6 (0.6 ) - AA+ MBS 5.8 4.5 1.3 (0.8 ) 0.5 AAA Total HTM fixed income portfolio $ 403.5 382.1 21.4 1.8 23.2 AA State and Municipal Obligations: General obligations $ 117.5 112.6 4.9 1.7 6.6 AA Special revenue obligations 246.8 235.3 11.5 1.7 13.2 AA Total state and municipal obligations $ 364.3 347.9 16.4 3.4 19.8 AA Corporate Securities: Financial $ 2.3 1.9 0.4 (0.1 ) 0.3 A- Industrials 7.1 6.0 1.1 (0.2 ) 0.9 A+ Utilities 13.6 12.2 1.4 - 1.4 A+ Consumer discretionary 1.5 1.5 - - - AA Total corporate securities $ 24.5 21.6 2.9 (0.3 ) 2.6 A+ ABS: ABS $ 0.8 0.8 - - - AA Alt-A ABS 2.5 1.9 0.6 (0.6 ) - AAA Total ABS $ 3.3 2.7 0.6 (0.6 ) - AA+ MBS: Non-agency CMBS $ 5.8 4.5 1.3 (0.8 ) 0.5 AAA Total MBS $ 5.8 4.5 1.3 (0.8 ) 0.5 AAA 39-------------------------------------------------------------------------------- Table of Contents December 31, 2013 Total Weighted Unrecognized Unrealized/ Average Fair Carry Holding Gain Unrealized Gain Unrecognized Credit ($ in millions) Value Value (Loss) (Loss) in AOCI Gain (Loss) Quality HTM Portfolio: Foreign government obligations $ 5.6 5.4 0.2 0.1 0.3 AA+ State and municipal obligations 369.8 352.2 17.6 4.0 21.6 AA Corporate securities 30.3 27.8 2.5 (0.3 ) 2.2 A ABS 3.4 2.8 0.6 (0.6 ) - AA+ MBS 7.9 4.7 3.2 (0.9 ) 2.3 AA- Total HTM portfolio $ 417.0 392.9 24.1 2.3 26.4 AA State and Municipal Obligations: General obligations $ 118.5 113.1 5.4 2.0 7.4 AA Special revenue obligations 251.3 239.1 12.2 2.0 14.2 AA Total state and municipal obligations $ 369.8 352.2 17.6 4.0 21.6 AA Corporate Securities: Financial $ 7.3 6.8 0.5 (0.1 ) 0.4 BBB+ Industrials 7.8 6.8 1.0 (0.2 ) 0.8 A+ Utilities 13.2 12.2 1.0 - 1.0 A+ Consumer discretionary 2.0 2.0 - - - AA Total corporate securities $ 30.3 27.8 2.5 (0.3 ) 2.2 A ABS: ABS $ 0.9 0.9 - - - A Alt-A ABS 2.5 1.9 0.6 (0.6 ) - AAA Total ABS $ 3.4 2.8 0.6 (0.6 ) - AA+ MBS: Non-agency CMBS $ 7.9 4.7 3.2 (0.9 ) 2.3 AA- Total MBS $ 7.9 4.7 3.2 (0.9 ) 2.3 AA- A portion of our AFS and HTM municipal bonds contain insurance enhancements. The following table provides information regarding these insurance-enhanced securities as of March 31, 2014: Insurers of Municipal Bond Securities Ratings Ratings with without ($ in thousands) Fair Value Insurance Insurance National Public Finance Guarantee Corporation, a subsidiary of MBIA, Inc. $ 196,191 AA- AA- Assured Guaranty 142,463 AA AA- Ambac Financial Group, Inc. 58,800 AA AA Other 10,631 AA A+ Total $ 408,085 AA AA- 40-------------------------------------------------------------------------------- Table of Contents The following table details the top 10 state exposures of the municipal bond portion of our fixed income securities portfolio at March 31, 2014: State Exposures of Municipal Bonds Weighted General Obligation Average Special Fair Credit ($ in thousands) Local State Revenue Value % of Total Quality Texas1 $ 56,190 1,075 46,854 104,119 8% AA+ Washington 35,566 6,811 47,510 89,887 7% AA New York 9,740 - 79,184 88,924 7% AA+ Florida - 15,267 49,597 64,864 5% AA Arizona 7,850 - 53,368 61,218 4% AA Colorado 31,624 - 16,793 48,417 4% AA- Maryland 25,374 - 19,120 44,494 3% AA+ Missouri 16,089 10,046 18,357 44,492 3% AA+ North Carolina 13,000 8,200 23,076 44,276 3% AA California 8,691 - 33,177 41,868 3% AA Other 151,638 139,566 295,449 586,653 44% AA 355,762 180,965 682,485 1,219,212 91% AA Pre-refunded/escrowed to maturity bonds 53,259 13,927 57,076 124,262 9% AA+ Total $ 409,021 194,892 739,561 1,343,474 100% AA % of Total Portfolio 30 % 15 % 55 % 100 % 1 Of the $56 million in local Texas general obligation bonds, $21 million represents investments in Texas Permanent School Fund bonds, which are considered to have lower risk as a result of the bond guarantee program that supports these bonds.

The sector composition and credit quality of our special revenue bonds did not significantly change from December 31, 2013. For details regarding our special revenue bond sectors and additional information regarding credit risk associated with our portfolio, see Item 7A. "Quantitative and Qualitative Disclosures About Market Risk." of our 2013 Annual Report.

To manage and mitigate exposure on our MBS portfolio, we perform analysis both at the time of purchase and as part of the ongoing portfolio evaluation. This analysis includes review of loan-to-value ratios, geographic spread of the assets securing the bond, delinquencies in payments for the underlying mortgages, gains/losses on sales, evaluations of projected cash flows, as well as other information that aids in determining the health of the underlying assets. We also consider the overall credit environment, economic conditions, total projected return on the investment, and overall asset allocation of the portfolio in our decisions to purchase or sell structured securities.

Equity Securities Our equity securities portfolio was 4% of invested assets as of both March 31, 2014 and December 31, 2013, while the value of this portfolio increased slightly to $197.7 million from $192.8 million over the same time period. During First Quarter 2014, we rebalanced our high dividend yield strategy holdings within this portfolio, generating purchases of $61.4 million and sales of securities that had an original cost of $53.3 million.

Unrealized/Unrecognized Losses Our net unrealized/unrecognized loss positions improved by $20.6 million, to $31.4 million, as of March 31, 2014 compared to December 31, 2013. The majority of this improvement was in our fixed income securities portfolio, which had a loss position of $31.3 million as of March 31, 2014.

The following table presents amortized cost and fair value information for our AFS fixed income securities that were in an unrealized loss position at March 31, 2014 by contractual maturity: Amortized Fair ($ in thousands) Cost Value Unrealized Loss One year or less $ 4,002 3,923 79Due after one year through five years 456,443 450,103 6,340 Due after five years through ten years 786,554 761,899 24,655 Due after ten years 7,030 6,856 174 Total $ 1,254,029 1,222,781 31,248 41-------------------------------------------------------------------------------- Table of Contents The following table presents amortized cost and fair value information for our HTM fixed income securities that were in an unrealized/unrecognized loss position at March 31, 2014 by contractual maturity: Amortized Fair ($ in thousands) Cost Value Unrecognized/Unrealized Loss One year or less $ 446 445 1 Due after one year through five years 2,524 2,495 29 Total $ 2,970 2,940 30 We have reviewed the securities in the table above in accordance with our Other-than-Temporary Impairment ("OTTI") policy, which is discussed in Note 2.

"Summary of Significant Accounting Policies" in Item 8. "Financial Statements and Supplementary Data." of our 2013 Annual Report. We have concluded that these securities were temporarily impaired as of March 31, 2014 and December 31, 2013.

For additional information regarding the unrealized/unrecognized losses in our AFS and HTM portfolios, see Note 5. "Investments" in Item 1. "Financial Statements" of this Form 10-Q.

Other Investments As of March 31, 2014, other investments of $106.7 million represented 2% of our total invested assets. In addition to the capital that we have already invested to date, we are contractually obligated to invest up to an additional $52.6 million in our other investments portfolio through commitments that currently expire at various dates through 2026. For a description of our seven alternative investment strategies, as well as redemption, restrictions, and fund liquidations, refer to Note 5. "Investments" in Item 1. "Financial Statements" of this Form 10-Q and Note 5. "Investments" in Item 8. "Financial Statements and Supplementary Data." of our 2013 Annual Report.

Net Investment Income The components of net investment income earned for the indicated periods were as follows: Quarter ended March 31, ($ in thousands) 2014 2013 Fixed income securities $ 31,028 30,089 Equity securities 1,449 1,207 Short-term investments 19 52 Other investments 5,218 3,602 Investment expenses (2,180 ) (2,080 ) Net investment income earned - before tax 35,534 32,870 Net investment income tax expense (9,048 ) (8,031 ) Net investment income earned - after tax $ 26,486 24,839 Effective tax rate 25.5 % 24.4 Annual after-tax yield on fixed income securities 2.2 % 2.3 Annual after-tax yield on investment portfolio 2.3 % 2.3 Net investment income before tax increased in First Quarter 2014 compared to First Quarter 2013 primarily due to higher income from our alternative investments. In addition, higher income from our fixed income securities was driven by an increase in the size of this portfolio, which more than offset the lower yield earned this year compared to last.

Realized Gains and Losses Our general philosophy for sales of securities is to reduce our exposure to securities and sectors based on economic evaluations and when the fundamentals for that security or sector have deteriorated, or to opportunistically trade out of securities to other securities with better economic return characteristics.

We typically have a long investment time horizon, and every purchase or sale is made with the intent of maximizing risk adjusted investment returns in the current market environment while balancing capital preservation. Total net realized gains and losses amounted to $7.2 million in First Quarter 2014 and $3.4 million in First Quarter 2013. These amounts included $1.0 million and $1.9 million in OTTI charges in each period, respectively.

We regularly review our entire investment portfolio for declines in fair value.

If we believe that a decline in the value of a particular investment is other than temporary, we record it as an OTTI, through realized losses in earnings for the credit-related portion and through unrealized losses in other comprehensive income ("OCI") for the non-credit related portion. If there is a decline in fair value of an equity security that we do not intend to hold, or if we determine that the decline is other than 42-------------------------------------------------------------------------------- Table of Contents temporary, we write down the cost of the investment to fair value and record the charge through earnings as a component of realized losses.

For discussion of our realized gains and losses as well as our OTTI methodology, see Note 2. "Summary of Significant Accounting Policies" in Item 8. "Financial Statements and Supplementary Data." of our 2013 Annual Report, and for qualitative information about our OTTI charges, see Note 5. "Investments" in Item 1. "Financial Statements" of this Form 10-Q.

Federal Income Taxes The following table provides information regarding federal income taxes from continuing operations: Quarter ended March 31, ($ in million) 2014 2013Federal income tax expense from continuing operations $ 7.1 6.6 Effective tax rate 28 % 23 Despite lower pre-tax net income in First Quarter 2014 compared to First Quarter 2013, federal income tax expense, as well as the effective tax rate have increased year over year. This increase is driven by our expectation of higher full-year insurance operations results in 2014. We are required, through accounting rules, to record each quarter's taxes at the expected annual marginal tax rate regardless of the relative magnitude of the individual components within any one quarter.

Financial Condition, Liquidity, Short-term Borrowings, and Capital Resources Capital resources and liquidity reflect our ability to generate cash flows from business operations, borrow funds at competitive rates, and raise new capital to meet operating and growth needs.

Liquidity We manage liquidity with a focus on generating sufficient cash flows to meet the short-term and long-term cash requirements of our business operations. Our cash and short-term investment position of $138 million at March 31, 2014 was comprised of $16 million at Selective Insurance Group, Inc. (the "Parent") and $122 million at the Insurance Subsidiaries. Short-term investments are generally maintained in "AAA" rated money market funds approved by the National Association of Insurance Commissioners. The Parent continues to maintain a fixed income security investment portfolio containing high-quality, highly-liquid government and corporate fixed income securities to generate additional yield.

This portfolio amounted to $55 million at March 31, 2014 compared to $56 million at December 31, 2013.

Sources of cash for the Parent have historically consisted of dividends from the Insurance Subsidiaries, borrowings under lines of credit and loan agreements with certain Insurance Subsidiaries, and the issuance of stock and debt securities. We continue to monitor these sources, giving consideration to our long-term liquidity and capital preservation strategies.

We currently anticipate the Insurance Subsidiaries will pay approximately $57.5 million in total dividends to the Parent in 2014. Cash dividends of $14.4 million were paid in First Quarter 2014. As of December 31, 2013, our allowable ordinary maximum dividend was approximately $127 million for 2014.

Any dividends to the Parent are subject to the approval and/or review of the insurance regulators in the respective domiciliary states and are generally payable only from earned surplus as reported in the statutory annual statements of those subsidiaries as of the preceding December 31. Although past dividends have historically been met with regulatory approval, there is no assurance that future dividends that may be declared will be approved. For additional information regarding dividend restrictions, refer to Note 20. "Statutory Financial Information, Capital Requirements, and Restrictions on Dividends and Transfers of Funds" in Item 8. "Financial Statements and Supplementary Data." of our 2013 Annual Report.

The Parent had no private or public issuances of stock during First Quarter 2014 and there were no borrowings under its $30 million line of credit ("Line of Credit") at March 31, 2014 or at any time during First Quarter 2014.

We have two Insurance Subsidiaries domiciled in Indiana ("Indiana Subsidiaries") that are members of the Federal Home Loan Bank of Indianapolis ("FHLBI"). These Insurance Subsidiaries are Selective Insurance Company of South Carolina ("SICSC") and Selective Insurance Company of the Southeast ("SICSE"). Membership in the FHLBI provides these subsidiaries with access to additional liquidity.

The Indiana Subsidiaries' aggregate investment of $2.9 million provides them with the ability to borrow up to 20 times the total amount of the FHLBI common stock purchased, at comparatively low borrowing rates. All borrowings from the FHLBI are required to be secured by certain investments. For additional information regarding the required collateral, refer to Note 5. "Investments" in Item 1. "Financial Statements" of this Form 10-Q.

43-------------------------------------------------------------------------------- Table of Contents The Parent's Line of Credit agreement permits collateralized borrowings by the Indiana Subsidiaries from the FHLBI so long as the aggregate amount borrowed does not exceed 10% of the respective Indiana Subsidiary's admitted assets from the preceding calendar year. Admitted assets amounted to $542.4 million for SICSC and $414.9 million for SICSE as of December 31, 2013, for a borrowing capacity of approximately $96 million. As our outstanding borrowing with the FHLBI is currently $58 million, the Indiana Subsidiaries have the ability to borrow approximately $38 million more until the Line of Credit borrowing limit is met, of which $30 million could be loaned to the Parent under lending agreements approved by the Indiana Department of Insurance. Similar to the Line of Credit agreement, these lending agreements limit borrowings by the Parent from the Indiana Subsidiaries to 10% of the admitted assets of the respective Indiana Subsidiary. For additional information regarding the Parent's Line of Credit, refer to the section below entitled "Short-term Borrowings." The Insurance Subsidiaries also generate liquidity through insurance float, which is created by collecting premiums and earning investment income before losses are paid. The period of the float can extend over many years. Our investment portfolio consists of maturity dates that are laddered to continually provide a source of cash flows for claims payments in the ordinary course of business. The duration of the fixed income securities portfolio including short-term investments was 3.5 years as of March 31, 2014, while the liabilities of the Insurance Subsidiaries have a duration of 3.8 years. In addition, the Insurance Subsidiaries purchase reinsurance coverage for protection against any significantly large claims or catastrophes that may occur during the year.

The liquidity generated from the sources discussed above is used, among other things, to pay dividends to our shareholders. Dividends on shares of the Parent's common stock are declared and paid at the discretion of the Board of Directors based on our operating results, financial condition, capital requirements, contractual restrictions, and other relevant factors.

Our ability to meet our interest and principal repayment obligations on our debt, as well as our ability to continue to pay dividends to our stockholders, is dependent on liquidity at the Parent coupled with the ability of the Insurance Subsidiaries to pay dividends, if necessary, and/or the availability of other sources of liquidity to the Parent. Upcoming principal payments on our debt include $13 million in December 2014 and $45 million in December 2016.

Subsequent to 2016, our next principal repayment is due in 2034. Restrictions on the ability of the Insurance Subsidiaries to declare and pay dividends, without alternative liquidity options, could materially affect our ability to service debt and pay dividends on common stock.

Short-term Borrowings Our Line of Credit with Wells Fargo Bank, National Association, as administrative agent, and Branch Banking and Trust Company (BB&T), was renewed effective September 26, 2013 with a borrowing capacity of $30 million, which can be increased to $50 million with the approval of both lending partners.

The Line of Credit provides the Parent with an additional source of short-term liquidity. The interest rate on our Line of Credit varies and is based on, among other factors, the Parent's debt ratings. The Line of Credit expires on September 26, 2017. There were no balances outstanding under the Line of Credit at March 31, 2014 or at any time during First Quarter 2014.

The Line of Credit agreement contains representations, warranties, and covenants that are customary for credit facilities of this type, including, without limitation, financial covenants under which we are obligated to maintain a minimum consolidated net worth, minimum combined statutory surplus, and maximum ratio of consolidated debt to total capitalization, as well as covenants limiting our ability to: (i) merge or liquidate; (ii) incur debt or liens; (iii) dispose of assets; (iv) make certain investments and acquisitions; and (v) engage in transactions with affiliates. The Line of Credit permits collateralized borrowings by the Indiana Subsidiaries from the FHLBI so long as the aggregate amount borrowed does not exceed 10% of the respective Indiana Subsidiary's admitted assets from the preceding calendar year.

The table below outlines information regarding certain of the covenants in the Line of Credit: Required as of Actual as of March 31, 2014 March 31, 2014 Consolidated net worth $813 million $1.2 billion Statutory surplus Not less than $750 million $1.3 billion Debt-to-capitalization ratio1 Not to exceed 35% 25.1% A.M. Best financial strength rating Minimum of A- A 1 Calculated in accordance with the Line of Credit agreement.

44-------------------------------------------------------------------------------- Table of Contents Capital Resources Capital resources provide protection for policyholders, furnish the financial strength to support the business of underwriting insurance risks, and facilitate continued business growth. At March 31, 2014, we had statutory surplus of $1.3 billion, GAAP stockholders' equity of $1.2 billion, and total debt of $392.4 million, which equates to a debt-to-capital ratio of approximately 25%.

Our cash requirements include, but are not limited to, principal and interest payments on various notes payable, dividends to stockholders, payment of claims, payment of commitments under limited partnership agreements and capital expenditures, as well as other operating expenses, which include agents' commissions, labor costs, premium taxes, general and administrative expenses, and income taxes. For further details regarding our cash requirements, refer to the section below entitled, "Contractual Obligations, Contingent Liabilities, and Commitments." We continually monitor our cash requirements and the amount of capital resources that we maintain at the holding company and operating subsidiary levels. As part of our long-term capital strategy, we strive to maintain capital metrics, relative to the macroeconomic environment, that support our targeted financial strength. Based on our analysis and market conditions, we may take a variety of actions, including, but not limited to, contributing capital to the Insurance Subsidiaries in our insurance operations, issuing additional debt and/or equity securities, repurchasing shares of the Parent's common stock, and increasing stockholders' dividends.

Our capital management strategy is intended to protect the interests of the policyholders of the Insurance Subsidiaries and our stockholders, while enhancing our financial strength and underwriting capacity.

Book value per share increased to $21.09 as of March 31, 2014, from $20.63 as of December 31, 2013, due to $0.32 in net income coupled with a $0.29 increase in unrealized gains on our investment portfolio. These items were partially offset by $0.13 in dividends to our shareholders.

Ratings We are rated by major rating agencies that issue opinions on our financial strength, operating performance, strategic position, and ability to meet policyholder obligations. We believe that our ability to write insurance business is most influenced by our rating from A.M. Best. In the second quarter of 2013, A.M. Best reaffirmed our rating of "A (Excellent)," their third highest of 13 financial strength ratings, with a "stable" outlook. The rating reflects our solid risk-adjusted capitalization, disciplined underwriting focus, increasing use of predictive modeling technology, strong independent retail agency relationships, and consistently stable loss reserves. We have been rated "A" or higher by A.M. Best for the past 83 years. A downgrade from A.M. Best to a rating below "A-" is an event of default under our Line of Credit and could affect our ability to write new business with customers and/or agents, some of whom are required (under various third-party agreements) to maintain insurance with a carrier that maintains a specified A.M. Best minimum rating.

Ratings by other major rating agencies are as follows: • Fitch Ratings ("Fitch") - Our "A+" rating was reaffirmed in First Quarter 2014, citing our improved underwriting results, strong independent agency relationships, solid loss reserve position, and enhanced diversification through continued efforts to reduce our concentration in New Jersey. Our outlook remained negative citing increased levels of statutory and financial leverage, a moderate decline in the National Association of Insurance Commissioners ("NAIC") risk-based capital levels, and a moderate decline of our operating earnings-based interest coverage, although Fitch noted that this measure has shown improvement in 2013.

• S&P Ratings Services ("S&P") - In the third quarter of 2013, S&P lowered our financial strength rating to "A-" from "A" under their recently revised rating criteria. The rating reflects our strong business risk profile and moderately strong financial risk profile, built on a strong competitive position in the regional small to midsize commercial insurance markets in Mid-Atlantic states and strong capital and earnings. The rating revision reflects S&P's view of our capital and earnings volatility relative to our peers. The outlook for the rating is stable citing the expectation that we will sustain our strong competitive position and business risk profile while maintaining a strong capital and earnings profile.

• Moody's Investor Service ("Moody's") - Our "A2" financial strength rating was reaffirmed in First Quarter 2013 by Moody's, which cited our strong regional franchise with established independent agency support, along with solid risk adjusted capitalization and strong invested asset quality. Our outlook was revised to negative, citing that our underwriting results have lagged similarly rated peers.

45-------------------------------------------------------------------------------- Table of Contents Our S&P, Moody's, and Fitch financial strength and associated credit ratings affect our ability to access capital markets. The interest rate on our Line of Credit varies and is based on, among other factors, the Parent's debt ratings.

There can be no assurance that our ratings will continue for any given period of time or that they will not be changed. It is possible that positive or negative ratings actions by one or more of the rating agencies may occur in the future.

Off-Balance Sheet Arrangements At March 31, 2014 and December 31, 2013, we did not have any material relationships with unconsolidated entities or financial partnerships, such entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or for other contractually narrow or limited purposes. As such, we are not exposed to any material financing, liquidity, market, or credit risk that could arise if we had engaged in such relationships.

Contractual Obligations, Contingent Liabilities, and Commitments Our future cash payments associated with: (i) loss and loss expense reserves; (ii) contractual obligations pursuant to operating leases for office space and equipment; (iii) notes payable; and (iv) contractual obligations related to our alternative and other investments portfolio have not materially changed since December 31, 2013. We expect to have the capacity to repay and/or refinance these obligations as they come due.

We have issued no material guarantees on behalf of others and have no trading activities involving non-exchange traded contracts accounted for at fair value.

We have no material transactions with related parties other than those disclosed in Note 17. "Related Party Transactions" included in Item 8. "Financial Statements and Supplementary Data." of our 2013 Annual Report.

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